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

Good morning, everyone. Thank you all for joining us for the next session of the Barclays Global Healthcare Conference. And for this session, I have the pleasure of presenting Elanco and Todd Young, the Chief Financial Officer of Elanco, and most particularly delighted that this is Elanco's first participation in our conference. Todd, especially with you. And so as we recently wrapped up a least a couple of weeks ago, what is new with a couple of recaps that we can go into Q&A?

Sure. So Elanco continues to make very good progress with respect to our execution. 2022 was a very good year with respect to our innovation and the continued delivery of milestones and new products through the pipeline. And on our productivity and we're able to reduce our OpEx by over 10% and maintain a flagger patient declining there. On the disappointing side, the portfolio didn't perform to the level we would have liked on the top line. That's something the team is very focused on improving in 2023 as we get going here in the first quarter.

And as we look at the business for the year, I think one of the big infections for you is that the Bayer integration is wrapping up? And can you just take us through that operation, I think more from an EBITDA perspective and cash flow perspective.

Certainly. So we acquired Bayer in August of 2020 and have been progressing the integration of their systems and processes that were hosted by Tata business consulting for us into the Elanco shared service center network, ERPs and technical side. This is projected to go live on April 1. It's tracking very well. And with that, we will have rolling blackouts where customers will not be able to order. For that reason, we said we expect some bringing stock purchases, higher customers of $40 million to $80 million in March that would otherwise typically occur in April, which is why we've provided guidance in the first half. The team, many of which were on the standup from Lilly and so we've had great continuity. The shared service center network has worked with all of our ops. And so we're confident that this will go smoothly. I'm sure it won't be perfect, as none of these are, but we're very good at the hypercare and readiness for that. So getting this behind us, we should then be passed a lot of the integration standup severance spend that we've had over the last 4 years. As we noted in our earnings slides, over $1 billion of cash spent, including this year to get that finalized. And then next year, we expect this sort of $160 million to $180 million. We have out the door this year from onetime items to drop to closer to $20 million, freeing up more cash to pay down debt.

Great. And the other kind of one-off impact is also going to be from the ERP systems and the two ERPs that you'll also run for big donations, can you take us through that?

So that's a big part of this integration is combining the Bayer ERP that's being run by Tata into ours. And then that will -- again, we'll be live using just one integrated system. There's no cost associated with that order EY still has -- system. So additional synergies will really happen starting next year from the conclusion of this deck. But overall, we'll simplify life for our customers. They'll get one invoice from Elanco versus and continue just to make it more efficient from a visibility of inventory and other just system-related integration items.

Great. Maybe moving to the business side of things. I think last year, there was an inordinate amount of focus on veterinary business print, though I think every single survey and discussion that we had with experts told us that the [indiscernible] environment was intact. And as we look forward now, we will start to analyze those numbers. So help us take us through your understanding and your expectations around the market outlook for the companion animal business for the year, and then you can run down into some of the specific parts of that.

Certainly, the infrastructure side vet clinics continues to be a little challenged by the labor side of things. That being said, we expect that business to be in a pretty tight range of plus or minus 1% to 2% with pricing up, I think as you're aware, Balaji, most of the manufacturers, diagnostic companies took price, that's been reflected in. So we expect spending to be up even if vet clinic visits are down somewhat.

Got it. Coming to CA again specifically, I think there are a couple of major launches that we're expecting from you now within this year or next year, especially getting into next year. So what -- into each one of these, starting maybe with the triple combination and both in terms of what it means for you to have Bayer coming in, [indiscernible] coming in, you mean as a third product, how could the market dynamics shape up on [indiscernible] of market?

Sure. So as we look across the -- that side of the parasiticide market, we always look globally, just given our presence across the world. Outside the U.S., we have our triple platinum product in Credelio Plus to go against those from both Zoetis and Boehringer Ingelheim. And again, we compete very well in those markets with our total portfolio of parasiticides. In the U.S., as we noted, our broad spectrum parasiticides, we expect to have a path for approval in the first half of next year. Overall, it's the biggest market in both and we think we see even today, Trifexis that was launched more than a decade ago and just as flees and heartworm was over a $100 million product last year. So there's a lot of loyalty amongst pet owners and vets. We think there's plenty of space for a number of companies to do well in this market, given just how large and how important it is to protect your dogs and cats from the parasiticides. The other aspect is compliance has been raising. Certainly, as we've seen more of the online pharmaceuticals with the drop ships as well as Covetrus providing greater services on that end. We've seen more consumption by pet owners regularly, which helps drive the overall size of the category as well.

Got it. It's interesting you mentioned compliance because I did get a few questions on it recently asking if we could quantify that impact? And how do we efficiently -- or track it, both in the U.S. and in Europe and just the impact of overall in the market.

Yes. I think the tracking of it is more challenging, certainly good data from the online pharmacies. They probably have the best view of it because they're seeing those shipments go out versus within the vet clinic someone behind 6 months and doesn't get a refill until month 8, you don't know if they used 5 fills or 4 fills or all 6 and then forgot the 2. So that becomes a bigger challenge from a data perspective.

Got it. And maybe just in terms of the role of compliance in expanding the market opportunity? Could you discuss that?

I think overall, we were historically thinking it was in the 4 to 5 months range on an annual basis. So there's a lot of space there to get it from 4 to 5 up to 12. We do think it's improved over the last few years, and that was a big driver of all of us developing the combination products is thinking that 1 fill would make compliance easier for the consumer and just having less things to think about. But we certainly think it's an area that will continue. And yet, as we all know, even on human health for life-saving drugs, people don't comply every day.

Got it. Shifting to the pain management side of it and that's where I got a few questions post earnings and investors did not particularly that you called out Galliprant, you said that there's still going to be a growth asset. And I guess this was in the context of competitive launch in Europe, which is also entering Europe -- U.S. market now. So can you take us through those dynamics a bit more? And what's driving this growth despite a major competitive launch coming in and maybe thoughts around the overall pain market itself?

Yes. So we've got a very broad pain portfolio across Elanco for both cats and dogs. We launched last year's ZORBIUM, which is a postoperative pain patch for cats, we're very pleased with Nocita and a number of our other pain portfolios. But certainly, the lead product there is Galliprant, which is in excess of blockbusters over $100 million in revenue globally. In Europe, it's more, I would say, fragmented just as that side of our business has less debt. And so it was impacted by the Librela launch, things have stabilized there. And the label in Europe, it does include information. It's just mild or moderate for osteoarthritis. So in the U.S., we have a much more established brand across the veterinarian channel. And it picks up inflammation as well as pain. So it's a broader label. It's got a better installed base that we think with that, it will be better against -- better than what we've done in Europe. We have reflected that competition coming into the guidance we provided for 2023.

Fair enough. And as we look at some of the pipeline drugs, I think your [indiscernible] is expected to come out of the market this year. I had different expectations of it when it was a part of Kindred's asset. And of course, greater expectations at the part of Elanco, could you take us through the market opportunity there. And I think it's a very unique asset in that your commercial strategy is very different in terms of selling for shelters, also -- for that.

Yes, we're very excited for the parvovirus vaccine. The first step along the path is for our L-wood manufacturing facility in Kansas that we acquired from Kindred to be approved by the USDA. That audit has now been scheduled. It will be coming up in the next few weeks. So we need to get that approved. Once that's done, then we'll get through the finalization of the conditional approval for the parvovirus vaccine. It is a cold chain product. And so we've developed a kind of a unique, I guess, box to provide to that, so it's in a regular refrigerator without having any deviations from a cold chain perspective. So that facilitates every vet clinic that's got standard freezers to be able to take this product. So overall the starting point is we're going to be a little limited in our supply as we launch, but that will ramp up as we ramp the total antibody manufacturing over the course of the year. And so we think it's a very exciting therapy because it saves dogs' life, and that's a very important part, and we've got very good interactions with a number of corporate chains as well as vets that are excited to have this product in the freezer, even though it's not expected that they've got one puppy a day needing this, but rather over the course of the year, they want to make sure they're there so they can easily save the puppy's life.

Got it. And any thoughts around the commercial opportunity of pricing?

We've said that we expect it to be over $100 million globally. We still need to get approvals and take it globally. So it's certainly not going to be that for a number of years. But we do think there's a big opportunity. My understanding is that the cost to treat parvovirus and type of that clinic today is now gets it is in the $15 to $200 range. And so are they at a price to product an appropriate value for this solution, we are very constructive on.

Maybe again, continuing on the pipeline themes that's where you're really coming to an infection. That a place where I got a lot of calls, questions is around the IL-31 opportunity and what the broader franchise would look like for Elanco, post any an approval. So take us through some of those on the...

So we're -- we have both the JAK inhibitor and IL-31 product, making their progress through our pipeline. We've set a path to approval for them in the first half of 2024. $4.3 billion market today with one company with two products. So we think there's a great opportunity. We all like voice, vets are no different. They very much like showing some series -- we know there are -- even just from the clinical data on the current product is not responders to those products and give them the biologic nature of the IL-31 as well as just different JAKs. So if we think there's an opportunity, even just nonresponders to pick up a market if our product reacts differently for those products. And again, it's a very big market, lots of opportunities. We've got sales-base -- sales force in the U.S. that's calling -- that day. They're having these conversations regarding our new launches, including ZORBIUM that I mentioned, which is the SGLT2 for feline diabetes, the parvovirus. And so these are all opportunities for Elanco to be in front of the bets and continue to do. We know that that's -- are looking for more alternatives in the derm space, and we're excited to bring those in the market.

Great. And as you start to build up your biologics franchise, in the way you would sell them commercially is going to be different. It will be a new field that you're expanding into the biologic side. What does it mean in terms of commercification in terms of even OpEx for you.

Yes. We're continuing to evaluate that. As we've announced, Tim Beddington coming in to join our team to help look at that and provide some guidance from his time managing these products, ads awareness. Overall, it's a very well-understood market. That are not needing to be educated about this. The protocol change for a Bexacat to go with an Implenia potent call it is the different blood test to go. Is it much more complicated itself than what bringing the JAK inhibitor and IL-31. So again, we'll be looking at the different ways to commercialize that. In this year, we don't expect it to have much of an OpEx impact. It will probably be more on the capital side where we're making sure we have the capacity to launch these effectively with product.

I'm probably tying up all of the R&D developments with the new R&D you had in place since last year -- last year, yes. So tell us more about the longer-term pipeline and how you plan to develop this now that you have like three or four assets, major assets coming into the market potentially?

Dr. Ellen de Brabander joined us in October of a year ago. She's taken what was really good underlying pipeline and continue to move that forward and develop it with an R&D team that's generally the same people that we had before, but just doing slightly different roles within the company. Again, we're very pleased with that progress. And the focus is certainly on bringing these late-stage products to Bayer and get them to the market. We're also focused on life cycle management, there has been pressure on our core portfolio over the last few years, more so than was expected. And so we're looking at how do we continue to refresh that in the face of a lot of generic competition on the farm animal business. And then we've got a lot of early-stage research. This is one of those where we're not shorting the need to continue to build the pipeline and to bring things along, so that we don't have the innovation gap that we've been facing the last couple of years in future years.

And just on the point on the generic side, that's the team that we've been working on recently, any major generic expiries in the next couple of years, Todd?

Nothing specific within our portfolio. I think as everyone is aware, in the animal health business, there's a lot of generics already. These products have been on the market for a long time. There's a lot of customer loyalty. To them, there's a lot of know-how when it comes to making them. So we're always ready for and expect more generics to enter. But nothing on our pipeline that has an expiration business.

Got it. Shifting slightly to the left outside of things again amongst my coverage companies, I think probably yours is one where the livestock portfolio gets a fair amount of attention. I mean, especially the launch of Experior last year, so between Experior now complementing it with Bovaer, how should we think about the go-to-market And what can you realize all the time what time frame?

Sure. If I separate them, Experior is a product whose label is ammonia reduction. It works within the cal to reduce ammonia and provide some productivity benefits as well for the farmers that use it. This market because it would replace the Optaflexx and the other beta agonist in the market at peak, that's been about $150 million to $200 million market before the new entries came in. So we've called that out of a blockbuster potential and are pleased as we continue to ramp more feed yards with all the major packers moving forward. Then if we split to Bovaer, this is a product we in-licensed from DSM just under a year ago. We've been fortunate with good interactions with the FDA to have a pathway to have that approved in the first half of 2024 now, which is a few years earlier than we originally thought. This is a methane reducing product. And so it reduces methane in the studies by 30% in dairy cows, up to 50% in the beef cows. And the key then is having a carbon market where those producers can get economic value for filling the reduction in carbon to someone who wants to buy those credits. We have a calculator called uplook that looks at the data coming off the form to do that calculation. And then we've put money into a seed investment in a company called Athian that's building out the market to certify and create the carbon market for that. Yesterday, Tyson invested in Athian as well as part of their goal to see this market get developed as part of the overall ecosystem for farm animal production.

Great. Moving on in swine has been a big mover for you in multiple directions. So thoughts on the recovery there in China and expect the ramp there as...

The China's ramp has been one of the more volatile markets in animal health for the last 4 years from African swine fever to the rebuild back and then the lockdowns that affected consumption. So again, a lot of it does depend on the producer profitability. Pork prices have started to increase a little bit over the last month but are still in the breakeven range. So for us, as we step back and look at all of China, it's our biggest individual country outside the U.S. It was roughly $240 million in revenue last year. We do expect it to grow this year after being about a 14% decline last year, about 25% of it is in the pet side. The pet side, we're focused on understanding how the pet retailers come back. The COVID lockdowns had a big impact on those retail operations with 10% to 15% of the stores closing. And as we've talked in the U.S., Bobby Mode and our U.S. pets, big pushes is more physical availability. And in China, that's being cut because it's just less retail outlets to buy the product. So we're cautiously optimistic on how it bounces back as people are out and about with their pets, but understanding that, that is something we're paying attention to. And then on the poultry and on the shrimp business, we continue to make good progress with greater volatility in swine still.

Got it. And are there any new launches coming through in any of the life segments coming apart from what we discussed?

No, those are the key ones for us right now is really that ramp with Experior bringing Bovaer to the marketplace.

Understood. Moving to the OTC market, maybe very quickly comment on the long-term reason in OTC. And also you -- can you share any additional details around the recent relaunch of K9 Advantix and advantage it has.

Yes. We're excited about what the over-the-counter market can do. It's a big part of pet health business. There's a number of pet owners that don't go to the vet, we do that at about 1/3. And so they still want the flea and tick protection that they can get from over-the-counter medicines. For us, the big family there is from the Bayer acquisition with advantage for Seresto. We're pleased if you see the Nelson data -- that Nielsen data that came out last week, which is a subset of physical inventories, not the complete picture on OTC, but it gives us some positive affirmation that the strategy that Bobby and the team have been putting in place and working the last 4 weeks simply in the category were up over 30% and positive for the last 12 weeks as well. So that is progressing well as we have brought new innovation there. So we've brought Advantage XD, which is a long-duration product for cats. We have Advantage 2, and we have Advantage 1 that we just relaunched. So it's really this good, better, best sort of category management that we're doing in that space. And the reason we brought Advantage 1 back as well as K9 Advantix 1 is a big part of that market, roughly, we believe $400 million is not playing in the premium space. It's people looking for protection, but at a lower price point. The Elanco brands were very much in the premium segment. So when Bobby came in and said, "Hey, what can I do to go after this, the team say, well, we've got these products on the shelf, but we'd have to get them reregistered on to the base. So between the U.S. commercial team, the manufacturing supply chain team and the regulatory team, from an IPO to 8 months later, we were skipping the product on the shelf of Walmart. So it's really a good example of cross-functional work to refresh that portfolio and change the shelf space. When we bought Bayer, we knew they had not been making the same level of investments that were needed to continue to drive this business, and we're excited by bringing the innovation, more physical availability of inventory and continued ability to meet shoppers where they want to shop. That all being said, the Seresto challenge continues from a PR standpoint, now the USA -- today article last week, again, similar to those in the past, it's not based on the science, but it is something that EPA and FDA are having discussions about the regulation of the over-the-counter kind of pesticide-based products, which again, we've all about science and science backed and obviously have a lot of FDA products and have the infrastructure to handle it either way and are very much engaged from an industry perspective with the regulators on that topic. Again, we're very confident in the registration of Seresto, the safety profile. Seresto will continue to be our biggest product moving forward.

And I know we're out of time, but I'll probably just squeeze in these questions. So -- what do you need from your side to effectively settled the Seresto debate?

Again, I think as we've said, we're in conversations with the EPA on the topic. We're confident in the science and the background on that and would love for them to come out with us with the proactive, so everyone would have the same pace as the rest of what we do.

Okay. Right. Todd, thank you so much for your time and for joining us here. I wish you a very productive rest of the conference, and see you later.

Great. Thanks, Balaji.

Thank you.