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

All right. Well, looking forward to this discussion going from human vaccines to animal vaccines and beyond. Todd, really looking forward to discussion. Thank you for joining us. I feel like there's been quite a few developments over the last couple of years, but I also think much of the pipeline story, which was sort of this -- a big thesis that was going to play out in due time is now upon us. And so it's a very important year for you guys coming up, truly very important after all this time. Let me have you kick things off and we'll start to go again.

No, certainly. And thanks, Mike. Thanks, Umer for having us at the conference and everyone turning out. This is a pivotal year for Elanco as our innovation pipeline is starting to produce. This year, we've seen the ramp of Experior, which is our ammonia reduction product and feedlots finally ramping after a slower start than we expected, but now annualizing here in Q4 to $60 million to $70 million run rate. Very pleased with the early performance of Adtab, which is our oral parasiticides for the over-the-counter market in Europe. Europe has been taking a little more like a leaner approach of things going over the counter versus through the vet prescription channel than the U.S. has. And given our omnichannel presence and our over-the-counter size and scale, Adtab has been off to a great start and then parvovirus, which is saving lives of puppies. It's going really well. We're currently ramping the production capacity for that monoclonal antibody at our facility in Elwood, Kansas and excited by the growth that we'll have in '24 as we get out of a supply-constrained environment. And then as we flip the calendar, we've said we've got a path to first half approval for Credelio, Quattro, which was our broad spectrum parasiticides we'll have the broadest coverage of any combo parasiticides for worms, fleas and ticks in the U.S. We're already in the market with our broad spectrum product outside the U.S. and then also getting in the dermatology space with Zenrelia. That's JAK inhibitor. It will be competition in the derma space that Zoetis has not had. So we're excited to broaden our total portfolio for the vet clinic by having a derm product for the first time to compete. And then finally, on the U.S. farm side, we'll be bringing Bovaer to the market. This is a product that reduces methane production of both beef and dairy cows, the initial approval, we expect will be in dairy, and it has the ability to reduce a dairy cows, methane production by 30%. So significant reduction in methane, and we seed funded a company that's created a carbon exchange called Athian and they begin certifying protocols in the carbon market will be a big driver as we've made a pivot to sustainability as part of our health care mission with farm animals.

Got it. So I feel like there's a lot to unpack there. And we really, especially on some of your highest profile pipeline programs next year because they truly are important programs. We want to go through sort of one each and really understand their competitive positioning, et cetera. But just before we do Todd, I realize heading into the types of launches and the breadth of launches you guys have, it will probably require some amount of spend, so can you speak to the OpEx dynamics into next year? I know you've been very clear about that previously, including on the recent 3Q call, I think 2 calls a follow-up as well. But just remind us how much incremental investments will be needed to appropriately fund some of the launches coming up?

Certainly, I think as you mentioned, Umer, in Q3, we returned to growth on the top line as a company. That was obviously an essential part of our journey. We also in August -- in November, committed to constant currency revenue growth in 2024 even without the new launches coming in and adding to that growth rate because of our relative positioning of our portfolio and the ramping of these products I mentioned that we've launched this year. We did not commit yet to EBITDA growth. There's a currency element there, but there's also the investments you're speaking of. And from an investment standpoint, we've added -- in the process of adding 75 people to our U.S. sales force for U.S. pet. As we've looked at our overall portfolio and the ability to drive that portfolio through the 28,000 vet clinics in the U.S., we realized we needed more people on the ground. We needed more consulting veterinarian, we need increased inside sales force. So that will be an incremental investment that hits us next year. The other big investments will be the marketing money as we launch Credelio, Quattro and [indiscernible] those will be more paced with the post approval and the launches. We want to get the products on the shelves in the vets before you really activate a consumer to be asking for the products. And so those will be a timing item and so that's affordable we are discussing of not yet providing guidance for 2024. The other thing to highlight in the P&L for next year we've got too much inventory on our balance sheet. We've had poor net working capital performance for the last 2 years. We've got a lot of focus across the company to improve that. One of the things we're doing is slowing down manufacturing plants. The impact of that has been the fixed costs get capitalized into fewer units, and that is going to reduce the gross margin as a result. We have other things going on from productivity, lowering the cost of API to increase price that helps gross margin, but this is going to be a drag. It's about a 120 basis point drag in Q3. We've said it will accelerate to 150 to 170 basis points going forward. So that's the other element that impacts the P&L in 2024.

Got it. And the gross margin, what is that 100 bps or so year-over-year impact from...

So we've not given the total puts and takes. What we've said is 150 to 170 basis points from slowing down the manufacturing facilities.

And also, [ Scott ], I know you mentioned EBITDA you have not guided to -- you're not committing to growth. I know the guidance for 2023 is midpoint around [ 980 ] or so. I would have said, based on some of the gross margin year-over-year plus some of the new reps and some marketing spend coming in even flattish may not be a reasonable base case. It should come in a little bit. Would you disagree with that?

We're not giving guidance on EBITDA today.

And with regards to the slowing down the manufacturing plants and realizing that you need to see how 2023 pans out in order to decide whether or not to slow down or reaccelerate the plants, but it sounds like the plants could be slowed down for a while? Or is that a moving target that's still TBD?

We think we need to get $250 million to $300 million of inventory value off the balance sheet and convert it to cash over the next, call it, 12 to 24 months. And so we'll continue and the flip side of this, Mike, is we're running some plants really hard right? I mean, Elwood, Kansas is running really hard on that production. We've got -- as we've launched these other products, and that's part of this is we've got inventory coming in. We'll have inventory from Bovaer on our balance sheet as we acquired it from contract manufacturer here this year, so there's obviously the growth elements, but there's some historic [indiscernible] products, some other pet all products where we're slowing it down. So it will vary by plant and even certain one side of the plant may be running differently than the other, but it will be in the 12- to 24-month time frame to get this through.

Got it. Maybe, Todd, since there are several pipeline programs, and I want to go through each of them. As we think about it, there's been a lot of Street focus on, obviously, the flea/tick and the Trio market. Is that also from an internal perspective, considered the highest profile? Or are you guys kind of valuing all 4 or 5 of them above the same.

Certainly, that innovation gap of not having a broad-spectrum product in the U.S. has been negative on our sales growth from our U.S. Vet Business. That continues to be the challenge this year. Our outside retail business has had a great year as we've really driven the changes that Bobby Modi has brought in, in that business. So yes, it's critical on Credelio, Quattro from the standpoint of being competitive because as we all know, the parasiticides market, the biggest one in pet health you've got to be a player there as 1 of the big 4. And with Credelio and Quattro we're excited to have a product with the broadest coverage, and that's going to be coming to the market next year.

With regards to Credelio and Quattro aside from the Tapeworm coverage and the fact that puppies are protected against heartworms and for mother dosing correct? Are there any other differentiating features.

You act as if to having the broadest coverage with Tapeworm just not a big deal, Mike. We're excited to have the broadest coverage product on the market.

Sorry to minimize.

That's the big one. Again, we did a dog park study a few years ago. So 1 in 6 dogs had Tapeworms as part of that IDEXX launch diagnostic earlier this year on Tapeworm. And so we're just trying to increase the visibility of that with clinicians.

You have to excuse, Mike, he is a fish guy. I'm not joking. Okay. And also, Todd, just before we move on from this. There's been some question marks over the cadence of launches ongoing in the triples that are out there in the market right now. I realize they're well saturated, but there were large enough franchises already. My sense is the market is still growing, maybe not growing at the same clip as it was. Is that consistent with how you guys see that on the triple side right now?

Yes. We see the market continuing to grow. We see compliance rates increasing. Some of that's the drop shipments and ease that online pharmacies are providing to consumers. Some of it is -- the reason everyone wanted the combo product is, remember, to give one product a month is expected to simplify the pet owners life and get higher compliance rate. So yes, we fully expect this to be a continued growing area. At the same time, pet owners are very well aware of parasiticides have been treating their animals for a long time with lots of products. So it is in a new space. I mean that's for us, that's where Zenrelia becomes a real growth driver is we're not in the dermatology space in a big way. We've got 1 product that gets used a lot when dogs aren't responsive to the other ones. But bringing a JAK to our IL-31 product, we're excited by that as well as the monoclonal but I'll just speak to a later in the process but that we think is probably a smaller market today, but obviously well in excess of $1 billion and continuing to grow.

One consideration for us, that was very relevant was this dynamic that from Zoetis perspective as well from our perspective. They had a very large presence as does BI, very large presence in the duals, meaning when they launch their trios, it has to be additive because there's like cannibalization within the offering they already had. I felt like from your perspective, the Credelio and the dual you have was sub-$200 million product. So to the extent it does anything, the absence of cannibalization internally means the true top line acceleration is higher in terms of the impact than it would be for some of the competitors. Is that a reasonable way to think about it?

I think you probably over benefited Simparica. It isn't that much of a presence. Simparica Trio clearly now is the dominant player. For us, I think Trifexis was the first oral for heartworm and fleas. It continued to be a blockbuster product for us last year that's one that's been on the market over a decade and really had a huge leadership position has been eroded as things have come on. So we've got in excess of $200 million with the Credelio and Interceptor Plus franchises. So it is a factor, is as much as a BI probably not, given the size and scale of the BI installed base.

And are these bundled offerings to these Vet practices that Trifexis and our new Trio or is it done more an ad hoc product-by-product basis?

That will carry multiple parasiticides on their shelves, right? You very rarely do go into that clinic and find, oh, there's only one parasiticide product. They carry multiple ones. Think all of us provide basically volume discounts to the vets. The more you buy from us, the better your rebates and pricing is. We've been at a competitive disadvantage on that by not having a dermatology product. And so because the #1 reason pet owners go into the vet is because of the itching dog, that always gave Zoetis a leg up in that, but that was always buying more from Zoetis from the start because of that derm portfolio. This is where having a complete portfolio solution with us having a derm product is going to be really helpful because it changes that dynamic.

And Todd, I know that bundling is a key part of your strategy with this new pipeline, but now that you'll be able to bundle in competition with Zoetis, do you see kind of a race to the bottom price wise, I mean, how is that going to pan out?

There's no reason to have a race to the bottom, right? And this is one of those where bringing innovation, bringing value to the pet owner and pricing appropriately for that value is critical. I think next guard priced at a premium to Simparica Trio. So we don't know what our competitors will do, Mike, but we're confident that we're going to be valued through our innovation and differentiation of those products. so that we can price appropriate to the value.

How is the market share evolving for NexGard versus Simparica Trio?

I think it's too early. It's my understanding, Umer, and they had a lot of short-dated products they were giving a lot of discounts because of just the time line of their approval relative to the dating. And so I think we'll learn more as the new year.

But it doesn't sound like it's been a big splash. Would you agree with that? Or is it.

I would say that's sort of the noise in the marketplace.

Okay. Got it. And is there any learnings from that for Elanco?

Again, I think we feel very comfortable about the launch preparation. The team has done a great job of working through and making sure we're ready having -- working through to make sure we have product supply, the marketing plan. So we're taking all the learnings. We've got a lot of industry veterans who've been and done other launches and are very well prepared to help us hit the ground well.

Got it. Well, got it. So on the JAK inhibitor, can you walk us through the differentiation? I know Zoetis has been in with the JAK, Apoquel for quite a while. What's the differentiation there?

We've not provided that yet. As we get closer to the launch, we will, but we're confident it has value in our market research studies.

But there's a real angle.

Yes.

And Todd, just to piggyback on that question, too. I mean, I think if you look at Zoetis Apoquel label around 68% or 70% response rates with that JAK. I mean, is it so entrenched by this point since that when Elanco's JAK comes to market, it will be your second line for that?

Again, we believe we can very much get first line. It will obviously vary by that. The question then becomes, all right, there's a lot of dogs that don't respond, right? 32% is not an insignificant amount. And then you get into, well, if dogs are responding better to our product well than maybe but that decides, "Oh, let me go with that one because the hard to treat dogs that have not been [indiscernible]. I don't know that, that will be the case. That's obviously what we're hoping is that we're responding to a higher level and that you get that kind of just efficacy benefit, but that will play out in the marketplace. But we're excited to get the product.

So unlike the trio where you could have an additional component here, it's an Apoquel JAK and your JAK. So structuralize or the molecule wise, there's not a differentiation per se. You're implying maybe there's an indication difference potential or something along those lines?

Yes, I think it's not the exact same molecule, so...

[indiscernible] JAK inhibitors.

Exactly. But there's obviously variability between biologics in that way.

Okay. Got it. Okay. And okay, got it. And do we have a sense for -- if there's any other JAKs that are hitting the landscape as well in due time?

Animal Health isn't overly disclosable pipelines, as you know, we've been the most forthcoming. So there's always noise in the marketplace, but we expect we'll be second.

Okay. But doesn't everybody work with the same CRO or anything in the works or is that...

I mean there's a few out there.

Okay. Mike, do you want to go into the next one?

Yes. I have some questions on the Bovaer markets. Is such a new market. And I'm likely oversimplifying it, Todd, but this entire new entry, I would say, hinges on the fact that big food corporations want to be able to say that their products are more environmentally friendly, correct?

I mean they've made commitments on Scope 3 reductions. So the big companies have done over 100 million tons of reductions they've committed to do. Is that to say they're more environmentally friendly? Is that part of just their overall ethos. A lot of them are European companies with Unilever, Nestle's and the like. But yes, fundamentally, what's getting created here is value because of the desire to reduce greenhouse gas emissions by big companies.

And can you speak to just the mechanics of how this carbon market will work? I get a lot of questions on this.

Yes. No, it's not exactly smooth and easy, which is why we've been spending so much time in order to make a marketplace where our products will create the value. So a dairy farmer today produces milk. That milk goes to milksheds that then sell it on to the big companies, be it grocery stores, be it Costco, Starbucks or Nestle, Unilever, makes some Ben & Jerry's. What we're having here is Athian, which is a carbon exchange, we'll have certifying -- independent certifiers that go on to farms and say, "Okay, if you feed Bovaer once it's approved, with this level of product, it will reduce methane by the 30%. That will convert into x amount of carbon reduction. That certification will create a credit. Athian will pay the farmer for that credit, and then Athian will sell the credit to, we'll use example, Nestle. The farmer now has more money from having the Bovaer and then they pay us for Bovaer. And so we're going to make our money through this selling of a product, just like we did today on all of our products. The dairy farmer needs to get paid. That's the reason we went and set up this exchange is while they want to be good for the environment, they run low-margin businesses. They need to get paid for the extra effort of the feeding of Bovaer, the tracking of the data. That's a very important part. It's tracking the data so that there's no question about the methane reduction. The good news is this reduces methane entirely. It's not a timing issue. Journal article today about sawdust getting buried in the ground and tracking to make sure it doesn't go back into the environment. This is just -- the cow doesn't burp as much, full stop. And that's the big win. So we're excited. There will also be some government subsidies that we've worked through with the Inflation Reduction Act. There's a lot of work to affect the environment as well, and those monies will flow to the dairy farmer as part of their ability to buy the product from us.

I know we're almost out of time. Is there one last thing do you want to touch up on, Mike, I want to be very respectful of [indiscernible].

Yes. Just real quick, switching gear totally on the debt. I mean you question, how much impact of P&L interest expense will result from selling your $3 billion of interest rate swaps.

We've given interest expense guidance for this year as well as for '24, and it's a little bit higher next year, about $10 million more in the range. So it's one of those things. There's a number of different moving pieces in the swap. Clearly, the selling of the swap and capturing the $57 million of cash we did in Q3 doesn't impact the P&L because we amortized that gain back into the P&L. It affects the cash interest.

Got it. Maybe, Todd, just before we wrap, just thinking out loud, I remember over the last couple of years, you guys went through some cost cuts. There were some changes in organizational structure, et cetera, as well. Candidly, I kind of lost track [indiscernible] and structure a little bit. Maybe could for folks listening in, could you remind us what are the -- some of the key new folks that have come into the team or not on the team anymore kind of thing.

Sure. So the -- overall, we run the business with 3 commercial leaders. So Bobby Modi, who runs our U.S. Pet Health business. He joined us about, I guess, just over 18 months ago and really seeing his experience on retail coming through with the activation and the movement of the A family, especially as well as Seresto. And then as he gets ready and get set to launch in the vet clinic with these big new products as well as arbovirus. Jose Simas runs our U.S. farm business. He's the one that really pushed and realized the importance of the sustainability side. And that strategic side that we're now seeing come together as the carbon credits have gone not just for Bovaer, once it's approved, but for Rumensin as well that we've been able to show given [indiscernible] also has a positive impact on the environment. And then Ramiro Cabral, runs our international business. So he's got accountability for all of the commercial operations outside the U.S., both the pet and the farm side.

And Tim Bettington.

Tim joined us in May. He launched Simparica Trio at Zoetis. Tim is doing both corporate strategy, business development and launch excellence. And so he's working very closely with Bobby and his team thinking through the sales force, how it sets distribution, strategy and the life.

So Tim is not launching it, he's working in partnership with Bobby.

exactly.

Okay. Got it. All right.

Very good. Well, thank you all.

Thank you. Thank you very much.