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

Good afternoon, everybody. I'm Chris Schott at JPMorgan, and it's my pleasure to be introducing Elanco today. From the company, we have Jeff Simmons, the company's President and CEO; and we're going to have the company's CFO, Todd Young, join us for Q&A. So with that, I'm going to turn it over to Jeff.

All right. Thanks, Chris, and thanks for all the great work you and JPMorgan are doing in animal health. Before I begin, I'll quickly reference Slide 2, just on the disclaimer for forward-looking statements. And with that, I will get started. Hey, 2024 marks a very important year for Elanco. It is our 70th year as an animal health company, the longest-standing brand in this durable, attractive industry. And we have a lot of great things that are happening this year as well that I'll get into and Todd will as well. And listen, given animal health brings a lot of interest at JPMorgan. It's the beginning of the year. We're going to level set and really cover a few things in detail in some prepared remarks, and then Todd and I will join Chris for some Q&A. So I'm going to cover three things. I'm going to first just talk a little bit about our perspective of the Animal Health industry and where it stands today. Second is a little background on Elanco, the momentum, the progress that we are making today with our strategy. And then third is really just the overall belief that we have and some positioning around how we are as a company and the value proposition that lies ahead for our company. So with that, let me get started. And I'll start really, before I get into the background of the industry, and just say that, to get into a broader overview, I want to kind of ground everyone on Elanco and the current state. We delivered top-line growth and improvement throughout all of 2023 or improvement over 2023 with a return to consistent constant currency revenue growth of 5% in the third quarter. Improvement was driven by an accelerating contribution from innovation, stabilizing core volumes and price growth. And we expect the upward trajectory to continue in 2024. We expanded gross margin in the first 3 quarters of the year and are prioritizing cash flow for debt pay down. We made meaningful progress on our pipeline. We had 3 FDA submissions made for potential blockbuster products in the third quarter, all with a path towards approval in the first half of 2024. We're executing on our key deliverables of growth, innovation and improved cash conversion and look forward to reporting fourth quarter results at the end of February. So with that, let me transition a little bit to the background of the industry, and I'll move to Slide 4. The Animal Health medicines and vaccine market represent an estimated $38 billion in size. The industry has delivered, historically, a 5- and 10-year CAGR of around 5%, with reported growth in each of the last 20 years. This attractive industry growth is driven by innovative products and solutions that address growing needs of veterinarians, farmers and pet owners. And as a cash-pay business, I think this is important, the customers' willingness to pay is driven by value, and the industry has historically fared well during times of this economic uncertainty as customers prioritize the animals in their care. And we expect this durability to continue. In 2024, we see the $15 billion global pet health market growing in line with historical mid-single digits. Growth in this space continues to be driven by rising global pet ownership and increased humanization of pets with higher expectation of care, creating increased willingness to spend. Capacity constraints in the veterinary community continue to limit visit growth, highlighting a clear need for vet practice optimization as well as more vets needed to be entered into the profession in the industry. We expect innovation will continue to be rewarded and increased compliance and convenience, enabled by omnichannel options, will continue to drive growth. On the Farm Animal side, consistent with the recent years, this $23 billion global industry is expected to grow in 2024, although at a lower rate than Pet Health. Farm Animal growth will be driven by the continued rise in global demand for animal protein aligned with GDP growth, popularity of high protein diets as well as efficient global trade. Producers, globally, on the Farm Animal side, are focused on food safety, disease prevention and productivity. And as global demand -- as demand for protein increases, sustainable production of meat and milk has never mattered more. I believe, in 2024, we will see the convergence between animal health and environmental health. This intersection of calories and climate creates the next era of industry opportunity and it positions livestock as a major contributor for climate solution rather than a detractor. Just last month at COP28, the United Nations highlighted the need for livestock efficiency to meet increased calorie needs while pointing to feed additives as one of the opportunities to reduce methane emissions. We have made tangible progress, as a company, to create a market in this space, whereby we can reduce methane, not animals while adding a value stream for farmers. In 2024, we expect these trends in Farm Animal to be balanced by negative cyclical trends in U.S. cattle and the continued uncertainty in Chinese protein markets. I think when you look at animal health companies, to take advantage of some of these tailwinds I've described, animal health companies must do the following: deliver consistent high-impact innovation; maintain broad scale and global reach; have robust, diverse portfolios; and have value-added capabilities. And over the last 5 years, as a public company, Elanco strategically invested in these capabilities, expanded reach and poised to drive improved profitability as we grow this top line. Let's move now to Slide 5, take a closer look at how we are executing on our strategy. While our products serve pet owners, veterinarians and farmers and the animals in their care, we know that we're not in the animal business, but also the people business. We believe in Elanco, making animals lives better, makes life better. Elanco is an independent global animal health leader with revenue balance between the U.S. and international markets. We focus on products, medicines and vaccines for 2 primary sectors: Pet Health, including dogs and cats; and Farm Animals, which primarily include cattle, swine, poultry and aqua. Since our 2018 IPO, we've successfully completed our separation and stand-up, increased our exposure to the higher-margin pet health market by acquiring Bayer Animal Health and taken decisive actions to capture value and deliver productivity. Last year, we completed the systems integration of Bayer Animal Health business, allowing us to move past significant cash outlays with a focus now on debt paydown and delevering in 2024. On innovation, our pipeline is maturing with opportunities to introduce 6 potential blockbuster products in the U.S. market by 2025. Two of those, Experior and our parvovirus monoclonal antibody, are already on the market and expected to contribute to growth in 2024, while we have a path to three additional approvals in the first half of this year. We also continue to invest in important commercial capabilities and expanded share of voice that will maximize the value of our current portfolio and expected launches in 2024. I'll go into each of these in just a moment. These actions and progress are building momentum in Elanco. We've invested in transform to build a global company that has the scale, the diversity, the pipeline and the optimized infrastructure that allows us to reach the world's animals to be a valuable partner to our customers. The diversity that we have created in our business across species, therapeutic areas and channels makes us durable and positions us to capitalize on these market opportunities. Moving to Slide 6, let's take a deeper look at how we're driving success. In Elanco, we've had a very consistent strategy focused with three pillars: innovation, portfolio and productivity, or IPP, with customers always at the center. We aim to deliver consistent high-impact innovation while optimizing our diverse portfolio to grow market share. Our company's wide strategic productivity efforts have supported margin expansion since the IPO, with improved cash flow and debt paydown expected in 2024. We are poised to optimize our ability to serve customers and create long-term value. Turning to innovation on Slide 7. We are committed to consistent investment in R&D to drive growth over the long term. And under the leadership of Dr. Ellen de Brabander, our team is making strong progress on efforts to transform care, bringing new solutions to our customers' greatest challenges. We're in the midst of launching one of the most exciting pipelines in our 70-year history, primarily in high value, the pet health market and pioneering a new frontier in the livestock sustainability market. Our R&D organization is streamlined and optimized, really, around three clear parallel priorities. First, we're focused on the late-stage pipeline, targeting high-value market segments, where we have first-in-class differentiated assets. We are balancing our late-stage efforts with investments to maximize the value of our current portfolio and refill the pipeline. A key differentiator in Animal Health is the importance of extending the life and value of existing brands and targeted life cycle management. It's a top of mind for us right now and has been a key contributor to stabilizing our base business. Finally, in order to deliver consistent high impact innovation in the years to come, we are refilling our early-stage pipeline with the next wave of innovation, focused on first and best-in-class opportunities. Our targeted areas of focus here include concentrated efforts, really, on the next generation of products for pet parasiticides, dermatology and pain and in livestock sustainability. Additionally, we're opportunistic for platform-aligned targets such as monoclonal antibodies broadly and other major emerging spaces of high unmet needs. We see a bright future ahead for Elanco with this next wave of innovation, and we're excited to share more as we progress. Slide 8 is a slide we've used in the past that highlights the 6 expected potential blockbuster products in major markets. We've already launched 2 of these: first, Experior, the first-ever FDA-approved product with environmental claim for the reduction in ammonia gases in cattle; and our canine parvovirus monoclonal antibody, CPMA, a revolutionary product that saves puppies from unnecessary death when faced with this highly contagious disease. We've completed our planned capacity expansion and expect unconstrained supply for CPMA in 2024. Both Experior and CPMA ended the year with strong momentum and are expected to be key growth drivers in 2024. In addition, we have 3 key late-stage assets that have a path to U.S. FDA approval in the first half of 2024, which we expect to contribute to growth primarily in the second half of the year. On the Pet Health side, this includes Zenrelia, our first product in the $1 billion global canine dermatology market; and Credelio Quattro, our broad spectrum parasiticide in the $6.5 billion global parasiticide market. Both of these are expected to be differentiated from the current market offerings. These new drug products will greatly enhance our current portfolio offering to veterinarians and corporate groups, elevating Elanco's competitiveness overall. Rounding out the near-term assets, Bovaer is a product to reduce methane emissions in cattle. Elanco has a U.S. commercial rights for the product and is helping to shape livestock sustainability market that we believe could become a $1 billion to $2 billion global market, fueling Elanco's next era of Farm Animal growth. Finally, we're progressing our IL-31 monoclonal antibody, another dermatology asset in 2025, as we leverage our expanded monoclonal antibody platform. Overall, Elanco is embarking on a historic innovation launch window, as we speak. Ellen and her team are focused optimizing and demonstrating proof points, positioning Elanco to deliver consistent high-impact innovation that contributes to future growth. We remain confident in our path towards incremental annual revenue contributions of $600 million to $700 million by 2025 from innovation launched since 2020 and are excited about the next wave of innovation in the pipeline. Moving now to the second pillar of our strategy, the portfolio. We sell products in more than 90 countries with about 200 brands, of which 10 are blockbusters or were in 2022. Our diverse global portfolio and our integrated and efficient systems, along with our competitive teams on the ground, have us well positioned to reach the world's animals. And let's take a closer look at each one of the segments, starting in Pet Health. Our vision in Pet Health is helping pets live longer, healthier, more active lives. As a major player in the global market, we have solutions for veterinarians and pet owners in parasiticides, dermatology, pain and other therapeutics as well as vaccines. Blockbuster brands like Seresto, Advantage, Credelio and Galliprant are core to our offering with additional portfolio-enhancing products in important therapeutic areas. As I mentioned earlier, we have intentionally shifted our mix to a higher-margin Pet Health products. Going from about 1/3 of our portfolio of our business in 2018 to today, Pet Health represents over half of our business. Elanco is a significant player in the pet health vet market. And because of the Bayer acquisition and additional investments we've made in the business, we're now the leader in the pet health retail channels, both in the U.S. and internationally. About 40% of our global Pet Health business is in the over-the-counter parasiticides products that do not require prescriptions. This means that we can meet pet owners where and how they want to shop for pet care at the vet clinic, their neighborhood store or online, and that comes at a wide variety of price points, too, giving us multiple ways to win. Additionally, our leadership in this market space uniquely positions Elanco compared to other public competitors and insulates a portion of our business from the capacity challenges and lower visit volumes at that clinics. We expect our Pet Health business to continue to improve in the U.S. and internationally through, really, 4 key enablers highlighted on Slide 10: first, innovation, as well as increased share of voice, expanded physical availability and strategic price execution. The strategy is delivering already. On a year-to-date basis through Q3, global price for pets was up 5% and the U.S. retail business grew 10%. And further, to support the anticipated approval of new products, we have invested to expand our U.S. Pet Health sales force by 20% or about 75 people, most of whom come to Elanco from the pet health industry. Shifting now to Farm Animals on Slide 11. We are focused on helping farmers improve the following: really, animal health and well-being and raise livestock more sustainably. Our business spans four key areas: efficiency and performance; disease prevention; and treatment, food safety, where we're a global leader in salmonella prevention in poultry; and the emerging area of livestock sustainability. Our Farm Animal business has proven to be resilient in a variety of market conditions as we expect to grow over time, enabled by our comprehensive complementary portfolio offerings, our value beyond product services, price and innovation, including both important life cycle management and new opportunities, primarily in livestock sustainability. Overall, our Farm Animal leadership, our intentional shift into more Pet Health and our late-stage pipeline is expected to create a more stable business with higher margins. Finally, on Slide 13, I'll elaborate on our productivity efforts. Over the last several years, we took decisive actions to optimize our physical footprint and corporate structure, allowing us to deliver adjusted EBITDA synergies above initial expectations while weathering significant inflationary, foreign exchange and other pressures. We've enhanced our ownership mentality of our global team, thanks to our shift to an EVA-like Elanco cash earnings compensation metric. Importantly, we're continuing to make improvements, which allow continued reinvestment in innovation and launches to drive growth and improve profitability. As we move past last year's cash outlay for ERP systems, integration and scale in margin-accretive innovation, we expect improved free cash flow leading to additional delevering. As I mentioned earlier, we believe our established strategic IPP framework is the flywheel necessary to optimize serving customers and creating value over the long term. And the flywheel is increasing momentum as we see on Slide 14. As we shared in our recent earnings call, along with improving market conditions, third quarter constant currency revenue growth of 6% for Pet Health and 4% for Farm Animal was enabled by our differentiated global omnichannel approach, our strategic leverage of our diverse portfolio and our enhanced capabilities as well as leadership. And we expect our growth to continue into 2024. In November, we shared our expectations for constant currency revenue growth this year, which we believe is achievable even before the expected launches of Bovaer, Credelio Quattro and Zenrelia. The key enablers in our portfolio, leveraging innovation, share of voice and physical availability are expected to be key tailwinds, while we continue to face competitive pressures from innovation and generics while the global macro uncertainty appears to be manageable going into 2024. We're excited with what lies ahead. Finally, as I close on Slide 16, we see Elanco as an attractive animal leader -- animal health leader, in a very attractive industry, offering really the following compelling long-term value proposition. First, our innovation, portfolio and productivity strategy positions us well to deliver on our late-stage pipeline. We're going to launch with excellence and remain focused on improving cash conversion and decreasing leverage. As we look ahead, we have a stabilizing core business that delivered both volume and price growth in the third quarter. We're preparing to launch innovation in big, high-value spaces and are pioneering new markets. We have a strategic mindset focused on optimizing our infrastructure to support future growth from innovation. Ultimately, we believe this strategy will deliver meaningful long-term value creation for our customers and shareholders. Chris, thanks for the opportunity. And Todd and I look forward to fielding your questions.

Thanks so much for the comments there. So I thought maybe just to kick off the conversation, looking back on 2023, can you just maybe elaborate on kind of what went better than expected? What went worse than expected? And, just, how do you think about those kind of trends playing out as we go into 2024?

Yes. I think overall, at the highest level, our company has been very focused on three things, it's growth; innovation; and cash, converting EBITDA to cash. I think as we look at last year, I think what went well was our pet retail business. And the overall pet business was, I think, a little better than expected. I think what Ellen is doing in the pipeline, she's created an engine of consistent innovation. The progress that we've made, a lot of it is as expected externally. But I think what we're seeing is the engine of what I see both on innovation as well as even the next wave on these clinical projects. And then look, completing the ERP stand-up was a significant feat. It's worked. It's now bringing savings. That stand-up is behind us, and we're integrated. So I think that's the positive. I think supply continues to be a challenge. We saw -- you saw that quarter-to-quarter, especially on the vaccine side with -- especially on the USDA and the vaccine. That was a challenge. And then I think the continued work with competition and moving forward. But overall, I think a solid year, net-net overall.

The only thing I'd add, our working capital management wasn't at the level we would have liked. We've done a lot of work to improve that, and it's improving in the second half as we stopped the degradation. But as we've communicated, we'll be slowing down manufacturing facilities in 2024 to manage that better and expect we'll be able to get about $250 million of cash off the balance sheet over the next couple of years.

Great. New launch is obviously going to be a big focus for the company as we go through this year. Maybe just the latest around timing and confidence on some of these approvals, so I guess any update on the regulatory front of how the applications are progressing. Any request for additional data? Just trying to get a sense of, like, how confident are you on the first half approval time lines.

Yes. So we've said, and I back up and say, as I mentioned just now, through '20 -- through 70 years, and we've got 10 blockbusters, we are now looking at 6 and then making between the 2 that we have approved and through 2025. So we're sitting here, I think, with the historical significant innovation. Yes, the 3 that are submitted or under the FDA, 2 of them are under ADUFA. So as we look at them, no new real news here, and that's good news. I mean, we have said it's rolling. It's iterative. The submissions are in. We're working on the regulatory side with them. It's a proactive and productive dialogue. So I think that's all moving forward. Again, we see a path to approval for these products in the first half of 2024.

No news is good news on that front, sounds like.

Yes.

Great. And then I guess the next question, I've had some of this discussion over time, how do I think about investment behind the launches? I know you made some investments in 2023. But as I think about these, these are obviously very important products for the company longer term. Going into competitive markets, how do you balance kind of the gating of expenses of -- do you push hard right away? Is this more of a gradual process that you kind of pick at here and there? Just help me understand that a little bit.

Maybe some opening comments, and Todd, you can add a little bit on maybe the staging piece. But Chris, I think what we've looked at first is, we've been launching, when we've got ZORBIUM, Bexacat, now parvovirus, I think the good news is we've been building the muscle for these launches with these other products. I mean, parvovirus we've shared that. As I mentioned in my comments, we've got unrestricted supply right now. Everybody wants it. From a clinic interest, it's really high. So the first thing is, really, we've been building this muscle from digital to share of voice. Second is our new sales force, our expanded sales force. Over 20% expansion is complete. Over 80% of that is coming from the industry, as we've mentioned. So that's really the fixed cost, and that's really helping our organic, our existing portfolio, and then that will be there and in place as we come. That's the first prong of any launch, is making sure that awareness is very high at the clinic to drive clinic penetration. That's the point of the arrow for the launch. And then we're going to stage and we're going to ramp. I mean, the mindset with these launches, because these are major markets, these are differentiated assets, especially when you look at a derm market or a livestock sustainability market, we will launch with no regrets, and we will put the right expenses behind it. We'll stage that. Maybe Todd, share a little bit of what we're thinking from a staging perspective.

Certainly. I think we've made the investment in the sales force expansion. So that's about a $20 million investment. Those individuals are onboard. They're working. We've recut the territories and are making that transition regardless here of the timing. With respect to the big investments, it's often the TV ads. That would be more ad sales are ramping and we're getting clinic penetration. So that will be toggled more in line. As we've mentioned, we'd expect revenue contribution from these products in the back half of the year. So from just a timing perspective, that's how I'd be thinking about the investments on the launch.

Okay. Great. And then you've got obviously a lot of launches. You've launched some, you've got some upcoming. How would you prioritize them in terms of what are you seeing as the biggest opportunities to Elanco if you kind of rank order these?

Yes. So the consistent message right now is we've got two great assets that have a lot of momentum in the marketplace right now, and that's where the energy is. It's what we have. So Experior, it's been a challenge to get it into the feeding programs, but it has. It's ramping. We've said that it'll end the year at an annual run rate of $60 million to $70 million. We see that being a key growth driver next year. That's going well, a lot of interest. Now we've unconstrained the supply on parvovirus, a blockbuster potential when we look at that product globally and the interest there. So one will be the focus of what we have. When we look at the other 3 assets, there's no question. The derm market, the atopic dermatitis market really, really interests us. It's new. It's expanding. It's double-digit growth. It's $1.2 billion. It's the #1 reason people go to the vet clinic, as a dog can kind of self-diagnose with the itching challenges. We see that, hey, there's unmet needs in that marketplace, and it actually adds one prong to the portfolio that we now will have, that few other major companies have, which is bringing derm with pain, para, vaccines. So that market is extremely of interest to us, and it's accretive to us, and it's an exciting global market that's still growing. There's no question that Bovaer and opening up livestock sustainability, we've spent a lot of time preparing the in-set carbon chain. Now dairy farmers are able to get another income stream from carbon in addition to protein. And our target's going to be the U.S. dairy market. We'll have a drug approved by the FDA with a Bovaer, and we see that market as a -- really, that market archetype is creating a new space and it will be, really, the first major time where environmental health comes into animal health. And then Quattro, look, it's the largest market. When I started in this industry, it was a couple of hundred million. It's now a $6.5 billion market parasiticides, and we're coming with a product that has one of the broadest coverages with a team that has some of the most expertise with an omnichannel approach, so a very competitive market, but we believe we have an offering. So three differentiated markets, our differentiated products in very big market spaces. But the priority right now inside the company is the 2 that we have is full execution. That will be part of the guidance that we've said on our existing portfolio to grow next year.

Excellent. Just on the macro side on Pet Health. I know it's maybe a little less of a driver. There was a lot of focus though on vet visits as we went through 2023. It seems like some of the recent data is showing maybe those visit trends improving a bit. I just -- a sense of, like, what are you seeing as you look at the market out there and how are you thinking about visit trends going to '24?

Yes. So I think I always say there are a lot of people here, too, that are kind of new to the business, is 20 years of consistent growth with a lot of market volatility seeing an average of 5% growth over time. I think when you bring that back in a cash market, a willingness to spend on pets continues to be the metric that matters. Now yes, vet visits has gotten a lot of exposure, and it is challenged, especially with the capacity challenges in the clinics. We have seen some marginal improvement maybe in the marketplace. I think we're a little more insulated to that given our portfolio and also the retail business. But we do see some marginal improvement. Nothing structurally has changed though from Q3 to Q4, so I think it's minimal. I do think a lot of things that are happening at the vet clinics out there in the U.S. to optimize, there's more convenience, there's more compliance and there's more willingness to spend. And I think that's what's going to make us a lot more durable in an economic time that might be a little more challenged.

Can I just ask another question on just the broader environment, on price? It seems like there's been some pretty healthy price given the inflationary environment we're in. Just how do we think about price going forward? Do we think about pricing coming back to more historic increased levels? Or could we be still in a period of time where there's still above average price increases?