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

All right. Well, good morning, once again. We're delighted to have Elanco with us here at Cowen's 44th Annual Healthcare Conference. Representing the company, Jeff Simmons, who is President and CEO. So Jeff, thank you so much for making the journey to be with us. We'd like to keep this interactive. Chris and I, my colleague, will ask some questions, but please chime in and follow up, ask any questions that you'd like to pose, and we'll make sure we get you answers.

So Jeff, let me just start out kind of big picture. What are the top three priorities for the company, for you in 2024?

Yes. Thanks for the opportunity, Steve. I will highlight just for us, the three priorities, and we've been talking a lot about this over the last probably a year. And the same priority as inside is outside and what's going to drive the value of the company is growth, innovation and cash. And let me just link to our 2023 results and our 2024 guide in that regard. So excited about our company's return to growth in 2023, full year 1%, two quarters in a row of 5% constant currency revenue growth, quality growth, probably the most diverse growth we've seen, a stabilizing core business that has really been driven by price and innovation has been driven by stronger portfolios, especially on the pet retail side, on poultry, overall pet and farm animal, different elements of growth on both sides. So -- and we're guiding for growth, 1% to 3%. So that growth is going to step up in constant currency and that's before our major new products that I know we're going to talk about. So they are not in that guide. So -- and we believe that makes the innovation even more appealing with that base continuing to grow. On the innovation side, our innovation sales, as we started tracking those innovation sales as we launched post Bayer in 2021, we set an external kind of target of $600 million to $700 million of innovation by the end of 2025. We've doubled innovation in 2023, led by Experior, by Parvovirus, by Adtab, and numerous -- numerous things that are driving that growth. So we're at the $275 million, we're guiding for another approximate $100 million of growth, again, before the major new products. So we continue to see the existing innovation growing as we've talked, and I think that will be key. And then, of course, the late-stage pipeline, the three key differentiated assets that are coming that have a path for our first half approval in '24. Zenrelia, that will be all accretive in the derm area for us. Parvo, a major player, largest market, $6.5 billion broad coverage parasiticide with a path as well, Credelio Quattro, and then Bovaer, a new product, major differentiated product in the whole area of livestock sustainability, so those late-stage assets. And then the next wave of innovation, we had a pretty significant year in '23 of new products going into development that will actually drive the innovation growth in the second half of the decade. So that's the second big priority for us. And then third is cash. Really, really critical for us. It's been a key priority. We base our pay on EBITDA growth, but also the use of cash for all employees. So this has been a big factor. We paid a little more debt than it was expected in Q4. So generating about $76 million of debt paydown. We expect now that the standup is done. Todd guided last week that will be in the neighborhood of $300 million of cash. So a 4x step-up in free cash flow conversion, and that's before the close of our Aqua deal that should generate over $1 billion. So we have a path to be at -- going from mid-5 debt-to-EBITDA to going to mid-4s approximately by the end of this year with those things happening and a path by the end of 2025, low 4s to high 3s. So again, return to growth, guiding to growth before the new products, historic innovation for the company, 6 potential blockbusters, a few in the market, more coming between now and 2025, and then a significant step-up in free cash flow conversion as a company. Those are the three drivers. These aren't things that are coming. These things are in the works that are happening.

Great. One more big picture question, then we'll drill down into some product-specific questions. But when you look at 2024 specifically, what are some tailwinds that could make results hit that high end? What are some headwinds that can make it hit the low end? And what are the scenarios that would play out for each?

Yes. I think no question innovation. We point to Experior's ended the year at 54 million cattle product, was at a run rate of 70 million. So you can do the math, and we continue to see [ levers ] probably our next blockbuster. So in the bucket of innovation, we see Experior as a key player. Parvovirus, we have moved. It's our first monoclonal antibody. We were limited at a small bioreactor at 200 liters. We're now to 2,000 liters. We've got really unrestricted supply. We're over 3,000 clinics. So look at parvovirus in the U.S. vet clinic. And then over in Europe, Adtab, it's really Credelio's active ingredient using the Advantage brand in an OTC market and some of even our restructuring to create more cash to invest behind these three innovations. I think, Steve, that's going to be probably the opportunity for some of the biggest growth and opportunity. I think Global Poultry continues to be a leadership position for us. It ended the year with a lot of momentum, and we see continued momentum. I mean, poultry consumption in places like the Middle East, South America, et cetera, [ if discontinued ], our portfolio gets stronger. Our food safety business in the U.S. and Europe continues to get bigger. I think our retail business, U.S. and Europe, especially in Europe, we had a really tough retail market last year. In Europe, especially in the first half, we continue to see that being a driver and then we've built a better price capability. Pricing has been historical for Elanco in the industry at 2%. We ended the year last year at 4%, and we see and we're guiding to 3%. And I think a lot of that is just multiple SKUs, multiple species and geographies, a stronger pricing capability. So those are -- and what the U.S. team is doing within the vet clinic with all of our new know-how. We've got a 20% larger sales force. My hope here in the first half of the year is even in some challenging markets, those would be the positives. I think on the other side, is just look, we've got increased consolidated competition in the U.S. vet clinic. We have a nice strong portfolio. We've got an omnichannel approach, but there is a lot of intensity in the U.S. vet clinic. There's some challenges even in that market. We're not as indexed on vet visits. But when you look at the overall, there was a cooler January. I do think that you've got to keep your eyes on as you look at headwinds, the U.S. pet vet clinic market. Always on the farm animal side, you got to look at generics. We believe we're doing well there, but that's something to keep your eyes on as a headwind. And look, markets that we still have hope for growth in that are a little softer like China. China -- the China economy, the China pet market are things that we got to watch relative to potential headwinds as well. And then we've got a couple of countries we're doing different. We noted Argentina, where we're going to move. We're in about 90 countries, 45 with people, approximate 45 with distribution. We're moving a few more to take the volatility out of our business by doing that, I'll point to Argentina that will impact some revenue be a little bit of a headwind that we noted in our guidance last year. So that's, I think, a good balance. We've -- we're confident in our guidance, 1% to 3% growth, and then the new products will be on top of that.

Before we move into specific questions or products, questions from the audience on the big picture outlook. Okay, we can always come back to it later. Let me turn it to Chris to drill down into some specific products.

Yes, of course. So moving to the new launches, could you provide an update on the regulatory status of these products? And then in your experience what are the most common reasons filings could be delayed? And then just is there any upside to a delayed filing, maybe a stronger label, maybe a more differentiated label with more data?

Yes. Good questions. Yes. So we -- just to reiterate, again, three assets: Zenrelia, our JAK-1 in derm; Credelio Quattro, broad-spectrum parasiticide; and Bovaer, all FDA approvals, starting with the U.S. market. We did announce though that Zenrelia, we've got nine submissions we've made in international markets, so that should play out into 2025 as a nice lift as well. So those submissions are made. But if I talk specifically about those assets in the U.S. with the FDA, I think, hey, we're in a productive proactive dialogue. There is an Animal Drug User Fee Act where there are steps. But in these final phases, it's very rolling. It's very iterative. And what we say is, if there's anything significant that changes, we'll share that. So we're still in that stage. And look, it's a lot about timing, label, and maybe any other final questions, those are the factors. We believe these assets are differentiated, but until you have the final label and until you have the final product in the market, that differentiation is still being defined. So that's -- and as we've said, just to be very open, again, we stand and are excited about the differentiation. Remember, derm is all accretive for us. It's a $1.2 billion market, and it's globalizing. Bovaer is all accretive. And then Quattro is coming into a market that really welcomes and rewards innovation. So we stand with -- we believe we're well positioned. And as we've said, when these assets do come, likely they'll be additive in the second half and, of course, very much so in 2025. And Todd shared the guide that not only will be additive to our guide on the revenue side, but because we've already added the sales force, et cetera, they also will be additive on the EBITDA accretive to the EBITDA side as well.

Okay. Great. And then can you talk a little bit more about those underlying markets, kind of the market size, the overall growth rate for canine parasiticide, derm and then sustainable protein?

Yes. So all three markets. So maybe I'll start with the biggest, parasiticides. We spent a lot of time talking about flea, tick, the worm market, [indiscernible] market, that's a $6.5 billion market, continuing to grow. As you look at the innovation that's been introduced from the isox in the first generation to now this broader spectrum second generation. The market growth continues to grow. The market is globalizing more. I think the biggest growth driver to us is the convenience. I mean, the ability to be more convenient and have things like drop shipping and reminders and digital and all the things that have been added by both distribution, Chewy, all sides, it's making people more compliant. And parasiticides, it's a very -- pet owners and vets aren't that active in tick, flea, heartworm. So getting them more active on compliance is the greatest growth driver for us. The second is the globalization, more markets are growing. So that's a $6.5 billion market that I think is durable, is growing and rewards innovation. The erosion comes from the legacy 2, 3, 4 generation back as pet owners that are loyal start to transition dogs, that's where you see the erosion mostly. On derm market, that's dynamic, but it is growing. Number one reason people take the pet to the vet, we say often is an itching dog, about 17 million dogs in the U.S. have this problem, atopic dermatitis, about 11 million are treated of the 70 million, 80 million dogs in the U.S., and this market is globalizing. It's probably growing faster internationally than it is in the U.S. That's why we've made nine submissions and this will be our fastest, Zenrelia will be our fastest global approval and launch of a product that we have. So that's a $1.2 billion market that's globalizing high single-digit growth approximately. And then look, Bovaer is something new. It is a methane -- enteric methane reduction. Maybe we can talk more about the market. We see a $1 billion to $2 billion market. Bovaer is approved already in 45 countries with DSM. We've got the rights to the U.S. This would be the first dairy product. And again, this will be not necessarily led by ESG, but led by profitability to the farmer driven by a Nestle or a CPG company and actually an inset market that's already been created. So that's how we see a $1 billion to $2 billion. We see Bovaer with $100 million to $200 million potential here in this first phase.

Wonderful. And then you mentioned some erosion that could possibly occur in the parasiticide market. Could you just talk about Elanco's exposure there and how you'll manage that conversion?

Yes. Good question. So we've got legacy brands that have been there. We've seen some of that erosion already. On Advantage, we see Advantage Multi, which is a legacy product sold inside the vet clinic. We've seen erosion from that as well as Trifexis. We've been pretty open to say we've seen a product that's a little over $100 million. I think we ended sales at a little over $80 million in 2023. We see that legacy business is probably the one that's going to be vulnerable. A lot of loyalty to Credelio Plus, Interceptor Plus. So we see a little less -- and look, Credelio Quattro is going to be targeted to people that want broad coverage. People that have -- we've had two diagnostics be launched with tapeworm. We've been open to say that tapeworm is a differentiator with the product. We're going to target people that are in vets that are aware of that, zoonotic disease, when there's a diagnostic awareness drives usually an interest to have that coverage and people who want broad coverage. That's where we're going to go with Quattro. But yes, there will be some cannibalization in that $600 million to $700 million number that we talk about with products like Trifexis and Advantage Multi.

And then moving to derm, what's the current market penetration there? And are you -- is there a large population of new pet owners who haven't been treated? Or is it mostly fighting for existing patients?

Yes. As I've mentioned that 17 million dogs or so in the approximate current set. Again, I think new innovation always creates more awareness, more options. It's a market that not just like JAK's and human, they don't all respond. So even labels show that there's not full response there, so it's a dissatisfied market. There's really only two significant products today that are out there and only one JAK-1. So we think that the 17 million, 11 million that are being treated, you've got that 6 million dogs, plus you've got, I think, some unsatisfied market and people that do want options. We've never seen a market this big have as few of options and veterinarians want options being offered, so we see opportunities. And then I think internationally, with more companies, with more innovation, it's just going to continue to grow. Every dollar for us will be accretive. I mean, we really don't have a derm business at this point in time.

Great. And then just thinking about kind of the product profiles and what feedback have you gotten on differentiation from pet owners, vets for your -- for Zenrelia and Quattro?

Yes. So we really -- on Quattro, we've been a little bit more open on that four active ingredients, first product with four active ingredients, thus Quattro, broad coverage, doing market research. Again, we say we believe that we've got a very differentiated asset here that the marketplace wants. Marketplace usually wants a broader coverage product. Again, we will wait for the final label and to see what we have in terms of a product. We've not been as clear on the differentiation of Zenrelia other than to say the market dynamics I just described. It is going to be welcoming to new innovation and new options, and that's all we're seeing at this point in time until we get closer to the marketplace.

And then moving to Experior and Bovaer. Can you just talk a little bit about those market dynamic, how that market is going to develop, and how producers monetize the value of these products?

Yes. So very quickly, this is a new area of opportunity that we believe is quite significant. It's really where animal health converges with environmental health and just very briefly and very simply, we have established in 2023 an inset carbon market to where you actually line up, and I'm just still very specific to U.S. dairy, to where you have consumer product good companies that are dairy-driven, and then you have dairy processors in the middle and you have a dairy farm. And what you have is we have created an inset market by an independent company called Athian that actually aggregates carbon data. So the simple steps are a dairy farmer with an analytics package can actually show the emissions that it's creating and any intervention in how much they lower their emissions. That data goes to this independent company. It's certified by independent environmental companies and then the carbon comes up for sale. And then the dairy processor and the CPG company will buy those credits for maybe 1%, 2% of total product cost. They get a lot of value. Most importantly, as they get a brand value on the #1 need their consumers want right now is they want more environmentally sustainable products. That money goes all the way to another income stream to the farmer. So when Bovaer is used, it reduces enteric methane 30%, that's more than anything that's been done in dairy in the last 20 years. For Nestle and the dairy farm, and a dairy farmer picks up farmer profitability, another income stream. We see this being a $1 billion to $2 billion market. It is to these large CPG companies, it is not a nice feel-good ESG Scope 3. It is a brand essential for their future and an investment to their brand. So that's what we see in Bovaer will be transformational. In the beginning, there will be some federal incentive, a human health payer type program. They've already designated $90 million, the USDA, into incentives designated around feed additives like Bovaer, specifically to Bovaer, that they'll actually be allocated those incentives upon approval of Bovaer.

And do you see any opportunity for that market outside the U.S.?

Yes, absolutely. So we wanted to create this inset market so that it can cross species and cross borders so that it can actually -- and there's a lot of interest in some of the others. We want to actually scale it and utilize it mostly for Bovaer and U.S. dairy initially, but there's absolutely interest in Canada, Mexico, other countries as well. Something we haven't spent a lot of time talking about because we wanted to prove this market out. So our product Rumensin has actually been monetized as a proof point, Bovaer will actually initiate it in a pretty big way. A lot of interest. I was in Washington last week, national dairy producer, milk producers, others, they have a lot of interest here.

Let's just pause for a moment. Questions from the audience. We covered a lot of material. Any? Yes.

So [indiscernible], there's one side you can say, hey, if you have pet insurance, that's kind of guarantee in terms of your [indiscernible] insurance. That's great for [indiscernible] profile. There's also the other side [indiscernible] underwriting for pet insurance [ if possible ]. And so that ends up being -- that [ supposed to be a ] subsidy and those subsidies get [indiscernible].

Right, right. So questions around pet insurance and the dynamics of pet insurance, very good question. Look, at this point in time, pet insurance has evolved. It's a lot further along than maybe it was 10 years ago, but maybe not as far along as people have expected. For us with products, it's probably less pertinent as it is for maybe big surgeries or the bigger costs. So when you start saying the $1,000, $2,000 cost if a dog or a dog breed that has cancer, maybe that's a bet you want to make. When you look at somebody that's buying a product that we serve on a monthly basis, it really is on to a chronic problem. It is probably less so. It doesn't -- economically, it doesn't make sense, and we haven't seen -- dependency on insurance for Elanco is less. It's not in our models at this point in time. We're a value-based market that we need to price accordingly and create value with our differentiation in our products, there won't be a dependency on insurance.

Okay. Other questions from the audience?

In that case, maybe we can move to financials. You have a great setup on the top line. Could you maybe talk about how these new launches in this launch window effect your bottom line, operating leverage? And just more mid- to long-term, how you're thinking about operating margins?

Yes. We have -- I think as you look at what we've been doing with this growth innovation cash is also a concentrated focus as a company. We are looking at bigger assets that are coming in bigger markets with higher margins with greater growth profiles for us. That was even into the decision for the Aqua business or some of our restructuring we announced last week to really think about pigs were moving to B2B, certain countries we're moving out of to really concentrate our focus. That's going to drive more margin for the next few years than anything we can do across the base. I mean, we're constantly looking at our cost base, but each one of these products have stronger profiles. I will point to Zenrelia and Credelio Quattro, they are already in Elanco existing plants already approved by the FDA, and our manufacturing process and the active ingredients will be accretive to our current gross margins. So -- and then when you think about these launches, we've already put the fixed base in, in terms of we've got the sales force we need. That's in the guide that we had. And really, we've done a lot of the stuff, the basic digital setup, the pricing, and really the manpower. So really what happens is we're going to get out there and create a lot of share of voice to create clinic penetration, then we'll turn on to DTC. That will be the additive cost that will come. So as highlighted in our guide last week, the sales -- this will be additive on sales, and it will be additive on EBITDA. The real ramp will start to happen in the second half and then really into 2025 as well. So that's the case. Bovaer, a little differently. Bovaer will be a little bit more stand-up costs with the carbon chain. Bovaer is also with a contract manufacturing, so not as accretive on Bovaer, probably bigger, longer runway with that livestock sustainability, but initially, Bovaer sales will not be as accretive to the company as our current gross margins.

And then on the balance sheet, you've set the high 3x to low 4x net leverage target by 2025. Can you talk about kind of the path to get there?

Yes. As I just mentioned, I think that first of all, it's all around we've taken a lot of measures relative to net working capital. A big one that there's some short-term pain is slowing down our plants to decrease internal inventories with a lot of the shifts in the business. We started to see the benefit of that in Q4. That will be one of the key factors. The second is just the whole ERP setup. We will -- the synergies from that will create when you compare a 2024 to 2023, we'll pick up another $100 million or so of just savings from the lack of standup and the synergies and the efficiencies of the ERP system. So you combine those with the EBITDA and the sales that we have, that's where we're looking at taking cash flow is about $300 million this year. That's organically on the business. That's a 4x step-up. That will be going right to debt pay down and then with the Aqua deal that we're expected to close with Merck midyear, that will be a little over $1 billion. You put those two together, mid-4s, mid-5 ratio, 5.5, 5.6 will go to 4.5. And then as you go into 2025 with the continued margin, expansion expectations and cash increasing will be in the low 4s, high 3s at the end of 2025. And we'll have a lot more of a concentrated focus on bigger assets and bigger markets with faster earnings profile and aligned with our pipeline that's coming.

We're almost out of time, but maybe you could just touch again on the pipeline, kind of what area do you see as the most exciting, differentiated aspect of Elanco's pipeline?

Well, look, I think I'll start with livestock sustainability. I mean, I leave here tonight, I go to London. There's going to be a lot of [indiscernible] into an innovation summit. There's a lot of innovators that are innovating in this space of enteric methane and the opportunity here. But as you come back over on the pet side, derm is exciting because it's a big market that wants alternatives and it's going to be exciting for us to bring differentiated assets. We have an IL-31 short-acting product, a monoclonal antibody coming in. I think pain is a market where we have a large portfolio. We've got a pipeline following it. There's innovation going on right now in pain. Pain's the third fastest. So, para, derm and pain. And we -- you've got to win in those, and we've got differentiated assets in a pipeline coming in all these markets and they're large markets. And then look, we're leaning in on diabetes. We think diabetes is also an opportunity on the pet side and some new spaces as well that we're working on.

Great. We are actually out of time. Is there one question from the audience that you'd like to ask before we conclude? Thank you so much. Jeff, this has been a wonderful overview. Thank you.

Thank you.