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

Good afternoon, everyone. Thank you for joining us for the next session with Elanco. My name is Balaji Prasad, I'm the senior analyst for the Spec Pharma Space for Barclays. And joining us from Elanco side, we have Todd Young, the Chief Financial Officer Elanco. Todd, thank you for joining us today. And I hope you had a productive conference until now.

We have. I appreciate it, Balaji, and appreciate the comforts Barclays provided. So thank you for inviting us.

Yes. I know it's an exciting phase for Elanco with multiple upcoming launches of some pretty strong products out there. But I would leave it up to -- maybe provide a brief overview of the recent earnings and what you've seen and the outlook, as I said, and we can dive deep into those.

Sure. [indiscernible] the opportunity to talk about Elanco and where we are. As we move forward here into 2024, we finished 2023 with earnings about 2 weeks ago now, and provided guidance for 2024 that has us growing 1% to 3% in constant currency and delivering EBITDA between $960 million and $1.01 billion. So overall, that does not include our 3 big products that are currently being reviewed by the FDA. Bovaer, which is a methane reduction product in dairy cows. Credelio Quattro, which is our broad spectrum parasiticide for the U.S. market. And Zenrelia, which is a JAK inhibitor for atopic dermatitis. Those will be accretive to sales and to EBITDA [indiscernible], so we've kept them out of the guidance to provide the baseline. The other element is we announced earlier this year that we're selling our Aqua business [indiscernible] Merck Animal Health for approximately $1.3 billion. We expect that to close midyear. Our Aqua business is still in our numbers and our guidance up until close, and we'll update at that point. But that transaction is going to allow us to focus our R&D efforts in pet health, parasiticides, pain and dermatology and farm animal side will be on animal sustainability and livestock production. It will provide significant cash for debt pay down and allow us to get by the end of '25 into the high 3s, low 4s on our net leverage versus the approximately 5.5x levered we were at the end of '23. So very excited currently. Inside the company, people are excited for what we're bringing from an innovation perspective. Our International team, our U.S. Farm Animal team had nice -- good growth last year and accelerated and our Pet Health franchise has accelerated their growth in '23 versus in '22. So overall, a lot of exciting things going on in Elanco and a culture that's handled a lot of change over the last few years. And again, we just announced the restructuring 2 weeks ago as well, not items we ever like to do, but again, allows us to allocate capital to where we think we'll get the biggest returns. I would say the team inside Elanco understands that and appreciates the investments we're making to drive growth.

Thank you for that overview, Todd. And maybe getting a couple of things, both the guidance, I think on the sale of Aqua business, the message was well received by investors. We saw the market reaction to it. Let me get the Aqua business out of the way, I think. So considering that the Aqua protein segment is one of the fastest growth segments and maybe one of the proteins of the future. As we think about it, what was the rationale in divesting this business? And is there a way retaining it?

Yes. At the end of the day, we got over 7x multiple on sales for the business. And to do that, you have to have a good business, and we agree the Aqua business is a good business. At the end of the day, I think we question it being the protein of the future from just the standpoint of overall market size today and general people's desire to eat the proteins we've been eating for a long time. And so it really became an issue of notional size and opportunity. The salmon market, the shrimp market is about $400 million to $450 million globally today. We had a little less than $200 million in revenue in that space last year. The pet health market -- tens of billions -- farm animal, $14 billion. Outside of Aqua, we just think there's better opportunities for our relative investment dollars, relative to that notional size impact. So again, good business, we agree, but we just thought our capital returns could be bigger in other areas of the portfolio.

Got it. Getting back to the guidance, again, the 1% to 3% constant currency growth, again, well received, $1 billion of EBITDA on the higher end of the side, again, that was well received too. As I think about this, can you maybe elaborate the pushes and pulls towards this guidance? And what could phase upside or downside risks to this?

Sure. Overall, when we think about -- we've been, I guess, good over the last couple of years of really controlling the expense base. That is an element we continue to focus on now. The inflationary environment is one that we face as well with cost of labor and talent as well as continued inputs. But overall, we feel good about that. We did have restructuring savings, I would say, from a kind of P&L by quarter element. We think our best opportunities for growth is in our over-the-counter parasiticides, where we've got leading franchises like Seresto, the Advantage family and now AdTab, which is our oral parasiticide that's been approved for OTC purchases in the European Union. Those are Northern Hemisphere flee and tic seasons. So we're making investments today in those markets. The savings from the restructuring will be more back-half loaded because a lot of those are sales reps in certain Western European markets where it just takes longer to capture the severance benefit. So there's a little bit of a disconnect between the investments we'll make in pet health and the $30 million to $35 million we'll get in savings from the restructuring this year. Net-net, it will play out over the course of the year. The other element that we've highlighted is we are slowing down our manufacturing facilities because we've got excess inventory on our balance sheet. That will have a headwind of about 150 to 170 basis points on a full year basis, most of which will be hitting in the first half of the year. It gets to be pretty close to flat in Q3 and a tailwind in Q4, given we started this process in Q3 of last year. So again, that doesn't change the fact that the highest-margin products are the OTC retail stuff that will be in the first half, but the headwind will also be there. So again, just items we've called out, as we look at growth, the pet health business is the higher margin business. And so as we think about things that drive us to the high end of the range or the lower end of the range, a lot of it does get into that pet health growth and where it falls out. It is a competitive space. While we're excited by AdTab, BI has an oral parasiticide in that same market, they're excited by it. So we'll continue to focus our efforts on driving continued penetration. Bobby Modi, who runs our U.S. Pet Health business; Ramiro Cabral, who runs all of International, continue to execute and we're seeing the value of continuity of commercial leadership with Bobby now in his role for 2 years, Ramiro back running all of International for a couple of years and Jose Simas in our U.S. farm business. Adding to that is we're seeing the benefits of our innovation. The canine parvovirus monoclonal antibody we launched last year. It's a great product. It is going to be highly [indiscernible] in the clinics. We're getting good reorder rates from vets that have purchased [indiscernible] used it and that opening up doors to vet clinic as they are interested in this life-saving treatment for puppies, for our broader portfolio. We see that same portfolio effect on the farm animal side as well. Experior, it's our -- on the label, it's for ammonia reduction from feedlot cattle [indiscernible] adds significant weight [indiscernible] to the animal -- as there's a low end on the herd size across the U.S., having more meat on every animal becomes economically beneficial element and we've seen Experior ramp as its part of that feeding regime. As that happens, the complete portfolio makes it more efficient for many of those feedlot operators to buy Rumensin that's been under a generic challenge for the last year. And so in Q4, you saw a really nice growth from our U.S. farm business, both as vaccine supply came back, but as Experior ramped and brought Rumensin with it. That portfolio effect is what we're also excited about when we think about Bovaer, Zenrelia and Credelio Quattro as well.

Great. Interesting point about Rumensin, sorry, are you saying that you're seeing a rebound in growth for Rumensin and especially now with Bovaer expected in a couple of months from now, that there's a synergistic portfolio effect?

There absolutely is. We saw with Experior in the feedlot as customers come back because the total pricing they get from the portfolio can make it more cost effective than using the generic. Similarly, a lot of generic Rumensin momentum has been in the dairy side. And with Bovaer coming on board, we expect a similar effect as the farmer will be better positioned to buy both products from us versus just one.

Got it. So shifting maybe gears towards the innovation side of things. Again, exciting period for you. So let's start with the combination parasiticide side. As we think about Credelio Quattro coming through in a few months from now, your confidence on approval being on time? And how do you expect the positioning in the market relative, of course, a market leader, Trio, Simparica Trio, or Nexgard Plus and any expectations around the label that you think will help this differentiation?

Yes. The differentiation, and we've called it out with respect to Credelio Quattro, we expect to have month 1 heartworm coverage, which will be in line with Simparica Trio, but superior to -- differentiated from BI. I'm probably not supposed to say superior. And then with respect to all the products, we will have tapeworm coverage, which the other products don't have. So we do expect to have the broadest coverage in the marketplace, which we view as a positive item because it seems like pet owners should want to prevent as much parasiticides from the dogs if they can and Credelio Quattro will do that. So we are excited to bring it, as I think everyone knows, we've had competitive share loss inside the vet market the last few years by not having the broad spectrum in the U.S. So this will help again -- stop that bleeding as we then grow and take advantage of a complete portfolio to really compete better there than we have the last few years.

And expectations around the approvals, still very much on...

Yes. All 3 products, we continue to have a path to first half approval. We've said contribution of revenue growth would be second half. So no change on that communication.

Got it. Okay. To the extent that you can, can you maybe discuss the commercial plans around Quattro pricing, commercial launch strategies?

Again, I think we're looking at it in terms of a complete portfolio. We know today the #1 reason you take your dog in the U.S. is dermatology reasons. And with that, [indiscernible] get volume discounts. The more product they buy from us, the better pricing we're willing to provide them. Our competitors do the same thing. And so today, the biggest check they're going to write is to Zoetis for the derm products. We're excited that with Zenrelia and Credelio Quattro, we're going to have parasiticides, we're going to have dermatology, we're going to have vaccines and we're going to have the clinical therapeutics like Galliprant, canine parvovirus, ZORBIUM, Bexacat. That will put us on an even playing field with Zoetis and ahead of the BI and Merck. We don't talk a lot about BI and Merck given they're both inside bigger pharma companies, but they're tough competitors as well. And so we look forward to having a portfolio advantage relative to them as we go into the vet clinic. And so our pricing will be in totality. It won't be specific to an individual product. But as a general matter, we don't view price as a lever to gain share. We view our differentiation, our sales force, our ability to execute [indiscernible] what will drive our growth going forward.

Fantastic. Maybe just in parasiticides side itself. Seresto, I think it operated under a cloud for the last couple of years. That's been resolved fully. So congratulations. How is the renewed interest being on this product?

Yes. We're excited as we go into the parasiticide season, as cruel a statement as that is. But when it's your business, fleas and tics are good. To have Seresto without that overhang and be a little more aggressive on our marketing campaigns. We went with a little more edgy campaign at the end of last summer. But as we go into the season, we're excited for that -- our retail partners are really good partners. When you go into Walmart, you'll see some really great [indiscernible] Seresto that we view as a real positive given the number of consumers that Walmart touches every day. So Seresto is a spot we're excited about going into 2024. Certainly, in International, we'll have a bounce back in the Spain market that was a headwind last year that we feel good about as we go into 2024. So -- and the other part on Seresto, we had MAP pricing suspended last year as we did our ERP cutover. There was a lot of pricing where Seresto was in the market at $54, $55. As we looked at our overall pricing strategy for Seresto for 2024, we concluded that having a standard lower price was a better strategy than how we had typically done with lots of different promotional. And so you see kind of MSRP for Seresto is now $59.98. So you've got this [indiscernible] but it is higher then a lot of the pricing was in Q1 of last year. But overall, we think that will be a better overarching pricing strategy for us as we move forward.

Okay. Moving from parasiticides to derm, again, exciting time for you with approval on one of your first biologic for atopic derm. I think what we have seen in terms of competitive maneuver, at least from Zoetis side, is to have a chewable Apoquel. So help me understand how relevant is this chewable formulation from a competitive perspective? And how much of a barrier does it set up? And is that something that Elanco would want to develop or have in the future?

We all know that in animal health, unlike human health, delivery into the animal is an important element. The easiest way to get medicine into a cow is through feed, and we lead in feed, and that's a very big part. So we're certainly aware of tolerability in cows and cats, and how you get the medicine in them is a critical component. We feel good about the product we're going to bring -- and so I'll just leave it at that from a competitive standpoint.

Okay. Maybe a quick question on the pain side. Again, you have a marketed product, Galliprant and we've had -- we've seen launch of Librela in the U.S. last year, Europe, the year before. So how is this all competitive dynamics with Galliprant panned out since the entry of Librela and how should we think about Librela's growth in 2024?

Well, for Librela's growth in '24, I'll let you ask a... From the standpoint of our -- we've obviously factored it into our guidance. we're well aware that we've been competing in Europe with Galliprant. Galliprant is a great product. In the U.S., it has a bigger installed base and a better label than it does in Europe. Fundamentally, Galliprant treats inflammation, which is the big underlying cause of the osteoarthritis. And we think that's what you should treat with dogs that are suffering from that versus just masking the pain and hoping that they don't hurt themselves if something happens otherwise. So for us, we're very focused on continuing with our totality of our pain portfolio, [indiscernible] the Galliprant is the one we talk a lot about, but we've also got ZORBIUM for postoperative pain. We've got NOCITA inside the operating room. So we've got a lot of pain portfolio in addition to Galliprant, and we've got in our next wave of innovation that [indiscernible] is leading, we have more opportunities in pain. We do think, as dogs continue to live longer, age, have better care and treatment, that there'll be more opportunities in the pain space. And it will be a market area that we can all be successful in from a manufacturer perspective.

Great. Is there some incremental color that you can provide on what you're working on?

No.

I tried. Going on to the livestock side of things, considering that you're almost through to the end of the first quarter, would love to get some update for you in how 1Q has panned and are you on track with the guidance provided. And then how is...

Yes, I am not going to comment on the guidance we gave 2 weeks ago. Again, I guess, the benefit of providing guidance so deep into February is we have a pretty [indiscernible].

Fair enough. Shifting to livestock again, as we discussed Bovaer, exciting launch coming around, so help us understand the broader TAM for this opportunity. [indiscernible] as you've reiterated multiple times on this portfolio approach to both companion animal and livestock with Experior, Bovaer and Rumensin, help us understand [indiscernible] option?

We've said that Bovaer, we believe, can be a $200 million product on the top line in the U.S. We're getting it a couple of years earlier than we expected when we in-licensed it from DSM. And as a reminder, we only have U.S. rights, the broader livestock sustainability opportunity is very big. In the U.S., there's about 9 million dairy cows. And so that's sort of the addressable market of cows that could be taking Bovaer and get a 30% reduction on the methane being produced. And it's really effective from a greenhouse gas because methane -- the 10-year short-lived gas versus carbons much longer and the fact that it's never produced versus trying to sequester it [indiscernible] the carbon capture, and that's [indiscernible]. Now the complexity of Bovaer, I'd refer everyone to our Q3 earnings materials from November. You can see the money flow in the chart we provided. What we have done with other partners in order to be effective, we think the farmer needs to make money. And reducing methane doesn't give them an economic benefit. It doesn't make the milk taste better. It doesn't make more fat in the milk. So there's no incremental value to the dairy farmer. What we're doing is setting up a value stream where they can get paid from reducing their impact on the environment by less methane. That means we need the CPG companies and think right now, a big focus is on the European ones. The Nestles, Danones, Mars, Unilevers, who have made lots of commitments on reducing their impact. To reduce their Scope 3 impact, they have to impact at the farm level because that's where the methane is being produced as part of the milk that drives milk, chocolate bars, yogurt, ice cream. Methane reduction by Bovaer is really effective. And so what we've done is we seeded a company [indiscernible] Athian. It certifies and makes sure that all of the protocols are followed. There's a calculator we've created called UpLook that tracks the data and the usage of Bovaer on the farm and that then is what creates the carbon credit. The credit gets sold to Nestle. And then Nestle -- that cash gets into the farmers' hands, they can buy Bovaer from us. So there's a lot of pieces to this value chain, but we've shown it through protocols using Rumensin that also will reduce carbon. We've shown that it works. But once approval, I think there'll be more things from just a ramp perspective as this -- it's -- because of the complexity of the supply chain. But it's going to be really impactful because of creating a new value stream for dairy farmers is huge, that's a pretty capital-intensive low-margin business. So for them to make more money without a lot of incremental work has real value to them on the profitability of the farm.

And maybe a quick update on where the carbon credit market is today in terms of its maturity and how do you see this evolving over the next couple of years?

Yes. I would say it's very immature. It really looking at -- we're trying to do in set markets, so the whole value chain from farm to end consumer in the agricultural products, [indiscernible] can be one to offset and claim by the different participants. Is it possible that carbon credit could be sold to an airline as an offset? Yes. I mean [indiscernible] there's greater value, Nestle. We had our Board meeting 2 weeks ago at this point, I think. And we had a dairy farmer in California. We have the California Dairy Association, that's the milk [indiscernible] that organizes a lot of dairies. We had the Athian CEO and we had the Nestle sustainability [indiscernible], and he was saying that the only way for them to get to their commitment is really impacting on the farm and Bovaer is by far the best product. We're doing that. It's been approved in 40-odd countries around the world, that is buying it from producers in Brazil and a few others [indiscernible] already. So we're excited for the FDA to let it be used here in the U.S.

Got it. Maybe one quick question on the swine side of things. I mean it used to be a reasonable sized market for product for your area [indiscernible] before 2019 and [indiscernible]. So thoughts around recovery in this market and maybe also by extension, thoughts around recovery in the broader Chinese market, which has been a tough spot for...

Yes. I mean we grew somewhat in China last year, but it was much smaller than what our expectations would have been back in 2021, going into 2022. The economics of the swine market continues to be challenging for the producers there. I think from a market standpoint, there's a desire to have pork prices lower for consumers in China, and that's what's happening. So for us, we actually had poultry become our biggest species in China last year, which again, we would not have guessed a few years ago that poultry would have grown at that level of pace. But our installed base and our portfolio is very effective. The chicken flock is healthy and growing. And so overall, we do think swine, of the 3 big animal protein markets, is the most challenged. A lot of Western European swine is getting to Eastern Europe. That's part of the reason that we did the restructuring as we needed to change where our head count was because the market dynamics have changed and that led to us needing to restructure reps in certain locations to have more in others, as the market moves. But in the U.S., swine has been going well. We have a Prevacent vaccine for PRRS that's been a market [indiscernible] in the last couple of years.

Okay. Great. With that, we're out of time. And Todd, thank you so much for your time and sharing your thoughts. For -- as a reminder for investors, we also have Todd at the dinner meeting at 6:00. For those who have signed up, looking forward to that meeting too. Todd, I hope you had [indiscernible] conference, and thanks for joining us again.

Thank you.