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

Fantastic. So everyone's still coming back from lunch. Apparently, the fried chicken was a huge hit is what I kept hearing around the hallway. So really looking forward to discussing food side of animal health -- chicken is in demand. We're running slightly behind, but let's go and get started. We can go slightly over actually, I think. So Mike, I'll let you -- Jeff, sorry, I'll let you kick things off and we'll jump right in.

Yes. Look, we look forward to a big day. It's been 5 years as you and I've talked Umer since our last Investor Day. We'll be in New York Tuesday. So excited about talking about the rest of the decade for Elanco. My message has been pretty consistent the last 2.5 years, growth, innovation, cash. We're in a very durable space in animal health. We have with the last quarter, delivered 9 quarters of growth. That growth continues to increase in quality and size, innovation. I think the big story for us is we've got a basket of innovation, 6 products that have been approved. We were expecting another one with our IL-31. So big products differentiated in big markets. And then lastly, with cash as we've taken 2 turns of debt out in 2 years, done a lot of that with EBITDA and a couple of exits with aqua and monetizing of a human asset. So we're in a really good place, and we're looking forward to guiding the rest of the decade a little bit or setting up the rest of the decade as well as getting a little color to '26 as well.

So Jeff, first of all, kudos to the team on a turnaround, which, in our opinion, is still only beginning. Some people think the turnaround is done. So this is it. I think this is just getting started. We want to go through all the aspects of revenue, drop-down EBITDA, all that. But just before that, there's a very basic point which prevents a lot of investors from even being involved. And it's a question we get asked, which is, hey, I didn't realize this is not even investment grade, so we can't own. So could you just start to give us some visibility? Because for those investors, what I find is if they know there's a path to being IG, then they can make the case internally.

Yes. And if you look at the profile of our investors over the last 1.5 years, Umer, as you know, there's been a lot of movement into the stock for some of those. So yes, we are right now at 3.7x. We've been very clear to say that our trajectory is to get to low 3s, high 2s as soon as possible, and it will be our #1 use of cash, and we're going to see some nice EBITDA growth as well, which is going to drive that. And we're going to do it with a combination of better margins with bigger blockbuster products. That's what's going to drive EBITDA. We've also launched a productivity initiative with Elanco Ascend, which is going to -- and you'll hear a lot more about that next week, brought in a new CFO from a low-margin industry background with a real focus on margins and cash. So -- we do have an expectation and our Board is very committed to get into the 2s, which we believe will please those investors that are looking for that.

Got it. Excellent.

Yes. No, it's been a phenomenal year so far, Jeff. So just to maybe start to focus on just the innovation basket of drugs. JPMorgan this year, you guided to initially $600 million to $700 million. Since then, you raised guidance 4x. Now the midpoint is around $860 million. So $110 million delta from your original guidance. So as we think about the future trajectory of revenues from this innovation basket, could we expect the same level of initial conservatism in 2026?

Well, I think what's different about Elanco is you're in major markets, you know this. So we believe we've got best medicine in that oral broad-spectrum parasiticide market that's about $1.4 billion in size, growing at 40%. We've talked about puppy starts, we talked about the share that we've taken. So what I would tell you is best medicine in a major fastest-growing animal health market, and we're going to globalize that's one. Derm is the second largest market, $2 billion, growing double digits. We're globalizing Zenrelia. We believe we've got an efficacy differentiation. So that's good. Nobody talks about the Farm Animal side enough, I believe, but the cattle side with Experior, we've already surpassed $100 million. We've been growing at 70% on a quarter-to-quarter basis, like-to-like, year-to-year. So what I like is we've got a basket of innovation in major markets that, yes, we see a nice trajectory and runway of continued innovation growth. We will add to that basket. We've said that we're still optimistic to bring our IL-31. So it would be a competitor to the IL-31 in the derm space. We did have a government shutdown that may have stopped some dialogue, but that dialogue is back and going, and we'll put more color on that next week. So that will add #7 to the basket. So yes, I continue to see that. And next week, we'll put more color to how high we see that innovation going.

And needless to say, as Ellen's bundling capabilities and new product introductions continue to improve, I'm sure this acceleration in innovation basket will continue. My point is it's not short-lived. It will continue well past next year, I imagine.

That's correct. And then Ellen will share in R&D next week. Our big challenge has been a consistent flow of high-impact innovation. We've delivered 6 major innovation, the seventh is coming, and you're going to see that we've replenished that pipeline and we're expecting that innovation pipeline to continue. There's a lot of great spaces in animal health that we see both on the Pet side, the Farm Animal side, the Protein, the movement back to animal protein, the humanization of pets, I was chewy this morning. If we just look at some of the things that are happening across all the channels in pet and the globalization of both of these trends. This is a very durable space. And we believe we're the most compelling investment proposition inside of it right now.

Got it. Excellent. I guess I want to start to go through the top line in a fair amount of detail, Jeff. But just a head of that, one of the questions that people want to make sure is as the next $500 million in revenues comes in from pipeline, can we reasonably expect a meaningful drop down to EBITDA level? Because I realize for the prior stuff, there was a lot of investment still happening. So people want to make sure the top line doesn't get lost in the totality of the franchise.

Top question we're getting at this conference and probably since the Q3 earnings is just that, Umer, which is -- and it's a good question. It's the right question. We've said we know we have to bring EBITDA growth next year and more leverage in that top line down, and that's got to start. So look for us to share an algorithm next week, look for us to talk about how we're going to do that. We are not going to do it singly. At the same time, these innovations are big. The competition is big, and we're taking share. So we are going to have no regrets approach to launch. So that's the tension. But we are going to bring EBITDA growth, and we'll put more color to that in 2026 next week. The second is we will not do it just with new products. We've launched a 5-year productivity initiative called Elanco Ascend. Think about procurement, manufacturing, gross to net across the board, productivity initiatives, and that's what our new CFO, Bob, brings in experience in and a real double down on. So we will put some numbers to that next week. So it won't be one dimensional, and you can look for us to give both. And we will be bringing leverage down to the bottom of the income statement starting next year.

But Jeff, just so -- and I'm sure you're aware of this. Consensus has $200 million year-over-year in top line growth and $100 million year-over-year EBITDA growth more or less. So like there's a pretty high operating margin on the incremental revenues being modeled by consensus. Now you can't say it's just on those revenues and will be on -- but like you're aware of some of those where the consensus is at as well.

We'll put a lot more context to that. And I think the majority of the analysts are understanding that we've had a year of -- these are bigger products than we realized and the markets continue to grow. I mean you got a market growing 40% parasiticides, double digit in derm and the cattle shortage in beef has created a very nice upside for our cattle portfolio. So we have made a choice to really go after share...

Shortage has created upside. Sorry, you say that again? What shortages?

No, we've put a lot of money behind the launches, and that's why we've highlighted that. So -- but more leverage will come next year. So I think you'll be happy with some of the things we'll share as we get into it next week.

And real quick, just obviously, the mix of products will help grow EBITDA. You said the productivity issues will also kind of help grow EBITDA. That's more of a COGS thing, gross margin thing. But on the OpEx side of things, can we expect any squeeze there or...

Absolutely. No, I would say I wouldn't assume it's all COGS, okay? I think we know EBITDA growth is the driver and especially think about our Farm Animal business, it's about 50%. That doesn't have as strong of gross margin. It's good. It's respectable, but we have 10% OpEx on a Farm Animal business. So our EBITDA quality in Farm Animal is just as good as the EBITDA quality in pet. So look for Elanco Ascend to talk about productivity initiatives that hit all fronts, not just manufacturing.

Got it. Got it. I'm sorry.

Okay. Excellent. So let's start to get a little more -- I feel like we only have little time. So we need to spend more time on some of the things. But Jeff, one of the observations we had was some very large vet practices report not using any of the Elanco stuff, mostly because they have a full portfolio of stuff they're buying from Zoetis right now. I look at that as a very large untapped opportunity right now as you start to gain scale. Do you think sitting here today, you finally do have the range of products needed to start to break into some of those accounts where you have the -- all the Trio offerings, the JAK and the list goes on.

Absolutely. So I'll just highlight a few things. I think let's just take Quattro that we've said, fastest blockbuster we've had in history, one of the fastest in pet health. It's acting more like best medicine than third to market. It has 4 points of differentiation and from the quickest tick kill to the broadest coverage to first and only product from the FDA in this space with 4 active ingredients in the pill. The palatability has been something that's been talked about. And I highlighted in the quarter, puppy starts as a notion is higher for Quattro than the other 2. So we are replacing and 75% is coming from those other products. So we're taking share now, Umer, and I think that trajectory is starting. On the derm side, in the first 3 markets we launched in, we're already at double-digit market share. So that is acting a lot more like the efficacy differentiation on Zenrelia is significant. So as these globalize and these markets continue to grow, we are picking up new. But Quattro is only in 1/3 of the clinics. So there is a lot more runway, and we will put a lot more detail into that next week. You're going to hear from all 3 of our commercial leaders next week.

Has Zoetis started responding in any way from pricing from what you hear?

There's no question, especially in U.S. pet health, it's competitive. But I would say, if you think about this is a value-based market. It is a market where veterinarians attribute a lot of value to animal health products. So keeping value in that market is really important. And so I think competition really comes back to differentiation in the products.

Right. Excellent. On JAK inhibitor, Jeff, I feel like some investors think it's over. It's like fully done, but my sense is it's still a work in progress. You've gotten an improvement to the label, but the real sort of upside will come when any dosing holiday gets dropped completely from label. So that's still another year plus away, correct?

Yes. Look at the whole market, $2 billion globally, and we doubled between Q1 and Q2. We nearly doubled again to Q3. We are picking up significant number of clinics. And outside of the U.S., it is taking share more like not a second to market, but it's got a differentiation. It's approved in 36 countries with a nonrestrictive label. In the U.S., the FDA has improved the label with the PCR data. And what I would say in the U.S. is we've got about 12,000 clinics and a lot of those 12,000 clinics are using this and moving to first-line treatment. So I think that concern is really targeted to a limited number of clinics in the U.S. So yes, Zenrelia has had quite a run in the last 2 quarters, and we see nice growth. It's off to a very good start. We're just launching in Europe, and it's off to a very good start in Europe.

Jeff, in the U.S., can you update us on the breakdown between first-line versus switch patients for Zenrelia?

Yes, we haven't gone into that detail, but I would say of the 12,000 clinics, if you think about 30,000 clinics in the U.S., more than 1/3 are on Zenrelia and seeing this as a key product for them. And then yes, there's probably 1/3 of the clinics that are saying, hey, with that box warning, we're not going to utilize. But hey, when you take Credelio and other blockbusters we've had, 10,000, 11,000 clinics is a high number of clinics.

Jeff, one dynamic I want to sort of almost bring up, but also ask you about for next year is I felt like this year, some of the early numbers on innovation came in pretty good in 1Q and 2Q. And they were already annualizing at north of your full year's guidance. I remember it was like around $200 million in 2Q and then the full year guidance was still $720 million to $800 million. So it was looking like there's a real chance this guidance is conservative. That dynamic doesn't exist for next year because I think, a, people know what the run rate is coming off of this year. So how are you going to best prepare the Street where you still continue to show the growth but not set up something where you're not able to raise later. So it's a very fine balance now.

It is. We're going to talk very clearly. We're going to talk the basket of innovation. We have something that other animal health companies don't have, and that is a mix between Farm and Pet, 6, soon to be 7 innovations and they're going to be globalizing. So we're going to talk about the basket because we have many paths to get to those numbers with the basket. And we will -- again, we will talk -- I don't want to keep emphasizing, we will talk a lot more about where we see that trajectory going in 2026. But we won't -- we will not get down to specifics by product, by country, by quarter. There's -- I don't think there's any benefit in that.

Makes sense. Excellent. Maybe in the last minute or a few seconds or so, Merck has a product launch next year as well in the flea and tick space. I think there's some amount of confusion on what exactly that is, how that will be from a competitive landscape perspective? And does that affect your launch performance, if you could just remind us?

Yes. Remember, Elanco, with our OTC business and our overall vet business, we've got the broadest parasiticide portfolio to meet more pet owners where they want to shop at the price point they want to shop at online, inside the vet clinic across the board. So we're very well versed there. And you've seen a very strong OTC business from Elanco because of that. There's still 1/3 of pet owners that don't go to the vet clinic. But to answer your question is look at the fastest-growing market, and this is not where that competitive entry would be, and that is the broad spectrum oral product market is $1.4 billion growing at 40%. And the majority, over 70% of puppies are going on this category. We believe we've got best medicine there. And our goal here is to just really focus on that segment, globalize that segment and a lot of runway to grow there. So step back, growth, innovation, cash, great trajectory. We've had now 2.5 years of delivery and increasing improvement and look for that to continue. And we're going to keep those 3 pillars and talk more about that next week. No questions -- i think 3 hours next week, you'll have chance to see the entire leadership team and a lot more color to this.

Excellent.

Excellent.

Thank you so much, Jeff, very helpful.

Fantastic, thank you. Jeff. Thank you.