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

All right. Good morning, everybody. I'm Dave Westenberg. I cover Animal Health here at Piper. Next up is our fireside chat with Elanco. With us today is Elanco's CFO; Bob VanHimbergen and Bobby Modi, Animal Health, EVP. Thank you for here, and we'll -- thank you for being here, and we'll jump right into Q&A.

Bob, I'll start with you. You have products that can really drive gross margins. What are your thoughts about margin expansion? How can you -- how much can you attribute to gross margins in the coming years, especially since you have all this innovation that's recently came out?

David, thanks for the question. Yes. So as I think about just gross margin over the next several years, we're going to have just a natural enabler with our basket of innovation continuing to grow and accelerate. Just the margins on our innovation basket does come at a higher rate than our corporate average. So we'll see that natural mix benefit. But you may have heard us talk in the last couple of months about Elanco Ascend, and that's where the company is taking a very proactive approach to some cost-related items and some productivity measures and really investing in things like automation and AI that will help us be more proactive towards improving margins, both gross margins when you think about the costs within the 4 walls of our manufacturing facilities with the procurement side of partnering differently with suppliers and then with -- on the G&A line item, which is more EBITDA margins, obviously, where we can make some choices around what we're doing and invest in R&D and marketing to grow that top line. So we're going to have a natural mix and then we're going to be proactive on some cost things.

Can you dive in a little bit further on Elanco Ascend, what we can expect from it?

Yes. So we're going to share a lot of color next week in our Investor Day. But think of Elanco Ascend as a -- we're in the early stages of a company-wide initiative. So this is covering really all 4 quadrants of our business and every corporate function, really, really supporting the program. But this is going to allow us to grow EBITDA in 2026 with, again, some of the cost measures and some automation opportunities. So we're going to be able to grow EBITDA with leveraging some of these opportunities, but then investing in R&D and really marketing to support Bobby's world. But early stages, again, more color next week. But again, this is going to cover the entire business.

Got you. And Bobby, I want to switch to you. The U.S. Pet Health business has been transforming into a growth business. How has that happened?

Yes. Thanks, Dave, and good morning, everyone. I would say what transformed the U.S. Pet Health business has been a lot of things, but anchored in what's driving the change is innovation and really launching differentiated assets in growing spaces. And then secondarily, launching those assets really well. And there's really 2 areas where we focused on in terms of launching those assets well. One is share of voice, and we've drastically increased our share of voice. So how much we're talking to our end customers and how much we're talking to our end consumers with direct-to-consumer advertising with breakthrough creative. And then the second sort of strategy is physical availability. And our sort of purpose is to have our products everywhere if a consumer wants to buy our products. And we've been solely increasing the points of distribution either in clinics, whether that be independent or corporate or retail stores for our OTC portfolio.

Got it. Can you talk about some of the products? I'm going to start with Zenrelia. What's the market potential for Zenrelia in the U.S.? And can you talk -- contrast that a little bit with outside the U.S.?

Yes. Look, the derm market in the U.S. is $1.3 billion, growing double digits. The derm market globally is about $2 billion. I would say we've got about a year of experience under our belt, both OUS and certain markets, think Brazil, Japan and Canada. In those markets, we've already seen double-digit share gains. And then we've got a year of experience in the U.S. with what I would say is a more restrictive label that's getting a little bit better. But the momentum on Zenrelia has been really positive in the U.S. in the last couple of quarters. In Q3 to Q2, our total sales for Zenrelia doubled for the company. We're seeing clinic penetration at close to 45%. We're adding about 2,000 clinics every quarter. And we're seeing more first-line usage of the product as people get more comfortable with the safety and efficacy of the product and see its real-world benefits.

Got you. I want to switch back to Bob, can -- which specific innovation products beyond Quattro, Zenrelia, Experior are expected to be the highest contributors to innovation revenue growth in '26?

Yes. So David, so we really think about innovation as the entire basket of products. You did mention really kind of the big 3 that we've seen perform well in 2025. I'd also highlight Adtab in Europe performed well in the first half of the year, certainly the first half of the year product, and we expect growth in 2026. But maybe I'll just give you a little bit of color on the 3 that you highlighted. So Quattro, we -- this medicine is not acting like a first -- third to the market. I mean the acceleration in growth has been well beyond what we've expected, and that's why we've been heavily investing in marketing to continue to grow that top line. But more importantly, to think about what Quattro, what it does for us is with the rest of the portfolio we have with ecto, endo and endecto and just a wide variety of solutions for parasiticides, it's helping us really get in front of corporates at a different level, and that's an area where we've been under-indexed. I think about Experior on the Farm Animal side, this is -- we see continued runway for this blockbuster just in Canada and U.S. alone, it's a $350 million market. And so we expect growth there in 2026 and beyond. And then Bobby just talked about Zenrelia. I'd say the one big opportunity for us is the globalization of all of these products as we think about going into 2026. And then as we said in the past, we have IL-31, most likely going to be a first half launch next year. That will be a contributor, but not as big as the other 3 that we just highlighted.

Got it. Maybe we can dive in a little bit more on the farm side. It's been performing really well. The macro in Farm, despite the fact that, of course, the herd size has been smaller, it's been really, really good. What are some of the things that investors might be overlooking about on the Farm business because traditionally, investors do look at the Pet Health business a lot more.

Yes. So this is one of my most exciting things to talk about. So when I first joined the company, it was probably within a week. I went to Jeff and said, hey, Jeff, why aren't we spending any time really talking about the Farm business externally because it's half of our business. The EBITDA margins is what I think people are losing sight of. The EBITDA margins in the business are on par with the pet side. And what that means is if you think about the U.S., for instance, on the Farm business, OpEx is 10% of sales. And so the pull-through to the bottom line is equal -- is much stronger. So our EBITDA margins are equal with the pet side. But it just shows our strategy of innovation, having the right innovative products, have the right portfolio, providing the right solutions to the end customers works. And so what I'm trying to do is make sure people understand the stability of the Farm Animal business, the profitability of it. We're going to continue to grow there. We see this market growing in a $25 billion market already. I think about Experior, as I mentioned, it's a blockbuster. We expect that to continue to grow in U.S. and Canada and then certainly with the international opportunities as well. And then as I think about Bovaer, the growth has been a little bit muted from what we had anticipated originally just because of the lack of government incentives. But I'd say there's multiple levers we're working to really get the growth within the product. And we still believe this to be a blockbuster. I'd say adoption rates for Bovaer have been great. It's sticky. We have over 95% of customer retention on Bovaer. So we know the market is there. The end customer sees about $20 ahead of additional profitability from Bovaer. So there's just a lot of great exciting opportunities there that I think there's really just not a lot of visibility to, and we're going to try to bring that out a little bit more next week as well in Investor Day.

Got you. And hopefully, I'm not jumping in front of Investor Day when I ask -- so I the margins is, I think, kind of actually unique to you. When I look at competitor portfolios in that Farm Animal business, I don't see necessarily that same kind of good margin relative. And you have a portfolio that has MFAs and some of the others. So what's some of the efficiency that you have in the portfolio that you're able to actually drive that kind of EBITDA or operating margin in that portfolio?

Yes. I mean think about just how we go to the market, we have less of a sales force, right? So the middle of the P&L, we have a lot less cost associated with dispersing across -- really across the nation and even the globe. So I know the P&L is just more efficient naturally just with how we go to market. And again, the customer stickiness is very high, really across all the products.

Got you. Bobby, I want to move to you on the potential of Quattro. Why has the ramp been so good? What strategy do you have to drive broad spectrum parasiticide market in 2026? Obviously, this is still a pretty good growth market, and we're seeing very good transition from single product.

Yes. I'll start with where Bob sort of left off. It's certainly not behaving like a third to market sort of archetype. It's behaving much better and frankly, much faster, as you alluded to, Dave. And we think there's really a couple of reasons for that. And the main reason is the 4 degrees of differentiation, right? So think about broadest coverage, think about speed of pill on ticks, think about heartworm coverage in 1 month. And then what the market has told us is it's got great palatability. If anybody tried to pill their dog and they reject the medicine, you know how difficult that is. And that's a barrier for vets when they are ultimately trying to sort of transition people to new medicine. Why do we think there's still a lot of potential? Well, I think it's simple. The first thing is the endecto market is $1.6 billion, it's growing in double digits. We're going to get our share of that growth, and we're going to also contribute to that growth. And we expect that to continue because, frankly, it's more convenient for a pet owner to give 1 pill versus 2 pills. Second, we're still only in about 1/3 of clinics in the U.S. today. So every month, we are adding clinics, and we expect that to continue sort of going forward. And the third reason is our market share from an endecto's perspective in the clinics where we have Quattro is still fairly low. And that share will continue to grow really driven by 2 factors. One, as more puppies come onboard, which we over-index in our puppy share index, you'll see our share start to grow. And two, as we continue our dispensing programs like our direct-to-consumer advertising, you would expect share to continue to grow in those clinics. So I would end with all things being equal in the endecto space, why wouldn't a vet or consumer choose Quattro versus the alternatives?

That's really helpful. So Bobby, continuing with you, we talked about the retail business in the hall and how traditionally, I've not necessarily been a big fan of retail business. However, yours might be kind of unique particularly around this time of low veterinary visits. So how should we think about that retail business as kind of a differentiation in your portfolio versus kind of your competitors?

Yes. So I'd say a couple of things. One, we know 1/3 of pet parents don't visit the vet regularly. That's a little bit higher with cat owners versus dog owners, but that's sort of generally the standard. Two, we have market share leadership in a $1.1 billion category, and we've continued to expand that market share for sure. Three, we still believe there's ample white space for growth in that segment. We predominantly played in the premium space of the OTC flea and tick category, and we have now recently started to play in the value space, and we are very underrepresented from a share perspective in the value space, which is still roughly 40% of the dollars in the category.

That's great. Maybe I can switch to both of you in terms of kind of thinking about that same theme. I mean all of us can see what kind of the macro visits have been looking like. Can you talk about leveraging your diverse portfolio across pet and Farm Animal to mitigate the slow visit trends in vet?

Yes. Maybe I'll start. First, one, I still think this is a great industry, and there's a couple of reasons. One, dogs and pets are living longer than they ever have before. And if you think about -- dogs and cats, sorry, are living longer than they ever have before. And if you think about when pets need the most medical care, it's when they're very young, sort of the puppy stage, and it's when they're older and they have chronic illness. I think the second thing we would say is the humanization of pets continues. AKA, people's willingness to spend on their pets is still very high and very strong and continues to grow. I think a stat I use frequently is 50% of people would rather spend Valentine's Day with their pets and their significant other, which tells you how they feel about it. And then as I think about Elanco's sort of role in how we think about the industry, we've got 2 things helping us. One, we have the OTC portfolio for those folks that don't go to the vet regularly and still want medical care and maybe want a more affordable price point. Two, our strategy in the RF space has been to innovate in growing segments. And so we don't necessarily need that business to grow because we're innovating in the spaces that are already growing and are able to take market share where we don't have a large market share today.

Yes. And then on the farm side, again, half of our business is farm. And that market is very stable. It's a growing market with -- you think about just the components of it with a relatively low herd size, products like Experior are more important for the farmer. And so that's why we've seen such success there. But obviously, as that herd continues to rebound over the next several years, we'll see growth there. Proteins is just a macro demand where we're seeing growth and poultry really globally. So that stability, the cash flows from the farm business is, again, why I'm excited, but that prevents or mitigates some of the, I'd say, the macro of vet visits being done.

Got it. And maybe we can even stick with the same kind of concept and that the affordability in veterinary medicine. We've seen since COVID a 50% cumulative inflation in veterinary. So can you talk about some of the different channels and the balance of the portfolio given that big the veterinary services inflation.

Yes. Look, our strategy is always to go where the consumer is going, and we offer a wide portfolio of products at different sort of standards of care and price spectrum, right? So think about getting a Credelio Quattro with flea and tick coverage for roughly $8 a month versus you could go all the way to something like Credelio Quattro that gives you broader coverage is maybe more convenient because it's easier for you to pill your dog than to sort of put a collar around them for $25, $28 a month. And so depending on where the consumer is in their affordability journey, it's important for us to have sort of price points that meet their need. And we do that across not just parasiticide, but other parts of our portfolio as well.

Got you. A little bit about the -- and this is another one for both of you. Commercialization time lines, market penetration strategy for Zenrelia, particularly in international markets where your label differs. And how does the U.S. box warning impact the global strategy for Zenrelia?

Yes, I'll start. I mean congratulations to Ellen and the regulatory team. It's the fastest globalization we've had of a product in Elanco's history. Zenrelia is now approved in 36 OUS and more are coming. And what we've seen in the countries where we've had the product in the market for the longest time is we've got double-digit share and in some cases, very, very high double-digit share. We're seeing very little impact of the U.S. label on sort of the OUS marketplace. And in fact, what we're seeing is a more positive benefit of the success OUS translating into the U.S. in terms of confidence of the product in terms of safety and efficacy, given all of the other countries around the world have a clean label.

Got you. Okay. Moving on to Bob. You -- after driving a deleveraging strategy, I believe you've reducted 2 turns in 2 years. What's the time line to get below 3x.

Yes. Great. So yes, you're right. The company has done a fantastic job of really being disciplined and focused on deleveraging. We were at 5.6x in 2023. We expect to be at 3.738 by the end of this year. And we did have some onetime items in there. We have the aqua divestiture and then we have the royalty monetization that helped. But I would also highlight the free cash flow conversion. I've been really impressed with a dedicated team we have in-house focused on the fundamentals of trade working capital. And so that -- the trade working capital component has really been a nice accelerator to free cash flow. So as I think about moving forward, we're going to continue to have good free cash flow. I'd also mentioned 2026. What we're going to have behind us is going to be the tax associated with the Aqua divestiture. So we'll have some natural tailwinds coming from that. So as you just kind of model out where we'll be, I would expect us to be below 3 in 2027. There's going to be some M&A, I'd say, smaller tuck-under M&A as a part of our growth strategy. But I would tell you these are going to be small tuck-under R&D sort of related options for us that would not derail us from being below 3 in 2027. And then I'd say once we get there, we'll talk a little bit more next week as well, but that's going to give us some optionality as far as returning cash to shareholders.

All right. I want to talk about the IL-31 business. For a lot of investors that don't know, I mean, I think the category of monoclonal antibody injectables has been growing a little bit faster than the small molecule version. So what can you talk about expectations around IL-31 and then the timing of it, particularly in light of -- we had maybe some impacts from U.S. government shutdown, maybe not, but I'd love to hear if there was any for me.

Yes. I think we're fairly confident that our approval is imminent, hopefully, Q4. It may get delayed a little bit because of the government shutdown, but we've been in regular contact with the USDA, and we feel like the approval is tracking. As we sort of said before, the approval is actually not our critical path from a time line perspective. Commercialization is and more particularly how we scale up our manufacturing. And so we're still expecting a first half approval for IL-31. As you rightly pointed out, the 90% of the U.S. derm market from a dollar perspective is either JAK inhibitor or IL-31, and it's split roughly equally between those 2. And so us having an IL-31 mAb will give us access to -- we'll be 1 of 2 players with sort of access to that space. And as we've said previously, we're excited about the degree of differentiation we'll add with that product. And what we're also very excited about is having a portfolio effect. And we believe that IL-31 will also help drive Zenrelia and vice versa as we think about sort of the launch and the acceleration of that product.

Yes. I just want to clarify, the first half launch of the product.

Yes, yes. I got you.

You said approvals so it's launch date.

No, no. So can you talk about your go-to-market model? And this is a follow-up on IL-31, but maybe you can talk about some of the other products in terms of go-to-market model.

Yes. As I said, one of the key enablers for success for U.S. Pet Health has been share of voice. And there's really a couple of ways we've driven share of voice. The first way we've driven share of voice is with the capabilities we've built internally. So expanded sales force, new capabilities from a vet engagement digital perspective and then inside sales force going forward. But the other thing that we do maybe a little more differently than some of our competitors is really leaning in with our distribution partners. And what that allows us to do is that allows us to amplify our share of voice by a factor of 2.5, 3x in terms of the number of people talking to customers going forward. And we think that has allowed us to expand our physical availability, AKA, get into more clinics where consumers want to buy our product. And so that approach has served us well for Quattro and Zenrelia, and we expect to apply something similarly to IL-31.

Got you. I want to talk about maybe some of the competitor launches Numelvi, Ecitra, and what impact they could have on Elanco's market share and pricing power in 2025 and 2026. Obviously, I think the products they are going to launch. Competitor products are going to be more impactful next year than this year. But anyway, any way to think about these competitive launches?

Yes. I think the first thing I would say is we thought about these competitive launches, and we factored them into our sort of outlook for the business. I think the second thing I would say is we've had a great opportunity to learn from what's happening OUS, which is happening OUS, both sort of Numelvi and some of the other products you may be thinking about like Bravecto Quantum. And we've sort of seen what those products can do in those markets and how our products stack up and ultimately compete. And what I would ultimately anchor back to is medicine. And we believe in the differentiation that we have on the parasiticide side with Credelio Quattro, we really believe in the differentiation that we have in Zenrelia in terms of value, convenience and efficacy. And we think that will help those 2 products continue to grow in light of competitive threats.

Right. Moving back to Bob on some of the financials. You had a recent refinancing. What changes ahead for capital structure, CapEx expectations?

Yes, that's great set of questions. Yes, so we were extremely successful in refinancing our 2027 tower as we did push out the maturity from 2027 into 2029 and 2032. We incorporated some euro debt, which helped us on the rates. We pick up about 40 basis points of improvement there. So from a debt perspective, our methodology and our allocation is going to be consistent, continue to pay down debt. Our next tower is in 2028. But we're going to continue to be balanced and disciplined. So think about CapEx. This year in 2025, we did have a bit of spike in investment, particularly with our facilities as we ramp up for not only the launches that we've had, but also for volumes associated with IL-31. I'd expect next year to be more balanced and our CapEx will be in line with historical averages. But ultimately, really no change to the capital allocation strategy. It's going to be focused on paying down debt, investing in the business. M&A will be -- we'll take a critical eye on making sure it's got the right investments, but those won't derail us from deleveraging and again, getting below 3 in 2027, so we can have some flexibility around shareholder return.

Got you. So I'm sorry to get in front of this, but what can we expect to hear at Investor Day? You can give us at a high level to keep expectations? Great, Jack.

So we're extremely excited. So we did talk to some investors about what was important for us to talk about. And so we're going to have the ability to have every leader speak about their ownership. So Bobby and the presidents will talk about their strategy and growth profile. We're going to have Grace speak a bit about the manufacturing capabilities, the success that she's had and also how she's going to be supporting Ascend with opportunities there. Ellen is going to give a nice perspective on innovation and how -- what she sees the next several years, but also how we continue to fund her with more capital to continue to go down that path. And then I'm going to finish the day off with some discussion on Ascend and give some more granularity there. And then we'll end with an outlook over the next 3 years that will give some -- an outline of growth and EBITDA and cash projections.

All right. We're out of time. Thank you very much.

Yes, thanks, Dave.

Thank you.