Elanco Animal Health Incorporated ($ELAN)

Good morning, everyone. My name is Steve Dechert. I'm with KeyBanc Capital Markets on the Healthcare Tech team. This morning, we have the pleasure of CFO, Bob VanHimbergen joining us from Elanco Animal Health.

Before we get started, if anyone would like to ask a question, you can do so through the webcast on the chat. But Bob, maybe just to kick things off. You guys saw some really strong growth in some of your key products to close out fourth quarter with Zenrelia and Credelio Quattro. Maybe just talk about some of the metrics that you saw to close out the year.

Steve, thanks for the question. Yes, you're absolutely right. We continue to see some strong momentum in the business and particularly with our basket of innovation. We did land the year with revenues of $892 million from that basket of innovation. And we exceeded our expectations and our guide of $840 to $880 million throughout the year, and that actually enabled us to continue to, I'd say, accelerate and increase our guide on that basket for 2026. Back in December, our Investor Day, we did highlight we expected $1.1 billion of revenue coming from that basket. And a couple of weeks ago with our 2026 guide, we did raise that to be $1.150 billion, again, on the momentum that we saw through December. And you're right, it's the Quattros and Zenrelias but also on the farm side, our Experior, but just a couple of data points. Quattro, we firmly believe is best medicine in the fastest-growing animal health market in parasiticides. Broad spectrum is about a $1.4 billion market growing at 30%, and that represents about 40% of the U.S. para market. Quattro right now is in 1/3 of our vet clinics. We have the highest Puppy Index. And just recently, we announced that we did get approval in Australia. And so you'll start seeing us launching and getting approval in further countries overseas. In regards to Zenrelia, again, we believe this is a special best product as well. We did reach a double-digit share in the U.S., and that's with the current label. And then certainly, there is some opportunity to improve that label working through the FDA. But even with the label cleanup we saw in September, now Zenrelia, we've added 3,500 clinics since that September language update. It's still not a perfectly clean label that we hope to get. But certainly, we took the fatally induced language off, we saw some clinics really lean into again, what we think is best medicine. And then overseas with Zenrelia, we've got double-digit share in many countries several countries in Europe, France, Italy, Spain. In Brazil, we have a 30% market -- I'm sorry, a 40% market share and then in Japan a 30% share. So strong on the pet side. And then on the farm side, Experior, those revenues are north of $200 million that we saw in 2025. It grew 80% in a TAM now that's $350 million between the U.S. and Canada. And listen, we see growth in 2026 with the extended use of that product. And continued adoption. And then over time, we expect to see just the globalization of that product. So I feel really great about the overall basket that we have right now.

That's awesome. And before we get more into '26 guide, I just wanted to touch on the conflict in Iran. We've got sustained oil prices around $100 a barrel now. We're in the third week of the war. What impact are you seeing maybe to the logistical side of your business, any inputs to your manufacturing process? And then just to maybe build off that a little bit. If this goes on for another few months, prolonged conflict and you see oil prices remain high. What does that mean for Elanco?

Yes. I mean it's something that we're certainly paying attention to. I'd say right now, Steve, it's not a material impact to us. Fuel prices, certainly, those are escalated, but that's not a significant piece to our cost base. What we're seeing short term is just obviously disruptions with supply chain. But again, we think that's pretty immaterial and there's going to be some minor timing within the quarter right now. But certainly, as time progresses, if this war should extend something that we'll certainly keep an eye on and certainly provide updates. But as of now, it's really not a material impact.

Okay. Awesome. Yes. So on the '26 guide, I just want to touch on the different considerations to the low end versus high. You're guiding to 4% to 6% organic constant currency, 8% adjusted EBITDA growth and then 10% adjusted EPS growth. So just kind of touch on low end versus high end, if you could.

Yes. No, that's great. So listen, we feel great about the guide. It's right in line with what we shared at Investor Day back in December. But we've been successful in launching our products here over the last 1.5 years and continue the momentum on that basket of innovation. But with that being said, obviously, we do think about different puts and takes as we give guide and I think of various scenarios. And if I think about what would we need to do to get to that high end, it'd be a couple of things. One, it'd be the continued strength in that basket of innovation. And so we've seen momentum, obviously, the last several quarters. And if we continue to see that momentum that would be an opportunity for us to get to that higher end. The only thing I would say is just the foreign business continues to perform extremely well. And so that would be another -- that macro trend continues, which we expect it will, that would be another lever to get us to that high end. Now obviously, there's things that could bring us to the lower end. And again, things we contemplate. But one would be the overall macro environment. Two, I would say would be just competitive response to the success that we've had. And so it's something that we're certainly thinking through what that could look like. And I'd say more recently, I'd say foreign exchange rates could be an impact, more so obviously, on the reported number as we've seen strengthening of the dollar, but certainly wouldn't impact our organic growth.

Perfect. You kind of talked about trying to avoid air pockets with your innovative product launches. Just as we move beyond 2026, you've had tremendous success with Quattro, Zenrelia. And hopefully, with Befrena coming up later this year. Just how do we think about your cadence of product launches as we get into '27, '28?

Yes. So great question, and it's something that we're extremely excited about internally. So at Investor Day, we did highlight that we're adding mAbs and immunotherapy technology as additional areas that we're focused on and investing. But right now, we're focused on maximizing capacity and throughput and really focused on the larger markets, particularly derm and para. So although we're expanding some of the areas that we're looking at, derm and para is really going to be the biggest markets and areas that we see tremendous growth. And we're a company that we don't need to go create new markets. Our expectation is we're going to have best medicine and grow share within those markets. And I'd tell you, I firmly believe we're well positioned to win in these large markets. And really, a lot of credit goes to our R&D team that's ensured that we don't have these big air pockets. We're going to go several years without a major innovation coming to the front line. We really have a good approach to continue to fill the pipeline. At our Investor Day, we did highlight we have over 10 products we think could be blockbusters over the next decade, and we kind of put them in 2 buckets, Steve. The first being the next wave, which we highlighted, we expect 5 to 6 potential blockbusters to come to the market by 2031 with an unprobabilized sales opportunity of about $2 billion, which is twice the value that we see here today on the current big six. And then we've got this next wave, which would be another 5-plus opportunities beyond 2031. So internally, we're heavily focused on continuing to fund the R&D team, continuing to fund opportunities and again ensure we don't have an air pocket where we go several years without a major product coming to the market.

Got it. Just now that you have Quattro, you have Zenrelia, you have this more big suite of products than before. How is that helping you grow with vet clinics and add new clinics?

Yes. I mean -- so it's helping tremendously on a couple of fronts, Steve. The first one I'd say was just the portfolio lift that we're seeing from Quattro. There's thousands of clinics that have brought in Quattro that have also made first-time purchases of other Elanco products, including Zenrelia and vaccines, all right? So we're seeing this natural lift really just from this basket of innovation. And you go back to 2025. Q1, our base business deteriorated a little bit more than what we would have liked. But once we saw our launches coming through, particularly in Q2 with Quattro and Zenrelia and starting to see that ramp, we actually saw a much more stabilizing base. And our view of stable base, our definition, if you will, is up or down low single digits. And that will shift by quarter and by geography. But starting in Q2 because of the innovation, we saw the stabilizing base because of this halo impact from really the broader portfolio that we're bringing. The other thing I would say is just the progress we're making with corporate accounts, where having a broad portfolio is important and critical. In 2025, if you look at our corporate accounts, 90% of them grew. When you compare that to 2024 when we didn't have the innovation, only 13% grew, all right? So that's the importance of innovation. It's not only stabilized in base, but then something we're obviously super focused on just because the margin profile of the basket of innovation is also higher than our corporate average. So we're seeing a lot of benefits just from this basket to improve.

Okay. Got it. I wanted to touch on Zenrelia. You mentioned a label change in September. You've added 3,500 clinics as a result of that. I believe that's up from 2,500 to what you gave on your last update. If you get a full black box removal that you're trying to go for this year, I'm just trying to gauge what that could mean for that product? How -- what's the potential magnitude of that complete removal?

Yes. So a great question. And you're right, Steve. We did -- previously, we had said 2,500 clinics at a couple of weeks ago, and now that's up to 3,500 clinics through the last couple of days. And so we continue to see momentum on Zenrelia. And really what's triggered that is just a little bit of the label cleanup we saw in September, where we took the fatally induced language off that label. And so we've been actively working with the FDA over the course of the last year and obviously got that update in September. But we're actively working with the FDA now on further improvements in the label. We did submit data to them back in October. There is not a formal time line when we expect a response. But I would tell you we are having active discussions with the FDA. And I think the FDA certainly recognizes and part of our submission back to them was the fact that we do have a clean label in 40 countries. There's now over 1 million dogs that have been treated with Zenrelia and it's been in the market here for over a year now. And so we're seeing, obviously, good adoption of that. But listen, like what the upside could be. We expect Zenrelia to be a blockbuster in the U.S., but also a blockbuster overseas. So again, we think it's a special project. We've been -- it might have been a blessing in disguise, Steve, that with the label, and here's why. Zenrelia is being used as a second line of defense, where puppies and dogs were not getting the treatment or the relief from other products in the market. And so we were coming in as another option, and it's worked tremendously. And so what we're seeing is that work in the market and so if you step back and think about just the clinics within the U.S., there's 30,000 clinics or so. I'll put them in kind of 3, 10,000 clinic buckets. The first 10,000 clinics are -- were really using Zenrelia right away. They believed in the efficacy of the product. Then there's 10,000 on the other end of the spectrum, that because of the label and the risk aversion, they weren't going to use Zenrelia. And then there's 10,000 in the middle that were kind of in this wait-and-see mode. And because of the label update and because of how well it's working in the market, we saw them really start to convert, and that's that 3,500 bucket. So listen, right now, our guidance assumes the label as is, and that's not only for '26, but also for the next 3 years. But certainly, a label update, I think, would move Zenrelia to that first-line use and certainly would be a major differentiator for what our trajectory could be.

Okay. Perfect. Yes. So this kind of leads into my next question, which I had here, which is the guidance doesn't include Zenrelia, which clearly some upside there potentially, if you get the label change. But just wanted to touch on Befrena. I get it's not probably launched until midyear, but is there any -- is that being included in the guidance of '26 at all, and if so, to what degree?

Yes. So it is in our guide. It's not a meaningful impact to 2026, but it's a special product, right? So as we think about the second half of '26 and into '27 because of the value of Befrena and the dosing intervals being a major differentiator moving from 4 to 8 weeks, which is currently in the market. But Befrena providing a 6- to 8-week coverage is important. We did survey over 350 vets and 83% of them expect to bring Befrena into their clinics. But as far as the launch, we're right in line with our expectations. So we did get approval in Q4 of '25. We've been ramping up production. We do expect to commercialize Befrena here in the second quarter, but it's going to be a phase launch throughout Q3 and Q4. And so it is in our guide. It's not a meaningful impact to revenues and earnings. But as we get scale throughout the second half and into 2027, it'll be a more meaningful impact to both revenues as well as profitability.

Got it. You mentioned the Quattro approval in Australia. You guys, I believe, are expecting more geographic approvals this year. What can you tell us about those maybe what regions are you potentially expecting how many? Just any color you can give would be great.

Yes. No, that's great. Yes. So yes, we did get approval in Australia, which is important. That's our first overseas market. The overseas market is about $700 million. We do have submissions in Canada, the EU, U.K., Japan as well. We do expect to get those approvals here throughout 2026. But with that being said, we don't expect that to be a material impact to 2026. That's going to be more in 2027 and beyond. But certainly, the globalization of Quattro is certainly a key driver to our longer-term growth profile.

Okay. Yes, that's actually going to be my next question. It was how much of international growth at Quattro was being put into guide, but it sounds like it's kind of...

Yes.

Okay. And then Jeff has talked about over-indexing the vet visits as an industry and that we should be looking at other metrics that are more important. Just what are those metrics you're referring to? And what are those telling us?

Yes. So that's a great question. So a couple of things I'd highlight. One, the willingness to spend on pet health right now has never been higher and continues to grow. The younger population, the millennials and Gen Zs, they expect higher expectations of care for their pet. 1/3 of pet owners right now, Steve, spend more money on their pet's health than their own. Then you couple that with the decision-making power shifting more towards the pet owner and that connection to the pet owner is really critical. And so you think about just the OTC opportunities and our leadership position within retail puts us really in a position of strength. The omni-channel approach and capabilities is key. It ensures that pet owners can shop what's most convenient for them. And obviously, convenience is probably the most important factor right now. As you look at omnichannel shoppers, they spend 30% more than single channel users. And then another data point subscription sales represent 40% of pet health sales. So as you think about in your own world, when you're shopping with Amazon, right? A lot of people have shipments coming once a week. And if you're in my household, they're probably coming every day with what we do. But a lot of that is on subscription, right? And so the pet market has certainly shifted towards that as well. The one thing I would highlight is just the globalization of pet care. What we're seeing in the U.S. is expanding globally as well. And then comprehensive portfolios matter. So as we get more decision-making to the pet owner and the convenience of shopping online, having a complete portfolio for pet owners is critical.

Okay. So I think one of the impressive things about your 2025 growth is that you grew 7% organic constant currency, and that was with only a 2% price increase. And now this year, you're taking a price by the highest in 5 years. So could you dive into what's allowing you to take price up by that much versus that 2% increase from last year?

Yes. No, great. So yes, you're absolutely right. So we did see 2% price in 2025. We do expect that to accelerate in 2026 and a couple of factors. One, as you mentioned, in the U.S. pet side, we did take pricing to the clinics. It's the highest pricing we've taken in 5 years. But really, what we're doing is pricing to value. And we believe we've got best medicine across our entire portfolio. And so we'll continue to lean in to that strategy. The thing I would tell you as well is last year with the launches of Zenrelia and Quattro, we're now lapping those, right? And so those are the opportunities to take pricing. So that gives us confidence that we'll see some price acceleration in '26 versus 2025.

You talked about doing some tuck-in acquisitions on the R&D side. Can you provide more color on where Elanco could strengthen its R&D capabilities through these acquisitions?

Yes. So yes, so we'll continue to have M&A as part of our mid- and long-term growth strategy. It's going to be the areas where we can expand R&D and be more efficient with an M&A transaction versus with our own spend or M&A could be aligned with where there's a good product in the market, and we can provide significant value with our distribution model, much like with the AHV acquisition we announced a couple of weeks ago. So that's going to be really where the strategy is going to be, Steve. But financially, a couple of things I would highlight. My focus, and we've been clear on this, we're not going to let any M&A transaction derail us from our deleveraging time line. And so we still expect to get in the low 3s by the end of this year. and we'll expect to get below 3 in 2027 as far as leverage. Then a couple of other financial metrics I'd highlight. At Investor Day, as you -- as we've talked about, we did highlight mid-single-digit top line growth, high single-digit EBITDA growth and low double-digit EPS growth. And the M&A transactions need to be accretive to that model. Now they won't be necessary in the first year. But as you get into year 2 and year 3, that's my expectation. And then the last thing that's really critical for me particularly is ROIC. I do want to make sure ROIC exceeds our weighted average cost of capital within 3 to 5 years and it might be near that 5-year time horizon depending on launches of products. But if I think about the AHV acquisition we announced a couple of weeks ago, that's going to be on the shorter end of that time frame. Then the last thing I would say is what's super critical is that we're not going to let any M&A really derail us and distract us from the big 6 products that we've launched internally here as far as innovation goes.

Got it. Okay. Here at KeyBanc, we cover a handful of AI drug discovery companies on the human health side that really speed up the discovery stage of drug discovery. I'm just curious, is that something that there's room to be implemented on the animal health side? Is it already being implemented? How is Elanco looking at that? Just anything you can provide there?

Yes. Listen, so with Elanco Ascend, that is a -- that's really our program over the next 5 years, where we expect to get cost savings through just being more efficient within our P&L. But also how we adopt AI and lean into AI and automation a little bit differently. And so we're seeing AI be applied really across every function within the business. And so if I think about the commercial teams, AI is going to enable them with better real-life data, real-time data to our frontline sales team so they can be more effective. Within the 4 walls or manufacturing facilities, predictive maintenance and our procurement team using data to understand cost opportunities. And then G&A opportunities in the back office we're using AI and we've implemented many already, including the finance organization, where we're seeing hard save already because of some of the efficiencies. Now in particular to R&D, let's say, a couple of areas where we expect AI to provide some value. One is going to be just with regulatory filings and accelerating that, but also AI to help us, I'll say, fail fast as we think about how molecules work together. And so that will create the opportunity for our R&D team to really focus in areas where we see some success. And so ultimately, we do expect to see products come to the market a little bit quicker because of the help of what AI can do for us. Then the last thing I'd say is more kind of macro opportunity. With the new headquarters we've built here at Indianapolis, we are building what we call a One Health innovation district, which really provides researchers the opportunity to bring their innovation to concept. And that's something that Elanco is acting as really a catalyst to bring products to the market. And so we're really attacking innovation from many different angles there, Steve.

Okay. I should have asked this earlier, but just we had some M&A activity on the distributor side earlier this year. Just how does that impact Elanco to build on that, you guys have talked about how you guys are adding value to the distributors, and they're adding value to Elanco. Just how is that relationship? Or just talk about that more, I guess, yes.

Yes. So great question. So listen, as we sit here today, we don't see an impact in 2026. And TBD, if there's an impact beyond, but I'd say our relationship is very good with both MWI and Covetrus where there was that announced potential merger. But our President of our U.S. pet business, he's got a great relationship with both and probably talks to them on a weekly basis. So listen, we don't see an impact. Again, great relationship with them. We are doing better with them and they're doing better with us. And these distributors are very good at launching product, and you've seen that here in 2025. We expect the same with Befrena in 2026. But listen, if that model changes and we see not the same value, I mean, obviously, we'll pivot where we need to. But right now, a great partnership with both.

Okay. Great. We do have a question in the queue. As Credelio Quattro, Zenrelia and Befrena scale, how much of current growth is coming from structural share gains versus launch-based tailwinds? And when should we expect growth to normalize?

Yes. I mean -- so listen, I'm going to -- I'll pivot back to our algorithm that we gave at Investor Day. I mean with our basket of innovation, we see stabilization of our base and so we're still committed to that mid-single-digit top line growth and high single-digit EBITDA growth. But you'll see us continue to fund the pipeline with R&D and continue to grow that basket of innovation. And listen, internally, it's very important to us that basket of innovation because, one, we see growth, we see the market expanding and we see margin enhancement from that basket because the margins are higher than our corporate average.

Maybe just one on Befrena as you're launching later this year. You guys have that great head-to-head study with Zenrelia, Apoquel incumbent. Any additional head-to-head studies you guys have planned, maybe even one with Quattro versus Trio, just anything in the pipeline on that front?

Yes. I mean I think there's various head-to-heads that we're investing in. Again, we feel we have best medicine. And so we're really leaning into that opportunity. And I'd say that's really more across the front on Zenrelia right now. But again, Quattro, again, we believe it was best medicine. So head-to-head studies are something that we're certainly leaning into.

Okay. I think we can close it out there, Bob. I mean, I guess, maybe before we go, why don't we just -- the 3-year outlook from Investor Day. Maybe just kind of walk us through the expectations there, where the savings are coming from on the gross margin side versus the OpEx side. Yes, that would be great maybe to end.

Yes. No, that's great. Yes. So Elanco Ascend is a big contributor to margin enhancement. But maybe we'll put that to the side first and just talk about the natural tailwinds we expect. The first, the basket of innovation continuing to grow that basket again carries higher margins than our corporate average, right? And so that grows, you'll see margins grow. I'd say volume leverage and so leveraging our existing cost base will also be a tailwind to margins. And then we get to Elanco Ascend. And Elanco Ascend, we expect $200 million to $250 million of net EBITDA improvement by 2030. That's going to be net of inflation and net of investment. And 75% of that save is going to be in the gross margin areas. And so think of that as really focused on the commercial areas, again, using AI to help our frontline sales team think through how they can be more effective with better data. And then we're going to see some improvement within the 4 walls of our manufacturing facilities. And then procurement. Procurement has already done a fantastic job of locking in lower raw material prices than what we've had in the past. And so we'll see that natural benefit come through. And then 25% of the benefit from Elanco Ascend is going to be in OpEx. And a lot of that comes from the restructuring program that we did announce on December. And I'm really pleased really across the board on how the Elanco global team has initiated and actively gone after, I'd say, every opportunity that we have. But we're well in line with the restructuring, for instance. We expect $25 million to save this year. We expect that to happen and really all activities to be completed here this year. So we'll see that $60 million benefit come through in 2027. But overall, we highlighted we expect 30% of the Elanco Ascend benefit to come through in 2026. And again, we're right in line with that expectation.

Okay. Awesome. Bob, thank you so much for joining us. It's been a pleasure speaking with you. And hope we'll speak again soon.

Great. Thanks, Steve. Appreciate it.