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

Hi. Good afternoon, everyone, and welcome to the Morgan Stanley Global Healthcare Conference. I'm Erin Wright, Healthcare Services Analyst at Morgan Stanley. For more important disclosures, please see the Morgan Stanley research disclosure website at morganstanley.com/researchdisclosures. And with that, happy to have Elanco Animal Health with us today. Thanks so much for joining us. We have CEO, Jeff -- we have the full team, CEO, Jeff Simmons; CFO, Bob VanHimbergen; and also Bobby Modi, who heads up, I think I have this right, U.S. Pet Health and Global Digital Transformation Head. So thanks so much for joining us. I'm going to hand it over to Jeff first, who wants to give some prepared remarks or some initial remarks. There is obviously a press release [Audio Gap]

That's just an animal number. So Elanco is well positioned there. I think on the Pet side, Pet grew last year, 5%. It grew in all the major markets and all the major companies, most of the -- 80% companies grew in the first half of this year. So we continue to see pet spending for health as a protected budget item as also another contributor to durable growth. And yes, some changing pet behavior, we can talk about pet buying behavior. So we do see the industry growing from $40 billion to $60 billion over the next 10 years or so because of these trends. Innovation wins. Innovations be rewarded. In the release today, what we do tried to do is put a little color around the here and now of some of these trends. And so I think in summary, we continue to see the market growing. We see a responsible market. We see and expect our pricing to accelerate as it has in July and August. And that, I would say, is because of really the headline of the release, is the need on the pet side has grown. As some of you may know, this tick challenge has actually grown at the highest level since 2017 when CDC recorded, and the itching dog in the Northern Hemisphere has continued to be a challenge. So the seasonality, just to be a [ 73 ] Elanco first half, second half is becoming more 50-50. So we have some -- we have 3 pet products that we believe are medically differentiated, best medicine, I believe, and they're taking share. They're allowing us to take price and add clinics, and we can put some color to that. So that was the essence of the release. And again, we can get into a little bit of our strategy in details.

Okay. Great. So let's get into the release since you brought that up. So you reiterated kind of [indiscernible] single digit to low double-digit U.S. Pet Health in the second half. I guess can you unpack that a little bit in terms of innovation, contribution, volume, price, other dynamics to call out?

Yes, I'll toss it to Bobby that's running the business. But I'd just come back to, I think, one of the things that needs to, and it came from a lot of our meetings this morning, is, look, these are big markets, and I'll step back and say derm is a market that is the itching dog challenge continues to grow and the markets grow. International grew 9%. And the overall market is continuing to grow and blood spectrum parasiticide is growing, and we're in early innings. We just announced $100 million in derm and a little over $100 million in para. In these 2 and $4 billion markets, we're in the early, early innings with differentiated medicines. So no matter what's happening in the marketplace, we have a lot of runway relative to our share in very big growing markets. Maybe a little color, Bobby, on the U.S.

Yes. I think our growth is going to be really balanced. So I would think about a portion coming from price, innovation being the main contributor to growth across 3 products, right, Zenrelia, Quattro and then Befrena, probably more Q4, a little than Q3, and then a stable base. And that's sort of how we think about sort of the contribution of the business and what's going to contribute to the sustained momentum that we saw in the first half of the year. .

Okay. And you gave that guidance potentially before you were fully kind of aware of what a competitor in the market was going to do from a pricing perspective. What has played out relative to your expectations on that front?

Yes, it's a great question. So on pricing, things have played out exactly as we had anticipated. First half of the year, we saw a price of about 2%, and that's really across Farm and Pet, it's across International and U.S., so it's pretty broad-based. But we did say we expected price to accelerate in the second half of the year. And in today's press release, we did state, but, hey, we have seen that price accelerate 2 months into the quarter. And so we feel great about what we expected and what we've seen there.

Yes. And I'd just say broad strokes, what we see in the marketplace is responsible pricing. We see some investments in pockets that tend to be time bound. That's not been very different in our industry for sort of years to come. And we're not seeing massive sort of price investment that's sustained because, frankly, you can't generate a return on that. And what we really lean into is medical differentiation and commercial execution and largely driven by share of voice. And we think those are the most for success with the customers. .

And when you're talking about price in the competitive environment, you're talking about broad-based price too. And I think that that's important across the portfolio given some of the competitors to blame bundling tactics across the portfolio. Are you seeing anything outside of the innovation and outside of the more innovative product, meaning in [indiscernible] in terms of price pressure?

I would start and add here. But I mean it's always typical to have a pocket or 2 around the world in a certain segment where there may be -- it is a competitive environment. It's not a payer environment, but there's nothing that has changed from the first half in July and August that we see this any different. Maybe what, to Bobby's point, what has changed and why we wanted to highlight in the release, the need has increased. The speed of tick kill that we're seeing with Quattro and the significance of that differentiation had increased because of the need and the willingness to come. We're adding, again, 500 to 600 clinics a month, and that's because I think the differentiation continues to grow through our opinion. And the same with [indiscernible]. As we highlighted in the competitive derm market in Europe, we picked up 10 share points in the first semester, and that's to 2 points to our competitor, the new incumbent coming in.

And I would just say innovation has given our portfolio greater relevancy. So we've seen our vaccine business grow market share. The most it has this year in the first half prior to the previous 5 years, and we've seen Credelio, a product that's been on the market for 8-plus years, in the most clinics that it's ever been in as sort of these new products give us greater relevancy both pet parents, but also our customer base in clinics. And that's a nice sort of fuel that's allowed our base to sort of stabilize and put us in a really good position. .

That was my next question because I think that was the other highlight I think that I like to focus on a lot too in the press release this morning was the base business. And how much you truly are seeing some of that halo effect on the back of innovation and how that's truly materializing? Any other examples you can give us? You mentioned the vaccine portfolio. Obviously, you've had some innovation there too with [indiscernible] vaccines that gives you more well-rounded kind of portfolio there. But in the other areas where you do see probably a longer tail in terms of like you're under-indexed in this category, but there's a long runway for growth as you continue to take share to leverage the broader innovative portfolio around it.

Yes, we have a very large therapeutic portfolio, and those products tend to be sort of smaller in nature, and it's nice that when you get into a clinic and have a discussion with the clinic that you haven't had normally, you get to talk about portfolio, and we're seeing really nice growth on those products as well.

And I jump over on the Farm Animal side. We had the second quarter, Bobby's business grew 11% U.S. Pet Health. Our U.S. Farm Animal grew 11%. We had [ Experior ] with the beef shortage adding a lot of value to the U.S. beef industry, but that's pulled the majority of the beef portfolio with it as there is a portfolio effect that we get from innovation as well on the Farm Animal side. .

I think I know the answer to this, to some extent, given kind of the way you're answering the questions in the press release this morning, but they ask a competitor the same question. But do you think some of this behavior truly is temporary in nature in terms of some of the competitive moves or maybe you're not even seeing it hardly at all, but -- and what could be more of a structural change in -- across Animal Health in terms of industry pricing and durability of pricing across the...

I think our industry has been very durable. I think if you look at the 12 or so companies that report in Animal Health and what they did in the first half, we saw more than 80% of them show growth. We see innovation being rewarded. We've been on both sides of this. I mean, when you get the next generation of innovation, our customers rewarded. Bobby and I had dinner with some of the major vets here in Manhattan last night, and it's very clear to say, "Hey, they're move into the innovation because a vet clinic wants pet owners to be satisfied." And they'll do that because it's the right thing to do, but it also adds value to them. So I believe that we're moving to another era of innovation in our industry and Elanco is well suited going into that area. .

Okay. Let's take a step back in terms of so much on kind of price and competition and everything else, but just overall health of the market in terms of underlying utilization trends or demand trends across Companion Animal? And then also if you want to comment on livestock as well.

Yes. Maybe I'll start, Bobby, and talk some, I think, also about the channel and what we're seeing with changing pet behavior in the channels as well.

Yes, I'll start with just Q2, the Companion Animal market in the U.S., and it grew roughly 500 to 700 basis points faster than Q1. So you saw a sequential sort of improvement in the growth of the Companion Animal market. But what we actually focus on is actually pet parent behavior. And what we're seeing is pet parents are buying their products in different places. And what we're seeing is more and more pet parents are buying omnichannel and more and more pet parents are buying online. And actually, what we see is 40% of pet care has now moved to subscription base. And that's a good thing because it drives greater compliance, more doses. What we see in Elanco's own portfolio is when somebody buys online, they buy 50% more when they're on a sort of subscription based. And that's good for the veterinarian, that's good for Elanco, and that's good for the pet parent, and it's a win-win. And so we really think the future is going to be being everywhere the consumer wants to buy the product and showing up with the right education and information they need to make their sort of purchase decision.

And then I think just jumping to the protein market. So with this protein revolution and increased demand, it's increasing numbers of animals and then the demand for more value. And so I would say that the winner right now is dairy. If I ask everyone in this room who's more concerned when thinking more about eating more protein, statistics would show that over 80% of you are doing that, that's driving animal numbers globally. So poultry and dairy are probably the global winners. Beef, we're in for about a 5-year global shortage of beef. And so Brazil, Argentina -- I was in Brazil last week, they're are going to take advantage of this shortage of cattle in the U.S. And so when it gets to Elanco, it means our portfolio is adding more value. There's a higher ROI. Food safety, we got a big food safety vaccine portfolio. Food safety has never mattered more. And they want to win with the retailers in the food chain. So that's -- and they are looking for more innovation. Where we're probably under-indexed, where some of our competitors have a little advantage is we need more vaccines as a whole. But overall, we're well positioned on the farm side. And we see a 5-year run here with this protein change.

And just one quick clarification for Bobby. The 40% was that inclusive of OTC?

That's just pet care in general. So it's broad. .

And then so when I put this all together in terms of thinking about the fundamentals across kind of Companion Animal, but also livestock and then you raised your organic growth target, so growing off of sort of a faster kind of growth rate into 2027. Like what's durable? How do we think about the continued growth as we head into next year, just higher level?

Yes, maybe I'll take that one, right? So I think it's going to be innovation-led, is what's going to grow business and the continued stabilization of our portfolio with this halo effect. That's important for us, the innovation growth that we see because it does carry higher margins, Erin, than our corp average as we think about just the margin profile for next year. So we expect to grow, we're going to stick with our algorithm we gave it at Investor Day, right, although we do have a couple of proof points where we've outperformed the algorithm, but innovation growing at higher margins. . 2027 and beyond, we're going to have fixed cost leverage as we continue to execute on our current cost structure. And then we have Elanco [ Ascend ] coming in, being very proactive on margins. And remind you, 75% of that value is going to be in gross margin, 25% in OpEx. And again, we've accelerated some of those opportunities in the second quarter, and we saw that benefit come through margins in Q2. But as I think about going forward, I'm incredibly enthused about the globalization of what we have with Ascend. We have over 5,000 projects that are being tracked on a global basis. We have visibility to new opportunities within procurement, within G&A, with AI opportunities [indiscernible] even cash. All right. So as I think about '27 and beyond, I think we're going to have continued growth in innovation, margin improvements. We did lay out or stated in our last earnings call, we have the 60% gross margins. Not putting a time frame on it, when you think about the levers I've just highlighted, I think just a high degree of confidence that we can do that, and Ascend is a major part of that.

Okay. Okay. That's great. So Credelio Quattro and dig into that a little bit. So can you talk about where we stand now in terms of share, however you want to quantify it, whether it's healthy share, broader share? And then can you talk a little bit about what you're seeing more specifically from a pricing perspective there? Has there -- there was no need for kind of competitive response, but if you feel like there was, anything to call out from a pricing perspective on that front?

Yes. I'll highlight just the marketplace backdrop of we continue to see the differentiation across palatability in our minds, the tick differentiation and speed of tickhill. We're going to continue to invest in medical data to continue to show and demonstrate what we believe is a product that has medical differentiation or in my opinion, best medicine. We've got a quick warm kill in month 1 and just the broader coverage, tapeworm, et cetera, with 4 active ingredients. So I think we're going to build a medical program that just continues to demonstrate that differentiation. And the marketplace has given us a problem that we're going to lean into in a big way. This [ alpha gal ] concern on the human side as well as the Lyme disease has opened up, I think, a much higher interest by veterinarians to have that tick be removed before the dog removes back to the house. But maybe now talk a little bit about the marketplace, Bobby, and the specific dynamics.

Yes. We've been very consistent. There's 3 really drivers for growth for us think about Credelio Quattro. One is market growth. And the nice thing to see is the [ endecto ] market grew mid-single digits in Q2, and that was a significant increase from Q1, and we expect that to sort of continue to grow through the balance of the year. The second is we're adding new clinics each and every month, and the [indiscernible] talked about the run rate of 500 to 700 clinics a month. So we added 1,100 clinics between July and August. And that's really not a slowdown in spite of whatever competitive reactions you may sort of see in the marketplace. And the third area of growth is share within the clinics. And as our P Index continues to grow and is higher than sort of that 1 ratio, that means our share is only going to grow within the clinic, and we're certainly seeing that play out thus far this year.

And any seasonal dynamics to call out, I think when we go kind of after the most recent quarter and sort of the sell-side Brexit, you kind of called out some dynamic in terms of the quarter-to-quarter progression in terms of Quattro. Is there anything else to call out or any nuances? Should we see that sort of seasonal slowdown? Or should you be able to grow through that as still in your product?

Yes. I think -- look, the index market is still seasonal. So you'll see it sort of the market itself sort of the absolute number shrink in the, call it, the October, November, December time frame, January even as well. So -- but what we're seeing and what we talked about this morning is an elongated season. So we still see very strong demand in August and September.

We've shifted a lot as a company when, as I said, we were at 70-30 from coming out of [ Bayer ] to now it's more 55-45 in terms of the split. .

And then where do you think share ultimately shakes out in terms of the combo parasiticides, either overall as a category and then with Quattro?

I would just speak into the $800 million international market. It just continues to -- it's growing at a faster rate. Again, we've got dog numbers continuing to grow where they've leveled off in the U.S. Internationally, they continue to grow. And again, I see this segment continue to grow at a faster rate internationally. So when you balance that out, I continue to say this is the fastest-growing segment in parasiticides, our largest market. And to Bobby's point, we had a cold January, February, which I think caused a lot of concern in the marketplace. I think it was more weather-related than market related, and we've seen the bounce back pretty consistently all the way through August. So that growth that Bobby is talking about in the second quarter is pretty important to note. And look, and I would just say our belief is Credelio Quattro, as I've said, and the family of Credelio will be our largest brand family. We feel strongly about that in our 70-year history, and we're going to continue to invest as we continue to see this product, continue to add clinics inside those clinics, as Bobby said, it's going to take share. And next year, we plan to launch in Europe, U.K., most of the major pet markets, Brazil, others. So next year, look for not just Befrena to be a big driver, but OUS Quattro will also be a driver of growth.