Elanco Animal Health Inc (ELAN) Q2 2024 Earnings Call Transcript

Ladies and gentlemen, thank you for your patience. Welcome to Elanco's Animal Health Second Quarter 2024 Earnings Conference Call. All lines are currently muted to minimize background noise. After the presentations, we will have a question-and-answer session. I will now pass the call to Katy Grissom, Head of Investor Relations. Katy, you may proceed.

Good morning. Thank you for joining us for Elanco Animal Health's second quarter 2024 earnings call. I'm Katy Grissom, Head of Investor Relations and ESG. Joining me on today's call are Jeff Simmons, our President and Chief Executive Officer; Todd Young, our Chief Financial Officer; and Scott Purucker from Investor Relations. The slides referenced during this call are available on the Investor Relations section of elanco.com. Today's discussion will include forward-looking statements. These statements are based on our current assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from our forecast. For more information, see the risk factors discussed in today's earnings press release as well as in our latest Form 10-K and 10-Q filed with the SEC. We do not undertake any duty to update any forward-looking statement. Our remarks today will focus on our non-GAAP financial measures. Reconciliations of these non-GAAP measures are included in the appendix of today's slides and in the earnings press release. After our prepared remarks, we'll be happy to take your questions. I will now turn the call over to Jeff.

Thanks, Katy. Good morning, everyone. Elanco continued to deliver in the second quarter, exceeding the top end of our guidance range on our key metrics: revenue; adjusted EBITDA; and adjusted EPS. With four consecutive quarters of underlying revenue growth behind us, we continue to make significant progress on our three strategic outcomes: growing revenue; improving cash flow; and notably delivering innovation. In the second quarter, we delivered consistent operational results and achieved key milestones in advancing our innovation, portfolio and productivity strategy. Elanco delivered our fourth consecutive quarter of underlying revenue growth, driven by strength in U.S. farm animal, international pet health and added contributions from new products. On innovation, commercial activities are underway for Bovaer after the FDA completed its review in May. Zenrelia and Credelio Quattro continue to track in line with our late June update and we continue to expect to launch a potential blockbuster in each of the next three quarters. For Zenrelia, the final 60-day administrative window is underway with approval expected in late September. Credelio Quattro remains on track for final approval in the fourth quarter. With improved operating cash flow and the proceeds from the sale of our Aqua business, we have repaid $1.3 billion of debt in 2024. We expect net leverage to be in the mid-4x level by the end of the year. Looking forward, we remain confident in our full year outlook. We now expect organic constant currency revenue growth to be 3% to 4% for the full year. This reflects the removal of the Aqua business, maintained expectations for the base business in the second half and the expected increase in innovation contribution shared in June. Excluding Aqua, we are maintaining expectations for adjusted EBITDA with improved sales, offsetting increased investments in strategic launches in the second half. We are also maintaining our adjusted EPS guidance with lower interest and tax expense offsetting the removal of Aqua. Finally, we issued our 2023 ESG report demonstrating progress on Elanco's Healthy Purpose sustainability efforts in our internal operations, customer collaborations and beyond.

Thank you, Jeff, and good morning, everyone. Today, I will focus my comments on our second quarter adjusted measures, so please refer to today's earnings press release for a detailed description of the year-over-year changes in our reported results. In the second quarter, we delivered $1.184 billion of revenue, an increase of 12% or 13%, excluding the unfavorable impact of foreign exchange rates. Price contributed 4% in the quarter. The ERP system blackout that occurred in 2023 impacts our year-over-year comparison to the second quarter. Last year, we estimated sales of $90 million to $110 million shifted from the second quarter into the first quarter, reflecting a 9 to 10 percentage point benefit to growth in the second quarter of this year. We estimate the underlying business grew 3% to 4%, slightly ahead of our expectations. The estimated impacts are noted for each business area. For Pet Health, second quarter constant currency revenue growth was 13% and with an estimated benefit to year-over-year growth of approximately 13 to 14 percentage points from the ERP blackout. In the U.S., Pet Health revenue grew 1% in the second quarter, including a benefit to year-over-year growth of approximately 10 percentage points from the ERP blackout. In the Vet Clinic, the underlying decline was driven by competitive innovation pressure on legacy products. This pressure was partially offset by our recently launched products. On the retail side of the business, lower second quarter revenue in 2024 was primarily attributable to changes in purchasing patterns and more conservative inventory management.

Next, I want to provide more context on some of the key drivers in our U.S. Farm Animal and International Pet Health results. In the first half of the year, we delivered constant currency revenue growth of 4%, building on the mid-single-digit growth in the back half of 2023. Our consistent strategic enablers drove improved execution over the last 18 months. Despite a competitive environment, this allows us to maintain a high level of optimism for the future of U.S. Pet Health as we bring Zenrelia and Credelio Quattro to the market over the next two quarters. In the first half of the year, U.S. Pet Health revenue declined 3%. On the retail side, the underlying business is strong as dispensing growth, a key indicator of product demand, accelerated significantly in May and June this year and continued into July. This growth was driven by increased share of voice from targeted investments in our flagship brands, expanded physical availability with more than 10,000 new points of distribution as well as capitalizing on the elasticity of Seresto. However, retailer purchasing patterns created variability in our reported results, impacting net sales growth in the quarter. We anticipate this dynamic to normalize in the back half of the year when retailers are expected to begin to order more in line with dispensing trends.

Thanks, Jeff. We'd like to take questions from as many callers as possible. So we ask that you limit yourself to one question and one follow-up. Operator, please provide the instructions for the Q&A session and then we'll take the first caller.

We will now begin the question-and-answer session. Your first question comes from Jon Block from Stifel.

I'll start on Zenrelia. Jeff, could you provide the timing of the head-to-head study? Will that be ready for the launch ramp in the fourth quarter of 2024? Additionally, could you share any high-level comments on the vaccine response study that appeared to prompt the warning label? How should we interpret that? Was it primarily related to euthanasias or non-responders to the vaccine? If you could clarify that a bit, it would be helpful. I also have a follow-up.

Thank you, Jon, for your efforts and the questions. I'll directly answer one of your questions, then provide some broader context since this is our first discussion since the June release. We plan to include the head-to-head study against the market incumbent in the initial launch materials as part of the European submission package. I'm excited about Zenrelia and our entry into the derm market, which is rapidly growing and still has millions of untreated dogs. Following Zenrelia, we’ll introduce IL-31 along with Ellen's pipeline in derm. We're weeks away from this launch, and we're thrilled about it. I want to emphasize that we will respect the FDA process and will limit comments on the label and data packages until we receive full approval. Currently, we are undergoing a 60-day administrative review which is on track for late September approval. After the approval, we anticipate holding a comprehensive investor call where Jon will discuss this study, other studies, and label details, as well as our go-to-market strategy, potentially involving external experts, veterinarians, and dermatology specialists. Importantly, we do not expect any aspects of the Zenrelia label to hinder its wide adoption across various veterinary clinics. We believe Zenrelia will stand out positively in terms of efficacy based on the head-to-head study against the market incumbent, as well as in convenience and value.

That was great. I think just as a quick follow-up. Todd, this one might be for you. For 2025, I think the prior, call it, high-level messaging was that these new blockbusters would be, obviously, gross profit dollar-accretive in 2025 but likely gross margin-dilutive due to some investments associated with the new products. Now we believe Zenrelia's price is going to be lower, maybe you need to make more investments to explain the label. When we think about these new blockbusters, do we still think gross profit dollar-accretive in 2025 or more neutral? Maybe you can just flush that out a bit.

Sure, Jon. I appreciate the question and all the work you and your team have been doing over the last few months. Certainly, we're excited to bring Credelio Quattro, Zenrelia and Bovaer to the marketplace, two of those coming this year. And we're making investments behind those here in the second half where those will be not accretive to EBITDA in the second half given the investments, including investments for Credelio Quattro. We do expect that to flip in 2025, where they will be both gross margin-accretive but also that they're going to be accretive to EBITDA. We're not going to get into 2025 guidance today. That will be early next year. But as Jeff said, we're very excited for these products and excited to get Zenrelia in the hands of vets here in the fourth quarter.

Your next question comes from the line of Michael Ryskin.

Great. I want to follow up on Zenrelia. Jeff, you consistently emphasize efficacy and value as key differentiators. You've discussed pricing in the past. Clearly, there’s a value aspect for the vets and a price aspect as well. To clarify, how has your launch plan for Zenrelia changed after the Black Box warning? You mentioned increasing vet education and related expenses, but regarding its positioning with the vets, how willing are you to adjust pricing in order to gain market share?

Thank you for the question, Mike. To begin with, we will increase our share of voice through expanded marketing and attention. This launch will be one of our largest, especially as we enter the market second. Our first goal is to broaden the market, as there are millions of untreated dogs. Any new innovation, along with the growth we’ve seen in the first half of this year in dermatology, suggests we expect market size to expand. Regarding pricing, we will continue our value-based approach. We will consider all aspects of value and believe we can align our positive differentiation with what veterinarians prioritize most, which includes better efficacy as well as value, convenience, and other factors. Our launch plan has two main objectives: first, to work closely with veterinarians to ensure they understand the label, science, and data, fostering a vet-to-vet comprehension. Therefore, our initial launch effort will be very vet-focused, utilizing data with significant intensity and preparation.

Okay. Jeff, you addressed my second question regarding the breadth of the portfolio when you mentioned Para-derm therapeutic vaccines. The breadth of the portfolio frequently arises in discussions about how purchasing decisions are made and what criteria are prioritized. With the addition of many products to the companion portfolio from early '23 to early '24, you are likely to have one of the broadest portfolios available to veterinarians. How does this impact the value proposition for the rest of the business concerning the benefits of other products beyond the blockbusters and new launches? Is this being discussed already? Is this included in your strategy with some of these distributors and major consolidator groups as you move towards 2025?

It's a great question. An important point to mention is that we are now present in more clinics than ever before. The combination of our expanded sales force and the introduction of the parvovirus monoclonal antibody has significantly increased our access, and this was also aided by the diabetes product we launched last year. Our goal has been to prepare for the launch of two differentiated blockbuster products in the two largest pet markets in the U.S., specifically Derm and Para. Access to clinics is crucial, and there is definitely interest in which companies carry particular products. We believe that Derm will enhance our Para portfolio as well as our vaccine offerings, and we are already engaging with stakeholders on this. There is a lot of interest in these dynamics, and we plan to leverage our entire portfolio effectively, including our corporate and distribution strategies.

It's good to hear all the constructive language on Zenrelia. So let me just pressure test that a little more. As I dig into it, I know the Apoquel study, the vaccine response study had 2 out of 8 dogs that were euthanized and the dose was 3x human. I'm assuming the 3x human dose is probably more standard than not. So it sounds to me like considering you're getting a black box, your euthanasizations were more than 2 out of 8. Could you give us some more color on that? And then also, was the timing of these euthanasizations, or whatever the safety finding is, more pronounced towards the back end of the study? I'm trying to understand why the cap on duration. And then finally on Credelio, my sense is the CMC stuff is probably much more trivial and it's just information like sourcing packaging. Could you confirm that it was just a straightforward trivial request?

Thank you, Umer, for the questions. I cannot share details about the studies and label until we receive FDA approval, but rest assured, we will communicate openly with you as investors and the veterinary community once that happens. It’s important to remember that once a product is approved by the FDA, it is considered safe and effective when used according to its label. The label serves to guide veterinarians on the proper use and administration of the product. Our main priority will be to extensively educate and inform the veterinary community about this product from the start.

Your next question comes from the line of Chris Schott with JPMorgan.

Just 2 for me. Maybe just another one on Zenrelia. Can you just talk about the duration of this education process? And I'm trying to get my hands around how long you think it's going to take post-launch to get vets into a place where they'll understand the label and we can expect a normalized uptake? And is this a matter of this quarter? Is it something longer than that? I'm just trying to get some sense there. My second question was just on the guidance update and the flow-through of the sales upside to EBITDA. I think you mentioned higher manufacturing losses and then some of this increased investment in the product launches. I guess what's the mix between how much of it is investment versus manufacturing and what's happening on that manufacturing side?

Yes, Chris, regarding the first question, we are currently training our sales force and technical team while collaborating with key opinion leaders. This will be a comprehensive approach, and we expect it to be our most extensive launch to date using these varied strategies. Initially, we will scale back in Phase I of DTC, but we will be increasing our resources. This boost in resources, including the sales force training and engagement with key opinion leaders, will expedite our educational efforts. We can effectively reach the veterinary community quickly, making this our top priority. We plan to accomplish this before the Quattro launch, emphasizing the urgency of educating and providing product experiences to as many clinics as possible across the U.S. This will be a key focus for us in Q4.

Chris, thanks for the question on the back half guidance. Very pleased with the Q2 beat that was primarily driven by underlying strength of sales in the business. There was some timing of OpEx between Q2 and Q3. But primarily, as we go into the back half, there are some additional headwinds in manufacturing with some additional losses on some of our vaccine supply that's hitting us. The other element really becomes investing behind these launches. We're going to continue to invest in Zenrelia. We're also going to be investing in Credelio Quattro but now given our update in June, we won't have any revenue from Credelio Quattro in 2024. The other thing to remind folks of is we're really excited for Bovaer.

Your next question comes from the line of Erin Wright with Morgan Stanley.

On Zenrelia, I apologize for asking another question about it. Regarding the safety warning, I assume you have to coordinate its administration with vaccines. Considering that, how much of the chronic market can you capture? Additionally, how do you ensure customer loyalty for the product if it can't be used year-round? Is it designed more for seasonal use, or for chronic conditions, and how do you view the omnichannel approach?

Thanks, Erin. On the first one, we will take each country as it is. Brazil, what we will say, has not a warning label on the label and we expect that, that will be the case as we go forward in other international markets. And as we've said, we will work post the approval of this product with the FDA to continue to improve the label and do what's necessary to do that.

Yes, Erin. Thanks for the question on retail. Yes, as we noted, less inventory was built in the second quarter of this year than last year. That was the primary driver of U.S. Pet Health. Sales being down in the quarter, we feel like the retailers have inventory levels that will require them to continue to buy in line with dispensing and our focus is on dispensing. As noted, it continues to grow July, it grew year-to-date in the first half of the year.

Maybe I'll switch. We haven't talked about Farm Animal yet and U.S. Farm Animal was actually really strong. Can you just give us a little bit more detail what was going on there? Were there any one-times in there? I think there was a comment in the press release about resupplying of vaccines. So basically, just trying to get at what's the strength and how durable is that level of U.S. Farm Animal as we go through the rest of the year in '25.

Yes, thank you, Brandon. The global Farm Animal strategy is performing very well, particularly in the U.S. We have a diverse portfolio that includes medicated feed additives, vaccines, and therapeutics, and we are continuously adding innovation. This is strengthening our offerings in cattle, both beef and dairy, as well as in poultry and swine. Our value proposition goes beyond just products, ultimately helping our customers increase their profits. In low-margin cyclical businesses, this is where our connection with Elanco becomes strong, and it explains our leadership in the market. We are experiencing growth and gaining market share. There is significant interest in Bovaer from farmers, with 500,000 cows in our database and expected to reach a million by year-end. This demand from farmers and the potential for additional revenue streams have generated considerable interest in both the dairy sector and the pharmaceutical level.

Yes, Brian, I think we're really pleased with how the portfolio of innovation adds to the portfolio, be it Experior, be it our Prevacent vaccine for birds and swine, continue to really drive this business. We expect these trends to continue in the third quarter but will face a difficult compare in the fourth quarter, lapping last year's initial resupply of cattle vaccines and positive poultry rotations.

Yes, Ellen is with the team, and there is a lot of momentum and excitement in innovation. First, we plan to have a blockbuster product each quarter for the next three quarters. That is our goal and what we are working towards. Two of those markets will be new and beneficial for us. I won't discuss the specifics of the differentiation, but we believe it will be a great complement. Following that, we will introduce other assets as planned. We have a long-acting product from Kindred, along with other new technology in dermatology. We are really excited about this and expect both categories to grow, with no significant changes to our strategy at this time.

A couple of questions from me. Firstly, on the competitive dynamics side. I think you called out competition and parasiticides on pain. Could you quantify the market share loss, if any, for each of these segments? And how have the brands been impacted example, is Galliprant just losing market share alone? Or are you seeing a decline in absolute number?

Yes, great questions. Again, in the Pain market with innovation, with more share of voice, with more diagnostics, the Pain market continues to grow. Galliprant is meeting our expectations but it's been challenged with some of the competition. When we look at our pipeline and we look at our current portfolio, we like the prospects of the Pain market. And again, Galliprant, we continue to see a very strong part of our portfolio going forward.

We're at the top of the hour, so I'll just ask one question. Can you discuss the IL-31 product considering it has a different label than expected with the JAK? Based on my research, it appears that new patient starts are more likely to use Cytopoint instead of Apoquel, at least in the U.S.

Yes, thanks, David. The derm market is experiencing growth in both product forms and categories, each offering distinct benefits. We believe that Zenrelia, with its current label, has the potential to become a blockbuster. It will be launched globally and will be followed by IL-31.

This concludes today's conference call. Thank you for your participation and you may now disconnect.