Elanco Animal Health Incorporated (NYSE: ELAN) Q2 2023 Earnings Call Transcript August 7, 2023
Operator: Good early morning. My name is Rob, and I will be your conference operator today. At this time, I wish to invite everybody to the Elanco Animal Health Second Quarter 2023 Earnings Conference Call. All lines have actually been put on mute to avoid any background sound. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] Thank you. Katy Grissom, Head of Investor Relations, you might begin your conference.
Katy Grissom: Good early morning. Thank you for joining us for Elanco Animal Health’s 2nd quarter 2023 incomes call. I’m Katy Grissom, Head of Investor Relations. 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 throughout this call are available on the Investor Relations area of elanco.com. Today’s conversation will consist of positive declarations. These declarations are based upon our present presumptions and expectations, and undergo threats and unpredictabilities that might trigger real outcomes to vary materially from our projection. For more details, see the danger elements gone over in today’s incomes news release, in addition to our latest Form 10-K and 10-Q submitted with the SEC.
We do not carry out any task to update any positive declaration. Our remarks today will concentrate on our non-GAAP monetary procedures. Reconciliations of these non-GAAP procedures are consisted of in the appendix these days’s slides and in the incomes news release. After our ready remarks, we’ll enjoy to take your concerns. I’ll now turn the call over to Jeff.
Jeff Simmons: Thanks, Katy. Good early morning, everybody. Elanco provided a strong 2nd quarter with significant development in our late-stage pipeline, the effective conclusion of our ERP combination and surpassed the leading end of our assistance variety on income by $4 million, changed EBITDA by $61 million and changed EPS by $0.13. We continue to anticipate this consecutive enhancement in the very first half to continue with an expected go back to income development in the 2nd half of 2023. We are upgrading our expectations for the year, raising assistance for income, changed EBITDA, and changed EPS. Starting on Slide 4. Since our last call, we provided enhanced functional efficiency and accomplished essential turning points advancing our method. First, in Q2, we provided the 2nd successive quarter of consecutive enhancement and year-over-year income efficiency, leaving out the ERP blackout effect, driven by strong efficiency from the U.S. Pet Health business, International Farm Animal and contributions from brand-new items.
Additionally, we finished our ERP combination and revealed resolution of the EPA Seresto evaluation, validating the item’s ongoing registration. On financial obligation, we are finishing the refinancing of our August 2023 notes today. Next, in the quarter, we saw strong adoption in a number of EU markets for Adtab, our freshly released oral OTC flea and tick service; and in July, we released our Canine Parvovirus Monoclonal Antibody in the U.S. We made substantial development on our late-stage smash hit pipeline advancing essential programs and acquiring extra self-confidence on the distinction and launch strategies. Finally, we provided our 2022 ESG report showing development on our Healthy Purpose sustainability efforts in our internal operations, consumer cooperations and beyond.
Focusing now on monetary efficiency, on Slide 5, we supply a view of year-over-year income for the very first half of the year, leaving out the effect of the ERP combination in between the very first 2 quarters. Elanco reported a 1% decrease in consistent currency, showing a significant enhancement from the 5% decrease in the 2nd half of 2022 and exceeding our assistance expectations of a 2% to 4% decrease. Looking now to the essential drivers in our 4 business locations that drove this overachievement. First, U.S. Pet Health. U.S. Pet Health went back to development in the very first half of the year, providing 1% development year-over-year. Our method to increase share of voice, enhance physical accessibility, utilize development, and grow cost added to the enhanced efficiency.
The strong parasiticides season added to the OTC retail market giving development in both systems and overall sales, while Elanco execution caused share gain in this market through the very first 6 months of the year. Both Seresto and the Advantage Family grew income high-single digits, going beyond expectations, as our brand-new innovative projects and boost in overall circulation points started to reward. On the veterinarian center side, our financial investment in digital and boosted sales force efficiency drove a 36% boost in overall touch points in the very first half of the year. This much deeper engagement with vets and centers added to penetration development for Credelio and Interceptor Plus and Galliprant. While competitors stays impactful in the U.S. veterinarian market, these increased touch points and penetration added to the stabilization of our business in this channel.
Bobby Modi’s group’s tactical execution is enhancing results, and we anticipate continued positive momentum from this business in the 2nd half as we get ready for an amazing development launch window in 2024 and beyond. Next in our International Pet Health business. This business decreased 7% in consistent currency in the very first half. 6 portion points of the decrease was driven by the effect of continuous need pressure in the Spain retail parasiticide market. More broadly, we saw ongoing development in our Credelio franchise, stabilized by slower markets, mostly affecting retail and other essential locations like Italy, China and Japan. The European launch of Adtab exceeded expectations, increasing its anticipated complete year contribution. Our market penetration method and fast action has actually placed us well in the emerging OTC oral parasiticide market in Europe.
We anticipate enhancement in our International Pet Health business in the 2nd half as we utilize development and prepare for a much better financial environment in Europe compared to the 2nd half of 2022. Now transferring to Farm Animal. Our International Farm Animal business, the biggest of the 4 quadrants, grew 4% in consistent currency in the very first half, driven by strength in poultry, aqua and cost. We anticipate these drivers to stay strong in the 2nd half of the year. The U.S. Farm Animal business decreased 5% in the very first half, with 4 portion points driven by supply interruption for livestock vaccines and the staying driven by implant guideline modifications and timing of poultry rotations. These were partly balanced out by increased adoption of Experior and contribution from NutriQuest.
In the 2nd half, we anticipate more powerful efficiency from our U.S. Farm Animal business, driven by enhanced vaccine supply, the ongoing ramp of brand-new items and increased need for our poultry portfolio. A couple of talk about Experior. Experior stays an essential development sales development driver for this year. Beginning in March, we saw a positive trajectory modification in using the item, which continued to speed up through July, leading to 2nd quarter sales at 3 times those of the very first quarter. Adoption in Canada is tracking on a comparable trajectory as the U.S. We continue to concentrate on broadening usage with existing consumers and anticipate to leave the year at an annualized run rate of around 60 million to 70 million. Finally, we’re motivated by the recent statement from Tyson Foods to reestablish animal-only prescription antibiotics or ionophore into their poultry supply chain.
Elanco leads the in-feed poultry services location with a range of tools from nutritionals to our distinguished narasin, an ionophore, items, Maxiban and Monteban, which we anticipate will be essential items in these brand-new programs. As the processor of about one-fifth of all the U.S. chickens, our company believe Tyson shift will lead to a more sustainable production, enhanced animal well-being and a positive net effect on Elanco’s business. Moving now to Slide 6. Let’s take a look at the tactical drivers of our development, portfolio and efficiency structure over the previous couple of months. First, with efficiency. In April, we effectively finished our ERP combination, streamlining our internal and customer-facing business procedures and making it possible for synergies. Among other things, the simplification used the capability to participate in a typically utilized balance dues property securitization program.
This program will supply most of the funds to retire our 2023 notes, which we are finishing today. Next, onto the portfolio. For Seresto, we’re really happy with the result of the EPA’s thorough evaluation and the verified continued registration of the item. We never ever fluctuated in our data-driven self-confidence in the safety profile of Seresto, and we are motivated by the robust science-based technique taken by the company. We see the stewardship strategy as a chance to raise the bar throughout the collar classification. We see the EPA result as a positive for the Seresto brand name, family pet retail, vets and, most significantly, family pet owners. We now move our focus to making the most of the industrial chance for Seresto internationally, with an item going back to high single-digit development in the U.S. in the very first half of this year.
Next, cost continues to be strong, driven by the enhanced abilities over the in 2015 with 4% development on a year-to-date basis. We now anticipate cost development of a minimum of 3% for the complete year. With the motivating pipeline development and our expectations concerning distinction, we’re increasing our financial investment in the U.S. Pet Health business. The industrial organization, led by Bobby Modi, in collaboration with Tim Beddington, leading our market method efforts, are concentrated on building on our digital development, including skilled animal health marketing skill and accelerating our efforts to broaden our field force. This financial investment is concentrated on making the most of the capacity of our overall family pet health portfolio, including our launches this year and the development we anticipate to launch in 2024 as we globalize the portfolio gradually.
Finally, transferring to Slide 7, I’ll supply an update on our late-stage pipeline. Overall, the pipeline is enhancing with essential development in essential late-stage programs and portfolio-enhancing approvals in significant markets throughout types. Ellen de Brabander and her group are driving early-stage developments, moving interesting tasks from research study into medical advancement as we continue to build the elements required to provide constant, high-impact development. In the U.S., we released our canine parvovirus monoclonal antibody, an extremely expected treatment for among the most infectious and lethal dog infections. The supply chain is making it possible for responsiveness and the item is already conserving dogs’ lives, driving reorders. As anticipated, in 2023, need is surpassing supply due to the expected capability restrictions in our center at launch.
We are on track to increase our capability to 10x today’s volume to support the anticipated boost in need in the coming years. This year, we anticipate income contribution of $5 million to $7 million. However, we see this item as an essential development driver to both the top- and fundamental beginning in 2024 and anticipate smash hit contribution as we broaden outside the U.S. gradually. As we have actually shared formerly, we took a phased technique to submitting our late-stage possible hits. With 3 items in late-stage evaluation, we value the foreseeable nature of the FDA procedure, driven by ADUFA, the Animal Drug User Fee Act. Our views about our items are based upon the information we have actually created and, naturally, undergo the approval procedure.
Today, we are happy to share that our company believe the FDA has all the information essential to authorize our distinguished JAK inhibitor for canine dermatology. We are motivated by this item’s development and think it will be extremely valued by vets and family pet owners. Additionally, by the end of August, we anticipate the FDA will have all the information essential to authorize our broad spectrum parasiticide for dogs, and for Bovaer, our methane-reducing item for livestock. Based on this, we continue to see a course towards FDA approval in the very first half of 2024 for all 3 of these possible smash hit items. With the advancements in the parasiticide space, over the last month, our self-confidence concerning the anticipated distinction for our canine broad spectrum parasiticide has actually increased.
Our item, upon approval, will be called Credelio Quattro. A mix of lotilaner and 3 other active components, it will concentrate on fleas and ticks in addition to broad protection of internal parasites, consisting of heartworm, round warm and tapeworm. The item is looking for to show 100% heartworm avoidance after one month. We anticipate that distinguished protection of Credelio Quattro and the distinction of our JAK inhibitor for dermatology, this will enable Elanco to supply a more thorough and important portfolio of canine items to veterinary centers in 2024. Shifting to Bovaer, our first-in-class development to make it possible for methane decrease in livestock where we will focus our preliminary efforts initially on dairy. Based on the broad body of research study supporting the item’s approval in lots of nations around the globe and our conversations with the FDA, we’re extremely positive in the course to approval for this item in the very first half of 2024.
Importantly, our company believe we have actually protected essential launch supply with an agreement maker, a crucial part of the 2024 development contribution. As we leader brand-new ground with items to decrease ecological effect, we are working throughout the worth chain to verify, aggregate and develop worth for lowering animals’ ecological effect and we are motivated by the interest from the food cycle. Regarding our IL-31 short-acting monoclonal antibody for canine dermatology, we now anticipate a distinguished item profile relative to the present innovation. However, our expectation for U.S. approval has actually moved to 2025 as an outcome of the USDA’s increased information requirements throughout monoclonal antibody platforms. We stay positive in the item and its worth in our total portfolio.
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Our development sales for 2023 continue to track to our assistance of $210 million to $250 million, and we still anticipate to have incremental development income of $600 million to $700 million by 2025. The shift of IL-31 is stabilized by increased expectations for our other late-stage possible smash hit items in addition to self-confidence in our views on Experior, Parvo and Adtap. Over the last a number of months, our launch income expectations for our late-stage possible hits have actually increased as an outcome of greater self-confidence in our distinction, boosted launch strategies and the progressing competitive landscape. We comprehend providing on our opportunities and our pipeline work out beyond getting the item over the regulative goal, and we are buying skill and abilities to completely record the worth of our portfolio in 2023 and beyond.
Now I’ll pass it to Todd to supply more on the 2nd quarter outcomes and monetary assistance.
Todd Young: Thank you, Jeff, and good early morning, everybody. Today, I’ll focus my talk about our 2nd quarter changed procedures, so please describe today’s incomes news release for an in-depth description of the year-over-year modifications in our reported outcomes. Starting on Slide 9. In the 2nd quarter, we provided $1.057 billion of income, a decrease of 10% or 9% in consistent currency. Price contributed 4% in the quarter. In April, we finished our worldwide systems combination, bringing the tradition Bayer Animal Health business into the Elanco ERP environment. We stay positive in our May quote, that includes an earnings shift in between quarters from the ERP blackout approximated in the series of $90 million to $110 million, representing an 8 portion indicate 9 portion point hinderance to development in the 2nd quarter.
Outside of this, the base business carried out above our expectations in the 2nd quarter with an approximated flat to 1% income decrease in consistent currency compared to previous year, as revealed on Slide 10. This represents a trajectory modification from mid-single-digit consistent currency decrease we reported in the last couple of quarters. Consistent with last quarter, on Slide 11, we supply our income results by business location on a reported and consistent currency basis. For Pet Health, consistent currency decrease was 14%, with an approximated headwind of 11 portion indicate 13 portion points from the ERP blackout. In the U.S., Pet Health income decreased 9%, consisting of an approximated 11 portion point headwind from the ERP blackout. The approximated 2% development in the underlying business was driven by OTC retail, as our tactical efforts drove enhanced giving while likewise taking advantage of cost, development and supply interruption in the 2nd quarter of 2022.
This year, we increased our involvement in seller promo occasions with essential e-commerce partners, leading to increased getting in the 2nd quarter. Relative to our assistance in May, we approximate around $10 countless OTC items were offered to merchants in the 2nd quarter versus our expectation for the 3rd quarter. Additionally, we saw development in our discomfort portfolio in vaccines in spite of supply interruptions on specific vaccines. Growth was partly balanced out by ongoing pressure on our tradition prescription parasiticide portfolio; nevertheless, share loss has actually slowed over the last a number of quarters. International Pet Health decreased 23% in consistent currency, with an approximated headwind of 14 portion points from the ERP blackout. Excluding the blackout effect, the underlying business decrease was driven mostly by our Spain retail business.
Exceptionally strong need expectations and buying from suppliers and merchants in the very first half of 2022 was followed by [pressured] (ph) financial conditions. As an outcome, need did not emerge in the 2nd half of 2022 and stay listed below expectations in the very first half of 2023, leading to a year-over-year decrease in both durations for our business. In 2023, this affected our business in the very first quarter, however was more substantial in the 2nd quarter. We think ongoing enhancement in customer need will drive sales enhancements in the 2nd half of 2023 and the very first half of 2024. Moving to Farm Animal. Our worldwide business decreased 3% with an approximated 5% headwind from the ERP blackout. Excluding that, the underlying business development was driven by strength throughout global poultry and aqua, partly balanced out by anticipated decreases in U.S. livestock associated to vaccine supply interruption and regulative modifications for implant.
Supply interruption for livestock vaccines is anticipated to be remediated in the 3rd quarter, supplying a tailwind in the 2nd half, however to a lower degree than we anticipated in our contact May. Continuing down the earnings declaration on Slide 12. Gross margin increased 10 basis indicate 58.9%. Gross margin consisted of 150 basis indicate 180 basis points of unfavorability from the ERP blackout. The underlying enhancement was driven by cost development, efficiency and the favorable effect of FX on cost of sales, balanced out by greater inflation. Operating expense increased 2% year-over-year in the quarter, with R&D costs down 1% to $81 million and SG&A expenses up 3%, driven by increased marketing financial investment and employee-related costs, partly balanced out by the favorable effect of foreign exchange rates.
Interest expense was $74 million compared to $50 million in 2015, somewhat much better than our expectations. Adjusted EBITDA was $222 million in the quarter or a decrease of 27% with an approximated $70 million to $90 million headwind from the ERP blackout. Adjusted EBITDA margin was 21%, a decrease of 490 basis points with an approximated 450 basis indicate 540 basis point decrease from the blackout. Adjusted EPS was $0.18 in the quarter, with an approximated $0.11 to $0.14 headwind from the ERP blackout, presuming a business combined tax rate in line with the very first quarter of 21.9%. On Slide 13, we supply a walk from our 2nd quarter assistance to actuals. The over efficiency compared to assistance for changed EBITDA and adjusted EPS in the quarter was driven by greater-than-expected sales and our higher margin U.S. Pet Health business.
Additionally, the adjusted EBITDA advantage of $61 million compared to the leading end of the assistance variety, consisted of favorable effect on COGS and lower operating expense. The changed EPS advantage of $0.13 was likewise affected by $0.03 of favorability from interest and tax. Before transferring to assistance, let me use a couple of words on our money, working capital and financial obligation on Slide 14. Cash supplied by operations was $61 million in the quarter. The year-over-year decrease in the 2nd quarter running capital shows the effect of in 2015’s rate of interest swap settlement, greater money interest and a boost in net working capital, particularly from stock. Inventory was using money once again this quarter, driven mostly by increased Farm Animal stock, mostly as an outcome of pressure on sales volumes over the last a number of quarters.
We are really concentrated on actions to enhance working capital. The system combination allows opportunities to enhance collections throughout our whole business, enhancing balance dues, and we are enhancing stock management by lowering warehouse. We are taking further actions to manage our inventory, including renegotiating the timing of delivery on API and raw material contracts, assessing safety stock levels by product and ongoing reduction of throughput at certain manufacturing facilities. These efforts are expected to deliver benefits to the balance sheet gradually over time as we implement changes while also prioritizing new product launch supply needs. We ended the quarter with net debt of $5.75 billion, with $250 million drawn on our $750 million revolver.
Today, we will retire the $344 million of notes due in 2023 as we reported on our Form 8-K from early July. We will fund the retirement with a $250 million asset securitization facility on accounts receivable and approximately $100 million from the revolving credit facility. As Jeff mentioned, the consolidation of our ERP system provided us the flexibility to enter into the securitization agreement. At the end of June, our net leverage ratio was 5.9x, up from 5.4x at the end of the first quarter, but below our expectations due to our adjusted EBITDA outperformance in the second quarter. Given the increased use of cash for inventory above our expectations in the second quarter, we now expect to pay down $50 million of debt in 2023. We anticipate our year-end net leverage ratio will be between 5.5x and 5.8x.
Importantly, we continue to expect durable cash flows from our business over time with debt paydown as the primary capital allocation priority. The next significant debt obligation is due in 2027. We have updated Slide 23 to reflect our key debt information after the retirement of the 2023 notes. In May, we fixed an additional $750 million of variable rate debt with interest rate swaps that mature in 2028. As a result of these two financing transactions, our fixed rate debt will remain approximately 75% of total debt through the end of this year. After including the late July rate hike by the Federal Reserve, if we assume flat interest rates throughout 2024, no more Fed rate adjustments, we expect next year to have income statement interest expense of approximately $305 million to $315 million and cash interest between $340 million and $355 million or a $40 million to $55 million improvement compared to this year on cash interest.
Finally, we have also included Slide 24 in the appendix which points to our expected meaningful reduction in project cash costs beginning in 2024. Now let’s move to our financial guidance, starting on Slide 16. As Jeff said, we are raising our full year guidance for revenue, adjusted EBITDA and adjusted EPS. For the full year, we now expect revenue to be between $4.35 billion and $4.41 billion or approximately 1% growth to a 1% decline in constant currency. For adjusted EBITDA, we now expect $950 million to $1.01 billion. Adjusted EBITDA reflects the improved sales outlook and the second quarter overperformance. It also factors in gross margin headwinds we expect from reducing manufacturing throughput to reduce inventory and improve cash and the investment in our pet health business that Jeff described.
For adjusted EPS, we are raising our guidance to $0.80 to $0.89, reflecting the adjusted EBITDA impacts and improved assumptions for interest expense and tax. On Slide 17, we are introducing financial guidance for the third quarter. We expect revenue of $1.025 billion to $1.06 billion, representing a constant currency growth range of 1% decline to 2% growth. We expect adjusted EBITDA between $170 million and $200 million, and adjusted EPS of $0.08 to $0.13. Finally, moving to Slide 18. Our implied second half revenue guidance represents flat to 3% constant currency growth. We remain confident in the second half return to growth, led by contributions from price, new product ramps, improved supply for vaccines and continued growth in poultry and aqua, offsetting continued pockets of competition.
Now I’ll hand it back to Jeff for closing comments.
Jeff Simmons: Thanks, Todd. As we close, I want to thank the global Elanco team. This team around the world is laser-focused on delivering value for our customers and shareholders, and our results this quarter reflect significant progress. We delivered a strong second quarter, demonstrating operational improvement, exceeding our expectations and contributing to our raised full year guidance. The continued sequential improvement in year-over-year underlying revenue performance was driven by a return to growth in the U.S. Pet Health business, strong International Farm Animal performance and contribution from the new products. We expect this momentum to continue with an anticipated return to revenue growth for the company in the second half of 2023.
Importantly, we’ve reached the pivot point with our standup and combination now behind us and an optimized infrastructure to build our next era of innovation and growth. Our team is making strong progress on our efforts to transform animal care, bringing new solutions to some of our customers’ greatest challenges from diabetes and cats to deadly parvovirus and puppies to environmental solutions in cattle. This quarter, we made significant pipeline progress on our late-stage pipeline, enhancing our confidence in our differentiation and launch revenue expectations. We are very encouraged by this advancement and are investing to maximize the potential of our full portfolio and the expected launches. Our focus is on consistent shipment and sustained innovation with a balanced outlook for future growth, improved cash flow and long-term value generation.
With that, I’ll turn it over to Katy to moderate the Q&A.
Katy Grissom: 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.
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