Elanco Animal Health, Inc. (ELAN) Presents at Cowen Healthcare Broker Conference Call - (Transcript)

Elanco Animal Health, Inc. (NYSE:ELAN) Cowen Healthcare Conference March 2, 2021 2:50 PM ET

Company Participants

Jeffrey Simmons - President, CEO & Director

Conference Call Participants

Kathleen Miner - Cowen and Company

Stephen Scala - Cowen and Company

Kathleen Miner

Thank you. Good afternoon, everyone. Today, we're pleased to have Elanco here at Cowen's 41st Annual Health Care Conference. As most of you know, Elanco is a leading animal health care company that was spun out of Lilly almost 2 years ago this month, I guess. And in mid-2020, the company acquired Bayer's Animal Health business that further bolstered its global position in both pet and farm animal health. The company is in the early stages of margin expansion. We continue to see the company is well positioned in the attractive animal health market.

So with us today, we're pleased once again to have President and CEO, Jeff Simmons. Jeff, welcome, and happy to have you back again.

Jeffrey Simmons

Great. Great to be with you. Thanks, Kathy.

Kathleen Miner

Sure. And we're going to get started. We've got a number of questions. But if anyone in the audience would like to ask something, you can either use the box on your screen or you can e-mail either Steve Scala or myself, Kathy Miner at cowen.com, and we can look at those.

Question-and-Answer Session

Q - Kathleen Miner

So just to get started, we'll go with one of the big picture issues and that's been a topic, and that has to do with the political and legislative front. And as you look at the new Biden administration, can you talk about what proposals or initiatives might be most important to animal health and particularly to Elanco?

Jeffrey Simmons

Yes. I think the first thing, Kathy, would be what we proved over the last year, a very durable industry, a cash business and the need, the growing need globally of pets and protein, that durability was shown a lot. And I even think, as you look at the new administration here and others around the world, we don't see anything that's material.

I think three things to watch. One is tax, of course, and to monitor that. We don't see anything again meaningful at this stage. Trade, we see the current administration and Secretary Vilsack that actually had a lot of time with the Obama administration, but also with the dairy industry and dairy exports while he was out of the administration and back, a supporter of trade, a supporter of the Phase 1 China agreement as well, which will be very important to protein producers. And then last is innovation. We've got our Animal Drug User Fee Act, the USDA with vaccines and the importance of a consistent, measured and a good process around innovation. So no material change, those are the 3 things we'll be watching.

Kathleen Miner

And anything in particular in 2021?

Jeffrey Simmons

No. We don't see anything in particular. The Animal Drug User Fee Act has been updated. And I think trade is going to be important with $5 corn, the importance of trade for our protein producers, west going east is going to be important.

Kathleen Miner

I want to move down and a question that at least that we hear from some investors. And at your Investor Day in December, you laid out how you're going to get to 3% to 4% revenue growth over the next few years. And you talked about the different aspects of the new products and the core products. And historically, we've seen the industry growing at roughly 4% to 6%, the overall animal health industry. So can you talk about your 3% to 4%, where you think there may be some upside or areas you're particularly confident in that could boost that closer to what we have seen as the industry average?

Jeffrey Simmons

Yes. I think a few things to keep in mind on growth. First of all, our IPP strategy hasn't changed as we became public and even before that, so innovation, portfolio, productivity. Bayer and independence from Lilly, I think, has strengthened, expanded that. And we're seeing that even in the Q4 moving to Q1 of this year. So I think that's important.

What we try to do in that investor conference is show an algorithm that will show the balance to that growth. So innovation, focused brands, the core brands, all contributors to growth, and then a few defense brands like Trifexis, Advantage and Rumensin, and then 5 key enablers that are going to drive that growth. We'll keep coming back to that on a consistent basis.

Now the 3 to 4 percentage points of growth, what I would highlight there is a few things. First of all, it's profitable growth. We're going to turn that into, as you already see, double-digit significant EBITDA, EPS. And that's cash flow that will then, of course, delever, and it'll create even more of a flywheel. Second is that 3% to 4% is going to come in targeted areas where there'll be more growth or we'll take leadership positions. So China swine, pet retail, raised without antibiotic poultry, we see more growth there, salmon and actually increasing share. So I would say it's balanced growth. We've had a balanced plan. You see the momentum. We've met our expectations since August 1, Day 1 with Bayer. We've carried that momentum in. We've raised guidance. And the goal is to have a balanced, predictable growth rate that turns into the most profitable growth in the industry.

Kathleen Miner

Okay. I guess part of that -- and when you talk about the growth going forward and some of your core products have to do on the companion animal parasiticides. And maybe we can start there on some product topics with Credelio and Interceptor Plus. Can you give us a sense of how much of those products right now are sold in alternate sites or the omnichannel, if you will, and where you see that going over the next 3 or 4 years? And could it be the majority of sales for parasiticides go online?

Jeffrey Simmons

Well, I think there's no question, and I would really highlight this is when you say when COVID is over, what's going to stay? And I'll start with a really big point. People always jump to the pet adoptions that occurred and other things. I don't think it's adoption. I think it's access.

Let's just look at a few key statistics that I think are going to stay in our world post-COVID for this decade, and they're going to be meaningful. So first of all, globally, we only access about half of the pets in the world, 250 million of the 500 million. So globalization and reaching pets and pet owners where they are matters.

In the U.S. before Bayer, we talked about 1/3 of the pet owners that weren't going to the vet. There's also 1/3 now post-COVID of pet owners that have experienced doorstep delivery and don't want to go back. And I think the vet clinics have done a transformational job during COVID of meeting pet owners where they want to shop with autoship, with telemedicine with curbside service. These are the trends that are going to stay. So I think the word that I stick with post-COVID will be animal access, pet access. Bayer and the transaction was built heavily around 3 or 4 principles. That was one of them. We are a leader in this space. We are outgrowing this double-digit growth rate.

Now the veterinarian still will be in the center. Scripted products will be as well. And that will be important. But yes, this capability matters and is significant.

Credelio, Interceptor Plus, a combination today that offers the broadest coverage. And really to get that broad coverage, you're going to need 2 products today with all the offerings, and this is the combination that matters.

I may also note, Kathy, just to take the liberty here to take a second and say, there's not many $200 million brands, let alone $400 million brands. And Seresto had a very big year, as you know. It is a leader as a collar, as an OTC brand that is growing globally, and it is a significant product for us going forward. It offers pet owners 8 months of coverage. It has got a great price point. And it's significant. It's going to be part of a connected care platform as we go forward.

Today, there was a little bit of news questioning or wondering about the safety of Seresto. It is one of the differentiations of this product. I always start by saying the safety of our products and the safety of pets, and pet owners care for that, it matters. It is a top, top priority for us as a company and for me personally.

Seresto, just a couple of statistics, it's been approved since 2012. In the U.S. alone, 25 million pets have been treated or used a Seresto collar. It's approved in over 80 countries. And I looked just today, this morning, in 2020, less than 1%, a fraction, a very small fraction of 1% of Seresto users called in. This is a regulatory process where they complain about the product. And the majority of the fraction of 1% was nothing. It was a nonserious question. So we have a very safe product, critical for pet owners and critical globally as we move forward. I just want to take a moment to highlight that.

Kathleen Miner

No. Appreciate that. And Jeff, just in comparison, is that less than 1% of users that called in with a comment about the product, would that be similar to what you would see with the oral flea and tick, for example?

Jeffrey Simmons

I don't have that data in front of me, but no, it'd be unusually, even maybe -- it's very small. So a fraction of 1% of all users being called in, I think, highlights the safety of the product. And then I want to really emphasize, again, this is a regulated process. This data is used with the regulatory bodies, which I think is great. The bar is very high. It's very regulated. It's exactly what we want for our pet owners. But again, a fraction of 1% and then the majority of the fraction was nonserious.

Kathleen Miner

Okay. And on the Seresto collar, it's been such a growing product. Are you looking at that technology for other species or other indications?

Jeffrey Simmons

Yes. Bayer, yes, the answer is yes. Bayer has brought that technology in. It is everything from R&D to manufacturing to also the ability, as you know, and we've talked about at the Investor Day, Aaron Schacht, the opportunity for connected care. During this decade, we're going to give the pet more of a voice. It's easy when you see a dog itching or is lame and not able to get up. But the ability to know when that dog, how much activity the dog has had, the movement of its head and is there something wrong maybe with otitis in its ears, we're going to see that also as a way to take Seresto into a connected care platform as well.

Kathleen Miner

Just to stay on the companion side for a moment. You're working on some biologics and for canine, feline pain. Are you working on them, I guess? And are they something other than the nerve growth factors, which have already been moving forward?

Jeffrey Simmons

Yes. We're not commenting a lot about the deeper part of our pipeline. What I would emphasize, if I look at just the different areas that we're focused on in our area, of course, we've talked about our JAK1, our monoclonal antibodies that both are in derm. We've got the parvovirus technology that's come over from Kindred. We continue to see a lot of opportunity in the parasiticide and the next generation of vaccines are just examples of a few areas that we see as key to our pipeline in the pet health space.

Kathleen Miner

Of that list of 11 potential parasiticides and 8 pet therapeutics that you put forward, are there any that you would like us to pay special attention to or that you're most excited about?

Jeffrey Simmons

I think it's important to look at the whole. I mean, I always say when we talk about parasiticides, it's close to a $5 billion market. It's global. It's canine, feline. It's inside the vet clinic. It's outside the vet clinic with the retail. It's inside the pet. It's outside of the pet. I think understanding that whole entire aspect of the market, and pet owners have more choices than they've ever had, but we still have, again, as I said, half the pets in the world not being treated, so global access matters.

I would highlight Credelio Plus that we're launching right now. This is about $1.5 billion of that market I just described outside of the U.S. We're launching this in Japan going into the season. Europe will be going into the season with it as well as Australia later in the year when they go into their season. So I would use Credelio Plus as an example of a continuous flow of parasiticide innovations from Elanco. We've committed to one a year. We'll have Credelio Cat here in the U.S., first kind of in class oral product for tick and flea for cats, which is feline. You'll hear more about cats from Elanco over the upcoming years is really important. So continuous flow of innovation, one a year, looking at this holistic market.

Kathleen Miner

Very good. Last one just on companion side. Gene therapy, is that an area you're interested in? We're asked about that as there are some smaller companies looking at those prospects.

Jeffrey Simmons

Yes. You prompt a question with that. I would say not a lot at this time. There's not a lot of richness of data in pets at this stage or what we would look at as important data. And the other you got to keep considering, and you all know this, is COPS, the cost of products sold in a cash market in animal health matters. So you've got to make something that does have a value proposition that may be a little different than a payer market on the pharma side. So that's important. But Kathy, I would say I've never seen in my years, as I talk about the 3 trends that matter for the decade or the first half of the decade, omnichannel in pets, climate policy in farm animal, but innovation, the maturity of innovation in animal health, gene therapy triggers this, the funding, the sourcing and the partnering of innovation is really the next gen for this industry, and it's going to be an opportunity.

Kathleen Miner

Maybe we'll move over to the farm animal side of the business right now. And perhaps we could start with swine and talk about the rebuilding process in China. And where do you see this process? Do you view that China is halfway back to its pre-ASF days or do you think less than that? How much more to go? And how is Elanco benefiting from that?

Jeffrey Simmons

Yes. I think the very first thing that we want to look at is how we look at the market. So pre-ASF, if you look at sow operations, sows that are over 500, it was between 10% and 12% of the market. We have seen a major acceleration of industrialized farms that have greater biosecurity. Backyard farms are a risk in China, really a risk anywhere. So they have an integrated process. The predictions now, Kathy, we will see before the end of this decade, I predict even sooner than that, that we'll see over 50% of the sows in China coming from operations of 500 sows or greater. So that, to me, is an example, I think, of the importance of this as you go forward.

So what I would say is, yes, we are seeing ourselves in the Bayer business and looking at our customer base, we are back at the industrialized market at pre-ASF levels, not at a country level. High pork prices, we're seeing better biosecurity with that and that shift to the market. You've seen, we, Elanco, we see double-digit growth. I think the industry is going to be growing double-digit pigs in China. It will represent, total China, 1% of total growth for Elanco.

Now let me highlight, I think, just over the last 10 days to 2 weeks, there continues to be challenges from ASF in the marketplace. It's still there. It's still prevalent, mostly in the backyard farms, but also there is some with some of the operations. So it's something we need to monitor and watch. We've considered that in our guidance. We don't see anything that's materially going to impact our plans, but it's something we want to watch as we go over the next couple of months.

Kathleen Miner

And you did say, these are in the smaller farms where this is showing up again?

Jeffrey Simmons

It is. There are some in some of the larger industrialized farms as well. And there's some overlap between those. But yes, it is in both. And there's been a little bit more prevalence over the last few weeks in the last month than we've seen in some time, especially in the industrialized segment. So we'll continue to monitor that.

Kathleen Miner

Okay. And when you talk about China representing 1% of Elanco's growth this year, is that virtually all on the farm animal side or is there some companion animal in that, too?

Jeffrey Simmons

Yes. It's actually, I'm going to say across really the 3 Ps that matter in China. Pigs matter the most, and that's going to be the most material. We've had a long legacy poultry business, strong portfolio. Again, another industry that's further along than pigs on being industrialized. And bird flu and other things have caused that. And then the pet market that comes with Bayer. So we're a major player in pets. Pets will drive some nice growth as we're launching Advantage and Seresto. We're more than a year into that launch. That's going well.

I would add one fourth business that's come in from Bayer, which is warm water fish. So the shrimp and the tilapia market as well, that's a nice business that we see significant growth in, very small still. So a very strong China business, but it'll be all species that will drive that 1% growth.

Kathleen Miner

Okay. Maybe now just moving over to the cattle side for a moment. Just one question first on, kind of a big picture. The pandemic, we've seen some changes in terms of how protein is consumed, the types of it, the amounts of it. And also throwing in there plant-based alternatives to protein. As we go forward from this pandemic, what sort of changes do you see in the cattle, beef cattle industry? And how might that impact Elanco?

Jeffrey Simmons

Yes. I got to make my one plug here. I'll be in Amarillo, Texas with cattle customers tomorrow. And I'll just say that, it's important to look at a $1.2 trillion animal protein market that's growing 1.5% to 2% as predicted. Yes, a $20 billion to $30 billion market on the alternative protein is fine, but I actually think it's increased the exposure of protein, the importance of protein, but we don't see a slowing of animal-based protein. We ate more beef in 2019 than any time in the United States ever.

And so as GNP grows outside the United States, that's moving people to animal-based diets. But secondly, any diet in the U.S., it seems like anymore, has less carbs and more protein, more animal protein. So there's a tailwind I still see here.

Now when you look at the cattle market, there was a historical number of cattle in the feedyard on feed, 12.1 million in January, never been that high before. I will say, though, cattle typically bookends the year. In the beginning, it's a little higher. So we're starting typical, more typical than last year. And we'll probably end high. And we'll have the normal decline that we see in the summer. So look for a more normal year in beef in 2021 than we saw in 2020. And I believe the processing plants, the protein companies have done an amazing job of bringing in a medical adviser and vaccinating their employees with COVID. And they've done a nice job, I believe, at creating a stronger, more sustainable supply chain.

Kathleen Miner

Okay. Well, I think you mentioned you're going to Amarillo tomorrow. Are there any issues in Texas with the business, either with your customers or anything that we might see when you do report first quarter numbers?

Jeffrey Simmons

Yes. I think like everybody else, there was definitely a supply chain challenge in that week, 1.5 weeks during that time, but we don't see anything that's material or lasting. It was maybe a little bit more of a lag and again, impacting the livestock side more than the pet side. But nothing that we see and nothing that would impact our guidance.

Kathleen Miner

Okay. I want to move to one of your new products that's launching this year, Experior, for ammonia emission. Are there certain countries where you anticipate that's going to be better received? And what kind of potential market would that unique product be?

Jeffrey Simmons

Yes. So this product would be used late in feedyard cattle. That's the claim. And this would be to reduce ammonia. And so one of the very first, I think the first FDA-approved beef products with an environmental claim through the FDA. And we have been very careful here. We're working very much in concert with the industry to, first, make sure because beef exports matter so much that we've waited to ensure that we get MRLs, maximum residue limit certifications in all the countries that are critical. 95% of the beef export markets are now approved with MRLs for Experior. It is approved in the U.S. and Canada now, which are the major feedyard markets. And we'll be working with operations. Our first one made a commitment, as I shared on earnings last week, production, processing and sales all aligned. We'll continue to keep you updated.

Again, we see, Kathy, I think the global policy, animals are part of the solution, not the problem. They are on 60% of the land people don't use and reducing methane can actually create global cooling. Animals only represent 4% of the greenhouse gases. And I've been on many operations, and most of the leaders in this industry believe they can be net zero by 2050, some in this decade, and be part of the solution. You can't eat your way out of this. Animals can be definitely a natural recycler and help us be part of the solution. Experior is part of that.

Kathleen Miner

Okay. On Increxxa, has it launched in the U.S. at this point?

Jeffrey Simmons

It has not launched in the U.S. That will be late Q1, Q2, early Q2 launch. It is approved.

Kathleen Miner

Because of the nature of that product, would you expect that to gain share rapidly or do you think that this is going to be a slower buy-in as the producers start to use this alternative product that's generic?

Jeffrey Simmons

Yes. It's definitely a unique situation that I don't think we've seen much in the animal health industry. Injectable products have different barriers to entry when it comes to manufacturing, when it comes to market entry and regulatory. What I would say for Elanco is, this is a complement to a broad portfolio, Baytril that came from Bayer, Cydectin that brings the worm and parasiticide market. We've got the broadest beef portfolio. We see Increxxa as one of those complements to be a full line solution, added with our value beyond product offering, Kathy. So this is all about increasing the total value proposition of Elanco to a beef producer, just like we're bringing them Experior as well. More to learn, though, on this market dynamic because I don't think we've seen something like this. So we'll learn a lot, and I'm not specific on right now what the conclusions will be. We'll know more at the end of this year.

Kathleen Miner

Fair enough. Are you also interested in livestock monitoring, whether it be cattle or other species? We saw Merck made a recent acquisition in the poultry side of it. Is this a space that Elanco will be more, will be present in?

Jeffrey Simmons

Yes. We made our first value-add livestock acquisition in 2007, acquiring AgSpan. And since then, different moves we've made in partnership and through acquisition have been more focused on precision farming and performance from the precision farming. So the Benchmark database with all the cattle operations, that will be important as we roll out these next two new products. So we're more performance-based versus animal ID.

Kathleen Miner

Okay. We're doing well on time. A few more topics to try to go through here. You've talked about your pipeline. We'll just go back to that for a moment. You have 45 pipeline opportunities. You've got to get 25 launches over the next 4 years. How does this success rate compare to Elanco in the past? And if it's changed, how has that changed?

Jeffrey Simmons

Yes. So just to reiterate, again, as we said in December, we're coming off from the last era, and we talked even about the results of those products that Aaron and his team in R&D, we've seen 14 new products since 2015. They're contributing over $450 million to our sales, and they're going to continue to grow. They grew 5% last year, products like Galliprant and Credelio and other products we've added. And some of those were trade-offs that we further developed at the end from an acquisition even. Now we're looking at these 45 candidates, 25 products contributing 2% to 3% growth, $500 million to $600 million between now and 2050.

What I would say is, our proposition from innovation continues to grow at a growing pace. Our number of options continues to grow. Our capabilities and our size and our scale continue to grow with the Bayer acquisition. So I believe innovation is growing. It's growing in the potential of what it can deliver as well as the capabilities. And we're going to continue to keep within that P&L of R&D optionality to do things like we did in December with the Kindred parvovirus as well.

Stephen Scala

Can I follow up on one pipeline dimension? Earlier, Kathy asked you about pain products, monoclonal antibodies for pain. And I understand you're not able to answer for disclosure reasons. And we totally get that. But would you identify any limitations or substantial hurdles in a monoclonal antibody, whether it be TNF or not, as you did with gene therapy? So with gene therapy, you identified the cost hurdle. Are there any hurdles with TNF or monoclonal antibodies?

Jeffrey Simmons

Not anything that's unusual by any new science that comes in. So I do think that the things I mentioned, I maybe add one more to the list, Steve, but I think there's no question the complexity to do the research. So the safety profile is always going to be important and being able to get efficacy with dose and duration that's convenient for a pet owner or a livestock or a pet owner, in this case. And so then you jump from that safety and use and being practical to over, is it done in the vet clinic or not? And then you jump over and say, okay, then you got to look at the economics, I think, is important. And then the speed to market and the ability, is there another platform of science that maybe allows you to do something differently. And so those are the kind of trade-offs that we're looking at.

The convenience to the pet owner post-COVID matters more than it's ever mattered. And so that is also a factor in this. And the manufacturing cost, as you know, is critical to a cash-driven business and probably our biggest difference to human pharma is that.

Stephen Scala

Okay. I'd like to follow up on one other thing that you mentioned very early on, and that was when Kathy was asking about possible changes in Washington. And one of the first things you mentioned was tax. We and others perhaps are looking for a relatively stable tax rate for Elanco going forward. Is that too optimistic? Are we more likely to see tax rates rise at Elanco?

Jeffrey Simmons

I don't want to predict the future in that area. But as our guidance shows and as we go forward, no, we see a stable tax, nothing unique or different from us, from anyone else.

Stephen Scala

Okay.

Kathleen Miner

Jeff, could you comment on your business development activity? Now that Bayer is on board and as you're looking forward, are there certain areas or types of products or services or geographies that might make some sense for Elanco to bring them in?

Jeffrey Simmons

We will continue to be the partner of choice in innovation. And I think you've seen that, whether that is with what has happened over the years with the Novozymes and Aratana, now with Kindred. We'll continue to say, hey, we're independent. We're agile. We can partner. And we'll keep our P&L that way. I wouldn't say that comes off the balance sheet as much as the ability to bring in a deal or a compound or help someone globalize and get to the global -- world's animals or regulatory late-stage development. So that's something that I would say is more part of our operations.

When I look at the balance sheet and I look at business development, look, there's 2 things I would mention. One, we drive that 3 to 4 percentage point into double-digit growth in cash and delever. And number two, I think that we reinvest. As we even did some in the fourth quarter, we have a lot of growth opportunity in our existing portfolio, our existing geography and the pipeline. So that's the highest priority, delevering and fueling growth, not needing anything else to drive that algorithm going forward.

Kathleen Miner

Could you remind us what the dividend policy is for Elanco now?

Jeffrey Simmons

Yes. It's something that we've entertained since Day 1 coming out of Lilly. We know the importance of that to investors over time. But again, with what I just highlighted as our capital allocation focus, dividend is not something that's on the agenda here in the short and medium term.

Kathleen Miner

Okay. Fair enough. And with that, we have managed to go exactly on time. Steve, if you have any other last ones in there?

Stephen Scala

I'm good. Thank you.

Kathleen Miner

You're all good? Jeff, it's been a terrific overview of the progress you're making, and we appreciate you spending this time with us and going through this. So thank you very much, and we hope you have a good rest of the day. Thank you, everyone.

Jeffrey Simmons

Great. Thank you, Kathy. Thank you. Thanks, Steve. Bye, bye.

Kathleen Miner

Take care.