Elanco Animal Health Incorporated

and welcome to the Elanco Animal Health Q1 earnings call. At this time, all participants are in listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today's conference is being recorded. If you press star zero. I would now like to hand the conference over to your speaker today. Mr. Jim Graffay. Sir, please go ahead.

Good morning. Thank you for joining us for Alanko Animal Health's Q1 2020 earnings call. I'm Jim Graffay, the 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 Katie Grissom from investor relations. During this conference call, we anticipate making projections and forward-looking statements based on our current expectations. Our actual results could differ materially due to a number of factors, including those listed on slide 2 and those outlined in our latest forms 10-K and 10-Q filed with the Securities and Exchange Commission. The information we provide about our products and pipeline is for the benefit of the investment community. It is not intended to be promotional and is not sufficient for prescribing decisions. You can find our press release, the slides referenced on this call, and an investor workbook on elanco.com. The slides and the information about the non-GAAP financial measure. After our prepared remarks, we'll be happy to take your questions. This morning, our introductory comments are longer than usual, so we are prepared to extend the call to ensure we. With that, let me turn the call over to Jeff to provide the highlights.

Thanks, Jim. Good morning, everyone. These are truly unprecedented times. And by offering our thoughts, prayers, and well-wishers, we also express our gratitude to those on the front lines battling this disease, caring for the afflicted, and providing the essential needs of life for all of us. This includes the farmers and veterinarians working to maintain the availability of our food supply and keeping our pets healthy. I'd like to personally thank all of my Elanco colleagues who remain available to pet owners, farmers, and veterinarians. As you know, Elanco is a purpose-driven company guided by our vision of food and companionship enriching life. This vision has never been more relevant than the last couple months. With the animal health industry designated as essential, our manufacturing plants and research labs continue operating to serve our customers, having implemented appropriate personal safety measures. Employees and all other company functions are working remotely, abiding by social distancing rules and maintaining virtual engagement with our customers, investors, regulators, and other stock stakeholders. We are beginning to put phased return to site measures in place where appropriate. Elanco and the Elanco Foundation, formed in 2019, are also doing their part. We're collaborating with leaders and their communities where we operate providing financial support from the Elanco Foundation to help fight rising food insecurity challenges brought on by this outbreak. Elanco and the Foundation will continue to look for more ways to help. The COVID-19 virus and ensuing pandemic are impacting our lives and our industry. From declining vet clinic visits and revenue to pressures in protein production and logistics, our customers began to feel the impacts in the second half of March, and the pressures have continued into April and May in both companion animal and food animal markets. We are carefully watching the leading indicators, and I'll discuss this in more detail at the end of the call. The COVID-19 pandemic has impacted Elanco in Q1, particularly the effect on our commercial distribution partners liquidity and thus actions that the pandemic has prompted us to take and working with them as shown on slide four. The decline in our Q1 revenue is a direct result of these discrete commercial actions. I will summarize first and then provide more details. The COVID pandemic created significant working capital and liquidity pressures and uncertainty on near-term end customer demand for our distributors, prompting reductions in the amount of inventory they hold. This unprecedented event also created a tipping point in the changes we were executing in our distribution approach. Recall, at the start of 2020, we consolidated our U.S. companion animal distributors from eight to four, and we instituted specific targets for them to generate end customer demand. I also personally established a monthly review meeting with each of them. Based on this evaluation of distributor performance across our capabilities, both across the promotional mix and across individual distributors, distributors are valuable in servicing vet clinic accounts, providing logistics, home delivery services, but a critical conclusion is that our distributors' ability to generate demand is much less effective than our own, especially in generating new clinic placements for our products. As the Elanco demand creation was increasing, we were seeing less impact directly by distributors in today's environment. Furthermore, the volume of product being held by distributors was not impacting their ability to create demand. This is an insight and a change from our historical experience. The COVID pandemic also impacted the inventory shift from our distributor consolidation. We expected the four remaining distributors would need to increase their inventory levels to handle the larger volume going through their operations, offsetting the inventory drawdown in the eliminated distributors. With the liquidity and working capital pressure from COVID, the distributors are managing their inventory more tightly. Consequently, in Q1, we reduced the amount of product in distributor inventory by approximately 60 million, mainly in the U.S. companion animal space. And we expect to further reduce an additional 80 million to 100 million, mainly in the second quarter, as we apply these new tactics across our business and geographies. The evaluation of our distributors was a priority. as I took primary responsibility for our U.S. operations last December. With the insights gained into distributors' capabilities and broader actions that drive demand, as well as the upcoming close on the Bayer acquisition, I'm excited by the changes in the Elanco's commercial leadership, and I'm confident we'll continue to create industry-leading execution in demand creation, product launches, and full utilization of the omni-channel. This is an important modification in our tactics, and the COVID pandemic was a trigger that accelerated this change at the end of March and into Q2. We've gained important insight where our own capabilities are superior, and we're adjusting our investments accordingly. We are confident that this tactical change will improve our cash flow, working capital, level of control, and commercial execution. In the near term, however, this decision negatively impacts our reported sales. With that summary, let me provide additional commentary on how we have worked with distributors in the past and how we're changing now. Manufacturers have a variety of arrangements with distributors. We established our buy-sell distribution structure when we started our companion animal business in 2007, and inventory has been an important part of the equation to do the following maintain elanco as a priority in their promotional efforts ensure strong positioning of our products in the face of new market entrance generics or other competitive dynamics facilitate flow through to own the end vet clinic and ensure safety stock at multiple nodes of supply chain with steadily increasing demand and expanding portfolios this strategy had worked successfully over the years as we grew share, we introduced new products, we created new clinic placements, and built brand awareness with both the clinics and pet owners. We have been evolving the structures, but the basic arrangements, including the assumed value of their promotional efforts and importance of inventory, has been unchanged for 13 years. However, as we have built our internal promotional capabilities, and dug into the data with clear deliverables for our distribution partners and dealt with our customers' liquidity challenges that were triggered by COVID, we concluded we needed to accelerate the change in inventory levels. As I mentioned, there are areas where distribution plays a valuable role, and we're moving to hybrid approaches to focus scope and targeted value efforts. The planned Bayer acquisition also enables us to do this now, since we will have expanded portfolio across more channels. We will also have the capabilities to use arrangements beyond the buy-sell structure we use now. The majority of our efforts are in the companion animal categories, but we've made adjustments in the food animal space as well. The Q1 decreases and the reported sales in our companion animal disease prevention and companion animal therapeutic categories are the direct result of these channel inventory adjustments. We expect second quarter decreases in our food animal business as COVID began impacting this portion of our business more in Q2 as the processing plants across the US began closing. These changes will strengthen our position. optimize our promotional approach, and enable us to direct investment in the commercial activities that drive demand for our products over the long run. These actions fit directly into our broader price and productivity priorities and our innovation portfolio and productivity strategy. This change in tactics with our distribution partners and resulting one-time negative impact will largely occur in the first half of 2020. but have immediate positive impact on our commercial competitiveness. And very important to note, I'm also willing to make this change in tactics because I see positive trends in the underlying business already in 2020 that are the result of Elanco capabilities in sales and purely commercial competitiveness, as well as a targeted marketing approach and leveraging value beyond product throughout the organization. Here are some material examples that highlight why Elanco's own demand creation will become the priority and distribution will play a targeted enabling role. First and foremost, in the U.S., the outbound sales of our companion animal products into vet clinics or alternative channels, what we call EDI sales, have been growing in the mid-single digits over the past year, and that continued in the first quarter. In the outside DeVette channels, Elanco is outgrowing the overall market and gaining share in Q1. Elanco Q1 growth in these alternative channels is nearly 35%. This is a great example of a trend that we've been betting on, especially with the Bayer acquisition. We are seeing the market evolve even faster than we anticipated when assembling the Bayer transactions. The same trend and positive execution was demonstrated with solid double-digit growth with Bayer through Q1. Our U.S. food animal business has had flat to slightly negative EDI sales, despite the trade challenges with Palene, the inconsistency of supply related to the contract's sterile manufacturing partner, and the launch of a generic reminiscence. And I can say that our strategy to maximize remittance sales in the U.S. against the generic is working. And for our productivity agenda, the areas that we directly control, price and cost-facing actions, continue to be positive, even in a challenging Q1. External market data from Kinetic, a third-party provider, is also encouraging. In Q1, Credelio's $7 percent growth and market penetration exceeded all other canine flea and tick brands. Credelio obtains nearly 10% of sales from new puppy starts, nearly double the category average. New patient acquisition is a critical part of our strategy in order to significantly capture the lifetime value of the pet. Relative to last year, Interceptor Plus has increased penetration, even in the face of new competition, with over 22% growth in the number of patients. Interceptor Plus continues to see strong growth through our marketing efforts, highlighting the benefits of comprehensive coverage against the worms that pets can be exposed to in their current environment. And in clinics where the product is on the shelf, Galloprant, is increasingly used as the first or second most recommended inset for osteoarthritis pain in dogs. Finally, some environmental pressures are abating. China, which was a significant drag on our industry last year, is showing signs of recovery in their swine herds among the large corporate customers, even tracking ahead of our expectations in Q1. Moreover, our international poultry vaccine business and aqua business continue to lead our future protein and health category. I am aware that our quarterly results have been noisy, and this year presents unique challenges we did not expect when we started the year. But beyond this, behind this, noise is a durable business with strong brands, innovation, and execution, even through the current pandemic and in line with our IPP strategy. The reduction in channel inventory is a structural change with our distribution partners and was a move brought on by COVID-19 pandemic. But ultimately, it strengthens our proven commercial capability while increasing our control, our productivity, and our growth potential. So let's now transition to slide five and review progress on our IPP strategy and the Bayer Animal Health acquisition. We continue to make progress on all of the key elements of our strategy. We launched Galloprant in Brazil in Q1, continuing the geographic expansion for that product. We gained approvals for Galloprant in companion animal markets Australia and Japan. Social distancing measures are driving increased companion animal sales through alternative channels, primarily in the U.S. This dynamic validates our omni-channel strategy with the Bayer acquisition, which will give us a much larger presence in the alternative channels. As an illustration, Bayer Animal Health posted 17% growth in their Q1 earnings in April. Teresto grew 51%, and Advantage grew 10.5%, with both products showing the strongest sales gains in the U.S. While these benefited from pandemic-related purchasing and a favorable prior year comparison in the U.S., the underlying demand growth is strong. Additionally, we announced a collaboration with VetNow to provide veterinarians access to an industry-leading telemedicine platform. Telemedicine is a part of a bigger agenda to enable the connection between pet owners and veterinarians across multiple mediums and platforms from our sales team, telesales, targeted use of distribution, and omnichannel leadership that will come from the combination of both Elanco and Bayer. And our productivity agenda, anchored in our cost-facing activities throughout manufacturing, is on track and delivering. Our productivity efforts were a benefit to gross margin in the quarter. Todd will discuss the overall margin in more detail later. The independent company stand-up and ERP development remains on track, even with social distancing and remote working arrangements. The Bayer acquisition continues to progress towards a mid-year close. We recently received antitrust clearances in Colombia, South Africa, and Vietnam in addition to the previous approvals in China, Ukraine, and Turkey. After several months of constructive pre-notification discussions, On April 14th, we submitted Form CO to the European Commission. They now have until June 8th to make a decision. The UK Competition and Markets Authority has accepted the merger filing from Dectra, who is purchasing Acernia, and commenced their review. This is another positive event towards close. All of the financing elements for the acquisition are in place. We are making progress in preparation for day one integration activities and the build-out of the SAP system at Tata Consulting Services. Despite the need to work remotely, the Bayer and Elanco teams are making significant progress on all integration activities, including preparations to capture synergies. And we announced the new executive team, including personnel from Elanco, Bayer, as well as external hires. We have structured the team and the organization to maximize the value of our combined portfolio, channels, and capabilities in all markets. We're expanding the Executive Committee to include new leaders of U.S. Pet Health and U.S. Farm Animal. We're also dividing our international commercial organization with leaders of Europe and international focused on emerging markets. And these changes become effective when the Bayer acquisition closes. Finally, we're adding a chief marketing officer now to bring greater focus on brands and their connection to pet owners, veterinarians, and producers. These leadership changes give us proven delivery, deep expertise, and a continued chemistry that's been established since the IPO. It also gives us a flatter, more agile structure that is closer to the customer, increased animal health and consumer packaged good marketing experience, deeper expertise on commercial execution in animal health, diversity of Elanco bear and external tenure on the executive team, and a dedicated focus on four market areas that operate substantially different in the competitive landscape, go-to-market models, and product priorities. It is our intent that each of these executives will have their lead teams named and in place by day one to accelerate value capture and create a more positive initial transition, all combined with increased marketing capabilities to grow across channels and businesses as we enter the next era of launching multiple products. You will have the opportunity to hear from our combined leadership team during an investor day that we plan to host within an appropriate time after the Bayer transaction closes. Let me summarize. Clearly, our sales in the quarter are impacted by COVID and its triggering effect to accelerate an important commercial change. As I look beyond this event, I am positive on the value of our products, our commercial strategy, and the moves we are making to position Elanco for the future. We have also made changes to ensure that our execution remains on track and our intensity sustains as we move to a mid-year projected close of Bayer. Now I'll turn the call over to Todd to provide more color on our results and outlook.