Elanco Animal Health Incorporated

Good day and thank you for standing by. Welcome to the Elanco Animal Health Incorporated Q1 2021 earnings conference call. At this time, all participants are in a 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 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star zero. I would now like to hand the conference over to your speaker today, Tiffany Kanega. Please go ahead.

Good morning. Thank you for joining us for a Lenco Animal Health first quarter 2021 earnings call. I'm Tiffany Kanega, 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. As always, 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 two 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 and the slides referenced on this call in the investor section of elanco.com. The slides and press release also contain further information about the non-GAAP financial measures that we will discuss today during this call. After our prepared remarks, we will be happy to take your questions. I will now turn the call over to Jeff to provide the highlights.

Thanks, Tiffany. Good morning, everyone. Before moving to Q1 results, I want to acknowledge our team and the challenges that they've overcome in the last two years through both the COVID and the African swine fever pandemics, the completion of our separation and independent system stand-up, and the integration of Bayer Animal Health. in what remains a difficult environment they've stayed focused on accelerating sustainable long-term value for customers for yourselves as shareholders and each other as you all know over the past two years in elanco we have made several hard strategic decisions four of these decisions stand out to me first the bayer animal health acquisition not long after the ipo also transforming our distributor strategy as well as changing commercial leadership and accelerating our restructuring. Today, we are seeing the payoff from those choices and from the discipline execution that I believe truly sets Elanco on a path to be a global animal health leader. Elanco started 2021 with better than expected sales, profits, and EBITDA. building on the strong momentum our business has shown since we closed the Bayer acquisition in August of 2020. Turning to Q1 results on slide three, our first quarter revenue of $1.242 billion surpassed the midpoint of our guidance range by over $80 million, with broad-based outperformance across many categories and geographies. Our adjusted EPS of 37 cents landed 15 cents above the midpoint of guidance, with expense leverage and synergy execution driving strong flow-through to bring adjusted EBITDA to $343 million. Our expectation for continued sales momentum and operational execution is reflected in our increased full-year guidance for revenue, adjusted EBITDA, and adjusted EPS. This includes the eight innovation launches in 2021, which remain on track to contribute $80 to $100 million in revenue this year. Our raised outlook demonstrates execution against our strengthened and expanded IPP strategy and continues to be in line with our long-term growth algorithm. I'd like to take a moment to address Seresto on slides five and six before progressing to a more detailed review of our performance in the first quarter. Today in a separate 8K, filing, we released additional scientific data to correct the misinformation spread through media reports regarding our Seresto flea and tick collar. The filing includes conclusions from a comprehensive review of adverse event data which we have also provided directly to regulators and legislators. First and foremost, let me emphasize the health and the well-being of pets and their ability to enrich the lives of people through companionship is core to what we do and who we are at Elanco. One of our greatest concerns from these stories is that pet owners stop using safe, proven products to protect their pets from potentially harmful fleas and ticks, which can transmit dangerous disease and impact pets' quality of life. The potential danger around non-use presents a risk to pets and their owners. That's why our team has worked tirelessly to clarify the science and safety around this trusted brand. So let me summarize and be clear on Seresto. First, the product's strong safety profile is supported by registrations from more than 80 regulatory bodies around the world and our robust pharmacovigilance process. Also, there is no scientific evidence in clinical studies or pharmacovigilance reporting to substantiate that Seresto's active ingredients cause pet deaths. We are providing additional product surveillance information on Seresto to the EPA And we've shared information with the House of Representatives Subcommittee on Economic and Consumer Policy to set the record straight. We continue to actively cooperate with both on any supplemental requests for facts. Our proprietary market research indicates high levels of confidence among consumers and veterinarians, bolstered by our proactive efforts to share the facts with pet owners, retailers, and veterinary clinics. Importantly, in terms of revenue, in the first quarter, we saw no deviation in two-year growth for global Seresto compared to historical trends. April revenue in the U.S. is ahead of our original expectations from the start of 2021, and we are on track towards full-year expectations for the Seresto brand. I'd like to highlight a few details I think are particularly noteworthy. Since the launch of Seresto in 2012, more than 28.5 million collars have been distributed across the U.S. Through our robust pharmacovigilance investigation process, 12 pet deaths have been classified as probably or possibly caused by the Seresto collar, using an internationally recognized classification system known as the ABON coding. As a percentage of total Seresto collars sold, this results in an incident rate of 0.000042%. And very importantly, as recently reinforced by an independent third-party review, none of those 12 cases since 2012 were deemed causally linked to the active ingredients in Seresto. The cases reflect other highly unlikely but unfortunate situations, such as a collar getting caught on an object and resulting in harm. We're deeply disappointed when any adverse event or reaction occurs associated with a product. Our entire Elanco team is dedicated to ensuring the quality, safety, and efficacy of our products. In the light of the misinformation around Soresto over the last two months, we've taken proactive steps to ensure consumer understanding of the product's strong safety profile. We've offered educational materials across 20,000 veterinary clinics through enhanced in-store and online retailer advertising and directly to consumers through targeted social and online channels. In turn, our recently completed proprietary market research indicates that veterinarian and consumer confidence in Seresto remains high. Of the approximately 1,500 U.S. pet owners surveyed the week of April 23rd, 98% of Seresto users intended to repurchase the product, aligning with the loyalty data cited with the Bayer acquisition. A representative national sample of 246 veterinarians found that while about half of those veterinarians are familiar with the negative press coverage of Seresto, their reported use of the product and intent to recommend has not changed. Slide 6 shows first quarter Seresto global revenue of $152 million. Recall that in Q1 2020, the brand achieved very robust 49% growth with the strongest sales gains in the U.S., benefiting from the retailer-driven stock in due to increased consumer demand related to the pandemic. Last year also saw a meaningful increase in points of distribution at certain major retailers. In the first quarter of 2021, Seresto declined 9% versus tough comparisons and with colder February in the U.S., resulting in what are still very healthy and consistent multi-year trends. Looking at two-year global Seresto growth, first quarter 2021 revenue was up 35% versus the first quarter of 2019. U.S. retail and veterinary dispensing data from Kinetic, Nielsen, and 1010 data represents our closest view of pet owner purchasing. Two-year growth trends in March were well above a weather-impacted February and closer to January. While we do not intend to report dispensing data on a regular basis, we believe it provides important context in this case. Additionally, let me share that we have not seen any material increases in Soresto returns. Looking forward, we continue to see a long runway for this trusted brand. To fuel that growth, we're investing in omni-channel efforts and digital engagement to deepen our relationship with current customers and reach new pet owners, including additional investments in the U.S. in the second quarter. Continued expansion and market building in key emerging markets, including China, as well as a lifecycle management plan and connected care initiatives creates ample opportunity over time for this unique platform and trusted brand. Moving now to overall pet health for the quarter. On slide seven, the global business drove approximately half of the upside versus the midpoint of guidance. reaching $646 million for the quarter, with good execution in a competitive but favorable industry backdrop. The Advantage family performed well in the quarter, posting global revenue of $143 million, up 14%. Growth reflected our targeted consumer retention efforts in the U.S. and particular strength in international markets, including China. Pet health vaccines also remain strong in the quarter in a beneficial vet clinic backdrop and reflecting operational discipline under new leadership installed last August. U.S. pet health, including vaccines, was a key driver of the 2% increase in price achieved for Totally Lanco. It reinforces that our channel strategy is working and creating real demand. In the U.S. and across the global business, our aggregate channel inventory levels at distribution remain consistent with prior quarters. In parasiticides, Cordelio saw robust double-digit revenue growth. EDI accelerated from the fourth quarter, and trends were especially strong at retail. Our omni-channel leadership as one of our five key growth enablers positions us well as the retail channel outgrew this industry in the first quarter, despite beginning to cycle difficult comparisons from the consumer-driven demand. Cordelio and Interceptor Plus revenue were in line with our expectations for the quarter as the pairing opportunity continues to resonate with veterinarians and pet owners, offering comprehensive flea, tick, and worm coverage. Meanwhile, our defend brand, Trifexis, continues to see share erosion by industry innovation. We're managing declines and optimizing profitability for this older brand through targeted omni-channel efforts with trifectas growth at retail once again acting as a partial offset to decreases in the clinic. In therapeutics, Gallup-Prant had robust double-digit growth in the first quarter with share gains in the U.S. inset market, according to the kinetic data. Gallup-Prant is also running a bit ahead of our expectations in Europe. We're working to grow the brand to be our 10th blockbuster through our positioning strategy as first-line treatment with easy at-home dosing and through its continued global expansion. Overall, I'm encouraged by our commercial execution in pet health in the first quarter, exceeding our expectations from our last earnings call in February. We head into the remainder of the year with an optimistic but balanced view for the pet health business. Our increased full-year guidance incorporates growth from upcoming and recent innovation, omnichannel leadership, leveraging our digital ecosystem, optimizing our selected channel partners, and expanding in new geographies, including the fast-growing Chinese market, while recognizing the highly competitive nature of the pet health industry. Turning now to the farm animal business. In the first quarter, we saw stabilization in our U.S. cattle and swine businesses as the backdrop has normalized from the COVID pressure we saw in 2020. Elevated fee costs continue to pressure producer economics. However, they enhance the value proposition for our efficiency products like OptiFlex and Remensin, which outperformed our forecasts in the quarter. With Reminson, we continue to navigate generic competition, and our share assumptions remain in line with our expectations. Finally, we benefited from competitor stockouts in U.S. cattle vaccines and implants, a tailwind we do not anticipate extending into the second quarter. Outside the U.S., poultry and aqua continue to be negatively impacted by unfavorable macroeconomic conditions and reduced consumption. As we shared previously, international poultry challenges are concentrated in mid-sized emerging markets. While the outlook for global poultry industry is gradually improving, significant differences remain between countries, and the global poultry trade is still very competitive. In aqua, we were encouraged to see salmon prices inflect positive year over year to end the first quarter. We continue to look for trends in our international poultry and aqua businesses to improve mid-year with reduced pandemic and economic-related headwinds. Both species, again, remain important growth drivers for Elanco over time. And then finally, in China swine, we saw another quarter of strong recovery from African swine fever headwinds, while remaining vigilant around the potential impact of new outbreaks. Chinese producers are under pressure with hog prices down 40% over the course of the quarter, driven by sow herd reduction from new ASF spikes, as well as higher ASF-related costs and more expensive feed. The sow herd reduction is likely to impact the second quarter and third quarters. We continue to expect China across swine, poultry, and pet health to contribute a full percentage point of growth to total elanco revenue in 2021. Our first quarter results reflect progress in several key areas, including the Bayer acquisition, changing our revenue mix from 30% pet health and 70% farm animal to a 50-50 split. The commercial execution that our new leadership is bringing across U.S. pet health, U.S. farm animal, Europe and international. Our accelerated pace of synergy capture and finally the underlying demand that our teams are generating as part of changing our distribution strategy in 2020. As you will see on slide eight, our outperformance in the first quarter comes as we continue to execute against our strengthened and expanded innovation portfolio and productivity strategy or IPP. Turning to slide nine, I'd like to provide a status for the eight launches planned this year with 11 of the 13 geographic approvals received and the focus now turning towards launch execution and excellence. On the farm animal side, INCREXA is meeting our expectations in the competitive EU market and is performing well as part of the first tranche of launches in the U.S. Xperia, a first-of-its-kind product indicated to reduce ammonia gas emissions per pound of carcass weight in cattle, shipped to its first feedlot customers in the first quarter and is being fed to cattle today. We're introducing two products to support the Raised Without Antibiotics, or RWA, market. Clinicox, which launched in the first quarter, and Zooshield, which we sourced externally to build our portfolio in this key space. These two products join Kosabadi and a nutritional supplement, which has now achieved the necessary heat-stable formulation. Moving to pet health, as we shared in February, Credelio Plus launched in Japan at the beginning of the year. We have now received a marketing authorization in the EU clearing the way for a second quarter launch, while Australia remains on track for the third quarter in time for the local parasiticide season. And finally, CredelioCat and Allura have launched in the U.S., adding to our growing feline portfolio. With that, I'll turn the call to Todd to provide more color on our results, the rapid progress being made on Bayer Animal Health integration, and our independent stand-up, as well as our outlook.

Thanks, Jeff. Slide 10 summarizes our financial performance highlights, including our reported net income and earnings per share. On slides 27 to 34 in the appendix, you can find a summary of the adjustments made to the reported results to arrive at our adjusted presentation. I'll focus my comments on our first quarter adjusted measures in order to provide insights on the underlying trends in our business, so please refer to today's earnings press release for a detailed description of the year-over-year changes in our reported results. Looking at the adjusted measures on slide 11, you'll see that total Elanco revenue increased 89% in the quarter on a reported basis with a neutral impact from foreign exchange for legacy Elanco. I'll break down the effect of BEAR on our revenue growth in a moment. On slide 12, there's a visual representation of our revenue outperformance versus the guidance range that we provided in February. The key drivers of the better-than-anticipated results, in order of magnitude, were commercial execution in our international pet health business, stabilization in U.S. cattle and swine, recovery in China's swine, execution and a favorable backdrop in U.S. pet health vaccines, as well as currency tailwinds. Adjusted gross margin as a percentage of revenue was 59.2%, an increase of 920 basis points compared to the first quarter of last year. As Jeff mentioned earlier, the Bayer acquisition dramatically increased our exposure to the rapidly growing pet health side of the industry. This higher margin portfolio, driven by Soresto, the A family, and the first half seasonality of the northern hemisphere's flea and tick season, had a very positive impact on our gross margin. In addition, we saw the benefit of positive price on Elanco's legacy portfolio, some shift of expenses into the second quarter with the legacy Elanco ERP cutover, and continued productivity gains. Total operating expense increased 75% in the first quarter, including the addition of the bear animal health business. Compared to our guidance from February, we experienced an approximate $30 million shift of investments from the first quarter into the second quarter, or approximately $0.05 per share of earnings. The delayed expenses include more opportunistic and effective phasing for direct-to-consumer and digital advertising with the cooler weather delaying the early parasiticide season and with the timing of R&D project spend. Operating income increased 271%, reflecting the Bayer Animal Health acquisition, the shifted operating expenses that I just described, the broad-based outperformance in revenue and gross margin, expense leverage, and synergy execution. At the bottom line, Q1 adjusted net income increased 239% to $182 million. The Q1 effective tax rate was 21.3%, and with our adjusted EBITDA at $343 million, our adjusted EBITDA margin for the quarter was 27.6%. Now let's discuss our revenue performance more closely. On Flight 13, you will see a breakdown of the contribution from Legacy Elanco and Legacy Bear portfolios by category. Legacy Bear products contributed $559 million in the quarter. As previously discussed, with the first quarter results, we have transitioned to reporting revenue by species to provide greater transparency. Pet Health had $645 million of revenue, or 52% of total Elanco, marking our first quarter ever with more than half our business attributed to pets. Cattle contributed $267 million, or 20%, 21% of total Elanco revenue in the quarter. Poultry added $166 million, representing 13%. Swine, $123 million, or 10%. And aqua, $22 million, or 2%. On slide 14, you can see the effect of price, rate, and volume on revenue performance. The benefit of the Bayer acquisition is reflected in volume. As is typical with acquisitions, we will continue to report the addition of the Bayer business in volume through the third quarter of 2021 when we begin to lap the closing of the acquisition. For the Legacy Elanco business, price was up 2% for the quarter, demonstrating the value of our innovation, the ongoing discipline we are applying despite competitive pressures, improved commercial execution, and evidence that our channel strategy is working. Slide 15 provides a breakdown of our overall performance between the U.S. and our international operations. We have further outlined our geographic performance by pet health and farm animal, as well as contract manufacturing, all of which benefited from the addition of BEAR. We expect to file a 10-Q shortly. But moving to slide 16, let me offer a few words on working capital, cash, and our debt leverage. In the U.S., consistent with the prior three quarters, we held all distributors at 60-day payment terms. In the first quarter, day sales outstanding stood at 69 days, up slightly from 66 in the fourth quarter, but well below the peak of 103 in the first quarter of 2020. The three-day increase in Q1 reflects $102 million of additional sales compared to Q4 2020, including $75 million more in our international business, where we generally have slightly longer terms than in the U.S. We ended the first quarter with $515 million in cash and equivalents on our balance sheet. With gross debt of $6.25 billion, our net debt is $5.74 billion. As a result of system cutovers, we exited the quarter with $50 million drawn on our revolver to manage intercompany-related liquidity. This drawdown has already been repaid in full. We continue to anticipate gross debt paydown of $500 million in 2021, and we now expect to end 2021 with net leverage of approximately five times, compared with our prior year-end target of approximately five and a half times, reflecting our increased adjusted EBITDA outlook. Now we'll transition to our full year and second quarter 2021 outlook, starting on slide 18. Today, we are updating full year 21 guidance by increasing and tightening the ranges for total revenue, adjusted EBITDA, and adjusted EPS to reflect the good momentum to start the year. We now anticipate 2021 revenue of $4.68 to $4.73 billion, adjusted gross margin of 56.75 to 57.25%, and OPEX of $1.78 to $1.8 billion, leading to adjusted EBITDA of $1.055 to $1.095 billion. Our full-year spend as a percentage of revenue is expected modestly higher than previously forecasted as we lean into strategic commercial opportunities and with increased legal expenditures and the impact of foreign exchange. Our interest expense and tax rate assumptions are unchanged, while we now expect depreciation of approximately $195 million and weighted average diluted shares of $488.7 million. that the flow through from our higher revenue guidance is driving our increased adjusted EPS outlook of $1 to $1.06. We also continue to anticipate approximately the same capex, net cash outlays, and cash taxes as discussed in February. Slide 19 offers a refreshed view of the bridge from our 2020 combined revenue to our raised 2021 guidance. In comparison to our February update, the anticipated currency headwind has shifted to a $20 to $30 million tailwind. COVID recovery is occurring at a faster than expected pace, and we are reflecting the strength we saw in our portfolio growth in the first quarter. Importantly, we continue to expect innovation to contribute $80 to $100 million in new revenue, which combines with our base portfolio to deliver approximately 4% to 5% underlying growth for the year. Our guidance remains balanced and grounded in the reality of ongoing headwinds from competitive pressures, generic insurance, ASF outbreaks in China, and macroeconomic challenges in international poultry and aqua. Moving to slide 20, we are providing guidance for the second quarter of 2021. We expect revenue of $1.225 to $1.255 billion, adjusted EBITDA of $250 to $275 million, and adjusted EPS of 22 to 27 cents. Our outlook reflects a sequential increase in OpEx in terms of dollars and as a percent of revenue, with the delayed timing of investments from the first quarter. We are also increasing investments to drive Seresto. I want to spend a moment on the seasonality of our combined company and the resolving quarterly cadence as detailed on slide 21. Our full year guidance currently anticipates in the first half of the year will represent approximately 53% of full year revenue and approximately 60% of full year adjusted EPS in 2021. This dynamic is reflected of typical seasonality in our higher margin parasiticide products, more than offsetting innovation gaining traction in the second half of 2021. For reference, on slide 22, historically, just over 70% of Soresto revenue and just under 60% of Advantage family revenue occurs in the first half of the year on average. Combined, Soresto and the A family had $578 million of revenue in the first half of 2020 compared to $320 million in the second half, equating to a $258 million more of this higher margin revenue in the first half. Given the relative scale of these products and their margin contribution, the revenue timing translates to an outsized first half contribution to EPS as well. Additionally, this year, we have discussed the shift of $30 million or five pennies of earnings from the first quarter into the second, impacting the cadence of EPS. This pushback of operating expense creates a pull forward of $30 million in adjusted EBITDA. While seasonality may create shifts in any given year, like this $0.05 push of expenses in 2021, we would expect EPS between Q1 and Q2 to be more similarly size, assuming normalized weather conditions. Before I conclude, let me provide an update on the Bayer Animal Health integration and our independent Elanco stand-up. We are progressing toward the synergy capture targets that we accelerated with the December Investor Day, contributing to our margin expansion in the quarter. We continue to expect $160 to $175 million in synergies this year, on the path toward $300 million by 2023. Meanwhile, our cost to achieve in 2021 has come down by $30 to $35 million, resulting in a forecast of $125 to $130 million in cash costs for the year, compared to $160 million that we anticipated at our December investor day. Our team has managed the complexities of an acquisition of this size while completing our separation from Lilly on time in the first quarter. While we are saving $30 to $35 million on the cost to achieve the bear synergies, the separation of Stand Up from Woolly is projected to cost $15 to $25 million more than we forecasted last year, as continued hypercare is needed to manage through the transition to our new ERP system, business process changes, and the startup of our new shared service centers in Poland and Malaysia. To close, I would like to echo Jeff's comments at the beginning of the call and thank our global team for their dedication, resilience, and execution as we went live on our standalone Elanco ERP system during the quarter. The efforts to establish new legal entities across the world, transition significant IT infrastructure, applications, and data, open two regional shared service centers, and exit the nearly 1,300 Lilly TSAs was a significant effort. I'm grateful to all of those who contributed to make this achievement possible. While we are not finished in making these changes efficient in their execution, our team continues to work through a hyper care support model to ensure we are taking care of our customers, vendors, and team members. Now I'll hand it back to Jeff. Thanks, Todd.

Before questions, let me just briefly summarize. Elanco started 2021 with strong results, building on the good momentum to end last year. Our team is now executing, and we're clearly beginning to see the payoff from those hard decisions I discussed that we've made since our IPO. We expect momentum to continue in the second quarter, and the balance of the year is evidenced by our raised guidance ranges today. We're demonstrating commercial competitiveness in pet health with the benefit of a favorable industry backdrop, and we're successfully mitigating the misinformation around Seresto with both April and full-year revenue on track for our original expectations for 2021 with Seresto. Our U.S. farm animal fundamentals have stabilized, while China's swine was ahead of our expectations, although ASF outbreaks and animal numbers must be watched closely. Our forecasts are balanced, as Todd said, as we recognize a highly competitive pet health environment, as well as the headwinds from generics, particularly in the farm animal side. Overall, we are confident that our strengthened and expanded IPP strategy will continue to drive long-term value creation for our shareholders and society. Elenco's Healthy Purpose or our 2030 Sustainability Pledges continue to fold into our business objectives, and we are focused on the opportunity to partner across industry players as we strive to create a better future for society. As a part of our separation from Lilly and the integration with Bayer Animal Health, we're building a fit-for-purpose organization with the governance, controls, and initiatives in place to create a global animal health leader. We look forward to sharing our first Environmental, Social, and Governance, or ESG, report in the coming weeks as further reflection of our commitment to a healthy enterprise. With that, I'll turn it over to Tiffany to moderate the Q&A.

Thanks, Josh. 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. Tamara, please provide the instructions for the Q&A session, and then we'll take the first caller.

Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, please press the pound key. Please stand by while we compile the Q&A roster. The first response is from Nathan Rich with Goldman Sachs. Please go ahead.

Good morning. Thanks for the questions. And Jeff, thanks for all the additional details on Seresto. I have a few questions on that, and maybe I'll throw them out to you all up front. On the survey of vets that you referenced, it sounds like there's no change in intent to recommend the product. I just wonder if there's any additional feedback or color that you can share from vets on how they view the efficacy and the safety of the product. And then in terms of the conversations you've had with the House subcommittee, can you maybe talk about the nature of those discussions? And are there any timelines that we should be watching here? And then lastly, can you share your expectations for global stressor revenue this year? Is that kind of two-year growth of 35 percent, maybe without putting too fine a point on it? Is that how we should be thinking about growth for the full year for stressor? Thanks a lot.

yes let me let me cover the first couple questions that todd you can you can add on this so thank you nate for the questions yes a lot of effort again on seresto and my comment up front i think is very important is this misinformation it's very important to clarify that's why we've worked tirelessly against this that's why we filed the 8k because we believe that non-user the removal of a collar with non-use presents significant risks. So with that said, just to answer, we saw in the surveys very much what we saw when we did the diligence on Bayer relative to loyalty, loyalty by pet owners as well as the veterinary community. We've engaged very closely with the veterinary community, of course, on the science. on the pharmacovigilance data. And all I can say, Nathan, is there's no change in their intent to recommend the product. And again, it's being used, you know, differently around the country and the U.S. with vets and with retail. But again, overall support has been reinforced in a significant way, and the veterinary community has been outspoken and supportive and we're very appreciative of them relative to the regulatory process that the EPA has, pharmacovigilance process, and the science. So that's important. And then... When we look at the subcommittee, what I would say is we've engaged with them, we have presented them information, and we will continue to engage with them. Nathan, there's no timeline or next steps that I can report here other than to say that we're being collaborative. The information that was in the 8 was a representative sample of what we've shared with them, and we'll continue to engage with them as well as the EPA as we go forward.

Nate, with respect to guidance for Seresto, we're not guiding on any specific brand or product on a full-year basis. We'll say that we're pleased with how Seresto has held in in the face of this misinformation campaign and the dedicated, loyal users of this trusted brand and why we've sold over 75 million collars since its launch on a global basis. That being said, we talked about the tough compare from COVID. As you can see on our slide 19 in the revenue bridge, we do expect a $40 million to $50 million headwind this year on the Bayer OTC products from the COVID lift they got a year ago. And as Jeff said, generally tracking with our expectations for a full year, Seresto, in 2021.

And we'll continue to invest in the second quarter, as we mentioned, on digital and omni-channel efforts to to sustain the momentum need as well.

We'll take the next question.

Thank you. Your next response is from Michael Riskin with Bank of America. Please go ahead.

Hey, thanks for taking the question, Beth. Jeff, one for you to start. You had a couple comments in your prepared remarks on China and obviously good growth in the quarter, but then also there was some concerning thoughts on ASF resurgence and herd reduction. I was just wondering if you could quantify that a little bit more. How much of that are you seeing already? How much of a risk is it to China revenues for the year? You mentioned solid contribution of 1% to full-year growth, but just want to go a little bit more into the ASF way up there, so how you think that could play out. And then for Todd, on the gross margin line, really great result this quarter, you know, 59% well ahead of consensus expectation. And it seems like for the full year guide, that's where, you know, most of the EBITDA margin gains have come from. I was just wondering if you could clarify sort of where you've seen the gross margin improvements over the last couple quarters. You know, is it on product mix? Is it some of the operational initiatives? Is it Bayer integration? Sort of where are you seeing the gains and how, you know, is that going to continue going forward?

Yes, Michael, relative to ASF, thank you for noting that. Again, a really strong first quarter for China overall. I will note that. We continue to reiterate that they'll represent and still believe a full percentage point of growth for Elanco. I see all three dimensions of the business doing really well with... pets and poultry, complementing a very big pig business, and even our warm water fish business that we got from Bayer. So, China's doing extremely well. But we do note a few things that have happened here during the quarter. We've seen a new wave of ASF resurgence. It's impacted prices, as I mentioned, in animal numbers. We've seen Michael largely fell in the northern provinces with reports showing 20% to 30% of the sows lost. So that's going to impact pig numbers as we go forward in the second and third quarter. Price is also pressured. So they've seen really three impacts on their P&L. They've seen the impact of... prices, the economics of the pigs coming out, increased feed costs, and then ASF costs. So, there's some economic pressure. But I think as we look at our customer base, again, the industrialized customers are getting hit by some of this, but are more prepared to weather this change. They've got stronger biosecurity and are probably being impacted much less than the other parts of the industry and still experiencing high profitability. So again, we feel strongly that China swine will be a major contributor for us for the year, but we're noting a watch out as we go into this second and third quarter relative to these resurgence. We'll give you more updates as we go forward.

Michael, thanks for mentioning the 59-plus percent gross margin here in Q1. Very pleased on the productivity initiatives. Dave Urbanik and his manufacturing quality team continue to execute on a broad-based productivity initiative in order to hold costs flat as we grow revenue. You combine that with the mix, that we see with high-margin parasiticides in the first half of the season, and we get this dramatic increase in Q1 in gross margin. You know, noting it sequentially, we actually increased margin in Q1 more than we increased sales. And that's purely that product mix that happens. It's why we've called out today the seasonality and provided the slides as part of the earnings presentation. This change that we now have as a lanko with the 50 plus percent cuts here in the first half and that high margin that comes with it you know we continue to take price as we called out um we apologize for not being able to provide greater price transparency in the bear business but that's the nature of the acquisition and, you know, next year in this time we'll be providing price on the total business versus just on the legacy of Lanco side. So, again, just great effort by the team along with great sales execution and the next benefits that comes from that.

Next caller, please. Thank you. Your next response is from Aaron Wright with Credit Suisse. Please go ahead.

Great. Thanks for taking my question. So the first one is on the broader livestock business. Can you give us a breakdown of the U.S. and international performance at Legacy Alonco and Legacy Bear, at least anecdotally, how maybe rumens and competition is playing out relative to your expectations there and how we should be thinking about the quarterly progression of the livestock segment? And then on Advantage came to the strength across that Advantage portfolio in the quarter. Were there any stocking dynamics we should be aware of for that product line? Or did you see any sort of shift to Advantage from Soresto, for instance? Or how should we be thinking about the quarterly progression there? You did mention, obviously, the seasonality, but will this be bumpy going forward? Thanks.

Thanks, Aaron. Let me start with just briefly on Advantage, and then I'll jump to Farm Animal and Todd if you want to share anything on the breakdown. But real quick, yeah, the Advantage families performed very well in the quarter, as we mentioned, posting 14% growth, even with challenging weather in February. Aaron, this really plays back to what we shared a little bit in our diligence with the Bayer acquisition. First of all, we're benefiting from that shift out of the vet clinic and into retail. We also have put a very increased effort on digital and marketing efforts that we really acquired with Bayer that really is targeted around customer retention coming from last year's COVID, that people that have moved to Advantage maybe for the first time or They've come back to the brand. So, with digital marketing efforts in the U.S. particularly, we're increasing that. And then, I think the third contributor is, it's doing extremely well in China. It is a well-known brand. Multinational brands do well there. We have a large team focused on this. And Advantage is exceeding our expectations in China at this time. And then, you know, again, it's a defend brand. We'll continue to look at it in a balanced way. But we do have some, you know, some new opportunity here that we see between COVID, China, international markets. And then we'll put lifecycle management behind that. On the farm animal side, I'll say at a high level, and Todd, if you'd like to elaborate any more on the breakdown. But, look, we have seen a stabilization coming through COVID. We've seen increased feed costs, which means our value products continue to do very well. We've seen particularly the U.S. swine industry looking at growing 6%. Cattle beef yards are as full as they've been. That's continued from fourth quarter of last year into this quarter. So cattle on feed is up as well. And so what we see is in a maybe low single-digit marketplace, we're looking to grow low to mid-single-digit with a combination of these dynamics, with the performance products, with our Remenson generic strategy working very well, with the broadest portfolio, the Bayer additions. I was in the cattle industry out traveling last week. Our enhanced and expanded cattle portfolio with products like Cydectin and Batril have helped our offer, total offer. And then we're introducing, as you know, five new products on the farm animal side. So we do expect to take market share this year on the farm animal side and have a balanced approach as we've put that into the guidance.

Aaron, just to add on the first part of Jeff's answer on stocking, no stocking issues at all on advantage, no benefit from that in the Q1 results. With respect to Legacy Alanko farm animal growth, as reported, it was down 7% in the quarter. That did include, you know, last year we had a pretty significant OUS buy-in on COVID that you know, affects that, as well as a few of the divestitures from the bear deals. That gets us closer to flat in Q1 from a growth standpoint, with the China swine being the big driver, while aqua and international poultry continue to pressure things. On the legacy bear side, as we had mentioned in Q4 results, there was the timing of the price increase year over year. We had moved that from a January 1 out into February to be aligned with when we do the prices in the middle of the quarter, so there's no timing elements on pull-forwards or push-outs of revenue. That change did drive an increase in sales for the bear portfolio on a year-over-year basis here in Q1 that we've reflected in our guidance, given we'd expected the lower amount in Q4 of last year.

We'll take the next caller, please.

Thank you. Your next response is from John Block with Stifel. Please go ahead.

Thanks, guys. Good morning. First question is just on Seresto. If you can talk to just what the plan is with the outreach. In other words, Jeff, is it to further increase overall awareness of the collar, or actually do you want to proactively highlight, you know, the perceived safety issues? Because I think there's actually a good number of consumers who that aren't even in the weeds and, you know, aware of the details. And then just to shift gears, Todd, the innovation of 80 to 100 million, I believe that's unchanged. Is there a way to sort of weight the 1H versus 2H contribution, just as we sort of think about and try to frame the year-over-year growth rates of the innovation bucket? Thanks, guys.

Yeah, John, great question. So the first thing we did right out of the gate was, in addition to the market research to understand the status and the impact of the misinformation, we looked at that first immediately, as well as working with our pet retailers. Again, a good share of use also is with these major retailers. So that was... The first thing we did was we looked at this, and as I noted, and as you even comment, the awareness was very low. So we balanced really three segments, users, pet retailers, and the veterinary community. What we did was we've increased our share of voice. We have moved safety up as, as you look at staging messages, no question efficacy and the benefits to the overall product still remain as, you know, message one, but we moved with our new expertise in marketing and digital capabilities. We moved safety up as just a key message as part of our messaging. What we're planning to do as we go into Q2 is to build on the momentum, similar to what we have with advantage and to reach more, you know, uh, owners, as well as continue to assure that we get the loyal users that we've had in the past going into the new season. So those are the things that we're doing. Then I would also say we're continuing to be very aggressive in international markets as well. It's still a very strong brand in Europe, and it's meeting our expectations in Europe. And again, being launched and still in the early stages in China as well.

John, thanks for the question on our innovation portfolio. As we have called out, we still expect the $80 to $100 million of revenue for the full year. I would say on a first half, second half basis, it's closer to 70% weighted to the second half.

Next caller, please.

Thank you. Your next response is from Chris Schott with J.P. Morgan. Please go ahead.

Great. Thanks so much for the questions. Just going back to Seresto, I guess just bigger picture, do you feel you're kind of out of the woods, I guess, from a commercial standpoint? So if there were going to be some impact from the headlines you saw in 1Q, you would have already seen it, and now it's more about going on offense. I'm just trying to get a sense of, you know, are you still kind of worried about this lingering issue playing out, or is that more in the rearview mirror at this point? And then I think you touched on some of the individual products, but just bigger picture, I guess, on international pet health dynamics. You highlighted that as your biggest upside driver versus the 1Q guide. I guess just how much of this is execution versus just the broader markets being a bit healthier than expected? And are there any particular products or markets that are, I guess, standouts relative to that broader business? Thanks so much.

Thanks, Chris. Look, we're going to be diligent and execute with – excellence here on Seresto. As Todd highlighted, it is a seasonal product. We are into May. We highlighted that, you know, April was a strong April. So, you know, what I would say is we are, you know, feeling, you know, very good where we stand today. But again, we won't take anything for granted. The other is we'll continue to work very closely with the EPA. and the legislators to answer their information. But we are, you know, not letting up on this brand. This brand is a significant, it is the fifth largest brand of all time in animal health. It has a loyal customer base. It has a much bigger platform for us globally, as well as with Connected Care. So what I would tell you is it's probably created another level of intensity, Chris, in our organization to lean in. We're not going to make a noise, wrong noise to other people on this. What we're going to do is just continue to build what we saw when we acquired Bayer. So look for us to be vigilant, balanced, execute with excellence. And we've got, again, a couple more months here that this brand has still a big seasonal aspect to it that we'll execute. More to report probably after this second quarter on that answer. And then I think on international, yeah, so our international business in pets, as you know, went up three times in size. I think this is the first quarter ever in Elanco's history where we had more pet sales in a quarter than farm animal sales. International contributed a big part of this. So what I would say is a couple things to look at. One is... you know, an international marketplace as we divided Europe and international. International, a lot more growth, a lot more capabilities, the combining of Elanco's portfolio with Bayer's portfolio, and markets like China, Brazil. So, international, Pat, we've got a great team that's focused on a lot of growth initiatives. But that's on a smaller base. Then I think on Europe, look for Europe to really take advantage of a Credelio Plus, plus a Galloprant, Credelio Cats. So some launches to expand that portfolio, Chris, that I think will be also a big driver. And then, again, continued innovation, as we've mentioned, one new parasiticide a year going forward, and new products that we continue to roll out. So... So we're in a good position internationally with the pet business.

We'll take the next caller.

Thank you. Your next response is from David Reisinger with Morgan Stanley. Please go ahead. Yes.

Excuse me. Thanks very much, and congrats on the phenomenal performance here. So could you please provide more color on the next Seresto steps to be taken with both the Congressional Committee and with the EPA? And also, are there any XUS inquiries which have been initiated since the USA Today article was published earlier this year and kicked off this misinformation debacle? Thank you.

Yes, Chris, just real quick, like to answer your second question, no, we are unaware of any others. We're monitoring and managing the public affairs side of this, again, engaging with both the subcommittee as well as with the EPA. And, you know, nothing new to report here on next steps. We're continuing to work closely with the EPA. There's normal re-registration processes and providing pharmacovigilance and scientific data which we have and we'll continue to engage with them. But from a legislative next step perspective, we again have provided the information and we'll continue to stay engaged with them. So that's really it. And again, I think it's heavily around the pharmacovigilance process, the science, and the recent actions we've taken, Chris, that I think to be noted are the independent reviews that we've had done on the data as well to provide further substantiation and an outside look at the way we're looking at it as well. So nothing new to report on next steps, and we'll continue to keep you updated, and nothing new beyond the USA Today story that was noted.

We'll move to the next column. Thank you. Your next response is from John Krieger with William Blair. Please go ahead.

Hey, thanks. A couple of questions. Jeff, I'm curious. So about a year ago, companion animal spend seemed to really jump with the pandemic. And now that we're lapping that in the second quarter, it would be interesting to hear if you think those trends are sustainable or would you expect them to kind of ease with the tougher conditions? That's the first. And the second is with the eight launches that you've laid out for this year, would you consider those to be sort of normal given the pandemic, or will your access to customers be somewhat constrained? And should we think about these launches as a little bit more gradual over the next few years? Thanks.

Great question. So, look, as we look at the pet health trends, I think there's three or four things that are happening in a real positive way. And I do believe there'll be some lessening, but there'll be a lot of persisting as well. So, you know, pet numbers are up about 5%. Visits are up. Wellness, with inside those visits, wellness visits compared to past wellness visits are up 15%, which is driving things like surgery, vaccines, and other things. And then I think the globalization is the other trend that, you know, pets are becoming more and more. important to families internationally than ever before, and that's a real growth market. Remember, half the pets globally are unmedicalized or are unreached. So when I step back, you know, I think that the trend that's going to matter the most is access, not adoption from shelters or these, but I think getting to pet owners where they want to shop, allowing to build and as they go back to work and re-enter into the workplace us to be able to sustain that relationship and most importantly bridge the veterinarian into it i believe this is going to allow the overall market to rise will it lessen maybe from the peaks that we've seen in covid yes but i think what we're seeing here in q1 is they're not they're not lessening to maybe what some of the past expectations were and i think some of this persisting is we have enabled capabilities as an industry to reach pet owners and influence them and make actually purchasing even easier for them and their relationship with the veterinarian. So that's what I see. As you look at the launches, I don't think that access has been restricted to any material way. That's why we're not backing off from our 80 to 100 million. I do think that if it will, it would probably impact our pet business more than our farm animal business. But we don't see that at this stage. Again, we believe that we've moved from a regulatory challenge coming out of the gate to now all the major products being approved. Our focus now is on launch excellence, and we'll keep you updated. It'll be a big quarter here in the second quarter on launch, and then the sales will start to deliver in the second half. Thank you.

Next caller. Your next response is from Elliot Wilber with Raymond James.

Hi, guys. This is actually Michael Parallarian for Elliott. Thanks for taking my questions. Two quick modeling questions for you. First of all, obviously understand that gross margin positive impact in the first half of the year due to product mix and shifting to pet health. But if you could just speak to the cadence over the rest of the year, obviously expecting a step down in the second half of the year, but just any specific details as to how we can think about that. And then timing of that towards your longer-term target of 60%, if the strong margin quarter is expected to move up that timing or not. And then if you have it on hand, if you could provide us with a cash flow from operations number and kind of talk to the cadence around that for the rest of the year, that would be helpful. Thanks.

Sure, Michael. As we guided for the full year, we're expecting gross margin at 56.75 to 57.25%. The seasonality of the first half to second half, as we talked, is pretty similar between Q1 and Q2 on the gross margin side. We are filing our 10Q here shortly. It'll show operating cash flow of a positive $22 million for the quarter, and we'd expect that to continue to improve over the course of the year as we continue to expect to pay down $500 million of gross debt by the end of the year.

We'll move to the next question. Thank you. Your next response is from Umar Farhat with Evercore ISI.

Hi. Thanks so much for taking my question. So in the House letter, they said Seresto was quote-unquote associated with 1,700 pet deaths. And I thought that was very interesting because in your 8K, you're pointing out Seresto was mentioned quote-unquote alongside pet deaths. And I guess I'm so confused. Did they not look to establish causality perhaps in the media reports or in the House letter? Because that's a material misinterpretation the way it reads based on your causality analysis. And secondly, I did want to also touch up on your pharmacovigilance evaluation and perhaps extend beyond pet deaths. So I know the 8K today focuses specifically on the 12 cases that were probable or possible deaths. What about cases of tumors? Is it safe for us to assume there's no causality with any other serious adverse events? Thank you.

Yeah, Oomer, I think what's really important to note, and it's even highlighted in the independent review that we note in the 8K, is that, and I think this is really important where the 1700 comes, is case does not equal cause. So what we've done is we've actually articulated and gone through and reviewed each one of those. So if somebody calls in with a sorestal problem and there's an affiliation with the death and sorestal is mentioned, then that's part of the 1700. When you pull out probably or possibly, again, in this system that I noted, internationally known pharmacovigilance system, there were 12 dogs, further review of those 12 dogs where there was a direct linkage, It was typically, you know, an accident that was caused, but there has been, and I think what's really important is there is no linkage to the ingredients, the two active ingredients in Soresto with pet death. So that to me is a very important articulation. That's the biggest point of misinformation. And again, that's why, you know, independent regulatory body overseeing this is so important as well as the pharmacovigilance process.

Thanks, Umar. We'll move to the next question.

Thank you. Your next response is from Kathy Minor with Calvin and Company. Please go ahead. Great. Thank you. Just, again, one more question on Seresto, but it's been such a tremendous product, very resilient. Can you just remind us why customers are so loyal to this collar, and would you expect this to continue, or would you see market dynamics that may encourage people to use different formulations going forward? And my second question also on parasiticides is you talk about the success of the combination of Crudelio and Interceptor Plus. Can you give us any percentage or any sense of how much of the sales in the first quarter were as a combined entity, if you will? Thank you.

Thanks, Kathy. Yes, Seresto, you know, continues to grow every year. And I think part of this is the unique offering that this provides. So eight months of coverage, a strong price point, great efficacy, great safety have all been contributions to this. And then as we've globalized it, this continues to hit a demographic from the standpoint of both price, convenience, and safety and efficacy. It provides something unique when you look at eight months of coverage. And then, again, I believe that what Bayer has done and now we're doing together is, you know, building the brand with this and, you know, the loyalty that the pet owner has with the brand. Look for us to continue to expand and build on this as we go forward with lifecycle management as well. We won't note any specifics here on the pair. But what I would say, Kathy, to you, and let me say one last thing on Soresto, too, is, you know, again, April revenue in the U.S. is ahead of our original expectations. And I want to just solidify with all these questions on Soresto that as we collaborate with the EPA and the legislative bodies, we feel strongly that the product is on track for our full-year expectations as a total brand globally. As we look at the broader parasiticide market, you know, if you want full coverage of out there today, you're going to need two products, no matter which product you're using, either New Innovation or others. Credelio and Interceptor Plus provide that broadest coverage. And we continue to see that pairing is something that's occurring in the marketplace. And we saw, again, very strong growth, especially with Credelio as we go forward. So that's the strategy we'll continue to execute against that.

Thanks, everyone, for the questions today. The camera will end the call here.

This concludes today's conference call. Thank you for participating. You may now disconnect.