Elanco Animal Health Incorporated

Ladies and gentlemen, thank you for standing by and welcome to the Elaine Coe Animal Health Inc. Q2 2021 Earnings Call. At this time, all participants are in a listen-only mode. After the speaker 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. If you require any further assistance, please press star 0. I would now like to hand the conference over to your speaker today, Tiffany Kanega. Thank you. You may begin.

Good morning. Thank you for joining us for Elanco Animal Health second 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 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 and the slides referenced on this call in the investor section of elanco.com. The slides and the 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. As I reflect on our progress in the nearly eight months since our investor day, we see evidence that our transformation is creating sustainable, long-term value for our customers, our shareholders, and our globally land-goed team. Our results demonstrate we are executing against the strategy we laid out in December. Second quarter revenue, EBITDA, and EPS on slide four were all above our expectations. continuing to build on the strong momentum our business has shown since closing the Bayer acquisition a year ago. Revenue of $1.279 billion surpassed the midpoint of our guidance range by nearly $40 million, with outperformance in both sides of our now relatively balanced business between pet health and farm animal. Our adjusted EPS of 28 cents was 4 cents above the midpoint of guidance range, including an approximately $0.03 headwind from discrete items in the quarter that pushed our tax rate to nearly 30%, more than offset by approximately $0.07 of operating improvement. Adjusted EBITDA of $291 million was $29 million above the midpoint, demonstrating good flow through and showing significant headway toward our long-term margin targets. Today, we are raising our 2021 full-year revenue guidance for the third time by $15 million at the midpoint to $4.68 to $4.73 billion. The business is delivering beyond our long-term growth algorithm, providing total revenue up 5% to 7%. This includes approximately 4% to 5% for our underlying business, with a reduced innovation range entirely due to external challenges for Zooshield, which I'll discuss later, that is more than offset by portfolio gains in a good industry backdrop. While we exit the second quarter with strong momentum, we're taking a balanced approach to the rest of the year, factoring in many moving pieces, including seasonality, moderation in pandemic-driven pet health tailwinds in the vet clinic, and ongoing competitive dynamics. During the second quarter, we made two strategic moves with some near-term implications and important medium and long-term benefits. First, we announced the bolt-on acquisition of Kindred Bio, which can contribute three potential blockbusters alongside our own dermatology assets and more quickly build a presence in this essential part of the industry. The transaction also provides attractive shots on goal and other therapeutic fields, including securing full ownership of the canine parvovirus therapy. We've completed antitrust review and expect the transaction to close this month. Second, we announced the exit of the three manufacturing sites. In further streamlining our footprint, we're accelerating our gross margin efforts, reducing annual CapEx and improving working capital. Todd will provide details on how these two decisions impact our revenue, EBITDA, and EPS in 2021. Both strategic moves are examples of Elanco's increasing position of strength from continued transformation, driving value creation. We're taking the next steps in our journey to build a global, independent, fit-for-purpose animal health leader. with consistent double-digit adjusted EBITDA and adjusted EPS growth in a durable industry. Moving now to overall pet health for the quarter on slide five, the global business drove approximately two-thirds of the upside versus the midpoint of the guidance, reaching $685 million in revenue for the quarter, with continued good execution in a competitive but favorable pet industry. As you know, pet spending has many structural tailwinds, which were amplified during the pandemic. Industry research shows that the number of U.S. pet-owning households surged by nearly 6% in 2020 versus the slightly positive pre-COVID run rate. This trend is not isolated to America, with 3.2 million U.K. households having acquired a pet since the start of the pandemic, and a 2020 survey shows by the Japan Pet Food Association, showing a 15% increase in dog and cat ownership. This increased pet ownership also drove greater vet clinic traffic in the second quarter. Trends were most robust in April, up strong double digits against last year's quarantine impacts. Our pet health vaccine business was a standout in the quarter in this beneficial vet clinic backdrop. Vaccines were a key driver of Elanco's 2% improvement in price, reinforcing that our channel strategy is working and creating real demand. Our aggregate channel inventory levels at distribution remain consistent with prior quarters in the U.S. and across the global business. Turning to parasiticides, second quarter global Soresto revenue was $129 million, down 1% year over year, and global A family revenue was $148 million, down 3%. Both faced similar dynamics with a tough comparison against last year's retailer-driven stock-in, and Soresto also lapped a meaningful increase in points of distribution at certain major retailers. Additionally, cooler and wetter weather in May across many parts of the U.S. impacted seasonal traffic in the broader OTC channel as seen in the Nielsen data. Seresto and A-family trends rebounded in June alongside the industry with more favorable weather. Moreover, both achieved gains outside the U.S. in the quarter, leading our overall performance in international pet health. We remain on track toward full-year expectations for Seresto. The brand's resilient performance demonstrates high levels of confidence among consumers and veterinarians. Let me add that the EPA 60-day public comment period, which opened July 13th following an NGO petition, is a standard and expected practice. We have full confidence in Soresto's strong safety profile, which is supported by registrations from more than 80 regulatory bodies around the world, and our robust pharmacovigilance process. We continue to see a long runway to grow this trusted brand. Rounding out parasiticides, the Credelio franchise drove healthy growth across its combined platform of U.S. vet clinics, retail, and international, along with the launches of both Credelio Plus and Credelio Cat. In the U.S. market, Credelio maintained robust double-digit EDI growth in the second quarter, representing outbound sales into the vet clinics or alternative channels, and trends remained especially strong at retail. This focus brand is performing well in light of industry innovation, which is driving greater-than-anticipated share erosion from our older defend brand, Trifexis. We will continue to maximize profitability with targeted investments across our portfolio and grow revenue through new innovation as we compete for greater share of the expanding, growing global parasiticide market. Our combined international portfolio is highly competitive in both parasiticides and therapeutics, bolstered by our outperformance from new innovation like Credelio Plus. Finally, in therapeutics, Gallup Rant continued It's global expansion and also posted double-digit EDI growth in the second quarter with year-to-date share gains in the branded U.S. inset market, according to the kinetic data. While we exceeded second quarter guidance and exit the quarter with good momentum, we head into the remainder of the year with a number of variables to consider. We believe pet health is recalibrating back towards normalcy against tougher comparisons and with a natural moderation of tailwinds from the puppy boom. We're watching vet clinic trends in light of the limited practice capacity and labor constraints. We're monitoring pet ownership trends as the economy opens up, offset by potential impacts in the Delta and other variants. Additionally, we recognize the increasing competitive nature of the industry, especially in the U.S. and ecto-parasiticides. In balance, our pet health strategy is tracking to overall expectations. Innovation is performing ahead of plan, driving growth alongside focused brand contributions. We have established omni-channel leadership and digital initiatives to generate long-term growth with expansion in new regions like China, all supporting our full-year outlook and more consistent and competitive levels of pet health growth over time. Turning now to our farm animal business. In the second quarter, we saw demand-driven improvement in our U.S. cattle and swine businesses with protein benefiting from a return to food service. The first half of 2021 also benefited from higher numbers of cattle on feed. Elevated and volatile feed costs continue to pressure producer economics, likely extending through the back half of the year. However, they enhanced the value proposition for our efficiency products, like Skycis, Optiflex, and Remensin, which all outperformed our forecasts in the quarter. In China's swine, we experienced experienced impacts from the reemergence of African swine fever. Hog prices ended the quarter down about 65% since the start of the year, severely pressuring profitability for Chinese producers. The sow herd reduction is likely to also impact the third quarter. But overall, we still expect our China business to deliver at least a percentage point of growth to total elanco revenue in 2021. Finally, international poultry and aqua will remain negatively affected by unfavorable macroeconomic conditions and reduced consumption as expected, but are exhibiting green shoots of industry improvement. We are seeing easing pressure on Clinav as salmon prices improve, averaging up double digits year over year during the quarter. Clinav is also beginning to benefit from our recently published Phase 4 study, demonstrating superior ROI versus alternatives. Q2 also saw a very robust lift from the timing of aqua orders shifting into the period from the third quarter. While we do remain cautious around these businesses, we anticipate overall improvement ahead against a soft COVID-driven comparison. As you will see on slide six, our second quarter outperformance is driven by discipline execution against our strengthened and expanded IPP strategy. I'd like to share more on our innovation progress on slide seven with details around the eight launches planned this year. Pet health innovation is running above expectations, and I'm pleased with the global team's commercial execution around each of these three launches. Credelio Plus is exceeding planned in Japan and Europe and is on track to launch in Australia in Q3 in time for the local parasiticide season. While differing thresholds around heartworm production prevent us from bringing this product to the U.S., Credelio Plus is proving to be very competitive in the $1.5 billion international market. Meanwhile, Credelio Cat and Allura are growing our feline portfolio. In farm animal, Encrexa is faring well in a competitive and unprecedented market dynamic. It remains early days for Xperia, but we're making important strides towards achieving Packer ecosystem integration with continued potential for blockbuster status. Xperia's value proposition is being validated in the field and Packer acceptance is growing, now reaching seven Packers versus one at the end of Q1. The first Xperia customers have now reordered product and expanded use. finally zoa shield which we source externally to build our portfolio in the raised without antibiotic space zoa shield is currently facing greater than anticipated market supply of the leading competitive product as a result we're taking a prudent approach to total pipeline forecasts in 2021 reducing our innovation revenue outlook by 15 million dollars to $65 to $85 million. However, we remain confident in the value contributions of Zoeshield to our poultry portfolio. It's important to understand that this year's reduction does not impact 2025 total innovation potential of $600 to $700 million, which we raised in mid-June with the announcement of the Kindred bioacquisition. Before I turn the call over, let me say a few words on the regulatory item. On July 1, Elanco received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We've cooperated in providing documents and information to the SEC and will continue to do so. We believe strongly that our actions were appropriate. Finally, I'd like to just stop and thank our entire global team for continued diligent execution and focus during these unprecedented times. From our South Africa colleagues determining how to reach customers amid riots to those in Vietnam sleeping in our plant to ensure supply amid another COVID lockdown. Their commitment to our purpose is unwavering and inspiring. With that, I'll hand it over to Todd to provide more color on our results and our outlook.

Thanks, Jeff. Slide 8 summarizes our financial performance highlights, including our reported net income and earnings per share. On slides 31 to 40 in the appendix, you can find a summary of the adjustments made to the recorded results to arrive at our adjusted presentation. I'll focus my comments on our second 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 9, you'll see that total Elanco revenue increased 118% in the quarter on a reported basis, with five points of benefit from foreign exchange for legacy Elanco. Our second quarter revenue on approved form of combined company basis would have represented growth of approximately 10%, assuming the bear acquisition had happened at the start of the year and adjusting for the impact of strategic distribution changes. On slide 10, there's a visual representation of our revenue outperformance versus the guidance range we provided in May. The key drivers, in order of magnitude, were commercial execution in our international pet health business. continued improvement in U.S. cattle and swine, currency tailwinds, and order phasing in aqua. Adjusted gross margin as a percent of revenue was 57%, an increase of 750 basis points compared to the second quarter of last year. The year-over-year improvement reflects the bear acquisition that dramatically increased our exposure to the rapidly growing pet health side of animal health. Remember also that this higher margin portfolio is first half weighted, due to the northern hemisphere's flea and tick season. Additionally, we saw the benefit of positive price and volume on Elanco's legacy portfolio and continued productivity gains. The sequential deceleration of 220 basis points versus the first quarter includes impact from a temporary plant shutdown due to a weather-induced power outage, logistics costs, and the shift of some expenses into the second quarter with the legacy Elanco ERP cutover, as discussed last quarter. Total operating expense increased 116% in the second quarter, driven by the addition of the Bayer Animal Health business. At $475 million, the amount was $42 million above the first quarter and includes the previously identified approximately $30 million shift of investments into the second quarter. The delayed expenses included more opportunistic and effective phasing for direct-to-consumer and digital advertising. Operating income increased 268%, reflecting the bear animal health acquisition, our top-line execution, expense leverage and discipline, and synergy execution. The sequential step-down of $47 million from the first quarter is attributable to the sequential gross margin and shifting investment impacts I just described. Our adjusted EBITDA was $291 million, and our adjusted EBITDA margin for the quarter was 22.8%. At the bottom line, Q2 adjusted net income increased 274% to $135 million, reflecting our effective tax rate of 29.6%. Two discrete items primarily drove our rate above our prior full-year forecast of 21% to 22%. First, tax rate changes in several jurisdictions required the re-measurement of our deferred tax assets and liabilities, with the net impact adding nearly $5 million to our Q2 tax expense. The largest impact was in the UK, where the tax rate increased from 19% to 25%, resulting in $3 million in additional tax expense. This impact will not repeat. Second, we finalized a number of international tax return to provision and transfer price adjustments that increased our expense by nearly $4 million. For the back half of the year, we anticipate an effective tax rate in the 22% to 23% range. Now, let's discuss our revenue performance more closely. On slide 11, you will see a breakdown of the contribution from Legacy Elanco and Legacy Pair portfolios by category. Legacy Bear Products contributed $529 million in the quarter. Pet Health drove $685 million of revenue, or 54% of total Elanco. Cattle contributed $231 million, or 18% of total Elanco revenue in the quarter. Poultry added $179 million, representing 14%. Swine, $113 million, or 9%. And aqua, $44 million, or 3%. On slide 12, you can see the effect of price, rate, and volume on our revenue performance. The benefit of the bear acquisition is reflected in volume. We will continue to report the addition of the bear business in volume to the third quarter of 2021 when we lap the transaction close. For the legacy of Lanco business, price was up 2% for the quarter, led by pet health vaccines, and demonstrated the value of our innovation, the discipline we are applying despite competitive pressures, and enhanced commercial execution, all continued evidence that our channel strategy is working. Farm animal price was flat in the quarter, reflecting competitive dynamics in U.S. cattle and swine. We continue to target a 2% increase for the total business in 2021 with revenue management in focus as we are observing some inflationary pressures in areas such as transportation costs. Slide 13 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 our 10Q shortly, but moving to slide 14, let me offer a few words on working capital, operating cash flow, and debt paydown. In the U.S., consistent with the prior four quarters, we held all distributors at 60-day payment terms. In the second quarter, day sales outstanding stood at 75 days, up from 69 in the first quarter, as our average accounts receivable throughout Q2 was higher, as a result of Q1 revenue being significantly higher than Q4 revenue. We ended the second quarter with $580 million in cash and equivalents on our balance sheet. We have secured a commitment for additional prepayable floating rate bank debt of $500 million to refinance our $500 million of senior notes that come due on August 27th. We will use cash from our balance sheet and draw on our revolving credit facility to fund the Kindred bioacquisition. Consequently, we expect net leverage of 5.5 times at the end of 2021, in line with our original projection from December 2020. Before I discuss our guidance, I'd like to remind everyone of the 2021 financial impacts from streamlining our manufacturing footprint announced June 9th. We closed the sale of the Shawnee, Kansas site on August 1st, removing $10 to $20 million of associated contract manufacturing revenue in the last five months of this year. This impact was reflected in the guidance we confirmed when we announced the Kindred bioacquisition on June 16th. We do not expect an impact to adjusted EPS from the sale, but we do anticipate a $5 to $10 million EBITDA headwind in 2021, including an effect on depreciation. Please refer to our press release this morning for the GAAP impact for our second quarter results from this divestment. With respect to the Kindred Bio acquisition, we expect slight dilution to both reported and adjusted EPS for the full year 2021, an approximately $10 million impact to net loss, and an approximately $10 million impact to EBITDA as we continue to execute against Kindred Bio's R&D programs. Now we'll transition to our full year and third quarter 2021 outlook, starting on slide 16. We are raising our full year 2021 guidance for total revenue and updating EBITDA and EPS for a number of factors, including our second quarter outperformance. We now anticipate 2021 revenue of $4.68 to $4.73 billion, including the loss of $10 to $20 million of contract manufacturing revenue from the Shawnee facility exit. To walk from our last update in June on slide 17, our increased outlook flows through the approximately $40 million outperformance in the second quarter, partly offset by a reduced outlook this year for ZOA Shield and the impact of aqua order phasing. Slide 18 offers a refreshed view of the bridge from our 2020 combined company revenue to our 2021 guidance. In comparison to our May update, we now expect innovation to contribute $65 to $85 million in new revenue. This reduced range is offset by growth in our base portfolio. As a result, we anticipate approximately 4% to 5% underlying growth for the year and 5% to 7% total growth. Moving to slide 19, we expect adjusted EBITDA of $1.035 to $1.075 billion based on adjusted gross margin at 56.75 to 57% and OPEX of $1.78 to $1.8 billion. Our gross margin rate is being negatively impacted by increased logistics expense and inflationary pressures on our supply chain.

The $20 million reduction to the adjusted EBITDA range also reflects the change in order to produce a performance of nearly $30 million. This is to incorporate strategic investments in commercial growth opportunities.

Slide 20 provides the moving pieces informing our updated, adjusted, and reported EPS guidance range. which is $0.03 lower than the range discussed in May, factors in $0.02 of dilution from Kindred Bio, from the ZoaShield and Aqua phasing, $0.03 from logistics and inflation, and $0.03 from the discrete tax items affecting Q2. We are flowing through the $0.07 of operational execution and outperformance from Q2. 2021 guidance of $0.97 to $1.03. Our outlook demonstrates the underlying fundamentals of our business remain strong. The reported E3S bridge likewise closed through the second quarter outperformance in the aforementioned items, as well as the $0.46 write-down streamlining announcement. the impact to reported earnings from integration and stand-up are sequentially decreasing in magnitude from approximately $80 million in the first quarter of 2021 to approximately $20 million this quarter. Moving to slide 21, we are providing guidance for the third quarter of 2021. We expect revenue of $1.075 to $1.1 billion adjusted even

Our outlook, which is a sequential step down from the first half of the year, and the resulting quarter of May.

Remember, just over 70% of Soresto revenue and just under 60% of Advantage family revenue occurs in the first half of the year on average.

The revenue timing translates to an outsized first half contribution Now I'll hand it back to Jeff for closing comments.

Thanks, Todd. To summarize the link with strong results, extending our track record of execution since acquiring Bayer Animal Health and driving long-term strategic actions with the expected further streamlining our manufacturing footprint and delivering on our vision of food and companionship enriching life.

We head into the back.

back half of the year with confidence in our ability to drive sustainable double-digit adjusted EBITDA and adjusted EPS growth anchored by steady growth on the top line. Our fundamentals are above algorithm revenue velocity in 2021. Our productivity agenda continues to deliver with rapid action towards synergy capture. Finally, I'd like to express a heartfelt thank you to Katie Grissom as she transitions to a new role in global marketing finance. Katie has been an instrumental part of the IR team during our journey since the IPO, and I look forward to the impact of her contributions in our commercial organization. With that, I'll turn it over to Tiffany to moderate the Q&A.

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

Again, if you would like to ask a question, please press star, then the number one on your telephone keypad.

And your first question is from Michael Riskin with Bank of America.

Thanks. Hi. Thanks for taking the question this morning. I want to start on the guide methodology and the rationale from earlier in the year. And I think slide 16 in your deck summarizes it really well. You raised the guide a number of times earlier this year, most recently in May. And now we're in a situation where you're lowering it on adjusted EBITDA, adjusted EPS, despite the solid second quarter. And obviously that's a little disappointing. So I'm just wondering if given all the moving pieces in the Bayer deal, the moving pieces in the underlying market, you know, it'd be more prudent to take a more conservative approach, leave more wiggle room for things like the Zillow shocks and the inflationary pressures.

Mike, you know, appreciate the question. We've been trying to give the, you know, I guess most consistent and best information we have at the time. When we did the Kindred deal,

as well as the streamline of our manufacturing, those did have impacts on EP. Those are the key items we've had. The overperformance from Q2 that we factored in.

plus this tax rate impact in Q2 that, you know, spiked the tax rate and cost us about three cents of EPS as a result of, you know, the law changes in the UK as well as, you know, some return of provision adjustments. So, you know, overall, we've been very pleased with the underlying growth in our business. You know, as noted, the portfolio contribution from our product is growing faster now than we had previously communicated, which we view as a very big positive. The one-off with the ZOA shield on supply, again, would play out differently at the start of the year. We're still confident in our raise without antibiotic portfolio going forward. So, overall, we're trying to be as clear on the moving pieces. And, again, second half is very much in line or slightly better on our total Elanco portfolio than we expected back in May, offset by some of the inflationary jumps on the logistics side of the teams managing.

Hi, guys. Thanks so much for taking my question. Jeff, in your prepared remarks, you mentioned SEC is looking into the inventory practices. Could you expand on that a bit more? What specifically are they alleging, and do you expect this to be a multi-year process?

Yeah, thank you, Umar, for the question. Yes, on July 1 of this year, our company received this.

It was relating to our channel inventory and sales practices prior to the mid-2020 period.

We cooperated in providing the documents and information to the SEC at this stage, and we'll continue to do so.

And as I said, stated, management, starting with myself, believed strongly that our actions were appropriate.

Now, Umer, maybe to put this in proper context that I think is important and what you're asking for.

First, to continue to keep with the theme of transparency, to ensure continued transparency, that is very important to us. And that's why we chose to voluntarily disclose the subpoena we received from the SEC last month. I think secondly, as I discussed today, the scope of the subpoena is related to our channel inventory and sales practices prior to the middle of last year after we reduced channel inventory and changed our distribution strategy. And you can appreciate this, that I'm not able to provide more detail since we don't comment on litigation or regulatory investigations. But I can say we're cooperating with the SEC, and we believe our actions were appropriate. We remain confident in our business strategy and also the decision. And our teams will continue to be highly focused on executing UMA against our outlook in 2021 and driving long-term shareholder value, which I think we demonstrated with consistent business performance.

at or above expectations over the past year.

And as much as I appreciate the desire for more details that comes with this transparency at this current time, we do not intend in compliance with security laws.

We'll take the next caller. Your next question is from Nathan Rich with Goldman Sachs.

Hi, good morning. Thanks for the questions. Just two on the revenue outlook for the back half of the year. The change in the expectations for Zillow Shield led to a pretty large reduction in the guidance for new products. products, that $15 million reduction that you called out, especially with pet health running ahead of your expectations with the new launches there. Could you just maybe talk about your updated assumptions for ZOA Shield and maybe how we should think about additional variability in the back half of the year? And then, if I could also just ask on the competition in parasiticides, Jeff, that you called out with some of the changing dynamics you've seen, Are you still expecting that $50 million revenue headwind from competition this year? Thank you.

Yeah, Nathan, let me just anchor back on some important points. First on Zooshield, you know, it's an externally sourced product to build out, are raised without antibiotic portfolio, as Todd highlighted. We believe strongly that this portfolio is well positioned to be competitive in the medium and long term. So this is an alternative coccidiostat and fits nicely as a portfolio play. um it's currently i mean let me speak very very directly on what has happened it's currently facing greater than anticipated market supply of a leading competitive product or said another way there's we anticipated as we go into these health program rotations with poultry integrators um so this this dynamic is you know discreet maybe a little bit more short-term in nature it's leading to a reduced innovation outlook for this product we remain confident and our overall value contributions we see from zoa shield and our poultry portfolio and and more so i want to reiterate and no change to our 2025 innovation revenue target that six to seven hundred million range that we updated in june with the kindred bio and more to come. And I would pivot, too, to the two critical platforms of new products in that portfolio of eight that matter the most are Credelio Platform, again, Credelio Plus, Credelio Cash. at exceeding expectations and Xperia tracking very nicely on that track to be a blockbuster that we've talked about. Relative, Nathan, to the parasiticide competition, it's playing out as expected and as we've even talked about it. New innovation is driving and expanding the parasiticide market. It is a little bit more. But when I step back, Nathan, and I look at the push's parasiticide strategy, the proof points are pretty evident that things are tracking and we're in a very strong position. We see the Cordelio franchise here in the U.S. and globally growing, driven by, you know, a vet clinic traffic and a good industry backdrop, as well as, you know, growth in EDI sales. Cordelio Plus, Cordelio Cat, as I mentioned, new products. Retail continuing to do well. And then when I brought it out even a little further, we're seeing nice growth in international markets. Advantage is doing well in Asia, as we've mentioned. Again, exceeding expectations. And Soresto is on track to meet our 2021 expectations. So pushes and pulls, pipeline progressing. We're in a good place overall in global parasiticides.

We'll move to the next caller, please. Your next question is from Chris Shaw with J.P. Morgan.

Great. Thanks so much for the questions. I just had two here. I think you mentioned in the open remarks that there was some moderation in pet health trends reflected in the second half guidance. I was hoping you could elaborate a little bit on, is that something that you're seeing already there or expecting? I'm just trying to get a sense of what's kind of leading to that expectation. And the second question was on, I think you mentioned weather impacting the OTC business in May. Can you just help us quantify a little bit of what you saw there? I'm just trying to get a sense of what you think about the two key results overall, which I think is more of a normalized result on the quarter. Thanks so much.

Yeah, Chris, I would say overall, I want to highlight a few things in these trends.

I think that it's a little early to see.

say what's going to stick post uh post the pandemic but as we highlighted and i think other companies have highlighted the trends are significant that numbers of pets have gone up globally pet visits have gone up globally u.s and international and the market changes will not reverse they will stick we've seen a rising of the oil which is positive um We know when we look at what's really driving the ultimate growth, vet clinic traffic, we believe, will start to go more to that two-year average versus where we are today as we move through the second half. So moving from double-digit growth in those vet clinic traffic to seeing it move to maybe more low single-digit. That is what we're predicting and assuming we're seeing that from the standpoint of Just the ability to sustain this, we think, is a challenge. I think retail purchasing as well has had, as you know, a significant growth, especially e-commerce, fastest-growing segment. We see that lessening a little bit as well. Joe, as two things happen, one, activity goes back up in the household, and two is innovation in the vet market is also driven, I think, I think Elanco is well-positioned with omni-channel portfolio and geo-expansion. Relative to your second question, yes, we saw a cooler May. We saw a rebound in June. I don't know if we're going to quantify that at this time, but again, what we believe is that the message we would say is relative to the tough compares, Advantage and Seresto are tracking to our overall expectations for the year.

We'll take the next question.

Your next question is,

Todd, maybe for the first one, for the innovation bucket in the next year, the year two contribution is greater than the year one, just when we try to isolate the innovation bucket revenue contribution to growth going forward.

And then, Jeff, to circle back on Seresto, my figure is I think Seresto is up 35% from 1Q21 to 1Q19, some of the color you gave last quarter. And then it looks like 2Q was up 5%. I know you said it got better in June, but maybe you can just talk about that disparity, why you have the confidence that it's still on track for your 2021 expectations, and just more broadly speaking, why you think it's more weather-related than market share. Thanks, guys.

Sure, John. Thanks for the question. We're not getting into 2022 guidance, but as we noted previously, the innovation portfolio, we have expected it to be growing faster in the second half from a contribution in 21 to that what it would do in the first half of 21, 22, as Xperia or something would continue to lay the groundwork on getting the Packer integration and the like, but then

Once that becomes standard feeding protocol in the feed yards, it's an option to assume that back half contribution would have been a better ramp into 2022.

John, great question on Seresto. Let me just highlight, I think at the highest level, you're exactly right on the trends. I'll reiterate that With the expectations we have, we did know that the ramp that came from COVID was unusual. First of all, you know, probably done in a four or five month period than the last four or five months on Soresto. What we would tell you is, one, we stand behind the safety of the product. Two, proprietary shows the belief in the product from pet owners and veterinarians. We've increased the advocacy by the veterinarian as well to this product. It's serving a niche and a need when you look at duration and cost and economics. And then I think most importantly is the global kind of focus. especially in international, with our increased dedicated investments and capabilities like digital and omni-channel. So strong IP protection, stronger capabilities as an independent Elanco, maybe versus Bayer. Again, we see this as a product with a long runway of value that can help drive overall growth as a key focus brand for our company.

Next question. Question is from Steve Scala with Caldwell.

You mentioned the higher corporate tax rates in the UK. But doesn't the UK tax rate increase from 19% to 25% as of April of 2023? If yes, then why is the impact occurring now?

And the second question is one of just curiosity.

If Alenco delivers full-year earnings at the midpoint of the range, then 65% of earnings would be delivered in the first half. In 2018 and 19, about 50% of earnings were delivered in the first half. Also true of 2020, that that was an unusual year. You noted a handful of temporary factors, but I'm wondering if there's any permanent factors that will drive this trend into the future. Thank you.

Sure, Steve. Thanks for the question. The remeasurement of the U.K. is really driven by the deferred tax assets and liabilities of the balance sheet that are longer-term in nature, and so we've got to take that in time now versus later.

Then with respect to this is the fundamental change that has happened with with the Bayer acquisition. With Soresto, historically, it's been about 70% of its sales is in the first half of the year.

A-Family's close to 60% in the first half of the year. So, you know, that dives into about 250% versus the second half of the year from those two products. And with that, you get a substantial will persist clearly as we get this over time that can affect the mix but you know here in 21 that was expected that's why when we've given guidance both for q1 and q2 we've called it out always a little bit of timing and shifts between quarters so if we look at you know a first half you know aspect of 65 cents of eps you know that's about the right percentage, as you know, for the dollar at the midpoint for the full year. And then as we go into 2022, we'd expect a similar seasonality to occur. As I mentioned, we called out some phasing of expenses or aqua sales. Those things are always going to happen in a broad-based global business like we have. But the seasonality will certainly continue and in line with how we've been

diving since December of last year.

And then I think the normalization, Steve, you know, as you look at a kindred portfolio coming on, we move to non-parasiticide growth in pet health as well as in Xperia.

God says this is all beneficial to Milanko.

Your next question is from Balaji Hassan from Barclays.

Hi, good morning. So two-part questions for me. Firstly, on ASF, I just want to call out some recent developments, especially the outbreak of ASF in the Dominican Republic, and inquire whether this could pose a risk to a swine revival for the industry and you.

Maybe some specific

specific commentary around the possibilities around ASF entering the U.S. from this region. And secondly, you called out reemergence. I'm not sure I got the full connection there. Could you comment on that and the expectation?

Yes, good. Great, great question, Blasi. So just at a high level, as we noted in our comments, you know, African swine fever, you know, did have an impact. In fact, as we've talked about in the first half, just overall to the Chinese industry, pig industry, slaughter rates were unexpectedly high in Q2, and that pushed pork production up. The sudden supply increase impacted some supply demand, and we saw, again, a decline of about 65% since the start of the year, as I mentioned. We're going to monitor this going forward. Our overall business continues to be very strong in China, but this surge we saw in the first quarter will lessen as we go into the second half. If I look at African swine fever specifically even in the Dominican, I believe that in the risks of that, I believe all the right measures are being taken and 30 is at a different place than it was in China when the virus hit.

It's China.

And, you know, I'm confident that at this point in time, first, it doesn't have any impact on our material impact on our business in Latin America. And I do believe.

Thanks. We'll move to the next question.

Next question is from Elliot Wilber with Raymond James.

Thanks. Good morning. Just wanted to ask a question.

around synergy target progression and cash cost spending against that. I presume your 2021 synergy targets are, in fact, intact, but specifically wanted to focus more on the cash costs associated with realizing those synergies. I think it was previously $160 million just in light of some of the inflationary pressures that were seen sort of across sort of early days in the integration on the working capital side. But if there's anything that you could give us at this point to sort of help us think about conversion operating cash flow conversion relative to adjusted net or adjusted EBITDA. Any help there in sort of trying to model operating cash flow going forward? Thanks.

Sure, Elliot. Thanks for the question. Things going very well.

The team's delivered on the productivity initiatives. Our manufacturing team continues to over-deliver in this area, finding opportunities to reduce the number of heads needed to drive our manufacturing facilities. and continuing to capture that. A large part of the cash costs to capture those synergies related to the layoffs that we did with the restructuring announcements from September of last year and then in January from an inflationary pressure that has less of an impact. And then we're also doing a lot of combination of purchasing, especially with media spend and other agency-related costs. You know, we are, you know, fighting against some inflationary pressure there, but we have better buying power now as a combined company with Bayer. So, overall, feel good about how that is tracking. As we look at the cost to both integrate Bayer as well as to set up our separate ERP system, pleased that we went from an $80 million of cash spend in Q1 to only $20 million in Q2. And that's with us going live on the ERP system in Q1, most of the integration from BEAR being completed. That is getting lower. Now, a lot of work to be done, a lot of great work by our global team to use the new system, transition to new processes and the like. We are continuing to stabilize the system, and then we'll be looking towards, all right, how do we integrate the TCS system that we had with – that bears businesses being run on versus our SAP for HANA system where we're operating our business on to integrate those in to drive additional savings in the back half of the 2025 timeframe we've talked about.

So all of those things in play.

With respect to operating cash flow, we will be filing the 10Q shortly. As a reminder, in Q1, we had $22 million of operating cash flow. In Q2, operating cash flow jumped to $149 million. And, again, that's a continued execution on these items of the integration popping up and then just continued cash conversion on our working capital goals and the like. So, overall, tracking very well on all those items as we move through 2021.

We'll take our last question. Your last question is from Devon Pye with Citi.

Hi. Good morning. Can you comment on the higher cost? I think you mentioned higher transportation costs that company specific or otherwise and then a follow-up on zora shield are you able to comment on the supply and also the demand dynamics and what did you expect and what has differed from your expectations thank you

Yeah, Naveen, thanks for the question. I think, you know, overall, the logistics costs and just the global freight and the mechanisms to get product moved across the world continues to be more disrupted by the COVID and the bounce backs and labor issues. that I think we expected. And then we're seeing some inflation playing in there as well. Teams opening up different trade routes. We're dealing with this in a very proactive manner, but we are seeing those costs come through and wanted to highlight it. From a pricing standpoint, we continue to think We will get a 2% price improvement across our portfolio in 2021, and we look for opportunities in gross to net or other ways to continue to be sure we're not missing out on opportunities on that end from our own level. With respect to the question on Zooshield, as we've mentioned, this was a dynamic of supply in the market already as poultry producers in the non-antibiotic space look at how they want to operate. This is something that we are focused on. Again, overall, $15 million on our $4.68 to $4.73 billion of revenue. is a small percentage we're looking across and very pleased that our other innovation is tracking ahead of expectations and you know we'll continue to do that as we look at the business going forward so that's where we land at the moment and we'll continue to update over the course of 2021.

I'll close by, as we close out the first half, thanking all of you for your interest in the questions today and look forward to working and engaging with you in the second half. Again, good, strong fundamentals in the marketplace. The strategy is working. Execution is extremely strong in Elanco. Good momentum is highlighted and exceeding our expectations today. and raising guidance for the third time and look forward again and engaging with you as we go forward. Thank you for your time today.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect.