Elanco Animal Health Incorporated

Good morning. My name is Joelle and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question and answer session. If you would like to ask a question during this time, simply press star and followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press the star one. Thank you. Katie Grissom, you may begin your conference.

Good morning. Thank you for joining us for Elanco Animal Health fourth quarter and full year 2021 earnings call. I'm Katie Grissom, head of investor relations. Joining me on today's call are Jeff Simmons, our president and chief executive officer, Todd Young, our chief financial officer, Ellen DeBrobender, our executive vice president of innovation and regulatory affairs, and Scott Perucker from investor relations. The slides referenced during this call are available on the investor relations section of elenco.com. Today's discussion will include forward-looking statements. These statements are based on our current assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from our forecast. For more information, see the risk factors discussed in today's earnings press release, as well as in our latest form 10-K and 10-Q filed with the SEC. We do not undertake any duty to update any forward-looking statements. Our remarks today will focus on non-GAAP financial measures. Reconciliations of these non-GAAP measures are included in the appendix of today's slides and in the earnings press release. After our prepared remarks, we will be happy to take your questions. I'll now turn the call over to Jeff.

Thanks, Katie. Good morning, everyone. Today we look forward to sharing our fourth quarter and full year results, as well as introducing our financial guidance for the first quarter and full year of 2022. Additionally, as you heard, we're excited to have Ellen with us today. She'll share a brief update on our pipeline and the progress she has made since joining the team last October. While the world continued to adapt to the COVID-19 pandemic and its challenges in 2021, at Elanco, it underscored the significance of what we do. The role of pets as our constant companions has never been more significant and ready access to sustainable, affordable protein remains top of mind. We remain optimistic and confident in the importance of our industry and the valuable role of veterinarians, farmers, and pet owners in caring for animals. Starting on slide four, the Elanco story is one of building, delivering, and strengthening. We are building a global leader in the attractive animal health industry. We are consistently delivering. while taking actions to further strengthen our company and our value proposition. 2021 marked our third full year as a public company. Since the IPO, we have made strategic decisions, including the acquisitions of Bayer Animal Health and Kindred Bio that position Elanco for long-term delivery and value creation. We've instilled a relentless focus toward ongoing corporate simplification, building a fit-for-purpose animal health company as we have completed the full separation from Lilly and continued our integration of Bayer. With the fourth quarter of 2021, we are reporting our first full year as a combined company with Bayer. Compared to when Elanco went public, today we are more diverse, more global, with more comprehensive product portfolios. We have also improved our revenue mix, balanced between pet health and farm animal and U.S. and international. We're an omnichannel leader providing for pet owners in the veterinary clinic and in retail and in e-commerce. Ultimately, we have built a diverse global business that we expect to deliver durable growth and significant margin expansion. That level of transformation, particularly amidst a challenging environment, is significant. None of this would be possible without the dedication, commitment, and ownership mindset of our globally lanco team the resiliency they demonstrated their achievements and discipline focused on execution must be commended the leadership team and i have deep appreciation and are truly grateful for all they have achieved the fourth quarter represents the fifth quarter of outperformance on our key metrics in 2021 we recorded 4.765 billion dollars in revenue growing approximately 7% compared to our 2020 pro forma combined company revenue, with pet health growing 10% and farm animal up 6%. We launched new, innovative products, advanced our pipeline, and our focus brand Galluprant became a blockbuster. We improved our adjusted gross margin to 56.6%, making progress towards our target of 60% by 2023. We delivered $226 million of adjusted EBITDA synergies, all contributing to our $1.057 billion in adjusted EBITDA, representing 22.2% of sales and adjusted EPS of $1.05. We ended the year with $638 million in cash and equivalents and saw improvement in key operational metrics, including reduced days of sales outstanding. We achieved our net leverage ratio target of five and a half times while funding the Kindred bio acquisition. And finally, we have been proactive and decisive, taking strategic actions to strengthen our business and further solidify our trajectory to deliver expanded value. We have optimized our R&D manufacturing footprint, which is expected to reduce CapEx and improve working capital. We also have expanded our pipeline with Kindred Bio and concentrated our R&D resources on our late-stage pet health assets, while also balancing for the future. We increased both the value of the pipeline and the probability of success for our key programs. And in November, we announced changes to streamline and simplify our organization, including shifting our marketing teams to be more integrated with commercial colleagues and closer to the customer to more efficiently drive our business in 2022 and beyond. As you can see, the Elanco team delivered this past year. We are confident that we have the right team and the right structure to drive our business forward in 2022 as we continue to advance our IPP strategy and make progress on our longer-term commitments, despite the expected challenges from inflation, supply chain, COVID-19, and competition. Let's now move to slide five, where I'll provide the highlights of our 2021 financial results. For each of our key metrics, revenue, adjusted EBITDA, and adjusted EPS, we outperformed our initial expectations set forth at our December 2020 investor day. Our results demonstrate progress toward our long-term margin expansion targets with profitability and earnings delivery enabled by the continued implementation of productivity efforts and synergy realization in the year on the top line last year is representative of elanco's durable diverse growth profile as i shared we grew seven percent compared to our 2020 pro forma combined company revenue our growth came from multiple areas across species across geographies and from innovation in 2021 we grew and four out of five species, with pet health growing 10% and farm animal growing 6%, led by poultry and cattle compared to our 2020 pro forma combined company revenues. We grew in all three commercial regions, with our international business also delivering 7% on a pro forma basis. Contributing to that, China represented over one percentage point of growth for the total company. Our well-positioned farm animal business also grew, and grew market share nicely in 2021. And globally, we launched new innovative products to kick off the next era of innovation for Elanco. Our broad, diverse portfolio provides Elanco with a wide range of pathways to deliver growth as evidenced in 2021. In our December 2020 Investor Day, we introduced a growth formula to describe our revenue expectations and our long-term growth algorithms. over time we expect average annual top line growth of three to four percent with varying contributions from our categories of focus core defend and innovation brands on slide six i'll go deeper on our 2021 revenue performance through this lens first in our defend category the advantage family delivered 517 million in sales growing approximately 2% on a pro forma basis, driven by the growth of Advocate in China. Remenson grew last year as well, bouncing back from the COVID-related impacts in the U.S. beef production industry in 2020, and is continuing to exceed our expectations for maintaining market share despite generic competition for nearly two and a half years. Our ability to differentiate Remenson's attributes Our value beyond product offerings and portfolio selling approach is resonating with customers. And rounding out our defend category, Trifexis, continues to experience competitive pressures in the U.S. market, but it remains a profitable blockbuster product, delivering sales of $137 million in 2021. Our core category, which represents dozens of key portfolio products, delivered approximately one percentage point of growth. That was offset by decreased contract manufacturing revenue as well. Growth was led by our pet health vaccines in the U.S., where we have strong momentum and are excited to drive innovation in our differentiated portfolio of highly purified, low-injection volume vaccines. On our focus brands, they delivered approximately three percentage points of growth, led by Credelio, Interceptor Plus, Claro, and our newest blockbuster, Gallup Brands. Seresto delivered 394 million in 2021, a year-over-year decline after an exceptionally strong 2021. Importantly, the two-year stacked growth of Seresto was approximately 21% in 2021 compared with 2019. And for the fourth quarter, it was 19% over 2019. This year, we have a robust activation plan for Soresto, leveraging a breadth of pet owner engagement touchpoints, including direct-to-consumer advertising while improving our digital shelf space and expanding into additional retail channels, as well as growing our vet clinic penetration by adding Soresto to our distributor buy-sell agreements in the US. We expect Soresto to return to growth in 2022. Finally, on innovation, our revenue from innovation-related products launched and 2021 was $72 million. We saw a strong uptake from our pet health launches led by Credelio Plus, while Encrexa was a valuable addition to our cattle portfolio. Also in Q4, both Zoeshield and Xperia laid solid foundations for 2022. Over the last year, with the introduction of Zoeshield and Clinicox, we've vastly expanded our presence in the poultry raised without antibiotics or RWA market. As a result of this and process optimization challenges limiting improvement for cost of sales, we have decided to discontinue the sales of COSABATI. Now moving to slide seven. I'd like to introduce our expectations for 2022. In line with our statements in early January, we expect to grow revenue two to 3% at constant currency. We expect innovation-related revenue to contribute approximately 120 to 160 million in revenue this year, representing an incremental 48 to 88 million over 2021, contributing one to two percentage points of growth for the total company. We expect adjusted EBITDA to be $1.14 to $1.18 billion, representing growth of 10% at the midpoint, or an expected 210 basis point improvement for adjusted EBITDA margin. For adjusted EPS, we expect $1.18 to $1.24 or 15% growth at the midpoint. And finally, we expect to continue reducing our net leverage ratio to approximately 4.75 times adjusted EBITDA by year end. On slide eight, let's take a deeper look at some of the specific 2022 revenue drivers. We expect price growth above our historical 2% level with disciplined analysis and execution critically important as the inflationary environment extends into our industry. Overall, we expect continued growth in the global pet health market, benefiting from COVID era increase in pet ownership. And while growth from these trends is slowing, we expect it to persist as a result of the increased expectation of care and awareness of our pets. Our broad global pet health portfolio is expected to deliver growth from key focus brands, from vaccines, and the addition of newly launched products. In parasiticides, we have a diverse portfolio globally. The combination of Credelio and Interceptor Plus remains the broadest coverage available for the treatment and prevention of internal and external parasites for U.S. pet owners. And Credelio Plus provides important Indecto coverage for pet owners in several international markets. We expect the competitive pressure in parasiticides to be mainly contained to the U.S. parasiticides market with an approximate $60 million headwind. while we expect to maintain our leadership in retail channels. More broadly, Gallup Rant remains one of our key focus brands and is expected to grow double digits again in 2022. Also, as we announced earlier this week, we're excited to welcome Bobby Modi as our Executive Vice President of U.S. Pet Health on March 14th. Bobby's leadership experience, track record of building and growing consumer brands, including pet brands, positions him well to lead and grow this business. Additionally, his experience in integrating and transforming businesses, leading sales teams, and expertise across innovation, digital, and e-commerce makes him a great addition to the Elanco executive team. On the farm animal side, we expect continued stabilization of global poultry and aqua markets. We also expect an outsized contribution from our newly launched U.S. farm animal products. led by Xperia and Zooshield, which we believe will be key drivers of our innovation sales in 2022. Importantly, Xperia continued to gain traction in the field with continuously increasing packer acceptance and processing of Xperia fed cattle. We've seen a growing demand from cattle producers with 100% return use and continued expansion of routine feeding. with the number of cattle on Xperia doubling every month since November. Given Xperia's compelling proposition, growing producer demand, and assumed continued packer acceptance, we expect a substantial step up in Xperia use moving into the second quarter, as we expect it to provide the most significant incremental contribution to our innovation-related sales this year. We continue to believe it will be our next farm animal blockbuster. Xperia is building another new sizable growth market in animal health around sustainability. We have taken critical actions over the last few months to drive producer value that will catalyze Elanco's growth in this new space starting in 2022. On that note, earlier this month we announced we're piloting a new tool called Uplook that helps cattle feeders benchmark greenhouse gas emissions and identify key drivers of their operations carbon footprint, providing an important baseline for their current stewardship efforts. Additionally, we announced our investment in a startup company called Atheon that focuses on creating and really aggregating, creating and monetizing producers' sustainability efforts. Finally, we continue to leverage the expertise of Dr. Sarah Place with customers. She's the leader of our livestock sustainability efforts and one of the most respected thought leaders in this space. Elanco is building a differentiated portfolio with products, tools, and expertise that we expect will create the next new major market opportunity in the farm animal health market called livestock sustainability. And finally, we expect our business in China will again deliver at least one percentage point of growth for Total Elanco with contributions across pet health and farm animal despite headwinds in the swine business expected in at least the first half of the year. Overall for 2022, we are confident. We have a balanced plan that is expected to deliver two to three percentage points of growth in constant currency. Before we turn to Todd to go deeper on our fourth quarter results in 2022 guidance, I'd like to welcome Dr. Ellen de Brabander. Ellen is a highly accomplished R&D leader. with a proven track record in animal health product development. I have known and admired Ellen's leadership over the years as she's delivered significant innovation and created robust, sustainable R&D capabilities. In just under five months, she has quickly hit the ground running, and I'm very impressed with her immediate progress. We're excited today to introduce her to the investment community. Ellen?

Thank you, Jeff. On slide nine, I will cover our 2022 innovation expectations and share with you why I believe this organization is well positioned to deliver on our existing pipeline and refill our pipeline with early stage assets to ensure innovation remains a key growth driver for Elanco over time. And while our 2021 launches were more spated toward farm animal, the expected approvals in 2022 will be skewed more towards our pet health business. in spaces such as pain, parasiticides, parvovirus, and vaccines. In January, we received FDA approval for Zorbium, a long-acting post-operative transdermal pain product for cats that is expected to launch mid-year. Later this year, we expect approvals for an extended duration topical ectoparasiticide for both dogs and cats called Advantage XD. And we are excited to bring this legacy Elenco innovation to market under the legacy Bayer Advantage brand, and to provide a new and innovative option for pet owners. These OTC products fall into one of the parasiticide target innovation areas described during the 2022 Investor Day. With Cradelio Plus, the broad-spectrum parasiticide we launched last year outside the US, and Advantage XD this year, we remain committed to our intention to deliver one parasiticide innovation on average per year through 2025. Overall, aligned with the outlook provided at the 2020 Investor Day, we expect to receive approval for and launch at least seven new products in major markets in 2022. And additionally, I'm further driving project in lifecycle management and geographic expansion to support the global durable growth of our current portfolio, as Jeff referenced already earlier. Looking deeper into the development pipeline, we expect 2022 to also be a productive year for regulatory submissions and progress of our late stage assets. Overall, we expect to make five to seven submissions to regulatory authorities in major markets across pet health and farm animal. And of these, we expect to make submissions for up to two differentiated pet health potential blockbusters in the U.S. in dermatology and parasiticides. And for competitive reasons, we are not going to share further details on these specific assets. However, we are pleased with the progress we are making with these projects. The last five months have been a pleasure getting to know the team, digging in on the pipeline, and building on the strong foundation within the organization. The R&D and regulatory leadership team has remained the same, providing consistency and stability. Our global organization grew substantially with the addition of both the Bayer and Kindred biobusinesses. And in 2021, we have successfully consolidated into one Elenco R&D. We are leveraging the diversity of expertise from all legacy companies and building upon the pillars of scientific and technical expertise and integrated project management. We believe our new organizational structure and consolidated footprint allow us to work in more streamlined ways and be more resource efficient, all while focusing on delivering and refilling the innovation pipeline. We completed a robust prioritization exercise resulting in a focused pipeline that is well aligned with Elenco's long-term strategic priorities. We have concentrated the resources on our late stage pet health products, shifting our investment in pet health development from 57 to 73% of total project spend expected in 2022, while also appropriately allocating across research and development phases. Over the last year, Elanco R&D has increased both the value of the innovation portfolio as well as its capability to progress the project towards regulatory approval in a resource efficient way. And while we are focused on the key projects in the development phase, we are not losing sight of refilling our pipeline by pursuing early stage innovation projects, both in pet health and farm animal. Overall, I am confident my experienced and highly capable team is well positioned to progress the pipeline and deliver the expected $600 to $700 million of innovation-related revenue by 2025. And now, let me hand it to Todd to speak more about our financial results and guidance.

Thanks, Ellen. Slide 11 summarizes our financial performance highlights for the fourth quarter of 2021 including our reported net income and earnings per share. This is our first apples-to-apples comparison for a full quarter since closing the bear acquisition in the middle of the third quarter of 2020. On slides 31 to 33 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 fourth 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 12, revenue in the fourth quarter was $1.113 billion, a year-over-year decline of 2%. When we guided for the fourth quarter last November, we shared that revenue growth would be unfavorably impacted by approximately $60 million of unique items related to customer purchasing patterns and short-term competitor stockouts in 2020, and exited products and reduced contract manufacturing, impacting our 2021 results. On slide 13, we have depicted our sales growth excluding these items and the FX impacts, representing growth of approximately 4% in the quarter driven by innovation and portfolio growth in pet health, poultry, and aqua partially offset by pressure in our China swine business. A breakdown of the region, species, and price-rate volume results for the quarter can be found on slides 25 and 26. As we looked beyond revenue in our fourth quarter results, our productivity efforts drove improvement. We increased our adjusted gross margin to 54%, an increase of 130 basis points compared to the fourth quarter of last year. This gross margin improvement came from our continued productivity efforts, improved price and mix, partially offset by inflation. In the quarter, we began to experience constrained supply of some raw materials and other important manufacturing inputs. We are working with our suppliers and contract manufacturers to minimize the impact of constrained inputs for 2022, but do expect some continued disruption. Moving down the income statement, our operating expenses decreased $66 million, or 14% in the fourth quarter. The realization of synergies and continued cost discipline allowed us to more than offset inflation while investing in our key strategic priorities. Our improved gross margin and lower operating expense drove adjusted EBITDA to $212 million in the quarter, growing 20%. Adjusted EBITDA margin for the quarter was 19%, up 360 basis points versus last year. At the bottom line, Q4 adjusted net income increased 84% to $105 million and included an effective tax rate of 14.6% for the quarter. The lower than expected Q4 tax rate was driven by certain favorable return to revision results. Earnings per share was 21 cents, a 75% increase year-over-year in the quarter. Beginning on slide 14, I'll provide a few highlights on our full-year performance. We delivered revenue of $4.765 billion and adjusted EBITDA of $1.057 billion, or 22.2% of sales. Continued productivity improvements, a disciplined approach to managing operating expenses, and delivering on synergies all contributed to our performance. Adjusted earnings per share for the year was $1.05. On slide 15, we break down the revenue performance, updating the bridge we have shared with you over the last year. While reported growth was 46%, pro forma growth was approximately 7%. Underlying growth from innovation and the portfolio delivered approximately 4 percentage points of growth in constant currency. Overall, our revenue remained fairly balanced between the U.S. and international, and between pet health and farm animal. China remained our number two affiliate, outgrowing the local market in pet health and gaining overall share in farm animal, despite pressured producer profitability in the local swine market. A breakdown of the region, species, and country-specific results for the full year can be found on slides 28 and 29. We expect to file our 10-K by the end of the month, but moving to slide 16, let me offer a few words on cash, debt, and working capital. In Q4, we delivered operating cash flow of $223 million. We ended the fourth quarter with $638 million in cash and equivalents on our balance sheet and net debt of $5.763 billion. At year end, our net leverage ratio was just below 5.5 times in line with our previous expectations. Finally, day sales outstanding decreased to 73 days at the end of the fourth quarter compared to 81 days at the end of the third quarter, reflecting improved execution on collections globally. Additionally, as we've regularly updated you, our aggregate channel inventory levels and distribution remain consistent with prior quarters in the US and across our global business. Moving to slide 17, I'd like to provide an update on our value capture efforts. As Jeff mentioned, in 2021, we realized adjusted EBITDA synergies of $226 million driven by headcount reductions, procurement savings, targeted R&D project rationalization, and site optimizations. This exceeds our original expectation by about $60 million in 2021 as a result of our additional restructuring efforts and acceleration of planned 2022 savings. We've captured synergies in our bottom line results and also reinvested in our U.S. pet health and China businesses to drive growth while also funding our standalone IT infrastructure and higher than expected legal costs. We expect progress to continue this year and to deliver approximately $345 million in adjusted EBITDA synergies by 2023, as we shared earlier this year. Today, we are also sharing certain synergy expectations for 2024. By the third quarter of 2023, we expect to have fully integrated the legacy Bayer business into our own ERP system and business processes. and thus expect to generate an additional $50 to $60 million of adjusted EBITDA synergies in 2024 and beyond. In 2022, we expect the one-time cost to achieve synergies to be approximately $260 million. This includes an incremental $100 to $120 million this year as compared to our investor day expectations to enable delivery of the incremental synergies from the November 2021 restructuring actions and the system integrations. Now let's move to our 2022 Financial Guidance starting on slide 19. We expect revenue to be between $4.745 and $4.8 billion, with reported growth at the midpoint and constant currency growth of 2 to 3%. For adjusted EBITDA, we expect $1.14 to $1.18 billion, or 24 to 24.6% of revenue. Finally, we anticipate adjusted EPS of $1.18 to $1.24 or growth of approximately 15% at the midpoint. As we did last year, slide 37 in the appendix provides a number of additional assumptions to help support your modeling efforts. Now let's discuss some of the underlying factors behind our 2022 expectations. On slide 20, we provide a revenue bridge from our 2021 results to our 2022 guidance. First, we expect the impact from foreign exchange rates to be a headwind of approximately $95 million or a two percentage point drag on growth year over year based on spot rates as of early February. Additionally, we expect another year of step down in contract manufacturing revenue from the sale of our facility in Shawnee, Kansas. While this represents an approximately $40 million headwind to the top line, these sales were lower margin and thus should be accretive to overall gross margin. Next, we expect our innovation and broader portfolio to deliver underlying growth of 3% to 4% this year in constant currency. Building off the $72 million delivered in 2021, the innovation sales Jeff and Ellen described should contribute an incremental $48 to $88 million in 2022, and the rest of the portfolio is expected to contribute about 2 percentage points of growth. Our portfolio outlook includes price improvement and volume growth in many key areas, partially offset by expected declines in defend and core brands. On slide 21, we've provided a bridge depicting our expected adjusted EBITDA improvement in 2022 of 10% at the midpoint. Revenue flow through to gross profit enabled by productivity and partially offset by inflation will be the largest drivers of improvement. Additionally, we expect contribution from decreased operating expense as a result of synergy realization and cost discipline that will offset inflation and allow us to continue making strategic investments. Our 2022 expectations are in line with our long-term algorithm and we remain committed to our expected 31% adjusted EBITDA margin by 2024. Finally, we are introducing guidance for the first quarter of 2022 on slide 22. We expect revenue of $1.2 billion to $1.23 billion, adjusted EBITDA of $310 million to $340 million, and adjusted EPS of $0.33 to $0.38. Given the timing of our step-down in contract manufacturing in the second half of 2021 and expected continued headwinds on our China swine business, we have a more difficult compare on the top line in the first quarter of 2022. Additionally, I will also take the opportunity to remind you that last year, we shifted approximately $30 million of operating expense from Q1 to later quarters in the year. We don't expect that shift in 2022, which will create a headwind in the quarter and make it difficult for our synergy capture efforts to shine through. Despite these factors, the business has entered the year with momentum and we are confident in the guidance we've shared today. Now I'll hand it back to Jeff for closing comments.

Thanks, Don. To summarize, Elanco delivered a strong 2021. Financially, we exceeded the expectations in our long-term growth algorithm with five quarters of delivery since closing the Bayer acquisition. We simplified our global sales and marketing operations and optimized our manufacturing and R&D site footprints. We went live on our own independent technology infrastructure and shared service center networks. We also progressed our internal pipeline and added additional pet blockbuster candidates with the acquisition of Kindred Bio. And finally, we issued our first ESG summary in June of last year. And earlier this year, we shared that we expect to introduce an EVA-like performance metric into our short-term compensation to drive capital optimization and further align employee and shareholder interest. It's working. Our IPP strategy is delivering. The results of our productivity are showing through. Elanco is a stronger company. These actions, along with the addition of Ellen and Bobby to our experienced leadership team, have set Elanco up for another strong year in 2022 as we continue to build, strengthen, and deliver on our value proposition in this durable animal health industry, and we look forward to engaging with you all throughout the year. With that, I'll turn it over to Katie to moderate the Q&A.

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

At this time, I would like to remind everyone, in order to ask a question, press star, then the number one on your telephone keypad. Your first question comes from the line of Erin Wright from Morgan Stanley. Your line is open.

Great, thanks. You spoke to double-digit EBITDA growth in early January, but the lower half of the range today doesn't quite hit that mark. I get the midpoint, Des, but what are some of the swing factors that get you to the high versus low end of that range, and is there some conservatism there, or has anything changed relative to your expectations in early January? On the two blockbuster submissions in Pet Health and Parasiticides and DERM, Can you speak to the geographies of focus for those products, and will the parasiticide product be a flea, tick, and heartworm triple combination product in the U.S.? And will these be before the all-important flea and tick season in 2023? Thanks.

All right. Todd, if you want to take the first question on EBITDA, and then we'll go to Ellen.

Thanks, Erin, for your question. Our reference early in the year was to our expected midpoint, so no change on our EBITDA expectations. Right now, we do have some FX headwinds. We'd be 12% at the midpoint in constant currency as provided in the bridge. We've got about 20 to 25 million of FX headwinds to the EBITDA numbers. From the respect to what could drive us higher or lower, clearly there's a lot of moving pieces globally. Right now, as we all know, it's very dynamic. We feel confident in this plan and our ability to deliver it over time. With that, I'll hand it to Ellen to address your R&D question.

Thanks, Todd, and thanks for the question. Pipeline assets, indeed we are quite excited not only with the pipeline but also with the progress we are making with the key projects in the pipeline. And we plan indeed to do the submissions of up to two new potential innovations with differentiated blockbuster potential later this year in the pesticide field and in the derm field. For now, we can actually not give more specifics on the individual assets, but the only thing I can share is that, indeed, we are excited with the progress we are seeing so far of these differentiated potential blockbusters.

And, Aaron, I'll pick up. I mean, no question, our focus will be on the U.S. market, you know, followed by the other major, you know, pet markets, West Europe and, you know, Japan, Australia. But the U.S. is our primary focus.

Great. We'll take the next call here.

Your next question comes from the line of Michael Riskin with Bank of America. Your line is open.

Great. Thanks for taking my question and congrats on the quarter and guide. I want to start on the innovation side of things. I think you called out that the innovation portfolio contributed $41 million in the fourth quarter, and that's the products you launched in 2021. And yet you're guiding to $120 to $116.22. So maybe there's some strong seasonality there, but just given how we've seen new products launch, if you hit 41 in the last quarter, shouldn't that be sort of a steady run rate going forward? And then particularly given there's incremental launches on top of that this coming year, so why wouldn't that number come in a little bit higher? And then for the follow-up, maybe one for Todd, on the gross margin guide, your comments on 57, 58 this year, and yet you're still reiterating 60% the following year, So 200 to 300 BIPs gross margin expansion next year. Could you just talk through the moving pieces, you know, what makes this year a little bit less in terms of margin expansion and next year that much more? Thanks.

Great. Thanks, Mike. We'll let Todd address those.

Sure, Mike. Appreciate the question. There is some seasonality with respect to the poultry season and how that plays in Q4, you know, the incremental growth. Uh, in next year at the 48 to 88Million, a lot of that will be on the uptake of exterior. We're really excited by the foundation that's laid and the continued growth of our cattle portfolio as we've become more and more important to our customers and our. Products beyond just the novel solutions we provide, including the new Uplink, Uplook calculator, are all very big. So, you know, that's a big part of the innovation that clearly excited for Crudelio Plus outside the U.S., where we have all the broad triple combination product there in Australia, Japan and the EU. With respect to the margin, again, we've all called out the inflation. That's certainly something that has impacted us more than what was expected when we gave out our initial guidance at our 2020 investor day. We've been able to overcome that with better than planned performance in 2021, and we're still tracking to continued uptake in 2022 despite those inflationary pressures. as we focus on taking incremental price versus historical expectations, as well as continuing to drive synergy and value capture initiatives. So overall, we feel good on how we're tracking, as well as the procurement and manufacturing quality savings the team's driving.

Great. We'll take the next caller.

Your next question comes from the line of Nathan Rich with Goldman Sachs. Your line is open.

Hi, good morning. Thanks for the questions. Maybe following on Mike's questions on margins, looking at just the long-term EBITDA margin target of 31% by 24, the guidance for this year is for a margin rate in the low 24% range. You know, the synergy walk that you provided was helpful. I think, you know, kind of 100 million incremental in 23 and 24. I think that adds about 200 basis points to margin. So it seems like there's still kind of meaningful underlying improvement implied in that 31% guidance. So could you maybe just help us think about what drives that? And then my follow-up, Jeff is on Gallup, and I think you had said you expected to grow double digits in 22. You also alluded to the competitive launch in OA in the EU as a headwind. I guess maybe what have you seen so far around that, and are you still expecting GallupRent to grow in the EU this year despite that competitive entry? Thank you.

Great. Thanks, Nate. Todd, you want to take the first question on margin, and then we'll go to Jeff.

Sure. Yeah, the EBITDA range and the sales range at 24 to 24.6 would be a continued step up from what we've done here in 2021. There are some inflation headwinds that we would expect to come out by the time we get to 2024 that would provide incremental. We've also run higher legal fees than historical that also could come out. And then just the natural continued growth in sales while we hold our cost of manufacturing flat will drive that incremental gross margin that will also then flow through to the EBITDA margin. So we feel great about the year we had in 2021. ahead of that early expectations and still feel like we're very much tracking to the 31% commitment we have for 2024.

And, Nate, relative to Gallup Ranch, you know, it did become our latest blockbuster in 2021, meeting our expectations. We do expect, as you said, it will grow double-digit in 2022. A couple things that I would note is we do see pain. One of the largest pet health markets, probably behind parasiticides and derms, to be one of the faster growing markets. Elanco comes into that with the largest portfolio overall. And we see Gallup being very competitive with, you know, value from, you know, home treatment to the safety profile and the unique offering. I think, you know, what happens as you look at the EU market, I think that the interesting data is the EU market expanded over 30% in the fourth quarter. So new innovation is going to expand the pain market. We continue to focus on differentiation, first-line treatment, and also portfolio selling overall to the veterinarians, not just in Europe but across the globe. So, again, expect double-digit coming into this year and expect some nice growth, including our new product, Zorbium, as we bring that into the pain portfolio as well. Great. We'll take the next question.

Your next question comes from the line of Chris Schott from J.P. Morgan. Your line is open.

Great. Thanks so much. Just for me, just can you elaborate a little bit more on the defend brands? It seems like those outperformed in 2021. And I'm trying to get a sense of what enabled that outperformance and how sustainable could that be as we look out to 2022. And then on the two blockbusters, I know you're not going to go into full details. But can you comment if these are as clinically de-risked at this point, and you're moving forward with the filing? Or is there still key clinical or registrational data that we're waiting on. Just trying to get a sense of, you know, you may be getting a profile, but, you know, are these largely products that will be at some point filing and moving forward? Thanks so much.

Great. Let's start with Jeff on the Defend brand, and then we'll go to Ellen.

You know, Chris, great question. As we said during our investor day with this growth algorithm, we're concentrating, you know, different strategies against these different categories. And with Defend, you know, we put a concentrated focus on three brands. And there are some commonalities there, but one is we are looking at them, we are defending them in the appropriate markets where we believe it's the right thing to do to defend. So I'll start with Advantage, the Advantage family, a real focus effort on that whole brand family that is still, we believe, a very valuable brand to pet owners. It was led with an increased investment, reps, and promotion in China with the Advocate product. And that was one of the fastest growing products in the overall China market overall, all competitors involved. So I think we'll continue to expand and use that. As Ellen mentioned, we're going to continue to leverage that Advantage brand as we bring a new product to market, actually an Elanco compound with now a Bayer brand Advantage and leveraging that with Advantage XT. Remensin, it's very simple. It is differentiated. It is selling value beyond product. and really leveraging our total portfolio. And we saw Ramensen grow against a COVID compare, but we continue to see that that product is going to be a very strong product for us, especially as corn prices increase and the importance of performance products. And then Trifexis, again, we're containing it. We're leveraging it into the market segments we know. We said it's a little over $130 million in size. We do see that erosion will come to that brand as well as Confortis. from the competition that we noted as $60 million total erosion. But again, overall, defend brand strategy is working.

And Ellen, on the blockbusters? Yeah, thanks. We expect to make submissions for up to two differentiated potential pet health blockbusters later this year. And right now, I can tell you, these are complex projects. A lot of work is happening in parallel. Both the studies are still in flight. Some of them are in the final stages, and we are preparing the dossiers. So they are not fully de-risked, but we have said we are expecting the submissions later this year for up to two of these potential differentiated pet health blockbusters.

Good. We'll take the next call.

Your next question comes from the line of Uma Rafit from Evercore ISI. Your line is open.

Hi, guys. Thanks for taking my question. Two here, if I may. First, I know you're guiding to 80 to 120 million EBITDA growth into 2022. But of that 80 to 120, it looks like about 60 million is coming from the restructuring announcement in November 2021, where I think you guys eliminated 20% of the leadership team. So I guess the question is this. As we think about the growth, the margin growth beyond 2022, would substantial additional actions have to happen to deliver such growth, margin growth in 23 and beyond? Or would a more tempered inflation plus your existing efforts be sufficient to drive that EBITDA growth in 2023 and beyond? And then secondly, and this ties into the EBITDA growth as well, should we be expecting revenue acceleration perhaps 5% plus into 2023 as you potentially launch your JAK inhibitor plus a second key blockbuster, or would that not really impact the numbers till 2024? Thank you.

Todd, you want to get us started on the EBITDA?

Sure.

Thanks for the question, Umar. Yes, we have a lot of benefits flowing from the restructuring. Those are helping to offset inflation while we continue to drive our sales growth and productivity across the entire gross margin platform. So that is in play. From the standpoint of improving EBITDA, most of the actions have been taken as we annualize a lot of our benefits. The one thing to note, as we called out, we are integrating the Bayer ERP system that's currently run with our partner, Tata Business Consulting, into ours. That will provide incremental synergies that drive that forward. And then we do expect some mitigation from the inflationary side to also drive that. But a lot of this is really the underlying efforts we have. We're not expecting another significant restructuring, though there will be some impacts once we finalize that integration of the systems and business processes in the middle of 2023. So overall, we feel good about how the business is looking. And certainly, you know, growth of innovation products like Xperia that have a very, you know, above average, corporate average margin profile will also, you know, help drive that increasing EBITDA profitability.

And, Umar, I'll just pick up on that. I mean, no question, in addition to all of that, continued growth of innovation brands and focus brands will be, and price, will continue to be, you know, contributors to that margin expansion. What I would just say is we outlined in December 2022 this growth algorithm, Boomer, relative to the different categories of products, and it is working. We saw in our pro forma basis, 7%, constant currency, 5%. And what we're seeing here is we're off to a good start in year one. We believe that no question innovation will be a key driver. We're more than doubling innovation this year. The focus brands have strength. Last year's innovation will be the biggest contributors. All of these things are the aspects we believe. We think price and our digital enablement will help. China and geo-expansion will also be a big driver. Not going to give future forecasts, but we do believe strongly in the growth algorithm and the durable, diverse, sustainable growth that we're getting from our business that was represented in 21. All of that leads to staying to our commitments that we highlighted in December last year.

Good. We'll get ready to take the next caller. I'll just mention we'll probably go a couple minutes over. I know we still have several in the queue, so we spoke a bit long and we started a few minutes late, so we can go ahead to the next caller, Joelle.

Your next question comes from the line of John Block with Stifel. Your line is open.

Good, thanks. Good morning, guys. Maybe just a couple. For price, I believe it was 2% in 2021, but I don't think that's a pro forma number. So, Todd, is there a pro forma number to think about for price? And more importantly, how do we think about price in 22? I know you guys said higher. You know, is it 3%? Is it 6%? Maybe just some way to think about it for the year. And then, Jeff, the plans for reacceleration and seresto sales in 22 that you called out, what's the primary driver for that? Is it opening it up to the vets? I think you also mentioned some advertising or new markets. And just maybe a clarity question, if the product's going to the distributors to sell into the vet practices, is there any sort of an inventory bill that has or will take place that we should be aware of? Thanks, guys.

thanks for the question john uh the two percent uh for the full year that's pretty solid the you know the difficulties on a pro forma basis gets harder as you know as we included the uh most of bear in volume for most of the year but you know generally speaking the twos in line with respect to other price increases we have uh increased price in both the vet channel as well as uh at retail and then also on our farm animal products already with list price increases to start the year Those will be, you know, intended to be higher than that historical 2% number we've had, but we're not getting into specifics as it varies by product line. You know, clearly there's some OTC products where we've got a little bit more pricing power, and then in the farm animal side, you know, it can be pretty competitive. And at that point, you know, our value beyond product really helps drive our overall portfolio as we continue to take market share in U.S. farms.

Jeff, on Soresto.

Yeah, on Soresto, just again, it met our expectations, John, as I highlighted in 2021 with a challenging compare in 2020. And we have activated a lot of efforts, probably some of the maybe highest activity against Soresto in a long time for the brand going into 2022. And again, I'll just hit, it's ultimately about putting the product in more geography and more channels with more access to the pet owners, we continue to see tremendously high loyalty and return use to this product. And we will, you know, continue to support that with DTC increased digital shelf space. Um, and then yes, more, more consumer channels and more geography relative to the U S move. Um, yeah, there'll be a very small incremental, you know, increase. I think, uh, vet clinics will take on maybe less retail product, OTC product inventories compared to scripted products. But our goal here is veterinarians as pet owners come in with that loyalty to Soresto, um, and the segments that it serves, you know, for the first time, you know, putting this into our distributors hands and putting it into clinics is just another channel to allow more access. in a buy-sell arrangement versus a different arrangement. So we believe that's also going to be a key driver to Soresto's expanded use and, again, growth in 2022.

Thanks. We'll take the next question. Your next question comes from the line of Elliot Wilbur. Your line is open.

Thanks. Good morning. Question for Jeff and or Todd. I guess just with respect to your overall top-line outlook for the year, anything you can say specifically in terms of anticipated relative performance of the various segments and individual species within the farm animal segment in terms of anticipated year-on-year growth? you know, how are those individual segments expected to form versus your overall top line outlook of two to 3% and, you know, where, why we see the strongest growth kind of within the farm animal segment. And then follow up question for Todd, relatively strong cash flow conversion for the full year. I think the number is 94, 95% in terms of adjusted net income cash flow conversion. Is that sort of the new norm for the company outside of just maybe some seasonal swings in working capital around year-end. Thanks.

Yeah, Ellie, real quick, I would say, you know, overall, our growth as we look at it at a high level, innovation brands, as we mentioned, will be a key driver. Price, our focus brands, especially as we think about Credelio, Interceptor Plus, Gallup Rant, and then China. Those will be some of the major material drivers offset by the CMO some FX and the, and the parasiticide concentrated, uh, you know, competitiveness in the U S um, as you look at the species overall, again, pet health, we see strong, even though the numbers are flattening a persistence there is positive. We think wellness and visits being up spend being up the overall experience has improved. We see a strong fundamental pet market in 2022. We see poultry and aqua recovering from the COVID situation. Better economics in countries internationally have helped both of those markets, as well as return to restaurant purchasing for the salmon market. And then, you know, I would say on the cattle market, the market has tightened, supplies have tightened, exports are strong, especially coming out of the U.S. That's going to drive price up. And we believe our performance driven portfolio supports that nicely. And then swine really is one of overall a pretty stable market. with headwinds probably still in the first half, more from an economic perspective, not an African swine fever perspective in China. So contained challenges in the first half. We see recovery in the second half of China's swine.

Thank you for the question on the operating cash flow. Yeah, we're thrilled with the $223 million we did in Q4. That 94% conversion of net income to operating cash for the full year feels to be in a range that we expect to continue to deliver. I think as we look out over the next couple of years, that acceleration and operating cash flow is a very key component of our strategy as we continue to, you know, de-lever. And, you know, we only expect it to get better as we get beyond 2022 where it'll be the last big year of one-off cash expenditures with the consolidation of the system as well as paying out the cash on severances from our latest restructuring. So, you know, overall feeling very good about the cash flow generation and our net leverage improvements.

Great, thanks. We'll take the last caller.

Your last question comes from the line of Navan Tai with Citi. Your line is open.

Hi, good morning. I have a follow-up on the cash generation. Can you comment on the cash needs? So I know there's some costs to integrate Bayer and Elanco SAP systems. Will they step down in 2022 or remain significant and Any guidance or comments on free cash flow expectations for this year?

Sure, Naveen. Thank you. Yes, we're going to have about the same one-off cash needs for the integration and the severance costs as we had in 2021. We've got our assumptions on slide 37 at about $260 million. This all gets built into our operating cash flow, which we talked about on a gap basis. So with that, we do expect to have in the range of $450 to $500 million of free cash to allow us to continue to reduce debt and get our net leverage to the 4.75 times we guided to today.

All right, thanks. We'll hand it back to Jeff to close.

Yeah, thank you for the time, and we appreciate your interest in Elanco. Again, a strong historical 2021. The integrations, IPP, and our overall strategy is working. As I referenced back to the investor day in 2020, we are on the trajectory. We're exceeding some of those expectations and staying to our commitments as we go forward. Thanks for your interest. We look forward to engaging with you throughout the year.

This concludes today's conference call. You may now disconnect.