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spk06: Good morning. My name is Rob and I will be your conference operator today. At this time, I'd like to welcome everyone to the Elanco Animal Health's first quarter 2022 earnings 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 followed by the number one on your telephone keypad. If you would like to withdraw your question, again, press star one. Thank you. Katie Grissom, Head of Investor Relations, you may begin your conference.
spk12: Good morning. Thank you for joining us for Alanko Animal Health's first quarter 2022 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, and Scott Perucker from Investor Relations. The slides referenced during this call are available on the Investor Relations section of elanco.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 section discussed in today's earnings press release, as well as our latest Form 10-K and 10-Q filed with the FCC. We do not undertake any duty to update any forward-looking statement. 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'll be happy to take your questions. I'll now turn the call over to Jeff.
spk08: Thanks, Katie. Good morning, everyone. Elan goes off to a strong start in 2022 as we continue building, delivering, and strengthening our company. The first quarter marked another consistent quarter of delivery with our key three metrics, revenue, adjusted EBITDA, and adjusted earnings per share, all exceeding the midpoint of our guidance. We remain well positioned as a leader in the durable animal health industry and have taken important actions to streamline our organization for continued delivery, even in an increasingly challenging environment. Since our last earnings call, several macro dynamics have intensified. from the strengthening U.S. dollar and continued cost inflation to emerging situations with the war in the Ukraine and COVID protective measures in China. Today, we are updating our guidance for revenue, adjusted EBITDA, and adjusted EPS to reflect changes in foreign exchange rates since last February. We remain confident in our constant currency revenue growth outlook of 2% to 3% for the year and we are encouraged by the foundation we are building for Elanco's next era of growth. Reviewing our key financial metrics on slide four, we delivered 2% constant currency revenue growth in the first quarter despite the increasingly volatile macro environment. Adjusted EBITDA margin was 27.7% and we delivered adjusted EPS of 36 cents. Our portfolio delivered at the high end of our guidance with $1.225 billion of revenue, including pet health growth of 2% and farm animal growth of 1% at constant currency. Several key factors drove this growth. First, our focus brands, with growth led by Poultry & Aqua, as well as key pet health brands, Soresto, Cordelio, and Galaprant. These helped drive a 4% constant currency growth in our international business, despite the expected challenges in the swine market in China. Next, price. Price improved 2% in the quarter, and we expect it will accelerate in the second half of 2022. And finally, our innovation products are tracking in line with our expectations for the year with positive results for ZOA Shield and strong indicators for Xperia. Before we cover our updated expectations for the year, on slide five, I believe it's important to remember why animal health is such a durable business and how the industry and Elanco remain well positioned for sustained value creation in today's macro environment. First, protein and pets have proven to be essential. The role of pets as our constant companion has increased our expectation of care. With respect to protein, the availability and affordability of sustainable protein is no longer taken for granted and growing at historical levels. This animal health business is also diverse spread across the global economy, five major species groups, and multiple therapeutic classes, all providing numerous avenues to deliver growth and value to customers while limiting dependency on any one specific dimension. And finally, this remains almost entirely a cash pay business, where innovation and value-added services are rewarded by customers. I would specifically point to a few key trends we're watching this year. First is the improving pet owner experience, which transformed during COVID. While vet visits are normalizing, the transition to omni-channel and direct-to-door purchasing, both through e-commerce and the veterinarian, has improved convenience and compliance and is supporting higher pet owner spend. A recent Elanco survey showed a third of pet owners expect to spend more on their pets in 2022. This is especially true of younger generations, with nearly half of Gen Z indicating they expect to increase their spending on pet care. Next, with underlying pet ownership above pre-pandemic levels, we believe this higher base, along with improved expectations of care, will continue to drive industry growth going forward. And finally, the pet industry has historically demonstrated resiliency in inflationary times. On the farm animal side, we continue to see strong long-term protein demand despite higher protein prices. Increasing global GDP and shifting diets are driving a significant increase in demand for animal protein this decade compared to last decade. In the near term, post-pandemic stabilization of food service demand in most parts of the world is driving improvement, notably in poultry and salmon markets. Importantly, we continue to see producer profitability across most species despite increasing input cost. In times of elevated fee cost, Elanco's portfolio is highly valued by our customers as it supports improved fee conversion and efficiency. While macro factors could have short-term cross-industry impact, overall, the underlying fundamentals in animal health remain strong, and Elanco remains well-positioned to deliver in today's environment and over the long term. With this industry backdrop, we continue to expect 2% to 3% constant currency revenue growth for 2022. On slide 6, While we have adjusted our guidance for continued strength in the U.S. dollar, the underlying revenue assumptions we shared in February remain largely intact. Focused brands, pricing, international, and innovation will continue to support growth for the year, while competitive and generic pressure primarily on our defend brands, softness in China's wine, and year-over-year step-down in contract manufacturing were expected headwinds. Emerging macro pressures in the Ukraine and China and certain stockouts in the U.S. retail are expected to negatively impact the business, primarily in the second quarter. For the full year, we expect to offset these incremental headwinds with strong performance in poultry and aqua, incremental growth in pet health-focused brands in Europe, and price growth above our initial expectations, especially in international markets. Importantly, Seresto continues to be a key growth driver and is off to a strong start, growing 6% year over year in the first quarter. Our new consumer campaign for the brand is driving credibility and positive brand sentiment and is outperforming our KPIs for impressions and engagement rates. We continue to invest in the robust activation plans for the brand, optimizing the depth and the breadth, of our direct-to-consumer exposure and doubling down on e-commerce with incremental spend in targeted areas to drive conversion. Overall, we are pleased with our positioning and continue to see a nice runway of growth for Soresto. On innovation, our launch products are gaining traction in the market and we continue to expect a contribution of $120 to $160 million for the year. For Xperia, As we see the increased focus on the environmental sustainability and a growing validation of the product's value proposition, all major packers are now evaluating or fully accepting exterior-fed cattle. As a result, we're seeing strong producer demand pivot from trial to full feed yard use, including several of the country's largest cattle feeders. In addition to our revenue expectations, we're updating our guidance for adjusted EBITDA and adjusted EPS to reflect the strengthening U.S. dollar, but remain committed to our year-end net leverage target. Our consistent delivery against our company-wide productivity initiatives and the decisive actions we took to simplify the organization provide confidence in our ability to mitigate the impact of increasing cost inflation on our global business. Finally, on slide seven, I'd like to highlight progress and actions we're taking to build the foundation for the next era of growth at Elanco. On near-term innovation, we've already received five of at least seven expected portfolio-enhancing approvals in major markets for the year, primarily in pet health. Dr. Ellen DeBroadmander and her highly capable team are very encouraged by the pipeline progress we made in the first quarter, including achieving two major milestones that advance our late-stage dermatology and parasiticide development programs. We continue to expect to make five to seven regulatory submissions in major markets in 2022, with up to two being differentiated pet health potential blockbusters in the U.S. in dermatology and parasiticides. Additionally, we added another potential blockbuster to our longer-term pipeline with our recent strategic alliance with DSM to develop, manufacture, and commercialize Beauvoir in the U.S. Based on dozens of published studies, DSM has proven Beauvoir to be a revolutionary methane-reducing product for beef and dairy cattle, already approved in several international markets, including Europe. Once approved in the U.S., we expect Beauvoir to have blockbuster revenue potential in excess of $200 million annually, with initial contribution by mid-decade. We believe livestock sustainability is the next frontier of innovation and and the next new material farm animal market. The alliance with DSM further strengthens our leadership position in transforming this space, and we expect it will be foundational to Elanco's next era of growth. And finally, we completed the carve-out of our microbiome platform and pipeline by launching Biomedic under the direction of Aaron Schott. This was a great outcome for all parties, and we wish Aaron and the team at Biomedic great success. Now I'll hand it over to Todd to provide more color on our first quarter results and outlook. Todd?
spk13: Thank you, Jeff, and good morning, everyone. Today I'll focus my comments on our first quarter adjusted measures in order to provide insights on the underlying trends in our business, so please refer to today's earnings press release for a detailed description of the year-over-year changes in our reported results. Starting on slide nine, as Jeff mentioned, we had a strong start to the year, with revenue of $1.225 billion, delivering 2% constant currency growth driven by a 2% increase from price, primarily in pet health. Foreign exchange rates provided a headwind of $36 million in the quarter, or 3%, slightly above our expectations. Slide 10 breaks down our revenue performance by species, and slide 11 provides revenue by region in the quarter. For pet health, we grew 2% of the constant currency for the quarter, led by our international business, which grew 8% at constant currency. Globally, Soresto contributed $161 million in revenue, growing 6% on a reported basis, and Credelio grew double digits, while earlier generation parasiticides declined in the U.S. The Advantage family contributed $137 million in the quarter, an overall decline of 5%, with growth in several international markets more than offset by a decline in the U.S., Multiple dynamics impacted the performance in the U.S., including declining vet sales of prescription product, Advantage Multi, and supply chain input challenges for items like paper and packaging, impacting our ability to supply retailers. In some cases, this caused stockouts at retail. We expect this to be resolved late in the second quarter, as we are already seeing improvements in the paper supply situation. On the farm animal side, the business grew 1% at constant currency, driven by improving in-market prices and innovation in poultry and robust growth for aqua, which included some phasing from Q2, partially offset by the continued and expected pressure in the China swine market in the quarter. Additionally, after growing mid-single digits on a pro-form basis in 2021, our global cattle business declined 3% in constant currency in the first quarter of 2022. primarily driven by generic competition impacting price on several key brands. Slide 12 further summarizes our financial performance highlights for the first quarter. Aligned with the decrease in reported sales, adjusted gross margin was 58.4%, a decline of 80 basis points compared to the first quarter of 2021. While price and mix largely offset each other, the unfavorable impact of approximately $30 million of year-over-year inflation was partially offset by approximately $25 million in manufacturing productivity improvements. Given the structural nature of our price and productivity improvements, we expect their benefits to sustain over time. We continue to experience constrained supply of certain raw materials and other important manufacturing inputs, as well as labor shortages at several of our contract manufacturers. This created disruption in our ability to efficiently run our manufacturing operations from an absorption perspective, providing a headwind to our gross margin expansion and limited supply for a few select products in our U.S. retail channel, including certain advantage family SKUs. Our commercial, manufacturing, and supply chain teams are working closer than ever to prioritize SKUs in key markets. Dave Urbanik, our head of manufacturing quality, and his organization have been working tirelessly for nearly two years to mitigate supply challenges for Elanco and our customers. We are deeply appreciative of this team's relentless focus to maintain supply while continuously improving manufacturing efficiency, reducing overhead costs, and driving procurement savings. Operating expenses for the quarter were $401 million. a reduction of 8% year-over-year and 5% sequentially compared to the fourth quarter of 2021. The impact of FX was approximately $10 million favorable in the first quarter or a 2% benefit year-over-year. This improvement highlights our disciplined execution of last November's restructuring and demonstrates our ability to sustain synergies while more than offsetting inflation and continuing to invest in key strategic priorities. Our R&D spend was in line with expectations as we concentrated investments going into this year and prioritized our pet health blockbuster development pipeline. Interest expense was $52 million in the quarter, a year-over-year decline of 15%, driven by the repayment of our 2021 senior notes last August. The non-GAAP effective tax rate was 30% for the quarter compared to our initial expectations of 23 to 24% for the year, which reduced our EPS by approximately 4 cents versus those expectations. The higher than expected first quarter tax rate was driven by the 2017 US tax law change that became effective in 2022 requiring the capitalization of certain R&D expenses. This impacted our tax rate by approximately 10 percentage points. For the full year, we now expect our tax rate to be approximately 25 to 26% to reflect this change in U.S. tax law. Adjusted net income was $177 million, and adjusted EPS was 36 cents for the quarter, both declining 3%, largely driven by the U.S. tax law change. Adjusted EBITDA was $339 million in the quarter, or 27.7% of revenue, representing a modest expansion of 10 basis points, despite the headwinds of inflation felt on both the gross profit and operating expense lines and the revenue headwind from foreign exchange rates. Additionally, I'll take the opportunity to highlight our positive gap net income and EPS performance in the quarter. As we continue building and strengthening the Elanco business, we are reducing the gap expenses associated with the restructuring, integration, and our independent company stand-up. As we shared in February, we are in the process of integrating the legacy Bayer business processes into the Elanco ERP system and operating network. This is the last significant integration activity and remains on track to be completed by the third quarter of 2023. We expect to file our 10Q in the coming days, but let's move to the balance sheet and cash flow metrics on slide 13. We ended the quarter with $5.87 billion in net debt, slightly higher than at the end of the fourth quarter of 2021 as the first quarter has heavier cash outlays due to the timing of annual compensation payments. We expect to end the year with a net leverage ratio of less than 4.75 times. In the first quarter, our operating cash flow was negative $62 million. While we continued to reduce DSOs globally, we had a significant year-over-year reduction in accounts payables and other liabilities as our back office vendor processes continued to gain efficiency. Additionally, in the first quarter of this year, we had higher compensation payments partially due to having a full year of bonus payments for legacy bear employees and higher severance payments as compared to the first quarter of 2021. Finally, in April, we tendered $406 million of the $750 million of outstanding senior notes due in August of 2023. A significant portion of this debt was refinanced by increasing our term loan aid with farm credit by $250 million. Now, let's transition to our updated outlook for 2022 on slide 15. Today, we are updating our full-year guidance for revenue, adjusted EBITDA, and adjusted EPS to reflect foreign exchange rate assumptions as of early May. For the full year, we now expect revenue to be between $4.7 and $4.755 billion, with constant currency growth still expected to be 2% to 3%. The impact from foreign exchange rates is now expected to be a headwind of approximately $140 million for the full year, incrementally $45 million above our February projections, or now a three percentage point drag on reported growth year over year. While our first quarter results were not materially impacted by the war in Ukraine or COVID-19 protective measures in China, we do expect some impact, primarily in the second quarter in China, but acknowledge there's a significant uncertainty given the volatile and evolving nature of the situations. In 2021, Russia and Ukraine collectively represented less than 2% of our global business. We continue to operate in the region, providing essential healthcare products for animals, despite an increasingly challenging environment and our decision to stop promotional spend. With respect to China, the increased protective measures around COVID-19 are impacting consumer access to goods and services. In the first quarter, our pet health business in the country grew double digits, but momentum has slowed across the industry through April and into May. While we foresee some headwinds in the second quarter as a result, we believe it will be temporary in nature and our pet health business in China will still grow meaningfully for the year. On the farm animal side, restrictions in major population centers in China are limiting social gatherings and food service consumption, exacerbating the already imbalanced supply and demand for pork. Sow prices continue to be the leading indicator we are watching, and producers are expected to remain unprofitable through the first half of the year. We remain cautiously optimistic about improvements in the second half, but now expect a more gradual slope of recovery. Jeff shared our confidence about several areas expected to counterbalance the potential headwinds I just described, including improved price expectations, especially in international markets, performance in poultry and aqua, and contribution from our key focus brands, primarily in international parasiticides. Moving down the income statement, we are also updating adjusted EBITDA and adjusted EPS for FX. We now expect adjusted EBITDA of $1.125 to $1.165 billion and adjusted EPS of $1.15 to $1.21. This guidance reflects continued execution of our manufacturing productivity agenda, which is delivering real improvements to our cost structure, allowing us to absorb the increased impact of inflation. On the operating expense side, we are leveraging our reset cost base as evidenced by our year over year and sequential decline in expenses in the first quarter. The higher tax rate expectations for the full year are offset by lower share count expectations, which allow us to maintain our full year EPS expectations outside of the impact from FX. Finally, we are introducing guidance for the second quarter of 2022 on slide 16. We expect revenue of 1.16 to $1.20 billion, adjusted EBITDA between $245 million and $275 million, and adjusted EPS between 22 cents and 28 cents. On slide 17, we've provided further detail on the top line expectations for the second quarter. At the midpoint of our revenue guidance for the second quarter, we are projecting a four percentage point decline at constant currency. Our initial guidance in February expected a 1 percentage point of growth at constant currency, with portfolio and innovation growth of 3%, offset by a 2 percentage point decline as a result of known headwinds, primarily from the step-down in contract manufacturing, known competitive and generic pressures, and the weakness in the China swine business year-over-year. Since February, the emerging macro pressures impacting our business in China, Ukraine and along with the stock outs in our U.S. retail channel and quarter-to-quarter phasing in aqua, are expected to provide an incremental 5 percentage points of headwind in the quarter. Additionally, as a reminder, the second quarter is our highest sales and marketing investment quarter as we ramp up our promotional spend for our parasiticide business in the U.S. and Europe. Finally, on slide 18, I'd like to provide some additional context on our expectations for the second half of the year. I wanted to comment on our expected performance in the first six months of 2022 compared with the second six months. Our implied second half guidance includes accelerating sales growth and accelerating profitability. We are confident in this second half acceleration for several reasons. The improvement of year-over-year unfavorable comparisons across many parts of our business, including contract manufacturing. The benefit of our pricing actions early in the year that will accelerate in the second half. as well as the increasing contribution from innovation. And finally, the accelerated growth in China from the easing of COVID restrictions. Additionally, supporting the profitability acceleration, we expect to continue capturing lower operating expenses year over year in the back half. With that, I'll hand it back to Jeff for closing comments.
spk08: Thanks, Todd. As we finish up and consider the pushes and pulls in our market, I encourage us all to step back and put the world into perspective. The economic ripple effects and the personal toll of the war in Ukraine is significant. We condemn the war and are working daily to support our colleagues, customers, and the health and the well-being of animals. Despite today's dynamic macro environment, the animal health industry and Elanco are well positioned for sustained value creation with continued positive industry trends. We are off to a strong start in 2022 with another consistent quarter of delivery. We are confident in our outlook for the year as the Elanco team is executing with excellence on the factors in our control. We are committed to delivering for our customers, building on our improved operational efficiency, and diligently managing expenses while investing in the future growth of Elanco. I want to personally thank our Elanco colleagues for their extraordinary efforts and delivery thus far in 2022. With that, I'll turn it over to Katie to moderate the Q&A.
spk12: Thanks, Jeff. 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.
spk06: 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 Aaron Wright from Morgan Stanley. Your line is open.
spk09: Great. Thank you so much for taking the questions. Just first on guidance, it does imply a meaningful ramp here in the second half. What does it assume in terms of the supply chain headwinds, China, the broader geopolitical headwinds in the second half? Do you think you've embedded sufficient buffers in there in your expectations at this point? And what does the high versus the low end of the range imply in terms of some of these headwinds persisting or potentially getting better? And then in terms of the long-term targets, Excluding DSM, have you changed your long-term innovation contributions that you're thinking about here? And do you continue to view that your long-term gross margin and EBITDA margin targets are still intact at this point? Thanks.
spk12: Yeah, sure. Thanks, Erin. Jeff, maybe you'll open with a little bit about Q2 and setting the stage and then long-term targets. And the question was about DSM, too, and how that impacts the innovation.
spk08: Yeah, maybe Todd will let you take the latter part of that. Thanks, Erin, for the question. You know, I'd start just – Just given the kind of summary of coming out of Q1 into Q2, Aaron, I think, you know, another quarter of consistent delivery. The strategy is working. We are committed to full-year guidance and constant currency. As we noted in our comments, 2% to 3% sales and then the EBITDA EPS. We're also committed to the 4.75 leverage and the $120 million to $160 million of innovation. I think what's coming out of Q1 and the drivers of growth, the fundamentals we highlighted, will prevail through the year. So we start there, the focus brands. Aqua and Poultry are recovering, and they're going to create, you know, acceleration as we go into, you know, even into the second quarter, but especially the second half. Seresto performing well. Crudelio and Gallup brand double-digit growth. International, you see the 6% growth. We continue to see a lot of affiliates growing and that diversity, durability is playing out a lot in international. As mentioned by Todd, the 2% price, we put a lot of the price increases in play in Q1. That will accelerate, especially as we go into the second half of the year. And then innovation. with Xperia, Zoashield, and the Crudelio franchise. So those are the fundamentals, Aaron, that we see as we go forward. Combined with margin, you see the streamlined, simpler organization. We've had one of the best quarters of execution. You see it in the sequential OPEX decline overall. What I want to just do is highlight, and then we can go maybe a little bit to the detail with Todd, is yes, in Q2, Aaron, what we already had in was You know, contract manufacturing, our $60 million of parasiticide competition, China swine. What we've added here is the aquafazing, a little bit of Q2 came into Q1. Great, strong salmon market. A lot of demand for our product that was actually because they're trying to take advantage of those prices and good profitability. That drove a little demand from Q2 into Q1. Ukraine is added now for the rest of the year, starting in the second quarter. China lockdowns are impacting both pork and pets. We are putting that in in Q2, but we see it lessening in the second half. And then the U.S. pet health stockouts, primarily with products like Advantage. It was paper and packaging. These issues impacted us in Q1. They're continuing a little bit in Q2, but we expect that we see, you know, we have this resolved. It's not a supply chain active ingredient. This is more a sourcing and supply of packaging. And we're resolving that and expect to have that resolved in Q2. So that will also be an accelerator. So when you point to the second half, it's the focus brands and international led by Poultry and Aqua and some EU pet health. Improved comparisons, as Todd said. Price increases that are already in play and continuing. our innovation and China lockdowns lessening. So very clear, we're committed, we're confident in this. And I would end by saying we're taking the same planning approach, Aaron, that we've taken since our investor day, a balanced approach. That's how we're looking at a Q2, but it's also how we're looking at the second half. And that's what gives us the commitment, what's given us really the delivery the last six quarters. So with that, I don't know, Todd, if there's any other specific thing that I've not touched on.
spk13: Aaron, just to add on your one question of high versus low on that second half guide, we have made an assumption that China does reopen and that that pulls our pet health business that's going to be more challenged in Q2 from the lockdowns, that that improves in the second half. Again, we've all been watching COVID across the globe over the last couple of years. We know there's high spikes. it re comes back down and that's the one assumption to just call out there the other bit is fx rates were of early may so that's you know roughly a 105 euro given that you know the big number we're not making a call on future of dollar strength or weakness but rather just using those rates and so there's always volatility that will come on that end
spk12: Yeah, and Todd, maybe finish on the DSM announcement and how that's impacting our innovation or not impacting our innovation assumptions going forward.
spk13: Yes, thanks, Katie, for that reminder. DSM, we've assumed mid-decade on that, so no impact on our revenue expectations out to 2025. So the $600 to $700 million of innovation sales still holds as part of that guidance.
spk04: Thanks, Aaron.
spk06: Your next question comes from the line of Michael Riskin from Bank of America. Your line is open.
spk03: Great. Thanks for taking the question. For the first one, I want to touch on Seresto specifically. You had 6% growth. So it's nice to see a return to positive growth in the quarter, but that is on a negative 10% count from last year. So I think we'd have hoped to see a slightly bigger result. Are you still seeing some of the wind down from the really robust numbers you were putting up during COVID? Or are you potentially seeing any impact on customer demand as a result of the continued news flow around Soresto and the health concerns there? What are your goals for Soresto this year and longer term? And then for the follow-up question on price, just following up on the previous point, I You know, price accounted for essentially all of the growth in the first quarter, and you're planning on taking more. Are you assuming any volume growth in the second half, and are you at all worried that the continued price increase could have a negative impact on volume demand for customers? Thanks.
spk12: Thanks, Mike. Jeff, you want to start with Seresto, and then we'll go to price with Todd.
spk08: Yes, Michael, thank you. Great question. No, Soresto, it did return to growth in both the U.S. and international. It's been balanced growth across the board. The lead indicators are giving us a lot of confidence on the lag indicators, and I would say that it's meeting our expectations at this point in time, and that would be globally as well. A couple comments I would make is, you know, we are investing heavily, Michael, in media advertising, as I mentioned in my comments. It's all about really more awareness, More channels. It's now in the U.S. vet channel for the first time and with our distributors and more geography. And I think also I would note this eight-month collar, when you look at economics, this actually provides increasing value, which has even allowed us to take some price as well. So when we look going forward, this product is in a good place relative to awareness. It's growing. I would also call out Bobby Mody is joined and leading, as you know, our U.S. Pet Health. He's brought a lot of experience in retail, brand awareness, really building on our current retail team. omni-channel and pricing. So at this point in time, we see Soresto meeting our expectations and a key driver for the rest of this year and longer term, as we've said, with more channels, more awareness, more geography, and lifecycle management, we see Soresto with quite a long runway of growth. Maybe, Todd, you want to pick up on the second question?
spk13: Sure, Mike, great to hear from you. One thing to add on Soresto, the 6% growth is at reported dollars. And so Q1 is the biggest quarter for Soresto in Europe. And so as you saw in the slides, international pet health grew 8% on a constant currency basis. So while we don't break it out at the product level, Soresto would have been much faster on a constant currency basis with respect to year over year comparable. With respect to the question on volume, as we look at, Yes, price is going to continue to accelerate. Total sales are going to accelerate at constant currency in the back half. That's the waterfall that we walked through there. And with that, there will be additional volume growth. China's swine had a big negative impact on volume, as we would have expected. And then as we look at the overall parasiticide competition in the U.S. on those legacy brands, Advantage Multi, which is a prescription product in the vet clinic, Trifexis, Comfortis, all of those had volume challenges offset by the pricing across the entire portfolio.
spk12: Thanks. We'll take the next caller.
spk06: Your next question comes from a line of Nathan Rich from Goldman Sachs. Your line is open.
spk14: Hi, good morning. Thanks for the questions. On China, I think China was expected to contribute about 100 basis points to constant currency growth this year. I'd just be curious to get your updated expectations now. I guess maybe specifically how the headwind in the swine markets played out relative to your expectations. And then on the pet house side, are you expecting any recapture in sales as those lockdowns ease? And how should we think about that and what's assumed in the back half of the year? And then if I could, just a quick follow-up on one of your earlier comments on the pet health stockouts. It sounds like they're primarily an advantage. I guess, is there a restocking impact that you're assuming going forward as that supply constraint starts to ease? And do you feel like you can still have sufficient product on the market for the flea and tick season this year? Thank you.
spk12: Thanks, Nate. I'll let Todd start off here with China and then follow pet health.
spk13: Mike, thank you for the question and give you how we're thinking about it today. As we start, you know, the 1% growth in China overall, it's going to be a little lighter than that this year in constant currency because of the timing on things. As we think about China's swine, we originally planned for a, you know, quicker bounce back in the second half. We've got a more gradual slope to that now assumed, and that's part of the reason for the slightly slower growth in China overall. With respect to the pet health business, we do expect that as the second half improves from a COVID restriction base, that will pull and catch up some of the phasing of pet health from Q2 out into the back half of the year, which is driving some of the back half acceleration. As we think about stock outs in the U.S., overall, we are going to have some impact there. That's been baked in, especially in Q2. The challenge is we get product back, and we certainly are. There was a paper strike with workers in Finland that's been resolved. That's helping on our supply chain constraints. There's a timing issue. So we are going to have a little impact. That's why we've got the Q2 down. And again, as we look at full year, well, you say, well, how do you accelerate then, Todd? And it's really about that poultry and aqua growth that continues to be very strong, continued price, and then those China restrictions. So again, overall, yes, some impact here in Q2. We've tried to be very transparent on how much that is, but confidence that the back out recovers and gets stronger to deliver on those second half constant currency numbers.
spk12: Thanks. We'll take the next caller.
spk06: Your next question comes from the line of Chris Scott from JP Morgan. Your line is open.
spk02: Great. Thanks very much. Just two for me. On the price front, you mentioned this 2% price increase in one Q, and that's going to accelerate in the second half. Can you help quantify what we should be thinking about here? So is that two going to three, four, five? I'm showing you a sense of just how much price is enabling the offset of some of these headwinds you've articulated. And the second was on the pipeline front. I think in the slides you referenced two major milestones for the late-stage pipeline. Should we assume that means you've got kind of registration-enabling data for those targeted 2022 blockbuster filings, or just maybe just a little color of specifically what those milestones were, I guess? Thanks very much.
spk12: Yeah, thanks, Chris. We'll start with Todd on pricing and then go to Jeff on pipeline.
spk13: Chris, we feel very good about the execution of across the globe on price increases from our US pet health business at retail to in the vet clinic where we still think we took a little less price than some of our competitors early on. And so I think back to Nate's question, I didn't answer, yeah, we're not expecting the price to negatively impact volume at all for those reasons on our relative value proposition. Second half, again, we do expect that to accelerate. We're not going from 2% to 5%, Chris, but it is going to be a stepped-up improvement from the 2% we saw in Q1. And then I'll turn it back to Jeff for the pipeline.
spk08: Yeah, Chris, thank you. You know, maybe just a few comments on innovation to put things in context. What I think is most important for you to understand is, one, a very productive Q1 in R&D overall. Ellen and her team Um, five of the seven key approvals already. And yes, we did want to note that. Two major milestones for competitive reasons. We won't get into specific details, but you know, one on the DERM asset, one on the para, all of this, you know, driving, as you look at it, you know, driving, you know, ourselves closer to approvals in the marketplace, whether that's, you know, a mix of timing as when speed as well as probability. So key, key milestones, I kind of step back also and just emphasize You know, we're building this next era of, of growth and innovation and this progress, you know, gives us excitement about that. Um, these are differentiated assets. Um, we do have a late stage pipeline, as you know, Chris, that's heavier based on pet health blockbusters that are differentiated. And, uh, these milestones are just closer steps to move us there. I would also emphasize that bringing both air in, um, is just another contribution That will be probably more mid-decade, but it will be another product that's going to have potential in excess of $200 million and be something that's in a very differentiated position, really starting a new marketplace. So that's the update. And again, overall, the innovation team is operating at an extremely high level right now. Thanks. We'll take the next question, please.
spk06: Your next question comes from the line of Uma Rafat from Evercore ISI. Your line is open.
spk05: Hey, guys. Thanks for taking my question. Todd, so to your point, if price goes from 2% to, let's say, sub-5%, call it 3% to 4%, and stockouts are no longer an issue because paper and packaging supply disruption is over, is Elanco in a position to meet full-year guidance if China lockdowns do drag on and Russia-Ukraine challenges do continue? And also, if you could remind us, where is the channel inventory in 1Q versus where it was in 4Q, and how do you expect it to change for the balance of the year?
spk13: Sure. As we start with that question, thinking about, you know, the China, yes, we feel like we hit our numbers. Now, again, where we fall within our range is really what is driven by the China expectations, as we called out. Right. We are assuming that picks up if it doesn't pick up. All right. Then there are going to be some sales. Maybe we have some other things that offset because it's a very dynamic world at the moment and things do change, but we feel good about our overall guidance and understand that assumption on China. So again, hopefully that addresses kind of where you asking on the respect to the range. channel inventory was consistent coming out of q4 we've been consistent on our inventory with our distribution partners around the world you know since the end of you know q2 of 2020 that hasn't changed and we don't expect a change on that uh going forward either you know i would just build on todd's point i think you're looking at the right way you know there's an aggregate of pushes and pulls um some that i would note on the push as well positive is you know the poultry and aqua
spk08: Markets, as we've been noting, are rebounding and definitely driving growth, and we see them persisting. That will be another underlying fundamental. And as we mentioned in our comments, you know, EU Pet Health is doing extremely well. Soresto, the Advantage family. So, you know, I think when we look at the aggregate, we feel very good about it. No question that the lessening of lockdowns is an assumption, but it is something that, you know, we could weather within the range if,
spk13: you know with some of these other fundamentals and aggregate so again commitment to this overall full year guidance because of the mix that we have going into the second half just picking up on one thing you also asked about uber we have assumed that the ukraine russia situation negatively impacts us for the rest of 2022 so that isn't something that we expect to affect you know the range on guidance thanks we'll take the next question
spk06: Your next question comes from the line of Elliot Wilber from Raymond James. Your line is open.
spk04: Hi, guys. This is actually Michael Parlarion for Elliot. Thanks for taking my questions. So first one, I guess, you might have mentioned this. Apologies if I missed it. But just with the headwinds on the legacy parasiticides for the quarter, if you could just talk about how these stacked up against the full year expectations. Were they relatively in line with how you guys were previously looking at those? And then second one from me tied to the DSM deal, just any details on regulatory submission, approval timelines, anything that we could look for there on the regulatory pipeline front just to kind of see progression and how things are going. Thank you.
spk12: Great. Thanks. I'll turn it to Jeff for both of those.
spk08: Yeah, Michael, thank you for the question. On the parasiticide front, let me be very clear, we still expect The full year impact to be, you know, roughly 60 million is introduced in our initial guidance. That's what's in our guidance. We're staying to that expectation. Being, you know, the brands being impacted, Trifexis, Confortis, a little bit of Advantage Multi as well. I think those are the key drivers. You know, balanced by, as we've said, holistically, we're seeing nice growth in international, Credelio Plus, Advocate in China, Soresto in several international markets. And look in the U.S. again, Seresto, where Credelio and Interceptor Plus are combined, we have a very competitive portfolio with those two and some nice growth actually in Credelio Cat. So Credelio is actually the fastest growing. If you look at that first generation ISOX class, it's the fastest growing brand inside that class right now. So our parasiticide strategy overall U.S. and globally is tracking with our expectations. Relative to Bovair, just at the highest level, again, excited about this alliance coming together with DSM. I think two companies that see livestock sustainability globally in a big way. So there's a lot with the partnership, and it aligns with our strategy. We are working diligently with the regulatory bodies. Again, this is approved already in Europe, in Brazil, in Chile, in Australia. So every major continent with cattle has already approved this product. And we'll be working diligently, already have started with the FDA, looking at the most appropriate and fastest path to market as this, with reducing methane 30% in dairy and 50% in beef, this can be one of the biggest contributors this decade to cooling the climate. We're excited about that. So more to come as we work with the regulatory body on bull bear. Thanks. We'll take the next question.
spk06: Your next question comes from the line of John Block from Stiefel. Your line is open.
spk10: Great. Thanks, guys. Good morning. Todd, the first one might be for you. The 2022 gross margin guidance is 57% to 58% from last quarter. I think I've got that correct. Is that still intact or anything on the cadence throughout the year that you want to talk about? And then what about the thoughts on 60% in 2023? Is that still intact? What do you have to start thinking about next year? And then maybe the follow-up Jeff, more for you, just on Gallupon, you know, we'd love to get your thoughts about that franchise, not necessarily today, but just over the next 12 to 24 months. Obviously, there's a canine mad competitor, and I know they've done a really good job expanding the market. But, you know, are you seeing any sort of slowdown in the rate of Gallupon growth? Call it in Europe, you know, where that competing product is currently more readily available. Thanks for your time, guys.
spk12: Great. Yeah, let's start with Todd on gross margin and then Jeff on Gallupon.
spk13: Thanks, John. As we look at gross margin this year, we're not changing our full year guidance on that front. team is really doing a nice job of continuing to drive productivity across the footprint and you know we're seeing you know pickups from a lot of the api procurement initiatives you know we've done over you know three years ago that now flow through the p l today i think you'll see a bigger pickup in the back half of the year just based on continued improvements on that plus accelerating price you know is a positive on the gross margin front With respect to the guidance and expectations of 60% next year, you know, we feel great about the execution we're doing in the face of significant inflation. You know, we're up, you know, well over $100 million relative to when we set that initial target for our gross margin. And if not for that, you know, we'd be, you know, up against that door to 60% here in 2022. So a lot of time you have to play as we view it, but really excited by the work our team is doing on this front on a global basis to continue to drive productivity and deal with lots of procurement challenges, supply chain challenges. But overall, we feel good about where we are on an execution front and look forward to continuing to march forward from here.
spk08: John relative to Gallup brand thanks for the question here's how we're looking at Gallup brand first it grew globally in the quarter, led by strength in the US so and it's expected to grow double digit and 2022. It is meeting our expectations, we see a medium long term, you know runway here for continued growth, just like a seresto brand. Um, there are some differences between the U S and EU with Gallup Pranta. We have a more expansive label in the U S and a larger pain portfolio in the U S and it's been in the U S longer. So we're, we're doing some things, uh, you know, catching up and doing some things, uh, you know, in EU to actually build off from our U S learnings. I do think as you step back and look at us, we're seeing Gallup brand as a focus brand now with strong double digit growth going forward. but also building a pain portfolio. We think pain is the third largest market in PET. And if you look at innovation that's come in, EU grew the pain market 36% in 2021. So I think an example of more solutions will grow this just like we've seen in parasiticides and DERM. So we're introducing Zorbium with Nocita, Onsior to really look at OA, antisergical pain leadership, as something that we, as we go forward. So, again, Gallup Rant, meeting our expectations, continued growth, some differences between Europe and the U.S., and we think it's a differentiated offer even compared to the innovation that's coming into the market.
spk12: Thanks. We'll take the next question.
spk06: Your next question comes from the line of Balaji Prasad from Barclays. Your line is open.
spk01: Good morning, and thanks for the questions. Two from my side. Firstly, it's been a while since you acquired Kindred. Can you give an update on some of the pipeline from their side, which was in late stage, specifically looking at the parvovirus map and the IL-31 map and what the update is from you and what stage it is at? Secondly, getting to the companion animal side and parasite side, clearly seeing some pressure there. One of the Reasons for you to acquire Bayer, merge with Bayer was the omni-channel positioning. And I thought that should have helped you be relatively more resilient. Don't seem to see that in the numbers. So could you give an update on how this channel positioning helps you or not with the U.S. net revisit trends that we're seeing? Thanks. Yeah.
spk12: Yeah, Jeff, you want to start on Kindred?
spk08: Yeah. So I think, Balaji, thank you for the question. You know, first of all, the assets are, you know, progressing nicely. We've integrated them into Ellen's R&D organization, bringing in the expertise, also the monoclonal antibody manufacturing that also came with the assets. So overall, it's doing very well. We're expecting on Parvo, again, you know, complexities with everything from regulatory manufacturing and commercializing. But again, currently, right now, it's our expectation we'll be bringing the Parvo to the market later this year. And then the three DERM assets, you know, we're continuing to integrate, progress, you know, as rapidly as possible, as well as even be looking at the synergies with assets that we had in our current pipeline. So again, tracking to our value propositions that we have, differentiated assets, and really bringing a monoclonal antibody capability into Elanco at another level.
spk12: And then on the pet health parasiticides, just the channel and OTC, I'm sorry, the omni-channel and OTC.
spk08: You know, Balaji, I think we always want to look at this market as a $5 billion plus market globally. And we are reviewing actually and have reviewed with our board just Bayer overall and would tell you we're seeing a lot of synergy on the sales side. We're looking at a lot of capability synergy overall. And examples of that that I would point to to say if you look at China, we've significantly increased, you know, across Asia our pet health capabilities because of a brand like Advocate. We have the next kind of era of growth coming with Seresto. So international doing very well. Large affiliates in Europe from Elanco combined with Seresto. The portfolio and affiliates from Bayer have, you know, this will be a growth accelerator in the second half as pet health in Europe, as an example. So especially on the retail side, we're actually leveraging the brand. So Advantage XD is off an Elanco asset. So that's another area of synergy overall. So we are, we're right now actually exceeding our expectations relative to our business case. And a lot of that is in the pet health international retail and brand side. Again, we anticipated the competition, $75 million last year, $60 million this year on Para. That's mostly against the legacy Lanco brands, with maybe one exception, and that's Advantage Multi, which played out a little bit this quarter. Thanks. We'll take the next question.
spk06: Your next question comes from the line of Steve Scala from Cowan. Your line is open.
spk07: Thank you. The Q1 SG&A and R&D numbers were the lowest in five quarters. I appreciate that there are many moving parts, which you've very nicely reviewed, and that Elanco has aggressive cost control initiatives underway as well. But are those numbers sustainable in absolute terms? And if not, is SG&A or R&D more sustainable at the Q1 level than the other, for instance? And then secondly, if I might ask, the company has been consistent in saying it sees differentiation in its German parasiticide pipeline opportunities. What deficiencies do you see in the currently marketed products where there could be opportunities to improve? Thank you.
spk12: Todd, do you want to start on the OPEX numbers, and then we'll go to Jeff?
spk13: Sure. Thanks for the question, Steve. As we look at overall execution across Elanco, the team is very focused on continuing to deliver and think about how to take cost downs while doing that. And you see that in even just a 5% sequential improvement from Q4 of this past year to Q1 of this year. It will be a step up in Q2. Tried to call that out in my prepared remarks, but just a reminder, it is the time when we run the more TV ads and really publicize our parasiticide business during the season in both the U.S. and Europe. So on a sequential basis, it will be a step up in Q2 versus Q1, but then dropping back down in Q3 and Q4. uh we're also getting a little tailwind the strong dollar negatively impacts our top line but does then provide a benefit on the sgna as we call that two percentage point uh pickup in q1 so overall we do feel this is sustainable the r d team is very focused and across the board we're looking at different ways to continue to drive value from an opex standpoint and i'll flip it over to jeff
spk08: Yes, Steve relative to the differentiation you don't you look at these big classes that usually falls into three categories one is efficacy. And second is just the whole ease of use or administration and then last is the label and safety, I mean, I would say, everything can kind of fall into those three categories. That leads to a value proposition, then the commercial approach could be another way to differentiate relative to to channel marketing. you know, and overall approach to, you know, different segments of the marketplace.
spk12: Thanks. I think we've got one more question in the queue, so we'll take that now.
spk06: Your final question comes from the line of Christine Raines from William Blair. Your line is open.
spk11: Good morning. Thanks for taking the question. My first one is on your product approvals. Specifically, you mentioned that... Elanco has received five product approvals since the beginning of the year, mostly in pet health, and then expects at least seven in 2022. So can you kind of talk about the highlights in your approvals and slated approvals for the year outside of that potential German parasiticide blockbuster? And then my second question is just on your sustainability products in livestock specifically. an initiative there. You have Experian, now this DSM Alliance, obviously. So that's like ammonia and methane. But kind of what does Alonco have their eyes on in terms of sustainability on that front next? Thanks.
spk12: Yes, thanks. Jeff, you want to take the first question on approvals and then sustainability portfolio as well?
spk08: Yeah, Christine. So these are portfolio enhancing approvals. I would note that You know the the one that we're working on the most in the field, right now, that I would notice or VM which is a pain product. And that will go into our fee line pain portfolio advantage xd is also another product that will be coming that. it's got an approval and again take state approvals with EPA side note those and there's a couple others that we we consider approvals and major markets that have bigger opportunities. The Cordelio franchise continues to get approvals around the world as well. You know, my comment on livestock sustainability is, you know, a few things here that I think are absolutely critical as you start to think about livestock sustainability is we see today this being the number one challenge that our livestock producers have, especially in major markets with ESG growing as well as even consumers One of the top reasons that consumers today will continue to consume or be challenged to continue to consume is the impact that animals have on the environment we're finding one out of three you know beef consumers approximately today that are backing off or not eating beef it's because of the impact on the environment not necessarily the diet so this is going right into a space of need as you know we have got the first fda product approved exterior that's being received very well as people look at that sustainability value proposition and The second is, you know, we're really looking at how we can help the producer track. That's going to be the most important thing is the producer's benchmark of data, and that's the launching of Uplook, a database that can help producers understand their footprint and the levers to reduce it. And then lastly, as people ask about value, the carbon market will be key, and that's some of the investment we made in a company called Atheon, a company we've spun out that will actually help sophisticate the carbon market, and aggregate, certify, and monetize carbon credits. So the excitement we're seeing and the movement we've seen with Xperia, with the value-added tools, one of the reasons DSM came to the U.S., the largest cattle market, and selected Elanco were these capabilities, was the connection we have. We see this market globally, one to two billion methane reduction. And again, we see the entire value chain from the retailers back to the packers and the producers all engaging at another level. And Bovair will be transformational in this space. And we see Washington very interested, of course, is this is a big part of the Biden administration's agenda and look forward to working with them closely. So thank you.
spk12: All right. Thanks for all the questions today. I'll let Jeff close here.
spk08: Yes, thank you, everybody. Thanks for a great dialogue here and the great questions. Elanco delivered another consistent quarter at the top end of our guidance range. We're off to a great start for the year. We are confident in our guidance for the year, updating our key metrics to reflect the current foreign exchange rate environment, and importantly, maintaining our constant currency revenue growth of 2% to 3%. Our innovation, very importantly, is progressing, and we may remain diligently focused on executing our plans in these increasingly volatile times. Thank you for your interest in Elanco and your time. Have a great day today. This concludes today's conference call.
spk06: Thank you for your participation. You may now disconnect.
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