Elanco Animal Health Incorporated

good morning and welcome to elanco animal health fourth quarter and full year 2022 earnings call all participants are in a listen only mode after the speaker's presentation we will conduct a question and answer session to ask a question you'll need to press star followed by the number one on your telephone keypad as a reminder this conference is being recorded i would now like to turn the call over to katie grissom head of investor relations thank you please go ahead

good morning thank you for joining us for elanco animal health fourth quarter and full year 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 discussed in today's earnings press release, as well as our latest Form 10-K and 10-Q filed with the SEC. We do not undertake any duty to update any forward-looking statement. Our remarks today will focus on our 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 will now turn the call over to Jeff.

Thanks, Katie. Good morning, everyone. Reflecting on our four years since completing our IPO, I am proud of and grateful for the determination and dedication of the Elanco team. We have fully separated and established an independent company. We've integrated the industry's largest acquisition, reset our cost base, and built a strong leadership team. In 2022, we continued to execute our IPP strategy, significantly advancing our innovation pipeline while driving productivity gains across all areas of the company and positioning the business for acceleration in 2024 and beyond. In 2022, our financial results were negatively impacted beyond our expectations due to significant challenging macro factors and competitive innovation. However, we are encouraged as we look forward, as shown on slide four. First, while macro pressures remain in 2023, we see strengthening Elanco tailwinds, with early proof points giving us confidence in our guidance for the year. Also, our late-stage innovation is on track, and we continue to see a path towards U.S. approval of five potential Blockbuster products by the first half of 2024. And today, Very importantly, after close collaboration with the FDA, we are pleased to announce we now anticipate a first half 2024 U.S. approval and launch of Bovair, a methane-reducing product for cattle. This adds another potential blockbuster to our suite of late-stage innovation and adds to our confidence in 2024 and beyond. In addition, this year we're executing on our plans to reduce operational complexity. Our final step in the Bayer integration, the systems transition, is on track for an early Q2 go live. We are well prepared, and this will be a key step to improve efficiencies, offer a better customer experience, and reducing integration cash needs. Finally, with a historic launch window in front of us, we're enhancing our focus on commercial and launch excellence. Along with our experienced commercial lead team, We are pleased to welcome Tim Beddington as our new head of strategy and market development. A seasoned animal health leader, Tim will help us shape, enhance, and execute on this opportunity. Moving to slide five. In 2022, Elanco delivered just over $4.4 billion in revenue, a 3% decline in constant currency, with farm animal flat and pet health declining 5%. Despite the revenue decline, we delivered more than $1 billion in adjusted EBITDA. The 10% reduction in operating expenses contributed to adjusted EBITDA margin of 23.2%, an improvement of 90 basis points. This operating cost discipline and better-than-expected tax rate enabled adjusted EPS growth for the full year of 4% to $1.11. Over the last four years, Elanco has maintained a consistent strategy of innovation, portfolio, and productivity, or IPP. In 2022, this flywheel continued to strengthen, and I'll provide a few key proof points of this momentum on slide six. First, with innovation. We had a productive year with eight product approvals in major markets. This included differentiated feline innovations like Zorbium, Advantage XD, and Bexacat, as well as important geographic expansions like Credelio for dogs in China. Additionally, the organization delivered valuable lifecycle management regional innovation, and geographic expansions across the portfolio. We continue to grow adoption for Xperia and integrate value beyond product offerings like Uplook and PenPoint. Overall, our combined portfolio of innovation products contributed $133 million in revenue this year, or an incremental $61 million year-over-year. Zoashield, Xperia, and Credelio Plus led the growth with our feline innovations demonstrating momentum in the fourth quarter. Most importantly, we made the initial U.S. submission of two differentiated pet health potential blockbusters, our broad-spectrum parasiticide and our JAK1 inhibitor in dermatology. The solid progress of each of our key late-stage innovation projects continues to increase our confidence in Elanco's next era of growth. Moving to portfolio, globally price contributed two percentage points of growth for the year. Despite known competitive dynamics in the U.S. vet parasiticide market, Elanco remains an established market leader across many areas of our diverse portfolio. In pet health, Gallup-Prant and our global pain portfolio grew double digits last year. And while our retail OTC parasiticide sales declined in 2022, Our analysis shows our continued global market leadership in this space, despite pressure on the category overall. In farm animal, we're the number two player in the U.S. and gained market share over the course of 2022. Outside the U.S., we remained very competitive in the medicated feed additive space, including leading in poultry and swine, and are a top two player in aqua. Finally, on productivity, we delivered savings and cost avoidance despite significant inflation and product mix pressure, allowing for a slight expansion of gross margin in 2022. To date, we have delivered approximately $360 million in cumulative adjusted EBITDA synergies from the Bayer acquisition, exceeding our expectations. Finally, we reduced gross debt by approximately $500 million last year from $6.4 billion to $5.9 billion. debt pay down remains our key capital allocation priority. In summary, our IPP strategy is delivering foundational value with multiple proof points that we believe set up our next era of innovation, growth, and improved cash conversion. Now pivoting to 2023, we expect the animal health industry to remain resilient. The global pet health market is poised to continue growing this year. albeit at a slower pace, as we expect the post-COVID normalization to continue and a weaker economic environment to persist for at least a portion of the year. While vet labor and capacity constraints are expected to stabilize this year, we expect innovation, increased product compliance, enabled by e-commerce, and geographic expansion to drive market growth. In farm animal, we expect lower industry growth rates than pet health. Long-term tailwinds from the continued increase in global animal protein demand are expected to be balanced by higher input costs, a cyclical decline in the U.S. cattle herd, and continued generic competition. Moving to slide seven, in 2023, our overall business will continue to be impacted by many of the same trends we faced in 2022, economic slowdown, competitive innovation, and rising interest rates. While these factors will contribute to a challenging year for elanco we expect strengthening elanco specific drivers to partially offset macro headwinds. We expect top line trends to modestly improve from a 3% constant currency decline last year to an expected one and a half percent constant currency decline at the midpoint of our guidance in 2023. Outside of FX, we expect aggregate headwinds from environmental factors to be similar in magnitude to what we experienced in 2022 in the range of $120 to $130 million. While we are seeing improving external supply chain dynamics and promising signs of recovery in China, the impact of economic-driven pressure on retail OTC products is expected to continue. For China, our business grew 9% in constant currency in the fourth quarter, a reversal from four previous consecutive quarters of decline. We expect improved performance this year in China, but continue to watch pork prices and consumer confidence levels as key leading indicators. Regarding retail OTC, encouraging early data points in the U.S. and Europe suggest improving demand trends compared to the second half of 2022. but we expect continued economic driven pressure on the category. Given the larger notional size of the business in the first half of the year, driven by the Northern Hemisphere parasiticide season, we anticipate a headwind to Elanco's performance in the first half, despite sequentially improving trends. Although some U.S. retail partners reduced inventory levels in the fourth quarter, we do not anticipate a meaningful step down in 2023, from 2022 ending levels. Importantly, we believe our strategy to bring innovation, expand physical availability, and strategically price our products will help us maintain leadership in the category and position us well for the long term. With regard to more Elanco-specific drivers, we expect strengthening tailwinds will partially offset the environmental headwinds I just described by approximately 60 million at the midpoint of our guidance. The Elanco-specific drivers of price and accelerated innovation sales are expected to be partially offset by continued pressure from competitive innovation, internal supply constraints, and continued plan reduction in our contract manufacturing business. We expect price to deliver more than two percentage points of growth as we annualize our 2022 increases and implement incremental increases in certain markets. with the majority of pricing actions already taken. Innovation revenue contribution is expected to be $210 to $250 million, or approximately 80 to 120 million incremental, representing two to nearly three percentage points of growth from innovation. This includes $20 to $30 million of contribution from a small bolt-on acquisition we closed in early January to enhance our farm animal medicated feed additive portfolio with nutritional products. We expect these antibiotic alternatives will enhance our farm animal mix, be accretive to growth, and help us grow share in the US and globally. We continue to expect $600 to $700 million of innovation revenue contribution by 2025 from products commercialized by Elanco in 2021 and beyond. On slide eight, we highlight the key milestones and expected timing for several late-stage assets. Before getting into updates on our pet health portfolio, I'll provide an update on Bovair. As you recall, last spring we announced the in-licensing of the methane-reducing product for cattle from DSM for the U.S. market, and we continue to believe it has blockbuster revenue potential in excess of $200 million. Our development team has been working swiftly on Bovair since finalizing our licensing agreement. Through close collaboration with the FDA, we have made great strides in meeting their requirements to commercialize the product. Given these positive developments with the FDA and our parallel work to finalize contract manufacturing capacity, we anticipate a first half 2024 approval and launch. We look forward to integrating this product into our portfolio of strategic sustainability offerings for our beef and dairy customers. Shifting to our more near-term pet health drivers, Bexacat, the first-in-class SGLT2 inhibitor for cats, gained FDA approval in December. We are taking pre-orders and expect to ship product in the coming months. For our parvovirus innovation, we continue to await USDA approval of our monoclonal antibody manufacturing facility an important milestone for our broader monoclonal antibody platform. The expected conditional approval for the product will be followed by state approvals. We expect strong interest for this first-in-class treatment and expect to ramp supply over time as we expand capacity. In addition to advancing our vet clinic innovation, we expect 2023 to benefit from Pet Health OTC retail innovations and refreshes. In the coming months, We are preparing to launch two of the three new OTC parasiticides in the U.S. and Europe that we expect this year. In the U.S., we're relaunching the original formulation of Advantage, a flea preventative for cats, and Canine Advantage, a flea and tick preventative for dogs. These products will be positioned as value offerings that capture the cost-conscious consumer. We expect these products to be on the shelves of a small subset of retailers over the next few months. It's important to note our Advantage family of products has the highest brand recognition of our pet retail products. And as we move into this critical northern hemisphere flea and tick season, we're excited to now have Advantage and Canine Advantix alongside Advantage 2, Canine Advantix 2, and Advantage XD for cats on the shelves to meet our customers' needs. Refreshing our OTC product offerings and driving physical availability of the Advantage family in Soresto are key initiatives that our pet health teams are driving globally. Now I'll pass it to Todd to provide more on our fourth quarter results and 2023 guidance.