Elanco Animal Health Incorporated

Good morning. My name is Krista and I'll be your conference operator today. At this time, I would like to welcome everyone to the Elanco Animal Health fourth quarter 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 that time, simply press star followed by the number one on your telephone keypad. And if you'd like to withdraw your question, again, press star one. Thank you. I would now like to turn the conference over to Katie Grissom, Head of Investor Relations. Katie, you may begin.

Good morning. Thank you for joining us for our Lanco Animal Health fourth quarter and full year 2023 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 Perrecker 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 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 statements. 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'll now turn the call over to Jeff.

Thanks, Katie. Good morning, everyone. Today, Elenko reported fourth quarter and full year results for 2023. Our strong performance last year gives us confidence that our innovation portfolio and productivity strategy is working and that our actions and investments to launch our new innovations and optimize our core portfolio are paying off. As we enter 2024, we are focused on advancing our strategy to deliver these three priorities, sustained revenue growth, innovation, and improved cash conversion. Starting on slide four with revenue growth. In the fourth quarter, we delivered 5% constant currency revenue growth in line with our performance in the third quarter. Fourth quarter growth was driven by innovation, strength across our farm animal business, improved conditions in the European pet health retail market, and increased price. While we exceeded our sales expectations and demonstrated strong operating expense management for the quarter, adjusted EBITDA was adversely impacted by approximately $18 million of unexpected items, primarily related to the 54% devaluation of the Argentinian peso that occurred in December. Our fourth quarter sales growth drivers, Along with the strength in our US pet health retail business led to a return to full year constant currency sales growth at 1% importantly, we expect growth to continue in 2024 at one to 3% even before the potential upside of our late stage pipeline. On innovation, we made significant progress in 2023 with the approval and launch of our canine parvovirus monoclonal antibody, or CPMA, and ABTAB, our new over-the-counter oral parasiticide in Europe, as well as the submissions to our three late-stage potential blockbuster products that have a path towards approval in the first half of 2024. We exceeded our expectations for innovation revenue in 2023 and our outlook for 2024 puts us on track to deliver our expected 600 to 700 million of contribution by 2025. We continue to prioritize free cash flow improvements, paying down debt and reducing leverage and exceeded our debt pay down expectations from our November guidance. In 2024, we expect cash available for debt pay down to be approximately $300 million, four times that of 2023. Earlier this month, we announced the sale of our aqua business to Merck Animal Health, allowing us to prioritize our investments going forward in larger markets with greater earnings potential and meaningfully improve our leverage profile. We expect net debt to adjusted EBITDA to be in the mid four times range by the end of this year and the high three times to low four times range by the end of 2025. Importantly, we are making disciplined decisions and taking actions to reallocate capital within our operations and invest for the future. Today, we announced a strategic restructuring that will allow us to do three things. first shift resources from farm animal to pet health across the international business as we drive adoption of innovation products and prepare to globalize our late-stage pipeline. It also allows us to capitalize on efficiencies resulting from the completion of our ERP system integration and concentrate roles into strategic locations. And lastly, it allows us to transition our business model to distribution or other third-party models in certain markets, notably Argentina. The restructuring will impact approximately 420 personnel, or about 4% of the global workforce, and is expected to deliver net savings of $20 to $25 million in 2024, annualizing to $30 to $35 million of savings in 2025 and beyond. The savings will be reinvested in areas with more significant value creation opportunity, specifically in pet health globally and livestock sustainability. While we expect a limited amount of top-line headwind from the shift to distribution markets, we do not expect our restructuring efforts to have a meaningful downside to sales otherwise, notably in international farm animal markets where we expect to realize savings. We have a strong track record. of delivering productivity and will continue to look for additional opportunities to more efficiently allocate capital. I credit our senior leadership with these proactive actions that we believe will set Elanco up to deliver our next era of growth. Moving to slide five, our full year constant currency revenue growth of 1% was led by Farm Animal, but we saw marked improvement in our pet health business as well. Starting in Farm Animal, 4% constant currency revenue growth for the full year for farm animal represented accelerated growth rates for poultry, cattle, and swine compared to 2022. The team executed across the business, but especially in places where we have strong market positions, notably international poultry and U.S. cattle. International Farm Animal, the largest revenue contributor of our four quadrants, delivered 4% constant currency revenue growth, primarily driven by increased price and strength in poultry, a result of robust underlying demand and share growth in key markets like the UK, Brazil, and China. Our U.S. farm animal business also delivered 4% growth for 2023, driven by increased price, and strengthened cattle and swine, with poultry improving in the fourth quarter. Xperia delivered $18 million in the fourth quarter, above the expected annualized run rate of $70 million that we shared in November. We remain encouraged by Xperia's progress and expect continued growth for the product globally in 2024. Moving to pet health, global revenue declined 1% in constant currency. representing an encouraging improvement from the 5% constant currency decline in 2022. For the U.S. pet health business, revenue declined 1%, a significant improvement from the 9% decline in 2022. Enhancements in share of voice, physical availability, innovation contribution, and increased price were more than offset by competitive pressure in the vet clinic market. Our OTC, parasiticide business, had a strong year in 2023, growing net sales 11% in retail channels as our top six retailers grew dispensing sales in both units and dollars. In the vet clinic, we're encouraged by the growth of Cordelio and new products like CPMA, Zorbium, and Bexacat. As we look towards 2024, we are investing in an expanded sales force, and implementing enhanced incentives to drive growth ahead of our anticipated new innovation launches in the vet clinic this year. Finally, in international pet health, the 1% constant currency revenue decline was primarily driven by demand pressure in the Spain retail market in the first half of the year, which more than offset the encouraging growth from the Cordelio family and AdTab in Europe. the Spain situation improved in the second half of the year, and we expect that market to recover in the first half of 2024. Moving to slide six, I'll cover our execution highlights across our innovation portfolio and productivity strategy for 2023. Starting with productivity, improving cash conversion continues to be a key priority across the organization. We continue to drive cross-functional efforts to improve networking capital, specifically on balance sheet inventory management, which gradually improved in the second half of the year, with inventory being a source of cash in the fourth quarter. For the full year, we paid down $76 million of gross debt and finished with a year-end leverage at 5.6 times, slightly better than the midpoint of our November guidance. Finally, earlier this year, we achieved a significant milestone of completing our ERP system integration, which will free up over $100 million of free cash flow for debt pay down in 2024. Moving now to portfolio. Price growth was 4% for the year, up from our previous average of 2%, with 4% in both pet health and farm animals. The core portfolio continues to stabilize, driven by stronger commercial capabilities, global omni-channel approach, and the complement of new innovation. We continue to invest in our highest value creation opportunities across commercial, R&D, and manufacturing. Now on to innovation, where we had a very productive year of submissions, new product approvals in major markets, and advancement of our early stage pipelines. In-market innovation contributed $275 million of revenue in 2023, representing three percentage points of growth for Elanco and more than doubling the contribution from 2022. Growth was led by Xperia and NutriQuest on the farm animal side and Credelio Plus, Credelio Cat, AdTab, and CPMA on the pet health side, with lifecycle management and geo expansions also contributing across both. CPMA finished in line with our expectations in 2023 with sales of $6 million. Expanded supply capacity and increased marketing efforts aimed at both veterinarians and pet owners are expected to make this product a key contributor to growth in 2024. On the late stage pipeline, our three differentiated assets, Cordelia Quatro, Xenrelia, and Bovair are all progressing with the FDA. As we shared previously, the regulatory process is rolling and iterative at this stage, and we are in ongoing productive dialogue with the FDA's Center for Veterinary Medicine. These three potential blockbusters continue to have a path towards U.S. approval in the first half of 2024. While we are focused on the U.S. market first for these products, We are pleased to share, we have also completed submissions for Xenrelia in nine additional markets, including the EU, UK, and Australia. Additionally, the team continues to deliver targeted lifecycle management, which extends the life and the value of existing brands, helping to stabilize and protect the core. Total innovation sales in 2024 expected to be 350 to 400 million dollars before the potential upside from our three late stage pipeline assets, putting us well on track to deliver the 600 to 700 million dollars of innovation sales by 2025. Finally, 2023 marks significant progress in our early stage portfolio with a number of promising assets in our next wave expected to drive growth in the second half of the decade. A special credit to Ellen DeBra Bander and her global R&D and regulatory team as they've really set Elanco up to deliver significant high impact innovation in major markets for the years ahead. Before I cover our outlook for 2024 on slide 8, I want to briefly discuss the announcement we made earlier this month to sell our aqua business for approximately $1.3 billion. This decision was a result of a strategic process that started about a year ago as we evaluated the expected growth drivers of our business in the future. We saw the opportunity to focus our investment in larger markets with greater earnings potential, namely pet health and livestock sustainability, which are aligned with our pipeline efforts. We expect the transaction to close around mid-year. Importantly, with over a billion dollars of expected proceeds from this transaction combined with improved free cash flow from the business, we expect to accelerate that pay down. We are deeply grateful to our AQUA team's dedication to delivering to our customers as well as our bigger purpose of enriching lives with animal protein. Now moving to our outlook for 2024 on slide 9. As we begin the year, we remain confident in the resilient, underlying demand for animal care. Our outlook for the animal health market reflects underlying tailwinds from the humanization of pets and global protein demand, balanced by economic conditions impacting consumers, cyclical and profitability factors in livestock, and the macroeconomic and political tensions around the world. Despite this, we believe Elanco is uniquely well-suited for growth this year. Our innovation expectations, our investment and key capabilities, our restructuring actions, the experienced team, and differentiated omni-channel strategy contribute to this confidence. For the full year 2024, we expect 1% to 3% constant currency revenue growth. This includes price growth of approximately 3%, and incremental innovation revenue contribution of at least 2% to 3%. Headwinds on a year-over-year core volumes are expected to lessen sequentially as we stabilize our base business through improved execution and lapping as well some regulatory and macroeconomic challenges last year. Importantly, our guidance includes the aqua business for the full year, but it excludes the contribution from our three late stage products currently under regulatory review with the FDA. We plan to update our expectations in line with our quarterly cadence to account for the transaction close and product approvals. This year, we expect revenue growth in both pet health and farm animal. For pet health, we see value drivers across all parts of our omnichannel strategy. Improved supply and innovation led by CPMA and ADTAB are expected to be tailwinds. Our overall SG&A is increasing in 2024 as we reallocate investment from other parts of the business into our pet health portfolio. As part of this, we have expanded our U.S. field force, increased investment and efforts with our corporate groups, and are shifting resources in our international business to support improved share of voice. Importantly, this increased investment will be front half loaded as we increase promotional investments behind our market leading retail OTC parasiticide business during the Northern Hemisphere flea and tick season. On the retail side, we've expanded physical availability in new channels like club and dollar and within the existing channels like mass, pet specialty and grocery. These efforts in both the US and Europe paired with enhanced brand activations are expected to drive increased awareness. Overall, our pet health business is set up for improved performance and growth in 2024, even ahead of our anticipated new products and parasiticides and dermatology. Moving to farm animal, we also expect growth for this business globally, with innovation and price offsetting market challenges and generic pressure. We expect poultry and cattle to remain growth drivers. The livestock sustainability market continues to develop, and the functionality of the carbon credit marketplace has been validated. We look towards the Bovera approval as a catalyst for further expansion. The durability and the diversity of our global farm animal business is well positioned for both revenue and market share growth in 2024. With that, I'll turn it over to Todd.

Thank you, Jeff, and good morning, everyone. I will focus my comments on our fourth quarter and full year adjusted measures, 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 11, in the fourth quarter, revenue was $1.035 billion, a 5% increase with price growing 3%. Slides 12 and 13 break down our revenue performance in the quarter by price, rate, and volume, as well as species and region. For Pet Health globally, we declined 1% in constant currency in the quarter. Our U.S. business declined 5% as competitive pressure in the veterinary clinic was partially offset by innovation revenue, increased price, and an improved retail inventory situation compared to the reduced purchasing we experienced in the fourth quarter of last year. Our international pet health business grew 4% in constant currency, primarily driven by the economic rebound in Europe compared to the back half of last year and innovation revenue, partially offset by soft market dynamics in several Asian countries. Globally, sales of Seresto grew 25% in the quarter, driven by the U.S., which implemented a lower list price starting in December to maximize elasticity of the brand and the rebound in Europe I just described. The Advantage family sales declined 8% in the quarter, primarily driven by international markets. Both products benefited from the improved retail inventory situation in the U.S. in the quarter compared to last year. Shifting to farm animal, global revenue grew 10% in constant currency in the fourth quarter. As anticipated in our November guidance, U.S. farm animal growth was driven by a resupply for cattle vaccines, strong exterior growth, and favorable timing of poultry rotations. While we expected U.S. farm animals to have a strong quarter, the 28% growth was significantly higher than we expected, which is the key contributor to us delivering above the top end of our revenue guidance. Solid international farm animal growth of 3% was driven by continued strength in international poultry. Continuing down the income statement on slide 14, gross margin decreased 440 basis points to 50.1%. The decline was driven by an approximate 150 basis point headwind from slowing manufacturing output as we worked to reduce balance sheet inventory, as well as unfavorable manufacturing performance, including higher than expected inflation on certain key inputs. And higher affiliate expenses, including a recently implemented higher import duty rate in Argentina, partially offset by improved price. Operating expenses declined 3% year over year in the quarters. R&D expenses were largely in line year over year, while SG&A declined 3%, driven by disciplined cost management across the business and savings from completing our systems integration, partially offset by higher employee-related expenses. Moving to slide 15, where we bridge adjusted EBITDA and adjusted EPS to our guidance from November. Adjusted EBITDA was $165 million in the quarter. Along with the gross margin headwinds from unfavorable mix in manufacturing performance, this was adversely impacted by approximately $18 million of unexpected items, primarily related to Argentina. Adjusted earnings per share was $0.08 in the quarter. Our adjusted effective tax rate in the fourth quarter was 39.7%, primarily as a result of unfavorable return-to-provision adjustments, partially offset by the benefit of certain refundable state income tax credits. On slide 16, I'll provide a few comments on our 2023 full-year performance. We delivered just over $4.4 billion in sales, with 1% constant currency growth driven by improved price, adoption of new products, and strength in international poultry. These were partially offset by competitive pressure in the U.S. vet clinic, a soft European economic environment in the first half of last year, and generic pressure and changes in regulatory requirements in the U.S. farm business. On slides 27 to 28, we provided additional revenue breakdowns, including by top affiliates and certain products. Continuing down the P&L, gross margin was 56.3%, a decrease of 30 basis points compared to last year. The impact of slowing down manufacturing output and inflation was partially offset by improved price. These factors, combined with a 2% increase in operating expenses and the fourth quarter impact of the devaluation in duty rate in Argentina, resulted in adjusted EBITDA of $979 million for the full year. Adjusted earnings per share was $0.89 compared to $1.11 last year, with $0.14 coming from higher interest expense and tax. Our non-GAAP tax rate increased from 17.7% in 2022 to 22.3% in 2023, primarily driven by the items I described impacting the fourth quarter. Before moving to our 2024 guidance, let me offer a few words on our cash, debt, and working capital on Flight 18. Operating cash flow was $271 million for the full year and $157 million in the fourth quarter. The year-over-year increase in the fourth quarter reflects improved net working capital performance, specifically on inventory and receivables, partially offset by higher cash interest costs. We ended the year with net debt of $5.472 billion and the net leverage ratio at 5.6 times. We reduced gross debt by $76 million for the full year, exceeding our November expectations of $50 million. In a moment, I'll touch on our expectations for debt pay down in 2024 and the factors improving our cash outlook. Now, let's move to our 2024 financial guidance, starting on slide 20. As Jeff mentioned, today's guidance includes full-year contribution from our aqua business, but excludes contribution from our three key late-stage pipeline assets, Credelio Quattro, Zenrelia, and Bovair. We will update our guidance throughout the year to reflect evolution on both topics. For the year, we expect revenue to be between $4.45 billion and $4.54 billion, or approximately 1% to 3% constant currency growth. We expect innovation to contribute $350 to $400 million, or $75 to $125 million of growth year over year. Credelio Cuatro, Zinrelia, and Bover would increase this range, and regardless of timing, once launched, We expect these products to be accretive to EBITDA in 2024. Additionally, we expect a revenue headwind of approximately $50 million as a result of strategic choices to change our distribution model, primarily in Argentina, exit low-margin distribution agreements, and the continued phase-out of contract manufacturing agreements. Gross margin is expected to decline slightly in 2024 as benefits from revenue growth will be more than offset by the impact of actions we are taking to slow down our manufacturing output to reduce balance sheet inventory and improve networking capital. The headwinds experienced in the second half of 2023 related to this and certain increased operating costs are expected to continue in the first half of the year, improving in the third quarter and shifting to a tailwind in the fourth quarter. Operating expenses are expected to increase 2-4% in 2024, driven by increased employee-related expenses and investment in commercial capabilities to support our pet health business. The increase is expected to be partially offset by reduced expenses, primarily in the second half of the year, from the restructuring we announced this morning, taking advantage of efficiencies resulting from our ERP system consolidation and reallocating resources to the business areas and countries with ability to generate greater earnings potential over time. For adjusted EBITDA, we expect $960 million to $1.01 billion. We anticipate adjusted EPS of $0.87 to $0.95. Given the cadence of dynamics in gross margin and operating expenses, adjusted EBITDA and adjusted EPS are expected to decline in the first half of the year and increase in the second half of the year. Slide 22 provides year-over-year bridges for adjusted EBITDA and adjusted EPS, and slide 32 in the appendix provides a number of additional assumptions to help support your modeling efforts. On slide 23, we share our first quarter 2024 guidance. We expect revenue of $1.16 billion to $1.185 billion, adjusted EBITDA of $255 million to $275 million, and adjusted EPS of 25 cents to 28 cents. As a reminder, as a result of our ERP system blackout in 2023, approximately $100 million of revenue, $80 million of adjusted EBITDA and $0.13 of adjusted EPS shifted into the first quarter from the second quarter. In addition to the manufacturing headwinds discussed above impacting the first quarter, we are also increasing our investments in pet health, with both the U.S. Salesforce expansion and the increase in promotional investments behind our retail OTC products. Given the timing of the northern hemisphere flea and tick season, we are making these investments starting in Q1, which will be in advance of the savings we expect to realize from the restructuring we announced this morning. Finally, I'll share a few comments on our cash and balance sheet expectations for 2024 on slide 25. We expect meaningful improvement in free cash flow conversion, with $280 to $320 million available for debt paydown. about four times more than our $76 million in 2023. The improvement is driven by reduced project costs, most notably moving past our ERP system implementation, plus lower cash interest and improved networking capital from our inventory efforts, all set by slightly higher CapEx to support new launches. Using the same assumptions for innovation in the AQUA transaction as we did with the P&L, at year-end 2024, we expect the net leverage ratio to be between 5.2 and 5.5 times. With the anticipated $1.05 to $1.1 billion in net proceeds from the AQUA transaction, we expect to reduce our net leverage to the mid-4 range by year-end. Now I'll hand it back to Jeff for closing comments.

Thanks, Todd. As we enter our 70th year as a company and as the longest-standing brand in animal health, we are humbled by the opportunity to serve our customers around the globe, the farmers, veterinarians, and pet owners, and the animals in their care. As we enter 2024, we are laser-focused on three priorities, sustain revenue growth, innovation, and improve cash conversions. importantly, this management team is taking disciplined decisive actions to improve our earnings potential and leverage profile over time. As evidenced by the sale of our aqua business for over a billion dollars of net proceeds the restructuring announced today to reallocate resources to higher value creation areas. Our investment in expanding our U.S. pet health field force to enhance share of voice and maximize innovation in our highest margin business area. And our focused efforts to manage manufacturing throughput to improve networking capital performance while investing to support the launch of differentiated products in years to come. These are difficult but the right decisions. We are executing on our IPP strategy. Our investments, our improved capabilities, and experienced team delivered a return to top-line growth in 2023, and that growth will continue in 2024. We are encouraged by our strong pipeline and the next wave of innovation, which we expect to fuel long-term sustainable growth for Elanco. With that, I'll turn it over to Katie to moderate the Q&A.

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.

Thank you. If you'd like to ask a question, please press star followed by the number one on your telephone keypad. And if you'd like to withdraw that question, again, press star one. Your first question comes from the line of John Block from Stiefel. Please go ahead.

Thanks, guys, and good morning. Jeff, you know, it's good to see the filings that you mentioned for Zinrelia OUS. Any thoughts, high-level thoughts, on the approval timelines for EU, UK, and Australia? You know, when you look at one of your competitors, I believe, you know, it's actually about 40 percent of worldwide applicable revenues outside the United States is where it actually resides. So, certainly, it seems like a material opportunity. Any more color on potential approval timelines OUS?

Yeah, thanks, John. Yeah, we've made a lot of progress and would say that Zenrelia will be the fastest product in the history of Elanco. in globalizing the major innovations. So nine major markets we've made submissions in. And it's very similar, I think, to the U.S. on these submissions or final submissions in the case of about a year. It varies from Japan to Australia to Europe. But if you figure that, we count on this being in an early 2025 mode when we would start to get these approvals.

Got it. Helpful. And then for the second question, it might be a little bit of a two-parter, but, you know, My thought was that the ADUFA date for Xenrelia was in February. And Jeff, can you discuss any high-level thoughts on what still remains to get done after any interaction with the agency? Do you have increased conviction with Xenrelia and 1H24 approval timeline? And Todd, quickly, just to pivot, the 2024 GMs being down, arguably that's off of sort of a lower number where people's heads were at a couple months ago. How do we think about the cadence of GMs for you guys? Usually you have the benefit from parasiticides in one age, but at the same time you're trying to slow the plant, and that's going to be a headwind. So any thoughts around GM cadence throughout 24? Thanks, guys.

Yeah, John, no update today on the Xenrelia timeline. We continue really with no change in terms of just a very productive dialogue with the FDA. We believe that market adoption, as we know, will be driven on value and execution. But again, the dialogue with the FDA is going well. No change. When there is change, of course, we'll be announcing approval. And if there's any change to that, we'll let you know. So no change at all.

john thanks for the question on gross margin uh as you know for the full year we expect gross margin to be you know pretty close to the same in 24 is 23. the cadence of that will be a little different we'll still have higher gross margins in the first half of the year but just not as high as we would have had last year because of the plant slowdowns and so it's a you know first half of the year slightly lower than last year Q3 becomes pretty much in line and then Q4 we get a tailwind as we started to slow down the plants during Q3 of 23 such that we don't have that same headwind in the fourth quarter of 24. Thanks, John.

Your next question comes from the line of Erin Wright from Morgan Stanley. Please go ahead.

Great, thanks. Another one on Zenrelia. Can you talk a little bit about the latest thoughts on your go-to-market strategy for Zenrelia, your thoughts on differentiation of the product, leveraging distribution, price, how you can leverage also your positioning in the online channels, just given that this is a significant category for the online channel as well? Thanks.

Yeah, thanks, Erin, and thanks for the focus from you and John. As you know, we're excited about entering the DERM market. It'll be a new market for us. We've got Zenrelia, followed by our IL-31 short-acting, both of these being differentiated assets. And our next wave of innovation that Ellen has made a lot of progress on in her team this year in bringing more products into development into our pipeline in DERM, there'll be added assets. So this is a market we're going to be in and be a key player in in the decades. So And, you know, I think we come back consistently as we look at this market and see that, you know, there's still a lot of unmedicalized dogs that are, you know, leaving vets without being treated. There's a strong desire for more choice by vets and pet owner. And these fundamentals, we believe, matter, that this is a market that wants choice. And it's globalizing, as John just referenced as well. So, you know, I would emphasize that we continue to feel strongly that vets You know, our differentiation is going to be key as well. When you look at how we're going to launch this product, maybe just a couple points. First of all, we keep coming back to the two most important pillars are value and then execution. So value gets around the differentiation in the product, the product itself, the portfolio that it's going to be in. And then as you look at execution, you know, the first thing that we really focused on, Aaron, was getting the share of voice, you know, at a level that can be extremely competitive, and we believe we're there now. We've got this sales force in place out there selling Parvo, preparing, and, you know, we need to create share of voice high enough to create awareness at the vet clinic so that when the product, you know, gets into the market, that vet clinic is aware, and then we'll start to turn up additional factors like digital and DTC. So that's going to be the staged approach. We're still looking at distribution. The great news is we've got lots more options with distribution given our ERP setup. We will intend to price to value and focus. We believe innovation will be rewarded and differentiation will be rewarded, so we will focus on a value-based pricing approach relative to our differentiation. And I think the last thing is, you know, what DERM does with us now is it adds kind of the fourth pillar. We've got para, we've got therapy, and we've got the vaccines. And we think as we look at, you know, corporates and other vet clinics, other segments, that fourth pillar having DERM and that total portfolio is going to give us advantage. And that'll be a key part of our launch strategy as well, Aaron. Thank you.

Okay. Thanks. And then, and then just on restructuring and in the bigger picture around the sale of Aqua too. And are you just continuing to evaluate other parts of your businesses here or what other segments could you evaluate as potential divestitures?

yeah um maybe just a comment here here's how we're looking at it i mean you know we are concentrating our focus let me be very clear on pet health and livestock sustainability and both of these decisions both the sale of our aqua business and the restructuring we announced today is all around creating enough resources to win and align to our pipeline in these bigger markets with greater earnings potential with these large blockbuster differentiated assets that we have. We have no intention of, you know, making any more strategic decisions here relative to other segments. Really, I would highlight coming to the restructuring, you know, we're doing really three things as my comments, you know, that I made this morning. We're shifting resources into these markets, pet health and livestock sustainability. Think like in Europe, we're going to move to a much more of a B2B approach in pigs and put a lot more resources in pets. Second is we're going to capitalize on this ERP implementation that's now done and concentrate roles in strategic areas. And then lastly and importantly is we're going to transition our business model, you know, in non-strategic markets like Argentina. We've got about 90 countries we're in, about 45 of them we're in with people, and we're moving some additional markets like Argentina into what we're doing in the other 45, which is using a distribution model. So all of this allows us, you know, more resources that we can double down on these big areas, pet health and livestock sustainability.

Your next question comes from the line of Michael Reiskin from Bank of America Securities. Please go ahead.

Great. Thanks for taking the question. Can you guys hear me?

Yes.

Great. Thanks, guys. So first, I want to clarify a question on the guide for you, Todd. I think you're really clear that the revenues from the Zinrelli, Accordelli, Quattro, Bovair are not included in the guide. But I want to be clear on how much of the cost is because... From an OPEX perspective, obviously the expansion of the commercial sales force, things like that, you've already put that into place. That's already in numbers as it is. But what about incremental spend as the products get approved? So let's say they get approved. Let's say they go to market and you do put some of that digital and DTC spend behind it in the second half of this year. Is that already included in the OPEX numbers or would that also be incremental just like the revenues?

So, Mike, those will also be incremental. But what we did say in the prepared remarks is that we expect it to be accretive to EBITDA. So the EBITDA guidance you have will get better with the launch of the big three.

Got it. Okay. No, that's up. I just want to get that clarification on, like, you know, how the model would change as a product to get approved. So I appreciate that. And then a follow-up question on, again, on the guy for 24. I think you talked about 3% price. uh the revenues about two to three percent from existing innovation so from you know uh regular cordelio um and gallup ram things like that uh but you know two percent total business current constant currency so volumes uh another year of down volumes could you break that again into what you're expecting from end market versus specific headwinds

um you know to the legacy portfolio or maybe headwinds for competition just help us uh sort of deconvolute the volume expectation to 24 a little bit thanks sure mike you know we do expect volumes down in 2024 volumes were down in 2023 but less than they were in 2022 uh some of this is just the competition inside the vet clinic that we've called out previously you'll see trifax has declined 21 In 23, it's down to being about $82 million in total revenues. It's still a big product for us, but one that we just know has greater competition there. You'll also see both Soresto and Advantage Family were down last year. Again, that's a lot of that's in the vet clinic, the retail side of our business. in the U.S. grew double digits. It was really strong as Bobby and his team got to more points of distribution, more physical availability, the share of voice, and all of the work they're doing. So some of the volumes are that legacy. You know, Xperia RAMP is great. As you know, that generally takes out OptiFlex, which is a different part of the portfolio, and so that impacts volumes as Xperia RAMP. Overall, we continue to feel very good about the sales momentum we have, the acceleration in 23 versus 22. And so as we move forward, we have that. There's also an impact from these two different countries on volume as we exit some of the low-margin distribution and flip Argentina and a few other markets to using a third-party distributor versus our own internal people on the ground.

Your next question comes from the line of Balaji Prasad from Barclays. Please go ahead.

Good morning and thanks for the question. Firstly, with regard to the decline in pet health in 4Q and Outlook, so you spoke about competitive pressure in veterinary clinics. Can you help us understand if this is transient or otherwise? Is it driven by new launches from competitors or are there some other factors at work? Also on 2024, as you speak about enhancing the sales force, could you quantify the sales force add and do you think you'll be adequately staffed to support the new launches? Thank you.

Yeah, thank you very much. Yeah, you know what the... highest level just on the U.S. pet, you know, and I would step back and say we've made a lot of progress in U.S. pet overall. And at the highest level, I think we're much more competitive today. We've seen significant improvement in our overall engagement, our team, and I think the strategy is working that Todd just highlighted in terms of shareable waste, physical availability, you know, innovation and price. So we're much more, you know, competitive as a as an organization today. And, you know, 2023 was a strong year. If you step back and look, it was, you know, we saw an eight-point improvement sequentially from down minus nine in 2022 to minus one overall. And I see this from the standpoint of stronger portfolios, more share of voice, a stronger team. We've changed incentives for the sales force. And just our overall portfolio is stronger when you start adding Bexacat, you know, Zorbium, and now Parvo. And Parvo is opening a lot of doors for the vet clinic. So as we step back, there's no question we're set up and we see nice growth coming ahead of, you know, our total global pet health business and farm animal business both contributing to growth in 2024. No question the competitiveness in the vet clinic in the U.S. is high. I mean, without question, I would say there's a few factors that we would note is, you know, there's always the seasonality and weather factors. There's some economics we've seen more on the retail side where there's some trade down and, you know, the competitive pressure inside the vet clinic. I think we're well positioned as we're bringing innovation forward. As we're, you know, there's an anticipation of these blockbusters that are coming and our omni-channel approach, being able to have the retail business complementing the vet clinic business, you know, we're probably better indexed relative to those vet visits than most companies.

Your next question comes from the line of Uma Ruffrat from Evercore ISI. Please go ahead.

Hi, guys. Thanks for taking my question. Just two here, if I may. First, There's some language on distribution model changes. Could you just confirm there's no changes in distributor strategy in U.S., nor are there any payment term extensions in U.S. for 2024? And then secondly, on heading into your sort of the Quattro launch, there's some feedback that Zoetis is starting to preempt that potentially by making free tapeworm treatments available in case a dog does contract tapeworms. How are you thinking about that relative to your differentiation and expectations for launch?

Well, let me take the first one, Umar, and I'll pass over to Jeff on tapeworm. So with respect to distribution, we're really speaking in this case to like Argentina. As Jeff mentioned, we're in 90 countries in total with people on the ground and about 45. Those other countries we use distributors to take our products to market and we just sell to them. So that's what we're speaking to. With respect to the U.S., we are bringing some Bayer products into the U.S. distribution channel. It's reflected in the guidance. It's not material, but with our system consolidation, we're able to now be more efficient and do it one way versus having two different models that we've been running the last few years. Jeff, on that.

Yeah, thanks, Umar. Yeah, we're excited about Crudelio Quatro. And again, no update. The timeline continues. We continue to have productive dialogue with the FDA. You know, I think I would just back up and just make a couple comments. I think we know parasiticides is really an uninvolved category for pet parents and vets. know that that recommendation is key so i come back to the core strategy which is you know making sure share voice is high and noted yes we've added our 75 reps they've got experience or in the field right now and uh you know they're they're trained and they're they're they're adding values we speak selling parvo and other products um so we've got the share voice and then the second is yes differentiation and you know we believe there's you know a few fundamentals that are key as you look at differentiation you know one is broader coverage is always better and full solutions are per you know definitely preferred by the veterinarian the second is diagnostics that can match the disease And there's evidence today with increased diagnostics from IDEX and others around tapeworm that this concern is there. And it's a zoonotic concern as well. So I think that's second. And with more people and more focus, both on the diagnostic side and the animal health side, the awareness is higher. That usually leads to more prevalence. And I think the last trend is zoonotic concerns, Oomer, continue to be there, especially after COVID. And, you know, specific to tapeworms, look, one common tapeworm is transmitted by fleas, but there's many tapeworms, you know, relevant to domestic dogs and have the potential to carry tapeworms. And that's, you know, a serious disease impact. So we always say that If all else is equal, why wouldn't you use a product with more coverage? So that's our approach. Again, we've got the right teams in place preparing for the launch. We've had a long history in parasiticides with the broadest portfolio in and outside the vet, and we're excited to be bringing Quattro to the market.

And just one thing, Umar, on your payment terms. Payment terms generally stay the same. We're always different things with different customers. But overall, accounts receivables was a big inflow of cash in Q4 as we had strong operating cash flow performance relative to previous quarters. And a lot of that was just the work done by our teams around the globe to collect cash and really focus with our one system to get after AR in a better way.

Your next question comes from the line of Glenn Santangelo from Jefferies. Please go ahead.

Oh, yeah. Thanks for taking my questions. Just two quick ones for me. You know, I just want to follow up on the competitive pressure in the vet clinics. It sounds like you're certainly making some progress. And I'm just kind of curious about your confidence in the ability to take those 3% price increases this year that you're forecasting, you know, in the guidance. Have you taken those already? And has there been any pushback as far as those are concerned?

Yeah, first of all, Glenn, thank you for the coverage and joining the interest in research on Elanco. Yeah, so absolutely, the competitive pressure is there. I would believe, as I've said, we're in a much stronger position with stronger teams, stronger portfolio, and I think a lot of the tactics that we're doing relative to this, and I think the anticipation of our Innovation as well, Glenn, really creates partnerships with distributors, corporate clinics, and others. It's opened a lot more doors, which has been strong. And I would say even the introduction, and an example of proof point, if you point to the introduction of the latest broad-spectrum parasiticide, what we're actually seeing is really more share taken within those actually less share compared to other competitive launches taken from us and I think that shows our differentiation our segmentation digital all these things are working so we're set up well and relative to price you know we've continued to you know execute price in a very value-based way and you know more innovation always allows us to bring those prices and we've not seen you know a pushback on price and continue to see strong resilience for you know, the market and a lot of interest in adoption from the vet side of our products and our portfolio.

Perfect. Maybe I can just ask one revenue follow-up here. I'm just trying to, you know, triangulate your comments on innovation sales in 2025. And I appreciate you don't want to talk about 2025 at this point, but you're sort of guiding people to six to 700 million sales from new innovation products. And if I sort of you know, back out, you know, what you've done so far in 23 and what you're expecting in 24. Is it fair to say that we can sort of triangulate what you're sort of talking about with respect to the three pending launches?

Yes, we have, again, been very consistent to the commitment of six to seven or a million. It isn't all exact math, as you do see, as Todd is a reference, you know, you're going to have Xperia climb and you're going to have some, you know, uh, overlap and, and products that come out, uh, such as, uh, an OptiFlex. So, but, uh, yes, as you, we start to guide to the, you know, 350, 400 million this year before the new products, then with the launches of the new products and our IL 31 that we have coming in 2025, those products will contribute. And yes, we were, we're staying and feel very confident in our commitment of the six to 700 million by the end of 25. That is, that is correct.

Your next question comes from Chris Schott from JP Morgan. Please go ahead.

Great. Thanks so much. Just two questions for me. Maybe first on just the Parvo opportunity in 2024, just any additional color of how much inventory you have this year and how big of a product that could become. And maybe just as you think about longer term with that, just updates on the XUS opportunity for Parvo. And then my second question was just on gross margins. Just any color you can provide on how much some of these inventory and manufacturing slowdown actions are having on gross margins in 2024. We're just trying to get some color in what the underlying trends are as we start to think about kind of beyond this year of where gross margins can go. Thanks so much.

Yeah, thanks, Chris, for the question on Parbar. I'll take that one first. It did land in line with our expectations in the quarter, but the bigger news is, yes, we've demonstrated the ability to scale our 2,000 liter, which gives us confidence that we've got the capacity and the supply to really go into the marketplace full force, and we're doing that with our new sales force right now. The product is performing well. That's very important. I think another important note, Chris, is the product's already in about 3,300 clinics and more so with the general practitioners, which demonstrates that, you know, there's – This is out there. There's prevalence, and many clinics are seeing this. Seventy-three percent of the adoption of those clinics is in general practitioners. You know, 12 or so is in the shelter market. So we see the uptake initially. We're seeing reorders as well. So we see this product being a key contributor to growth and a real step up this year. And then, yes, we would – and we've launched also, just to highlight, we've launched a pretty significant defender campaign to really drive – you know, just awareness of Parvo. You know, right out of the gate, we've got about 1.2 billion impressions in a social media marketing campaign that we're doing. We've set a charge with a vet clinic industry and a pledge to save a million puppies by the end of the decade. So all of that, I think, is just creating awareness, strong marketing, more share of voice. And then, yes, the next thing is we are starting to target key markets internationally to where we can actually bring that product in, where there's a higher prevalence of Parvo. And that may not be always the typical, just a European market. There are other emerging markets as well with higher Parvo. And we see a blockbuster here potential as we globalize the product. So off to a good start. We'll definitely be updating you quarter to quarter on some of the key metrics and the adoption.

Chris, with respect to the manufacturing slowdown, embedded in our guidance for 2024 is 150 to 170 basis point headwind from those plant slowdowns.

Your next question comes from Steve Scala from TD Cowan. Please go ahead.

Hi, this is Chris. I'm Christine. Thanks for taking our questions. We had two. First, on the new marches, are there any other gating factors for U.S. launch post-FDA approval, like state-level approvals, building inventory, or contracting with distributors? And then second, on the U.S. sales force, what sort of initial feedback have you received, and has that had any positive impact on the positioning of the company's current portfolio? Thank you.

Yeah, thanks, Chris. Real quick. As we've noted here on gating factors, we expect that upon approval, there's typically a couple months before actually, you know, there is a launch and that's driven heavily by manufacturing, packaging, labeling, and that's the typical gating factor. And then, you know, a lot of positive feedback. We had a tremendous interest in and many, many applications, and believe we selected a very experienced, strong sales force, and actually the transition's gone faster, and we don't believe the distraction factor may be as high as we expected, and we're looking forward to that sales force with that added investment in the first half to help us ramp our existing sales here in the first half.

Your next question comes from the line of from BMP Paribas. Please go ahead.

Hi, good morning. Thanks for taking my questions. My first one is you touched base on pricing for Zenrelia. Are you able to expand on general pricing strategy versus potential differentiation for Quattro, Bover, and Zenrelia? And my second question is just a clarification. Does EPS guidance reflect the lower interest expenses resulting from the ACWA sale? Thank you.

Let me take the first one, Naveen, and welcome back to coverage. We have not reduced interest expense in our guidance for the ACWA sale. So that interest expense is as if ACWA sale doesn't happen.

So we'll update all the guidance for ACWA post-conclusion of that sale on the quarterly call.

Yeah, Naveen, on all of our products, actually, we see the future blockbusters with the differentiation, with our portfolio. You know, we intend to price for value. We see this in past innovations that have been launched, and we believe that innovation will be rewarded, and that will be part of our offering.

Your next question.

Your next question comes from Nathan Rich from Goldman Sachs. Please go ahead.

Great. Thanks for the questions. Just a few quick ones at the end here. So, Todd, you highlighted the $20 million to $25 million investment in pet health in the first quarter. Could you give us the rough split between what's related to the field force expansion versus what might be promotional dollars focused on parasiticides, just as we think about maybe what the underlying kind of expense base goes up in 2024? And then on the OTC growth for 2024, anything more specific you could share about on your expectations for Advantage and Seresto this year. And then lastly, Jeff, maybe just going back to your comments on having that kind of fuller, more innovative portfolio in pet health with Derm and Parvo, could you maybe talk about what that means in the market and the flexibility that gives you? Is that better access to corporate accounts, the ability to use volume discounts, just any additional color there would be great.

Sure, Nate. Thanks for the question. Yes, there's about the total investment for the sales force is about 20 million on a full year basis. So, you know, essentially that's pretty, given its people, it's pretty standard over the course of the year. So about five in Q1. And then the investments in pet health are really about the promotional spend. And a lot of that is to drive AdTab, which we're excited about. That's the first oral parasiticide in the OTC markets in Europe. And part of our kind of oddity of first half, second half is the restructuring we announced today, that's going to provide a lot of savings that we're using to fund these incremental investments behind big opportunities. But that savings is more second half loaded, where with the northern hemisphere parasiticide season, we really got to make the investments in the first half to drive the uptake of those products. With respect to Seresto and A-Family, we're not guided by product today, but overall, we are feeling good about the positioning of those in retail, and that's a big place where we have leadership and we expect that leadership to continue.

Yeah, and then relative to just the overall portfolio, I would say no matter the segment, when you enter a clinic and have all four dimensions that I just mentioned, and DERM will be the new one for us, it really puts us in a unique position as you know, the next company to be able to do that, and that just gives that optionality to the vet. And we'll be looking at that against all segments, but I do think that will be a major factor and a major differentiator to most of the major animal health companies to be able to have the breadth of the portfolio that we do have with the DERM edition.

Thanks. We'll take the last caller.

Your last question today comes from Brandon Vasquez from William Blair. Please go ahead.

Hi, everyone. Thanks for taking the question and sneaking me in. Can I just ask one? I'll ask two up front here. First, on the FDA conversations that you guys are having, I guess as you get closer to an approval here in first half 24 that you're reiterating, I think maybe I would have expected you could give a little bit more confidence or a little narrowing of the timeframe. So, am I overreading that? Is there anything going on in conversations? Do you guys feel more confident as you're going through these discussions And then maybe the second one is just highlight a couple key products within innovation, that bucket, that are driving growth into 24. Thank you.

Yeah, let me take the second one first. You know, there's no question, and we're excited about Xperia. Xperia exceeded our 70 million run rate at the end of the year at 54 million. And with that growth and that trajectory, we see a shortage of cattle numbers. Xperia plays into all of that relative to the value proposition. And then, of course, Parvo will be a driver, one we don't talk as much about. But with this restructuring, we're really adding significant investment in ADTAB in Europe. that had a good, strong finish to the year. So those would be the three key that I would point to. And then, look, Brandon, I wouldn't read into anything. Our confidence remains. Our confidence in the differentiation remains. These are great assets. Our regulatory team is doing a great job, and we're in a very proactive, productive dialogue with the CBM, and we'll update you if anything does change.

Thank you, ladies and gentlemen. I will now turn the conference over to Jeff Simmons for closing remarks.

I know we're on time here, but I just want to say to everybody, thank you for the time. I think 2023, the second half, really marks progress and momentum. Two quarters at 5% constant currency growth. We doubled our innovation. We increased our debt pay down beyond our expectations. And as you look to 2024, the priorities remain the same. sustained growth on the top line, innovation and bringing innovation forward, and cash. And against all of those metrics, we have inside the guide strong expectations to continue to make great progress. Thank you for your interest and your investment in Elanco. We look forward to a very exciting year and a year with high engagement with all of you.

This concludes today's conference call. Thank you for your participation, and you may now disconnect.