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.