Elanco Animal Health Incorporated

Good morning. Thank you for joining us for Elanco Animal Health's third quarter 2024 earnings call. I'm Katie Grissom, head of investor relations in ESG. Joining us on today's call are Jeff Simmons, our president and chief executive officer, Todd Young, our chief financial officer, and Beth Haney 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 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. The information we provide about our products and pipeline is for the benefit of the investment community. It is not intended to be promotional, and it is not sufficient for prescribing decisions. 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 will be happy to take your questions. I'll now turn the call over to Jeff.

Thanks, Katie. Good morning, everyone. Elanco reported a strong third quarter, delivering constant currency, organic top-line growth with adjusted EBITDA and adjusted EPS above the midpoint of our guidance ranges. Organic constant currency revenue growth of 1% was driven by the contribution from new products led by Xperia, AdTab, Cordelio Plus, and Zenrelia. This marks our fifth consecutive quarter of growth in our underlying business, and we continue to expect to deliver constant currency organic revenue growth of about 3% in 2024. Our consistent strategy focused on growth, innovation, and cash is paying off, with innovative new products driving growth, enabling improved cash flow. Beginning on slide four, we achieved key milestones advancing our innovation portfolio and productivity strategy. Third quarter revenue growth, excluding the impact of our aqua divestiture, was led by our U.S. farm and international pet health businesses. For Elank overall, we expect organic growth to accelerate sequentially in the fourth quarter and into next year. Since our last earnings call, we achieved several milestones for key potential Blockbuster products as we now shift from regulatory into commercial launch mode. On the pet health side, we received U.S. FDA approval for both Senrelia and Crudelio Quattro, positively differentiated products expected to be meaningful competitors in the two largest markets in pet health. On the farm side, Bovair saw the first on-farm feeding into dairy cows. The flywheel is beginning to move as multiple consumer packaged good companies have signed contracts to purchase inset carbon credits from Athene derived from the use of Bovair to reduce methane emission from dairy cows. As we shared in August, we paid down $1.3 billion of debt in the third quarter, enabled by the divestiture of our aqua business. Debt pay down remains our top capital allocation priority and net leverage down from the mid five times at the start of the year now expected to be in the mid four times range at the end of this year. Finally, today, we're introducing a framework around our 2025 expectations. With continued confidence in our expected $600 to $700 million of revenue from new products, we expect 2025 organic constant currency revenue growth to accelerate to mid single digits in 2025. We expect the underlying business to drive mid single digit adjusted EBITDA growth, excluding the aqua divestiture, as we invest strategically in our new pet health launches. Ultimately, We expect organic adjusted EBITDA to grow low single digits driven by an expected headwind from the court supervised insolvency of one of our key CMOs located in the UK. We continue to expect year-end net leverage to be in the low four to high three times range. Todd will further address our outlook towards the end of our prepared remarks. Moving to slide five, we provide third quarter year-over-year revenue growth by our four business areas. We've separated out the impact of the aqua divestiture to show the underlying organic constant currency growth of 1%. First, starting with the U.S. pet health revenue, which declined 4% in the quarter as strong retail performance was more than offset by competitive pressure and vaccine supply volatility in the vet clinics. On the retail side, the business returned to growth as the positive dispensing trends we saw starting in May continued in the third quarter. U.S. Seresto sales grew over 20% in the third quarter, driven all by volume. On the vet side, we're excited about the launch of Xenrelia late in the third quarter and the expected first quarter 2025 launch of Cordelia Quattro. These products will be key contributors to the U.S. pet business, expected return to growth in the fourth quarter of this year and into 2025. Outside the U.S., Pet Health delivered constant currency revenue growth of 2%, driven by the continued strength of ADTAP, Credelio Plus, and Soresto. ADTAP has exceeded our expectations each quarter this year, as our source of volume analysis points to less cannibalization of our existing portfolio in both VAT and retail channels. Our strategic investment in the brand is driving AdTab to lead category growth for both dogs and cats, recruiting more new users into the fast-growing oral over-the-counter market than competitors. Across markets in Europe, we are seeing significant penetration in key channels and very high reorder rates, while positive consumer preference survey data supports continued brand-building investment. We expect AdTab to be a key growth driver in 2025 as well. Now moving to farm animal, which grew revenue 3% globally. The U.S. business grew 11% led by cattle. Despite the declining U.S. cattle numbers, Elanco's cattle business remains strong, led by Xperia. With continued strong performance, we now expect Xperia to reach blockbuster status, with sales expected to exceed $100 million globally this year. Recent combination clearance approvals for Xperia are expected to allow for broader expansion into heifers, which represents nearly 40% of the U.S. feedlot population, a key growth driver in 2025. Additionally, we continue to see very strong demand for remensin as the strength of our integrated portfolio continues to deliver. Kettle vaccines benefited from favorable comparisons to the third quarter last year, but to a lesser extent, than in the prior three quarters. In swine, difficult producer economics in the US are impacting the industry as producers are reducing investment in productivity and certain other products. We expect this dynamic to continue in 2025. Finally, our portfolio benefited from poultry rotations again in the third quarter. Given the variability in purchasing patterns driven by rotations in this business, and our positive performance in late 2023, we expect a headwind of growth in the fourth quarter and into the first half of 2025. Finally, in international farm animal, the 3% organic constant currency revenue decline was driven by two discrete factors, the intentional do different commercial model changes we introduced with the initial 24 guidance, as well as the impact from the Keckstone product recall. Overall, we're encouraged by the performance of the business. With growth, led by price and the new products, along with a stabilizing base, allowing us to report our fifth consecutive quarter of underlying revenue growth. Moving to slide six we continue to advance our innovation portfolio and productivity strategy to hit the highlights our net leverage ratio was 4.3 times at the end of the third quarter and price growth is 3% on a year to date basis now on innovation. which delivered $112 million of sales in the third quarter and $321 million on a year-to-date basis, as shown on slide 7. Today, we are tightening our expectations for 2024 innovation sales, bringing up the bottom end of the range by $20 million, with $420 to $450 million now expected for the full year of 2024 and $600 to $700 million next year. Third quarter growth was driven by continued momentum from Xperia, ADTAB, and Credelio Plus, as well as the U.S. and Brazil launch of Xenrelia late in September. Now let's talk about our three key innovation products in more detail on slide eight. We are thrilled to be the second animal health company to enter the $1.7 billion global dermatology market. Since our U.S. approval in late September, the launch is progressing very well. We are pleased to be hitting all our key internal metrics as we've now been executing the strategy we laid out in our conference call on September 20th, focusing first on vet education, driving positive experience, and accelerating the incentive to buy. Our vet education strategy starts with our field sales team, who bring the product benefits and considerations to life in the clinic, utilizing the U.S. product label and the head-to-head study data results. Additionally, over the past several weeks, we have hosted numerous medical education meetings, advisory boards, weekly webinars, and regional dinner meetings where board certified dermatologists and well-respected veterinary thought leaders have shared their positive experiences. These discussions include clinical data outcomes and successful case studies from trial participants. Our survey data shows the intent to buy increases significantly after these educational touch points with KOLs and veterinarian peers. Additionally, in mid-October, a Xenrelia vaccine booster study was presented at the ISCADE symposium. The promising results concluded that when dogs were administered illicit NEB for 56 days at one time or three times the labeled dose, the number of dogs with protective titers on days 43 and 56 following administration of canine core booster vaccinations, including rabies, were similar among all treated and control groups. No serious adverse events were observed. The data is accessible to interested veterinarians and our Elanco regional consulting veterinarians continue to provide support on questions and individual treatment decisions. The second pillar of our strategy is driving a positive experience. We continue to execute a targeted sample strategy. We had a number of early adopters enrolled in our early experience program, allowing us to gain valuable success data around real-world outcomes of Xenrelia and a variety of different case types. We see a clear opportunity for Xenrelia to be used in all types of allergic itch cases and believe it has the profile to be a first-line treatment. It is very clear Xenrelia works and it works really well. Both veterinarians and pet owners that have experienced the product have been very pleased with the speed and the level of improvements of their dogs. With only a few weeks past since the booster vaccine data was presented, key launch metrics including clinic penetration, reorder rates, and average order size are all progressing in line with our expectations. We are tracking reorder rates for many clinics, demonstrating the product is being used and replenished. The key leading indicator we are tracking is clinic penetration. We are seeing the product placed in hundreds of new clinics each week. We plan to update the market quarterly on this metric beginning early next year. Our global launch is in full motion and we continue to invest in and execute a no regrets approach. Overall, we are pleased with the launch of Zenrelia and encouraged by the adoption we are seeing in both the U.S. and Brazil. We look forward to the fastest ever globalization of a launch for Elanco with Canada and Japan now approved, both with less restrictive labels than the U.S. and launching over the coming months. We are thrilled to be just the second company to offer an innovative new treatment in canine dermatology space and strongly believe in the efficacy benefits Xenrelia has to offer. We see relevance for all cases of atopic dermatitis for this product and believe Xenrelia has the potential to grow the market while unleashing a significant growth lever for Elanco. We are focused on building a sustainable leadership position in dermatology, and Xenrelia is just the beginning. Additionally, as expected, less than a month after the approval of Xenrelia, we received U.S. FDA approval for Credelio Quattro, the newest addition to the Credelio franchise, which includes Credelio Dog, Credelio Cat, and Credelio Plus. Credelio Quattro is the first and only canine oral parasiticide to protect against fleas, ticks, heartworms, roundworms, hookworms, and three different species of tapeworm in a single monthly dose. We are thrilled to bring this differentiated product to the U.S. market. Indecticides, or flea, tick, and intestinal parasite combination products, are the fastest growing category in the $3.8 billion U.S. parasiticides market, with these broad-spectrum products now making up nearly 25% of the market. And Quattro is positioned also to strengthen Elanco's value proposition in the prescription parasiticide market. We are progressing nicely through the final stages of manufacturing scale-up to optimize the launch, which remains on track for the first quarter of 2025, prior to the major parasiticide season. We expect Credelio Quattro to be a major consumer-focused launch, contributing to the growth of the overall parasiticide market, driving share growth for Elanco. Shifting to farm animal innovation, we are encouraged by the progress of Bovair. In the third quarter, we achieved several key milestones, Notably, permission was granted for the sale and use of Beauvair in California, a key dairy production state, and the first cows were also fed Beauvair. We continue to expand the reach of our Uplift database with approximately 800,000 dairy cows enrolled and activated, expected to trend towards 1 million cows by the end of the year. Overall, farmer demand is very robust. And finally, multiple large CPG companies have signed contracts with Atheon to purchase inset carbon credits. We've updated our pipeline chart on slide nine, and as you can see, we are now in or entering the commercial execution phase for the majority of these products. We're excited to share more information on the progress of these launches in the coming quarters, but early indicators are positive. We are focused on investing appropriately to ramp adoption, take share, expand markets, and build strong brands. With that, I'll hand it over to Todd to discuss our third quarter results and outlook in more detail.

Thank you, Jeff, and good morning, everyone. Today, I'll focus my comments on our third quarter 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. we delivered $1.03 billion in revenue, representing a 4% reported decline. Excluding the impact of foreign exchange rates and the divestiture of our aqua business, organic constant currency growth was 1%. Price contributed 2%, while volume declined 1% when excluding the aqua divestiture impact. Slide 12 provides revenue by the four quadrants of our business in the quarter. Total pet health revenue declined 2% in the third quarter, With price growth of 2% our US business declined 4% with supply volatility for vaccines and competitive pressure in the veterinarian clinic contributing an estimated 12 percentage points of decline in the quarter. We are pleased by the volume growth from our OTC retail parasiticide business, which saw the normalization of retailer purchasing patterns more in line with demand in the third quarter. and by the contribution of increased sales of new products, which together contributed eight percentage points of growth. Importantly, next year, as supply headwinds are expected to subside and innovation contribution continues to ramp, we expect a return to growth in U.S. pet health. Outside the U.S., Constant currency pet health revenue growth of 2% was driven by Europe, led by ADTAB and Seresto, as our retail investment strategy and execution continues to drive demand growth throughout the region. This was partially offset by competitive pressure in Australia. Moving to farm animal, globally, third quarter revenue growth was 3%, excluding the unfavorable impact of foreign exchange rates and the impact of the aqua divestiture. In the U.S., revenue growth was 11%, primarily driven by strength in cattle across both new and legacy products. Experian and Remenson continue to be key contributors to growth, along with poultry in the third quarter, partially offset by the profitability challenges for swine customers. We are very pleased with the 18% growth in U.S. farm animal over the trailing 12 months, as our innovation has driven greater benefit across the portfolio. In 2025, we expect growth will decelerate from this elevated level but remain above average industry growth rates driven by Xperia and Bovair. Outside the U.S., farm animal revenue declined 3%, excluding the impact of the aqua divestiture and the unfavorable impact of foreign exchange rates. Aligned with our expectations, the decline was driven by our strategic decision to change our go-to-market model in certain geographies, including Argentina, and exit low-margin distribution agreements. We estimate this do-different approach, and the Keckstone recall in Europe drove three percentage points of decline year-over-year. Excluding these discrete impacts, increased demand for our poultry products in Europe was offset by declines in Australia driven by drier weather and generic pressure. Continuing down the income statement on slide 13, gross margin declined 230 basis points to 52.2% of revenue. The decline was driven by the impact of the aqua divestiture on product mix, inflation, and unfavorable manufacturing performance. The impact from slowing down the plants over the last four quarters was largely neutral in the quarter. Operating expense increased by 3% in the third quarter, driven by higher employee-related expenses and increased expenses supporting the U.S. pet health business. partially offset by savings related to our first quarter restructuring announcement. Strategic investment in the key launches is critical to the long-term success and profitability of the brands, despite being a temporary, near-term EBITDA headwind. Interest expense was $46 million, a decrease of $26 million year-over-year as the proceeds from the Aqua divestiture enabled significant debt paid out at the beginning of the third quarter. Adjusted EBITDA was $163 million in the quarter, a decrease of $51 million on a reported basis, or $27 million excluding the impact of the aqua divestiture. Adjusted EPS was 13 cents, a decrease of 5 cents in the quarter. On slide 14, we include a bridge for the third quarter results compared to the prior year. Additionally, in the quarter, we recorded a gain on the sale of our aqua business, which impacted reported EPS by 94 cents. Now, let me offer a few words on our cash, working capital, and debt on slide 15. Cash provided by operations was $162 million in the quarter. On a year-to-date basis, operating cash improved by $250 million, driven by improved inventory performance, strong collections, and lower project expenses. We ended the quarter with net debt of $3.897 billion, inclusive of the $1.3 billion of debt pay down from the proceeds of our AQUA sale. The net debt to adjusted EBITDA ratio was 4.3 times at the end of the quarter, down from 5.7 times at the end of the third quarter in 2023. We remain confident in our year-end net leverage in the mid four times range. We've updated slides 25 and 26 in the appendix to reflect updates to our key debt information. Based on our third quarter debt paydown, we now expect to have income statement interest expense of approximately $225 million and cash interest of approximately $295 million in 2024. We expect 2025 income statement interest expense to improve by $5 to $15 million and cash interest to be lowered by $20 to $30 million. Additionally, we expect an incremental $150 million of cash taxes next year for deferred tax payments related to the ACWA transaction. Next, I'll provide an update to the September 13th press release regarding the UK contract manufacturing organization that entered court-supervised insolvency in September. This CMO is a critical supplier for Elanco, representing approximately $160 million to $180 million in annual farm animal revenue across species and countries. The entity remains in court-supervised insolvency, and we are working closely with the parties involved to maintain continued product supply. For 2024, we continue to expect an adjusted EBITDA headwind of approximately $5 to $10 million, primarily in the fourth quarter. For 2025, we believe there are a variety of scenarios, all with an expected year-over-year adjusted EBITDA headwind between $25 million and $35 million, primarily on gross profit. We expect to reach a resolution in the coming weeks that will reflect this expected outcome in our 2025 growth outlook. Finally, let's move to guidance on slide 17. For the full year, the outlook for our underlying business remains positive. We are narrowing the range for revenue to be between $4.42 billion and $4.45 billion, representing 3% growth when excluding headwinds from foreign exchange rates and the impact of the aqua divestiture. There is no change to the midpoint of the sales guidance range as increased expectation for innovation sales is offset by lower expectations for U.S. pet health parasiticide revenue. We expect adjusted EBITDA of $900 million to $930 million, reflecting expected gross margin headwinds from product mix and manufacturing performance. And finally, adjusted EPS is expected to be between $0.89 and $0.95, with improved expectations for interest expense and tax, offsetting the items impacting adjusted EBITDA to result in no change to the midpoint compared to August. Our fourth quarter guidance is detailed on slide 18, with organic constant currency revenue growth expected to be between 1% and 4%. Despite the headwind from AQUA, adjusted EBITDA and adjusted EPS are expected to grow primarily based on the comparison of the fourth quarter of 2023, which included meaningful headwinds related to Argentina, as detailed on slide 19. Finally, we wanted to provide some additional context on our expectations for 2025 on slide 20. On the top line, we remain confident in our trajectory towards innovation sales of $600 to $700 million with expected organic revenue growth to accelerate to mid-single digits compared to our expected 3% growth in 2024 with growth expected in both pet health and farm animals. In pet health, growth is expected to be enabled by increased contributions from new products and strength in our pet health OTC business. We expect continued headwinds on our legacy U.S. pet health vet clinic business, although lessening as Crudello Quattro and Zinrelia are expected to contribute to returning this business area to growth. On the farm animal side, we continue to expect above market average growth led by new products and cattle, but anticipate headwinds resulting from poor swine producer economics, generics, and unfavorable comparisons related to strong poultry rotations in 2024. Based on our updated guidance for 2024, the jump-off point, excluding the estimated AQUA contribution for the full year, should be approximately $875 million of adjusted EBITDA. This reflects our 2024 guidance midpoint of $915 million less approximately $40 million of estimated AQUA EBITDA contribution in the first half of 2024. Looking forward to next year, we expect the underlying business to drive mid single digit organic adjusted EBITDA growth, inclusive of meaningful strategic investments in our key blockbuster potential launches. As I shared earlier, the anticipated $25 to $35 million headwind from the UK CMO situation ultimately puts our organic adjusted EBITDA growth expectations in the low single digits range. From a cash perspective, We expect a few headwinds to our cash available for debt pay down, including deferred tax payments from the 2024 AQUA proceeds and increased capital expenditures to support capacity expansion at our monoclonal manufacturing facility. With all this in consideration, we continue to expect net leverage to be in the high threes to low fours range, continuing us on our deleveraging path. We will continue to keep our eyes on the foreign exchange markets over the coming months and look forward to providing our detailed 2025 guidance next February. Now, I'll hand it back to Jeff for closing comments.