Q4 2022 Elanco Animal Health Inc Earnings Call
Speaker 1: Thanks for watching!
Speaker 2: and full year 2022 earnings call.
Speaker 2: All participants are in a listen-only mode. After the speaker's presentation, we will conduct a question-and-answer session. To ask a question, you'll need to press star followed by the number 1 on your telephone keypad.
Speaker 2: As a reminder, this conference is being recorded.
Speaker 2: I would now like to turn the call over to Katie Grissom, head of investor relations. Thank you. Please go ahead. Thanks.
Speaker 2: Good morning. Thank you for joining us for Alenco Animal Health fourth quarter and full year 2022 earnings call. I'm Katie Grissom, head of investor relations. Joining me on today's call are Jeff Simmons, our president and chief executive officer, Todd Young, our chief financial officer, and Scott Purocker from investor relations.
Speaker 2: The slides referenced during this call are available on the Investor Relations section of elanco.com.
Speaker 2: 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.
Speaker 2: For more information, see the risk factors discussed in today's earnings press release, as well as our latest Form 10-K and 10-Q filed with the SEC. We do not undertake any duty to update any forward-looking statement. Our remarks today will focus on our non-GAAP financial measures.
Speaker 2: Reconciliations of these non-GAAP measures are included in the appendix of today's slides and in the earnings press release.
Speaker 2: After our prepared remarks, we'll be happy to take your questions. I will now turn the call over to Jeff.
Speaker 3: Thanks, Katie. Good morning, everyone. Reflecting on our four years since completing our IPO, I am proud of and grateful for the determination and dedication of the Elanco team. We have fully separated and established an independent company. We've integrated the industry's largest acquisition, reset our cost base, and built a strong leadership team.
Speaker 3: In 2022, we continue to execute our IPP strategy, significantly advancing our innovation pipeline while driving productivity gains across all areas of the company and positioning the business for acceleration in 2024 and beyond.
Speaker 3: In 2022, our financial results were negatively impacted beyond our expectations due to significant, challenging macro factors and competitive innovation. However, we are encouraged as we look forward as shown on slide 4.
Speaker 3: First, while macro pressures remain in 2023, we see strengthening Elanco tailwinds with early proof points giving us confidence in our guidance for the year. Also, our late-stage innovation is on track, and we continue to see a path towards U.S. approval of five potential Blockbuster products by the first half of 2024.
Speaker 3: And today, very importantly, after close collaboration with the FDA, we are pleased to announce we now anticipate a first half 2024 U.S. approval and launch of Bovair, a methane-reducing product for cattle.
Speaker 3: This adds another potential blockbuster to our suite of late-stage innovation and adds to our confidence in 2024 and beyond.
Speaker 3: In addition, this year we're executing on our plans to reduce operational complexity.
Speaker 3: Our final step into Bayer integration, the system's transition is on track for an early Q2 go live.
Speaker 3: We are well prepared and this will be a key step to improve efficiencies, offer a better customer experience, and reducing integration cash needs.
Speaker 3: Finally, with a historic launch window in front of us, we're enhancing our focus on commercial and launch excellence.
Speaker 3: Along with our experienced commercial lead team, we are pleased to welcome Tim Beddington as our new head of strategy and market development. A seasoned animal health leader, Tim will help us shape, enhance, and execute on this opportunity.
Speaker 3: Moving to slide five, in 2022, Elanco delivered just over $4.4 billion in revenue, a 3% decline in constant currency, with farm animal flat and pet health declining 5%.
Speaker 3: Despite the revenue decline, we delivered more than $1 billion in adjusted EBITDA. The 10% reduction in operating expenses contributed to adjusted EBITDA margin of 23.2%, an improvement of 90 basis points. This operating cost discipline and better than expected tax rate enabled adjusted EPS growth.
Speaker 3: for the full year, a 4% to $1.11.
Speaker 3: Over the last four years, the Lanko has maintained a consistent strategy of innovation, portfolio, and productivity, or IPP. In 2022, this flywheel continued to strengthen and I'll provide a few key proof points of this momentum on slide six.
Speaker 3: First, with innovation. We had a productive year with eight product approvals in major markets. This included differentiated feline innovations like Zorbiem, Advantage XD, and Bexacat, as well as important geographic expansions like Crudelio for Dogs in China.
Speaker 3: Additionally, the organization delivered valuable life cycle management, regional innovation, and geographic expansions across the portfolio.
Speaker 3: We continue to grow adoption for Experian and integrate value beyond product offerings like Uplook and PenPoint.
Speaker 3: Overall, our combined portfolio of innovation products contributed $133 million in revenue this year, or an incremental $61 million year-over-year.
Speaker 3: Zoah Shield, Experiare, and Crudelio Plus led the growth with our feline innovations demonstrating momentum in the fourth quarter.
Speaker 3: Most importantly, we made the initial US submission of two differentiated pad health potential blockbusters.
Speaker 3: our broad spectrum pair of citizens and our Jack one inhibitor in dermatology.
Speaker 3: The solid progress of each of our key late-stage innovation projects continues to increase our confidence in Elanco's next era of growth.
Speaker 3: Moving to portfolio, globally Price contributed 2 percentage points of growth for the year. Despite known competitive dynamics in the US vet parasiticide market, Elanco remains an established market leader across many areas of our diverse portfolio.
Speaker 3: In pet health, Gallup Rant and our global pain portfolio grew double digits last year. And while a retail OTC pair of CitiSide sales declined in 2022, our analysis shows our continued global market leadership in this space, despite pressure on the category overall.
Speaker 3: In Farm Animal, we're the number two player in the US and gained market share over the course of 2022. Outside the US, we remained very competitive in the medicated feed additive space, including leading in poultry and swine, and are a top two player in aqua. Finally, on productivity.
Speaker 3: We delivered savings and cost avoidance despite significant inflation and product mix pressure, allowing for a slight expansion of gross margin in 2022.
Speaker 3: To date, we have delivered approximately 360 million in cumulative adjusted EBITDA synergies from the Bayer acquisition, exceeding our expectations.
Speaker 3: Finally, we reduced gross debt by approximately $500 million last year from $6.4 billion to $5.9 billion.
Speaker 3: debt pay down remains our key capital allocation priority.
Speaker 3: In summary, our IPP strategy is delivering foundational value with multiple proof points that we believe set up our next era of innovation, growth, and improved cash conversion.
Speaker 3: Now pivoting to 2023, we expect the animal health industry to remain resilient.
Speaker 3: The Global Pet Health Market is poised to continue growing this year. albeit at a slower pace as we expect the post-COVID normalization to continue and a weaker economic environment to persist for at least a portion of the year.
Speaker 3: While vet labor and capacity constraints are expected to stabilize this year, we expect innovation, increased product compliance, enabled by e-commerce, and geographic expansion to drive market growth. In farm animal, we expect lower industry growth rates than pet health.
Speaker 3: Long-term tailwinds from the continued increase in global animal protein demand are expected to be balanced by higher input cost, a cyclical decline in the US cattle herd, and continued generic competition.
Speaker 3: Moving to slide 7, in 2023, our overall business will continue to be impacted by many of the same trends we faced in 2022. Economic slowdown, competitive innovation, and rising interest rates.
Speaker 3: While these factors will contribute to a challenging year-free Lanko, we expect strengthening the Lanko-specific drivers to partially offset macro-headwinds.
Speaker 3: We expect top-line trends to modestly improve, from a 3% constant currency decline last year to an expected 1.5% constant currency decline at the midpoint of our guidance in 2023.
Speaker 3: Outside of FX, we expect aggregate headwinds from environmental factors to be similar magnitude to what we experienced in 2022, in the range of $120 to $130 million.
Speaker 3: While we are seeing improving external supply chain dynamics and promising signs of recovery in China, the impact of economic-driven pressure on retail OTC products is expected to continue.
Speaker 3: For China, our business grew 9% in constant currency in the fourth quarter, a reversal from four previous consecutive quarters of decline.
Speaker 3: We expect improved performance this year in China, but continue to watch pork prices and consumer confidence levels as key leading indicators.
Speaker 3: Regarding retail OTC, encouraging early data points in the US and Europe suggest improving demand trends compared to the second half of 2022. But we expect continued economic driven pressure on the category.
Speaker 3: Given the larger notional size of the business in the first half of the year driven by the northern hemisphere parasiticide season, we anticipate a headwind to Elanco's performance in the first half despite sequentially improving trends.
Speaker 3: Although some U.S. retail partners reduced inventory levels in the fourth quarter, we do not anticipate a meaningful step down in 2023 from 2022 ending levels. Importantly, we believe our strategy to bring innovation, expand physical availability, and expand the quality of life for our customers.
Speaker 3: and strategically price our products will help us maintain leadership in the category and position us well for the long term. With regard to more Elanco specific drivers, we expect strengthening tailwinds will partially offset the environmental headwinds I just described by approximately 60 million at the midpoint of our guidance.
Speaker 3: The Elanco specific drivers of price and accelerated innovation sales are expected to be partially offset by continued pressure from competitive innovation, internal supply constraints, and continued planned reduction in our contract manufacturing business.
Speaker 3: We expect price to deliver more than two percentage points of growth as we annualize our 2022 increases and implement incremental increases in certain markets, with the majority of pricing actions already taken.
Speaker 3: Innovation revenue contribution is expected to be $210 to $250 million, or approximately 80 to 120 million incremental, representing 2 to nearly 3 percentage points of growth from innovation.
Speaker 3: This includes 20 to 30 million dollars of contribution from a small bolt-on acquisition we closed in early January to enhance our farm animal medicated feed additive portfolio with nutritional products. We expect these antibiotic alternatives will enhance our farm animal mix, be accretive to growth, and help us grow share in the US and globally.
Speaker 3: We continue to expect $600 to $700 million of innovation revenue contribution by 2025 from products commercialized by Lanko in 2021 and beyond.
Speaker 3: On slide 8, we highlight the key milestones and expected timing for several late-stage assets.
Speaker 3: Before getting into updates on our pet-held portfolio, I'll provide an update on Bovair. As you recall, last spring we announced the in-licensing of the methane-reducing product for cattle from DSM for the U.S. market and we continue to believe it has blockbuster revenue potential in excess of $200 million.
Speaker 3: and our parallel work to finalize contract manufacturing capacity, we anticipate a first-half 2024 approval and launch.
Speaker 3: We look forward to integrating this product into our portfolio of strategic sustainability offerings for our beef and dairy customers. Shifting to our more near-term pet health drivers, Bexacat, the first-in-class SGLT2 inhibitor for cats, gained FDA approval in December .
Speaker 3: We are taking pre-orders and expect to ship product in the coming months.
Speaker 3: For our Parvo virus innovation, we continue to await USDA approval of our Monoclonal Antibody Manufacturing Facility and important milestone for our broader Monoclonal Antibody platform.
Speaker 3: The expected conditional approval for the product will be followed by state approvals. We expect strong interest for this first-in-class treatment and expect to ramp supply over time as we expand capacity.
Speaker 3: In addition to advancing our vet clinic innovation, we expect 2023 to benefit from Pet Health OTC retail innovations and refreshes.
Speaker 3: In the coming months we are preparing to launch two of the three new OTC parasiticides in the US and Europe that we expect this year. In the US we're relaunching the original formulation of Advantage, a flea preventative for cats, and canine Advantix, a flea and tick preventative for dogs.
Speaker 3: These products will be positioned as value offerings that capture the cost-conscious consumer. We expect these products to be on the shelves of a small subset of retailers over the next few months.
Speaker 3: It's important to note our Advantage family of products has the highest brand recognition of our pet retail products and as we move into this critical northern hemisphere flea and tick season, we're excited to now have Advantage and canine Advantix alongside Advantage II.
Speaker 3: K9 Advantix 2, and Advantage XD for cats on the shelves to meet our customers' needs. Refreshing our OTC product offerings and driving physical availability of the Advantage family in Seresto are key initiatives that our pet health teams are driving globally. Now I'll pass it to Todd to provide more on our fourth quarter results and 2023 guidance.
Speaker 4: Thank you, Jeff, and good morning, everyone. Before I go over our results, I want to provide some additional information about the revisions we made to our 2020 and 2021 financials that were described in today's earnings release.
Speaker 4: In connection with finalizing our 2022 financial statements, a cumulative error was identified relating to the valuation allowance for taxes for a Southeast Asia affiliate that affected our GAAP financial statements for 2020 and 2021. All in material to prior years the Titus Castle bank video showing the CleverMusic.com underground initial lies pocketing.
Speaker 4: The error could not be addressed by a cumulative correction in the fourth quarter of 2022 without creating a material error to the 2022 results. Once we determined that a revision to prior periods was necessary, we then made additional revisions that would have otherwise been immaterial for 2020, 2021, and 2022 in each affected quarter. None of the revisions had an impact on revenue, and they had an immaterial impact on our adjusted results.
Speaker 4: If these revisions had been recorded in the correct reporting period originally, the impact through the first nine months of 2022 would have been an increase of $2.9 million of net income and an increase of $4.1 million of adjusted EBITDA.
Speaker 4: We are finalizing our consolidated financial statements, including our income tax items, and expect to file our Form 10-K timely. Accordingly, the amounts presented in today's press release and on this call are unaudited and subject to change pending such finalization.
Speaker 4: However, we believe that the numbers presented today will not change materially. We are also evaluating the effectiveness of our controls relating to income taxes.
Speaker 4: I will now 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.
Speaker 4: Starting on slide 10, in the fourth quarter, we delivered near the midpoint of our guidance range for our key metrics.
Speaker 4: Revenue was $988 million, an 11% decline, or a 6% decline in constant currency, with price growing 3%. Foreign exchange rates represented an approximate $53 million headwind in the quarter, or 5%. Slides 11 and 12 break down our revenue performance in the quarter by price, rate, and volume, as well as species and region.
Speaker 4: For pet health, we declined 10% in constant currency in the quarter with volume declines in our parasiticides portfolio, partially offset by growth in our pain portfolio. Our U.S. business declined 13% compared to last year, primarily due to retail channel pressure, competition in parasiticides, and supply challenges for certain vaccines.
Speaker 4: Our international business declined 6% in constant currency, primarily driven by the economic slowdown in Europe . As anticipated in our November guidance, Seresto and Advanced Family Products were impacted by pressure felt across the broader retail channel. We estimate approximately $10-15 million dollars of impact on our business year over year from a reduction in US retailer inventories.
Speaker 4: We believe the remaining decline for these brands was a result of decreasing consumer discretionary spending as well as competitive innovation in the vet channel.
Speaker 4: In the fourth quarter, our farm animal business declined 3% in constant currency. Increased demand for aqua products and strength in international cattle was more than offset by declines in swine outside the U.S. and in U.S. cattle.
Speaker 4: Our US cattle business was negatively impacted by supply challenges for certain vaccines and a reduction in distributor purchases. Poultry declined 4% at constant currency primarily driven by rotation timing in the US. Continuing down the income statement gross margin increased 70 basis points to 54.7% despite the decline in reported sales.
Speaker 4: The improvement was driven by our 3% top-line price performance and productivity partially offset by higher inflation and unfavorable product mix. Operating expenses declined 9% year-over-year in the quarter. Adjusted EBITDA margin was 17.6%, a decline of 160 basis points year-over-year.
Speaker 4: Adjusted earnings per share was $0.19 in the quarter, including a $0.07 benefit from a favorable fourth quarter tax rate. Referring back to the two-year revenue bridge on slide 7, I'll provide a few comments on our 2022 full-year performance.
Speaker 4: We delivered just over $4.4 billion in sales, a 7% decline, or 3% decline at constant currency, accounting for the approximate $200 million of impact from foreign exchange rate.
Speaker 4: Environmental factors, including COVID lockdown implications in China, external supply chain disruptions, and economic pressure on pet health retail represented an estimated $120 million, or 2.5 percentage point drag on our business.
Speaker 4: Outside of our planned reductions in contract manufacturing sales, which drove half a percentage point of decline, Elanco specific factors were effectively balanced with price and innovation delivering tailwinds, offset by competitive innovation and other factors primarily impacting the core, including internal supply challenges.
Speaker 4: On slides 24 to 28, we provided additional revenue breakdowns, including by top affiliates.
Speaker 4: Continuing down the P&L on slide 13, gross margin was 56.7%, an expansion of 10 basis points compared to last year. This was enabled by full year top line price growth of 2% and continued productivity improvements partially offset by inflation and unfavorable product mix.
Speaker 4: These factors, combined with reducing operating expenses by 10%, contributed to the 90 basis point expansion and adjusted EBITDA margin for the full year.
Speaker 4: Adjusted earnings per share was $1.11. Growth of 4% for the year as both adjusted interest expense and tax expense declined compared to 2021.
Speaker 4: Our non-GAAP tax rate dropped from 22% in 2021 to 17.9% in 2022. This year-over-year decline was primarily driven by a favorable tax ruling in the fourth quarter of 2022 in Brazil and the jurisdictional location of Elanco profits.
Speaker 4: Related to our productivity savings in 2022, on slide 14, we have updated or adjusted EVA-Dot Synergy Progress.
Speaker 4: We delivered approximately $140 million in incremental synergies, bringing the cumulative total to $363 million through 2022, exceeding previous expectations as we efficiently executed our fourth quarter 2021 restructuring and accelerated expected savings from 2023 into 2022.
Speaker 4: We have increased our adjusted EBITDA synergy expectations in 2023 to approximately $380 million. We remain committed to deliver more than $400 million of synergy capture by 2024 as the final triumph associated with our Bayer ERP and Business Process Integration annualizes.
Speaker 4: Before moving to our 2023 guidance, let me offer a few words on our cash, debt, and working capital on slide 15. While we are still finalizing our operating cash flow results for 2022, we expect full year to be between $450 million to $460 million for the year and between $10 million to $20 million for the fourth quarter.
Speaker 4: The year-over-year decrease in the fourth quarter reflects an increase in networking capital driven by an increase in inventories. We also had higher cash interest costs year-over-year in the fourth quarter as a result of the swap restructuring we executed in the second and third quarters of 2022 and rising interest costs on our floating rate debt.
Speaker 4: We ended the year with net debt of $5.6 billion as we reduced gross debt approximately $500 million for the full year and net debt $208 million. Our net leverage ratio was 5.4 times, slightly above our previous expectations, as a result of lower cash balances than expected at year end. We continue to see durable cash flows from this business and other
Speaker 4: And in a moment, I'll touch on our expectations for debt paydown in 2023 and the factors improving our outlook for free cash flow going forward.
Speaker 4: Now, let's move to our 2023 financial guidance starting on slide 17. We expect revenue to be between $4.28 billion and $4.4 billion, or approximately flat to a 3% decline in constant currency.
Speaker 4: For adjusted EBITDA, we expect $920 million to $1 billion. Finally, we anticipate adjusted EPS of $0.74 to $0.83.
Speaker 4: Slide 35 in the appendix provides a number of additional assumptions to help support your modeling efforts. On slide 18, we'll review some of the underlying factors in our 2023 revenue expectations.
Speaker 4: We expect the impact of foreign exchange rates to be a $10 to $15 million headwind for the full year. However, this will not be consistent across quarters. Utilizing spot rates from early February , we expect headwinds in the first half with tailwinds in the second half.
Speaker 4: In pet health, we expect improved performance. First, we expect continued global growth for the Crudelio franchise and accelerated growth from innovation. We expect a return to growth in our China pet health business as the market is expected to normalize by mid-year. Finally, we expect improving supply dynamics to benefit the advanced family products and
Speaker 4: and vaccines in the U.S. year over year. On the other hand, we expect ongoing pressure from competitive innovation and have incorporated assumptions for new entries in U.S. parasiticides, pain, and otitis. Collectively, we expect the magnitude of competitive pressures on volumes to be largely in line with 2022. On retail, the European economic outlook appears better overall but remains pressured along with the U.S. consumer. For more UN videos visit our website www.un.org
Speaker 4: That said, as we enter the heart of the flea and tick season starting next month, we expect consumers in both the U.S. and Western Europe to once again focus on prevention and to be less likely to trade down to lower cost and less efficacious post-infestation treatment options given the heavier risk of fleas and ticks during this time of year. We also believe the launch of our new adanings family products.
Speaker 4: and increased physical availability will enhance our competitive position in 2023. Moving to farm animal, we expect growth to be driven by the continued uptake and conversion of Xperia as well as the addition of several portfolio-enhancing bolt-on products. Additionally, we expect improvement in China throughout the year.
Speaker 4: Pork prices have been depressed over the last several months, but industry analysts believe this will be temporary. Finally, we expect to see continued strength in aqua markets globally.
Speaker 4: At the same time, we expect continued generic pressure and expect internal supply challenges on a few products globally. Finally, favorable weather conditions in 2022 led to a strong sheep season in the UK and Australia, which we don't expect to repeat in 2023.
Speaker 4: Moving to adjusted EBITDA on slide 19. Price increases are expected to offset reduced volumes and the impact of inflation on our manufacturing base. We expect a flat to modest increase in operating expenses primarily driven by global wage increases and strategic investments in key pet health brands. With the acceleration of synergies into 2022, we expect a flat to modest increase in operating expenses primarily driven by global wage increases and strategic investments in key pet health
Speaker 4: we expect less incremental savings contribution in 2023. After our re-priorization of the R&D portfolio and reduction in 2022, we expect our R&D investments to be approximately $80 million per quarter or generally flat year over year, as Elinor and her team continue to drive our innovation forward.
Speaker 4: Finally, adjusted EPS on slide 20. The reduction in adjusted EBITDA translates to 3 to 15 cents of the year-over-year decline with increased interest expense from our floating rate debt and the expectation of higher tax rate in 2023 primarily driving an additional 21 to 24 cents of decline.
Speaker 4: As we think about the shape of the year, let me offer a few words on phasing in the first half. With our ERP system go live in April , we expect a meaningful impact on the split of our financial results between the first and second quarters.
Speaker 4: We will have certain sales blackout periods for most affiliates in late March and early April that we expect will cause some customers to accelerate their orders of legacy bear products into the first quarter from the second quarter.
Speaker 4: As a result of this ordering uncertainty, we are providing financial guidance for the first half of 2023 versus first quarter guidance. We expect to return to quarterly guidance for the second quarter in May.
Speaker 4: On slide 21, we share our first half 2023 guidance. We expect revenue of $2.23 billion to $2.31 billion, adjusted EBITDA of $490 million to $540 million, and adjusted EPS of $0.43 to $0.50. We expect foreign exchange rates to be a headwind of approximately $40 million.
Speaker 4: or about 2% in the first half. While the cadence of the top line will be impacted by the bare system integration across the first half, interest and tax expense will not be. Finally on our balance sheet expectations for the year. We expect to end the year with a net leverage ratio between 5.3 and 5.9 times. The sensitivity to adjusted EBITDA is reflected in this wide range. While we aren't guiding to a specific change in gross depth.
Speaker 4: we expect to refinance a portion of our senior notes due in August of 2023. We remain confident in our ability to service our future debt obligations and generate cash as we bring meaningful, differentiated innovation to the market while relentlessly managing our costs. In 2024 and beyond, we expect increasing EBITDA and minimal one-time cash costs to drive improved operating cash flow. Over the last four years, Alenco has had significant uses of cash as we have stood up.
Speaker 4: integrated, and transformed our company. On slide 22, we have laid out the estimated cash costs for the three primary projects, the standup of Alenka's own independent ERP infrastructure, business processes, and shared service center network, the Bayer business integration and restructuring, and the Bayer systems integration. The independent company standup was completed in 2021.
Speaker 4: Most of the cash for the Bayer Business Integration was completed in 2022 and we will complete the Bayer System Integration in 2023. While we expect $140 to $160 million in 2023, there is a substantial step down starting in 2024 as cash expenses associated with these projects moves to less than $20 million.
Speaker 4: Moving past the approximately $1 billion necessary to stand up and integrate this company will substantially improve our free cash flow generation. Now I'll hand it back to Jeff for closing comments.
Speaker 3: Thanks Todd. Before we take your questions I'd like to provide our view on why the Lanko board and team have deep belief and confidence in our future.
Speaker 3: First, pipeline delivery. Dr. Ellen DeBraub-Ander and her team are consistently delivering milestones across the portfolio, from research to late-stage development. We're refreshing our Pet Health OTC portfolio with Advantage and K9 Advantix, as well as Advantage XD for cats. We are launching first-in-class innovation.
Speaker 3: in the vet clinic with zorbium, Bexacat, soon parvovirus, and Xperia's ramping. In the U.S., we have a path to approval by the first half of 2024 for our broad-spectrum parasiticide, our canine dermatology products, the JAK1 inhibitor, and the IL-31 monoclonal antibody, and now also Bovare, as I discussed earlier.
Speaker 3: Our excitement about Bovair is enhanced by tangible progress on farmers' ability to monetize environmental sustainability efforts. In 2023, we expect the first carbon credits will be minted for beef producers, which will be proof that Bovair is a
Speaker 3: Farm animal sustainability can transition from strategy to tangible action that can create value for farmers, investors, and society as a whole. The next reason for confidence is our focus on reducing operational complexity.
Speaker 3: With the Bayer system integration going live in April , we're fast approaching one operating environment for our complete portfolio, creating more stability, a better customer experience, and opportunity for more efficiencies.
Speaker 3: Importantly, it allows us to move past the distraction and the significant associated cash cost, pivoting the organization towards driving the portfolio and improving free cash flow generation as Todd laid out.
Speaker 3: And finally, we are building a commercial leadership team that will drive our commercial execution and launch excellence as we enter the next era, Freelancel.
Speaker 3: In his first year leading the US Pet Health business, Bobby Mote has built a data-driven organization, improving capabilities across Salesforce Excellence, pricing, digital engagement, retail marketing, and vet clinic targeting. Jose Simas, a nutritionist.
Speaker 3: and our U.S. farm animal leader is growing Elanco's share across the business while helping to shape the industry's future with antibiotic alternatives and game-changing sustainability offerings. Romero Cabral, a veterinarian and seasoned international animal health leader, has demonstrated his ability to lead across our diverse business outside the U.S. across many geographies, species, and products. And finally, we're pleased to announce we are further enhancing the strength.
Speaker 3: of our commercial leadership team with the addition of Tim Bennington. With his 25 years of industry experience across both farm, animal, and pet health, Tim will be a great complement to our commercial leaders and our organization broadly. He has led some of the most successful blockbuster launches in our industry and runs some of the largest P&Ls in animal health. We are confident he will enhance our overall competitiveness.
Speaker 2: as our team prepares for this historic launch window and sustainable growth. 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 colors 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. As a reminder to ask a question, please press star followed by the number one on your telephone.
Speaker 5: OTC market they're playing out longer term. It seems like we're seeing an increasing shift in recent years to some of the more prescription oral products in the market, including the combination products. So you're continuing to sort of double down at least this year on the OTC. That seems to be an area that lost market share in 2022 and is expected to do again in 2023. Let's talk about the OTC versus the OTC market.
Speaker 3: prescription, and particularly maybe you can comment on Sarasco expectations going forward given pretty disappointing 2022. Yeah absolutely Michael thank you for the question. So you know we believe this is an AND and not an OR. You can see the pipeline that's coming. We believe that the VET clinic in the VET is critical. We've got game changing technology that's coming. Some of the biggest blockbusters and some of the biggest spaces.
Speaker 3: So the vet clinic will be critical. And then really, this is about the omni channel, right, in terms of meeting more pet owners, where they want to shop. We still have a large segment of the pet owner population that does not go to the vet. And even, you know, the economic challenges may even drive some of that. So we believe this is a combination of both. And what we've done since picking up the Bayer portfolio is do what we said we were going to do more physical availability. We're in more retailers today than ever on more end caps and more.
Speaker 3: term is this is a growth segment. It's global. The key initiatives we said we were going to put in place are now coming to to to to life. And we see this as something in the medium and long term as strong. Seresto loyalty continues to remain high. It was impacted heavily by, you know, the economic pressures that we mentioned in the U.S. and EU to step down and retailer inventory as well.
Speaker 3: more physical availability, we'll see that in 23, more price, more geographic presence. So again, an improving year for Seresto in 23.
Speaker 5: Follow up, Mike. Yeah, your follow up for Todd. Great, thanks. Yeah, appreciate that. Todd, quick follow up on Cash Valet with a death pay-up plan. You probably have a lot more color on the cash project going on. So, I'd like to really help you. But, any you can say on operating cash flow that leverage targets for end of year 23, just so that we think through.
Speaker 4: 5.3 to 5.9 times projected. If you do look at all the assumptions we provided in the appendix for modeling purposes, you know, there's a lot of cash that still goes out the door on the project expenses. We said we've got cash taxes capex as well as the cash interest. So, you know, if you look at all that while we're not guiding to a gross debt pay down that gets you to about a hundred million dollars.
Speaker 4: of pay down depending on networking capital performance. That was a very disappointing area for us in 2022 and we've got new initiatives with a lot of focus on that across the company in 2023 as that needs to improve to help us drive better performance on the cash line. So those are the key things we're looking at. But at the end of the day, right now it'd be about 100 million of net pay down.
Speaker 6: Great, thanks. Thanks. We'll take the next caller. Our next question comes from Erin Wright from Morgan Stanley . Please go ahead. Your line is open. Great. Thanks for taking my question. So, one on innovation and one on the parasiticide. So, can you break down what you are baking in in terms of the guidance for 2023 in terms of innovation contribution and how we should be thinking about that ramping in 2024 and help that growth?
Speaker 6: as well as net contribution from Innovation in 24. Does your long-term innovation target now embed the small acquisition as well as the expedited launch of Bovair? And then just my second question is on the broad spectrum parasiticide. How are you thinking now in terms of the competitive positioning? Do you think you'll be still third to market or is it fourth to market? And will you be able to take share more so from the existing combination products out there or will it be mostly legacy, OCC, and oral parasiticides? Thanks.
Speaker 4: Sure. Todd, do you want to start on innovation? Sure. Aaron, we've got $220 to $250 million in innovation sales in 2023 after doing $133 million in 2022. That's ramping in the $90 to $115 million range.
Speaker 4: you know, overall, you know, we have not changed the 600 to 700 million that we are excited about these innovative antibiotic alternatives we're adding as well as Bovare coming earlier. Just gives us more confidence in the ability to deliver on that six to seven hundred million amount. And, you know, again, we look forward to ramping in 24, but we're not giving guidance on that today.
Speaker 3: Yeah, Aaron, and regarding the broad spectrum parasite aside, so submission made last year, continued path, I want to emphasize on really the whole pipeline. There really nothing has slipped. We have increased confidence in the overall pipeline and the progress, the quality of the submissions that are being made. I will highlight really the differentiation. We're not going to highlight all the details of what that is. But what we would say is differentiation matters most and we believe we have a differentiated, you know, leading product that can come in that's already past the heartwarming threshold coming into this product. The other new news here in this earnings call is our pivot as we finish the system stand up, we're pivoting now to commercial excellence.
Speaker 3: bringing Tim on, Tim Bennington, with his experience leading some of the largest launches in the business. Our energy is now channeled around launch readiness, commercial excellence globally, how we can ramp products more, segment them even better, and take more share earlier. That is the focus and Tim's charge as he comes in, complementing the existing team that's focusing on the existing business. Thanks, we'll take the next caller.
Speaker 7: Our next question comes from Nathan Rich from Goldman Sachs. Please go ahead. Your line is open. Great. Thanks for the questions. I'll ask both up front. One, I kind of just wanted to build on Erin's question. You know, Jeff, when you're thinking about the launches next year and that kind of historic launch window that you referenced, how should we think about the contribution of new products ramping up in 2024, and what are the biggest kind of swing factors? You know, atgemshire and other brands have if you want to get into this stuff,
Speaker 3: and what you kind of expect for kind of underlying growth as we move through the year. Thank you. Yeah, great question, Nathan. So I think, first of all, it is to us taking the existing capabilities that we're actually building and building on. And I think Zorbium's a good example of this as we're looking at...
Speaker 3: you know, adding, you know, enhanced back to our investor day marketing enablers from, you know, the right pricing to digital to globally making sure we've got the right, you know, share a voice in the right markets that will be absolutely critical. We feel like we're in a really strong place now. We don't need to add a significant number of sales reps, we believe, but it will be targeting and enhancing.
Speaker 3: the appropriate, you know, insurance of having the right share voice and the right capabilities to drive demand. And we're seeing that and we're able to test that with the zorbiums, the Bexacats, the parvo viruses coming inside the vet clinic. And actually these are first in class products that are drawing a lot of interest in bringing us into a lot more clinics. That's number one.
Speaker 3: Two, then, is all around the segmentation of the differentiation in the products and what segments that we'll go after, and that will be all building around this launch readiness. So we've had a lot of good progress on our launch plans for these products. What Tim is going to be able to do is bring his experience and take our existing teams and actually enhance those launch plans and ensure that we're...
Speaker 3: some that will come sooner than we expect and maybe some that will be a little bit delayed, but as a whole, you know, we'll be timing those resources and looking at how we can complement them together as well. And Nathan, let me provide you how we're seeing the first half, second half dynamics. First half, you know, Northern Hemisphere parasite season, the contribution from the retail product.
Speaker 4: a tougher EBITDA situation. The other part, I would say Bobby Modi came on at the end of the first quarter. Last year his team has really, you know, ramped up their execution as seen by bringing the new advantage, relaunches the play, and making sure we're investing appropriately behind our biggest brands at the right time and doing that. So I think that's probably the next element in that expectation of what those sales in the first half.
Speaker 4: contribute being the biggest item on the cadence and then on the second half again, it's just you know It was a really tough compare In the center an easy compare for the second half versus the first half for us and that again gives us confidence in the EBITDA split between the two halves of the year
Speaker 5: Great, thank you. Our next question comes from Chris Shot from JP Morgan. Please go ahead, your line is open. Great, thanks so much. Just two questions for me. Maybe first on price. It seems like some of your peers are seeing a larger contribution from price this year. So can you just elaborate?
Speaker 3: expense would look like if we're just kind of looking out to 2024, assuming rates stay where they are today. I guess we just kind of take that second half kind of run rate on interest expense and annualize that as a reasonable target or could it step up further from there? Thanks so much. Yeah, I'll take the first one on price. We saw, Chris, price increase throughout the year with the 3% and.
Speaker 3: We've also taken most of the significant price increases here at the end of last year, beginning of this year, so the price increases are in place. And we're doing the things necessary to sustain and build price, which is adding innovation, targeting customers better, building out value beyond product.
Speaker 3: and both on the farm animal and on the pet side. I mean adding nutritional health products, sustainability is going to help our bundle and our portfolio on the farm animal side bringing more innovation and pet will do the same. So, and we've added some price experts and capabilities coming in. So again, we're going to hold here saying more than 2% price, but we will say that price will be a key growth driver for us in 23 and beyond.
Speaker 4: Chris, on your question on interest, on our Q3 call in November , we provided the debt stacks as well as the facts regarding our interest rates while poor pulling. As you rightly pointed out, we do have another billion of swaps rolling off at the start of Q4. That would give us roughly...
Speaker 4: We're at about $1.8 billion of floating rate debt today. That would get you up to $2.8 billion. And so as we get into higher interest rate environments with the Fed, these are all at SOFR plus $1.85. So for the back half of the year, we're expecting to be in about the 7% range on our debt. So that's the big driver. So out of the $1.4 billionCap of the year, we're now up $3.4 billionj Lady bird number here in Santa Clara. So those are all
Speaker 4: wanted to make that clear back in Q3 on the impact of floating rate debt and the amount of leverage we have. As we looked at 2024, I'd focus you on the cash project slides, those dropping off dramatically as we finish up the integration, the bear systems and our systems will allow for more cash, free cash to pay down debt. And then the forward curves would suggest interest rates are going to drop with the Fed starting to cut rates.
Speaker 4: in 23 of 24, I'm not going to comment on that. That's why I really can't comment on, is the second half a good run rate into 24? Because a lot of it is floating right debt that will be driven by said policy and how the economies play out over time.
Speaker 2: Thanks. We'll take the next color. Our next question comes from Uma Raffet from Evercore ISI. Please go ahead. Your line is open. Hi guys. Thanks for taking my question. I have two here if I may. why do you think the Lanko team was overestimating numbers? Yes.
Speaker 8: in such a consistent way. And can we reasonably assume that the $74 to $0.83 is truly a trough first? And then secondly, on the base business EPS, which is no longer that $1 that it used to be, I think an important question for a lot of new investors, looking at the link, is what's the incremental operating margin on the new launches? Will they come in at 65% or so? Or would it be much less than that? Thank you very much.
Speaker 3: Yes, thanks, Mark. You know, we stand here today with confidence in our 23 guidance as Todd has highlighted. As we look back at last year and we came into you know our May call and went to the second half, we had you know put together six consistent quarters of holding and staying to our guidance and we had an environment that
Speaker 3: that hit us in a multitude of ways. And predicting war, COVID lockdowns in China, the inflation and the recession and the impact on really us where we were over indexed in a China and a pet retail situation in the Northern Europe , those were things that I'm not sure that we could have predicted. I would say that we've taken a very measured approach this year in looking at.
Speaker 3: overall our confidence in this guidance is looking at saying yes we've got a competitive portfolio on a team but looking at this macro environment as Todd highlighted we've taken assumptions we've assumed that we're going to carry a lot of these same headwinds and challenges out of 22 into the first half of 23 and we will you know we have seen a lot of you know consequential improvement but we're seeing this as a
Speaker 3: slower step up throughout the year. And so again, I stand here with confidence in the assumptions, the approach we've taken in our guidance, we start to return to growth in the second half of the year. We're gonna do it in a balanced way and also prepare for this next era of growth in 24 and 25. It's so critical to our investors and long-term value of this company. Over on the launches, certainly over time these launches will be incrementally higher margin and will provide really good either the doubt flow through.
Speaker 4: margins just continue to improve.
Speaker 9: All right, thanks. We'll take the next question.
Speaker 10: Next question comes from John Block from Steve folks. Please go ahead. Your line is open. Thanks guys. Good morning. I'm Todd just the 5-3-5-9 leverage for year and 23 and there's a lot of reasons in the slides. Why did cash requirements step down in 24? I think I get that but is there anything from a covenant perspective to be aware of? Any step downs?
Speaker 10: in 24 or 25 on the leverage ratios to call out. And then the second question, I'll ask about the front. Just the rest of down queue over a queue, yeah, I don't think it's been down three queue to four queue for the past four to five years, or at least since I've got the breakout. So can you talk about the product share, and then anything new with the EPA and the horizon, do you expect resolution with the EPA in 2023? Thanks, guys. And John , the leverage governments are over seven times. We don't think there's...
Speaker 3: that was definitely a big driver. Retailers stepped down in inventory. It was a little trade down and maybe a move over to the vet clinic, but not substantial. So we've done a lot of studying into this. I think the key lead indicators that give us a lot of confidence as we come into this season, and the early indicators in the year are positive, as we look at sequential change, is one, as we move into the season, Seresto's brand loyalty, the retail industry is going to be a little bit more positive.
Speaker 3: notion of our total business. So we're gonna see some step down, but as a whole, again, a lot of confidence in Seresto. I would highlight that as we look at the EPA, yes, we're having a very constructive, positive dialogue. We do expect to report as we look at the overall working arrangement with the EPA on how we can improve brand stewardship and oversight of this product is something that we're endorsing and looking at.
Speaker 9: We'll take the next caller and I realize we have a few in the queue. We'll continue to answer questions. We might go a little bit over the hour. Our next question comes from Elliot Wilbur from Raymond James. Please go ahead. Your line is open.
Speaker 3: Thanks. Good morning. First question for Jeff and Todd. I heard you the number you called out specifically for competitive pressures in the fourth quarter, but if you mentioned the foyer impact, I did not catch those. I wondered if you could detail what the foyer impact was of the
Speaker 3: competitive pressures that you have cited on a couple occasions in the last couple of calls. And then specifically, Jeff, how are you thinking about the forthcoming launch of
Speaker 3: on a couple occasions in the last couple of calls. And then specifically, Jeff, how are you thinking about the forthcoming launch of...
Speaker 3: a MAB for osteoarthritis in the US given what you've seen to date in Europe . I understand that product labeling is slightly more favorable in the US than Europe but just trying to sort of balance that versus what seems to be a growing desire on the part of vets to reduce or control this intermediation within the US.
Speaker 2: And then for Todd, can you just talk specifically about gross margin trends? The guide for next year, I guess at the low end of the range is down about 100 basis points, but trying to tease out all the different effects in terms of inflation or just reduce expectations for some of the performance products or higher margin products.
Speaker 3: in 2024, just trying to think about, you know, what in a more normal environment may allow those margins to improve a little bit more than just sort of modestly and how should we be thinking about your previous...
Speaker 4: longer-term targets in light of today's update. Thanks. Okay, a lot in there Will. Let me do the first and the third and I'll turn it back to Jeff on that. So first, we think competitive pressure was roughly a hundred million full year. We'd called out 80 previously the vet clinic traffic.
Speaker 4: continues to be reasonably similar, though there was a generic launch of a product that competes against Claro that hit us in Q4 plus some of the trade from retail channel into the vet channel. When we think about gross margin, a lot of this is mixed as we don't expect our pet health business to grow in Q23 in constant currency. That is our high.
Speaker 4: and inflation in 22 we were able to increase gross margin so the team continues to find ways but that mix element is certainly impacting it and then you know you know we did take off the the longer term targets a year ago you know right now we're looking to stabilize on a lot of different areas before we
Speaker 4: Think about, you know, reiterating any of those things. Do we expect margins to improve? Absolutely. The new products will drive it. The new retail innovations will continue, but we're not putting any commitments out there at this time. And I'll turn it over to Jeff for the Gallup grant.
Speaker 3: Yeah, we just did a high level gallopramp, again, had a very strong year and our overall pain segment continues to expand with Oncr, Noceda, Zorbium, as we know, and gallopramp. And that whole segment is, you know, pain is growing and really one of the fastest growing markets in pet overall and we're well positioned with a
Speaker 3: you know, an increasing way. And I would say pain for OA is multimodal. Most vets will recommend multimodal treatments with a focus on inflammation. I think that's important and we expect the treatment guidelines will recommend, you know, typically an inset like a galloprant we're becoming more of a first line treatment than an inset segment.
Speaker 3: in addition to maybe an overall treatment regimen that would include maybe innovation. Again, we believe we are well positioned overall in pain. Gallop rant in a much stronger position than we were in Europe . We believe that again, this segment even with our pipeline pain will become increasingly more and more important to the land goes we go forward. Thanks. We will take the next caller. Our next question comes from from Barclays. Please go ahead, your line is open.
Speaker 11: and another hundred to a hundred and ten million dollars of innovation driven incremental revenue. So that gives me around two minutes.
Speaker 11: Those are positive components, positive contribution and on the other side balancing it seems to be competitive innovation and supply. So is there a case where both competitive innovation and supply can fully offset this 200 million dollar benefit going with the range you're provided? That's one. And secondly, on the opposite side, I was surprised to see.
Speaker 11: effects not impacting the EVITA bridge. Can you help us understand that and also call out the investments this year as that needs to go into supporting new launches? Thank you.
Speaker 9: Todd, do you want to start on just the bridge for 23? Sure. Okay.
Speaker 9: Todd, do you want to start on just the bridge for 23? Sure. I think, you know,
Speaker 4: You've got a very good handle on how you think about the bridge. We have said more than 2% price, yes the innovation revenues, competitive and supply provide an offset but again this is all built into our constant currency guidance for sales being flat to down 3%. Certainly if certain things play out our way as we continue to execute through the year, we'll do better than that and that certainly...
Speaker 4: What our commercial leadership is focused on is they continue to drive demand for products. And again, as Jeff mentioned, China often starts getting better there, demands getting better at retail. So, again, we're confident in the guidance. With respect to the EBITDA, as we mentioned, it's about a 10 to 15 million dollars headwind on top line. It's just a little bit...
Speaker 4: off in the, it's a big headwind in the first half, it becomes a tailwind in the second half, then that out, it's, you know, three to five million, you know, headwind from an EBITDA standpoint at this point. But again, that's always some timing, so we just didn't make a big deal of it in the walk. And thank you. Good, thanks, we'll take the next caller. Our next question comes from Brandon Vasquez from William Blair. Please go ahead, your line is open.
Speaker 10: Thank you very much. Thank you for taking the question. I'll ask to a friend as well. The first is just given a couple of mentions of the Ventory levels. I think it was in the US and Q4. Curious if it's kind of like reduced inventory levels are expected to continue in 23. And if that's already baked into the guidance. And the second is just.
Speaker 10: on the relaunch of Advantage and Advantix, maybe these more value plays. Can you talk about, are those kind of margin accretive at launch? Does that need to scale as well as you were talking about before and can that help through the year? Thanks. Sure, thanks Brandon. So on inventory levels and how we're seeing those, again, there was a step down in Q4 from the farm animal side. We've not assumed a rebuild there, or rather just that they would continue to grow.
Speaker 4: it'll be volatile over the course of the year. We've not assumed an increase of that. So again, assuming it stays at this level and we think it's about at a level they need in order to serve the customers well, then again that would be part of the growth in the back half as we wouldn't have that headwind making for an easier comp. With respect to the relaunch products, again very efficient scale at our teal manufacturer.
Thank you for your time today. Coming off from a challenging environment in 2022, maybe three points to close as this next era of innovation and growth is really in front of us here in Elanco. We do see this challenging environment persisting into the first half of this year that came from 22 into 23, but I really leave it with one. We do have confidence in this 23 guide that was shared, our guidance. We do see our business returning to growth in the second half.
But when we back up and look at the overall macroenvironment or assumptions, it gives us confidence we believe that this guidance is the right guidance. And then second is really the 23 proof points as highlighted just in summary sequential improvements in EU, cell out data, China returning to growth, OTC, early signals, as well as FX.
And then the big drivers that will offset this environment is innovation, two to three percentage points of growth, price more than two and supply being better. And I really end with the third point, which is just really the next era of innovation growth. Over the next two months, we finish up this system stand up, which really takes the complexity out of Elanco and really allows us to lean into this pipeline.
six block busters as we add Bolvair now with a path to the first half of 2024. And that will again open the door for the next air of innovation and growth. So thank you for your time today. We look forward to engaging with you as we go through the quarter. This concludes today's conference call. Thank you for your participation.