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Ladies and gentlemen, thank you for standing by. Welcome to Elanco's Animal Health Second Quarter 2024 Earnings Conference Call. At this time, all lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. [Operator Instructions] I would now like to hand the call over to Katy Grissom, Head of Investor Relations. Katy, you may begin.

Good morning. Thank you for joining us for Elanco Animal Health's second quarter 2024 earnings call. I'm Katy Grissom, Head of Investor Relations and ESG. Joining me on today's call are Jeff Simmons, our President and Chief Executive Officer; Todd Young, our Chief Financial Officer; and Scott Purucker from Investor Relations. The slides referenced during this call are available on the Investor Relations section of elanco.com. Today's discussion will include forward-looking statements. These statements are based on our current assumptions and expectations and are subject to risks and uncertainties that could cause actual results to differ materially from our forecast. For more information, see the risk factors discussed in today's earnings press release as well as in our latest Form 10-K and 10-Q filed with the SEC. We do not undertake any duty to update any forward-looking statement. Our remarks today will focus on our non-GAAP financial measures. Reconciliations of these non-GAAP measures are included in the appendix of today's slides and in the earnings press release. After our prepared remarks, we'll be happy to take your questions. I will now turn the call over to Jeff.

Thanks, Katy. Good morning, everyone. Elanco continued to deliver in the second quarter, exceeding the top end of our guidance range on our key metrics: revenue; adjusted EBITDA; and adjusted EPS. With 4 consecutive quarters of underlying revenue growth behind us, we continue to make significant progress on our 3 strategic outcomes: growing revenue; improving cash flow; and notably delivering innovation. Beginning on Slide 4. Since our last earnings call, we delivered consistent operational results and achieved key milestones in advancing our innovation, portfolio and productivity strategy. Elanco delivered our fourth consecutive quarter of underlying revenue growth, driven by strength in U.S. farm animal, international pet health and added contributions from new products. On innovation, commercial activities are underway for Bovaer after the FDA completed its review in May.

Thank you, Jeff and good morning, everyone. Today, I will focus my comments on our second 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. In the second quarter, we delivered $1.184 billion of revenue, an increase of 12% or 13%, excluding the unfavorable impact of foreign exchange rates. Price contributed 4% in the quarter. The ERP system blackout that occurred in 2023 impacts our year-over-year comparison to the second quarter. Last year, we estimated sales of $90 million to $110 million shifted from the second quarter into the first quarter, reflecting a 9 to 10 percentage point benefit to growth in the second quarter of this year. We estimate the underlying business grew 3% to 4%, slightly ahead of our expectations. The estimated impacts are noted on Slide 13 for each business area. For Pet Health, second quarter constant currency revenue growth was 13% and with an estimated benefit to year-over-year growth of 13 to 14 percentage points from the ERP blackout. In the U.S., Pet Health revenue grew 1% in the second quarter, including a benefit to year-over-year growth of approximately 10 percentage points from the ERP blackout. In the Vet Clinic, the underlying decline was driven by competitive innovation pressure on legacy products. This pressure was partially offset by our recently launched products, specifically CPMA. On the retail side of the business, lower second quarter revenue in 2024 was primarily attributable to changes in purchasing patterns and more conservative inventory management at several large retailers. Over the course of the first half of the year, our top retail customers built significantly less inventory compared to the same time period last year as a result of our ERP cutover and purchasing timing ahead of discount days. However, as we focus on dispensing, we are encouraged by the positive momentum we see in the end market demand. In May and June, dispensing for our OTC products in our top 6 retailers grew approximately 13% and compared to a mid-single-digit decline in the first 4 months of the year. In July, dispensing growth for Elanco continued in those key retailers. As Jeff mentioned, the execution of our strategy is expected to drive continued dispensing growth throughout the back half of the year and we will benefit from retailer purchases expected to be more in line with dispensing compared to the second half of last year. International Pet Health grew 34% in constant currency, including a benefit to year-over-year growth of approximately 21 percentage points from the ERP blackout. Excluding the blackout impact, the underlying business growth was driven primarily by new products, led by AdTab and Credelio Plus and the rebound in the Spain retail business, offset by continued weakness in the China pet market. Moving to Farm Animal. Our global business grew 14% in constant currency, with an estimated benefit to year-over-year growth of 5 percentage points from the ERP blackout. The underlying business growth was driven by strength in U.S. cattle with continued Experior adoption and cattle vaccine resupply. Additionally, in the U.S., timing of poultry rotations provided a tailwind compared to the second quarter of last year. We expect these trends to continue in the third quarter but will face a difficult compare in the fourth quarter, lapping last year's initial resupply of cattle vaccines and positive poultry rotations. Outside of the U.S., growth was driven by continued strength in poultry and increased demand for cattle products in Latin America, partially offset by reduced sales of Kexxtone. Continuing down the income statement on Slide 14. The decline in gross margin was in line with our expectations of slowing the manufacturing plants created an approximate 190 basis point headwind in the quarter. We continue to expect this impact to be neutral in the third quarter and to flip to a positive in the fourth quarter as we lap the impact of our plant slowdowns starting in the back half of last year. Product mix was a headwind to margin in the quarter, partially offset by positive price. Operating expenses increased 2% driven by employee-related expenses and investment in our European pet business, timing of R&D spend partially offset by productivity benefits of being on one operating system. On Slide 15, we have provided walks to illustrate our year-over-year performance in adjusted EBITDA and adjusted EPS. Adjusted EBITDA was $275 million in the quarter. The year-over-year comparison includes a benefit of approximately $70 million to $90 million from the ERP blackout in the second quarter of last year. For the underlying business, the decline of $16 million to $36 million was driven by lower gross margin from slowing manufacturing output to reduce balance sheet inventory as well as negative product mix. Adjusted EPS was $0.30 in the quarter. The year-over-year comparison includes a benefit of approximately $0.11 to $0.14 from the ERP blackout in the second quarter of last year. Both interest expense and our tax rate were lower in 2024 than in 2023. Next, let me operate a few words on our cash, working capital and debt on Slide 16. The Cash provided by operations was $200 million in the quarter or an increase of $139 million compared to the second quarter of last year. This increase reflects lower project expenses and our strategic efforts to reduce balance sheet inventory. Our strategy and focused execution are paying off to deliver improved cash generation. We ended the quarter with net debt of $5.3 billion, a reduction of $163 million in the quarter. Subsequently, in July, we paid down $1.2 billion of debt with proceeds from the sale of our Aqua business. Importantly, a significant portion of our taxes related to the transaction will be paid out in 2025. This allowed us to pay down more debt than initially expected in 2024, resulting in interest expense savings but requires a cash tax increase next year of approximately $150 million related to the transaction. We have updated Slides 28 and 29 in the appendix to reflect our key debt information and factors impacting cash flow and leverage after this additional paydown. At the end of June, our net leverage ratio was 5.6x, down from 6.1x at the end of the first quarter. We expect year-end net leverage in the mid-4x range and in 2025, expect this ratio to move lower to the low 4x to high 3x range. Now let's move to our financial guidance, starting on Slide 17. We Today, we are introducing organic growth, a measure we intend to use over the next 12 months that excludes the impact of the Aqua divestiture across the full P&L. As Jeff said, we are maintaining guidance for the base business while increasing our organic growth expectations to include increased contribution from innovation, including

Thanks, Todd. Momentum continued in Q2, marking the fourth consecutive quarter of mid-single-digit constant currency revenue growth in the underlying business. With a stabilizing base business and increased contributions from innovation, our raised 3% to 4% expected organic constant currency revenue growth in 2024 demonstrates marked improvement over the past several years. We continue to execute on improving our leverage profile with the completion of the Aqua transaction and quick debt paydown. Importantly, our major innovation window is now upon us. With 3 potential blockbuster product launches imminent in each of the next 3 quarters. We have differentiated assets and we intend to invest strategically with no regrets to maximize the potential launch curve and peak sales trajectory. We have been preparing for these launches for some time, including recruiting top industry talent and conducting extensive market research to support our launch efforts. We look forward to hosting a conference call upon

Thanks, Jeff. We'd like to take questions from as many callers as possible. So we ask that you limit yourself to one question and one follow-up. Operator, please provide the instructions for the Q&A session and then we'll take the first caller.

We will now begin the question-and-answer session. [Operator Instructions] Your first question comes from Jon Block from Stifel.

I'll start on

Yes. Thank you, Jon and I appreciate all the work you've done on this and appreciate the questions. We do intend -- I'll just answer one of your questions directly, then I want to add a little bit of broader context because this is the first time we've spoken since the June release. But we do intend to have the head-to-head study that was done against the market incumbent that was part of the European submission package, it is our intention to have that as part of the initial day 1 launch materials. So -- but let me just share, I'd like to share just a couple of messages, just relative to

That was great. I think just as a quick follow-up. Todd, this one might be for you. For 2025, I think the prior, call it, high-level messaging was that these new blockbusters would be, obviously, gross profit dollar-accretive in 2025 but likely gross margin-dilutive due to some investments associated with the new products. Now we believe

Sure, Jon. I appreciate the question and all the work you and your team have been doing over the last few months. Certainly, we're excited to bring Credelio Quattro,

Your next question comes from the line of Michael Ryskin.

Great. I want to pick up right where you left off on

Yes. Thanks, Mike, for the question. Let me start by the first thing that we know will happen is we're going to increase share of voice. We're going to have a lot more marketing and attention. This is going to be one of the most expansive launches ever and being second to the market. The first thing we're going to do is increase the size of the market; there's millions of dogs that are still untreated. And any new innovation -- when you see even the existing growth that's even occurred so far in the first half of this year in derm, we expect the market size to grow. And so that will be the value driver number one, as we see this market growing and we see it not just in the U.S. but globally and I'll say, in parallel, we'll be in Brazil and we'll follow with other launches behind it. From a price perspective, we will do what we always do and that is take a value-based approach. We will look at it holistically and we will look at all aspects of the value and we do believe that we overlay upon approval -- we overlay our positive differentiation against what vets want most and that is better efficacy as well as we believe value and that comes with convenience as well as other aspects. We will -- we have 2 objectives as we think about the launch plan is, one is we will work closely with vets so they understand the label, the science, the data. We want a vet-to-vet understanding. So one way we've shifted is we're going to take a very vet-focused launch effort initially utilizing data and we will do that with a lot of intensity and preparedness. And then that's going to move us to want to have experience. We're going to want this product in more clinics hands quickly, so it can get into pet owners' hands, so we can demonstrate the differentiation of this product. And we will use appropriate programs to ensure and encourage the use of this product quickly upon adoption. But again, those are the things that we've done to adjust it. It will be one of the most expansive launches ever. We will use a multifaceted approach. And we've already started, as you know, with more share of voice, larger sales force, next-generation capabilities. It will be much more of a digital omnichannel approach initially -- and also a forward dimensional offer, we believe, will help having pair therapeutics and vaccines as well. So -- and we'll share more details of this again right after the approval on the call that we'll have.

Okay. And again, Jeff, you actually just took it to the second part -- to my second question on the breadth of the portfolio. You talked about Para-derm therapeutic vaccines. So breadth of portfolio comes up all the time when we talk about in terms of how they make their purchase decision which longer they prioritize. Now you jumped from early '23 to early '24, adding a lot of products to the companion portfolio. You're going to have arguably the first or tied for first broadest portfolio to the vet. How does that change the value proposition for the rest of the business in terms of the uplift of the other products beyond the blockbusters, beyond the new launches? Is that coming up in conversations already? Is that part of your plan, in some of these distributors and large consolidator groups as you approach 2025?

Yes, it's a great question. I think the other thing that I would add that's pretty important is we are now in more clinics than we've ever been. I mean I think between the increased sales force and the parvovirus monoclonal antibody, it's put us and given us more access -- even the diabetes product last year, it's given us more access. So that was our goal was when we're about to launch two differentiated products, blockbuster products in the two largest pet markets in the largest pet market here in the U.S. Derm and Para. And so as we look at this, one is access to clinics is one. And then two, no question. As we look at offerings and even purchasing, there is an interest in which products are carried by which companies and we believe Derm allows us to help our Para portfolio as well as even our vaccine portfolio and some of the purchasing plans that are available today. And we've already started that engagement and there's a lot of interest relative to that and we will use appropriate from corporates to distribution to across the board, we will leverage the portfolio.

Your next question comes from the line of Umer Raffat with Evercore ISI.

It's good to hear all the constructive language on

Yes. Thanks, Umer, very much and I appreciate the questions. We will not and just respecting the FDA process, I can't get into the details of studies and label until approval but I can assure you that we will be sharing that very openly with you as investors as well as the vet community upon approval and looking at it holistically. I will point though and you know this well and we when thinking about safety, I think it's important that if you look at the FDA process, once the product is approved by the FDA, it is deemed safe and effective when used according to the label. And then when you look at the label, it's about providing guidance to the veterinarians to assure appropriate use and administrate the product -- or maybe more simply set a label indicates how to use the product safely and that will be our primary focus out of the gate with this is to educate and inform vet community very extensively on this product. And again, that leads us to our confidence relative to we'll meet these standards and the differentiation will add value significantly in the marketplace. Bridging over to Quattro, just to give you a sense, yes, we believe we answered those questions and we believe that, that will move us through and getting this last technical section complete. And that will move us into administrative approval to keep us on track for a fourth quarter approval and a first quarter launch. I will say that following that and independent of the approval, we're still finalizing, as I said in my comments, the manufacturing scale up to optimize the launch on the manufacturing side and it's common with multiple acts of ingredients, the process validation side, there's complexity but we've done this before. And we've got a very experienced team and that's tracking again for the first quarter approval as well.

Jeff, if I may, I feel like we're putting less of an emphasis on black box than we should be. Am I hearing -- because I know you're very confident in the launch profile and everything else. But ultimately, the incumbent has been on the market for a while and they don't have a black box. So I'm just trying to put that into perspective on what you're hearing and why you're so confident in the black box is not as important.

Yes. Look, box warnings are -- as I said, labels are all about the use and the indication of the product. We're planning to, again, take a an altered approach to our launch strategy which is educating vets and we will make sure that the science and the data and that label is fully understood. And how to use the products accordingly. No question about that. So no, I wouldn't want you to read that at all. I do believe that veterinarians are very opportune and also able to understand labels and understand the science and use the products accordingly and that's common and there's products that have box warnings and are utilized very routinely in the industry and our goal initially is to educate and inform. So, I think that's very important. And then as market research shows, Umer, 70% of vets do want other derm options and they do want better efficacy and value and that's what this product brings. And we won't stand away from the safety of the product. We will educate and inform accordingly. And again, we look forward to sharing more detail, Umer, after the approval of this product with you and others.

Your next question comes from the line of Chris Schott with JPMorgan.

Just 2 for me. Maybe just another one on

Yes, Chris, to take the first one, we will -- and as we've said, we already are in parallel training the sales force, our technical team bringing together key opinion leaders. So it will be a multifaceted approach. It will be probably the most expansive launch we've ever done using these multifaceted approaches. We'll be backing away initially in Phase I of DTC and we'll be increasing the resources. That increase in resources, sales force, the training and the KOLs will bring an accelerated approach to education. And today, we can reach this vet community quite quickly. This will be our top priority. We'll be able to do this before the Quattro launch, so the timing is no question, a Q4 priority will be to educate and to create an experience with the product to as many clinics as we can across the U.S. and that's what we want to do. Educate first, get the experience -- fourth quarter, this will be our key priority.

Chris, thanks for the question on the back half guidance. Very pleased with the Q2 beat that was primarily driven by underlying strength of sales in the business. There was some timing of OpEx between Q2 and Q3. But primarily, as we go into the back half, there is some additional headwinds in manufacturing with some additional losses on some of our vaccine supply that's hitting us. The other element really becomes investing behind these launches. We're going to continue to invest in

Your next question comes from the line of Erin Wright with Morgan Stanley.

On

Thanks, Erin. On the first one, we will take each country as it is. Brazil, what we will say, has not a warning label on the label and we expect that, that will be the case as we go forward in other international markets. And as we've said, we will work post the approval of this product with the FDA to continue to improve the label and do what's necessary to do that. Relative to your question and why I wanted to really emphasize, we believe strongly that all itching dogs are part of the qualified market, chronic or acute. We believe once vets understand this product and the label, we won't get into the specifics of it now until the product has been approved and we'll go through those details. But we believe we can create stickiness with this and this is really driven by the market research we see, that there is a strong interest in having another option. They are non-responders in the market and there's an interest for better efficacy and value and we believe we can provide those, not just with the convenience but overall, our approach to the marketplace. So we believe we can address top needs of veterinarians in the derm market. and we can create, yes, with our omnichannel and our approach to the marketplace, the ability to be able to use this product with the label that we are going to have initially and that's been represented by the market research that we've already done with that label out there with the market research.

Okay. And then my follow-up's on the retail channel, just how tightly are you keeping an eye on inventory levels there? It sounds like you feel comfortable that things normalize here in the second half? And just given your exposure to over-the-counter products, what are you seeing in terms of the consumer in terms of trade down or any sort of consumer softness at retail.

Sure, Erin. Thanks for the question on retail. Yes, as we noted, less inventory was built in the second quarter of this year than last year. That was the primary driver of U.S. Pet Health. Sales being down in the quarter, we feel like the retailers have inventory levels that will require them to continue to buy in line with dispensing and our focus is on dispensing. As noted, it continues to grow July, it grew year-to-date in the first half of the year. And we're also transitioning out of the key element of the season. So the consumer is something we do pay a lot of attention to. We have seen some trade down. It has been on pack sizes. We've seen more two-packs purchased versus four-packs. And so that's something that we do continue to focus on. But over the last couple of years, we've expanded points of distribution with bringing back some lower-priced options that have been doing very well primarily in dollar stores as we've added all the 10,000 points of distribution we talked about. So overall, we feel like we're in a good spot as we move forward. Thanks.

Your next question comes from the line of Brandon Vazquez with William Blair.

Maybe I'll switch. We haven't talked about Farm Animal yet and U.S. Farm Animal was actually really strong. Can you just give us a little bit more detail what was going on there? Were there any one-times in there? I think there was a comment in the press release about resupplying of vaccines. So basically, just trying to get at what's the strength and how durable is at level of U.S. Farm Animal as we go through the rest of the year in '25.

Yes. Thank you, Brandon. Yes, the Farm Animal strategy globally is actually working very well and especially in the U.S., we've got a diverse wide portfolio from medicated feed additives, vaccines, therapeutics, we're adding innovation and that's making every portfolio cattle, both beef, dairy and poultry stronger -- and swine. And we're making -- with our value beyond product and our portfolio, we're making ultimately our customers more money and in low-margin cyclical businesses, this is ultimately where the stickiness comes from with Elanco and why we're leading. We're growing. We're taking share. And Ellen's team is even building continued pipeline, both on life cycle management and new products. So, great execution. We look forward to experiencing more with our effort clearance with Bovaer coming. So 2 nice innovations coming in the second half of the year and we see this as really this next era of livestock sustainability to Todd's point. The interest in Bovaer on the farmer side is extremely high. We've got 500,000 cows on our uplook database headed to $1 million by the end of the year. And so the farmer demand and that extra revenue stream has actually created a lot of interest in the dairy industry and the pharma level and it's other species, poultry and beef are also leaning in as well. So that's a little bit of the fundamentals. I don't know -- Todd, would you like to make a comment relative to the sales question?

Yes, Brian, I think we're really pleased with how the portfolio of innovation adds to the portfolio, be it Experior, be it our Prevacent vaccine for birds and swine, continue to really drive this business. We returned to growth in U.S. Farm in Q3 of last year at 2%, then we put up 28% growth in Q4, 11% growth in Q1 of this year and now 24% growth in Q2. So that team is really leveraging that innovation and growth. We expect that has continued momentum with over coming in to add to the dairy growth and we've seen Experior really pulling Rumensin forward. I'm not going to commit to double-digit growth in U.S. Farm for all the quarters to come. But certainly, given that team and the portfolio it has, we're excited that it will continue to be a nice profitable growth driver for Elanco going forward.

Great. And then maybe I'll take a shot and see if there's any other pipeline updates that you guys are willing to give beyond

Yes. Ellen is -- and the team continues. There's a lot of momentum and excitement in innovation. First, you've got a blockbuster per quarter the next 3 quarters. That's our intention. That's what we're tracking to. And 2 of those markets are going to be new accretive markets. Derm and Pet is going to be accretive sales and livestock sustainability. And then we're going into Para that's been growing in the broad-spectrum parasiticide market, as I mentioned, now 25% of U.S. Para growing 40%. So one is there's a lot of excitement. There's still work to be done. Yes, the IL-31 will follow

Your next question comes from Balaji Prasad from Barclays.

A couple of questions from me. Firstly, on the competitive dynamics side. I think you called out compaction and parasiticides on pain. Could you quantify the market share loss, if any, for each of these segments? And how have the brands been impacted example, is Galliprant just losing market share alone? Or are you seeing a decline in absolute number, that's one. Two, maybe stepping up a bit more on the Farm Animal side, considering the strength that we have seen in it, I'm curious to see how macroenvironment is impacting inflation rates how are they influencing distributor behavior? And how is this different from the retailer behavior that you're seeing.

Yes, great questions. Again, in the Pain market with innovation, with more share of voice, with more diagnostics, the Pain market continues to grow. Galliprant is meeting our expectations but it's been challenged with some of the competition. But when we look at our pipeline and we look at our current portfolio, we like the prospects of the Pain market. And again, Galliprant, we continue to see a very strong part of our portfolio going forward. And then on just protein economics, what I would just say at the highest level, if I look at our 2 biggest segments which is cattle and poultry, they are the strongest. So when you look at cattle, there's fewer cattle numbers on the confined side which has kept protein economic stronger. So even when fee costs have come down, our portfolio continues to add significant economic value because the protein and meat value is up. So that's been beneficial to Rumensin, Experior in the whole portfolio overall. And we've got these tools that can help even measure that. On the poultry side, globally, probably no more sustainable and more demanded protein in a more significant way. And we've got a leading portfolio. We continue to see consistent growth, as Todd mentioned, quarter-to-quarter globally on poultry and we're bringing innovation there from food safety to non-antibiotic replacements to our Onsior package [ph]. And then, swine -- what I'd say is we look at swine as we've got good leadership in North America and China. China, we saw a little bit of a green shoot with prices getting up over breakeven. In China in pork prices for the first time, first quarter in quite some time, still need to see that play out as we look at multinational portfolios being benefited. But as a whole, as I step back, with our portfolio, whether it's fee conversion advantage, protein economics or even food safety and disease, we are well positioned, especially in poultry, dairy and beef going forward to continue to have sustained growth and sustained competitive advantage.

Your next question comes from the line of David Westenberg with Piper Sandler.

We're up at the hour, so I'll just ask 1 here. Can you talk about the IL-31 product in light of the different label than expected with the JAK -- just at least in my research, we do suggest that new patient starts tend to be on Cytopoint rather than Apoquel, at least in the U.S. So does the different label change your strategy versus before when it comes to the IL-31 product marketing, et cetera. And then in terms of differentiation, I know Kindred used to really focus on half-life extension technology. Any other thoughts on what that could be? I realize you probably don't want to get too far ahead on that but I'm going to at least try.

Yes. Thanks, David. As you look at the derm market, really, both product forms and categories are growing nicely and they bring different benefits and we continue to see that. So -- and again, we see