Elanco Animal Health Inc (ELAN) 2021 Q4 法說會逐字稿

Good morning. My name is Joelle, and I will be your conference operator today. At this time, I would like to welcome everyone to the conference call. (Operator Instructions). Katy Grissom, you may begin your conference.

Good morning. Thank you for joining us for Elanco Animal Health's Fourth Quarter and Full Year 2021 Earnings Call. I'm Katy 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; Ellen De Brabander, our Executive Vice President of Innovation and Regulatory Affairs; 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 statements. Our remarks today will focus on 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, Katy. Good morning, everyone. Today, we look forward to sharing our fourth quarter and full year results as well as introducing our financial guidance for the fourth quarter and full year of 2022.

Additionally, as you heard, we're excited to have Ellen with us today. She'll share a brief update on our pipeline and the progress she has made since joining the team last October. While the world continued to adapt to the COVID-19 pandemic and its challenges in 2021, at Elanco, it underscored the significance of what we do. The role of pets as our constant companions has never been more significant and ready access to sustainable, affordable protein remains top of mind. We remain optimistic and confident in the importance of our industry and the valuable role of veterinarians, farmers and pet owners and caring for animals.

Starting on Slide 4. The Elanco story is one of buildings, delivering and strengthening. We are building a global leader in the attractive animal health industry. We are consistently delivering while taking actions to further strengthen our company and our value proposition.

2021 marked our third full year as a public company. Since the IPO, we have made strategic decisions, including the acquisitions of Bayer Animal Health and KindredBio that position Elanco for long-term delivery and value creation. We've instilled a relentless focus toward ongoing corporate simplification, building a fit-for-purpose animal health company as we have completed the full separation from Lilly and continued our integration of Bayer.

With the fourth quarter of 2021, we are reporting our first full year as a combined company with Bayer. Compared to when Elanco went public, today, we are more diverse, more global with more comprehensive product portfolios. We have also improved our revenue mix, balanced between Pet Health and Farm Animal in the U.S. and international.

We're an omnichannel leader providing for pet owners in the veterinary clinic and in retail and in e-commerce. Ultimately, we have built a diverse global business that we expect to deliver durable growth and significant margin expansion.

That level of transformation, particularly amidst a challenging environment, is significant. None of this would be possible without the dedication, commitment and ownership mindset of our global Elanco team. The resiliency they demonstrated, their achievements and disciplined focus on execution must be commended.

The leadership team and I have deep appreciation and are truly grateful for all they have achieved. The fourth quarter represents the fifth quarter of outperformance on our key metrics. In 2021, we recorded $4.765 billion in revenue, growing approximately 7% compared to our 2020 pro forma combined company revenue, with Pet Health growing 10% and Farm Animal up 6%.

We launched new innovative products, advanced our pipeline and our focused brand, Galliprant, became a blockbuster. We improved our adjusted gross margin to 56.6%, making progress towards our target of 60% by 2023.

We delivered $226 million of adjusted EBITDA synergies, all contributing to our $1.057 billion in adjusted EBITDA, representing 22.2% of sales and adjusted EPS of $1.05.

We ended the year with $638 million in cash and equivalents and saw improvement in key operational metrics, including reduced days of sales outstanding. We achieved our net leverage ratio target of 5.5x while funding the KindredBio acquisition.

And finally, we have been proactive and decisive, taken strategic actions to strengthen our business and further solidify our trajectory to deliver expanded value. We have optimized our R&D manufacturing footprint, which is expected to reduce CapEx and improve working capital.

We also have expanded our pipeline with KindredBio and concentrated our R&D resources on our late-stage Pet Health assets, while also balancing for the future. We increased both the value of the pipeline and the probability of success for our key programs.

And in November, we announced changes to streamline and simplify our organization, including shifting our marketing teams to be more integrated with commercial colleagues and closer to the customer to more efficiently drive our business in 2022 and beyond.

As you can see, the Elanco team delivered this past year. We are confident that we have the right team and the right structure to drive our business forward in 2022, as we continue to advance our IPP strategy and make progress on our longer-term commitments despite the expected challenges from inflation, supply chain, COVID-19 and competition.

Let's now move to Slide 5, where I'll provide the highlights of our 2021 financial results. For each of our key metrics, revenue, adjusted EBITDA and adjusted EPS, we outperformed our initial expectations set forth at our December 2020 Investor Day.

Our results demonstrate progress toward our long-term margin expansion targets with profitability and earnings delivery enabled by the continued implementation of productivity efforts and synergy realization in the year. On the top line, last year is representative of Elanco's durable, diverse growth profile.

As I shared, we grew 7% compared to our 2020 pro forma combined company revenue. Our growth came from multiple areas across species, across geographies and from innovation. In 2021, we grew in 4 out of 5 species with Pet Health growing 10% and Farm Animal growing 6%, led by Poultry and Cattle compared to our 2020 pro forma combined company revenues.

We grew in all 3 commercial regions, with our international business also delivering 7% on a pro forma basis. Contributing to that, China represented over 1 percentage point of growth for the total company. Our well-positioned Farm Animal business also grew and grew market share nicely in 2021. And globally, we launched new innovative products to kick off the next era of innovation for Elanco.

Our broad, diverse portfolio provides Elanco with a wide range of pathways to deliver growth as evidenced in 2021. In our December 2020 Investor Day, we introduced a growth formula to describe our revenue expectations and our long-term growth algorithm.

Over time, we expect average annual top line growth of 3% to 4%, with varying contributions from our categories of focus, core, defend and innovation brands.

On Slide 6, I'll go deeper on our 2021 revenue performance through this lens. First, in our defend category. The Advantage family delivered $517 million in sales, growing approximately 2% on a pro forma basis, driven by the growth of Advocate in China.

Rumensin grew last year as well, bouncing back from the COVID-related impacts in the U.S. beef production industry in 2020 and is continuing to exceed our expectations for maintaining market share despite generic competition for nearly 2.5 years.

Our ability to differentiate Rumensin's attributes, our value beyond product offerings and portfolio selling approach is resonating with customers. And rounding out our defend category, Trifexis continues to experience competitive pressures in the U.S. market, but it remains a profitable blockbuster product, delivering sales of $137 million in 2021.

Our core category, which represents dozens of key portfolio products, delivered approximately 1 percentage point of growth, that was offset by decreased contract manufacturing revenue as well. Growth was led by our Pet Health vaccines in the U.S., where we have strong momentum and are excited to drive innovation and our differentiated portfolio of highly purified low-injection volume vaccines.

On our focus brands, they delivered approximately 3 percentage points of growth, led by Credelio, Interceptor Plus, Claro and our newest blockbuster Galliprant. Seresto delivered $394 million in 2021, a year-over-year decline after an exceptionally strong 2021. Importantly, the 2-year stack growth of Seresto was approximately 21% in 2021 compared with 2019, and for the fourth quarter, it was 19% over 2019.

This year, we have a robust activation plan for Seresto, leveraging a breadth of pet owner engagement touch points, including direct-to-consumer advertising, while improving our digital shelf space and expanding into additional retail channels as well as growing our vet clinic penetration by adding Seresto to our distributor buy/sell agreements in the U.S. We expect Seresto to return to growth in 2022.

Finally, on innovation. Our revenue from innovation-related products launched in 2021 was $72 million. We saw strong uptake from our Pet Health launches, led by Credelio Plus, while Increxxa was a valuable addition to our cattle portfolio.

Also in Q4, both ZoaShield and Experior laid solid foundations for 2022. Over the last year, with the introduction of ZoaShield and Clinacox, we've vastly expanded our presence in the poultry raised without antibiotics or RWA market.

As a result of this and process optimization challenges limiting improvement for cost of sales, we have decided to discontinue the sales of Cosabody.

Now moving to Slide 7. I'd like to introduce our expectations for 2022. In line with our statements in early January, we expect to grow revenue 2% to 3% at constant currency. We expect innovation-related revenue to contribute approximately $120 million to 160 million in revenue this year representing an incremental $48 million to $88 million over 2021, contributing 1 to 2 percentage points of growth for the total company.

We expect adjusted EBITDA to be $1.14 billion to $1.18 billion, representing growth of 10% at the midpoint or an expected 210 basis point improvement for adjusted EBITDA margin. For adjusted EPS, we expect $1.18 to $1.24 or 15% growth at the midpoint.

And finally, we expect to continue reducing our net leverage ratio to approximately 4.75x adjusted EBITDA by year-end. On Slide 8, let's take a deeper look at some of the specific 2022 revenue drivers.

We expect price growth above our historical 2% level with disciplined analysis and execution critically important as the inflationary environment extends into our industry. Overall, we expect continued growth in the global Pet Health market benefiting from COVID era increase in pet ownership.

And while growth from these trends is slowing, we expect it to persist as a result of the increased expectation of care and awareness of our pets. Our broad global pet health portfolio is expected to deliver growth from key focus brands from vaccines and the addition of newly launched products. In parasiticides, we have a diverse portfolio globally. The combination of Credelio and Interceptor Plus remains the broadest coverage available for the treatment and prevention of internal and external parasites for U.S. pet owners and Credelio Plus provides important endecto coverage for pet owners in several international markets.

We expect the competitive pressure in parasiticides to be mainly contained to the U.S. parasiticides market with an approximate $60 million headwind, while we expect to maintain our leadership in retail channels. More broadly, Galliprant remains one of our key focus brands and is expected to grow double digits again in 2022.

Also, as we announced earlier this week, we're excited to welcome Bobby Modi as our Executive Vice President of U.S. Pet Health on March 14. Bobby's leadership experience, track record of building and growing consumer brands, including pet brands, positions him well to lead and grow this business. Additionally, has experience in integrating and transforming businesses, leading sales teams and expertise across innovation, digital and e-commerce makes him a great addition to the Elanco executive team.

On the Farm Animal side, we expect continued stabilization of global poultry and aqua markets. We also expect an outsized contribution from our newly launched U.S. farm animal products led by Experior and ZoaShield, which we believe will be key drivers of our innovation sales in 2022.

Importantly, Experior continued to gain traction in the field with continuously increasing packer acceptance and processing of Experior-fed cattle. We've seen a growing demand from cattle producers with 100% return use and continued expansion of routine feeding, with the number of cattle on Experior doubling every month since November.

Given Experior's compelling proposition, growing producer demand and assumed continued packer acceptance, we expect a substantial step-up in Experior use moving into the second quarter as we expect it to provide the most significant incremental contribution to our innovation-related sales this year.

We continue to believe it will be our next farm animal blockbuster. Experior is building another new sizable growth market in Animal Health around sustainability. We have taken critical actions over the last few months to drive producer value that will catalyze Elanco's growth in this new space starting in 2022.

On that note, earlier this month, we announced we're piloting a new tool called UpLook that helps cattle feeders benchmark greenhouse gas emissions and identify key drivers of their operations carbon footprint, providing an important baseline for their current stewardship efforts.

Additionally, we announced our investment in a start-up company called (inaudible) that focuses on creating and really aggregating, creating and monetizing producers' sustainability efforts.

Finally, we continue to leverage the expertise of Dr. Sara Place with customers. She is the leader of our livestock sustainability efforts and one of the most respected thought leaders in this space. Elanco is building a differentiated portfolio with products, tools and expertise that we expect will create the next new major market opportunity in the farm animal health market called livestock sustainability.

And finally, we expect our business in China will again deliver at least 1 percentage point of growth for total Elanco with contributions across Pet Health and Farm Animal, despite headwinds in the swine business expected in at least the first half of the year.

Overall, for 2022, we are confident we have a balanced plan that is expected to deliver 2 to 3 percentage points of growth in constant currency. Before we turn to Todd to go deeper on our fourth quarter results and 2022 guidance, I'd like to welcome Dr. Ellen De Brabander, Ellen is a highly accomplished R&D leader with a proven track record in animal health product development.

I have known and admired leadership over the years as she's delivered significant innovation and created robust sustainable R&D capabilities. And just under 5 months, she has quickly hit the ground running, and I'm very impressed with our immediate progress. We're excited today to introduce her to the investment community. Ellen?

Thank you, Jeff. On Slide 9, I will cover our 2022 innovation expectations and share with you why I believe this organization is well positioned to deliver on our existing pipeline and we fill our pipeline with early-stage assets to ensure innovation remains a key growth driver for Elanco over time.

And while our 2021 launches were more rated toward farm animal, the expected approvals in 2022 will be skewed more towards our Pet Health business in spaces such as pain, parasiticides, parvovirus and vaccines.

In January, we received FDA approval for ZORBIUM, a long-acting postoperative transdermal pain product for cats that is expected to launch midyear. Later this year, we expect approvals for an extended duration topical ectoparasiticides for both dogs and cats, called Advantage XD, and we are excited to bring this legacy Elanco innovation to market under the legacy Bayer Advantage brand and to provide a new and innovative option for pet owners.

These OTC products fall into one of the parasiticide target innovation areas described during the 2022 Investor Day. Credelio Plus, the broad spectrum parasiticide we launched last year outside the U.S. and Advantage XD this year, we remain committed to our intention to deliver one parasiticide innovation on average per year through 2025.

Overall, aligned with the outlook provided at the 2020 Investor Day, we expect to receive approval for and launch at least 7 new products in major markets in 2022. And additionally, I'm further driving project in life cycle management and geographic expansion to support the global durable growth of our current portfolio, as Jeff referenced already earlier.

Looking deeper into the development pipeline, we expect 2022 to also be a productive year for regulatory submissions and progress of our late-stage assets. Overall, we expect to make 5 to 7 submissions to regulatory authorities in major markets across Pet Health and Farm Animal.

And of these, we expect to make submissions for up to 2 differentiated Pet Health potential blockbusters in the U.S. in dermatology and parasiticides. And for competitive reasons, we are not going to share further details on these specific assets. However, we are pleased with the progress we are making with these projects.

The last 5 months have been a pleasure getting to know the team, digging in on the pipeline and building on the strong foundation within the organization. The R&D and regulatory leadership team has remained the same, providing consistency and stability.

Our global organization grew substantially with the addition of both the Bayer and KindredBio businesses. And in 2021, we have successfully consolidated into one Elanco R&D. We are leveraging the diversity of expertise from all legacy companies and building upon the pillars of scientific and technical expertise and integrated project management.

We believe our new organizational structure and consolidated footprint allow us to work in more streamlined ways and be more resource-efficient, all while focusing on delivering and refilling the innovation pipeline. We completed a robust prioritization exercise, resulting in a focused pipeline that is well aligned with Elanco's long-term strategic priorities.

We have concentrated resources on our late-stage Pet Health products, shifting our investment in Pet Health development from 57% to 73% of total cost spend expected in 2022, while also appropriately allocating across research and development phases.

Over the last year, Elanco R&D has increased both the value of the innovation portfolio as well as its capability to progress the projects towards regulatory approval in a resource efficient way. And while we are focused on the key projects in the development phase, we are not losing sight of refilling our pipeline by pursuing early-stage innovation projects, both in Pet Health and Farm Animal.

Overall, I am confident my experience and highly capable team is well positioned to progress the pipeline and deliver the expected $600 million to $700 million of innovation-related revenue by 2025. And now let me hand it to Todd to speak more about our financial results and guidance.

Thanks, Ellen. Slide 11 summarizes our financial performance highlights for the fourth quarter of 2021 including our reported net income and earnings per share. This is our first apples-to-apples comparison for a full quarter since closing the Bayer acquisition in the middle of the third quarter of 2020.

on Slides 31 to 33 in the appendix, you can find a summary of the adjustments made to the reported results to arrive at our adjusted presentation. I'll focus my comments on our fourth quarter adjusted measures in order to provide insights on the underlying trends in our business, so please refer to today's earnings press release for a detailed description of the year-over-year changes in our reported results.

Looking at the adjusted measures on Slide 12. Revenue in the fourth quarter was $1.113 billion, a year-over-year decline of 2%. When we guided for the fourth quarter last November, we shared that revenue growth would be unfavorably impacted by approximately $60 million of unique items related to customer purchasing patterns and short-term competitors' stock-outs in 2020 and exited products and reduced contract manufacturing impacting our 2021 results.

On Slide 13, we have depicted our sales growth excluding these items and the FX impacts, representing growth of approximately 4% in the quarter, driven by innovation and portfolio growth in pet health, poultry and aqua partially offset by pressure in our China-Swine business. A breakdown of the region, species and price rate volume results for the quarter can be found on Slides 25 and 26.

As we look beyond revenue in our fourth quarter results, our productivity efforts drove improvement. We increased our adjusted gross margin to 54%, an increase of 130 basis points compared to the fourth quarter of last year. This gross margin improvement came from our continued productivity efforts improved price and mix, partially offset by inflation.

In the quarter, we began to experience constrained supply of some raw materials and other important manufacturing inputs. We are working with our suppliers and contract manufacturers to minimize the impact of constrained inputs for 2022, but do expect some continued disruption.

Moving down the income statement. Our operating expenses decreased $66 million or 14% in the fourth quarter. The realization of synergies and continued cost discipline allowed us to more than offset inflation, while investing in our key strategic priorities.

Our improved gross margin and lower operating expense drove adjusted EBITDA to $212 million in the quarter, growing 20%. Adjusted EBITDA margin for the quarter was 19%, up 360 basis points versus last year.

At the bottom line, Q4 adjusted net income increased 84% to $105 million and included an effective tax rate of 14.6% for the quarter. The lower-than-expected Q4 tax rate was driven by certain favorable return to provision results.

Earnings per share was $0.21, a 75% increase year-over-year in the quarter. Beginning on Slide 14, I'll provide a few highlights on our full year performance. We delivered revenue of $4.765 billion and adjusted EBITDA of $1.057 billion or 22.2% of sales.

Continued productivity improvements, a disciplined approach to managing operating expenses and delivering on synergies, all contributed to our performance. Adjusted earnings per share for the year was $1.05.

On Slide 15, we break down the revenue performance, updating the bridge we have shared with you over the last year. While reported growth was 46%, pro forma growth was approximately 7%. Underlying growth from innovation and the portfolio delivered approximately 4 percentage points of growth in constant currency. Overall, our revenue remained fairly balanced between the U.S. and international and between Pet Health and Farm Animal.

China remained our #2 affiliate, outgrowing the local market in Pet Health and gaining overall share in Farm Animal despite pressured producer profitability in the local swine market.

A breakdown of the region, species and country-specific results for the full year can be found on Slides 28 and 29. We expect to file our 10-K by the end of the month, but moving to Slide 16, let me offer a few words on cash, debt and working capital.

In Q4, we delivered operating cash flow of $223 million. We ended the fourth quarter with $638 million in cash and equivalents on our balance sheet and net debt of $5.763 billion. At year-end, our net leverage ratio was just below 5.5x, in line with our previous expectations.

Finally, days sales outstanding decreased to 73 days at the end of the fourth quarter compared to 81 days at the end of the third quarter, reflecting improved execution on collections globally. Additionally, as we've regularly updated you, our aggregate channel inventory levels at distribution remained consistent with prior quarters in the U.S. and across our global business.

Moving to Slide 17. I'd like to provide an update on our value capture efforts. As Jeff mentioned, in 2021, we realized adjusted EBITDA synergies of $226 million, driven by headcount reductions, procurement savings, targeted R&D project rationalization and site optimization.

This exceeds our original expectation by about $60 million in 2021 as a result of our additional restructuring efforts and acceleration of planned 2022 savings. We've captured synergies on our bottom line results and also reinvested in our U.S. Pet Health and China businesses to drive growth while also funding our stand-alone IT infrastructure and higher-than-expected legal costs.

We expect progress to continue this year and to deliver approximately $345 million in adjusted EBITDA synergies by 2023, as we shared earlier this year. Today, we are also sharing certain synergy expectations for 2024.

By the third quarter of 2023, we expect to have fully integrated the legacy Bayer business into our own ERP system and business processes and thus expect to generate an additional $50 million to $60 million of adjusted EBITDA synergies in 2024 and beyond.

In 2022, we expect the onetime cost to achieve synergies to be approximately $260 million. This includes an incremental $100 million to $120 million this year as compared to our Investor Day expectations to enable delivery of the incremental synergies from the November 2021 restructuring actions and the system integrations.

Now let's move to our 2022 financial guidance, starting on Slide 19. We expect revenue to be between $4.745 billion and $4.8 billion, with reported growth at the midpoint and constant currency growth of 2% to 3%. For adjusted EBITDA, we expect $1.14 billion to $1.18 billion or 24% to 24.6% of revenue.

Finally, we anticipate adjusted EPS of $1.18 to $1.24 or growth of approximately 15% at the midpoint. As we did last year, Slide 37 in the appendix provides a number of additional assumptions to help support your modeling efforts.

Now let's discuss some of the underlying factors behind our 2022 expectations. On Slide 20, we provide a revenue bridge from our 2021 results to our 2022 guidance. First, we expect the impact from foreign exchange rates to be a headwind of approximately $95 million or a 2 percentage point drag on growth year-over-year based on spot rates as of early February.

Additionally, we expect another year of step-down in contract manufacturing revenue from the sale of our facility in Shawnee, Kansas. While this represents an approximately $40 million headwind to the top line, these sales will lower margin, and that should be accretive to overall gross margin.

Next, we expect our innovation and broader portfolio to deliver underlying growth of 3% to 4% this year in constant currency, building off the $72 million delivered in 2021, the innovation sales Jeff and Ellen described, should contribute an incremental $48 million to $88 million in 2022, and the rest of the portfolio is expected to contribute about 2 percentage points of growth.

Our portfolio outlook includes price improvement and volume growth in many key areas, partially offset by expected declines in defend and core brands. On Slide 21, we provided a bridge depicting our expected adjusted EBITDA improvement in 2022 of 10% at the midpoint. Revenue flow-through to gross profit enabled by productivity and partially offset by inflation, will be the largest drivers of improvement.

Additionally, we expect contribution from decreased operating expense as a result of synergy realization and cost discipline that will offset inflation and allow us to continue making strategic investments. Our 2022 expectations are in line with our long-term algorithm, and we remain committed to our expected 31% adjusted EBITDA margin by 2024.

Finally, we are introducing guidance for the first quarter of 2022 on Slide 22. We expect revenue of $1.2 billion to $1.23 billion, adjusted EBITDA of $310 million to $340 million and adjusted EPS of $0.33 to $0.38. Given the timing of our stepdown in contract manufacturing in the second half of 2021, expected continued headwinds on our China-Swine business, we have a more difficult compare on the top line in the first quarter of 2022.

Additionally, I will also take the opportunity to remind you that last year, we shifted approximately $30 million of operating expense from Q1 to later quarters in the year. We don't expect that shift in 2022, which will create a headwind in the quarter and make it difficult for our synergy capture efforts to shine through. Despite these factors, the business entered the year with momentum, and we are confident in the guidance we've shared today.

Now I'll hand it back to Jeff for closing comments.

Thanks, Todd. To summarize, Elanco delivered a strong 2021. Financially, we exceeded the expectations in our long-term growth algorithm with 5 quarters of delivery since closing the Bayer acquisition.

We simplified our global sales and marketing operations and optimized our manufacturing and R&D site footprints. We went live on our own independent technology infrastructure and shared service center network. We also progressed our internal pipeline and added additional pet blockbuster candidates with the acquisition of KindredBio. And finally, we issued our first ESG summary in June of last year and earlier this year, we shared that we expect to introduce (inaudible) performance metric into our short-term compensation to drive capital optimization and further align employee and shareholder interest.

It's working. Our IPP strategy is delivering. The results of our productivity are showing through. Elanco is a stronger company. These actions, along with the addition Ellen of and Bobby to our experienced leadership team, have set Elanco up for another strong year in 2022, as we continue to build, strengthen and deliver on our value proposition in this durable animal health industry, and we look forward to engaging with you all throughout the year.

With that, I'll turn it over to Katy to moderate the Q&A.

Thanks, Jeff. We'll have Jeff, Todd and Ellen available for the Q&A today. (Operator Instructions) Operator, please provide the instructions for the Q&A session, and then we'll take the first caller.

(Operator Instructions) Your first question comes from the line of Erin Wright from Morgan Stanley.

You spoke to double-digit EBITDA growth in early January, but the lower half of the range today doesn't quite hit that mark. I get the midpoint but what are some of the swing factors that get you to the high versus low end of that range and some conservatism there or has anything changed relative to your expectations in early January?

And on the 2 blockbuster submissions and Pet Health and parasiticides in derm, can you speak to the geographies of focus for those products? And will the parasiticide product be a flee and tick, and hardware and triple combination product in the U.S.? And will these be before the all-important flee and tick season in 2023?

All right. Todd, if you want to take the first question on EBITDA and then we'll go to Ellen.

Thanks, Erin, for your question. Yes, our reference at earlier in the year was to our expected midpoint. So no change on our EBITDA expectations. Right now, we do have some FX headwinds. We'd be 12% at the midpoint in constant currency as provided in the bridge.

We've got about $20 million to $25 million of FX headwinds to that FX -- or to the EBITDA numbers. From the respect to what could drive us higher or lower? Clearly, there's a lot of moving pieces globally, right now, as we all know, it's very dynamic. We feel confident in this plan and our ability to deliver it over time. With that, I'll hand it to Ellen to address your R&D question.

Thanks, Todd. And thanks for the question on the pipeline assets. Indeed, we are quite excited, not only with the pipeline, but also with the progress we are making with the key projects in the pipeline. And we plan indeed to do the submissions of up to 2 new potential innovations with differentiated blockbuster potential later this year in the pet parasiticide field and in the derm field.

For now, we can actually not give more specifics on the individual assets. But the only thing I can share is that indeed, we are excited with the progress we are seeing so far of these differentiated potential blockbusters.

And Ellen, I'll pick up. I mean our -- no question, our focus will be on the U.S. market followed by the other major pet markets: West Europe and Japan, Australia, but U.S. is our primary focus.

Your next question comes from the line of Michael Ryskin with Bank of America.

Congrats on the quarter and guide. I want to start on the innovation side of things. I think you called out that the innovation portfolio contributed $41 million in the fourth quarter and that's the products you launched in 2021, and yet you're guiding to $120 million to $160 million in '22. So maybe there's some strong seasonality there, but just given how we see new products launched, if you had 41 in the last quarter, shouldn't that be sort of a steady run rate going forward?

And then particularly given there's incremental launches on top of that this coming year. So why isn't that -- why wouldn't that number come in a little bit higher? And then for the follow-up, maybe one for Todd. On the gross margin guide, your comments on 57, 58 this year, I know you're still reiterating 60% net the following year.

So 200 to 300 bps gross margin expansion next year, could you just talk through the moving pieces, what makes this year a little bit less in terms of margin expansion in next year that much more?

Great. Thanks, Michael. We'll let Todd address those.

Sure, Mike. No, I appreciate the question. There is some seasonality with respect to the poultry season and how that plays in Q4. The incremental growth in next year at the $48 million to $88 million, a lot of that will be on the uptake of Experior. We're really excited about the foundation that's laid and the continued growth of our cattle portfolio as we become more and more important to our customers and our products beyond just the novel solutions we provide, including the new Uplink -- UpLook calculator are all very big.

So that's a big part of the innovation that clearly excited for Credelio Plus outside the U.S. where we have all the broad triple combination product there in Australia, Japan and the EU. With respect to the margin, again, we've all called out the inflation. That's certainly something that has impacted us more than what was expected when we gave out our initial guidance at our 2020 Investor Day.

We've been able to overcome that with better-than-planned performance in 2021, and we're still tracking to continued uptake in 2022 despite those inflationary pressures as we focus on taking incremental price versus historical expectations as well as continuing to drive synergy and value capture initiatives. So overall, we feel good on how we're tracking as well as the procurement and manufacturing quality savings the team is driving.

Your next question comes from the line of Nathan Rich with Goldman Sachs.

Maybe following on Mike's questions on margins, looking at just the long-term EBITDA margin target of 31% by '24, the guidance for this year is for a margin rate in the low 24% range. The synergy walk that you provided was helpful.

I think, kind of $100 million incremental in '23 and '24, I think that adds about 200 basis points to margin. So it seems like there's still kind of meaningful underlying improvement implied in that 31% guidance. So could you maybe just help us think about what drives that?

And then my follow-up, Jeff, is on Galliprant. I think you had said you expect it to grow double digits in '22. You also alluded to the competitive launch in OA in the EU as a headwind. I guess maybe what have you seen so far around that? And are you still expecting Galliprant to grow in the EU this year despite that competitive entry?

Great. Thanks, Nate. Todd, do you want to take the first question on margin, and then we'll go to Jeff.

Sure. Yes. The EBITDA range in the sales range at 24 to 24.6 would be continuing to step up from what we've done here in 2021. There are some inflation headwinds that we would expect to come out by the time we get to 2024, that would provide incremental.

We've also run higher legal fees than historical, but also can come out. And then just the natural continued growth in sales, while we hold our cost of manufacturing is flat will drive that incremental gross margin that will also then flow through to the EBITDA margin. So we feel great about the year we had in 2021 ahead of that early expectations and still feel like we're very much tracking to the 31% commitment we have for 2024.

And Nate, relative to Galliprant, it did become our latest blockbuster in 2021, meeting our expectations. We do expect, as you said, it will grow double digit in 2022. A couple of things that I would note is we do see pain, one of the largest pet health markets, probably behind parasiticides and derm to be one of the faster-growing markets.

Elanco comes into that with the largest portfolio overall. And we see Galliprant being very competitive with value from home treatment to the safety profile and the unique offering. I think what happens as you look at the EU market, I think the interesting data is the EU market expanded over 30% in the fourth quarter. So new innovation is going to expand the pain market, we continue to focus on differentiation, first-line treatment and also portfolio selling overall to the veterinarians, not just in Europe but across the globe. So again, expect double digit coming into this year and expect some nice growth, including our new product, ZORBIUM, is, we bring that into the pain portfolio as well.

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

Just for me, just can you elaborate a little bit more on the defend brands. It seems like that's outperformed in 2021, and I'm just trying to get a sense of what enabled that outperformance? And how sustainable could that be as we look out to 2022?

And then on the 2 blockbusters, I know you're not going to go into full details, but can you comment if these are, I guess, clinically derisked at this point and you're moving forward to the filing or is there still key clinical or registrational data that we're waiting on? I'm just trying to get a sense of you might get in the profile, but are these largely products that will be at some point in filing and moving forward?

Great. Let's start with Jeff on the Defend brand, and then we'll go to Ellen.

Chris, great question. As we said during our Investor Day with this growth algorithm, we're concentrating different strategies against these different categories. And with Defend, we put a concentrated focus on 3 brands.

And there are some commonalities there. But one is, we are looking at them, we are defending them in the appropriate markets where we believe it's the right thing to do to Defend. So I'll start with Advantage, the Advantage family. A concentrate -- a real focused effort on that whole brand family that is still, we believe, a very valuable brand of pet owners.

It was led with an increased investment, reps and promotion in China with the Advocate product. And that was one of the fastest-growing products in the overall China market overall, all competitors involved. So I think we'll continue to expand and use that.

As Ellen mentioned, we're going to continue to leverage that Advantage brand as we bring a new product to market, actually in Elanco compound with now a Bayer brand Advantage and leveraging that with Advantage XD. Rumensin is very simple. It is differentiated. It is selling value beyond product and really leveraging our total portfolio, and we saw Rumensin grow against a COVID compare, but we continue to see that, that product is going to be a very strong product for us, especially as corn prices increase and the importance of performance products.

And then Trifexis, again, we're containing it. We're leveraging into the market segments we know. We said it's a little over $130 million in size. We do see that erosion will come to that brand as well as comfort us from the competition that we've noted a $60 million total erosion. But again, overall, defend brand strategy is working.

And Ellen on the blockbusters?

Yes, thanks. Yes, we plan -- we expect to make submissions for up to 2 differentiated potential Pet Health blockbusters later this year. And right now, I can tell you, these are complex projects. A lot of work is happening in parallel. Both the studies are still in flight or I mean some of them are in the final stages, and we are preparing the doses. So they are not fully derisked, but we said, we are expecting the submissions later this year for up to 2 of these potential differentiated Pet Health blockbusters.

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

Two here, if I may. First, I know you're guiding to $80 million to $120 million EBITDA growth into 2022. But of that $80 million to $120 million, it looks like about $60 million is coming from the restructuring announcement in November 2021, where I think you guys eliminated 20% of the leadership team.

So I guess the question is this, as we think about the growth, the margin growth beyond 2022, what substantial additional actions have to happen to deliver such growth -- margin growth in '23 and beyond? Or would a more tempered inflation plus your existing efforts be sufficient to drive that EBITDA growth in 2023 and beyond?

And then secondly, and this ties into the EBITDA growth as well. Should we be expecting revenue acceleration perhaps 5% plus into 2023 as you potentially launch your JAK inhibitor plus a second key blockbuster? Or would that not really impact the numbers in 2024?

Todd, do you want to get a start on the EBITDA?

Sure. Thanks for the question, Umer. Yes, we have a lot of benefits flowing from the restructuring. Those are helping to offset inflation while we continue to drive our sales growth and productivity across the entire gross margin platform. So that is in play from the standpoint of improving EBITDA, most of the actions have been taken as we annualize a lot of our benefits.

The one thing to note, as we called out, we are integrating the Bayer ERP system that's currently run with our partner, Tata Business Consulting, into ours. That will provide incremental synergies that drive that forward. And then we do expect some mitigation from the inflationary side to also drive that.

But a lot of this is really the underlying efforts we have. We're not expecting another significant restructuring, though there will be some impacts once we finalize that integration of the systems and business processes in the middle of 2023.

So overall, we feel good about how the business is looking. And certainly, growth of innovation products like Experior that have a very above-average, corporate average margin profile will also help drive that increasing EBITDA profitability.

And Umer, I'll just pick up on that. I mean no question, in addition to all of that, continued growth of innovation brands and focused brands will be -- and price will continue to be contributors to that margin expansion.

What I would just say is we outlined in December 2022 this growth algorithm, Umer, relative to the different categories of products, and it is working. We saw, in our pro forma basis, 7% constant currency 5. And what we're seeing here is we're off to a good start in year one. We believe that no question, innovation will be a key driver. We're more than doubling innovation this year.

The focus brands have strength. Last year's innovation will be the biggest contributors. All of these things are the aspects we believe. We think price and our digital enablement will help. China and geo expansion will also be a big driver.

So not going to give future forecast, but we do believe strongly in the growth algorithm and the durable, diverse sustainable growth that we're getting from our business that was represented in '21, all of that leads to staying to our commitments that we highlighted in December last year.

Good. We'll get ready to take the next caller. I'll just mention, we'll probably go a couple of minutes over. I know we still have several in the queue. So we spoke a bit long, and we started a few minutes late. So we can go ahead to the next call, Joelle.

Your next question comes from the line of Jon Block with Stifel.

Maybe just a couple. For price, I believe it was 2% in 2021, but I don't think that's a pro forma number. So Todd, is there a pro forma number to think about for price? And more importantly, how do we think about price in '22?

I know you guys said higher. Is it 3%, is it 6%, maybe just some way to think about it for the year? And then, Jeff, the plans for reacceleration in Seresto sales in '22 that you called out, what's the primary driver for that? Is it opening it up to the vets? I think you also mentioned some advertising or new markets. And just maybe a clarity question. If the product is going to the distributors to sell into the vet practices, is there any sort of inventory build that has or will take place that we should be aware of?

Thanks for the question, Jon. The 2% for the full year, that's pretty solid. The difficulties on a pro forma basis gets harder, as you know, as we included the most of Bayer in volume for most of the year. But generally speaking, the 2 is in line. With respect to other price increases, we have increased price in both the vet channel as well as at retail and then also on our Farm Animal products already with list price increases at the start of the year.

Those will be intended to be higher than that historical 2% number we've had, but we're not getting into specifics as it varies by product line. Clearly, there's some OTC products where we've got a little bit more pricing power. And then in the Farm Animal side, it can be pretty competitive. And at that point, our value beyond product really helps drive our overall portfolio as we continue to take market share in U.S. farm.

And Jeff, on Seresto?

Yes. On Seresto, just again, it met our expectations, Jon, as I highlighted in 2021 with a challenging compare in 2020, and we have activated a lot of efforts, probably some of the -- maybe highest activity against Seresto in a long time for the brand going into 2022.

And again, I'll just hit, it's ultimately about putting the product in more geography and more channels with more access to the pet owners. We continue to see tremendously high loyalty and return use to this product, and we will continue to support that with DTC, increased digital shelf space, and then, yes, more consumer channels and more geography.

Relative to the U.S. move, yes, there will be a very small incremental increase. I think vet clinics will take on maybe less retail product, OTC product inventories compared to scripted products. But our goal here is veterinarians as pet owners come in with that loyalty to Seresto in the segments that it serves for the first time, putting this into our distributors' hands and putting it into clinics is just another channel to allow more access in a buy-sell arrangement versus a different arrangement. So we believe that's also going to be a key driver to Seresto's expanded use and again, growth in 2022.

Your next question comes from the line of Elliot Wilbur.

Question for Jeff and/or Todd. I guess just with respect to your overall top line outlook for the year, anything you can say specifically in terms of anticipated relative performance of the various segments and individual species within the Farm Animal segment in terms of anticipated year-on-year growth?

How are those individual segments expected to perform versus your overall top line outlook of 2% to 3%? And where -- we see the strongest growth kind of within the Farm Animal segment? And then a follow-up question for Todd, relatively strong cash flow conversion for the full year. I think the number is 94%, 95% in terms of adjusted net income, cash flow conversion. Is that sort of the new norm for the company outside of just maybe some seasonal swings in working capital around year-end?

Yes, Eli, real quick. I would say overall, our growth as we look at it at a high level, innovation brands, as we mentioned, will be a key driver, price. Our focus brands, especially as we think about Credelio, Interceptor Plus, Galliprant and then China, those will be some of the major material drivers offset by the CMO, some FX and the parasiticide concentrated competitiveness in the U.S.

As you look at the species overall, again, Pet Health, we see strong, even though the numbers are flattening, a persistence there is positive, we think wellness and visits being up, spend being up, the overall experience has improved, we see a strong fundamental pet market in 2022.

We see poultry and aqua recovering from the COVID situation, better economics in countries internationally have helped both of those markets as well as return to restaurant purchasing for the salmon market.

And then I would say in the cattle market, the market has tightened, supplies have tightened, exports are strong, especially coming out of the U.S. That's going to drive price up, and we believe our performance-driven portfolio supports that nicely.

And then swine really is one of -- overall, a pretty stable market with headwinds probably still in the first half more from an economic perspective, not an African swine fever perspective in China. So contained challenges in the first half, we see recovery in the second half of China-Swine.

Eli, thank you for the question on the operating cash flow. Yes, we're thrilled with the $223 million we did in Q4, that 94% conversion of net income to operating cash for the full year feels to be in a range that we expect to continue to deliver. Yes, I think as we look out over the next couple of years, that acceleration in operating cash flow is a very key component of our strategy as we continue to delever, and we only expect it to get better as we get beyond 2022 where it will be the last big year of one-off cash expenditures with the consolidation of the system as well as paying out the cash on severances from our latest restructuring. So overall, feeling very good about the cash flow generation and our net leverage improvements.

Great. Thanks. We'll take the last caller.

Your last question comes from the line of Navann Ty with Citi.

I have a follow-up on the cash generation. Can you comment on the cash, so I know there's some cost to integrate Bayer and Elanco SAP systems. Will step down in 2022 or remain significant? And any guidance or comments on free cash flow expectations for this year?

Sure, Navann, thank you. Yes, we're going to have about the same one-off cash needs for the integration and the severance costs as we had in 2021. We've guided our assumptions on Slide 37 at about $260 million.

This all gets built into our operating cash flow, which we talked about on a GAAP basis. So with that, we do expect to have in the range of $450 million to $500 million of free cash to allow us to continue to reduce debt and get our net leverage to the 4.75x we guided to today.

All right. Thanks. We'll hand it back to Jeff to close.

Yes. Thank you for the time, and we appreciate your interest in Elanco. Again, a strong historical 2021. The integrations, IPP and our overall strategy is working. As I referenced back to the Investor Day in 2020, we are on the trajectory. We're exceeding some of those expectations and staying to our commitments as we go forward. Thanks for your interest. We look forward to engaging with you throughout the year.

This concludes today's conference call. You may now disconnect.