New product innovation is a core part of our business strategy. Our R&D investment is focused on projects that target novel product introductions, as well as new indications, presentations, combinations and species expansion. Our approach is a build, buy, or ally strategy to develop compelling targets and conceptsinnovations that originate from our scientists and innovators, academia, agribusiness, or external partners including human pharmaceutical, agriculture and biotechnology at all stages of R&D. The ability to source our concepts from different areas allows us to create a pipeline that can be competitive in the categories in which we have chosen to compete, while reducing our risk by not owning and funding all aspects oforganizations. We focus our R&D projects.investment on projects that target novel product introductions with new active ingredients, as well as products leveraging known active ingredients in new indications, presentations, combinations, and species expansion.
Our global manufacturing and supply chain is also supported by a network of CMOs. As of December 31, 2018,2022, this network was comprised of approximately 100150 CMOs. Our External Manufacturing Networkexternal manufacturing network centrally governs our global CMO relationships and provides oversight to these CMOs through four hubs.CMOs.
We purchase certain raw materials necessary for the commercial production of our products from a variety of third‑partythird-party suppliers. We utilize logistics service providers as a part of our global supply chain, primarily for shipping and logistics support.
We intend to continue our efficiency improvement programs in our manufacturing and supply chain organization. We have strong globally managed and coordinated quality control and quality assurance programs in place at all internal manufacturing sites and external manufacturing hubs, and we regularly inspect and audit our internal sites and CMO locations. We recently conducted a review of our global manufacturing and supply network to improve efficiency. As a result of this review and our operational efficiency program, we exited ownership of our manufacturing sites in Vacaville, California; Dundee, Scotland; Sligo, Ireland; Larchwood, Iowa; and Cali, Colombia, reduced headcount from approximately 3,500 to approximately 2,300 employees and eliminated over 2,800 stock keeping units (SKUs). We currently supply approximately 4,500 SKUs.
Our primary competitors include animal health medicines and vaccines companies such as Zoetis Inc.; Boehringer Ingelheim Vetmedica, Inc., the animal health division of Boehringer Ingelheim GmbH; and Merck Animal Health, the animal health division of Merck & Co., Inc.; and Bayer Animal Health, the animal health division of Bayer AG. We also face competition globally from manufacturers of generic drugs, as well as from producers of nutritional health products, such as DSM Nutritional Products AG and Danisco Animal Nutrition, the animal health division of E.I. du Pont de Nemours and Company, a subsidiary of DowDuPont, Inc. There are also several new start‑upstart-up companies working in the animal health area. In addition, we compete with numerous other producers of animal health products throughout the world.
Our technology, brands and other intellectual property are important elements of our business. We rely on patent, trademark, copyright and trade secret laws, as well as regulatory exclusivity periods and non‑disclosurenon-disclosure agreements to protect our intellectual property rights. Our policy is to vigorously protect, enforce and defend our rights to our intellectual property, as appropriate.
Our product portfolio and certain product candidates enjoy the protection of approximately 3,0006,500 patents and applications, filed in over 5090 countries, with concentration in our major market countriesmarkets as well as other countriesmarkets with strong patent systems, such as Australia, Brazil, Canada, Europe, Japan and the U.S. ManyWhile many of the patents and patent applications in our portfolio are the result of our own work, while other patents and patent applicationsothers have been developed in our portfolio were at least partially developed, andcollaboration with partners, acquired through business transactions, or licensed to us by third parties. A subset of our current products or product candidates are covered by patents and patent applications in our portfolio.
We typically maintain all of our patents and assert our patent rights against third parties as appropriate.
We seek to file and maintain trademarks around the world based on commercial activities in most regions where we have, or desire to have, a business presence for a particular product. We currently maintain more than 9,00014,500 trademark applications and registrations in major regions, primarily identifying products dedicated to the care of livestock and companion animals.pets.
The sale of animal health products is governed by the laws and regulations specific to each country in which we sell our products. To maintain compliance with these regulatory requirements, we have established processes, systems, and dedicated resources with end‑to‑endend-to-end involvement from product concept to launch and maintenance in the market. Our regulatory function is Elanco's key interface with the relevant authorities. It is responsible for applying for and obtaining the necessary registrations and post-approvals: extending them if appropriate (e.g., developing claims in additional species), updating (e.g., changes to shelf-life or manufacturing site), and ongoing monitoring of safety and efficacy through our global pharmacovigilance system. In this way, the regulatory function ensures registrations remain valid, and the products can continue to be sold. To effectively do this, the regulatory function actively seeks to engageengages in dialogue with various global agenciesthe relevant authorities regarding their policies that relate to animal health products. In the majoritymost of our markets, the relevant health authority is separate from those governing human medicinal products.
Compliance. Reports of product quality defects, adverse events, or unexpected results are maintained and submitted in accordance with the law. Additionally, as part of the drug experience report, we are required to submit all new information pertaining to the safety or effectiveness of a product, regardless of the source.
The European Medicines Agency (EMA) is a centralized agency of the EU responsible for the scientific evaluation of many of the Veterinary Medicinal Products (VMP) developed by pharmaceutical companies for use in the EU. The agency has a veterinary review section distinct from the medical review section for human products. The Committee for Veterinary Medicinal Products (CVMP) is responsible for scientific review of the submissions for VMP, and Immunological Veterinary Medicinal Products.including immunological products. If the CVMP concludes that all requirements for quality, safety and efficacy are met and the product benefits outweigh the risks, it issues a positive opinion that is forwarded to the European Commission, whowhich takes the final decision following the European comitology procedure. The centralized marketing authorization (commission decision) of the European Commission is valid in all of the EU.EU and in Northern Ireland. All countries that are not part of the EU but belong to the European Economic Area (EEA), i.e., Norway,
Iceland and Liechtenstein, have been part of the scientific assessment done by the CVMP. These countries issue a national marketing approval in accordance with the CommissionEuropean Commission's decision. A series
If approval is sought for products that either cannot or do not need to follow the centralized procedure, approval can also be achieved by national approval in an EEA country agency. This national authorization can be mutually recognized by other EEA countries/EU member states (Mutual Recognition Procedure). In addition, national and mutual recognition can be done in a combined procedure (Decentralized Procedure).
The European Food Safety Authority (EFSA) is the agency of the EU that provides scientific advice and communicates with respect to existing and emerging risks associated with the food chain. Based on EFSA’s mandate, the agencyit evaluates applications for feed additives, including coccidiostats, enzymes and several nutritionals for animals.
The Institute of Veterinary Drug Control is responsible for the evaluation of new applications, renewals, variations, manufacturers, quality methods and tissue residue methods for pharmaceuticals, biologicals, disinfectants and medicinal feed additives.
The feed/feed additive office is responsible for the registration and renewal of feed and feed additives.
The pesticide bureau is responsible for the registration and renewal of pesticide products.
We are subject to various federal, state, local and foreign environmental, health and safety (EHS) laws and regulations. These laws and regulations govern matters such asas: the emission and discharge of hazardous materials into the ground, air or water; the generation, use, storage, handling, treatment, packaging, transportation, exposure to, and disposal of hazardous and biological materials, including recordkeeping, reporting and registration requirements; and the health and safety of our employees. Due to our operations, these laws and regulations also require itus to obtain, and comply with, permits, registrations or other authorizations issued by governmental
authorities. These authorities can modify or revoke our permits, registrations or other authorizations and can enforce compliance through fines and injunctions.
We have made, and intend to continue to make, necessary expenditures for compliance with applicable EHS laws and regulations. We are also monitoring and investigating environmental contamination from past industrial activity at certain sites. While we cannot predict with certainty our futureWe made no capital expenditures or operating costs for environmental compliance or the investigation and remediation of contaminated sites, we anticipate having capital and operational expenditures for each of the years ending December 31, 2019 and 2020 for environmental compliance purposes and for the monitoring, investigation or clean‑up of certain past industrial activities as follows:
Our website address is www.elanco.com. On our website, we make available, free of charge, our annual, quarterly and current reports, including amendments to such reports, as soon as reasonably practicable after we electronically file such material with, or furnish such material to, the SEC.U.S. Securities and Exchange Commission (the SEC). In addition, the SEC maintains an internet site that contains reports, proxy and information statements, and other information regarding issuers, including Elanco, that file electronically with the SEC at www.sec.gov.
Information relating to corporate governance at Elanco, including our Corporate Governance Guidelines, Code of Conduct, Financial Code of Ethics, Articles of Incorporation, Bylaws, Committee Charters; information concerning our executive officers and members of our board of directors; and ways to communicate are available on our website. We will provide any of the foregoing information without charge upon written request to Elanco’s Corporate Secretary, Elanco, 2500 Innovation Way, Greenfield, Indiana 46140. Information relating to shareholder services is also available on our website.
Information contained on our website is not part of, or incorporated by reference, in this Annual Report on Form 10-K.
Item 1A. Risk Factors
Investing in our common stock involves a high degreeOur business, financial condition and results of risk. You should consider carefullyoperations are subject to various risks, including but not limited to the following risks together with all the other information in this report, including our consolidated and combined financial statements and notes thereto, before you invest in our common stock.described below. If any of the followingsuch risks actually materializes, our business, financial condition and results of operations could be materially adversely affected. As a result, the trading price of our common stock could decline and you could lose part or all of your investment.
Risks Related to ElancoElanco's Business and Industry
The animal health industry is highly competitive.
The animal health industry is highly competitive. Our competitors include standalone animal health businesses, the animal health businesses of large pharmaceutical companies, specialty animal health businesses and companies that mainly produce generic products. Several new start-up companies also compete in the animal health industry. We believe many of our competitors are conducting R&D activities in areas served by our products and in areas in which we are developing products. Several new start‑up companies also compete in the animal health industry. We also face competition from manufacturers of drugs globally, as well as producers of nutritional health products. These competitors may have access to greater financial, marketing, technical and other resources. As a result, they may be able to devote more resources to developing, manufacturing, marketing and selling their products, initiating or withstanding substantial price competition or more readily taking advantage of acquisitions or other opportunities. Further, consolidation in the animal health industry could result in existing competitors realizing additional efficiencies or improving portfolio bundling opportunities, thereby potentially increasing their market share and pricing power, which could lead to a decrease in our revenue and profitability and an increase in competition. For example, many of our competitors have relationships with key distributors and, because of their size, the ability to offer attractive pricing incentives, which may negatively impact or hinder our relationships with these distributors. In addition to competition from established market participants, new entrants to the animal health medicines and vaccines industry could substantially reduce our market share, render our products obsolete or disrupt our business model.
To the extent that any of our competitors are more successful with respect to any key competitive factor, or we are forced to reduce, or are unable to raise, the price of any of our products in order to remain competitive, our business, financial condition and results of operations could be materially adversely affected. Competitive pressure could arise from, among other things, more favorable safety and efficacy product profiles, limited demand growth or a significant number of additional competitive products being introduced into a particular market, price reductions by competitors, the ability of competitors to capitalize on their economies of scale, the ability of competitors to produce or otherwise procure animal health products at lower costs than uswe can and the ability of competitors to access more or newer technology than us.we can. To the extent that any of our competitors are more successful with respect to any key competitive factor, or we are forced to reduce, or are unable to raise, the price of any of our products in order to remain competitive, our business, financial condition and results of operations could be materially adversely affected.
Disruptive innovation and advances in veterinary medical practices, animal health technologies and alternatives to animal‑derivedanimal-derived protein could negatively affect the market for our products.
The markets for our products are regularly impacted by the introduction and/or broad market acceptance of newly‑newly developed or alternative products that address the diseases and conditions for which we sell products, including “green” or “holistic” health products, specially bred disease‑resistantdisease-resistant animals or replacements for meat, milk, eggs or fish from alternative natural or synthetic sources. For example, the market for our companion animalpet health therapeutics has been particularly affected by innovation in new molecules and delivery formulations in recent years. Technological breakthroughs by others may render obsolete our products obsolete and reduce or eliminate the market for our products. Introduction or acceptance of competing animal health products and innovation or disruptive protein alternatives could materially adversely affect our business, financial condition and results of operations.
Our business is subject to substantial regulation.
As a global company, we are subject to various state, federal and international laws and regulations, including regulations relating to the development, quality assurance, manufacturing, importation, distribution, marketing, and sale of our products. In addition, our manufacturing facilities, including the manufacturing facilities operated by our CMOs, are subject to periodic inspections by regulatory agencies. An inspection may report conditions or practices that indicate possible violations of regulatory requirements. Our failure, or the failure of third parties we rely on, including CMOs, to comply with applicable regulatory requirements, allegations of such non-compliance or the discovery of previously unknown problems with a product or manufacturer could result in, among other things, inspection observation notices, warning letters or similar regulatory correspondence, fines, a partial or total shutdown of production in one or more of our facilities while an alleged violation is remediated, withdrawals or suspensions of current products from the market, and civil or criminal prosecution, as well as decreased sales as a result of negative publicity and product liability claims. Any one of these consequences could materially adversely affect our business, financial condition and results of operations.
In addition, we will not be able to market new products unless and until we have obtained all required regulatory approvals in each jurisdiction where we propose to market those products. Even after a product reaches market, we may be subject to re-review and may lose our approvals. For example, pending claims have been asserted in a lawsuit against the FDA's approval of Experior™,which was one of our eight new product launches in 2021. Our failure to obtain approvals, delays in the approval process, or our failure to maintain approvals in any jurisdiction, may prevent us from selling products in that jurisdiction until approval or re-approval is obtained, if ever.
In the EU, the Veterinary Medicinal Products Regulation updated the rules related to the authorization and use of veterinary medicines effective January 28, 2022. The updated rules limit the use of antibiotics, tighten importation rules, and impose stricter pharmacovigilance standards. This regulation must still be implemented at the member state level and as such, additional requirements may be adopted by individual member states which would have the effect of increasing the compliance requirements for our business in the EU with resulting costs.
Regulatory restrictions and bans on the use of antibiotics and productivity products in foodfarm animals, as well as changing market demand, may continue to negatively affect demand for certain of our foodfarm animal products.
Over the past few years, our operational results have been, and willmay continue to be, affected by regulations and changing market demand. In certain markets, including the U.S., sales of certain of our foodfarm animal products have been negatively affected by an increase in consumer sentiment for proteins and dairy products produced without the use of antibiotics or other products intended to increase animal production.
There are two classes of antibiotics used in animal health: shared‑class,shared-class, or medically important, antibiotics, which are used to treat infectious disease caused by pathogens that occur in both humans and animals; and animal‑onlyanimal-only antibiotics, which are used to treat infectious disease caused by pathogens that occur in animals only. See “Business of Elanco -For more information, see “Item 1. Business — Products -— Antibiotics.” Concerns that the use of antibiotics in foodfarm animal production may lead to increased antibiotic resistance of human pathogens have resulted in increased regulation and changing market demand. In December 2013, the FDA announced final guidance establishing procedures for the voluntary phase‑outphase-out in the U.S. over a three‑yearthree-year period of the use of shared‑classshared-class antibiotics in animal feed or water for growth promotion in foodfarm animal production. The guidance allows for continued use of shared‑classshared-class antibiotics in food‑producingfood-producing animals under the supervision of a veterinarian for treatment, control and, under certain circumstances, for prevention of disease. The FDA indicated that it took this action to help preserve the efficacy of shared‑classshared-class antibiotics to treat infections in humans. As part of those efforts, stricter guidelines governing the administration of shared‑class antibiotics have recently come into effect. As of January 1, 2017, under the FDA’s guidance and the related rule known as the Veterinary Feed Directive, the use of shared‑classshared-class antibiotics in the water or feed of food‑producingfood-producing animals requires written authorization by a licensed veterinarian. In June 2021, the FDA announced final guidance establishing procedures for drug sponsors to make similar changes to the approved marketing status of all other dosage forms of shared-class antibiotics to permit their use only under the supervision of a veterinarian, and only when necessary for treatment, control or prevention of specific diseases. The only products we currently market that are impacted by this guidance are Tylan™ 200 and Tylan™ 50, which will be transitioned from over-the-counter to prescription status. In addition, other countries in which we sell or plan to sell our products, such as France and Vietnam, have passed restrictions or bans on antibiotic use. Other countries have placed restrictions or bans on the use of specific antibiotics in certain food‑producingfood-producing animals, regardless of the route of administration (in feed or injectable).
From 2015 to 2018,2022, our revenue from shared‑classshared-class antibiotics has declined at a CAGRcompound annual growth rate (CAGR) of 6%1%, excluding the impact of foreign exchange rates. This was driven primarily by changing regulations in many markets, including the Veterinary Feed Directive, as well as changing market demand and our tiered approach to antibiotic stewardship, which included removing growth promotion from labels and requiring veterinary oversight in the U.S. and other markets. Globally, during 2018,2022, our revenue from shared‑classshared-class antibiotics declined 2%,decreased approximately 11% in comparison to 2021, excluding the impact of foreign exchange rates, and represented 12% (4%8% (3% from sales in the U.S. and 8%5% from sales outside the U.S.)international sales) of total revenue, down from 16% in 2015. The comparison to 2015 is impacted by our 2020 acquisition of Bayer Animal Health, which added certain shared-class antibiotics to our portfolio while significantly increasing our overall annual revenue.
From 2015 to 2018, our2022, we experienced a flat CAGR in revenue from animal‑onlyanimal-only antibiotics, grew at a CAGR of 5%, excluding the impact of foreign exchange rates, driven by sales outside the U.S., which offset a slight decline in the U.S. Globally, during 2018,rates. During 2022, our revenue from animal‑onlyanimal-only antibiotics grew 8%,increased approximately 2% in comparison to 2021, excluding the impact of foreign exchange rates, and represented 25%15% (6% from sales in the U.S. and 9% from international sales) and of total revenue, updown from 23% in 2015. In 2018, 87%2022, 13% of our revenue from animal‑onlyanimal-only antibiotics resulted from the sale of ionophores. Ionophores are a special class of animal‑onlyanimal-only antimicrobials, and because of their animal‑onlyanimal-only designation, mode of action and spectrum of activity, their use has not to date been impacted by regulations or changing market demand in many markets outside of the U.S.international markets.
The impact of changes in regulations and market preferences regarding the use of antibiotics in foodfarm animals could have a material adverse effect on our business, financial condition and results of operations. If there is an increased public perception that consumption of food derived from animals that utilize our products poses a risk to human health, there may be a further decline in the production of those food products and, in turn, demand for our products. In addition, antibiotic resistance concerns will likely result in additional restrictions or bans, expanded regulations or public pressure to further reduce the use of antibiotics in foodfarm animals, increased demand for antibiotic‑freeantibiotic-free protein, or changes in the market acceptance or regulatory treatment of ionophores, any of which could materially adversely affect our business, financial condition and results of operations.
In addition, our revenue has been impacted by regulatory changes inchanging trade dynamics with China and other markets restrictingthat restrict the use of productivity products, such as those containing ractopamine, in foodfarm animals. This has resulted in many U.S. food producers who access such markets eliminating their use of ractopamine.ractopamine to gain access to those markets. Our FA Ruminants & Swinefarm animal products OptaflexxOptaflexx™ and PayleanPaylean™ contain ractopamine. If more producers decide to access such markets or additional markets restrict the use of ractopamine or other productivity products, our business, financial condition and results of operations could be materially adversely affected.
Increased regulation or decreased governmental financial support relating to the raising, processing or consumption of farm animals could reduce demand for our farm animal products.
Companies in the farm animal sector are subject to extensive and increasingly stringent regulations. See "Item 1. Business — Regulatory" for further discussion. If farm animal producers are adversely affected by new regulations or changes to existing regulations, they may reduce herd or flock sizes or become less profitable and, as a result, they may reduce their use of our products, which may materially adversely affect our business, financial condition and results of operations. Also, many farm animal producers benefit from governmental subsidies, and if such subsidies were to be reduced or eliminated, these companies may become less profitable and, as a result, may reduce their use of our farm animal products. More stringent regulation of the farm animal sector, including regarding the use of farm animal products, could have a material adverse effect on our business, financial condition and results of operations.
Our results of operations are dependent upon the success of our top products.
If any of our top products experience issues, such as disruptive innovations or the introduction of more effective competitive products, negative publicity, changes to veterinarian or customer preferences, loss of patent protection, material product liability litigation, new or unexpected side effects, manufacturing disruptions and/or regulatory proceedings, our revenue could be negatively impacted, perhaps significantly. Our top five products, Seresto, Rumensin, Advocate, Advantix, and Maxiban contributed approximately 24% of our revenue in 2022. Any issues with these top products, particularly Seresto and Rumensin, which contributed approximately 8% and 6%, respectively, of our revenue in 2022, could have a material adverse effect on our business, financial condition and results of operations.
Generic products may be viewed as more cost‑effectivecost-effective than our products.
We face competition from products produced by other companies, including generic alternatives to our products. We depend on patents and regulatory data exclusivity periods to provide us with exclusive marketing rights for some of our products. Patents for individual products expire at different times based on the date of the patent filing (or sometimes the date of patent grant) and the legal term of patents in the jurisdictions where such patents are obtained. The extent of protection afforded by our patents varies from jurisdiction to jurisdiction and is limited by the scope of the claimed subject matter of our patents, the term of the patent and the availability and enforcement of legal remedies in the applicable jurisdiction. In 2018, approximately 72% of our revenue was from products that did not have patent protection, including revenue from someSome of our top products such as Rumensinthe Advantage Family, MaxibanRumensin, Maxiban, Denagard and Tylan Premix.do not have patent protection. Other products are protected by patents that expire over the next several years. For
example, certain patents related to Trifexis expire as early as 2020 in the U.S., 2021 in Japan and 2025 in European territories. As the patents for a brand name product expire, competitors may begin to introduce generic or other alternatives, and as a result, we may face competition from lower‑pricedlower-priced alternatives to many of our products. For example, we have experienced significant competitive headwinds from generic ractopamine in the U.S. In the third quarter of 2013, a large2019, an established animal health company received U.S. approval for generic ractopamine.monensin in cattle and goats for certain indications. U.S. revenue from OptaflexxRumensin, our ractopamine beefmonensin product, has declined at a CAGR of 24%3% from 2015 to 20182022 partly due to competition and may continue to decline as a result of the generic competition and international regulatory restrictions.competition. We may face similar competition in the future for existing products that do not benefit from exclusivity including Rumensin, which has not benefitted from patent protection in the U.S. for over 20 years, or for existing products with material patents expiring in the future. See “Business of Elanco -For further information, see "Item 1. Business — Intellectual Property.”
Generic competitors are becoming more aggressive in terms of launching products before patent rights expire, and, because of attractive pricing, sales of generic products are an increasing percentage of overall animal health sales in certain regions. Although the impact of generic competition in the animal health industry to date has not typically mirrored that seen in human health, product pricing and the impact of generic competition in the future may more closely mirror human health as a result of changes in industry dynamics, such as channel expansion, consolidation, an increase in the availability and use of pet insurance and the potential for generic competition by established animal health businesses. If animal health customers increase their use of new or existing generic products, our business, financial condition and results of operations could be materially adversely affected.
We may not successfully implement our business strategies or achieve targeted cost efficiencies and gross margin improvements.
We are pursuing strategic initiatives that management considers critical to our long‑term success, including, but not limited to: improving manufacturing processes, reducing our manufacturing footprint, achieving lean initiatives, consolidating our CMO network, strategically insourcing projects, pursuing cost savings opportunities with respect to raw materials through a new procurement process and improving the productivity of our sales force. We may pursue additional strategic initiatives in the future to improve gross margins and achieve our targeted cost efficiencies. We also have acquired or partnered with a number of smaller animal health businesses, and we intend to continue to do so in the future. There are significant risks involved with the execution of these initiatives, including significant business, economic and competitive uncertainties, many of which are outside of our control. Accordingly, we may not succeed in implementing these strategic initiatives. Realizing the anticipated benefits from these initiatives, if any benefits are achieved at all, may take several years. We may be unable to achieve our targeted cost efficiencies and gross margin improvements. Additionally, we may have insufficient access to capital to fund investments in strategic initiatives, or our business strategy may change from time to time, which could delay our ability to implement initiatives that we believe are important to our business.
Consolidation of our customers and distributors could negatively affect the pricing of our products.
Third‑partyThird-party distributors, veterinarians and foodfarm animal producers are our primary customers. In recent years, there has been a trend towardstoward the concentration of veterinarians in large clinics and hospitals. In addition, foodfarm animal producers, particularly swine and poultry producers, and our distributors have seen recent consolidation in their industries. Furthermore, we have seen the expansion of larger cross‑bordercross-border corporate customers and an increase in the consolidation of buying groups (cooperatives of veterinary practices that leverage volume to pursue discounts from manufacturers). The pace of consolidation and structure of markets varies greatly across geographies. If these trends towardstoward consolidation continue, our customers could attempt to improve their profitability by leveraging their buying power to obtain favorable pricing. The resulting decrease in our prices could have a material adverse effect on our business, financial condition and results of operations.
An outbreak of infectious disease carried by foodfarm animals could negatively affect the demand for, and sale and production of, our foodfarm animal products.
Sales of our foodfarm animal products could be materially adversely affected by thea general outbreak of infectious disease, or an outbreak of disease carried by foodfarm animals, which could lead to the widespread death or precautionary destruction of foodfarm animals as well as the reduced consumption and demand for animal protein. In addition, outbreaks of disease carried by foodfarm animals may reduce regional or global sales of particular animal‑derivedanimal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce demand for our foodfarm animal products due to reduced herd or flock sizes.
In recent years, outbreaks of various diseases, including African Swine Fever, avian influenza, foot‑and‑mouthfoot-and-mouth disease, bovine spongiform encephalopathy (otherwise known as BSE or “mad cow” disease) and porcine epidemic diarrhea virus (otherwise known as PEDV), have negatively impacted sales of our animal health products. The discovery of additional cases of any of these, or new, diseases may result in additional restrictions on animal protein, reduced
herd or flock sizes, or reduced demand for animal protein, any of which may have a material adverse effect on our business, financial condition and results of operations. In addition, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere.
We could experience demand, supply and operational challenges associated with the effects of a human disease outbreak, epidemic, pandemic or other widespread public health concern.
Our business has been and may continue to be negatively impacted by human disease outbreaks, epidemics, pandemics or other widespread public health concerns, such as the COVID-19 pandemic, including its variants, and the related travel restrictions and governmental mandates. These impacts include, but are not limited to:
•Reductions in demand or significant volatility in demand for one or more of our products, caused by, among other things: the temporary inability of our customers to purchase our products due to illness, quarantine, travel restrictions, and/or financial hardship; decreased veterinary visits; farm animal processing plant shutdowns; shifts in demand by trading down to lower priced products; or stockpiling activity;
•Inability to meet customer needs and achieve cost targets due to disruptions in our manufacturing and supply chains caused by labor constraints or inability to obtain key raw materials, increased transportation costs, or other manufacturing and distribution disruptions;
•Failure of third parties on which we rely, including our suppliers, contract manufacturers, distributors, contractors, and other external business partners, to meet their obligations, which may be caused by their own financial or operational challenges;
•Limited ability to access the global financial market, which could negatively impact our short-term and long-term liquidity; or
•Significant changes in the political environments in the markets in which we manufacture, sell or distribute our products, including lockdowns, import/export restrictions, or other governmental mandates that limit or close operating and manufacturing facilities, restrict travel to perform necessary business functions, or otherwise prevent us or our third-party partners, suppliers or customers from sufficiently staffing operations, including operations necessary for the production, distribution and sale of our products.
Despite our efforts to manage and limit these impacts, they are ultimately dependent on factors beyond our control, including the duration and severity of any such outbreak as well as third-party actions taken to contain its spread and mitigate its effects. For COVID-19, the emergence of variants may continue to occur across the geographies in which we operate, leading to varied government and consumer responses, resulting in further volatility in our results and operations.
Our R&D, acquisition and licensing efforts may fail to generate new products or expand the use of our existing products.
Our future success depends on both our existing product portfolio and our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through licenselicenses or acquisition.acquisitions, including the acquisitions of Bayer Animal Health and KindredBio. We commit substantial effort, funds and other resources to R&D, bothprimarily through our own dedicated resources andbut also through collaborations with third parties.
We may be unable to determine with accuracy when or whether any of our products now under development will be approved or launched, or we may be unable to develop, license or otherwise acquire product candidates or products. In addition, we cannot predict whether any products, once launched, will be commercially successful or will achieve sales and revenue that areis consistent with our expectations. The animal health industry is subject to regional and local trends and regulations and, as a result, products that are successful in some markets may not achieve similar success when introduced into other markets. Furthermore, the timing and cost of our R&D may increase, and our R&D may become less predictable as, among other things, regulations applicable to our industry may make it more time‑consumingtime-consuming and/or costly to research, develop and register products. If we are unable to generate new products or expand the use of our existing products, our business, financial condition and results of operations willcould be materially adversely affected. For example, between 2015 and 2017, prior to our February 2018 launch of Credelio in the U.S., we experienced an innovation lag in the companion animal parasiticide space. In the absence of a competitive combined oral flea and tick product, our U.S. companion animal parasiticide portfolio revenue declined 15% in 2017, excluding the impact on revenue resulting from a reduction in inventory levels within our distribution channel.
In addition, someAs part of our growth has occurred through Lilly’s acquisitions, including Novartis Animal Health, Lohmann Animal Health, Janssen Animal Healthdevelopment strategy, we often hire clinical research organizations to perform preclinical testing and the BI Vetmedica U.S. vaccines portfolio. However, following the separation, weclinical trials for drug candidates. Clinical trials and procedures are inherently uncertain and there can be no longer benefitassurance that these trials or procedures will be enrolled or completed in a timely or cost-effective manner or result in a commercially viable product or indication. Failure to do so could have a material adverse effect on our prospects. Furthermore, unfavorable or inconsistent clinical data from Lilly’s scale, capital base and financial strength.current or future clinical trials or procedures
We had losses in recent periods.In recent periods, we have incurred net losses, as reported on a combined basis, including a net loss for the years ended December 31, 2017 and 2016
conducted by us, our competitors or third parties, or perceptions regarding this clinical data, could continue to incur asset impairment, restructuring and other special charges and could report losses in the future. We also expect to continue to incur substantial expenditures to develop, manufacture and market our products and implement our business strategies. We may encounter unforeseen expenses, difficulties, complications, delays, adverse events and other unknown factors that may materially adversely affect our business.ability to obtain necessary approvals and the market’s view of our future prospects.
The misuse or off‑labeloff-label use of our products may harm our reputation or result in financial or other damages.
Our products have been approved for use under specific circumstances for the treatment of certain diseases and conditions in specific species. There may be increased risk of product liability claims if veterinarians, foodfarm animal producers, pet owners or others attempt to use our products off‑label,off-label, including the use of our products in species (including humans) for which they have not been approved. Furthermore, the use of our products for indications other than those for which our products have been approved may not be effective, which could harm our reputation and lead to an increased risk of litigation. If we are deemed by a governmental or regulatory agency to have engaged in the promotion of any of our products for off‑labeloff-label use, such agency could request that we modify our training or promotional materials and practices, and we could be subject to significant fines and penalties, and the imposition of these sanctions could also affect our reputation and position within the industry. Any of these events could materially adversely affect our business, financial condition and results of operations.
Animal health products are subject to unanticipated safety, quality or efficacy concerns, which may harm our reputation.
Unanticipated safety, quality or efficacy concerns arise from time to time with respect to animal health products, whether or not scientifically or clinically supported, leading to product recalls, withdrawals or suspended or declining sales, as well as product liability and other claims.
Regulatory actions based on these types of safety, quality or efficacy concerns could impact all, or a significant portion, of a product’s sales and could, depending on the circumstances, materially adversely affect our results of operations.
In addition, since we depend on positive perceptions of the safety, quality and efficacy of our products, and animal health products generally, by food producers, veterinarians and pet owners, any concern as to the safety, quality or efficacy of our products, whether actual or perceived, may harm our reputation. These concerns and the related harm to our reputation could materially adversely affect our business, financial condition and results of operations, regardless of whether such reports are accurate.
Our business may be negatively affected by weather conditions and the availability of natural resources.
The animal health industry and demand for many of our products in a particular region are affected by weather conditions, varying weather patterns and weather‑related pressures from pests, such as ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.
Food animal producers depend on the availability of natural resources, including large supplies of fresh water. Their animals’ health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, veterinarians or food animal producers may purchase less of our products.
Further, heat waves may cause stress in animals and lead to increased vulnerability to disease, reduced fertility rates and reduced milk production. Droughts may threaten pasture and feed supplies by reducing the quality and amount of forage available to grazing livestock, while climate change may increase the prevalence of parasites and diseases that affect food animals. Adverse weather conditions may also have a material impact on the aquaculture business. Changes in water temperatures could affect the timing of reproduction and growth of various fish species, as well as trigger the outbreak of certain water borne diseases.
In addition, veterinary hospitals and practitioners depend on visits from, and access to, the animals under their care. Veterinarians’ patient volume and ability to operate could be adversely affected if they experience prolonged snow, ice or other severe weather conditions, particularly in regions not accustomed to sustained inclement weather.
We may not be able to realize the expected benefits of our investments in emerging markets and are subject to certain risks due to our presence in emerging markets, including political or economic instability and failure to adequately comply with legal and regulatory requirements.
We have taken steps to increase our presence in select emerging markets, including by expanding our sales organization and product offerings in these markets. Failure to continue to maintain and expand our business in emerging markets could materially adversely affect our business, financial condition and results of operations.
In addition, certain emerging markets have legal systems that are less developed. Other jurisdictions in which we conduct business may have legal and regulatory regimes that differ materially from U.S. laws and regulations, are continuously evolving or do not include sufficient judicial or administrative guidance to interpret such laws and regulations. Compliance with diverse legal requirements is costly and time‑consuming and requires significant resources. Violations or possible violations of applicable laws or regulations by our employees may result in investigation costs, potential penalties and other related costs, which in turn could negatively affect our reputation and our results of operations.
Some countries within emerging markets may be especially vulnerable to periods of local, regional or global economic, political or social instability or crisis. For example, our sales in certain emerging markets have suffered from extended periods of disruption due to natural disasters. Furthermore, we have also experienced lower than expected sales in certain emerging markets due to local, regional and global restrictions on banking and commercial activities in those countries. In addition, certain emerging markets have currencies that fluctuate substantially, which may impact our financial performance. For these reasons, among others, doing business within emerging markets carries significant risks.
Modification of foreign trade policy may harm our food animal product customers.
Changes in laws, agreements and policies governing foreign trade in the territories and countries where our customers do business could negatively impact such customers’ businesses and adversely affect our results of operations. A number of our customers, particularly U.S.‑based food animal producers, benefit from free trade agreements, such as the North American Free Trade Agreement (NAFTA). In November 2018, the U.S. negotiated a new trade deal with Canada and Mexico known as the United States-Mexico-Canada-Agreement (USMCA), aimed at re‑negotiating and updating the terms of NAFTA. The USMCA still requires ratification by legislative bodies in all three countries before it can take effect. If the USMCA is not ratified and the U.S. were to withdraw from or materially modify NAFTA or other international trade agreements to which it is a party or if the U.S. were to engage in trade disputes or the imposition of tariffs, our customers could be harmed, and as a result, our business, financial condition and results of operations could be materially adversely affected.
Our business is subject to risk based on global economic conditions.
Macroeconomic business and financial disruptions could have a material adverse effect on our business, financial condition and results of operations. Certain of our customers and suppliers could be affected directly by an economic downturn and could face constraints on the availability of credit or decreased cash flow that could give rise to payment delays, increased credit risk, bankruptcies and other financial hardships that could decrease the demand for our products or hinder our ability to collect amounts due from our customers. If one or more of our large customers, including distributors, discontinues or modifies their relationship with us as a result of economic conditions or otherwise, our business, financial condition and results of operations may be materially adversely affected. In addition, economic concerns may cause some pet owners to forgo or defer visits to veterinary practices or could reduce their willingness to treat pet health conditions or to continue to own a pet. Furthermore, our exposure to credit and collectability risk is higher in certain international markets and our ability to mitigate such risks may be limited. Our procedures intended to monitor and limit our exposure to credit and collectability risk may not effectively limit such risk and avoid losses.
Our results of operations are dependent upon the success of our top products.
If any of our top products experience issues, such as disruptive innovations or the introduction of more effective competitive products, negative publicity, changes to veterinarian or customer preferences, loss of patent protection, material product liability litigation, new or unexpected side effects, manufacturing disruptions and/or regulatory proceedings, our revenue could be negatively impacted, perhaps significantly. Our top five products, Rumensin, Trifexis, Maxiban, Denagard and Interceptor Plus, contributed approximately 31% of our revenue in 2018. Any issues with these top products, particularly Rumensin, which contributed approximately 11% of our revenue in 2018, could have a material adverse effect on our business, financial condition and results of operations.
Our business is subject to risk based on customer exposure to rising costs and reduced customer income.
Feed, fuel, transportation and other key costs for food animal producers may increase or animal protein prices or sales may decrease. Either of these trends could cause deterioration in the financial condition of our food animal product customers, potentially inhibiting their ability to purchase our products or pay us for products delivered. Our food animal product customers may offset rising costs by reducing spending on our food animal products, including by switching to lower‑cost alternatives to our products. In addition, concerns about the financial resources of pet owners could cause veterinarians to alter their treatment recommendations in favor of lower‑cost alternatives to our products, which could result in a decrease in sales of our companion animal products, especially in developed countries where there is a higher rate of pet ownership. Rising costs or reduced income for our customers could have a material adverse effect on our business, financial condition and results of operations.
For our companion animal products, increased use of alternative distribution channels, or changes within existing distribution channels, could negatively impact our market share, margins and distribution of our products.
In most markets, pet owners typically purchase their animal health products directly from veterinarians. However, pet owners increasingly have the option to purchase animal health products from sources other than veterinarians, such as online retailers, “big‑box” retail stores or other over‑the‑counter distribution channels. This trend has been demonstrated by the significant shift away from the veterinarian distribution channel in the sale of flea and tick products in recent years. Pet owners also could decrease their reliance on, and visits to, veterinarians as they rely
more on internet‑based animal health information. Because we market our companion animal prescription products primarily through the veterinarian distribution channel, any decrease in visits to veterinarians by pet owners could reduce our market share for such products and materially adversely affect our business, financial condition and results of operations. In addition, pet owners may substitute human health products for animal health products if human health products are deemed to be lower‑cost alternatives.
Legislation has also been proposed in the U.S., and may be proposed in the U.S. or abroad in the future, that could impact the distribution channels for our companion animal products. For example, such legislation may require veterinarians to provide pet owners with written prescriptions and disclosure that the pet owner may fill prescriptions through a third party, which may further reduce the number of pet owners who purchase their animal health products directly from veterinarians. Such requirements may lead to increased use of generic alternatives to our products or the increased substitution of our companion animal products with other animal health products or human health products if such other products are deemed to be lower‑cost alternatives. Many states already have regulations requiring veterinarians to provide prescriptions to pet owners upon request and the American Veterinary Medical Association has long‑standing policies in place to encourage this practice.
Over time, these and other competitive conditions may increase our use of online retailers, “big‑box” retail stores or other over‑the‑counter distribution channels to sell our companion animal products. We may not be adequately prepared or able to distribute our companion animal products if an increased portion of our sales occur through these channels. Also, we may realize lower margins on sales through these distribution channels than we do on sales through veterinarians. Any of these events could materially adversely affect our business, financial condition and results of operations.
In addition, if one or more of our companion animal distributors discontinues or modifies their relationship with us, our business, financial condition and results of operations may be materially adversely affected. For example, in 2017, a change in our U.S. inventory management practices resulted in a revenue lag as existing inventory was sold down, which management estimates decreased our revenue by approximately $35 million.
Loss of our executive officers or other key personnel could disrupt our operations.
We depend on the efforts of our executive officers and other key personnel. Our executive officers and other key personnel are not currently, and are not expected to be, subject to non‑compete provisions. In addition, we have not entered into employment agreements with our executive officers or other key personnel. Any unplanned turnover or our failure to develop an adequate succession plan for one or more of our executive officers or other key personnel positions could deplete our institutional knowledge base and erode our competitive advantage. The loss or limited availability of the services of one or more of our executive officers or other key personnel, or our inability to recruit and retain qualified executive officers or other key personnel in the future, could, at least temporarily, have a material adverse effect on our business, financial condition and results of operations.
We may be required to write down goodwill or identifiable intangible assets.
Under U.S. GAAP, if we determine goodwill or identifiable intangible assets are impaired, we will be required to write down these assets and record a non‑cash impairment charge. As of December 31, 2018, we had recorded on our balance sheet goodwill of $3.0 billion and identifiable intangible assets of $2.5 billion. Identifiable intangible assets consist primarily of marketed products acquired or licensed from third parties, licensed platform technologies that have alternative future uses in R&D, manufacturing technologies, and customer relationships from business combinations. We also have indefinite‑lived intangible assets, which consist of acquired in‑process R&D projects from business combinations that are subject to impairment and non‑cash impairment charges.
Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment. Future events or new information may change management’s valuation of an intangible asset in a short amount of time. The timing and amount of impairment charges recorded in our consolidated and combined statements of operations and write‑downs recorded in our consolidated and combined balance sheets could vary if our management’s conclusions change. Any impairment of goodwill or identifiable intangible assets could have a material adverse effect on our business, financial condition and results of operations.
As a standalone public company, we may expend additional time and resources to comply with rules and regulations that did not previously apply to us, and failure to comply with such rules may lead investors to lose confidence in our financial data.
As a standalone public company, we are subject to the reporting requirements of the Exchange Act, the Sarbanes‑Oxley Act, the Dodd‑Frank Wall Street Reform and Consumer Protection Act and regulations of the NYSE. We have established all of the procedures and practices required as a subsidiary of Lilly, but we must continue to implement others as a separate, standalone public company. Continuing to establish and expand such procedures and practices will increase our legal, accounting and financial compliance costs, will make some activities more difficult, time‑consuming and costly and could be burdensome on our personnel, systems and resources. We are devoting and will continue to devote significant resources to address these public company requirements, including compliance programs and investor relations, as well as our financial reporting obligations. As a result, we have and will continue to incur significant legal, accounting and other expenses that we did not previously incur to comply with these rules and regulations. Furthermore, the need to establish the corporate infrastructure necessary for a standalone public company may divert some of our management’s attention from operating our business and implementing our strategy. However, the measures we take may not be sufficient to satisfy our obligations as a public company. In addition, we cannot predict or estimate the amount of additional costs we may incur in order to comply with these requirements.
We have made, and will continue to make, changes to our internal controls and procedures for financial reporting and accounting systems to meet our reporting obligations. In particular, as a public company, our management is required to conduct an annual evaluation of our internal controls over financial reporting and include a report of management on our internal controls in our annual reports on Form 10‑K. Under current rules, we will be subject to these requirements beginning with our annual report on Form 10‑K for the year ending December 31, 2019. In addition, we will be required to have our independent registered public accounting firm attest to the effectiveness of our internal controls over financial reporting pursuant to Auditing Standard No. 5 beginning with our annual report on Form 10‑K for the year ending December 31, 2019. If we are unable to conclude that we have effective internal controls over financial reporting, or if our registered public accounting firm is unable to provide us with an attestation and an unqualified report as to the effectiveness of our internal controls over financial reporting, investors could lose confidence in the reliability of our financial statements, which could result in a decrease in the value of our common stock.
Our R&D relies on evaluations of animals, which may become subject to bans, additional restrictive regulations or increased attention from activism movements.
As an animal health medicines and vaccines business, we are required to evaluate the effect of our existing and new products in animals in order to register such products. Animal testing in certain industries has been the subject of controversy and adverse publicity. Some organizations and individuals have attempted to ban animal testing or encourage the adoption of new regulations applicable to animal testing. To the extent that the activities of such organizations and individuals are successful, our R&D, and by extension our business, financial condition and results of operations, could be materially adversely affected. In addition, negative publicity about us or our industry could harm our reputation.
Manufacturing problems and capacity imbalances may cause product launch delays, inventory shortages, recalls or unanticipated costs.
In order to sell our products, we must be able to produce and ship sufficient quantities to our customers. We own and operate 12 internal manufacturing sites located in nine countries. We also employ a network of approximately 100 third‑party CMOs. Many of our products involve complex manufacturing processes and are sole‑sourced from certain manufacturing sites.
Minor deviations in our manufacturing or logistical processes, such as temperature excursions or improper package sealing, could result, and have in the past resulted in, delays, inventory shortages, unanticipated costs, product recalls, product liability and/or regulatory action. In addition, a number of factors could cause production interruptions, including:
the failure of us or any of our vendors or suppliers, including logistical service providers, to comply with applicable regulations and quality assurance guidelines;
mislabeling;
construction delays;
equipment malfunctions;
shortages of materials;
labor problems;
natural disasters;
power outages;
criminal and terrorist activities;
changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, shipping distributions or physical limitations; and
the outbreak of any highly contagious diseases near our production sites.
These interruptions could result in launch delays, inventory shortages, recalls, unanticipated costs or issues with our agreements under which we supply third parties, which may materially adversely affect our business, financial condition and results of operations.
Our manufacturing network may be unable to meet the demand for our products or we may have excess capacity if demand for our products changes. The unpredictability of a product’s regulatory or commercial success or failure, the lead time necessary to construct highly technical and complex manufacturing sites and shifting customer demand (including as a result of market conditions or entry of branded or generic competition) increase the potential for capacity imbalances. In addition, construction of sites is expensive, and our ability to recover costs will depend on the market acceptance and success of the products produced at the new sites, which is uncertain.
We rely on third parties to provide us with materials and services and are subject to increased labor and material costs and potential disruptions in supply.
The materials used to manufacture our products may be subject to availability constraints and price volatility caused by changes in demand, weather conditions, supply conditions, government regulations, economic climate and other factors. In addition, labor costs may be subject to volatility caused by the supply of labor, governmental regulations, economic climate and other factors. Increases in the demand for, availability or the price of, materials used to manufacture our products and increases in labor costs could increase the costs to manufacture our products, result in product delivery delays or shortages, and impact our ability to launch new products on a timely basis or at all. We may not be able to pass all or a material portion of any higher material or labor costs on to our customers, which could materially adversely affect our business, financial condition and results of operations.
We may be unable to meet demand for certain of our products if any of our third‑party suppliers cease or interrupt operations, fail to renew contracts with us or otherwise fail to meet their obligations to us.
We may incur substantial costs and receive adverse outcomes in litigation and other legal matters.
Our business, financial condition and results of operations could be materially adversely affected by unfavorable results in pending or future litigation matters. These matters may include, among other things, allegations of violation of U.S. and foreign competition law, labor laws, consumer protection laws and environmental laws and regulations, as well as claims or litigation relating to product liability, intellectual property, securities, breach of contract and tort. In addition, changes in the interpretations of laws and regulations to which we are subject, or in legal standards in one or more of the jurisdictions in which we operate, could increase our exposure to liability. For example, in the U.S., attempts have been made to allow damages for emotional distress and pain and suffering in connection with the loss of, or injury to, a companion animal. If such attempts were successful, our exposure with respect to product liability claims could increase materially.
Litigation matters, regardless of their merits or their ultimate outcomes, are costly, divert management’s attention and may materially adversely affect our reputation and demand for our products. We cannot predict with certainty the eventual outcome of pending or future litigation matters. An adverse outcome of litigation or legal matters could result in us being responsible for significant damages. Any of these negative effects resulting from litigation matters could materially adversely affect our business, financial condition and results of operations.
Our business is subject to substantial regulation.
As a global company, we are subject to various state, federal and international laws and regulations, including regulations relating to the development, quality assurance, manufacturing, importation, distribution, marketing and sale of our products. Changes in applicable federal, state, local and foreign laws and regulations could have a material adverse effect on our business, financial condition and results of operations. In addition, our manufacturing facilities, including the manufacturing facilities operated by our CMOs, are subject to periodic inspections by regulatory agencies. An inspection may report conditions or practices that indicate possible violations of regulatory requirements. Our failure, or the failure of third parties we rely on, including CMOs, to comply with these regulatory requirements, allegations of such non‑compliance or the discovery of previously unknown problems with a product or manufacturer could result in, among other things, inspection observation notices, warning letters or similar regulatory correspondence, fines, a partial or total shutdown of production in one or more of our facilities while an alleged violation is remediated, withdrawals or suspensions of current products from the market, and civil or criminal prosecution, as well as decreased sales as a result of negative publicity and product liability claims. Any one of these consequences could materially adversely affect our business, financial condition and results of operations.
In addition, we will not be able to market new products unless and until we have obtained all required regulatory approvals in each jurisdiction where we propose to market those products. Even after a product reaches market, we may be subject to re‑review and may lose our approvals. Our failure to obtain approvals, delays in the approval process, or our failure to maintain approvals in any jurisdiction, may prevent us from selling products in that jurisdiction until approval or re‑approval is obtained, if ever.
The illegal distribution and sale by third parties of counterfeit or illegally compounded versions of our products or of stolen, diverted or relabeled products could have a negative impact on our reputation and business.
Third parties may illegally distribute and sell counterfeit or illegally compounded versions of our products that do not meet the exacting standards of our development, manufacturing and distribution processes. Counterfeit or illegally compounded medicines pose a significant risk to animal health and safety because of the conditions under which they are manufactured and the lack of regulation of their contents. Counterfeit or illegally compounded products are frequently unsafe or ineffective and can be potentially life‑threatening to animals. Our reputation and business could suffer harm as a result of counterfeit or illegally compounded products which are alleged to be equivalent and/or which are sold under our brand name. In addition, products stolen or unlawfully diverted from inventory, warehouses, plants or while in transit, which are not properly stored or which have an expired shelf life and which have been repackaged or relabeled and which are sold through unauthorized channels, could adversely impact animal health and safety, our reputation and our business. Public loss of confidence in the integrity of vaccines and/or pharmaceutical products as a result of counterfeiting, illegal compounding or theft could have a material adverse effect on our business, financial condition and results of operations.
We are subject to complex environmental, health and safety laws and regulations.
We are subject to various federal, state, local and foreign environmental, health and safety laws and regulations. These laws and regulations govern matters such as the emission and discharge of hazardous materials into the ground, air or water; the generation, use, storage, handling, treatment, packaging, transportation, exposure to and disposal of hazardous and biological materials, including recordkeeping, reporting and registration requirements; and the health and safety of our employees. Due to our operations, these laws and regulations also require us to obtain, and comply with, permits, registrations or other authorizations issued by governmental authorities. These authorities can modify or revoke our permits, registrations or other authorizations and can enforce compliance through fines and injunctions.
Given the nature of our business, we have incurred, are currently incurring and may in the future incur liabilities for the investigation and remediation of contaminated land under the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or under other federal, state, local and foreign environmental cleanup laws, with respect to our current or former sites, adjacent or nearby third‑party sites, or offsite disposal locations. We could be subject to liability for the investigation and remediation of legacy environmental contamination caused by historical industrial activity as sites that we own or on which we operate. The costs associated with future cleanup activities that we may be required to conduct or finance could be material. Additionally, we may become liable to third parties for damages, including personal injury, property damage and
natural resource damages, resulting from the disposal or release of hazardous materials into the environment. Such liability could materially adversely affect our business, financial condition and results of operations.
Furthermore, regulatory agencies are showing increasing concern over the impact of animal health products and food animal operations on the environment. This increased regulatory scrutiny has in the past and may in the future necessitate that additional time and resources be spent to address these concerns in both new and existing products.
Our failure to comply with the environmental, health and safety laws and regulations to which we are subject, including any permits issued thereunder, may result in environmental remediation costs, loss of permits, fines, penalties or other adverse governmental or private actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial measures. We could also be held liable for any and all consequences arising out of human exposure to hazardous materials, environmental damage or significant environmental, health and safety issues that might arise at a manufacturing or R&D facility. Environmental laws and regulations are complex, change frequently, have tended to become more stringent and stringently enforced over time and may be subject to new interpretation. It is possible that our costs of complying with current and future environmental, health and safety laws, and our liabilities arising from past or future releases of, or exposure to, hazardous materials could materially adversely affect our business, financial condition and results of operations.
The actual or purported intellectual property rights of third parties may negatively affect our business.
A third party may sue us, or our distributors or licensors, including Lilly, or otherwise make a claim alleging infringement or other violation of such third‑party’sthird-party’s patents, trademarks, trade dress, copyrights, trade secrets, domain names or other intellectual property rights. If our distributors, licensors or we do not prevail in this type of litigation, we may be required to:
•pay monetary damages;
•obtain a license in order to continue manufacturing or marketing the affected products, which may not be available on commercially reasonable terms, or at all; or
•stop activities, including any commercial activities, relating to the affected products, which could include a recall of the affected products and/or a cessation of sales in the future.
The costs of defending an intellectual property claim could be substantial and could materially adversely affect our business, financial condition and results of operations, even if we successfully defend such claim. Moreover, even if we believe that we do not infringe a validly existing third‑partythird-party patent, we may choose to license such patent, which would result in associated costs and obligations. We may also incur costs in connection with an obligation to indemnify a distributor, licensor or other third party.
The intellectual property positions of animal health medicines and vaccines businesses frequently involve complex legal and factual questions, and an issued patent does not guarantee us the right to practice the patented technology or develop, manufacture or commercialize the patented product. For example, while we generally enter into proprietary information agreements with our employees and third parties, which assign intellectual property rights to us, these agreements may not be honored or may not effectively assign intellectual property rights to us under the local laws of some countries or jurisdictions. We cannot be certain that a competitor or other third party does not have or will not obtain rights to intellectual property that may prevent us from manufacturing, developing or marketing certain of our products, regardless of whether we believe such intellectual property rights are valid and enforceable or we believe we would otherwise be able to develop a more commercially successful product, which may materially adversely affect our business, financial condition and results of operations.
If our intellectual property rights are challenged or circumvented, competitors may be able to take advantage of our research and developmentR&D efforts or harm the value of our brands.
Our long‑termlong-term success depends on our ability to market innovative and competitive products. We rely and expect to continue to rely on a combination of intellectual property, including patent, trademark, trade dress, copyright, trade secret and domain name protection, as well as confidentiality and license agreements with our employees and others, to protect our intellectual property and proprietary rights. If we fail to obtain and maintain adequate
intellectual property protection, we may not be able to prevent third parties from using our proprietary technologies or from marketing products that are very similar or identical to ours.
Our currently pending or future patent applications may not result in issued patents, or be approved on a timely basis, if at all. Similarly, any term extensions that we seek may not be approved on a timely basis, if at all. In addition, our issued patents, or any patents that may issue in the future, may not contain claims sufficiently broad to protect us against third parties with similar technologies or products or provide us with any competitive advantage, including exclusivity in a particular product area.
The validity and scope of our patent claims also may vary between countries, as individual countries have their own patent laws. For example, some countries only permit the issuance of patents covering a novel chemical compound itself, and its first use, and thus further methods of use for the same compound may not be patentable. The validity, enforceability, scope and effective term of patents can be highly uncertain and often involve complex legal and factual questions and proceedings that vary based on the local law of the relevant jurisdiction. Our ability to enforce our patents also depends on the laws of individual countries and each country’s practice with respect to enforcement of intellectual property rights. Patent protection must be obtained on a jurisdiction‑by‑jurisdictionjurisdiction-by-jurisdiction basis, and we only pursue patent protection in countries where we think it makes commercial sense for the given product. In addition, if we are unable to maintain our existing license agreements or other agreements pursuant to which third parties grant us rights to intellectual property, including because such agreements terminate, our financial condition and results of operations could be materially adversely affected.
Patent law reform in the U.S. and other countries may also weaken our ability to enforce our patent rights or make such enforcement financially unattractive. For instance, in September 2011, the U.S. enacted theThe America Invents Act which permits enhanced third‑partythird-party actions for challenging patents and implements a first‑to‑inventfirst-to-invent system. These reforms could result in increased costs to protect our intellectual property or limit our ability to obtain and maintain patent protection for our products in these jurisdictions. Additionally, certain foreign governments have indicated that compulsory licenses to patents may be granted in the case of national emergencies, which could diminish or eliminate sales and profits from those regions and materially adversely affect our financial condition and results of operations.
Our trademarks and brands may provide us with a competitive advantage in the market as they may be known or trusted by consumers. In order to maintain the value of such brands, we must be able to enforce and defend our trademarks. We have pursued and will continue to pursue the registration of trademarks and service marks in the U.S. and internationally; however, enforcing rights against those who knowingly or unknowingly dilute or infringe our brands can be difficult. Effective trademark, service mark, trade dress or related protections may not be available in every country in which our products and services are available. Enforcement is especially difficult in first‑to‑filefirst-to-file countries where “trademark squatters” can prevent us from obtaining adequate protections for our brands. There can be no assurance that the steps we have taken and will take to protect our proprietary rights in our brands and trademarks will be adequate or that third parties will not infringe, dilute or misappropriate our brands, trademarks, trade dress or other similar proprietary rights.
Many of our products are based on or incorporate proprietary information. We actively seek to protect our proprietary information, including our trade secrets and proprietary know‑how,know-how, by generally requiring our employees, consultants, other advisors and other third parties to execute proprietary information and confidentiality agreements upon the commencement of their employment, engagement or other relationship. Despite these efforts and precautions, we may be unable to prevent a third party from copying or otherwise obtaining and using our trade secrets or our other intellectual property without authorization and legal remedies may not adequately compensate us for the damages caused by such unauthorized use. Further, others may independently and lawfully develop substantially similar or identical products that circumvent our intellectual property by means of alternative designs or processes or otherwise.
The illegal distribution and sale by third parties of counterfeit or illegally compounded versions of our products or of stolen, diverted or relabeled products could have a negative impact on our reputation and business.
Third parties may illegally distribute and sell counterfeit or illegally compounded versions of our products that do not meet the exacting standards of our development, manufacturing and distribution processes. Counterfeit or illegally compounded medicines pose a significant risk to animal health and safety because of the conditions under which they are manufactured and the lack of regulation of their contents. Counterfeit or illegally compounded products are frequently unsafe or ineffective and can be potentially life-threatening to animals. Our reputation and business could suffer harm as a result of counterfeit or illegally compounded products which are alleged to be equivalent and/or which are sold under our brand name. In addition, products stolen or unlawfully diverted from inventory, warehouses, plants or while in transit, which are not properly stored or which have an expired shelf life and which have been repackaged or relabeled and which are sold through unauthorized channels, could adversely impact animal health and safety, our reputation and our business. With the acquisition of the Bayer Animal Health business, we have now expanded our business more into direct to retailer and e-commerce channels in order to meet the pet owners where they want to purchase, which may increase the risk of counterfeiting of our products. Public loss of confidence in the integrity of vaccines and/or pharmaceutical products as a result of counterfeiting, illegal compounding or theft could have a material adverse effect on our business, financial condition and results of operations.
Unanticipated safety, quality or efficacy concerns or identified concerns associated with our products may harm our reputation and have an adverse impact on our performance.
Unanticipated safety, quality or efficacy concerns arise from time to time with respect to animal health products, whether or not scientifically or clinically supported, potentially leading to product recalls, withdrawals or suspended or declining sales, as well as product liability and other claims. Regulatory actions based on these types of safety, quality or efficacy concerns could impact all, or a significant portion, of a product’s sales.
For example, lawsuits seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been filed against us arising out of the use of Seresto, a non-prescription flea and tick collar for cats and dogs, based on reports alleging that the collar has caused injury and death to pets. Further, a U.S. House of Representatives' subcommittee chair requested that we produce certain documents and information related to the Seresto collar, made a request to temporarily remove Seresto collars from the market and, during a hearing at which our President and Chief Executive Officer (CEO) testified, again called for removal of the collars from the market. Similar actions relating to Seresto could be taken by regulatory agencies. If any such claims with respect to Seresto or our other products are resolved adversely to us, or if a regulatory agency determines that a recall of any of our products, including Seresto, is necessary, such action could cause harm to our reputation, reduce our product sales, result in monetary penalties and other costly remedies against us, and could therefore have a material adverse effect on our business, financial condition and results of operations.
In addition, we depend on positive perceptions of the safety, quality and efficacy of our products, and animal health products in general, by food producers, veterinarians and pet owners. Any concern as to the safety, quality or efficacy of our products, whether actual or perceived, may harm our reputation. These concerns, including those relating to Seresto, and the related harm to our reputation could materially adversely affect our business, financial condition and results of operations, regardless of whether such reports are accurate.
We may not successfully implement our business strategies or achieve targeted cost efficiencies and gross margin improvements.
We are pursuing strategic initiatives that management considers critical to our long-term success, including, but not limited to: improving manufacturing processes, reducing our manufacturing footprint, achieving lean initiatives, consolidating our CMO network, strategically insourcing projects, pursuing cost savings opportunities through alternate sources of supply and improving the productivity of our sales force. Following the acquisition of Bayer Animal Health and again in 2021, we conducted restructuring programs which included the elimination of positions across several countries, primarily in sales and marketing, R&D, manufacturing and quality, and back-office support. There are significant risks involved with the execution of these restructuring programs, including costly expenses related to severance, asset impairment and other charges as well as business disruption, loss of accumulated knowledge and procedural efficiency, failure to achieve some or all of the benefits of the restructuring programs,
lawsuits arising from the restructuring programs, and the need for a significant amount of management and other employees’ time and focus, which may divert attention from operating the business. We may pursue additional strategic initiatives in the future to improve gross margins and achieve our targeted cost efficiencies. We also have acquired or partnered with a number of smaller animal health businesses, and we intend to continue to do so in the future. There are significant risks involved with the execution of these initiatives, including significant business, economic and competitive uncertainties, many of which are outside of our control. Accordingly, we may not succeed in implementing these strategic initiatives. Realizing the anticipated benefits from these initiatives, if any benefits are achieved at all, may take several years. We may be unable to achieve our targeted cost efficiencies and gross margin improvements. Additionally, we may have insufficient access to capital to fund investments in strategic initiatives, or our business strategy may change from time to time, which could delay our ability to implement initiatives that we believe are important to our business.
Our business results fluctuate due to seasonality and other factors and the extent of such fluctuations may be unpredictable.
Historically, our operating results have fluctuated during the year, and we expect these fluctuations to continue. For example, on average, approximately 75% and 60% of total annual revenue contribution from our higher-margin parasiticide products Seresto and Advantage Family, respectively, occurs in the first half of the year. This dynamic is reflective of the flea and tick season in the Northern Hemisphere.
Other factors that may cause our operating results to fluctuate are:
•weather conditions, including those related to climate change, and the availability of natural resources;
•increased or decreased inventory levels in our distribution channels;
•timing of customer orders and deliveries;
•competitive changes, such as price changes or new product introductions that we or our competitors may make;
•timing of marketing programs and events; and
•availability of veterinarians to use our products, as there are seasonal impacts, due to veterinarian vacations or training events that limit their ability to serve their customers that result in the use of our products.
For more detailed information on some of the above-listed factors that can cause fluctuations in our operating results, see risks described below under the headings "Our business may be negatively affected by weather conditions and the availability of natural resources" and "Increased or decreased inventory levels in our distribution channels can lead to fluctuations in our revenues and variations in our payment terms extended to our distributors can impact our cash flows."
Accordingly, the fluctuations in our revenues due to seasonality and other factors, many of which are beyond our control, mean period-to-period comparisons of our historical results are not necessarily meaningful. Investors should not rely on such fluctuations as an indication of our future performance. To the extent that we experience the factors described above, our future operating results may not meet the expectations of securities analysts or investors, which may cause the market price of our common stock to decline.
Our business may be negatively affected by weather conditions and the availability of natural resources.
The animal health industry and demand for many of our products in a particular region are affected by weather conditions, including those related to climate change, varying weather patterns and weather-related pressures from pests, such as ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.
Farm animal producers depend on the availability of natural resources, including large supplies of fresh water. Their animals’ health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions. In the event of adverse weather conditions or a shortage of fresh water, veterinarians or farm animal producers may purchase less of our products.
Further, heat waves may cause stress in animals and lead to increased vulnerability to disease, reduced fertility rates and reduced milk production. Droughts may threaten pasture and feed supplies by reducing the quality and amount of forage available to grazing livestock, while climate change may increase the prevalence of parasites and diseases that affect farm animals. Adverse weather conditions may also have a material impact on the aquaculture business. Changes in water temperatures could affect the timing of reproduction and growth of various fish species, as well as trigger the outbreak of certain water borne diseases.
In addition, veterinary hospitals and practitioners depend on visits from, and access to, the animals under their care. Veterinarians’ patient volume and ability to operate could be adversely affected if they experience prolonged snow, ice or other severe weather conditions, particularly in regions not accustomed to sustained inclement weather.
Modification of foreign trade policy may harm our farm animal product customers.
Changes in laws, agreements and policies governing foreign trade in the territories and countries where our customers do business could negatively impact such customers’ businesses and adversely affect our results of operations. A number of our customers rely on duty reduction benefits provided by free trade agreements, such as the U.S.-Mexico-Canada-Agreement. However, trade partnerships and treaties can be modified by domestic and foreign governments, which could result in new or increased tariffs. Additionally, countries are becoming increasingly protectionist, both to protect local industries as well as to ensure domestic supply chain continuity for key products, such as medicine. Finally, as global security decreases, more countries will use sanctions and export controls as a method to deal with such insecurity, which could result in decreased markets for our products.
Our results of operations may be adversely affected by foreign currency exchange rate fluctuations.
Our results are reported in U.S. dollars. As a result, we are exposed to foreign currency exchange risk as the functional currency financial statements of non-U.S. subsidiaries are translated to U.S. dollars for reporting purposes. To the extent that revenue and expense transactions are not denominated in the functional currency, we are also subject to the risk of transaction losses. Given the volatility of exchange rates and despite the mitigating impact of foreign currency forward or option derivative contracts we enter into in order to reduce the effect of fluctuating currency exchange rates in future periods, there is no guarantee that we will be able to effectively manage currency transaction and/or translation risks, which could adversely affect our results of operations.
Customer exposure to rising costs and reduced customer income, as well as a lack of availability or significant increases in the cost of raw materials used in manufacturing our products, could have a material adverse effect on our profit margins and operating results.
Feed, fuel, transportation and other key costs for farm animal producers may continue to increase or animal protein prices or sales may decrease. Either of these trends could cause deterioration in the financial condition of our farm animal product customers, potentially inhibiting their ability to purchase our products or pay us for products delivered. Our farm animal product customers may offset rising costs by reducing spending on our products, including by switching to lower-cost alternatives. In addition, concerns about the financial resources of pet owners could cause veterinarians to alter their treatment recommendations in favor of lower-cost alternatives to our products, which could result in a decrease in sales of our pet health products, especially in developed countries where there are higher rates of pet ownership. Rising costs or reduced income for our customers could have a material adverse effect on our business, financial condition and results of operations.
We rely on third parties to source many of our raw materials and to manufacture products that we distribute. For more information, see "Item 1. Business — Manufacturing and Supply Chain." We have and may continue to experience cost increases in certain raw materials or other components required to manufacture our products due to increased shipping costs and other inflationary pressures. This may have a material adverse impact on our financial results if we cannot pass on such increases to our customers. Further, the unavailability or delivery delays of raw materials has affected and could continue to affect our ability to ship the related products timely, more severely impacting high-volume or high-margin products.
For our pet health products, increased use of alternative distribution channels, or changes within existing distribution channels, could negatively impact our market share, margins and distribution of our products.
In most markets, pet owners typically purchase their animal health products directly from veterinarians. However, pet owners increasingly have the option to purchase animal health products from sources other than veterinarians, such as online retailers, “big-box” retail stores or other over-the-counter distribution channels. This trend has been demonstrated by the significant shift away from the veterinarian distribution channel in the sale of flea and tick products in recent years. Pet owners also could decrease their reliance on, and visits to, veterinarians as they rely more on internet-based animal health information. Because we market our pet health prescription products primarily through the veterinarian distribution channel, any significant decrease in visits to veterinarians by pet owners could reduce our market share for such products and materially adversely affect our business, financial condition and results of operations. In addition, pet owners may substitute human health products for animal health products if human health products are deemed to be lower-cost alternatives.
Legislation has also been proposed in the U.S., and may be proposed in the U.S. or abroad in the future, which could impact the distribution channels for our pet health products. For example, such legislation may require veterinarians to provide pet owners with written prescriptions and disclosure that the pet owner may fill prescriptions through a third party, which may further reduce the number of pet owners who purchase their animal health products directly from veterinarians. Such requirements may lead to increased use of generic alternatives to our products or the increased substitution of our pet health products with other animal health products or human health products if such other products are deemed to be lower-cost alternatives. Many states already have regulations requiring veterinarians to provide prescriptions to pet owners upon request and the American Veterinary Medical Association has long-standing policies in place to encourage this practice.
Over time, these and other competitive conditions may further increase our use of online retailers, “big-box” retail stores or other over-the-counter distribution channels to sell our pet health products. We may not be adequately prepared or able to distribute our pet health products if an increased portion of our sales occur through these channels. Also, we may realize lower margins on sales through these distribution channels than we do on sales through veterinarians. Any of these events could materially adversely affect our business, financial condition and results of operations.
In addition, if one or more of our pet health distributors discontinues or modifies their relationship with us, our business, financial condition and results of operations may be materially adversely affected. For example, in 2020, we completed the previously communicated channel inventory reduction, moving to inventory levels across the world and across species that represent the minimum necessary to allow our distributors to maintain strong service levels with their end customers.
Increased or decreased inventory levels in our distribution channels can lead to fluctuations in our revenues and variations in payment terms extended to our distributors can impact our cash flows.
In addition to selling our products directly to veterinarians, we sell to distributors and retailers who, in turn, sell our products to third parties.Inventory levels at our distributors and retailers increase or decrease as a result of various factors, including end customer demand, new customer contracts, heightened competition, required minimum inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, and procedures and environmental factors beyond our control, including weather conditions or an outbreak of infectious disease such as COVID-19 or diseases carried by farm animals such as African Swine Fever. These increases and decreases can and have led to variations in our quarterly and annual revenues. In addition, like all companies that manufacture and sell products, we have policies that govern the payment terms that we extend to our customers. Due to consolidation amongst our distributors, as well as changes in the buying habits of end customers or the need for certain inventory levels at our tax rates,distributors to avoid supply disruptions, from time to time, our distributors have requested exceptions to the payment term policies that we extend to them. Extensions of customer payment terms can impact our cash flows, liquidity and results of operations.
We may be required to write down goodwill or identifiable intangible assets.
Under accounting principles generally accepted in the United States (U.S. GAAP), if we determine goodwill or identifiable intangible assets are impaired, we will be required to write down these assets and record a non-cash impairment charge. As of December 31, 2022, we had recorded on our balance sheet goodwill of $6.0 billion and identifiable intangible assets of $4.8 billion. Identifiable intangible assets consist primarily of marketed products acquired or licensed from third parties, licensed platform technologies that have alternative future uses in R&D, manufacturing technologies, customer relationships from business combinations and software. We also have indefinite-lived intangible assets, which primarily consist of acquired in-process R&D projects from business combinations that are subject to impairment and non-cash impairment charges.
Determining whether an impairment exists and the amount of the potential impairment involves quantitative data and qualitative criteria that are based on estimates and assumptions requiring significant management judgment. Future events or new information may change management’s valuation of an intangible asset in a short amount of time. The timing and amount of impairment charges recorded in the consolidated statements of operations and write-downs recorded on our consolidated balance sheets could vary if our management’s conclusions change. Any impairment of goodwill or identifiable intangible assets could have a material adverse effect on our business, financial condition and results of operations.
Our R&D relies on evaluations of animals, which may become subject to bans, additional restrictive regulations or increased attention from activism movements.
As an animal health medicines and vaccines business, we are required to evaluate the effect of our existing and new products in animals in order to register such products. Animal testing in certain industries has been the subject of controversy and adverse publicity. Some organizations and individuals have attempted to ban animal testing or encourage the adoption of new regulations applicable to animal testing. To the extent that the activities of such organizations and individuals are successful, our R&D, and by extension our business, financial condition and results of operations, could be materially adversely affected. In addition, negative publicity about us or our industry could harm our reputation. For example, farm animal producers may experience decreased demand for their products or reputational harm as a result of evolving consumer views of animal rights, nutrition, health-related or other concerns. Any reputational harm to the farm animal industry may also extend to companies in related industries, including our company. Adverse consumer views related to the use of one or more of our products in farm animals also may result in a decrease in the use of such products and could have a material adverse effect on our operating results and financial condition.
Manufacturing problems and capacity imbalances may cause product launch delays, inventory shortages, recalls or unanticipated costs.
In order to sell our products, we must be able to produce and ship sufficient quantities to our customers. We own and operate 18 internal manufacturing sites located in 11 countries. We also employ a network of approximately 150 third-party CMOs. Many of our products involve complex manufacturing processes and are sole sourced from certain manufacturing sites.
Minor deviations in our manufacturing or logistical processes, such as temperature excursions or improper package sealing, could result, and have in the past resulted in, delays, inventory shortages, unanticipated costs, product recalls, product liability and/or regulatory action. In addition, a number of factors could cause production interruptions, including:
•the failure of us or any of our vendors or suppliers, including logistical service providers, to comply with applicable regulations and quality assurance guidelines;
•mislabeling;
•construction delays;
•equipment malfunctions;
•shortages of materials;
•labor problems;
•natural disasters;
•power outages;
•criminal and terrorist activities;
•changes in manufacturing production sites and limits to manufacturing capacity due to regulatory requirements, changes in types of products produced, shipping distributions or physical limitations; and
•the outbreak of any highly contagious diseases.
These interruptions could result in launch delays, inventory shortages, recalls, unanticipated costs or issues with our agreements under which we supply third parties, which may materially adversely affect our business, financial condition and results of operations.
Our manufacturing network may be unable to meet the demand for our products or we may have excess capacity if demand for our products changes. The unpredictability of a product’s regulatory or commercial success or failure, the lead time necessary to construct highly technical and complex manufacturing sites and shifting customer demand (including as a result of market conditions or entry of branded or generic competition) increase the potential for capacity imbalances. In addition, construction of sites is expensive, and our ability to recover costs will depend on the market acceptance and success of the products produced at the new sites, which is uncertain.
We have invested and will continue to invest in improvements to our existing manufacturing facilities and in new manufacturing plants. These types of projects are subject to risks of delay or cost overruns inherent in any large construction project and require licensing by or approvals from various regulatory authorities. Significant cost overruns or delays in completing these projects could have an adverse effect on our financial condition or results of operations.
We may incur substantial costs and receive adverse outcomes in litigation, regulatory investigations, and other legal matters.
Our business, financial condition and results of operations could be materially adversely affected by unfavorable results in pending or future litigation, regulatory investigations, and other legal matters. These matters may include, among other things, allegations of violation of U.S. and foreign competition law, labor laws, securities laws and regulations, consumer protection laws and environmental laws and regulations, as well as claims or foreignlitigation relating to product liability, intellectual property, securities, breach of contract and tort. For example, shareholder class action lawsuits that were filed against us in 2020 allege, in part, that we and certain of our executives made materially false and/or misleading statements and/or failed to disclose certain facts about our supply chain, inventory, revenue, projections and our relationships with third party distributors and revenue attributable to those distributors. We intend to vigorously defend the claims made in these lawsuits; however, the ultimate resolution cannot be predicted, and the claims raised in these lawsuits may result in further legal matters or actions against us, including, but not limited to, government enforcement actions or additional private litigation.
Also, on July 1, 2021, we received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We have been responding to requests for documents and information from the SEC and will continue to do so. We believe that our actions were appropriate. However, we cannot predict the outcome of any particular proceeding, or whether the SEC investigation will be resolved favorably or ultimately result in charges or material damages, fines or other penalties, enforcement actions, or civil or criminal proceedings against us or members of our senior management.
Litigation matters and regulatory investigations, regardless of their merits or their ultimate outcomes, are costly, divert management’s attention and may materially adversely affect our reputation and demand for our products. We cannot predict with certainty the eventual outcome of pending or future legal matters. An adverse outcome of litigation or legal matters could result in us being responsible for significant damages. Any of these negative effects resulting from litigation, regulatory investigations and other legal matters could materially adversely affect our business, financial condition and results of operations.
In addition, changes in the interpretations of laws and regulations to which we are subject, or in legal standards in one or more of the jurisdictions in which we operate, could increase our exposure to liability. For example, in the U.S., attempts have been made to allow damages for emotional distress and pain and suffering in connection with the loss of, or injury to, a pet. If such attempts were successful, our exposure with respect to product liability claims could increase materially.
Our insurance policies may be insufficient to protect against all potential hazards or litigation claims.
We rely on a combination of insurance and self-insurance, and changes in predictions, assumptions, and interpretations could affect our operations. Insurance policies include limits and may be insufficient to protect against all potential hazards and risks or litigation claims. Our product liability insurance policy may not fully cover our potential liabilities. In addition, we may determine that we should increase our coverage, and this insurance may be prohibitively expensive to us or our collaborators or licensees and may not fully cover our potential liabilities.
We may incur additional tax legislationexpense or exposurebecome subject to additional tax liabilities.exposure.
We are subject to income taxes in the U.S. and numerous foreignother jurisdictions. Changes in the relevant tax laws, regulations, administrative practices, principles and interpretations could adversely affect ourOur future effective tax rates. The U.S. recently enacted tax reform legislation significantly revising U.S. tax law, and a number of othercountries are actively considering or enacting tax changes. Other organizations, such as the Organization for Economic Cooperation and Development and the European Commission, are also active concerning tax related
matters, which could influence international tax policy in countries in which we operate. While outcomes of these initiatives continue to develop and remain uncertain, modifications to key elements of the U.S. or international tax framework could have a material adverse effect on our consolidated results of operations and cash flows.
In December 2017, the President of the United States signed into law the Tax Cuts and Jobs Act (the ‘‘2017 Tax Act’’). The 2017 Tax Act included significantcould be adversely affected by changes to the U.S. corporate income tax system, such as the reduction in the corporate incomeeffective tax rate transition to a modified territorial tax system, changes to business related exclusions, deductions and credits, and modifications to international tax provisions. The U.S. Treasury Department and the IRS began to issue major proposed regulations related to the 2017 Tax Act during the second half of 2018 and are expected to continue issuing such regulations through spring of 2019. The proposed regulations are generally subject to comment before being finalized; however, once finalized, these regulations may require Elanco to make adjustments, in particular, as a result of certain complex international provisions containeda change in the 2017 Tax Act. Such adjustments might materially impact Elanco’s provision for income taxesmix of earnings between U.S. and effectivenon-U.S. jurisdictions or among jurisdictions with differing statutory tax raterates, changes in our overall profitability, changes in tax laws or treaties or in their application or interpretation, changes in tax rates, changes in generally accepted accounting principles, changes in the period in whichvaluation of deferred tax assets and liabilities, the adjustments are maderesults of audits and could also impact Elanco’s net income, earnings per share, consolidated cash flowsexaminations of previously filed tax returns and liquidity.
In addition, our effective tax rate is subject to potential risks that various taxing authorities may challenge the pricingcontinuing assessments of our cross border arrangements and subject us to additional tax adversely impacting our effective tax rate and tax liability.exposures. We are also subject to the examination of our tax returns and other tax matters by the Internal Revenue Service (IRS) and other tax authorities and governmental bodies. We regularly assess the likelihood of an adverse outcome resulting from these examinations to determine the adequacy of our provision for taxes. There can be no assurance as to the outcome of these examinations. If our effective tax rates were to increase, particularly in the U.S. or other material foreign jurisdictions, or if the ultimate determination of our taxes owed is for an amount in excess of amounts previously accrued, our operating results, cash flows and financial condition could be adversely affected.
We are subject to complex environmental, health and safety laws and regulations.
We are subject to various federal, state, local and foreign environmental, health and safety laws and regulations. These laws and regulations govern matters such as the emission and discharge of hazardous materials into the ground, air or water; the generation, use, storage, handling, treatment, packaging, transportation, exposure to and disposal of hazardous and biological materials, including recordkeeping, reporting and registration requirements; and the health and safety of our employees. Due to our operations, these laws and regulations also require us to obtain, and comply with, permits, registrations or other authorizations issued by governmental authorities. These authorities can modify or revoke our permits, registrations or other authorizations and can enforce compliance through fines and injunctions.
Given the nature of our business, we have incurred, are currently incurring and may in the future incur liabilities for the investigation and remediation of contaminated land under the U.S. Comprehensive Environmental Response, Compensation and Liability Act of 1980, as amended, or under other federal, state, local and foreign environmental cleanup laws, with respect to our current or former sites, adjacent or nearby third-party sites, or offsite disposal locations. We could be subject to liability for the investigation and remediation of legacy environmental contamination caused by historical industrial activity at sites that we own or on which we operate. The costs associated with future cleanup activities that we may be required to conduct or finance could be material. Additionally, we may become liable to third parties for damages, including for personal injury, property damage and natural resource damages, resulting from the disposal or release of hazardous materials into the environment. Such liability could materially adversely affect our business, financial condition and results of operations.
Furthermore, regulatory agencies are showing increasing concern over the impact of animal health products and farm animal operations on the environment. This increased regulatory scrutiny has in the past and may in the future necessitate that additional time and resources be spent to address these concerns in both new and existing products.
Our failure to comply with the environmental, health and safety laws and regulations to which we are subject, including any permits issued thereunder, may result in environmental remediation costs, loss of permits, fines, penalties or other adverse governmental or private actions, including regulatory or judicial orders enjoining or curtailing operations or requiring corrective measures, installation of pollution control equipment or remedial measures. We could also be held liable for any and all consequences arising out of human exposure to hazardous materials, environmental damage or significant environmental, health and safety issues that might arise at a manufacturing or R&D facility. Environmental laws and regulations are complex, change frequently, have tended to become more stringent and stringently enforced over time and may be subject to new interpretation. It is possible that our costs of complying with current and future environmental, health and safety laws, and our liabilities arising from past or future releases of, or exposure to, hazardous materials could materially adversely affected.
affect our business, financial condition and results of operations.
Significant portions of our operations are conducted in foreign jurisdictions, including jurisdictions presenting a high risk of bribery and corruption, and are subject to the economic, political, legal and business environments of the countries in which we do business.
Our international operations could be limited or disrupted by any of the following:
•volatility in the international financial markets;
•changes in the value of foreign currencies relative to the U.S. dollar or high inflation;
•compliance with governmental controls;
•difficulties enforcing contractual and intellectual property rights;
•parallel trade in our products (importation of our products from EU countries where our products are sold at lower prices into EU countries where the products are sold at higher prices);
•compliance with a wide variety of laws and regulations, such as the U.S. Foreign Corrupt Practices Act (the FCPA) and similar non‑U.S.non-U.S. laws and regulations;
•compliance with foreign labor laws;
•compliance with local, regional and global restrictions on banking and commercial activities in emerging markets;
•burdens to comply with multiple and potentially conflicting foreign laws and regulations, including those relating to environmental, health and safety requirements;requirements and those in emerging markets;
•changes in laws, regulations, government controls or enforcement practices with respect to our business and the businesses of our customers, including the imposition of limits on our profitability;
•political and social instability, including crime, civil disturbance, terrorist activities and armed conflicts;conflicts such as the Russia-Ukraine conflict and the related government and other entity responses;
•trade restrictions and restrictions on direct investments by foreign entities, including restrictions administered by the Office of Foreign Assets Control of the U.S. Department of the Treasury and the EU, in relation to our products or the products of farmers and other customers;
•government limitations on foreign ownership;
•government takeover or nationalization of business;
•changes in tax laws and tariffs;
•imposition of anti‑dumpinganti-dumping and countervailing duties or other trade‑relatedtrade-related sanctions;
•costs and difficulties and compliance risks in staffing, managing and monitoring international operations, including in the use of overseas third‑partythird-party goods and service providers;
•corruption risk inherent in business arrangements and regulatory contacts with foreign government entities;
•longer payment cycles and increased exposure to counterparty risk;
•continued uncertainty, potential instability and volatility due to the withdrawal of the U.K. from the EU; and
•additional limitations on transferring personal information between countries or other restrictions on the processing of personal information.
In addition, international transactions may involve increased financial and legal risks due to differing legal systems and customs.customs, as well as restrictions and sanctions that may be imposed on one or more jurisdictions, including those arising from the recent crisis in Ukraine. Compliance with these requirements may prohibit the import or export of certain products and technologies or may require us to obtain a license before importing or exporting certain products or technologies. A failure to comply with any of these laws, regulations or requirements could result in civil or criminal legal proceedings, monetary or non‑monetarynon-monetary penalties, or both, disruptions to our business, limitations on our ability to import and export products, and damage to our reputation. In addition, variations in the pricing of our products between jurisdictions may result in the unauthorized importation or unauthorized re‑importationre-importation of our products between jurisdictions and may also result in the imposition of anti‑dumpinganti-dumping and countervailing duties or other trade‑relatedtrade-related sanctions. While the impact of these factors is difficult to predict, any of them could materially adversely affect our business, financial condition and results of operations.
Further, changes in any of these laws, regulations or requirements, or the political environment in a particular country, may affect our ability to engage in business transactions in certain markets, including investment, procurement and repatriation of earnings.
Significant portions of our operations are conducted in Europe and could be impacted by the withdrawal of the United Kingdom (UK) from the EU, commonly referred to as “Brexit.”
In June 2016, voters in the UK approved an advisory referendum to withdraw from the EU, commonly referred to as Brexit. On March 29, 2017, the UK Prime Minister formally notified the European Council of the UK’s intention to withdraw from the EU under Article 50 of the Treaty of Lisbon. The notice began a two-year negotiation period to establish the withdrawal terms. The referendum and notice created political, regulatory and economic uncertainty, particularly in the UK and the EU, and this uncertainty may persist for years if the withdrawal becomes effective in March 2019 without clarification as to whether the UK will continue to be party to the EU Free Trade Agreements (FTA) at the end of the negotiation period.
Our business is subject to substantial regulation. If the UK withdraws from the EU without an agreement and mutual recognition of the EU FTAs, we may not be able to market certain products that entered the EU market following marketing authorization by UK authorities in all the nations that are parties to FTAs with the EU unless and until we have obtained all required regulatory approvals in each jurisdiction where we propose to market those products.
In addition, the uncertainty related to Brexit has caused foreign exchange rate fluctuations in the past, including the strengthening of the U.S. dollar relative to the euro and British pound immediately following the announcement of Brexit. The implementation of, or further developments with respect to, Brexit could further impact foreign exchange rates, which could materially adversely affect our business, financial condition and results of operations.
A withdrawal with no deal in place could significantly disrupt the free movement of goods, services, and people between the UK and the EU, and result in increased legal and regulatory complexities, as well as potential higher costs of conducting business in Europe and declining gross domestic product in many European markets. The UK’s vote to exit the EU could also result in similar referendums or votes in other European countries in which we do business.
If no agreement is reached at the end of the two-year negotiation period on March 29, 2019 and the UK’s separation becomes effective, unless the remaining EU members unanimously agree to an extension, the uncertainty surrounding the terms of the UK’s withdrawal and its consequences could adversely impact consumer and investor confidence, and could affect sales or regulation of our products. Any of these effects, among others, could materially adversely affect our business, financial condition and results of operations.
Foreign exchange rate fluctuations and potential currency controls affect our results of operations, as reported in our financial statements.
We conduct operations in many areas of the world, involving transactions denominated in a variety of currencies. In 2018, we generated approximately 52% of our revenue in currencies other than the U.S. dollar, principally the euro, British pound, Brazilian real, Australian dollar, Japanese yen, Canadian dollar and Chinese yuan. We are subject to currency exchange rate risk to the extent that our costs are denominated in currencies other than those in which we earn revenue. In addition, because our financial statements are reported in U.S. dollars, changes in currency exchange rates between the U.S. dollar and other currencies have had, and will continue to have, an impact on our results of operations.
We also face risks arising from currency devaluations and the imposition of cash repatriation restrictions and exchange controls. Currency devaluations result in a diminished value of funds denominated in the currency of the country instituting the devaluation. Cash repatriation restrictions and exchange controls may limit our ability to convert foreign currencies into U.S. dollars or to remit dividends and other payments by our foreign subsidiaries or businesses located in or conducted within a country imposing restrictions or controls. While we currently have no need and do not intend to repatriate or convert cash held in countries that have significant restrictions or controls in place, should we need to do so to fund our operations, we may be unable to repatriate or convert such cash, or may be unable to do so without incurring substantial costs.
We also bear foreign exchange risk associated with the future cash settlement of an existing net investment hedge. In October 2018, we entered into a fixed interest rate, 5-year, 750 million Swiss franc net investment hedge (NIH) against Swiss franc assets. The NIH is expected to generate approximately $25 million in cash and contra interest expense per year; however, there is potential for significant 2023 settlement exposure on the 750 million Swiss franc notional if the U.S. dollar devalues versus the Swiss franc.
We depend on sophisticated information technology and infrastructure.
We rely on various information systemsare continuing to manage our operations, and we increasingly depend on third parties to operate and support our information technology systems, including by way of virtual and cloud‑based operations. These third parties include large established vendors as well as small, privately owned companies. Failure by any provider to adequately service our operations, or a change in control or insolvency of one or more providers, may materially adversely affect our business, financial condition and results of operations. Prior to the separation, we relied on Lilly to negotiate and manage many of our relationships and contracts with these third parties.
In connection with the IPO and the separation, we have substantially changed, and will continue to develop,enhance a number of our business processes, including our financial reporting and supply chain processes and with respect to where and from whom we obtain information technology systems. In orderWe have made and will continue to support the new business processes under the terms of our transitional services agreement with Lilly, we will make significant configuration, process and data changes within many of the information technology systems we use. If our information technology systems and processes are not sufficient to support our business and financial reporting functions, or if we fail to properly implement our new business processes, our financial reporting may be delayed or inaccurate and, as a result, our business, financial condition and results of operations may be materially adversely affected. Even if we are able to successfully configure and change our systems, all technology systems, even with implementation of security measures, are vulnerable to disability, failures or unauthorized access. If our information technology systems or our service providers' information technology systems were to fail or be breached, this could materially adversely affect our reputation and our ability to perform critical business functions, and sensitive and confidential data could be compromised.
Breaches of our information technology systems or improper disclosure of confidential company or personal data, or a failure to comply with privacy laws, regulations and our contractual obligations concerning data privacy or the security of certain information could have a material adverse effect on our reputation and operations, or we may fail to comply with privacy laws, regulations and our contractual obligations.operations.
We rely on information technology systems to process, transmit and store electronic information in our day‑to‑dayday-to-day operations, including customer, employee and company data. The secure processing, maintenance and transmission of this information is critical to our operations andoperations. In addition, the legal environment surrounding information security, storage, use, processing, transmission, maintenance, disclosure and privacy is demanding with the frequent imposition of new and changing regulatory requirements.
We also store, process, and transmit certain information with third parties.parties, including the use of cloud technologies. Our information systems and those of our third‑partythird-party vendors are subjected to computer viruses or other malicious codes, unauthorized access attempts, phishing and cyber‑ or phishing‑attacksother cyber-attacks and are also are vulnerable to an increasing threat of continually evolving cybersecurity risks and external hazards, as well as improper or inadvertent staff behavior, all of which could expose confidential
company and personal data systems and information to security breaches.behavior. Any suchpotential cyber breach could compromise our networks, and the information stored therein could be accessed, publicly disclosed, lost or stolen. Such attacks could result in our intellectual property and otherthe unauthorized access, public disclosure, loss or theft of confidential information being lostdata, or stolen,unauthorized access to, disruption of, or interference with our operations and otherthat rely on information systems. Such breach can also have negative consequences, such as increased costs for security measures or remediation costs, and diversion of management attention.
In the wake of the COVID-19 pandemic, we are increasingly dependent on our information technology systems as our office workers, who are primarily working remotely, rely on third-party applications to perform their job duties and are processing information through our network via their home networks, which may be less secure. As such, our ability to effectively manage our business depends on the security, reliability and adequacy of our technology systems and data and the ability of our employees to follow our cyber security policies and protocols.
Any actual or perceived access, disclosure or other loss of information or any significant breakdown, intrusion, interruption, cyber‑attackcyber-attack or corruption of customer, employee or company data or our failure to comply with federal, state, local and foreign privacy laws or contractual obligations with customers, vendors, payment processors and other third parties, could result in legal claims or proceedings, liability under laws or contracts that protect the privacy of personal information, regulatory penalties, disruption of our operations, and damage to our reputation, all of which could materially adversely affect our business, revenue and competitive position. While we will continue to implement additional protective measures to reduce the risk of and detect cyber‑incidents, cyber‑attackscyber-incidents, cyber-attacks are becoming more sophisticated and frequent, and the techniques used in such attacks change rapidly. Our protective measures may not protect us against attacks and such attacks could have a significant impact on our business and reputation. In addition, prior to the separation, we relied on Lilly for certain privacy and compliance functions and personnel and may experience difficulties maintaining and implementing all policies and practices following completion of the separation.
Increased regulation or decreased governmental financial support relating to the raising, processing or consumption of food animals could reduce demand for our food animal products.
Companies in the food animal sector are subject to extensive and increasingly stringent regulations. See “Business of Elanco - Regulatory.” If food animal producers are adversely affected by new regulations or changes to existing regulations, they may reduce herd or flock sizes or become less profitable and, as a result, they may reduce their use of our products, which may materially adversely affect our business, financial condition and results of operations. Also, many food animal producers benefit from governmental subsidies, and if such subsidies were to be reduced or eliminated, these companies may become less profitable and, as a result, may reduce their use of our food animal products. More stringent regulation of the food animal sector, including regarding the use of food animal products, could have a material adverse effect on our business, financial condition and results of operations.
Our business could be materially adversely affected by labor disputes, strikes or work stoppages.
Some of our employees are members of unions, works councils, trade associations or are otherwise subject to collective bargaining agreements in certain jurisdictions, including the U.S. As a result, we are subject to the risk of labor disputes, strikes, work stoppages and other labor‑relationslabor-relations matters. We may be unable to negotiate new collective bargaining agreements on similar or more favorable terms and may experience work stoppages, higher ongoing labor costs or other labor problems in the future at our sites. We may also experience difficulty or delays in implementing changes to our workforce in certain markets. These risks may be increased by the separation because we will no longer be able to benefit from Lilly’s prior relationships and negotiations relating to such agreements.
Further, labor‑relatedlabor-related issues, including at our suppliers or CMOs, could cause a disruption of our operations, which could have a material adverse effect on our business, financial condition and results of operations, potentially resulting in cancelled orders by customers, unanticipated inventory accumulation or shortages and reduced revenue and net income.
The anticipated benefitsA loss of key personnel or highly skilled employees could disrupt our operations.
Our future success depends partly on the separationcontinued service of our highly qualified and the exchange offer may not be achieved.
well-trained key research, engineering, sales, marketing, manufacturing, executive and administrative personnel. We may not be ableface intense competition for these qualified personnel from our competitors and others, particularly for certain highly technical specialties in geographic areas where we continue to achieve the full strategic and financial benefits expectedrecruit. Due to result from the separation and the exchange offer. Further, such benefits, if ultimately achieved,this intense competition, we may be delayed. These benefits includeunable to continue to attract and retain qualified personnel necessary for the following:
improvingdevelopment of our business or to recruit or identify suitable replacement personnel. If we are unsuccessful in our recruitment and retention efforts, our business may be harmed. In addition, if we fail to effectively manage organizational and/or strategic and operational flexibility and streamlining decision‑making by providing the flexibility to implement our strategic plan and to respond more effectively to different customer needs and the changing economic and industry environment;
allowing us to adopt the investment policy and dividend policy best suited tochanges, our financial profilecondition, results of operations and business needs, and allowing us to raise capital as an independent business;
creating an independent equity structure that makes possible future acquisitions utilizing our common stockreputation, as well as compensation arrangements;our ability to successfully attract, motivate and
facilitating incentive compensation arrangements for retain key employees, more directly tied to the performance of our business, and enhancing employee hiring and retention by, among other things, improving the alignment of management and employee incentives with performance and growth objectives of our business.
We may not achieve the anticipated benefits of the separation and the exchange offer for a variety of reasons, which could materially adversely affect our business, financial condition and results of operations.be harmed.
We have underfunded pension plan liabilities. We will require current and future operating cash flow to fund these shortfalls, reducing the cash available for other uses.
We have certain defined benefit pension plans, predominantly outside of the U.S., thatin Germany and Switzerland, in which our employees participate in that are either dedicated to our employees or where the plan assets and liabilities that relate to our employees were legally required to transfer to us at the time of the separation.our separation from Lilly. The funded status and net periodic pension cost for these plans is materially affected by the discount rate used to measure pension obligations, the longevity and actuarial profile of our workforce, the level of plan assets available to fund those obligations and the actual and expected long‑termlong-term rate of return on plan assets. Significant changes in investment performance or a change in the portfolio mix of invested assets can result in corresponding increases and decreases in the valuation of plan assets or in a change in the expected rate of return on plan assets. As of December 31, 2018,2022, for pension plans with projected benefit obligations in excess of plan assets, the projected benefit obligation was $229.2$301 million with plan assets of $124.1$150 million. Any changes in the discount rate could result in a significant increase or decrease in the valuation of pension obligations, affecting the reported funded status of our pension plans as well as the net periodic pension cost in the following years. Similarly, changes in the expected return on plan assets can result in significant changes in the net periodic pension cost in the following years. The need to make additional cash contributions will divert resources from our operations and may have a material adverse effect on our business, financial condition and results of operations.
Risks Related to Acquisitions and Divestitures
We may not be able to successfully complete favorable transactions or successfully integrate acquired businesses when we pursue acquisitions, divestitures, joint ventures or other significant transactions.
From time to time, we evaluate potential acquisitions, divestitures or joint ventures that would further our strategic objectives. The completion of such transactions is often subject to conditions that may be outside our control, including obtaining the requisite approval of the shareholders of the target company and/or government approval pursuant to the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended. Accordingly, we may not be able to complete announced and signed transactions, and therefore, may not realize the anticipated benefits therefrom.
After the closing of an acquisition we are required to devote significant management attention and resources to integrating the portfolio and operations of the target company. Potential difficulties that we may encounter in the integration process, including as a result of distraction of our management, include the following:
•the inability to realize the anticipated value from various assets of the target company;
•the inability to combine the businesses of the acquired company with ours in a manner that permits us to achieve the cost savings or other synergies anticipated as a result of the transaction or to achieve such cost savings or other anticipated synergies in a timely manner, which could result in us not realizing some anticipated benefits of the transaction in the time frame anticipated, or at all;
•the loss of key employees;
•potential unknown liabilities and unforeseen increased expenses, delays or unfavorable conditions in connection with the closing of the transaction and the subsequent integration; and
•performance shortfalls at our or the target company as a result of the diversion of management’s attention from ongoing business activities as a result of completing the transaction and integrating the companies’ operations.
Additionally, as a result of our acquisition of Bayer Animal Health, we are operating under two separate enterprise resource planning (ERP) systems to support business operations such as invoicing, manufacturing, shipping, inventory control, procurement, supply chain management and financial reporting. We have started the process of integrating these two ERP systems into one primary platform and expect to complete the implementation process during 2023. ERP integrations have inherent risks, which can complicate our business operations and potentially lead to breakdowns in data integrity. The integration activities have also required, and will continue to require, significant resources to deploy. If we are unable to successfully integrate our systems to support critical business operations and to produce information for business decision-making activities, we could experience a material adverse impact on our business or an inability to timely and accurately report our financial results.
Future acquisitions could also result in potentially dilutive issuances of equity securities, the incurrence of debt, contingent liabilities or amortization expenses related to intangible assets, and increased operating expenses, which could adversely affect our results of operations and financial condition. Furthermore, if we issue equity or debt securities to raise additional funds, our existing shareholders may experience significant dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing shareholders. Furthermore, if we sell a substantial number of shares of common stock in the public markets, the availability of those shares for sale could adversely affect the market price of our common stock. Such sales, or the perception in the market that holders of a large number of shares intend to sell shares, could depress the market price of our common stock and impair our ability to raise capital through the sale of additional equity securities.
Risks Related to our Indebtedness
We have substantial indebtedness.
We have a significant amount of indebtedness, which could materially adversely affect our business, financial condition and results of operations. AsSee "Item 8. Financial Statements and Supplementary Data — Note 10: Debt" to the consolidated financial statements for further discussion.
We may incur substantial additional debt from time to time to finance working capital, capital expenditures, investments, acquisitions or for other purposes. If we do so, the risks related to our high level of debt could intensify. Specifically, ourOur high level of debt could have important consequences, including:
•making it more difficult for us to satisfy our obligations with respect to our debt;debt and any failure to comply with the obligations of any of our debt instruments, including restrictive covenants and borrowing conditions, could result in an event of default under the agreements governing other indebtedness;
•requiring us to dedicate a substantial portion of our cash flow from operations to the payment of interest and the repayment of our indebtedness, thereby reducing funds available to us for other purposes;
•limiting our ability to obtain additional financing to fund future working capital, capital expenditures, business development or other general corporate requirements, including dividends;
•increasing our vulnerability to general adverse economic and industry conditions;
•making us more highly leveraged than some of our competitors, which may place us at a competitive disadvantage;
•restricting us from making strategic acquisitions, engaging in development activities or exploiting business opportunities;
•causing us to make non-strategic divestitures;
•exposing us to the risk of increased interest rates as certain of our borrowings are and may in the future be at variable rates of interest;
•limiting our flexibility in planning for and reacting to changes in the animal health industry;
•impacting our effective tax rate; and
•increasing our cost of borrowing.
Despite our substantial indebtedness, we may still be able to incur significantly more debt, which could intensify the risks associated with our indebtedness.
We and our subsidiaries may be able to incur substantial indebtedness in the future. Although the terms of the credit agreement governing our credit facilities contain restrictions on our and our subsidiaries’ ability to incur additional indebtedness, these restrictions are subject to a number of important qualifications and exceptions, and the indebtedness incurred in compliance with these restrictions could be substantial. These restrictions do not prevent us from incurring other obligations that do not constitute indebtedness. In addition to our borrowings under our credit facilities, the covenants under the credit agreement governing our credit facilities are expected to, and the covenants under any other of our existing or future debt instruments could, allow us to incur a significant amount of additional indebtedness and, subject to certain limitations, such additional indebtedness could be secured. The more leveraged we become, the more we, and in turn our security holders, will be exposed to certain risks described above under the heading “We have substantial indebtedness.”
We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful.
Our ability to make scheduled payments on or refinance our debt obligations depends on our financial condition and operating performance, which are subject to prevailing economic and competitive conditions and to certain financial, business, legislative, regulatory and other factors beyond our control. We may be unable to maintain a
level of cash flows from operating activities sufficient to permit us to pay the principal and interest on our indebtedness.
If our cash flows and capital resources are insufficient to fund our debt service obligations, we could face substantial liquidity problems and could be forced to reduce or delay investments and capital expenditures, or to dispose of material assets or operations, alter our dividend policy, seek additional debt or equity capital or restructure or refinance our indebtedness. We may not be able to effect any such alternative measures on commercially reasonable terms or at all and, even if successful, those alternative actions may not allow us to meet our scheduled debt service obligations. The instruments that will govern our indebtedness may restrict our ability to dispose of assets and may restrict the use of proceeds from those dispositions and may also restrict our ability to raise debt or equity capital to be used to repay other indebtedness when it becomes due. We may not be able to consummate those dispositions or to obtain proceeds in an amount sufficient to meet any debt service obligations when due.
In addition, we conduct our operations through our subsidiaries. Accordingly, repayment of our indebtedness will depend on the generation of cash flow by our subsidiaries, including certain international subsidiaries, and their ability to make such cash available to us, by dividend, debt repayment or otherwise. Our subsidiaries may not have any obligation to pay amounts due on our indebtedness or to make funds available for that purpose. Our subsidiaries may not be able to, or may not be permitted to, make adequate distributions to enable us to make payments in respect of our indebtedness. Each subsidiary is a distinct legal entity and, under certain circumstances, legal, tax and contractual restrictions may limit our ability to obtain cash from our subsidiaries. In the event that we do not receive distributions from our subsidiaries, we may be unable to make required principal and interest payments on our indebtedness.
Our inability to generate sufficient cash flows to satisfy our debt obligations, or to refinance our indebtedness on commercially reasonable terms or at all, may materially adversely affect our business, financial condition and results of operations and our ability to satisfy our obligations under our indebtedness or pay dividends on our common stock.
Risks RelatedOur debt agreements contain restrictions that will limit our flexibility in operating our business.
Our credit facilities contain, and any other existing or future indebtedness of ours would likely contain, a number of covenants that impose significant operating and financial restrictions on us, including restrictions on our and our subsidiaries’ ability to, among other things:
•incur additional debt, guarantee indebtedness or issue certain preferred shares;
•pay dividends on or make distributions in respect of, or repurchase or redeem, our Relationshipcapital stock or make other restricted payments;
•prepay, redeem or repurchase certain debt;
•make loans or certain investments;
•sell certain assets;
•create liens on certain assets;
•consolidate, merge, sell or otherwise dispose of all or substantially all of our assets;
•enter into certain transactions with Lillyour affiliates;
•substantially alter the businesses we conduct;
•enter into agreements restricting our subsidiaries’ ability to pay dividends; and
•designate our subsidiaries as unrestricted subsidiaries.
In addition, certain of our credit facilities require us to comply with a net total leverage ratio and a minimum fixed charge coverage ratio under certain circumstances.
As a result of these covenants, we are limited in the separation,manner in which we will lose Lilly’s brand, reputation, capital base and other resources.
We believe our association with Lilly has contributed to our building relationships with our customers due to Lilly’s globally recognized brand and perceived high‑quality products. The separation could adversely affect our ability to attract and retain customers, which could result in reduced sales of our products.
The loss of Lilly’s scale, capital base and financial strength may also prompt suppliers to reprice, modify or terminate their relationships with us. In addition, Lilly’s reduction of its ownership of our company could potentially cause some of our existing agreements and licenses to be terminated. We cannot predict with certainty the effect that the separation will have onconduct our business, our clients, vendors or other persons, or whether our brand will be accepted in the marketplace.
Further, because we have not operated as a standalone company in the past, we may have difficulty doing so. We may need to acquire assets and resources in addition to those provided by Lilly, and in connection with the separation, may also face difficulty in separating our assets from Lilly’s assets and integrating newly acquired assets into our business. Our business, financial condition and results of operations could be materially adversely affected if we have difficulty operating as a standalone company, fail to acquire assets that prove to be important to our operations or incur unexpected costs in separating our assets from Lilly’s assets or integrating newly‑acquired assets.
Lilly may compete with us.
Lilly is not restricted from competing with us in the animal health business. Although Lilly has informed us it has no current intention to compete with us in the animal health business, if Lilly in the future decides to engage in the type of business we conduct, it may have a competitive advantage over us, which may cause our business, financial condition and results of operations to be materially adversely affected.
Certain of our directors may have actual or potential conflicts of interest because of their positions with Lilly.
A majority of our directors are employees of Lilly. Following the completion of the exchange offer, it is expected that each of these directors will resign from our board of directors and additional independent directors will be appointed. However, it is possible that our board of directors may determine that one or more of Lilly’s officers or employees should continue to serve on the board of directors for a period of time following the completion of the exchange offer. In addition, new or continuing directors may own Lilly common stock or equity awards. For certain of these individuals, their holdings of Lilly common stock or equity awards may be significant compared to their total assets. Their position at Lilly and the ownership of any Lilly equity or equity awards create, or may create the appearance of, conflicts of interest when these directors are faced with decisions that could have different implications for Lilly than for us. For example, these potential conflicts could arise, particularly if Lilly continues to own a substantial portion of our common stock following the exchange offer, over matters such as the desirability of changes in our business and operations, funding and capital matters, regulatory matters, matters arising with respect to the master separation agreement and other agreements with Lilly relating to the separation or otherwise, employee retention or recruiting, or our dividend policy.
Provisions relating to certain relationships and transactions in Elanco's amended and restated articles of incorporation address certain potential conflicts of interest between Elanco, on the one hand, and Lilly and its officers who are directors of Elanco, on the other hand. By becoming an Elanco shareholder, you will be deemed to have notice of and have consented to these provisions of Elanco's amended and restated articles of incorporation. Although these provisions are designed to resolve certain conflicts between Elanco and Lilly fairly, Elanco cannot assure you that any conflicts will be so resolved.
To preserve the tax‑free treatment to Lilly and its shareholders of the exchange offer and certain related transactions, we may not be able to engage in certain transactions.
To preserve the tax‑free treatment to Lilly and its shareholders of the exchange offer and certain related transactions, under the tax matters agreement, we are restricted from taking any action that prevents such transactions from being tax‑free for U.S. federal income tax purposes. These restrictions may limit our ability to pursue certain strategic transactions or engage in other transactions, including using our common stock to make acquisitions and in connection with equity capital market transactions that might increase the value of our business.
Lilly’s rights as licensor under the intellectual property and technology license agreement could limit our ability to develop and commercialize certain products.
Prior to the separation, we had the ability to leverage certain of Lilly’s intellectual property. As part of the separation, we entered into an intellectual property and technology license agreement. Pursuant to the intellectual property and technology license agreement, Lilly licenses to us certain of its intellectual property (excluding trademarks) related to the animal health business and also grants a license for us to use Lilly’s proprietary compound library for a period of two years plus up to three additional one‑year periods, each such period to be granted under Lilly’s sole discretion. If we fail to comply with our obligations under this agreement and Lilly exercises its right to terminate it, our ability to continue to research, develop and commercialize products incorporating that intellectual property will be limited. In addition, this agreement includes limitations that affect our ability to develop and commercialize certain products, including in circumstances where Lilly has an interest in the licensed intellectual property in connection with its human health development programs. These limitations and termination rights may make it more difficult, time consuming or expensive for us to develop and commercialize certain new products, or may result in our products being later to market than those of our competitors. For a summary description of the terms of the intellectual property and technology license agreement, see Note 19 in the consolidated and combined financial statements.
Our historical consolidated and combined financial data is not necessarily representative of the results we would have achieved as a standalone company and may not be a reliable indicator of our future results.
Our historical consolidated and combined financial data included in this report does not reflect the financial condition, results of operations or cash flows we would have achieved as a standalone company during the periods presented or those we will achieve in the future. This is primarily the result of the following factors:
our historical consolidated and combined financial data does not reflect the separation;
our historical consolidated and combined financial data reflects expense allocations for certain support functions that are provided on a centralized basis within Lilly, such as expenses for executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations that may be higher or lower than the comparable expenses we would have actually incurred, or will incur in the future, as a standalone company;
our cost of debt and our capital structure is different from that reflected in our historical consolidated and combined financial statements;
significant increases may occur in our costs as a result of us being a standalone public company, including costs related to public company reporting, investor relations and compliance with the Sarbanes‑Oxley Act; and
loss of economies of scale as a result of no longer being a part of Lilly.
Our financial condition and future results of operations, after giving effect to the separation, will be materially different from amounts reflected in our historical consolidated and combined financial statements included in this report. As a result of the separation, it may be difficult for investors to compare our future results to historical results or to evaluate our relative performance or trends in our business.
We have incurred and will continue to incur significant charges in connection with the separation and incremental costs as a standalone public company.
We will need to replicate or replace certain functions, systems and infrastructure to which we no longer have the same access after the separation. We may also need to make investments or hire additional employees to operate without the same access to Lilly’s existing operational and administrative infrastructure. These initiatives may be costly to implement. Due to the scope and complexity of the underlying projects relative to these efforts, the amount of total costs could be materially higher than our estimate, and the timing of the incurrence of these costs is subject to change.
Prior to the separation, Lilly performed or supported many important corporate functions for us. Our consolidated and combined financial statements reflect charges for these services on an allocated basis. Following the separation, many of these services are governed by our transitional services agreement with Lilly. Under the transitional services agreement we are able to use these Lilly services for a fixed term established on a service‑by‑service basis. Partial reduction in the provision of any service or termination of a service prior to the expiration of the applicable fixed term requires Lilly’s consent. In addition, either party is able to terminate the agreement due to a material breach of the other party, upon prior written notice, subject to limited cure periods or if the other party undergoes a change of control.
We pay Lilly mutually agreed‑upon fees for these services, which are based on Lilly’s costs (including third‑party costs) of providing the services through March 31, 2021 and subject to a mark‑up of 7% thereafter, with additional inflation‑based escalation beginning January 1, 2022. However, since our transitional services agreement was negotiated in the context of a parent‑subsidiary relationship, the terms of the agreement, including the fees charged for the services, may be higher or lower than those that would be agreed to by parties bargaining at arm’s length for similar services and may be higher or lower than the costs reflected in the allocations in our historical consolidated and combined financial statements. In addition, while these services are being provided to us by Lilly, our operational flexibility to modify or implement changes with respect to such services or the amounts we pay for them will be limited.
We may not be able to replace these services or enter into appropriate third‑party agreements on terms and conditions, including cost, comparable to those that we received from Lilly under the transitional services agreement. Additionally, after the transitional services agreement terminates, we may be unable to sustain the services at the same levelsengage in favorable business activities or obtain the same benefits as when we were receiving such services and benefits from Lilly. When we beginfinance future operations or capital needs.
A failure to operate these functions separately, if we do not have our own adequate systems and business functions in place, or are unable to obtain them from other providers, we may not be able to operate our business effectively or at comparable costs, and our profitability may decline. In addition, we have historically received informal support from Lilly, which may not be addressed in the transitional services agreement. The level of this informal support may diminish or be eliminated in the future.
In addition, our historical consolidated and combined financial statements include the attribution of certain assets and liabilities that historically have been held at the Lilly corporate level but which are specifically identifiable or
attributable to the businesses that were transferred to us in connectioncomply with the separation. The valuecovenants under the indenture that governs the senior unsecured notes and credit facilities, or any of the assets and liabilities we assumedour other existing or future indebtedness could result in connection with the separation could ultimately be materially different than such attributions,an event of default, which, if not cured or waived, could have a material adverse effect on our business, financial condition.condition and results of operations. In the event of an event of default under our credit facilities, it is expected that the lenders:
•will not be required to lend any additional amounts to us;
•could elect to declare all borrowings outstanding, together with accrued and unpaid interest and fees, to be due and payable and terminate all commitments to extend further credit;
•could require us to apply all of our available cash to repay these borrowings; or
•could effectively prevent us from making debt service payments on the notes (due to a cash sweep feature).
Such actions by the lenders could cause cross defaults under our other indebtedness, including our senior unsecured notes. If we were unable to repay those amounts, the lenders under our credit facilities and any of our other existing or future secured indebtedness could proceed against the collateral granted to them to secure our credit facilities or such other indebtedness. We have pledged a significant portion of our assets as collateral under our credit facilities.
Changes in our credit rating could increase our interest expense and restrict our access to, and negatively impact the terms of, current or future financings or trade credit.
Credit rating agencies continually revise their ratings for the companies that they follow, including us. Credit rating agencies also evaluate our industry as a whole and may change their credit ratings for us based on their overall view of our industry. We cannot be sure that credit rating agencies will maintain their ratings on us and certain of our debt. As a result of the acquisition of Bayer Animal Health, our credit ratings were downgraded, resulting in increased borrowing costs. Because the ratings of certain of our senior unsecured notes have been downgraded, we are required to pay additional interest under the senior unsecured notes. Any further downgrades could result in requirements to pay additional interest under the senior unsecured notes. Moreover, any decision to downgrade our ratings could restrict our access to, and negatively impact the terms of, current or future financings and trade credit extended by our suppliers of raw materials or other vendors.
Changes in interest rates may adversely affect our earnings and/or cash flows.
Certain of our credit facilities bear interest at variable interest rates that use the London Inter-Bank Offered Rate (LIBOR) as a benchmark rate. On July 27, 2017, the U.K.'s Financial Conduct Authority (FCA), which regulates LIBOR, announced its intention to stop persuading or compelling banks to submit LIBOR quotations after 2021.
In March 2021, ICE Benchmark Administration, the administrator of LIBOR, with the support of the U.S. Federal Reserve and the FCA, formally announced that LIBOR will cease to be published on June 30, 2023. The Alternative Reference Rates Committee in the U.S. has proposed that the Secured Overnight Financing Rate (SOFR) is the preferred alternative to U.S. LIBOR for use in derivatives and other financial contracts that are currently indexed to LIBOR; however, there are presently many variations of SOFR, and it is unknown whether these or any other alternative reference rate will attain market acceptance.
SOFR measures the cost of borrowing cash overnight, collateralized by U.S. Treasury securities, and is based on directly observable U.S. Treasury-backed repurchase transactions. Even though our credit facilities have either already transitioned to SOFR or provide for successor base rates, the discontinuance of LIBOR and the introduction of alternative reference rates, such as SOFR, could cause the interest rates calculated on our floating-rate debt and interest rate swaps to be materially different than expected.
Risks Related to Elanco Common Stock
The priceWe do not anticipate paying dividends on our common stock in the foreseeable future.
We do not anticipate paying any dividends in the foreseeable future on our common stock. We intend to retain all future earnings for the operation and expansion of our business and the repayment of outstanding debt. Certain of our credit facilities contain restrictive covenants that impose significant operating and financial restrictions on us, including restrictions on our ability to pay dividends and make other restricted payments. As a result, capital appreciation, if any, of our common stock may fluctuate substantially during and afterbe our shareholders' major source of gain for the exchange offer period, and you could lose all or part of your investment in our common stock as a result.
Our common stock has a limited trading history and there may be wide fluctuations in the market value of our common stock during and after the exchange offer period as a result of many factors. From our IPO through February 18, 2019, the sales price of our common stock as reported by the NYSE has ranged from a low sales price of $28.00 on February 6, 2019 to a high sales price of $37.61 on September 27, 2018. Some factors that may cause the market price of our common stock to fluctuate, in addition to the other risks mentioned in this report, are:
our announcements or our competitors’ announcements regarding new products, enhancements, significant contracts, acquisitions or strategic investments;
changes in earnings estimates or recommendations by securities analysts, if any, who cover our common stock;
failures to meet external expectations or management guidance;
fluctuations in our quarterly financial results or the quarterly financial results of companies perceived to be similar to us;
changes in our capital structure or dividend policy, including as a result of the exchange offer, future issuances of securities, sales of large blocks of common stock by our shareholders, including Lilly, or our incurrence of additional debt;
reputational issues arising from, among other things, negative publicity about us, our industry or personnel, including as a result of changing public attitudes regarding our products;
changes in general economic and market conditions in any of the regions in which we conduct our business;
changes in industry conditions or perceptions;
changes in applicable laws, rules or regulations and other dynamics; and
announcements or actions taken by Lilly, if Lilly were to retain a significant portion of our common stock following the exchange offer.
In addition, if the market for stocks in our industry or related industries, or the stock market in general, experiences a loss of investor confidence, the trading price of our common stock could decline for reasons unrelated to our business, financial condition and results of operations. If any of the foregoing occurs, it could cause our stock price to fall and may expose it to lawsuits that, even if unsuccessful, could be costly to defend and a distraction to management.
foreseeable future. While we currently intend to pay a quarterly cash dividend to our common shareholders, we may change our dividendthis policy at any time.
Although we currently intend to pay a quarterly cash dividend to our common shareholders, we have no obligation to do so, and our dividend policy may change at any time without notice to our shareholders. We currently intend to pay a quarterly cash dividend on our common stock of approximately $0.06 per share commencing following the quarter during which Lilly no longer owns shares of our common stock, subject to the discretion of our board of directors. Returns on your investment will primarily depend on the appreciation, if any,some point in the price of our common stock. We anticipatefuture, we cannot assure you that we will retain most of our future earnings, if any, for use in the development and expansion of our business, repayment of indebtedness and for general corporate purposes. The declaration and payment of dividends to holders of our common stock will be at the discretion of our board of directors in accordance with applicable law after taking into account various factors, including our financial condition, results of operations,
current and anticipated cash needs, cash flows available in the U.S., impact on our effective tax rate, indebtedness, legal requirements and other factors that our board of directors deems relevant.make such a change.
The distributions we pay on our common stock may not qualify as dividends for U.S. federal income tax purposes, which could adversely affect the U.S. federal income tax consequences to you of owning our common stock.
Generally, any distributions that we make to a shareholder with respect to ourits shares of our common stock will constitute a dividend for U.S. federal income tax purposes to the extent of our current or accumulated earnings and profits as determined for U.S. federal income tax purposes. OurFurthermore, our ability to generate earnings and profits, as determined for U.S. federal income tax purposes, in any future year is subject to a number of variables that are uncertain and difficult to predict.
Generally, any distribution not constituting a dividend under the rules described above will be treated as first reducing yourthe investor's adjusted basis in your shares of our common stock and, to the extent that the distribution exceeds yourthe adjusted basis in your shares of our common stock, as gain from the sale or exchange of such shares, and if you arethe investor is a domestic corporation, youit will not be entitled to claim, with respect to such non‑dividendnon-dividend distribution, a “dividends‑received”“dividends-received” deduction, which generally applies to dividends received from other domestic corporations.
Applicable laws and regulations, provisions of our amended and restated articles of incorporation and our amended and restated bylaws and certain contractual rights granted to Lilly may discourage takeover attempts and business combinations that shareholders might consider in their best interests.
Applicable laws, provisions of our amended and restated articles of incorporation and our amended and restated bylaws and, depending on the number of shares validly tendered and whether Lilly retains a significant portion of our common stock, certain contractual rights granted to Lilly under the master separation agreement may delay, deter, prevent or render more difficult a takeover attempt that our shareholders might consider in their best interests. For example, they may prevent our shareholders from receiving the benefit from any premium to the market price of our common stock offered by a bidder in a takeover context. Even in the absence of a takeover attempt, the existence of these provisions may adversely affect the prevailing market price of our common stock if they are viewed as discouraging takeover attempts in the future.
Our amended and restated articles of incorporation and our amended and restated bylaws contain provisions that are intended to encourage prospective acquirers to negotiate with our board of directors rather than to attempt a hostile takeover, which could deter coercive takeover practices and inadequate takeover bids. These provisions provide for:
•a board of directors divided into three classes with staggered terms;
•advance notice requirements regarding how our shareholders may present proposals or nominate directors for election at shareholder meetings (except for, depending on the number of shares validly tendered and whether Lilly retains a significant portion of our common stock, Lilly’s designation of persons for nomination by the board of directors);meetings;
•the right of our board of directors to issue one or more series of preferred stock with such powers, rights and preferences as the board of directors shall determine;
•only the board of directors being able to fill newly‑created directorships or vacancies on Ourour board of directors;
•limitations on the ability of shareholders to call special meetings of shareholders and the requirementrequire that all shareholder action be taken at a meeting rather than by written consent; and
a two‑thirds shareholder vote requirement to amend our amended and restated articles of incorporation;
•the exclusive right of our board of directors to amend our amended and restated bylaws;bylaws.
These limitations may adversely affect the prevailing market price and market for our common stock if they are viewed as limiting the liquidity of our stock or discouraging takeover attempts in the future.
We recently adopted a “proxy access” bylaw, which permits an eligible shareholder or group of shareholders to nominate, and have included in our proxy materials, director nominees constituting up to two individuals or 20% of our board of directors (whichever is greater), subject to the requirements and procedures in our bylaws.
If we fail to maintain an effective system of disclosure controls and internal control over financial reporting, our ability to produce timely and accurate financial statements or comply with applicable laws and regulations could be adversely impacted.
A material weakness is a deficiency or combination of deficiencies in our internal control over financial reporting such that there is a reasonable possibility that a material misstatement of our consolidated financial statements would not be prevented or detected on a timely basis. If we experience a material weakness or otherwise fail to maintain an effective system of internal controls in the future, we may not be able to accurately or timely report our financial condition or results of operations. Any failure to maintain effective disclosure controls and internal control over financial reporting could have an adverse effect on our business, financial condition, and results of operations.
In connection with preparing the financial statements as of and for the year ended December 31, 2022, a cumulative error was identified relating to the valuation allowance for taxes for a Southeast Asia affiliate. While immaterial to prior years, correcting this cumulative error in 2022 would have caused the 2022 results to be materially misstated. Therefore, immaterial revisions were made to the consolidated financial statements as of and for the years ended December 31, 2021 and 2020. We determined that this error was the result of a control deficiency that constituted a material weakness in our internal control over financial reporting related to income taxes. The material weakness had not been remediated as of December 31, 2022.
| | | | | | | | |
• | the requirement that a 662/3% vote is necessary to remove directors. These limitations may adversely affect the prevailing market price and market for our common stock if they are viewed as limiting the liquidity of our stock or discouraging takeover attempts in the future. 43 | |
Risks RelatedAlthough we intend to the Exchange Offer
The exchange offer and related transactionstake remedial actions in response to this control deficiency, there is no assurance that we will be able to prevent a material error or future control deficiencies (including material weaknesses) from occurring. Our inability to assert that our internal control over financial reporting is effective could result in a substantial amountloss of investor confidence in the accuracy and completeness of our financial reports, which could cause the price of our common stock entering the market, whichto decline, and we may adversely affect the market price of our common stock.
Immediately before the commencement of the exchange offer, Lilly owned 293,290,000 shares of our common stock, representing 80.2% of our outstanding common stock. Assuming the completion of the exchange offer and that it is fully subscribed, Lilly will distribute 293,290,000 shares of our common stock and all shares of our common stock not held by our affiliates will be freely tradable. If the exchange offer is not fully subscribed, Lilly intends, from time to time, to complete subsequent exchange offers and/or a pro rata spin-off of its remaining interest in Elanco. The distribution of such a large number of shares of our common stock in the exchange offer and any subsequent exchange offers or a distribution of our common stock on a pro rata basis to Lilly shareholders could adversely affect the market price of our common stock.
Following the completion of the exchange offer, the market price of shares of Lilly common stock and Elanco common stock will fluctuate and the final per-share values used in determining the exchange ratio may not be indicative of future trading prices.
The common stock price history for our shares may not provide investors with a meaningful basis for evaluating an investment in our common stock. Elanco has been a publicly traded company only since September 20, 2018. The prior performance of our common stock may not be indicative of the performance of our common stock after the exchange offer. In addition, the indicative and final per-share values used in determining the exchange ratio in the exchange offer may not be indicative of the prices at which our common stock will trade after the exchange offer is completed.
If the exchange offer is not fully subscribed, Lilly may continue to control us, which could prevent our shareholders from influencing significant decisions.
Depending on the number of shares validly tendered, Lilly may be able to influence the outcome of certain corporate actions requiring the approval of our shareholders so long as it owns a significant portion of our common stock and may retain certain rights pursuant to the master separation agreement. See "Agreements Between Lilly and Elanco and Other Related Party Transactions - Relationship between Elanco and Lilly - Master Separation Agreement." In addition, if the exchange offer is not fully subscribed, and Lilly were to waive the minimum amount and continue to hold more than 50% of our outstanding common stock, then we wouldcontinue to be considered a "controlled company" under NYSE rules. In such case, the typical independence requirements under the NYSE rules would not apply to us.
The exchange offer could result in significant tax liability.
The completion of the exchange offer is conditioned upon, among other things, the receipt by Lilly of the opinion of Skadden, Arps, Slate, Meagher & Flom LLP (Skadden Arps), to the effect that the exchange offer will qualify as a tax-free transaction under Sections 355 and 368(a)(1)(D) of the Internal Revenue Code and that, for U.S. federal income tax purposes, except with respect to the receipt of cash in lieu of fractional shares, holders of Lilly common stock will recognize no gain or loss upon the receipt of shares of our common stock in the exchange offer. A holder of Lilly common stock will generally recognize capital gain or loss with respect to cash received in lieu of a fractional share of our common stock.
The opinion of Skadden Arps will be based on the law in effect as of the time of the exchange offer and will rely upon certain assumptions, as well as statements, representations and certain undertakings made by our officers and those of Lilly. These assumptions, statements, representations and undertakings are expected to relate to, among other things, Lilly's business reasons for engaging in the exchange offer, the conduct of certain business activities by Lilly and Elanco, and the plans and intentions of Lilly and Elanco to continue conducting those business activities and not to materially modify their ownership or capital structure following the exchange offer. If any of those statements, representations or assumptions is incorrect or untrue in any material respect or any of those undertakings is not complied with, or if the facts upon which the opinion of Skadden Arps is based are materially different from the facts that exist at the time of the exchange offer, the conclusions reached in such opinion could be adversely affected.
Lilly does not intend to seek a ruling from the IRS as to the U.S. federal income tax treatment of the exchange offer. The legal authorities upon which the opinion of Skadden Arps will be based are subject to change or differing
interpretations at any time, possibly with retroactive effect. The opinion will not be binding on the IRS or a court, and there can be no assurance that the IRS will not challenge the conclusions reached in the opinion or that a court would not sustain such a challenge.
If the exchange offer were determined not to qualify as a tax-free transaction under Sections 355 and 368(a)(1)(D) of the Code, each Lilly shareholder who receives shares of our common stock in the exchange offer would generally be treated as recognizing taxable gain or loss equal to the difference between the fair market value of the shares of our common stock received by the shareholder and its tax basis in the shares of Lilly common stock exchanged therefor, or, in certain circumstances, as receiving a taxable distribution equal to the fair market value of the shares of our common stock received by the shareholder.
In addition, Lilly would generally recognize gain with respect to the transfer of our common stock in the exchange offer, as well as with respect to the receipt of certain cash proceeds from us in connection with the IPO.
The exchange offer could be taxable to Lilly, but not its shareholders, if we or our shareholders were to engage in certain transactions after the exchange offer is completed. In such cases, we would be required to indemnify Lilly for any resulting taxes and related expenses, which amount could be material.
If there is a later determination that the exchange offer is taxable for U.S. federal income tax purposes because the facts, assumptions, representations or undertakings underlying the tax opinion are incorrect or for any other reason, then we could incur significant liabilities.
The completion of the exchange offer is conditioned upon, among other things, the receipt by Lilly of the opinion of Skadden Arps, to the effect that the exchange offer will qualify as tax-free to Lilly and its shareholders for U.S. federal income tax purposes under Sections 355 and 368(a)(1)(D) of the Code, except with respect to the receipt of cash in lieu of a fractional share. The tax opinion will rely on certain facts, assumptions, representations and undertakings from Lilly and Elanco regarding the past and future conduct of the companies' respective businesses and other matters. If any of these facts, assumptions, representations or undertakings is incorrect or not otherwise satisfied, the conclusions reached in the opinion could be adversely affected and Lilly and its shareholders could be subject to significant tax liabilities. Furthermore, an opinion of counsel is not binding on the IRSinvestigation, litigation, increases in insurance premiums or courts,regulatory fines and the IRS could determine on audit that the exchange offer is taxable if it disagrees with the conclusions in the opinion, or for other reasons, including as a result of certain significant changes in the stock ownership of Lilly or Elanco after the exchange offer. Accordingly, no assurance can be given that the IRS will not challenge the conclusions set forth in the opinion or that a court would not sustain such a challenge. If the exchange offer is determined to be taxable for U.S. federal income tax purposes, Lilly and/or its shareholders could incur significant U.S. federal income tax liabilities, and Elanco could incur significant liabilities under applicable law or under the tax matters agreement.sanctions.
Item
ITEM 1B. Unresolved Staff CommentsUNRESOLVED STAFF COMMENTS
None.
Item
ITEM 2. PropertiesPROPERTIES Properties
The address of our global headquarters is currently 2500 Innovation Way, Greenfield, IN 46140. We plan to relocate our global headquarters to a new office building in Indianapolis, Indiana, with occupancy expected in 2025.
Our global manufacturing network is comprised of 18 manufacturing sites. The largest manufacturing site in our network is located in Clinton, Indiana. In addition, our global manufacturing network is supplemented by approximately 150 CMOs. For more information, see "Item 1. Business — Manufacturing and Supply Chain."
We have R&D operations co-located with certain of our manufacturing sites in the U.S. to facilitate the efficient transfer of production processes from our laboratories to manufacturing sites.manufacturing. In addition, we maintain R&D operations at non-manufacturing locations in the U.S., Switzerland,Germany, Australia, Brazil, China, India, and China. As part of the Separation, Lilly will transfer to us its interest in each of theseSwitzerland. Our R&D facilities. Our largest R&D facilityheadquarters is currently our U.S. R&D site located in Fort Dodge, Iowa, which has approximately 0.3 million square feet.
The address of our principal executive offices is currently c/o Elanco, 2500 Innovation Way, Greenfield, IN, 46140,Indiana and will relocate to Indianapolis, Indiana when we expect that our principal executive offices will remain at this address following the completion of this offering.
Following the separation,relocate our global manufacturing network will be comprised of 12 manufacturing sites. The largest manufacturing siteheadquarters, expected in our global manufacturing network is our manufacturing site located in Clinton, Indiana, which has approximately 0.7 million square feet. In addition, our global manufacturing network will continue to be supplemented by approximately 100 CMOs. See2025. For more information, see "Item 1. Business — ManufacturingResearch and Supply Chain.Development."
We own or lease various additional properties for other business purposes, including office space, warehouses and logistics centers. In addition, under the transitional services agreement, Lilly will provide us with continued access to certain of its premises currently occupied by our employees for up to two years.
We believe that our existing properties, as supplemented by CMOs, and access to Lilly facilities that will be provided under the transitional services agreement, are adequate for our current requirements and for our operations in the near future.
ItemITEM 3. Legal ProceedingsLEGAL PROCEEDINGS
Information pertaining to time subject to claimscertain legal proceedings is provided in "Item 8. Financial Statements and litigation arising in the ordinary course of business. These claimsSupplementary Data — Note 17: Commitments and litigation may include, among other things, allegations of violation of U.S.Contingencies " and foreign competition law, labor laws, consumer protection laws and environmental laws and regulations, as well as claims or litigation relating to product liability, intellectual property, securities, breach of contract and tort. We operate in multiple jurisdictions and, as a result, a claim in one jurisdiction may lead to claims or regulatory penalties in other jurisdictions. We intend to vigorously defend against any pending or future claims and litigation, as appropriate.is incorporated by reference herein.
At this time, in the opinion of our management, the likelihood is remote that the impact of such proceedings, either individually or in the aggregate, would have a material adverse effect on our consolidated and combined results of operations, financial condition or cash flows. However, one or more unfavorable outcomes in any claim or litigation against us could have a material adverse effect for the period in which they are resolved. In addition, regardless of their merits or their ultimate outcomes, such matters are costly, divert management’s attention and may materially adversely affect our reputation, even if resolved in our favor.
ItemITEM 4. Mine Safety DisclosuresMINE SAFETY DISCLOSURES
Not applicable.
PartPART II
ItemITEM 5. MARKET FOR THE REGISTRANT'S COMMON EQUITY, RELATED STOCKHOLDER MATTERS, AND ISSUER PURCHASES OF EQUITY SECURITIES
Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
MARKET INFORMATIONInformation
On September 20, 2018, our common stock began trading on the New York Stock Exchange under the symbol “ELAN.”
USE OF PROCEEDS
On September 24, 2018, we completedJanuary 30, 2020, our IPO resulting intangible equity units (TEUs) began trading on the issuance of 72.3 millionNew York Stock Exchange under the symbol “ELAT.” The TEUs were delisted from trading when they converted to shares of our common stock at a price to the public of $24.00 per share, which number of shares included the underwriters’ exercise in full of their option to purchase up to an additional 9.4 million shares of common stock at the IPO price, less underwriting discounts. The 72.3 million shares of our common stock sold in the IPO represent approximately 19.8% of our outstanding shares, while Lilly continues to own approximately 80.2% of our outstanding shares. The shares sold in the offering were registered under the Securities Act pursuant to a registration statementas scheduled on Form S-1 (File No. 333-226536), which was declared effective by the SEC as of September 20, 2018. The aggregate offering price of our common stock registered and sold under the registration statement was approximately $1,736.0 million (including the shares issued pursuant to the underwriters’ option to purchase additional shares). Our proceeds from the IPO were approximately $1,659.7 million, after deducting underwriting discounts and commissions of approximately $76.4 million. Goldman, Sachs & Co. LLC, J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC served as joint book-running managers and as representatives of the underwriters for the IPO. The offering commenced on September 20, 2018 and did not terminate before all of the securities registered in the registration statement were sold.February 1, 2023.
We have paid, or will pay, to Lilly approximately $4.2 billion in connection with the Separation, which includes the net proceeds from the IPO. A portion of the aggregate payment to Lilly is currently retained by us and is reflected on our balance sheet as restricted cash.
HOLDERSHolders
There were 232234 holders of record of our common stock as of February 18, 2019.24, 2023. This does not include the number of stockholdersshareholders who hold shares of our common stock through banks, brokers or other financial institutions.
DIVIDEND POLICYDividend Policy
We currently intend to pay a quarterly cash dividend to holders ofdo not anticipate paying dividends on our common stock of approximately $0.06 per share commencing followingin the completion of the quarter during which Lilly no longer owns shares of our common stock, subject to the discretion of our board of directors.
Our ability to pay dividends is subject to certain limitations, andforeseeable future; however, we may change our dividend policy at any time.
PERFORMANCE GRAPHPerformance Graph
This graph compares the return on Elanco's common stock with that of the S&P 500 Stock Index and the S&P 500 Pharmaceuticals Index from September 20, 2018 (the first day our common stock was traded in conjunction with our IPO) throughfor the period ended on December 31, 2018.2022. The graph assumes that $100 was invested on September 20, 2018 a person invested $100 each(our initial public offering date) in Elanco common stock, the S&P 500 Index, and the S&P 500 Pharmaceuticals Index. The graph measures total shareholder return, which takes into account both stock price and dividends. It assumes that dividends paid by a company are reinvested in that company’s stock.
|
| | | | | | |
| | 9/20/18 | 9/30/18 | 10/31/18 | 11/30/18 | 12/31/18 |
Elanco Animal Health Inc. | | 100.00 | 96.92 | 84.67 | 92.81 | 87.58 |
S&P 500 Index | | 100.00 | 100.57 | 93.70 | 95.60 | 86.97 |
S&P 500 Pharmaceuticals Index | | 100.00 | 102.91 | 100.36 | 106.93 | 98.62 |
Item*$100 invested on September 20, 2018 in stock or index, including reinvestment of dividends. Fiscal years ended December 31.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | September 20, 2018 | | December 31, 2018 | | December 31, 2019 | | December 31, 2020 | | December 31, 2021 | | December 31, 2022 |
Elanco Animal Health Inc. | | | | $ | 100.00 | | | $ | 87.58 | | | $ | 81.81 | | | $ | 85.19 | | | $ | 78.83 | | | $ | 38.76 | |
S&P 500 Index | | | | 100.00 | | | 86.97 | | | 114.36 | | | 135.40 | | | 174.26 | | | 142.70 | |
S&P 500 Pharmaceuticals Index | | | | 100.00 | | | 98.62 | | | 113.50 | | | 122.04 | | | 153.47 | | | 166.44 | |
ITEM 6. Selected Financial Data(RESERVED)
The following tables set forth our selected historical consolidated and combined financial data for the periods indicated below.Our consolidated and combined financial statements include the attribution of certain assets and liabilities that have historically been held at the Lilly corporate level but which are specifically identifiable or attributable to us. Through the completion of the IPO, our consolidated and combined financial statements also include expense allocations related to certain Lilly corporate functions, including executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. These expenses have been allocated to us based on direct usage or benefit where specifically identifiable, with the remainder allocated primarily on a pro rata basis of revenue, headcount or other measures. We believe that this expense methodology, and the results thereof, is reasonable for all periods presented. However, the allocations may not be indicative of the actual expense that would have been incurred if we would have operated as an independent, publicly traded company for the periods presented. It is impractical to estimate what our standalone costs would
Not applicable.
have been for the historical periods presented. After the IPO, a Transitional Services Agreement (TSA) between Lilly and Elanco went into effect. Under the terms of the TSA, we will be able to use certain services and resources related to corporate functions historically provided to us by Lilly, such as executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations (Lilly Services)9 for a fixed term, established on a service-by-service basis. We are paying Lilly mutually agreed upon fees for the Lilly Services provided under the TSA. Our consolidated and combined financial statements reflect the charges for Lilly Services after the IPO.
The financial statements presented may not be indicative of our future performance and do not necessarily reflect what our financial position and results of operations would have been had we operated as an independent, publicly traded company for the periods presented prior to IPO.
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ELANCO ANIMAL HEALTH INCORPORATED (Dollars in millions, except per-share data) | | 2018 | | 2017 | | 2016 | | 2015 | | 2014 |
Operations | | | | | | | | | | |
Revenue | | $ | 3,066.8 |
| | $ | 2,889.0 |
| | $ | 2,913.5 |
| | $ | 2,909.1 |
| | $ | 2,066.0 |
|
Cost of sales | | 1,573.8 |
| | 1,493.9 |
| | 1,409.0 |
| | 1,533.7 |
| | 932.6 |
|
Research and development | | 246.6 |
| | 251.7 |
| | 265.8 |
| | 291.0 |
| | 208.5 |
|
Marketing, selling and administrative | | 735.2 |
| | 779.8 |
| | 784.8 |
| | 916.0 |
| | 561.2 |
|
Amortization of intangible assets | | 197.4 |
| | 221.2 |
| | 170.7 |
| | 163.0 |
| | 57.6 |
|
Asset impairment, restructuring and other special charges | | 128.8 |
| | 375.1 |
| | 308.4 |
| | 263.3 |
| | 38.8 |
|
Interest expense, net of capitalized interest | | 29.6 |
| | — |
| | — |
| | — |
| | — |
|
Other (income) expense, net | | 41.3 |
| | (0.1 | ) | | (2.8 | ) | | 1.6 |
| | 1.4 |
|
Income (loss) before income tax expense | | 114.1 |
| | (232.6 | ) | | (22.4 | ) | | (259.5 | ) | | 265.9 |
|
Income tax expense (benefit) | | 27.6 |
| | 78.1 |
| | 25.5 |
| | (48.7 | ) | | 101.0 |
|
Net income (loss) | | $ | 86.5 |
| | $ | (310.7 | ) | | $ | (47.9 | ) | | $ | (210.8 | ) | | $ | 164.9 |
|
Net income (loss) as a percent of revenue | | 3 | % | | (11 | )% | | (2 | )% | | (7 | )% | | 8 | % |
Net income (loss) per share - basic and diluted | | $ | 0.28 |
| | $ | (1.06 | ) | | $ | (0.16 | ) | | $ | (0.72 | ) | | $ | 0.56 |
|
Weighted-average number of shares outstanding-diluted | | 313.7 |
| | 293.3 |
| | 293.3 |
| | 293.3 |
| | 293.3 |
|
| | | | | | | | | | |
Financial Position | | | | | | | | | | |
Total assets | | $ | 8,956.7 |
| | $ | 8,940.3 |
| | $ | 8,099.7 |
| | $ | 8,433.6 |
| | $ | 2,980.6 |
|
Long term debt | | $ | 2,443.3 |
| | $ | — |
| | $ | — |
| | $ | — |
| | $ | — |
|
Total liabilities | | $ | 3,759.2 |
| | $ | 1,160.0 |
| | $ | 1,082.3 |
| | $ | 1,004.1 |
| | $ | 551.5 |
|
Total equity | | $ | 5,197.5 |
| | $ | 7,780.3 |
| | $ | 7,017.4 |
| | $ | 7,429.5 |
| | $ | 2,429.1 |
|
ItemITEM 7. Management’s Discussion and Analysis of Results of Financial Condition and Results of OperationsMANAGEMENT'S DISCUSSION AND ANALYSIS OF RESULTS OF OPERATIONS AND FINANCIAL CONDITION
Introduction
Management’s discussion and analysis of financial condition and results of operations (MD&A) is intended to assist the reader in understanding and assessing significant changes and trends related to theour results of operations and financial position of our consolidated company.position. This discussion and analysis should be read in conjunction with the consolidated and combined financial statements and accompanying footnotes in Item 8 of Part II of this Annual Report on Form 10-K. Certain statements in this Item 7 of Part II of this Annual Report on Form 10-K constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements" and Item 1A, “Risk Factors,” may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements.
Overview
Founded For results of operations discussions related to years ended December 31, 2021 and 2020, refer to Item 7 of Part II in 1954 as part of Eli Lilly and Company, Elanco is a premier animal health company that innovates, develops, manufactures and markets products for companion and food animals. Headquartered in Greenfield, Indiana, we are the fourth largest animal health company in the world, with revenue of $3,066.8 millionour Annual Report on Form 10-K for the year ended December 31, 2018. Globally, we are #1 in medicinal feed additives, #2 in poultry2021 filed with the Securities and #3 in cattle, measured by 2017 revenue, according to Vetnosis.Exchange Commission on February 28, 2022.We have one of the broadest portfolios of pet parasiticides in the companionOverview
Elanco is a global animal sector. We offer a diverse portfolio of more than 125 brandshealth company that make us a trusted partner to veterinariansdevelops products for pets and food animal producersfarm animals in more than 90 countries.
With a heritage dating back to 1954, we rigorously innovate to improve the health of animals and to benefit our customers while fostering an inclusive, cause-driven culture for our employees. We operate our business in a single segment directed at fulfilling our vision of enriching the lives of people through food, making protein more accessible and affordable, and through pet companionship, helping pets live longer, healthier lives. We advance our vision by offering products in fourtwo primary categories: pet health and farm animal.
Companion Animal Disease Prevention (CA Disease Prevention):On August 27, 2021, we acquired KindredBio, a biopharmaceutical company that developed innovative biologics focused on saving and improving the lives of pets. We have one of the broadest parasiticide portfolioshad previously signed an agreement with KindredBio in the companionsecond quarter of 2021 to acquire exclusive global rights to KIND-030, a monoclonal antibody in development for the treatment and prevention of canine parvovirus. The acquisition of KindredBio further accelerates our opportunity for expansion in pet health, notably by expanding our research efforts in dermatology. See Note 6: Acquisitions, Divestitures and Other Arrangements to the consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of KindredBio
On August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal sector basedand pet health product categories. Our product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure. See Note 6: Acquisitions, Divestitures and Other Arrangements to the consolidated financial statements for additional information on indications, speciesthe acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and formulations, withcash flows of Bayer Animal Health.
We offer a diverse portfolio of approximately 200 brands that make us a trusted partner to pet owners, veterinarians and farm animal producers. Our products that protect pets from worms, fleasare generally sold worldwide to third-party distributors and ticks. Combiningindependent retailers, and directly to farm animal producers and veterinarians. With the acquisition of Bayer Animal Health, we have expanded our parasiticide portfolio withpresence in retail and e-commerce channels, allowing our vaccines presence, wecustomers to shop where and how they want.
A summary of our 2022, 2021 and 2020 revenue and net loss is as follows:
| | | | | | | | | | | | | | | | | |
| Year Ended December 31, |
| 2022 | | 2021 | | 2020 |
Revenue | $ | 4,411 | | | $ | 4,764 | | | $ | 3,271 | |
Net loss | (78) | | | (483) | | | (574) | |
As a global company, significant portions of our revenue and expenses are a leaderrecorded in currencies other than the U.S. dollar. Accordingly, in any period, our reported revenue, expenses and resulting earnings (loss) are impacted by changes in the United States (U.S.) in the disease prevention category based on shareexchange rates of revenue.
Companion Animal Therapeutics (CA Therapeutics): We have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprant product is one of the fastest growing osteoarthritis treatments inthose currencies relative to the U.S. We also have treatmentsdollar.
Increases or decreases in inventory levels in our distribution channels can positively or negatively impact our quarterly and annual revenue results, leading to variations in revenues. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the need for otitis (ear infections), as well as cardiovascularcertain inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, payment terms we extend, which are subject to internal policies, blackout shipping periods due to system downtime, implementations and dermatology indications.integrations, and procedures and environmental factors beyond our control, including weather conditions and the COVID-19 global pandemic.
Food Animal Future Protein & Health (FA Future Protein & Health): Our portfolio in this category, which includes vaccines, nutritional enzymes and animal only antibiotics, serves the growing demand for protein and includes innovative products in poultry and aquaculture production, where demand for animal health products is outpacing overall industry growth. We are focused on developing functional nutritional health products that promote food animal health, including enzymes, probiotics and prebiotics. We are a leader in providing vaccines as alternatives to antibiotics to promote animal health based on share of revenue.
Food Animal Ruminants & Swine (FA Ruminants & Swine): We have developed a range of food animal products used extensively in ruminant (e.g., cattle, sheep and goats) and swine production.
For the years ended December 31, 2018, 2017 and 2016, our revenue was $3,066.8 million, $2,889.0 million and $2,913.5 million, respectively. For the years ended December 31, 2018, 2017 and 2016, our net income (loss) was $86.5 million, $(310.7) million and $(47.9) million, respectively.
Key Trends and Conditions Affecting Our Results of Operations
Industry Trends
The animal health industry, which focuses onincludes both food animalspets and companionfarm animals, is a growing industry that benefits billions of people worldwide.
We believe that factors influencing growth in demand for pet medicines and vaccines include:
•increased pet ownership globally;
•pets living longer; and
•owners sharing a unique and loving bond with their pets.
As demand for animal protein grows, foodfarm animal health is becoming increasingly important. FactorsWe believe that factors influencing growth in demand for foodfarm animal medicines and vaccines include:
• onetwo in three people needneeding improved nutrition;
•increased global demand for protein, particularly poultry and aquaculture;
•natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, driving the need for more efficient food production;
•loss of productivity due to foodfarm animal disease and death;
•increased focus on food safety and food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.
Growth in foodfarm animal nutritional health products (enzymes, probiotics and prebiotics) is influenced, among other factors, by demand for antibiotic alternatives that can promote animal health and increase productivity.
Factors influencing growthAffecting Our Results of Operations
Global Macroeconomic Environment
Our operations are conducted globally, and we are exposed to and are impacted by various global macroeconomic factors. Global economic conditions continue to create uncertainty, most notably due to the Russia-Ukraine conflict, the COVID-19 pandemic, supply chain disruptions, and rising inflation. Continued evolution of these conditions has led to economic slowdowns in certain countries and/or regions. It has also led to volatility in consumer behavior, which has reduced demand due to consumption decreases and retailer destocking, particularly impacting our parasiticide products. We expect these global macroeconomic factors to continue in 2023.
Russia-Ukraine Conflict
In February 2022, Russia commenced military action against Ukraine. In response, the U.S. and certain other countries imposed and continue to impose significant sanctions and export controls against Russia, Belarus and certain individuals and entities connected to Russian or Belarusian political, business, and financial organizations. The U.S. and certain other countries could impose further sanctions, trade restrictions, and other retaliatory actions if the conflict continues or worsens. The broader consequences of the conflict, including related inflationary pressures, geopolitical tensions, additional retaliatory actions taken by the U.S. and other countries, and any counter retaliatory actions by Russia or Belarus in response, including, for example, potential cyberattacks or the disruption of energy and commodity exports, are likely to cause regional instability and could materially adversely affect global trade, currency exchange rates, regional economies and the global economy. The situation remains uncertain and it is difficult to predict the impact that the conflict and actions taken in response to the conflict will have on our business; however, they could increase our costs, disrupt our supply chain, reduce our sales and earnings, or otherwise adversely affect our business and results of operations.
As a global animal health leader, we have an obligation to support the health of animals and people. At the center of that work is ensuring access and availability of food and avoiding the spread of disease. At this time, we are limiting our business in Russia to only the essential products that support these needs, while complying with all imposed sanctions. We do not currently manufacture products or source any materials from companies in Russia for use in our products, but that could change because of new laws requiring products sold in Russia to be produced there as well. We do not conduct business with the Russian government. During the year ended December 31, 2022, revenue to Russian and Ukrainian customers represented approximately 2% of our consolidated revenue. Assets held in Russia as of December 31, 2022 represented less than 1% of our consolidated assets.
COVID-19 Pandemic
We continue to closely monitor the impact of the COVID-19 pandemic, including its variants, and the related economic effects on all aspects of our business, including impacts on our operations, supply chain, and customer demand. The extent to which the COVID-19 pandemic may impact our financial condition and results of operations remains uncertain and is dependent on developments that are out of our control, including a resurgence in positive cases, the emergence of new variants, governmental actions in response to the pandemic (for example, the lockdown orders in China that were lifted in late 2022), and the successful administration of effective vaccines and boosters. We cannot predict the impact that the ongoing COVID-19 pandemic will have on our employees, customers, vendors and suppliers; however, the COVID-19 pandemic has had and may continue to have an adverse impact on our business.
Supply Chain
We continue to experience disruption and volatility in our global supply chain network. This disruption, combined with increased demand for companion animal medicineskey raw materials and vaccines include:labor constraints, has also impacted our suppliers, resulting in shortages of raw materials and components required to manufacture our products. We continue to work closely with suppliers and freight partners to mitigate impacts to our operations and customers, including the addition of new transportation routes, targeted increases of certain safety stocks, and alternative sources of materials. Although we regularly monitor the financial health of companies in our supply chain, prolonged financial hardship on our suppliers and labor shortages could continue to disrupt our ability to obtain key raw materials, adversely affecting our operations. The global industry freight environment has experienced, and could continue to experience, lead time disruptions and high shipping costs, negatively impacting our profitability.
• increased pet ownership globally;
• pets living longer;Inflation
We are experiencing, and expect to continue to experience, inflationary pressures due to, among other things, the geopolitical events and macroeconomic factors noted above. Increased inflation rates primarily impact us by increasing our costs, including raw materials, labor, energy, transportation, and other input costs, adversely affecting our profit margins, operating results, and cash flows. In response to these inflationary costs, we have implemented price increases and may implement additional price increases in the future.
• increased pet spending
Revision of Prior Period Financial Statements Primarily Relating to Tax Valuation Allowance Adjustment
In connection with the preparation of our financial statements as pets are viewedof and for the year ended December 31, 2022, a cumulative error was identified relating to the valuation allowance for taxes for a Southeast Asia affiliate. While immaterial to prior years, correcting this cumulative error in 2022 would have caused the 2022 financial statements to be materially misstated. Therefore, immaterial revisions in relation to this item were made to our financial statements as membersof and for the years ended December 31, 2021 and 2020. The correction of this error was immaterial to our financial statements for those years.
As a result of having to make the revisions related to this error, we made other immaterial revisions to the consolidated financial statements as of and for the years ended December 31, 2021 and 2020. All of the familyrevisions are reflected throughout this Form 10-K. See Note 2: Revision of Previously Issued Consolidated Financial Statements to the consolidated financial statements for additional information.
Acquisitions of Bayer Animal Health and KindredBio
We have incurred expenses in connection with our acquisitions of Bayer Animal Health and KindredBio, including fees for professional services such as legal, accounting, consulting, and other advisory fees and expenses. Expenses incurred in 2022 and 2021 are primarily related to integration activities. In addition, we have incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics and to expand administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by owners.the former parent company of Bayer Animal Health. We anticipate that these additional costs will be partially offset by expected synergies. The ERP system integration of legacy Bayer Animal Health to the Elanco system is expected to be completed early in the second quarter of 2023. As a result, there may be a timeframe during which inventory shipments cannot occur. In response to this, we have built some additional inventory as of December 31, 2022 and expect to continue to increase our inventories on hand to ensure that our product is available to customers. Alternatively, we anticipate that certain customers may modify purchasing habits, which would cause a shift of revenue from the second quarter to the first quarter of 2023. In addition, we started extending payment terms in 2023 and may need to continue to extend payment terms to certain customers depending on the estimated timeframe during which shipments cannot occur and based on geography.
Product Development and New Product Launches
A key element of our targeted value creation strategy is to drive growth through portfolio development and product innovation, primarily in our three targeted growth categories. Our eleven product launches between 2015 and December 31, 2018, have had a significant positive impact on our revenue over those periods, and we expect new products and innovation will continue to have a positive impact on revenue in the future. Revenue from these product launches contributed $274.2 million to revenue for the year ended December 31, 2018.innovation. We continue to pursue the development of new chemical and biological molecules through our approach to innovation. Our future growth and success dependsdepend on both our pipeline of new products, including new products that we develop internally and may develop through joint ventures and products that we are able to obtain through licenselicenses or acquisition,acquisitions, and the expansion of the use of our existing products. We believe we are an industry leader in animal health R&D, with a track record of product innovation, business development and commercialization.
Impact of Changing Market Demand for Antibiotics
In recent years, our operational results have been, and will continue to be, affected by regulations and changing market demand relating to the use of antibiotics and other products intended to increase food animal production.
There are two classes of antibiotics used in animal health, shared-class, or medically important, antibiotics and animal-only antibiotics. Shared-class antibiotics are used to treat infectious disease caused by pathogens that occur in both humans and animals. As part of our antibiotic stewardship plan and in compliance with FDA guidance, shared-class antibiotics are labeled only for the treatment of an established need in animals and only with veterinarian oversight. However, not all pathogens that cause disease in animals are infectious in humans, and accordingly animal-only antibiotics are not used in human medicine (i.e., not medically important). From 2015 to 2018, our revenue from shared-class antibiotics declined at a CAGR of 6%, excluding the impact of foreign exchange. This was driven primarily by changing regulations in many markets, including the Veterinary Feed Directive, as well as changing market demand and Elanco’s tiered-approach to antibiotic stewardship, which included removing growth promotion from labels and requiring veterinary oversight in the U.S. and other markets.
Globally, during 2018, our revenue from shared-class antibiotics declined 2%, excluding the impact of foreign exchange, and represented 12% (4% from sales in the U.S. and 8% from sales outside of the U.S.) of our total revenue, down from 16% in 2015. From 2015 to 2018, our revenue from animal-only antibiotics grew at a CAGR of 5%, excluding the impact of foreign exchange, driven by sales outside the U.S., which offset a slight decline in the U.S. Globally, during 2018, our revenue from animal-only antibiotics grew 8%, excluding the impact of foreign exchange, and represented 25% of our total revenue, up from 23% in 2015. During 2018, 87% of our revenue from animal-only antibiotics resulted from the sale of ionophores. Ionophores are a special class of animal-only antimicrobials, and because of their animal-only designation, mode of action and spectrum of activity, their use, to date have not been impacted by regulations or changing market demand in many markets outside the U.S.Competition
We have intentionally shifted away from shared-class antibiotics,face intense competition. Principal methods of competition vary depending on the particular region, species, product category, or individual product. Some of these methods include product quality, price, cost-effectiveness, promotional effectiveness, new product development and are focusing on animal-only antibiotics, as well as antibiotic-free solutions. When an animal-only antibiotic exists, we believe it should be the first, preferred antibiotic treatment. Antibiotic resistance concerns, or other health concerns regarding food animalproduct differentiation. Certain products, may result in additional restrictions, expanded regulations or changes in market demand to further reduce the use of
antibiotics in food animals. We believe it is important to protect the benefits of antibiotics in human medicine, while responsibly protecting the health of food animalsboth existing and the safety of our food supply.
Impact of Competition
The animal health industry is competitive. Established animal health companies who consistently deliver high quality products enjoy brand loyalty from their customers, which often continues after the loss of patent-based or regulatory exclusivity. In 2018, approximately 72% of our revenue was fromnew products that did not have patent protection. In animal health, while potentially significant, erosion fromwe introduce, may compete with other branded or generic competition is often not as steep as in human health, withproducts already on the originator often retaining a significant market share. While our largest product, Rumensin, has been subject to generic competition from monensin outside the U.S. for more than 10 years, our revenue from Rumensin sales outside the U.S. grew at a CAGR of 5% from 2015 to 2018. However, generic competition can nevertheless significantly affect our results. We have experienced significant competitive headwinds from generic ractopamine in the U.S. In the third quarter of 2013, a large, established animal health company received U.S. approval for generic ractopamine. U.S. revenue for Optaflexx, our ractopamine beef product, has declined at a CAGR of 24% from 2015 to 2018 as a result of generic competition and the impact of international regulatory restrictions. In 2018, we had an estimated 70% market share of all U.S. ractopamine-treated beef cattle based on management estimates.
Although we believe brand loyalty is an important contributor to a product's ongoing success, the animal health industry is also impactedor that are later developed by innovation. We experienced an innovation lag in the companion animal parasiticide space from 2015 to 2017. In the absence of a competitive combined oral flea and tick product, our U.S. companion animal parasiticide portfolio revenue declined 15% in 2017, excluding the impact on revenue resulting from a reduction in inventory levels within our distribution channel. In February 2018, we launched Credelio in the U.S. for the treatment of fleas and ticks. Since the launch of Credelio, our sales of parasiticides in the U.S. have begun to grow again.competitors. See "Item 1. Business — Competition."
Productivity
Our results during the periods presented have benefited from operational and productivity initiatives implemented following recent acquisitions and in response to changing market demand for antibiotics and other headwinds.
Our acquisitions in the six years prior to the acquisition of LohmannBayer Animal Health in 2014, Novartis Animal Health in 2015 and the BI Vetmedica U.S. vaccines portfolio in 2017, added, in the aggregate, $1.4 billion in revenue, 4,5004,600 full-time employees, and 12 manufacturing and eight R&D sites. The acquisitions of Bayer Animal Health on August 1, 2020 and KindredBio on August 27, 2021 added 3,950 full-time employees, 10 manufacturing sites, and five R&D sites (before company-wide restructuring activities initiated in 2020 and 2021). In addition, from 2015 to 2018,2022, changing market demand for antibiotics and other headwinds, such as competition with generics and innovation, affected some of our highest gross margin products, resulting in a change to our product mix and driving operating margin lower. In response, we implemented a number of initiatives across the manufacturing, R&D and SG&A.marketing, selling and administrative functions. Our manufacturing cost savings strategies included improving manufacturing processes and headcount through lean manufacturing (minimizing waste while maintaining productivity), closing of threeand selling manufacturing sites, consolidating our CMO network, strategically insourcing certain projects, and pursuing cost savings opportunities with respect to raw materials via a new procurement process.through alternate sources of supply. Additional cost savings have resulted from reducing the number of R&D sites, from 16 to nine, SG&A savings from sales force consolidation and reducing discretionary and other G&Ageneral and administrative operating expense.expenses.
Foreign Exchange Rates
Significant portions of our revenue and costs are exposed to changes in foreign exchange rates. Our products are sold in more than 90 countries and, as a result, our revenue is influenced by changes in foreign exchange rates. For the years ended December 31, 20182022 and 2017,2021, approximately 52% and 50%, respectively,51% of our revenue was denominated in foreign currencies. We seek to manage foreign exchange risk, in part, through operational means, including managing same‑currency revenue in relation to same‑currency costs, and same‑currency assets in relation to same‑currency liabilities. As we operate in multiple foreign currencies, including the euro,Euro, British pound, Swiss franc, Brazilian real, Australian dollar, Japanese yen, Canadian dollar, Chinese yuan, and other currencies, changes in those currencies relative to the U.S. dollar will impact our revenue, cost of goodssales and expenses, and consequently, net income. Exchange rate fluctuations in emerging markets may also have an impact beyond our reported financial results and directly impact operations. These fluctuations may also affect the ability to buy and sell our products between markets impacted by significant exchange rate variances. Foreign exchange rates had a negligible effect onCurrency movements decreased revenue from 2016 to 2018.
General Economic Conditions
In addition to industry-specific factors, we, like other businesses, face challenges related to global economic conditions. Growth in bothby approximately 4% during the food animalyear ended December 31, 2022. Currency movements increased revenue by approximately 1% and companion animal sectors is driven in partdecreased revenue by overall economic developmentapproximately 1% during the years ended December 31, 2021 and related growth, particularly in many emerging markets. In recent years, certain of our customers and suppliers have been affected directly by economic downturns, which decreased the demand for our products.
The cost of our products to food animal producers is small relative to their other production costs, including feed, and the use of our products is intended to improve economic outcomes for food animal producers. Similarly, industry sources have reported that pet owners indicated a preference for reducing spending on other aspects of their lifestyle, including entertainment, clothing and household goods, before reducing spending on pet care. While these factors have mitigated the impact of recent downturns in the global economy, further economic challenges could increase cost sensitivity among our customers, which may result in reduced demand for our products and could have a material adverse effect on our financial condition and results of operations.
Weather Conditions and the Availability of Natural Resources
The animal health industry and demand for many of our animal health products in a particular region are affected by weather conditions, varying weather patterns and weather-related pressures from pests, such as fleas and ticks. As a result, we may experience regional and seasonal fluctuations in our results of operations.
Food animal producers depend on the availability of natural resources, including large supplies of fresh water. Their animals' health and their ability to operate could be adversely affected if they experience a shortage of fresh water due to human population growth or floods, droughts or other weather conditions.
Drought conditions could negatively impact, among other things, the supply of corn and the availability of grazing pastures. A decrease in harvested corn results in higher corn prices, which could negatively impact the profitability of food animal producers of ruminants, pork and poultry. Higher corn prices and reduced availability of grazing pastures contribute to reductions in herd or flock sizes that in turn result in less spending on animal health products. As such, a prolonged drought could have a material adverse effect on our financial condition and results of operations. Factors influencing the magnitude and timing of effects of a drought on our performance include, but may not be limited to, weather patterns and herd management decisions.
In addition, veterinary hospitals and practitioners depend on visits from and access to the animals under their care. Veterinarians' patient volume and ability to operate could be adversely affected if they experience prolonged snow, ice or other severe weather conditions, particularly in regions not accustomed to sustained inclement weather. Adverse weather conditions or a shortage of fresh water may cause veterinarians and food animal producers to purchase less of our products.
Disease Outbreaks
Sales of our food animal products could be adversely affected by the outbreak of disease carried by animals. Outbreaks of disease may reduce regional or global sales of particular animal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce demand for our products. Also, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere. Alternatively, sales of products that treat specific disease outbreaks may increase.
Manufacturing and Supply
In order to sell our products, we must be able to reliably produce and ship our products in sufficient quantities. Many of our products involve complex manufacturing processes and are sole-sourced from certain manufacturing sites.
Minor deviations in our manufacturing or logistical processes, unpredictability of a product's regulatory or commercial success or failure, the lead time necessary to construct highly technical and complex manufacturing sites, and shifting customer demand increase the potential for capacity imbalances.2020, respectively.
Components of Revenue and Costs and Expenses
Revenue
Our revenue is primarily derived from salesa diversified portfolio of products across species consisting of dogs and cats (collectively, pet health) and cattle, poultry, swine and aqua (collectively, farm animal). We market our products to veterinarians, pet owners, and farm animal producers, then sell directly or indirectly through third-party distributors, and directly to food producers and veterinarians.retailers, or e-commerce outlets. For additional information regarding our products, including descriptions of our products,product categories, see "Item 1. Business — Commercial Operations" and "Item 1. Business — Products."
We aggregate our products into five categories to understand revenue growth:
CA Disease Prevention includes parasiticides and vaccine products for dogs and cats;
CA Therapeutics includes products for the treatment of pain, osteoarthritis, otitis, cardiovascular and dermatology indications in dogs and cats;
FA Future Protein & Health includes vaccines, antibiotics, parasiticides and other products used in poultry and aquaculture production, as well as functional nutritional health products, including enzymes, probiotics and prebiotics;
FA Ruminants & Swine includes vaccines, antibiotics, implants, parasiticides, and other products used in ruminants and swine production, as well as certain other food animal products; and
Strategic Exits includes business activities that we have either exited or made the strategic decision to exit, including the transitional contract manufacturing activity that we acquired in connection with our acquisition of the BI Vetmedica U.S. vaccines portfolio, two terminated legacy U.S. distribution agreements, a terminated distribution agreement outside the U.S.; an equine product not core to our business and a transitional contract manufacturing activity associated with the supply to Lilly of human growth hormone.
Costs, Expenses and Other
Cost of sales consists primarily of cost of materials, facilities and other infrastructure used to manufacture our products, shipping and handling, inventory losses and expired products.
Marketing, selling and administrative expenses consist of, among other things, the costs of marketing, promotion and advertising and the costs of administration (business technology, facilities, legal, finance, human resources, business development, external affairs and procurement).
Amortization of intangible assets consist of the amortization expense for intangible assets that have been acquired through business combinations.
R&D expenses consist of project costs specific to new product R&D and product lifecycle management, overhead costs associated with R&D operations, regulatory, product registrations and investments that support local market clinical trials for approved indications. We manage overall R&D based on our strategic opportunities and do not disaggregate our R&D expenses incurred by nature or by product as we do not use or maintain such information in managing our business.
Marketing, selling and administrative expenses consist of, among other things, the costs of marketing, promotion and advertising and the costs of administration (business technology, facilities, legal, finance, human resources, business development, external affairs and procurement).
Amortization of intangible assets consists of the amortization expense for intangible assets that have been acquired through business combinations and other business development arrangements.
Asset impairment, restructuring and other special charges consistsconsist primarily of severance costs resulting from actions taken as part of our productivity initiatives and to reduce our costs; long-lived asset impairment charges and write-downs primarily related to product rationalizations, site closures, the sale of long-term assets, restructuring charges,manufacturing sites; transaction
and integration costs from acquired businesses and other related expenses, primarily Bayer Animal Health; costs associated with acquiringthe acquisition of KindredBio; and integrating businesses, and certain non-recurring expenses, including costs related to the build out of processes and systems to support finance and global supply and logistics, among others, as we become an independent company.others.
Interest expense, net of capitalized interest consists of interest incurred on our debt.
Other (income) expense, net consists primarily of various items including net interest (income)(gains)/expense,losses on asset disposals, realized orand unrealized foreign exchange translation (gains)/losses, (gains)/losses on equity investments, and loss or impairment on other investments.
Comparability of Historical Results
Our historical results of operations for the periods presented may not be comparable with prior periods or with our results of operations in the future due to many factors, includedincluding but not limited to the factors identified in "Key Trends and Conditions Affecting Our Results of Operations."
Our Relationship with Lilly and Additional Standalone Costs
Prior to IPO, our business operated solely as part of a division of Lilly. Our consolidated and combined financial statements have been derived from Lilly’s consolidated financial statements and accounting records for the periods prior to the IPO. Our consolidated and combined financial statements reflect our financial position, results of operations and cash flows of the business that were transferred at the time of the separation and do not purport to reflect what the results of operations, comprehensive income/(loss), financial position, equity or cash flows would have been had we operated as an independent, publicly traded company during the periods presented prior to the IPO.
Our historical and current results reflect an allocation of costs for certain Lilly corporate costs for the periods prior to the IPO, including, among others, executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. These allocations are not necessarily indicative of the expenses we may incur as a standalone public company. Although we entered into certain agreements with Lilly in connection with the IPO and the separation, the amount and composition of our expenses may vary from historical levels since the fees charged for the services under the agreement may be higher or lower than the costs reflected in the historical allocations. The total allocations included in our results for the years ended December 31, 2018, 2017 and 2016 were $105.2 million, $151.7 million, and $145.3 million, respectively. See Note 19: Related Party Agreements and Transactions to our consolidated and combined financial statements.
We are currently investing in expanding our own administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, finance and manufacturing, to replace services
previously provided by Lilly. Because of initial stand‑up costs and overlaps with services previously provided by Lilly, we have incurred and expect to continue to incur certain temporary, duplicative expenses in connection with the separation. We also incurred and expects to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics, among others. We currently estimate these costs in aggregate to be in a range from $240 million to $290 million, of which a portion will be capitalized and the remainder will be expensed.
Lilly utilizes a centralized treasury management system, of which we were part of until our IPO. For periods prior to the IPO, our consolidated and combined financial statements reflect cash held only in bank accounts in our legal name and no allocation of combined cash positions. Our consolidated and combined financial statements do not reflect an allocation of Lilly’s debt or any associated interest expense. In connection with the IPO, we incurred $2.5 billion of long-term borrowings. Our historical results reflect $29.6 million of interest expense during the year ended December 31, 2018 due to the timing of the borrowings, in comparison to our estimated interest expense of approximately $110.0 million on an annual basis.
For the periods prior to the IPO, our consolidated and combined financial statements reflect income tax expense (benefit) computed on a separate company basis, as if operating as a standalone entity or a separate consolidated group in each material jurisdiction in which we operate. Our consolidated and combined financial statements for the periods prior to the IPO also reflect certain deferred tax assets and liabilities and income taxes payable based on this approach that did not transfer to us upon the separation, as the underlying tax attributes were used by Lilly or retained by Lilly. As a result of potential changes to our business model and the fact that certain deferred tax assets and liabilities and income taxes payable did not transfer to us, income tax expense (benefit) included in the consolidated and combined financial statements may not be indicative of our future expected tax rate.
Our historical results also do not reflect the impact of costs we have incurred and expect to continue to incur as a consequence of becoming a standalone company, including incremental costs associated with being a publicly traded company.
We are seeking to institute competitive compensation policies and programs as a standalone public company, the expense for which may differ from the compensation expense allocated by Lilly in our consolidated and combined financial statements.
As a result of the IPO, we became subject to the reporting requirements of the Exchange Act and the Sarbanes‑Oxley Act. We have additional procedures and practices to establish or expand as a standalone public company. As a result, we will continue to incur additional costs as a standalone public company, including internal audit, external audit, investor relations, stock administration, stock exchange fees and regulatory compliance costs.
Recent Significant Acquisitions
Our financial results have been impacted by acquisitions and integrations. For the periods presented, these include primarily the acquisitions and integrations of Novartis Animal Health, which closed on January 1, 2015, certain rights to develop, manufacture, market and commercialize Galliprant outside the U.S. and co-promote it in the U.S. acquired from Aratana Therapeutics, Inc., which closed on April 22, 2016, and Boehringer Ingelheim Vetmedica, Inc.'s U.S. feline, canine and rabies vaccine portfolio and other related assets (BIVIVP), which closed on January 3, 2017. For more information, see Note 6: Acquisitions to our consolidated and combined financial statements.
Asset Impairment, Restructuring and Other Special Charges
During the years ended December 31, 2018, 2017 and 2016 including in connection with the productivity initiatives described above under "Key Trends and Conditions Affecting Our Results of Operations - Productivity," we incurred charges related to asset impairment, restructuring and other special charges, including integration of acquired businesses. These charges include severance costs resulting from actions taken to reduce our costs, asset impairment charges primarily related to competitive pressures for certain companion animal products, product rationalizations, site closures and integration costs related to acquired businesses, primarily Novartis Animal Health and costs related to the build out of processes and systems to support finance and global supply and logistics, among others, as we become an independent company.
For more information on these charges, see Note 7: Asset Impairment, Restructuring and Other Special Charges to our consolidated and combined financial statements.
Results of Operations
The following discussion and analysis of ourthe consolidated and combined statements of operations should be read along with ourthe consolidated and combined financial statements and the notes thereto included elsewhere in this report, which reflect the results of operations of the business transferred to Elanco from Lilly.report. For more information, see Note 2:3: Basis of Presentation to ourthe consolidated and combined financial statements.
| | | | | | | | | | | | | Year Ended December 31, | | % Change |
| Year Ended December 31, | | % Change | |
| 2018 | | 2017 | | 2016 | | 18/17 | | 17/16 | |
(Dollars in millions) | | (Dollars in millions) | | 2022 | | 2021 | | 2020 | | 22/21 | | 21/20 |
Revenue | $ | 3,066.8 |
| | $ | 2,889.0 |
| | $ | 2,913.5 |
| | 6% | | (1)% | Revenue | | $ | 4,411 | | $ | 4,764 | | $ | 3,271 | | (7)% | | 46% |
Costs, expenses and other: | | | | | | | Costs, expenses and other: | |
Cost of sales | 1,573.8 |
| | 1,493.9 |
| | 1,409.0 |
| | 5% | | 6% | Cost of sales | | 1,913 | | 2,132 | | 1,667 | | (10)% | | 28% |
% of revenue | 51 | % | | 52 | % | | 48 | % | | % of revenue | | 43% | | 45% | | 51% | |
Research and development | 246.6 |
| | 251.7 |
| | 265.8 |
| | (2)% | | (5)% | Research and development | | 321 | | 369 | | 329 | | (13)% | | 12% |
% of revenue | 8 | % | | 9 | % | | 9 | % | | % of revenue | | 7% | | 8% | | 10% | |
Marketing, selling and administrative | 735.2 |
| | 779.8 |
| | 784.8 |
| | (6)% | | (1)% | Marketing, selling and administrative | | 1,265 | | 1,403 | | 997 | | (10)% | | 41% |
% of revenue | 24 | % | | 27 | % | | 27 | % | | % of revenue | | 29% | | 29% | | 30% | |
Amortization of intangible assets | 197.4 |
| | 221.2 |
| | 170.7 |
| | (11)% | | 30% | Amortization of intangible assets | | 528 | | 556 | | 360 | | (5)% | | 54% |
% of revenue | 6 | % | | 8 | % | | 6 | % | | % of revenue | | 12% | | 12% | | 11% | |
Asset impairment, restructuring and other special charges | 128.8 |
| | 375.1 |
| | 308.4 |
| | (66)% | | 22% | Asset impairment, restructuring and other special charges | | 183 | | 634 | | 623 | | (71)% | | 2% |
Interest expense, net of capitalized interest | 29.6 |
| | — |
| | — |
| | NM | | NM | Interest expense, net of capitalized interest | | 241 | | 236 | | 150 | | 2% | | 57% |
Other (income) expense, net | 41.3 |
| | (0.1 | ) | | (2.8 | ) | | NM | | NM | Other (income) expense, net | | 32 | | 5 | | (178) | | NM | | NM |
Income (loss) before taxes | 114.1 |
| | (232.6 | ) | | (22.4 | ) | | NM | | NM | |
Loss before income taxes | | Loss before income taxes | | (72) | | (571) | | (677) | | 87% | | 16% |
% of revenue | 4 | % | | (8 | )% | | (1 | )% | | NM | | NM | % of revenue | | (2)% | | (12)% | | (21)% | | NM | | NM |
Income tax expense | 27.6 |
| | 78.1 |
| | 25.5 |
| | NM | | NM | |
Net income (loss) | $ | 86.5 |
| | $ | (310.7 | ) | | $ | (47.9 | ) | | NM | | NM | |
Income tax expense (benefit) | | Income tax expense (benefit) | | 6 | | (88) | | (103) | | 107% | | 15% |
Net loss | | Net loss | | $ | (78) | | $ | (483) | | $ | (574) | | 84% | | 16% |
Certain amounts and percentages may reflect rounding adjustments.
For additional information regarding our asset impairment, restructuring and other special charges, see Note 7: Asset Impairment, Restructuring and Other Special Charges to ourthe consolidated and combined financial statements.
No material transfers between Level 1, Level 2, or Level 3 occurred during the year ended December 31, 2017. The activity in the Level 3 investments during the year ended December 31, 2017 was not material.2021.