Washington, D.C. 20549
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Elanco Animal Health Incorporated
Unaudited Condensed Consolidated and CombinedStatements of Cash Flows (Unaudited)
(Dollars in millions)
| | | | | | | | | | | |
| Three Months Ended March 31, | | |
| | 2020 | | 2019 |
| Cash Flows from Operating Activities | | | |
| Net income (loss) | $ | (49.1) | | | $ | 31.5 | |
| Adjustments to reconcile net income (loss) to cash flows from operating activities: | | | |
| Depreciation and amortization | 81.5 | | | 75.2 | |
| Change in deferred income taxes | (25.1) | | | 16.3 | |
| Stock-based compensation expense | 11.1 | | | 7.7 | |
| Asset impairment charges | — | | | 4.0 | |
| Gain on sale of assets | (3.8) | | | — | |
| | | |
| Changes in operating assets and liabilities | (9.8) | | | (117.2) | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
| Other non-cash operating activities, net | (0.5) | | | (9.4) | |
| Net Cash Provided by (Used for) Operating Activities | 4.3 | | | 8.1 | |
| Cash Flows from Investing Activities | | | |
| Net purchases of property and equipment | (12.6) | | | (28.0) | |
| | | |
| Proceeds from settlement of net investment hedges (Note 11) | 25.2 | | | — | |
| | | |
| Purchases of software | (31.8) | | | (2.5) | |
| Other investing activities, net | (0.4) | | | (0.5) | |
| Net Cash Used for Investing Activities | (19.6) | | | (31.0) | |
| Cash Flows from Financing Activities | | | |
| Repayments of borrowings (Note 10) | (371.4) | | | (7.5) | |
| Proceeds from issuance of long-term debt (Note 10) | 79.2 | | | — | |
| | | |
| Proceeds from issuance of common stock and tangible equity units (Note 9) | 1,219.9 | | | — | |
| Debt issuance costs | (3.1) | | | — | |
| | | |
| | | |
| Consideration paid to Lilly in connection with the Separation (Note 1) | — | | | (175.1) | |
| | | |
| Other net financing transactions with Lilly | (15.2) | | | (156.4) | |
| Other financing activities, net | (12.8) | | | (0.5) | |
| Net Cash Provided by (Used for) Financing Activities | 896.6 | | | (339.5) | |
| Effect of exchange rate changes on cash and cash equivalents | (9.3) | | | (14.5) | |
| Net increase (decrease) in cash, cash equivalents and restricted cash | 872.0 | | | (376.9) | |
| Cash, cash equivalents and restricted cash at January 1 | 345.1 | | | 677.5 | |
| Cash, cash equivalents and restricted cash at March 31 | $ | 1,217.1 | | | $ | 300.6 | |
|
| | | | | | | |
| | Nine Months Ended September 30, |
| | 2018 | | 2017 |
| Cash Flows from Operating Activities | |
| Net income (loss) | $ | 70.1 |
|
| $ | (149.2 | ) |
| Adjustments to Reconcile Net Income (Loss) to Cash Flows from Operating Activities: |
|
|
|
| Depreciation and amortization | 222.3 |
|
| 231.3 |
|
| Change in deferred income taxes | 12.6 |
|
| (7.0 | ) |
| Stock-based compensation expense | 20.2 |
|
| 18.7 |
|
| Asset impairment charges | 102.5 |
|
| 43.8 |
|
| Gain on sale of assets | — |
|
| (16.0 | ) |
| Other changes in operating assets and liabilities, net of acquisitions and divestitures | (83.4 | ) |
| 42.7 |
|
| Other non-cash operating activities, net | 3.5 |
|
| 2.8 |
|
| Net Cash Provided by Operating Activities | 347.8 |
| | 167.1 |
|
| Cash Flows from Investing Activities | | | |
| Net purchases of property and equipment | (74.3 | ) | | (31.7 | ) |
| Cash paid for acquisitions, net of cash acquired | — |
|
| (882.1 | ) |
| Other investing activities, net | (4.6 | ) |
| (15.3 | ) |
| Net Cash Used for Investing Activities | (78.9 | ) | | (929.1 | ) |
| Cash Flows from Financing Activities | | | |
| Proceeds from issuance of long-term debt (Note 8) | 2,477.7 |
| | — |
|
| Proceeds from issuance of common stock (Note 1) | 1,659.7 |
| | — |
|
| Consideration paid to Lilly in connection with the Separation (Note 1) | (3,559.1 | ) |
| — |
|
| Other financing activities, net | (3.7 | ) |
| (0.5 | ) |
| Other net transactions with Lilly | (247.4 | ) |
| 844.0 |
|
| Net Cash Provided by Financing Activities | 327.2 |
| | 843.5 |
|
| Effect of exchange rate changes on cash and cash equivalents | 15.4 |
|
| 3.3 |
|
| Net increase in cash, cash equivalents and restricted cash | 611.5 |
| | 84.8 |
|
| Cash, cash equivalents and restricted cash at January 1 | 323.4 |
| | 258.8 |
|
| Cash, cash equivalents and restricted cash at September 30 | $ | 934.9 |
| | $ | 343.6 |
|
|
| | | | | | | |
| | September 30, |
| | 2018 | | 2017 |
| Cash and cash equivalents | $ | 300.0 |
|
| $ | 343.6 |
|
| Restricted cash (Note 14) | 634.9 |
|
| — |
|
| Cash, cash equivalents and restricted cash at September 30 | $ | 934.9 |
|
| $ | 343.6 |
|
| | | | | | | | | | | |
| March 31, | | |
| 2020 | | 2019 |
| Cash and cash equivalents | $ | 1,206.4 | | | $ | 272.1 | |
| Restricted cash (Note 16) | 10.7 | | | 28.5 | |
| Cash, cash equivalents and restricted cash at March 31 | $ | 1,217.1 | | | $ | 300.6 | |
See notes to unaudited condensed consolidated and combined financial statements.
Elanco Animal Health Incorporated
Notes to Condensed Consolidated and Combined Financial Statements (Unaudited)
(Tables present dollars in millions, except per-share data)
Note 1. Nature of Business and Organization
Nature of Business
Elanco Animal Health Incorporated (Elanco Parent) and its subsidiaries (collectively, Elanco, the Company, we, us or our) was formed as a wholly-owned subsidiary of Eli Lilly and Company (Lilly). Elanco is a global animal health company that innovates, develops, manufactures and markets products for companion and food animals. We offer a diverse portfolio of more than 125 brands to veterinarians and food animal producers in more than 90 countries.
Organization
Elanco Parent was formed in May 2018, as a wholly-owned subsidiary of Lilly, to serve as the ultimate parent company of substantially all of the animal health businesses of Lilly.
On September 24, 2018, Elanco Parent completed an initial public offering (IPO) resulting in the issuance of 72.3 million shares of its common stock (including shares issued pursuant to the underwriters’ option to purchase additional shares), which representsrepresented 19.8% of the outstanding shares, at $24 per share (IPO) for aresulting in total net proceeds, after underwriting discounts and commissions, of $1.7 billion. In connection with the completion of the IPO, through a series of equity and other transactions, Lilly transferred to Elanco Parent the animal health businesses that form its business going forward.business. In exchange, Elanco Parent has paid or will pay, to Lilly approximately $4.2 billion, which includesincluded the net proceeds from the IPO, the net proceeds from the debt offering completed by Elanco Parent in August 2018 and the term loan facility entered into by Elanco Parent in September 2018 (see Note 8)10: Debt). As of September 30, 2018, Elanco Parent has paid Lilly $3.6 billion. These transactions are collectively referred to herein as the Separation.
On February 8, 2019, Lilly announced an exchange offer whereby Lilly shareholders could exchange all or a portion of Lilly common stock for shares of Elanco common stock owned by Lilly. The disposition of Elanco shares was completed on March 11, 2019, and resulted in the full separation of Elanco along with the disposal of Lilly's entire ownership and voting interest in Elanco.
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
We have prepared the accompanying unaudited condensed consolidated and combined financial statements in accordance with the requirements of Form 10-Q and, therefore, they do not include all information and footnotes necessary for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted in the United States (GAAP). In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for a fair presentation of the results of operations for the periods shown. In preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates. The accounts of all wholly owned and controlled subsidiaries are included in the condensed consolidated financial statements and all intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to prior periods in the unaudited condensed consolidated and combined financial statements and accompanying notes to conform with current presentation. In addition, during the period ended September 30, 2018, certain combined balance sheet amounts related to the prior year have been revised to correct the sales rebates and discounts liability, which did not correctly reflect an accrual for rebates related to product held in the wholesalers' pipeline. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 99, Materiality, and Accounting Standards Codification (ASC) 250, Presentation of Financial Statements, we assessed the materiality of this correction and concluded that the accrual for the rebate related to product held in the wholesalers' pipeline was not material to prior periods, and therefore, amendments of previously filed reports are not required.
As such, in accordance with ASC 250, we revised the previously reported combined balance sheet and combined statements of equity. The adjustment, which originates in periods prior to those presented, resulted in a $10.5 million increase as of December 31, 2017 in the accrual for sales rebates and discounts of $155.0 million, total current liabilities of $632.6 million and total liabilities of $1,149.5 million. In addition, previously reported amounts at December 31, 2017 and December 31, 2016 of net parent company investment of $8,047.4 million and $7,484.8 million, respectively, and total equity of $7,790.8 million and $7,027.9 million, respectively, have been reduced by $10.5 million to reflect the correction above.
The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and combined financial statements and accompanying notes as of and for the three yearsyear ended December 31, 20172019 included in our final prospectus relating to our IPOAnnual Report on Form 10-K filed on September 21 2018 (IPO Prospectus) with the Securities and Exchange Commission (SEC). on February 28, 2020.
For
Our income taxes in 2019 and thereafter reflect the periods after Separation, the financial statements are preparedresults on a consolidated basis. For periods prior to the Separation, our financial statements are combined, have been prepared on a standalonestand-alone basis and are derived from Lilly's consolidated financial statements and accounting records. The unaudited condensed combined financial
statements reflect the financial position, resultsindependent of operations and cash flows related to the animal health businesses that were transferred to Elanco Parent and are prepared in conformity with GAAP.
The unaudited condensed 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 have been transferred to Elanco Parent. All intercompany transactions and accounts within Elanco have been eliminated. All transactions between us and Lilly are considered to be effectively settled in the unaudited condensed combined financial statements at the time the intercompany transaction is recorded. The total net effect of the settlement of these intercompany transactions is reflected in the unaudited condensed combined statements of cash flows as a financing activity and in the condensed combined balance sheets as net parent company investment.
These unaudited condensed combined financial statements include an allocation of expenses 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 and other measures. We consider the expenses methodology and results to be reasonable for all periods presented. However, the allocations may not be indicative of the actual expense that would have been incurred had we operated as an independent, publicly traded companyexcept for the periods presented. It is impractical to estimate what the standalone costs of Elanco would have beenperiod during which we were included in the historical periods.
a combined tax return with Lilly until full separation. The income tax amounts in the unaudited condensed combined financial statements have been calculated based on a separate return methodology and presented as if our operations were separate taxpayers in the respective jurisdictions. We file income tax returns in the United States (U.S.)U.S. federal jurisdiction and various state, local and non-U.S. jurisdictions. Certain
The significant accounting policies set forth in Note 4 to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2019 appropriately represent, in all material respects, the current status of these income tax returns are filed on a consolidated or combined basis with Eli Lilly and Company and/or its subsidiaries.
Lilly maintains various benefit and combined stock-based compensation plans at a corporate level and other benefit plans at a country level. Our employees participate in such programs andour accounting policies, except as it relates to the portionadoption of the coststandards that were effective January 1, 2020 as described in Note 4: Implementation of those plans related to our employees is included in our financial statements. However, the condensed combined balance sheets do not include any equity issued related to stock-based compensation plans or any net benefit plan obligations unless the benefit plan covers only our dedicated employees or where the legal obligation associated with the benefit plan will transfer to Elanco.New Financial Accounting Pronouncements, and are incorporated herein by reference.
Prior to Separation, the equity balance in the unaudited condensed combined financial statements represents the excess of total assets over liabilities, including intercompany balances between us and Lilly (net parent company investment) and accumulated other comprehensive loss. Net parent company investment is primarily impacted by contributions from Lilly which are the result of treasury activities and net funding provided by or distributed to Lilly. See Note 14 for further information.
Note 3. Impact of Separation
In connection with the Separation, we issued $2.0 billion aggregate principal amount of senior notes in a private placement, and we also entered into a $750.0 million senior unsecured revolving credit facility and $500.0 million senior unsecured term credit facility. See Note 8 for further information.
In connection with the Separation, we entered into various agreements with Lilly, including a master separation agreement. agreement, a tax matters agreement and the transitional services agreement (TSA).
In connectionaddition to the agreements referenced above, we entered into several other related party transactions with Lilly before and at the termstime of the Separation, there wereSeparation. For additional information regarding our ongoing agreements, as well as certain assetsactivities while Lilly was a related party, see Note 16: Related Party Agreements and liabilities included in the pre-Separation balance sheet that were retained by Lilly and there were certain assets not included in the pre-Separation balance sheet that were transferred to us. The cumulative adjustment to the historical balance sheet increased net assets and total equity by approximately $58.3 million. The impact on net assets primarily represent the elimination of certain income tax assets and liabilities and the contribution of additional fixed assets.Transactions.
After Separation, Lilly owns approximately 80.2% of the outstanding shares of our common stock. Lilly has informed us that it may make a tax-free distribution to its shareholders of all or a portion of its remaining equity interest, which may include one or more distributions effected as a dividend to all Lilly shareholders, one or more distributions in exchange for Lilly shares or other securities, or any combination thereof. Lilly does not have any obligation to pursue or consummate any further dispositions of its ownership interest in us by any specified date or at all. In connection with the Separation, we will continue to have certain ongoing relationships with Lilly as described in Note 14.
Note 4. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of accounting standards that were effective January 1, 20182020 and were adopted on that date:
|
| | | | | | | | | | | | | |
| Standard | | Description | | Effect on the financial statements or other significant matters |
Accounting Standards Update 2014-09 and various other related updates, Revenue from Contracts with Customers2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments | | This standard replaced existing revenue recognition standards and requiresmodifies the impairment model by requiring entities to recognize revenueuse a forward-looking approach based on expected losses to depict the transferestimate credit losses on certain types of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. An entity can apply the new revenue standard retrospectively to each prior reporting period presented or with the cumulative effect of initially applyingfinancial instruments, including trade receivables. | | We adopted the standard recognized atusing the date of initial application in retained earnings. We applied the latter approach. | | Application of the new standard to applicable contracts had no impact to net parent company investment as of January 1, 2018. Disclosures required by the new standard are included in Note 5. |
Accounting Standards Update 2016-16, Income Taxes: Intra-Entity Transfers of Assets Other Than Inventory
| | This standard requires entities to recognize the income tax consequences of intra-entity transfers of assets other than inventory at the time of transfer. This standard requires a modified retrospective approach to adoption. | | Uponapproach. The impact of adoption included the cumulative effectfirst-time recognition of applying the standardexpected credit losses (i.e., bad debt expense) on current receivables that are not past due, which resulted in a decrease to net parent company investmentin retained earnings of approximately $0.3$1.4 million. AdoptionRecognition of this standard did not result in a material change in net income for the three and nine months ended September 30, 2018. |
Accounting Standards Update 2017-07, Compensation-Retirement Benefits: Improving the Presentation of Net Periodic Pension Cost and Net Periodic Postretirement Benefit Cost
| | This standard was issued to improve the transparency and comparability among organizations by requiring entities to separate their net periodic pension cost and net periodic postretirement benefit cost into a service cost componentallowance and other components. Previously, the costsimpacts of the other components along with the service cost componentadoption were classified based upon the function of the employee. This standard requires entities to classify the service cost component in the same financial statement line item or items as other compensation costs arising from services rendered by pertinent employees. The other components of net benefit cost are now presented separately from the line items that include the service cost component. When applicable, the service cost component is now the only component eligible for capitalization. An entity should apply the new standard retrospectively for the classification of the service cost and other components and prospectively for the capitalization of the service cost component. | | Upon adoption of this standard, pension and postretirement benefit cost components other than service costs are presented in other–net, (income) expense. Retrospective application was not material to the combined statement of operationsconsolidated financial statements. |
Accounting Standards Update 2018-15, Intangibles - Goodwill and Other Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract | | This guidance aligns the three and nine months ended September 30, 2017. requirements for capitalizing implementation costs incurred in a cloud-based hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. | | We doimplemented the guidance on a prospective basis. The adoption did not expect application of the new standard to have a materialsignificant impact on an ongoing basis.the consolidated financial statements. |
| | | | |
The following table provides a brief description of the accounting standardstandards applicable to us that hashave not yet been adopted and could have a material effect on the consolidated financial statements:
|
| | | | | | | | | | | | | | | | | | | |
| Standard | | Description | | Effective Date | | Effect on the financial statements or other significant matters |
Accounting Standards Update 2016-02, Leases2019-12, Simplifying the Accounting for Income Taxes | | This standard was issued to increase transparencyThe amendments in this update simplify the accounting for income taxes by removing certain exceptions and comparability among organizations by recognizing lease assetsclarifying certain requirements regarding franchise taxes, goodwill, consolidated tax expenses, and lease liabilities, including leases classified as operating leases under current GAAP, on the balance sheet and requiring additional disclosures about leasing arrangements. An entity can apply the new leases standard retrospectively to each prior reporting period presented or with the cumulative effect of initially applying the standard recognized at the date of initial application in retained earnings. We plan to use the latter approach.annual effective tax rate calculations.
| | This standard is effective January 1, 2019,2021, with early adoption permitted. We intend to adopt this standard on that date. | | We are currently evaluating the effect of this standard on our consolidated financial statements. |
Accounting Standards Update 2020-04, Reference rate reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting | | This update provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. | | This standard can be applied immediately, but early adoption is only available through December 31, 2022. | | We are currently in the process of determiningevaluating the impact of the London Interbank Offered Rate (LIBOR) on our existing contracts, but do not expect that this update will have a material impact on our consolidated financial statements. We have selected a software solution to be compatible with our enterprise software system. Development of our selected solution is ongoing, as it is not yet fully compliant with the requirements of the standard. The timely readiness of the lease software system is critical to ensure an efficient and effective adoption of the standard. |
Note 5. Revenue
Effective January 1, 2018, we adopted Accounting Standards Update 2014-09, Revenue from Contracts with Customers (ASU 2014-09) and other related updates. The new standard has been applied to contracts for which performance had not been completed as of the date of adoption. Revenue presented for periods prior to 2018 were accounted for under previous standards and has not been adjusted. Revenue and net income for the three and nine months ended September 30, 2018 do not differ materially from amounts that would have resulted from application of the previous standards.
Product Sales
We recognize revenue primarily from product sales to customers. Revenue from sales of products is recognized at the point where the customer obtains control of the goods and we satisfy our performance obligation, which generally is at the time we ship the product to the customer. Payment terms differ by jurisdiction and customer, but payment terms in most of our major jurisdictions typically range from 30 to 100 days from date of shipment. Revenue for our product sales has not been adjusted for the effects of a financing component as we expect, at contract inception, that the period between when we transfer control of the product and when we receive payment will be one year or less. Any exceptions are either not material or we collect interest for payments made after the due date. Provisions for rebates and discounts, and returns are established in the same period the related sales are recognized. We generally, ship product shortly after orders are received; therefore, we generally only have a few days of orders received but not yet shipped at the end of any reporting period. Shipping and handling activities are considered to be fulfillment activities and are not considered to be a separate performance obligation. We exclude from the measurement of the transaction price all taxes assessed by a governmental authority that are imposed on our sales of product and collected from a customer.
Significant judgments must be made in determining the transaction price for sales of products related to anticipated rebates and discounts, and returns. The following describe the most significant of these judgments:
Sales Rebates and Discounts - Background and Uncertainties
Most of our products are sold to wholesale distributors. We initially invoice our customers contractual list prices. Contracts with direct and indirect customers may provide for various rebates and discounts that may differ in each contract. As a consequence, to determine the appropriate transaction price for our product sales at the time we recognize a sale to a direct customer, we must estimate any rebates or discounts that ultimately will be due to the direct customer and other customers in the distribution chain under the terms of our contracts. Significant judgments are required in making these estimates.
The rebate and discount amounts are recorded as a deduction to arrive at our net product sales. We estimate these accruals using an expected value approach.
In determining the appropriate accrual amount, we consider our historical experience with similar incentives programs and current sales data to estimate the impact of such programs on revenue and continually monitor the impact of this experience and adjust as necessary. Although we accrue a liability for rebates related to these
programs at the time the sale is recorded, the rebate related to that sale is typically paid up to six months after rebate or incentive period expires. Because of this time lag, in any particular period rebate adjustments may incorporate revisions of accruals for several periods.
Our sales rebates and discounts are based on specific agreements and the majority relate to sales in the U.S. As of September 30, 2018March 31, 2020 and 2017,2019, the liability for sales rebates and discounts in the U.S. represents approximately 70%71% and 71%72%, respectively, of our total liability with the next largest country representing approximately 8% and 6%8%, respectively, of our total liability.
The following table summarizes the activity in the sales rebates and discounts liability in the U.S.:
| | | | | | | | | | | | | | | |
| | | | | Three Months Ended March 31, | | |
| | | | | 2020 | | 2019 |
| Beginning balance | | | | | $ | 150.4 | | | $ | 118.5 | |
| Reduction of revenue | | | | | 60.5 | | | 65.7 | |
| Payments | | | | | (73.3) | | | (64.2) | |
| Ending balance | | | | | $ | 137.6 | | | $ | 120.0 | |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
| Beginning balance | $ | 99.1 |
| | $ | 118.7 |
| | $ | 114.8 |
| | $ | 116.1 |
|
| Reduction of revenue | 53.5 |
| | 48.6 |
| | 154.2 |
| | 184.9 |
|
| Payments | (49.1 | ) | | (49.6 | ) | | (165.5 | ) | | (183.3 | ) |
| Ending balance | $ | 103.5 |
| | $ | 117.7 |
| | $ | 103.5 |
| | $ | 117.7 |
|
Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three and nine months ended September 30, 2018March 31, 2020 and 2019 for product shipped in previous periods were not material.
Sales Returns - Background and Uncertainties
We estimate a reserve for future product returns related to product sales using an expected value approach. This estimate is based on several factors, including: local returns policies and practices; returns as a percentage of revenue; an understanding of the reasons for past returns; estimated shelf life by product; and estimate of the amount of time between shipment and return. Adjustments to the returns reserve have been and may in the future be required based on revised estimates to our assumptions, which would have an impact on our consolidated results of operations. We record the return amounts as a deduction to arrive at our net product sales.
Actual product returns have beenwere approximately 1%1.6% and 0.3% of net revenue for the three and nine months ended September 30, 2018March 31, 2020 and 2017 and have not fluctuated significantly as a percentage of revenue.2019, respectively.
Disaggregation of Revenue
The following table summarizes our revenue disaggregated by product category:
| | | | | | | | | | | | | | | |
| | | | | Three Months Ended March 31, | | |
| | | | | 2020 | | 2019 |
| Companion Animal Disease Prevention | | | | | $ | 140.3 | | | $ | 185.9 | |
| Companion Animal Therapeutics | | | | | 65.8 | | | 81.4 | |
| Food Animal Future Protein & Health | | | | | 180.0 | | | 167.2 | |
| Food Animal Ruminants & Swine | | | | | 252.6 | | | 274.1 | |
Strategic Exits(1) | | | | | 19.0 | | | 22.5 | |
| Revenue | | | | | $ | 657.7 | | | $ | 731.1 | |
(1)Represents revenue from business activities we have either exited or made a strategic decision to exit.
Note 6. Acquisitions and Divestitures
2019 Acquisitions
During 2019, we completed the acquisitions of all outstanding shares of Aratana Therapeutics, Inc. (Aratana) and Prevtec Microbia Inc. (Prevtec). These transactions were accounted for as business combinations under the acquisition method of accounting. Under this method, the assets acquired and liabilities assumed were recorded at their respective fair values as of the acquisition date in our condensed consolidated financial statements. The determination of estimated fair value required management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of these acquisitions are included in our condensed consolidated financial statements from the dates of acquisition.
Aratana Therapeutics, Inc.
On July 18, 2019, we acquired Aratana, a pet therapeutics company focused on innovative therapies for dogs and cats, for stock and cash-based contingent value rights. Aratana is the creator of the canine osteoarthritis medicine,Galliprant™, the rights to which we acquired in 2016. The acquisition enhances our presence in the areas of appetite stimulants in dogs, pain relief in dogs and cats, and treatments of other conditions in the U.S. and internationally. In connection with the acquisition, we issued approximately 7.2 million shares with a value of $238.0 million to Aratana shareholders, based on our stock price on the last trading day immediately prior to the closing date. The purchase consideration also included up to $12 million in contingent value rights, which represent the rights of Aratana shareholders to receive a contingent payment of $0.25 per share in cash upon the achievement of a specified milestone as outlined in the merger agreement. We calculated an immaterial fair value for the contingent value rights using the Monte Carlo simulation model.
Contingent consideration liabilities that we previously recorded for future royalty and milestone payments in relation to the 2016 acquisition of rights to Galliprant were settled upon the closing of our acquisition of Aratana.The liabilities were valued at $84.7 million as of the acquisition date using the Monte Carlo simulation model.The resulting $7.5 million loss upon settlement was recorded in other - net, expense in the consolidated and combined statement of operations for the year ended December 31, 2019.
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2018 | | 2017 | | 2018 | | 2017 |
| Companion Animal Disease Prevention | $ | 188.6 |
| | $ | 140.4 |
| | $ | 603.9 |
| | $ | 519.7 |
|
| Companion Animal Therapeutics | 80.5 |
| | 63.5 |
| | 211.1 |
| | 181.8 |
|
| Companion Animal Other | 27.7 |
| | 48.3 |
| | 69.3 |
| | 119.9 |
|
| Food Animal Future Protein & Health | 162.8 |
| | 164.5 |
| | 502.1 |
| | 456.0 |
|
| Food Animal Ruminants & Swine | 301.5 |
| | 280.4 |
| | 881.1 |
| | 857.3 |
|
| Revenue | $ | 761.1 |
| | $ | 697.1 |
| | $ | 2,267.5 |
| | $ | 2,134.7 |
|
The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date: | | | | | |
| Estimated Fair Value at July 18, 2019 | |
| Cash and cash equivalents | $ | 26.4 | |
| Inventories | 10.3 | |
| Acquired in-process research and development | 31.9 | |
Marketed products(1) | 36.7 | |
Other intangible assets(1) | 13.2 | |
| Other assets and liabilities - net | 23.2 | |
| Total identifiable net assets | 141.7 | |
Goodwill(2) | 11.6 | |
| Settlement of existing contingent consideration liabilities | 84.7 | |
| Total consideration transferred | $ | 238.0 | |
(1)These intangible assets, which are being amortized on a straight-line basis over their estimated useful lives, are expected to have a weighted average useful life of approximately 12.5 years.
(2)The goodwill recognized from this acquisition is attributable primarily to expected synergies from combining the operations of Aratana with our legacy business. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
The accounting for this acquisition is substantially complete, with the exception of the finalization of the valuation of intangible assets, tax-related amounts and minor working capital adjustments. No material measurement period adjustments were recorded during the three months ended March 31, 2020. The final determination of these amounts will be completed as soon as possible but no later than one year from the acquisition date.
We issued 0.1 million shares and recorded $3.6 million of stock-based compensation expense for the vesting of Aratana equity awards that was accelerated upon the closing of the acquisition during 2019.
Had Aratana been acquired on January 1, 2018, the unaudited pro forma combined revenues and income before income taxes of Elanco and Aratana would have been $735.1 million and $36.6 million, respectively, for the three months ended March 31, 2019.
Prevtec Microbia Inc.
On July 31, 2019, we acquired Prevtec in a cash transaction for approximately $60.3 million, inclusive of certain post-closing adjustments. Prevtec is a Canadian biotechnology company specializing in the development of vaccines intended to help prevent bacterial diseases in food animals. The acquisition allows us to expand on our previous distribution arrangement for Coliprotec™and is consistent with our efforts to explore innovative antibiotic alternatives.
The purchase consideration included up to $16.3 million in additional cash consideration, contingent upon the achievement of specific sales milestones by December 31, 2021. We have recorded a $4.7 million liability on the condensed consolidated balance sheet as of the acquisition date based on the fair value of the contingent consideration as calculated using the Monte Carlo simulation model.
A previously existing $0.7 million receivable owed from Prevtec to Elanco Animal Health UK Limited was settled upon the closing of our acquisition of Prevtec.The resulting immaterial gain upon settlement was recorded in other - net, expense in the consolidated and combined statement of operations for the year ended December 31, 2019.
The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
| | | | | |
| Estimated Fair Value at July 31, 2019 | |
| Cash and cash equivalents | $ | 0.9 | |
| Property and equipment | 0.5 | |
| Acquired in-process research and development | 2.8 | |
Marketed products(1) | 58.9 | |
| Other intangible assets | 1.1 | |
| Other assets and liabilities - net | (10.3) | |
| Total identifiable net assets | 53.9 | |
| |
Goodwill(2) | 11.1 | |
| Total consideration transferred | $ | 65.0 | |
(1)These intangible assets, which are being amortized on a straight-line basis over their estimated useful lives, are expected to have a weighted average useful life of 10 years.
(2)The goodwill recognized from this acquisition is attributable primarily to expected synergies from combining the operations of Prevtec with our legacy business and future unidentified projects and products. The goodwill associated with this acquisition is not deductible for tax purposes.
The accounting for this acquisition is substantially complete, with the exception of the finalization of the valuation of intangible assets, tax-related amounts and minor working capital adjustments. No material measurement period adjustments were recorded during the three months ended March 31, 2020. The final determination of these amounts will be completed as soon as possible but no later than one year from the acquisition date.
Pending Acquisition
Bayer Animal Health Business
On August 19, 2019, we entered into a Share and Asset Purchase Agreement (Purchase Agreement) with Bayer, a German corporation, to acquire Bayer's animal health business. Bayer's animal health business is a provider of products intended to improve the health and well-being of pets and farm animals. This acquisition is expected to expand our Companion Animal product category, advancing our planned intentional portfolio mix transformation and creating a better balance between our Food Animal and Companion Animal product categories. Pursuant to the Purchase Agreement and subject to the satisfaction of certain customary closing conditions, including the receipt of antitrust approvals and the absence of any law or order enjoining or otherwise prohibiting the transaction in specified jurisdictions, we will purchase Bayer’s animal health business for $5.3 billion in cash and shares of our common stock equal to approximately $2.3 billion divided by the 20-day volume-weighted average stock price as of the last day of trading before the closing of the acquisition (but subject to a 7.5% symmetrical collar centered on the volume-weighted average price for the 30 trading days ended August 6, 2019 of $33.60). The transaction will close no earlier than July 1, 2020, per the terms of the Purchase Agreement. See Note 13: Commitments and Contingencies for discussion regarding certain commitments related to this transaction.
Divestitures
In January 2020, we signed agreements to divest the worldwide rights to Osurnia™ and the U.S. rights to Capstar™, and in February 2020, we signed an agreement to divest the worldwide rights to Vecoxan™, for an aggregate of $285 million in all cash transactions. The agreements were signed with the intent to advance our efforts to secure the necessary regulatory clearances for the pending acquisition of the Bayer animal health business. The closing of these transactions is contingent on us entering into consent decrees with certain agencies in connection with the pending acquisition as well as customary closing conditions. The divestitures are expected to close by mid-2020.
The related assets for all 3 divestitures met the assets held for sale criteria as of March 31, 2020 and the assets for the Osurnia and Capstar divestitures met the assets held for sale criteria as of December 31, 2019. No adjustments were required to record the assets at the lower of their carrying amounts or fair values less costs to sell on the condensed consolidated balance sheet. Assets and liabilities considered held for sale in connection with the divestitures were included in the respective line items on the consolidated balance sheet as follows:
| | | | | | | | | | | |
| March 31, 2020 | | December 31, 2019 |
| Inventories | $ | 6.2 | | | $ | 10.6 | |
| Other intangibles, net | 70.6 | | | 61.2 | |
| Property and equipment, net | 0.2 | | | 0.2 | |
| Total assets held for sale | $ | 77.0 | | | $ | 72.0 | |
| | | | |
| Deferred taxes | $ | (0.1) | | | $ | (1.4) | |
| Total liabilities held for sale | $ | (0.1) | | | $ | (1.4) | |
Other intangibles, net classified as held for sale primarily consist of marketed products. We determined that the disposal of these net assets does not qualify for reporting as a discontinued operation because it does not represent a strategic shift that has or will have a major effect on our operations and financial results.
Note 6.7. Asset Impairment, Restructuring and Other Special Charges
We
In recent years, we have historically participatedincurred substantial costs associated with restructuring programs and cost-reduction initiatives designed to achieve a flexible and competitive cost structure. Restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions and the pending acquisition of Bayer's animal health business, we have also incurred costs associated with executing transactions and integrating acquired operations, which may include expenditures for banking, legal, accounting, and other similar services. In addition, we have incurred costs to stand up our organization as an independent company. All operating functions can be impacted by these actions; therefore, non-cash expenses associated with our tangible and intangible assets can be incurred as a result of revised fair value projections and/or determinations to no longer utilize certain assets in Lilly's cost-reduction initiatives. Our total charges relatedthe business on an ongoing basis.
For finite-lived intangible asset and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 2: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
Components of asset impairment, restructuring and other special charges including integration ofare as follows:
| | | | | | | | | | | | | | | |
| | | | | Three Months Ended March 31, | | |
| | | | | 2020 | | 2019 |
Restructuring charges: (1) | | | | | | | |
| Severance and other costs | | | | | $ | 0.4 | | | $ | 0.5 | |
| Facility exit costs | | | | | 0.6 | | | — | |
| | | | | | | |
| Acquisition related charges: | | | | | | | |
Transaction and integration costs (2) | | | | | 76.3 | | | 20.4 | |
| | | | | | | |
| Non-cash and other items: | | | | | | | |
Asset impairment (3) | | | | | — | | | | 4.0 | |
Asset write-down (4) | | | | | 1.3 | | | | — | |
Gain on sale of fixed assets (5) | | | | | (3.8) | | | | — | |
| | | | | | | |
| Total expense | | | | | $ | 74.8 | | | $ | 24.9 | |
(1)For the three months ended March 31, 2020, these charges primarily relate to the announced 2019 program to streamline operations in Speke, England as well as the remaining costs to close the Larchwood, Iowa facility.
(2)Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services. Integration costs represent internal and external incremental costs directly related to integrating acquired businesses, inincluding the unaudited condensed consolidatedpending acquisition of Bayer's animal health business (e.g., expenditures for consulting, system and combined statements of operations consisted of the following:
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2018 | | 2017 | | 2018 | | 2017 |
| Cash expense: | | | | | | | |
| Severance | $ | (0.2 | ) | | $ | 5.8 |
| | $ | (2.8 | ) | | $ | 62.1 |
|
| Integration and other | 4.9 |
| | 6.4 |
| | 10.5 |
| | 75.1 |
|
| Exit costs | 1.5 |
| | 11.5 |
| | 11.2 |
| | 24.3 |
|
| Total cash expense | 6.2 |
| | 23.7 |
| | 18.9 |
| | 161.5 |
|
| Non-cash expense | | | | | | | |
| Asset impairment | 6.2 |
| | — |
| | 63.9 |
| | 43.8 |
|
| Total non-cash expense | 6.2 |
| | — |
| | 63.9 |
| | 43.8 |
|
| Gain on sale of fixed assets | — |
| | — |
| | — |
| | (16.0 | ) |
| Total | $ | 12.4 |
| | $ | 23.7 |
| | $ | 82.8 |
| | $ | 189.3 |
|
Severance costs represent costs incurredprocess integration, and product transfers), as a result of actions taken to reduce our cost structure.
Integration and other costs primarily representwell as stand-up costs related to our integration efforts as a resultthe implementation of our acquired businesses.
Exit costs primarily represent contract termination costsnew systems, programs, and reserves for costs related to facilities which we have exited.
Asset impairment recognized during the nine months ended September 30, 2018 resulted from $19.9 million of intangible asset impairments and $44.0 million of fixed asset impairments. The intangible asset impairments primarily related to revised projections of fair value due to product rationalization. The fixed asset impairments were primarilyprocesses due to the decision to dispose of a manufacturing facility in the U.S. and to the suspension of commercial activities for Imrestor®.Separation from Lilly.
(3)Asset impairment recognized duringcharges for the ninethree months ended September 30, 2017 resulted primarily from intangible asset impairmentsMarch 31, 2019 related to revised projections ofan adjustment to fair value dueof intangible assets that were subject to product rationalizationrationalization.
(4)Asset write-down expenses for the three months ended March 31, 2020 result from adjustments recorded to write assets classified as held and used down to a lessor extent competitive pressures. Thetheir current fair value measurements utilizedvalue. These charges primarily relate to determine the intangible asset impairments in 2018 and 2017 represent Level 3 fair value measurements.
Gain on sale of fixed assets forin Wusi, China in connection with the nine months ended September 30, 2017 representsannounced 2019 program to streamline operations.
(5)Represents a gain on the disposal from the sale of a site thatan R&D facility in Prince Edward Island, Canada, which was previously closedwritten down during the three months ended September 30, 2019 as part of the acquisition and integration of Novartis Animal Health.announced 2019 program to streamline operations.
The following table summarizes the activity in our reserves established in connection with these restructuring activities:
| | | | | | | | | | | | | | | | | |
| Facility exit costs | | Severance | | Total |
| Balance at December 31, 2018 | $ | 9.3 | | | $ | 35.1 | | | $ | 44.4 | |
| Charges | — | | | 0.5 | | | 0.5 | |
| | | | | |
| Cash paid | (0.3) | | | (7.3) | | | (7.6) | |
| Balance at March 31, 2019 | $ | 9.0 | | | $ | 28.3 | | | $ | 37.3 | |
| | | | | |
| Balance at December 31, 2019 | $ | 5.4 | | | $ | 15.5 | | | $ | 20.9 | |
| Charges | 0.6 | | | 1.0 | | | 1.6 | |
| Reserve adjustments | — | | | (0.6) | | | (0.6) | |
| Cash paid | (1.0) | | | (9.8) | | | (10.8) | |
| Balance at March 31, 2020 | $ | 5.0 | | | $ | 6.1 | | | $ | 11.1 | |
|
| | | | | | | | | | | |
| | Exit costs | | Severance | | Total |
| Balance at December 31, 2016 | $ | 11.5 |
| | $ | 26.6 |
| | $ | 38.1 |
|
| Charges | 24.3 |
| | 62.1 |
| | 86.4 |
|
| Cash paid | (7.6 | ) | | (61.8 | ) | | (69.4 | ) |
| Balance at September 30, 2017 | $ | 28.2 |
| | $ | 26.9 |
| | $ | 55.1 |
|
| | | | | | |
| Balance at December 31, 2017 | $ | 34.9 |
| | $ | 43.1 |
| | $ | 78.0 |
|
| Charges | 11.2 |
| | (2.8 | ) | | 8.4 |
|
| Separation adjustment | (5.9 | ) |
| — |
|
| (5.9 | ) |
| Cash paid | (10.9 | ) | | (22.6 | ) | | (33.5 | ) |
| Balance at September 30, 2018 | $ | 29.3 |
| | $ | 17.7 |
| | $ | 47.0 |
|
These reserves are included in other current liabilities on the consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next twelve months. We believe that the reserves are adequate.
Note 7.8. Inventories
We state all inventories at the lower of cost or market.net realizable value. We use the last-in, first-out (LIFO) method for a portion of our inventories located in the continental U.S. Other inventories are valued by the first-in, first-out (FIFO) method. FIFO cost approximates current replacement cost.
Inventories consisted of the following:
| | | | | | | | | | | |
| March 31, 2020 | | December 31, 2019 |
| Finished products | $ | 384.2 | | | $ | 402.9 | |
| Work in process | 592.1 | | | 603.2 | |
| Raw materials and supplies | 80.7 | | | 83.9 | |
| Total (approximates replacement cost) | 1,057.0 | | | 1,090.0 | |
| Decrease to LIFO cost | (38.0) | | | (39.3) | |
| Inventories | $ | 1,019.0 | | | $ | 1,050.7 | |
Note 9. Equity
Common Stock Offering
On January 22, 2020, we entered into an underwriting agreement in which we agreed to sell approximately 22.7 million shares of our common stock at a public offering price of $32.00 per share. In connection with the offering, we granted the underwriters an option to purchase up to an additional 2.3 million shares, which was exercised in full on January 23, 2020. As a result, we issued and sold a total of approximately 25.0 million shares of our common stock for $767.5 million, after issuance costs.
Tangible Equity Unit (TEU) Offering
On January 22, 2020, we also completed our offering of 11 million, 5.00% TEUs. Total proceeds, net of issuance costs, were $528.5 million. Each TEU, which has a stated amount of $50, is comprised of a prepaid stock purchase contract (prepaid stock) and a senior amortizing note due February 1, 2023. Subsequent to issuance, each TEU may be legally separated into the two components. The prepaid stock is considered a freestanding financial instrument, indexed to Elanco common stock, and meets the conditions for equity classification.
The value allocated to the prepaid stock is reflected net of issuance costs in additional paid-in capital. The value allocated to the senior amortizing notes is reflected in long-term debt on the consolidated balance sheet, with payments expected in the next twelve months reflected in current portion of long-term debt. Issuance costs related to the amortizing notes are reflected as a reduction of the carrying amount and will be amortized through the maturity date using the effective interest rate method.
The proceeds from the issuance were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
| | | | | | | | | | | | | | | | | | | | |
| | Equity Component | | Debt Component | | Total |
| Fair value per unit | | $ | 42.80 | | | $ | 7.20 | | | $ | 50.00 | |
| | | | | | |
| Gross proceeds | | $ | 470.8 | | | $ | 79.2 | | | $ | 550.0 | |
| Less: Issuance costs | | 18.4 | | | 3.1 | | | 21.5 | |
| Net proceeds | | $ | 452.4 | | | $ | 76.1 | | | $ | 528.5 | |
The senior amortizing notes have an aggregate principal amount of $79.2 million and bear interest at 2.75% per year. On each February 1, May 1, August 1, and November 1 until the maturity date, we will pay equal quarterly cash installments of $0.6250 per each amortizing note with an initial principal amount of $7.2007 (except for the first
|
| | | | | | | |
| | September 30, 2018 | | December 31, 2017 |
| Finished products | $ | 408.1 |
| | $ | 452.0 |
|
| Work in process | 572.3 |
| | 580.0 |
|
| Raw materials and supplies | 71.4 |
| | 70.4 |
|
| Total (approximates replacement cost) | 1,051.8 |
| | 1,102.4 |
|
| Decrease to LIFO cost | (43.1 | ) | | (40.1 | ) |
| Inventories | $ | 1,008.7 |
| | $ | 1,062.3 |
|
During
Unless settled early at the nineholder’s or our election, each prepaid stock purchase contract will automatically settle on February 1, 2023 (the mandatory settlement date) for a number of shares of common stock per contract based on the average of the volume-weighted average trading prices during the 20 consecutive trading day period beginning on, and including the 21st scheduled trading day immediately preceding February 1, 2023 (applicable market value) with reference to the following settlement rates:
| | | | | | | | |
| Applicable Market Value | | Common Stock Issued |
| Equal to or greater than $38.40 | | 1.3021 shares (minimum settlement rate) |
| Less than $38.40, but greater than $32.00 | | $50 divided by applicable market value |
| Less than or equal to $32.00 | | 1.5625 (maximum settlement rate) |
The prepaid stock purchase contracts are mandatorily convertible into a minimum of 14.3 million shares or a maximum of 17.2 million shares of our common stock on the mandatory settlement date (unless redeemed by us or settled earlier at the unit holder's option). The 14.3 million minimum shares are included in the calculation of basic weighted average shares outstanding. The difference between the minimum and maximum shares represents potentially dilutive securities, which are included in the calculation of diluted weighted average shares outstanding on a pro rata basis to the extent that the average applicable market value is higher than $32.00 but is less than $38.40 during the period.
Note 10. Debt
Long-term debt consisted of the following:
| | | | | | | | | | | |
| March 31, 2020 | | December 31, 2019 |
| | | |
| Term credit facility | $ | — | | | $ | 371.4 | |
| 3.912% Senior Notes due 2021 | 500.0 | | | 500.0 | |
| 4.272% Senior Notes due 2023 | 750.0 | | | 750.0 | |
| 4.900% Senior Notes due 2028 | 750.0 | | | 750.0 | |
| TEU amortizing notes | 79.2 | | | — | |
| Other obligations | 0.3 | | | 0.4 | |
| Unamortized debt issuance costs | (17.9) | | | (16.8) | |
| | | |
| Total debt | 2,061.6 | | | 2,355.0 | |
| Less current portion of long-term debt | 26.0 | | | 24.5 | |
| Total long-term debt | $ | 2,035.6 | | | $ | 2,330.5 | |
TEU Amortizing Notes
On January 22, 2020, we issued $550 million in TEUs. We offered 11 million, 5.00% TEUs at the stated amount of $50 per unit, comprised of prepaid stock purchase contracts and a senior amortizing note due February 1, 2023 (the mandatory settlement date). Total cash of $528.5 million was received, comprised of $452.4 million of prepaid stock purchase contracts and $76.1 million of senior amortizing notes, net of issuance costs. See Note 9: Equity for further information.
Term Loan Extinguishment
On January 31, 2020, we repaid indebtedness outstanding under our existing term loan facility. We paid $372.4 million in cash, composed of $371.4 million of principal and $1.0 million of accrued interest, resulting in a debt extinguishment loss of $0.8 million (recognized in interest expense in the condensed consolidated statement of operations for the three months ended September 30, 2018, we recognized $38.6 million of inventory write-offs in cost of salesMarch 31, 2020) primarily related to the suspensionwrite-off of commercial activities for Imrestor.deferred debt issuance costs.
Note 8. Debt
Long-term debt as of September 30, 2018 consisted
New Credit Facility
On February 4, 2020, we successfully priced our senior secured credit facilities, consisting of the following:
|
| | | |
| | September 30, 2018 |
|
| Term credit facility | $ | 500.0 |
|
| 3.912% Senior Notes due 2021 | 500.0 |
|
| 4.272% Senior Notes due 2023 | 750.0 |
|
| 4.900% Senior Notes due 2028 | 750.0 |
|
| Other obligations | 0.2 |
|
| Unamortized debt issuance costs | (21.7 | ) |
| Total long-term debt | 2,478.5 |
|
| Less current portion of long-term debt | — |
|
| | $ | 2,478.5 |
|
Long-term debt as of December 31, 2017 was not material.
•Revolving and Term Credit Facilities
On September 5, 2018, we entered into a revolving credit agreement with a syndicate of banksfacility providing for a five-yearup to $750.0 million and a maturity of five years.
The term loan B facility was priced at par at LIBOR plus 175 basis points, and the revolving loan facility is expected to bear interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating.
We intend to use the proceeds from the equity and debt activities to finance the cash portion of the pending acquisition of Bayer's animal health business and to pay related fees and expenses. As a result, we have obtained substantially all of the financing necessary to consummate the acquisition and do not currently intend to pursue any additional financing previously provided under the commitment letter obtained in August 2019 (see Note 13: Commitments and Contingencies). We expect to execute the debt agreements upon closing the acquisition of Bayer's animal health business.
The senior unsecuredsecured credit facilities are expected to include two financial maintenance covenants which are solely for the benefit of lenders under the revolving credit facility (Revolving Facility).and no financial maintenance covenant for the benefit of the term loan B facility. The Revolving Facility bears interest at a variable rate plus specified margin as defined in the agreement and is payable quarterly. There were no borrowings outstandinglenders under the Revolving Facility at September 30, 2018. The Revolving Facility is payable in full atterm loan B facility will have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.
We expect the first financial maintenance covenant for the revolving credit facility to be a requirement to maintain a certain pro forma net total leverage ratio level (which will not be subject to step-downs) as of the end of each quarter, beginning with the term.fiscal quarter ending September 30, 2020 (assuming the closing of the acquisition of Bayer's animal health business occurs on July 1, 2020). The required level of this covenant will be based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) equal to 65% of our pro forma adjusted EBITDA for the four fiscal quarters ending March 31, 2020 (assuming the closing of the acquisition of Bayer's animal health business occurs on July 1, 2020).
On September 5, 2018 we also entered into a $500.0 million three-year term loan under a term
The second financial maintenance covenant for the revolving credit facility withis expected to be a syndicaterequirement to maintain a ratio of banks (the Term Facility and collectively with the Revolving Facility, the Credit Facilities.) The Term Facility bearspro forma adjusted EBITDA to cash interest at a variable rate plus marginexpense of no less than 2.00 to 1.00, tested as defined in Term Facility (3.50% at September 30, 2018) and is payable quarterly. The Term Facility is payable in full atof the end of each fiscal quarter, beginning with the term.
The Credit Facilities are subject to various financial and other covenants including restrictions on the level of borrowings based on a consolidated leverage ratio and a consolidated interest coverage ratio. We were in compliance with all such covenants as offiscal quarter ending September 30, 2018.
Senior Notes
On August 28, 2018, we issued $2.0 billion of senior notes (Senior Notes) in a private placement. The Senior Notes comprised of $500.0 million of 3.912% Senior Notes due August 27, 2021, $750.0 million of 4.272% Senior Notes due August 28, 2023, and $750.0 million of 4.900% Senior Notes due August 28, 2028. The interest rate payable on each series of Senior Notes is subject to adjustment if Moody's Investor Services, Inc. or Standard & Poor's Financial Services LLC downgrades, or subsequently upgrades, its ratings on2020 (assuming the respective series of Senior Notes.
The indenture that governs the Senior Notes contains covenants, including limitations on our ability, and certain of our subsidiaries, to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets, in addition, to other customary terms. We were in compliance with all such covenants under the indenture governing the Senior Notes as of September 30, 2018.
We have entered into an agreement that requires us to use commercially reasonable efforts to cause a registration statement to become effective with the SEC by August 28, 2019, relating to an offer to exchange the Senior Notes for registered Senior Notes having substantially identical terms, or, in certain cases, to register the Senior Notes for resale. If we do not register or exchange the Senior Notes pursuant to the termsclosing of the registration rights agreement, we will be required to pay additional interest to the holdersacquisition of the Senior Notes under certain circumstances.Bayer's animal health business occurs on July 1, 2020).
Note 9.11. Financial Instruments and Fair Value
Financial instruments that are potentially subject to credit risk consist principally of trade receivables. Collateral is generally not required. The risk associated with this concentration is mitigated by our ongoing credit-review procedures and insurance.procedures.
A large portion of our cash is held byin a few major financial institutions. We monitor the exposure with these institutions and do not expect any of these institutions to fail to meet their obligations. All highly liquid investments with a maturity of three months or less from the date of purchase are considered to be cash equivalents. The cost of these investments approximates fair value. We also consider the carrying value of restricted cash balances to be representative of its fair value.
As of September 30, 2018March 31, 2020 and December 31, 2017,2019, we had $14.9$20.0 million and$12.3 $18.8 million, respectively, of cost andprimarily related to equity method investments.investments included in other noncurrent assets on our condensed consolidated balance sheet.
The following table summarizes the fair value information at September 30, 2018March 31, 2020 and December 31, 20172019 for foreign exchange contract assets (liabilities), contingent consideration liabilities, net investment hedge assets (liabilities) and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items:
|
| | | | | | | | | | | | | | | | | | | |
| | | | Fair Value Measurements Using | | |
| Financial statement line item | Carrying Amount | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Fair Value |
| September 30, 2018 | | | | | | | | | |
| Other current liabilities- contingent consideration | $ | 17.4 |
| | $ | — |
| | $ | — |
| | $ | 17.4 |
| | $ | 17.4 |
|
| Other noncurrent liabilities- contingent consideration | 41.4 |
| | — |
| | — |
| | 41.4 |
| | 41.4 |
|
| December 31, 2017 | | | | | | | | | |
| Other current liabilities- contingent consideration | 1.3 |
| | — |
| | — |
| | 1.3 |
| | 1.3 |
|
| Other noncurrent liabilities- contingent consideration | 45.2 |
| | — |
| | — |
| | 45.2 |
| | 45.2 |
|
Contingent consideration liabilities relate to Galliprantitems, as well as long-term debt (including TEU amortizing notes) for which the fair value was estimated usingis disclosed on a discounted cash flow analysis and Level 3 inputs, including projections representative of a market participant view for the probability of achieving potential future payments to Aratana Therapeutics, Inc. and an estimated discount rate. The amount to be paid is dependent upon certain development, success-based regulatory, and sales-based milestones. In addition, the amount of royalties to be paid is calculated as a percentage of net sales dependent upon the timing and geography and will, therefore, vary directly with increases and decreases in net sales of Galliprant. There is no cap on the amount that may be paid pursuant to this arrangement. During the second quarter of 2018, as a result of an increase in therecurring basis:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair Value Measurements Using | | | | | | |
| Financial statement line item | Carrying
Amount | | Quoted Prices in Active Markets for Identical Assets
(Level 1) | | Significant
Other Observable Inputs
(Level 2) | | Significant
Unobservable
Inputs
(Level 3) | | Fair
Value |
| March 31, 2020 | | | | | | | | | |
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 28.0 | | | $ | — | | | $ | 28.0 | | | $ | — | | | $ | 28.0 | |
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (8.2) | | | — | | | (8.2) | | | — | | | (8.2) | |
| Other noncurrent liabilities - contingent consideration | (4.7) | | | — | | | — | | | (4.7) | | | (4.7) | |
| Other noncurrent assets - cross currency interest rate contracts designated as net investment hedges | 6.6 | | | — | | | 6.6 | | | — | | | 6.6 | |
| Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | (50.6) | | | — | | | (50.6) | | | — | | | (50.6) | |
| Long-term debt - senior notes | (2,000.0) | | | — | | | (2,067.3) | | | — | | | (2,067.3) | |
| | | | | | | | | |
TEU amortizing note (1) | (79.2) | | | — | | | (79.2) | | | — | | | (79.2) | |
| December 31, 2019 | | | | | | | | | |
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 0.8 | | | $ | — | | | $ | 0.8 | | | $ | — | | | $ | 0.8 | |
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (1.1) | | | — | | | (1.1) | | | — | | | (1.1) | |
| Other noncurrent liabilities - contingent consideration | (4.7) | | | — | | | — | | | (4.7) | | | (4.7) | |
| Other noncurrent assets - cross currency interest rate contracts designated as net investment hedges | 2.3 | | | — | | | 2.3 | | | — | | | 2.3 | |
| | | | | | | | | |
| Long-term debt - senior notes | (2,000.0) | | | — | | | (2,120.6) | | | — | | | (2,120.6) | |
Long-term debt - term credit facility (1) | (371.4) | | | — | | | (371.4) | | | — | | | (371.4) | |
| | | | | | | | | |
projected cash flows related to Galliprant, we increased the fair value of the contingent consideration liabilities by $8.5 million. The additional expense was recognized in other-net (income) expense.
We have long term debt of $2.5 billion that is recorded at amortized cost in our condensed consolidated balance sheet as of September 30, 2018. (1)We consider the carrying value of the long term debt to be representative of its fair value.
We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities.
Contingent consideration liabilities as of September 30, 2018.March 31, 2020 and December 31, 2019 related to contingent consideration associated with the acquisitions of Aratana and Prevtec during 2019. For Aratana, we will pay up to
$12 million in contingent value rights that are dependent on the achievement of a specified milestone as outlined in the merger agreement. For Prevtec, based on the terms of the purchase agreement, we will pay up to $16.3 million contingent upon the achievement of specific Coliprotec sales milestones by December 31, 2021. The fair value of this longboth contingent consideration liabilities was estimated using the Monte Carlo simulation model and Level 3 inputs including historical revenue, discount rate, asset volatility, and revenue volatility. See Note 6: Acquisitions and Divestitures for further discussion.
Derivative Instruments and Hedging Activities
We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures.
Derivatives Not Designated as Hedges
We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. These derivative financial instruments primarily offset exposures in the British pound, Canadian dollar, Euro, Japanese yen and Swiss franc (CHF). Foreign currency derivatives used for hedging are put in place using the same or like currencies and duration as the underlying exposures and are recorded at fair value with the gain or loss recognized in other – net, (income) expense. Forward contracts generally have maturities not exceeding 12 months. At March 31, 2020 and December 31, 2019, we had outstanding foreign exchange contracts with aggregate notional amounts of $898.4 million and $861.2 million, respectively. During the three months ended March 31, 2020 and 2019, the amount of net gains and losses on derivative instruments not designated as hedging instruments, recorded in other – net, (income) expense were $(28.0) million and $8.0 million, respectively. These amounts were substantially offset in other – net, (income) expense by the effect of changing exchange rates on the underlying foreign currency exposures.
Derivatives Designated as Hedges
In October 2018, as a means of mitigating the impact of currency fluctuations on our operations in Switzerland, we entered into a five-year cross-currency fixed interest rate swap with a 750 million CHF notional amount, which is designated as a net investment hedge (NIH) against CHF denominated assets (the fair value of which was estimated based on quoted market values of similar hedges and is classified as Level 2). During the three months ended March 31, 2020 and 2019 our interest expense was offset by $6.0 million and $6.1 million, respectively, as a result of the NIH. Over the life of the derivative, gains or losses due to spot rate fluctuations are recorded in cumulative translation adjustment in other comprehensive income. During the three months ended March 31, 2020 and 2019, we recorded a gain, net of tax, of $23.3 million and $12.2 million, respectively, on the NIH. In March 2020, approximately 75% of our cross-currency swaps were liquidated for a cash benefit of $26.7 million (including $1.5 million in interest). We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020. In April 2020, we liquidated our remaining position for a cash benefit of $8.3 million. Notwithstanding settlement, gains and losses within accumulated other comprehensive income loss will remain in accumulated other comprehensive loss until either the sale or substantial liquidation of the hedged subsidiary.
Separately, in March 2020, as a means of mitigating variability in cash flows associated with the anticipated term loan B issuance, we executed forward-starting interest rate swaps with a $4.05 billion notional amount, which are designated as cash flow hedges and have settlement dates ranging between 2022 and 2025. These instruments effectively convert floating-rate debt to fixed-rate debt. The cash flow hedges are recorded at fair value on our condensed consolidated balance sheet, while changes in the fair value of the hedge are recognized in other comprehensive income. Fair value is estimated based on quoted market pricesvalues of similar liabilitieshedges and is classified as Level 2. As of December 31, 2017, longAmounts recorded in accumulated other comprehensive loss will be recognized in earnings in interest expense when the hedged transaction affects earnings (i.e., when interest payments are accrued on the term debt was not material.
Note 10. Income Taxes
Prior to Separation
loan B). During the periods presentedthree months ended March 31, 2020, we recorded a loss of $39.2 million, net of tax benefit of $11.4 million, on the cash flow hedges in other comprehensive loss.
Note 12. Income Taxes
| | | | | | | | | | | | | | | | | | |
| Provision for Taxes on Income | | | | | | Three Months Ended March 31, | | |
| | | | | | 2020 | | 2019 |
| (Benefit) Provision for Taxes on Income | | | | | | $ | (18.7) | | | $ | 13.3 | |
| Effective Tax Rate | | | | | | 27.6 | % | | 29.7 | % |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
Our income taxes for the unaudited condensed consolidatedthree months ended March 31, 2019 and combined financial statements, our operations2020, respectively, reflect the results on a stand-alone basis independent of Lilly, except for the period during which we were generally included in a combined tax return until full separation. In the jurisdictions in which we were included in a combined tax return, our income taxes were determined based on the tax grouping of other Lilly entities within the respective entity's tax jurisdiction; however, in certain jurisdictions, we filed separate tax returns.matters agreement between us and Lilly. Prior to the Separation, the income tax expense included in these financial statements has been calculated using the separate return basis as if Elanco filed separate tax returns.
For the three and nine months ended September 30, 2018, we incurred $18.6 million and $46.2 million, respectively, of income tax expense. For the three and nine months ended September 30, 2018, the effective tax rate of 23.6% and 39.7%, respectively, was primarily attributable to a net operating loss in
In 2017, the U.S. for which no tax benefit was recognized and a valuation allowance was recorded.
For the three and nine months ended September 30, 2017, despite reporting a loss before taxes of $9.1 million and $77.2 million, respectively, we incurred $11.6 million and $72.0 million of income tax expense. The tax expense recorded related primarily to income generated in certain foreign jurisdictions as no tax benefit was recorded for U.S. net operating losses.
In December 2017, the President of the U.S. signed into lawenacted the Tax Cuts and Jobs Act (2017 Tax Act), which includes significant changessignificantly revised U.S. tax law. Guidance related to the U.S. corporate income tax system, including a reduction in the corporate income tax rate, transition to a territorial tax system, and modifications to the international tax provisions. At September 30, 2018, our accounting for the 2017 Tax Act, is incomplete; however,including Notices, Proposed Regulations, and Final Regulations, has been issued, and we expect additional guidance will be issued in 2020. This additional guidance could materially impact our assumptions and estimates used to completerecord our accounting by December 2018. As discussed in our combined financial statementsU.S. federal and accompanying notes as of and forstate income tax expense resulting from the year ended December 31, 2017 included in our IPO Prospectus, we recorded provisional adjustments for effects that we were able to reasonably estimate. Those effects included the one-time repatriation transition tax (also known as the Toll Tax), re-measurement of deferred tax assets and liabilities, unremitted earnings, executive compensation, and uncertain tax positions. At December 31, 2017, we were not able to make reasonable estimates for Global Intangible Low-Taxed Income (GILTI) deferred taxes or changes to the valuation allowances; therefore, we did not record provisional amounts. We are still evaluating the effects of the GILTI provisions and assessing our valuation allowances, and we have not yet concluded upon our accounting policy election with respect to GILTI deferred taxes or the application of intra entity transfers of inventory; therefore, the estimated annual effective tax rate reflects GILTI as a period expense. For the three and nine months ended September 30, 2018, we have not made any additional measurement-period adjustments related to provisional amounts as we are continuing to collect and analyze additional information as well as evaluate the interpretations and assumptions made. Updates to the calculations may result in material changes to the provisional adjustments recorded at December 31, 2017 and the estimated annual effective tax rate.Tax Act.
As part of Lilly, we
We are included in Lilly's U.S. tax examinations by the Internal Revenue Service (IRS). Thethrough the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with the IPO, the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. During the fourth quarter of 2019, the IRS began its examination of tax years 2013-2015 began2016 - 2018. Because the examination is still in 2016. While we believe it is reasonably possible that thisthe early stages of information gathering, the resolution of the audit could reach a resolution withinwill likely extend beyond the next twelve12 months.
For the three months ended March 31, 2020, we recognized an income tax benefit of $18.7 million. The effective tax rate of 27.6% differs from the IRS examinationstatutory income tax rate primarily due to a pre-tax book loss mainly driven by acquisition and integration costs. In addition, a discrete income tax benefit of tax years 2013-2015 remains ongoing. For periods prior to the Separation, Lilly will retain the liabilities related to such IRS audit resolutions.
Impact of Separation
In connection with the Separation, we entered into a tax matters agreement (TMA) with Lilly that, among other things, formalized our agreement$1.9 million was recognized related to the responsibilityexcess tax benefits for historicalstock-based compensation that vested in the three months ended March 31, 2020.
For the three months ended March 31, 2019, we incurred $13.3 million of income tax positionsexpense. The effective rate for the periods priorthree months ended March 31, 2019, of 29.7% was different from the statutory income tax rate primarily due to a one-time foreign exchange gain on the transfer of assets upon separation in addition to the Separation for jurisdictions where our business was included in the consolidated or combined tax returnsimpact of Lilly. The TMA also established a tax sharing agreement for jurisdictions where our business will continue to be included in Lilly's consolidated or combined tax returns for a period of time.state income taxes.
Based on the TMA, Lilly retained the tax benefitsNote 13. Commitments and liabilities associated with all periods prior to the Separation date for any jurisdiction where we were included in a consolidated or combined tax return. The financial statements for periods prior to Separation included certain deferred tax assets related to tax credit and net operating loss carryovers that resulted from our tax expense being calculated on a separate return basis that will not transfer to us either because they were used by Lilly or are retained by Lilly and reflected certain tax liabilities that will be retained by Lilly. We recorded an adjustment to our consolidated balance sheet at the date of Separation to reflect our tax positions based on the TMA. This resulted in a decrease in tax liabilities by $31.2 million as these tax liabilities will be retained by Lilly.Contingencies
At September 30, 2018, we have net operating losses for international tax purposes of approximately $190 million which will expire between 2022 and 2028. These net operating losses are partially reserved. Deferred tax assets related to state net operating losses are $6.2 million. The state net operating losses will generally expire between 2035 and 2037.
Note 11. Contingencies
We are party to various legal actions in the normal course of business. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality. We recordaccrue for certain liability claims to the extent that we can formulate a liability ifreasonable estimate of their costs and there is a claim for which it is probable a payment will be made and the amount is estimable.reasonable probability of incurring significant costs or expenses. At September 30, 2018March 31, 2020 and December 31, 2017,2019, we had no0 liabilities established related to litigation as there arewere no significant claims which were probable and estimable. We have not historically had any significant litigation expense and are not currently subject to anya significant claim.
Bayer Animal Health acquisition financing
In connection with our pending acquisition of the animal health business of Bayer as discussed in Note 6: Acquisitions and Divestitures, in August 2019, we entered into a commitment letter that provides for financing consisting of up to $750 million in a revolving facility, $3.0 billion in a term facility and $2.75 billion in a senior secured bridge facility. In connection with the financing commitment letter, we will incur fixed commitment fees of $40.4 million that will become due and payable upon the closing of the pending acquisition or the termination of the Purchase Agreement with Bayer. These fees have not been recorded on the condensed consolidated balance sheet as of March 31, 2020. As a result of the financing secured for the acquisition through the equity and debt activity
during the three months ended March 31, 2020, we no longer intend to use the full financing pursuant to the commitment letter. See Note 9: Equity and Note 10: Debt for more information.
Note 12.14. Geographic Information
We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both food animals and companion animals. Consistent with our operational structure, our President and Chief Executive Officer (CEO), as the chief operating decision maker, makes resource allocation and business process decisions globally across our consolidated business. Strategic decisions are managed globally with global functional leaders responsible for determining significant cost/investments and with regional leaders responsible for overseeing the execution of the global strategy. Our global research and development organization is responsible for development of new products. Our manufacturing organization is responsible for the manufacturing and supply of products and for the optimization of our supply chain. Regional leaders are responsible for the distribution and sale of our products and for local direct costs. The business is also supported by global corporate staff functions. Managing and allocating resources at the global corporate level enables our CEO to assess the overall level of resources available and how to best deploy these resources across functions, product types, regional commercial organizations and research and development projects in line with our overarching long-term corporate-wide strategic goals, rather than on a product or geographic basis. Consistent with this decision-making process, our CEO uses consolidated, single-segment financial information for purposes of evaluating performance, allocating resources, setting incentive compensation targets, as well as forecasting future period financial results.
Our products include Rumensin®Rumensin™, Optaflexx®Optaflexx™, Denagard®Denagard™, Tylan®Tylan™, Maxiban®Maxiban™ and other products for livestock and poultry, as well as Trifexis®Trifexis™, Interceptor™, Interceptor®Comfortis™, Comfortis®Galliprant and other products for companion animals.
We have a single customer whothat accounted for 11.1%13.6% and 9.4%12.3% of revenue for the three months ended September 30, 2018March 31, 2020 and 2017, respectively, and for 11.5% and 11.9% of revenue for the nine months ended September 30, 2018 and 2017,2019, respectively. The product sales resulted in accounts receivable with this customer of $79.5$87.5 million and $88.0$90.5 million as of September 30, 2018March 31, 2020 and December 31, 2017,2019, respectively.
We are exposed to the risk of changes in social, political and economic conditions inherent in foreign operations and our results of operations and the value of itsour foreign assets are affected by fluctuations in foreign currency exchange rates.
Selected geographic area information was as follows:
| | | | | | | | | | | | | | | | | |
| | | | | Three Months Ended March 31, | | |
| | | | | 2020 | | 2019 |
Revenue—to unaffiliated customers (1) | | | | | | | |
| United States | | | | | $ | 299.9 | | | $ | 383.9 | |
| International | | | | | 357.8 | | | 347.2 | |
| | | | | | | |
| | | | | | | |
| Revenue | | | | | $ | 657.7 | | | $ | 731.1 | |
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2018 | | 2017 | | 2018 | | 2017 |
Revenue—to unaffiliated customers (1) | | | | | | | |
| United States | $ | 382.2 |
| | $ | 321.4 |
| | $ | 1,108.6 |
| | $ | 1,054.6 |
|
| International | 378.9 |
| | 375.7 |
| | 1,158.9 |
| | 1,080.1 |
|
| Revenue | $ | 761.1 |
| | $ | 697.1 |
| | $ | 2,267.5 |
| | $ | 2,134.7 |
|
| | | | | | | | | | | |
| March 31, 2020 | | December 31, 2019 |
Long-lived assets (2) | | | |
| United States | $ | 732.7 | | | $ | 709.8 | |
| United Kingdom | 181.8 | | | 192.6 | |
| | | |
| Other foreign countries | 232.9 | | | 244.7 | |
| Long-lived assets | $ | 1,147.4 | | | $ | 1,147.1 | |
|
| | | | | | | |
| | September 30, 2018 | | December 31, 2017 |
Long-lived assets (2) | | | |
| United States | $ | 589.5 |
| | $ | 604.7 |
|
| United Kingdom | 195.9 |
| | 204.4 |
|
| Other foreign countries | 190.5 |
| | 190.2 |
|
| Long-lived assets | $ | 975.9 |
| | $ | 999.3 |
|
(1)Revenue is attributed to the countries based on the location of the customer.
(2)Long-lived assets consist of property and equipment, net, and certain noncurrent assets, including right-of-use assets.
Note 13.15. Earnings Per Share
Basic Earnings Per Share
We have calculatedcompute basic earnings (loss) per share by dividing net earnings (loss) available to common shareholders by the actual weighted average number of common shares outstanding for the reporting period. For the three months ended March 31, 2020, weighted average number of common shares outstanding used to calculate basic earnings per share assuming 365,625,000includes the impact of approximately 25.0 million shares and 14.3 million shares relating to the common stock issued in connection with the January 2020 common stock offering and the shares of common stock issuable at the minimum settlement rate under the TEU prepaid stock purchase contracts, respectively. See Note 9: Equity for further discussion.
Diluted Earnings Per Share
Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements and the TEU prepaid stock purchase contracts. Diluted earnings per share reflects the potential dilution that could occur if holders of the unvested equity awards and unsettled TEUs converted their holdings into common stock. The weighted average number of potentially dilutive shares outstanding is calculated using the treasury stock method.
Weighted average diluted shares outstanding included common stock equivalents of 0.3 million for the three months ended March 31, 2019.
Potential common shares that would have the effect of increasing diluted earnings per share are considered to be anti-dilutive and as such, these shares are not included in the calculation of diluted earnings per share. During the three months ended March 31, 2020, we reported a net loss. Therefore, dilutive common shares are not assumed to have been issued since their effect is anti-dilutive. As a result, basic and diluted weighted average shares are the same, causing diluted net loss per share to be equivalent to basic net loss per share.
For the three months ended March 31, 2019, approximately 0.2 million shares of potential common shares were outstanding for all periods presented. This represents an aggregateexcluded from the calculation of 293,290,000 shares of our common stock held by Lilly (which represents the 100 shares held by Lilly prior to givingdiluted earnings per share because their effect to the 2,932,900-for-1 stock split that occurred on September 19, 2018), the issuance of 62,900,000 shares of our common stock in the IPO, and the issuance of 9,435,000 shares of our common stock sold pursuant to the underwriters’ option to purchase additional shares.was anti-dilutive.
Note 14.16. Related Party Agreements and Transactions
Separation-Related Agreements
Transactions with Lilly Subsequent to Separation and Related to the Separation
Amounts due from/(due to) Lilly in connection with the Separation and agreed upon services were as follows:
| | | | | | | | | | | |
| March 31, 2020 | | December 31, 2019 |
| TSA | $ | 10.8 | | | $ | 10.5 | |
| Other activities | 8.6 | | | (15.8) | |
| Local country asset purchases | (10.7) | | | (11.1) | |
| Total receivable from/(payable to) Lilly | $ | 8.7 | | | $ | (16.4) | |
As described in Note 1, we completed an IPO in September 2018 and Lilly fully divested all ownership of Elanco in March 2019. In connection with the Separation, Lilly transferred to us substantially all of its animal health businesses in exchange for approximately $4.2 billion. This is reflected as consideration to Lilly in our statement of equity. In addition, we entered into various agreements with Lilly related to the form of our separation and certain ongoing activities that will continue for a period of time. These included, among others, a master separation agreement (MSA), a TSA and a transitional services agreement with Lilly.
Master Separation Agreement (MSA)
As stated in Note 1, Lilly transferred to us at the time of Separation, throughtax matters agreement. In addition, there was a series of transactions, the businesses that will continue as part of Elanco. For a certain portion of our operations for which the legal transfer of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries. Under the MSA entered into with Lilly, we are responsible for the business activities conducted by Lilly on our behalf and are subject to the risks and entitled to the benefits generated by these operations and assets. As a result, the related assets and liabilities and results of operations have been reported in our unaudited condensed consolidated and combined financial statements. The total net assets associated with these jurisdictions are $84.5 million and the annual profits are insignificant. Upon Separation, we retained $275.0 million, which is reflected as restricted cash, that will be used to fund the purchase of these operations from Lilly at the time of the local country closing and have an offsetting payable to Lilly. If the amount of local purchases is less than $275.0 million, we are required to repay the remaining amount to Lilly.
In addition, based on the MSA, we are required to distribute to Lilly any amount of cash in excess of $300.0 million held at September 30, 2018. As a result, we have reflected an additional $359.9 million of restricted cash on our balance sheet with an offsetting payable to Lilly at September 30, 2018.
Transitional Services Agreement (TSA)
Historically, Lilly has provided us significant shared services and resources related to corporate functions such as executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations, which we refer to collectively as the "Lilly Services." Under the terms of the TSA, we will beare able to use Lilly Services for a fixed term established on a service-by-service basis. We will pay Lilly mutually
agreed-upon fees for the Lilly Services provided under the TSA, which will beare based on Lilly's cost (including third-party costs) of providing the Lilly Services through March 31, 2021, and subject to a mark-up of 7% thereafter, with additional inflation-based escalation beginning January 1, 2020.2022. The fees under the TSA becomebecame payable for all periods beginning after October 1, 2018.
We also entered into a TMA, an employee
Separation Activities
Subsequent to our IPO, there continue to be transactions between us and Lilly related primarily to the completion of the local country asset purchases and finalization of assets and liabilities associated with the legal separation from Lilly, combined income tax returns and the impact of the tax matters agreement, a toll manufacturinghistorical Lilly retirement benefits, and supply agreementcentralized cash management. The most significant of these activities includes the finalization of the local country valuation of business and a registration rights agreementthe resulting impact on deferred tax assets and the impact of combined tax returns.
Other Activities
We continue to share certain services and back office functions with Lilly, which in connection withcertain instances result in Lilly paying costs for Elanco (e.g., utilities, local country operating costs, etc.) that are then passed through to Elanco for reimbursement. These amounts are included in cash flows from operating activities in our consolidated statements of cash flows. In addition, we operate through a single treasury settlement process and prior to the Separation.local country asset purchases (as described below) continued to transact through Lilly's processes in certain instances. As a result of these activities, there were certain amounts of financing that occurred between Lilly and Elanco during the three months ended March 31, 2019. Further, during the three months ended March 31, 2020, our financing cash flows include a $15.2 million outflow to Lilly related to a local country asset purchase that was in addition to the original Separation plan. This amount will be reimbursed by Lilly in the second quarter of 2020. These amounts are included in cash flows from financing activities in our consolidated statements of cash flows.
Local Country Asset Purchases
The legal transfer of certain of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries. The related assets, liabilities, and results of operations have been reported in our condensed consolidated financial statements, as we are responsible for the business activities conducted by Lilly on our behalf and are subject to the risks and entitled to the benefits generated by these operations and assets under the terms of the MSA. We held restricted cash, and the associated payable to Lilly, at the date of Separation to fund the acquisition of these assets. As of March 31, 2020, the majority of these assets have been legally acquired and the remainder are expected to be purchased during 2020. Restricted cash and Payable to Lilly of $10.7 million are recorded on the condensed consolidated balance sheet for the remainder of the assets expected to be purchased by the end of 2020.
Transactions with Lilly Prior to Full Separation
We
Prior to the IPO, we did not historically operate as a standalone business and had various relationships with Lilly whereby Lilly provided services to us.
Transfers to/from Lilly, net
As discussed in the basis of presentation, net parent company investment is primarily impacted by contributions from Lilly which are the result of treasury activity and net funding provided by or distributed to Lilly. For the three months ended September 30, 2018 and 2017, respectively, the net transfers (to)/from Lilly were $(116.8) million and $38.1 million. For the nine months ended September 30, 2018 and 2017, respectively, the net transfers (to)/from Lilly were $(226.3) million and $862.7 million, respectively. The most significant activity impacting the 2017 transfer was the financing by Lilly ofimpact on our acquisition in the amount of $882.1 million for Boehringer Ingelheim Vetmedica, Inc.'s United States feline, canine, and rabies vaccine portfolio and other related assets in 2017. Other activities that impacted the net transfers (to)/from Lilly include corporate overhead and other allocations, income taxes, retirement benefits, and centralized cash management.
Corporate Overhead and Other Allocations
Lilly provides us certain services, including executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. We provide Lilly certain services related to manufacturing support. Ourhistorical combined financial statements reflect an allocation of these costs. When specific identification is not practicable,includes the remainder have been allocated primarily on a proportional cost method on a basis of revenue or headcount.following:
The allocations of services from Lilly to us were reflected as follows in the unaudited condensed consolidated and combined statements of operations:
|
| | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | Nine Months Ended September 30, |
| | 2018 | | 2017 | | 2018 | | 2017 |
| Cost of sales | $ | 7.0 |
| | $ | 7.7 |
| | $ | 21.8 |
| | $ | 23.0 |
|
| Research and development | 0.7 |
| | 0.7 |
| | 2.2 |
| | 2.1 |
|
| Marketing, selling and administrative | 26.4 |
| | 27.7 |
| | 81.2 |
| | 82.7 |
|
| Total | $ | 34.1 |
| | $ | 36.1 |
| | $ | 105.2 |
| | $ | 107.8 |
|
We provide Lilly certain services related to manufacturing support. Allocations of manufacturing support from us to Lilly of $1.3 million and $1.5 million for the three months ended September 30, 2018 and 2017, respectively, as well as $3.7 million and $4.5 million for the nine months ended September 30, 2018 and 2017, respectively, reduced the cost of sales in the unaudited condensed consolidated and combined statements of operations.
The financial information herein may not necessarily reflect our consolidated financial position, results of operations and cash flows in the future or what they would have been if we had been a separate, standalone entity during the periods presented. Management believes that the methods used to allocate expenses are reasonable.
Stock-based Compensation
Our
Prior to full separation, our employees participateparticipated in Lilly stock-based compensation plans, the costs of which have beenwere allocated to us and recorded in cost of sales, research and development, and marketing, selling and administrative expenses in the unaudited condensed consolidated and combined statements of operations. The costs of such plans related to our employees were $6.9 million and $6.2$5.1 million for the three months ended September 30, 2018 and 2017, respectively, as well as $20.2 million and $18.7 million for the nine months ended September 30, 2018 and 2017, respectively.March 31, 2019.
Our employees participate in defined benefit pension and other post retirement plans sponsored by Lilly, the costs and benefits of which have been recorded in the unaudited condensed consolidated and combined statement of operations in cost of sales, research and development, and marketing, selling and administrative expenses. For the three and nine months ended September 30, 2018, the benefit of such plans related to our employees was $1.6 million and $0.3 million, respectively, and for the three and nine months ended September 30, 2017 the costs of such plans related to our employees were $1.7 million and $5.1 million, respectively.
Centralized Cash Management
Lilly uses a centralized approach to cash management and financing of operations. Until Separation, the majority of our business was party to Lilly’s cash pooling arrangements to maximize Lilly's availability of cash for general operating and investing purposes. Under these cash pooling arrangements, cash balances were swept regularly from our accounts. Cash transfers to and from Lilly’s cash concentration accounts and the resulting balances at the end of each reporting period were reflected in net parent company investment in the condensed consolidated and combined balance sheets.
Debt
Lilly’s third-party debt and the related interest expense have not been allocated to us for any of the periods presented as we were not the legal obligor of the debt and Lilly borrowings were not directly attributable to our business.
Commercial Operations
We sell certain products to and receives certain goods and services from a customer/vendor, whose chairman and Chief Executive Officer is a member of Lilly's Board of Directors. These product sales resulted in revenue of $4.2 million and $6.6 million for the three months ended September 30, 2018 and 2017, respectively, and of $16.4 million and $17.8 million for the nine months ended September 30, 2018 and 2017, respectively. The product sales resulted in accounts receivable of $1.9 million and $2.0 million at September 30, 2018 and December 31, 2017, respectively. The purchase of goods and services resulted in cost of sales and operating expenses of $1.4 million and $1.1 million for the three months ended September 30, 2018 and 2017, respectively, as well as $3.3 million and $5.3 million September 30, 2018 and 2017, respectively. The purchase of goods and services resulted in accounts payable of $0.4 million and $0.3 million at September 30, 2018 and December 31, 2017, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tables present dollars in millions, except per-share data)
The management’s
Management’s discussion and analysis of financial condition and results of operations is intended to assist the reader in understanding and assessing significant changes and trends related to our results of operations and financial position. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated and combined financial statements and accompanying footnotes in Item 1 of Part I of this Quarterly Report on Form 10-Q. Certain statements in this Item 2 of Part I of this Quarterly Report on Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements"Statements," Item 1A, "Risk Factors," of Part II of this Quarterly Report on Form 10-Q, and inItem 1A, “Risk Factors” included inFactors,” of Part I of our final prospectus relating to our initial public offering filedAnnual Report on September 21, 2018 (IPO Prospectus),Form 10-K for the year ended December 31, 2019, may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements.
Overview
Founded in 1954 as part of Eli Lilly and Company (Lilly), 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. world, with revenue of $3,071.0 million for the year ended December 31, 2019. Globally, we are #1 in medicinal feed additives, #2 in poultry, and #3 in other pharmaceuticals, which are mainly companion animal therapeutics, measured by 2018 revenue, according to Vetnosis.
We have one of the broadest portfolios of pet parasiticides in the companion animal sector. We offer a diverse portfolio of more than 125 brands that make us a trusted partner to veterinarians and food animal producers in more than 90 countries.
On September 24, 2018, we completed our initial public offering (IPO), pursuant to which we issued and sold 19.8% of our total outstanding shares. On September 20, 2018, our common stock began trading on the New York Stock Exchange (NYSE) under the symbol “ELAN.” On September 24, 2018, immediately preceding the completion of the IPO, Lilly transferred to us substantially all of its animal health businesses in exchange for (i) all of the net proceeds (approximately $1,659.7 million) we received from the sale of our common stock in the IPO, including the net proceeds we received as a result of the exercise in full of the underwriters’ option to purchase additional shares, (ii) all of the net proceeds (approximately $2,000 million) we received from the issuance of our senior notes; and (iii) all of the net proceeds ($498.6 million) we received from the entry into our term loan facility. In addition, immediately prior to the completion of the IPO, we entered into certain agreements with Lilly that provide a framework for our ongoing relationship with them.
On February 8, 2019, Lilly announced an exchange offer whereby Lilly shareholders could exchange all or a portion of Lilly common stock for shares of Elanco common stock owned by Lilly. On that date, we filed a Registration Statement on Form S-4 with the SEC in connection with that exchange offer. The disposition of Elanco shares was completed on March 11, 2019, and resulted in the full separation of Elanco along with the disposal of Lilly's entire ownership and voting interest in Elanco.
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 four primary categories:
Companion Animal Disease Prevention (CA Disease Prevention): We have one of the broadest parasiticide portfolios in the companion animal sector based on indications, species and formulations, with products that protect pets from worms, fleas and ticks. Combining our parasiticide portfolio with our vaccines presence, we are a leader in the United States (U.S.)U.S. in the disease prevention category based on share 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 Galliprant™ product is one of the fastest growing osteoarthritis treatments in the U.S. We also have treatments for otitis (ear infections), as well as cardiovascular and dermatology indications.
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.
On September 24, 2018, we completed an initial public offering resulting in the issuance of 72.3 million shares our common stock (IPO), which represented approximately 19.8% of our total outstanding shares. Our common stock began trading on the New York Stock Exchange under the symbol "ELAN" on September 20, 2018. Prior to and in connection with the IPO, we completed a $2.0 billion senior notes offering and entered into a $500.0 million term loan, and Lilly transferred to us substantially all of the assets and liabilities of their animal health business. Lilly continues to own the remaining 80.2% of our outstanding shares. Lilly has informed us that it may make a tax-free distribution to its shareholders of all or a portion of its remaining equity interest in us, which may include one or more distributions effected as a dividend to all Lilly shareholders, one or more distributions in exchange for Lilly shares or other securities, or any combination thereof. We refer to any such potential distribution as the Distribution. Lilly has no obligation to pursue or consummate any further dispositions of its ownership interest in us, including through the Distribution, by any specified date or at all.
For the three months ended September 30, 2018March 31, 2020 and 2017,2019, our revenue was $761.1$657.7 million and $697.1$731.1 million,
respectively. For the three months ended September 30, 2018March 31, 2020 and 2017,2019, our net (loss) income (loss) was $60.2$(49.1) million and $(20.7)$31.5 million, respectively.
For
Increases or decreases in inventory levels at our channel distributors can positively or negatively impact our quarterly and annual revenue results, leading to variations in quarterly revenues. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the nine months ended September 30, 2018need for certain 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, and 2017,procedures and environmental factors beyond our revenue was $2,267.5 millioncontrol, including weather conditions.
Key Trends and $2,134.7 million, respectively, ForConditions Affecting Our Results of Operations
Industry Trends
The animal health industry, which includes both food animals and companion animals, is a growing industry that benefits billions of people worldwide.
As demand for animal protein grows, food animal health is becoming increasingly important. We believe that factors influencing growth in demand for food animal medicines and vaccines include:
•one in three people need 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 nine months ended September 30, 2018need for more efficient food production;
•loss of productivity due to food animal disease and 2017 our net income (loss) was $70.1 milliondeath;
•increased focus on food safety and $(149.2) million, respectively.food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.
Growth in food 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.
We believe that factors influencing growth in demand for companion animal medicines and vaccines include:
•increased pet ownership globally;
•pets living longer; and
•increased pet spending as pets are viewed as members of the family by owners.
Factors Affecting Our Results of Operations
COVID-19 Pandemic
The recent outbreak of COVID-19 originating in Wuhan, China, in December 2019 has since rapidly increased its exposure globally. On March 11, 2020, the World Health Organization declared the outbreak a pandemic. We are monitoring the global outbreak of COVID-19 and are working with our customers, employees, suppliers and other stakeholders to mitigate the risks posed by its spread. The COVID-19 pandemic is affecting the economy in the United States and globally, and has affected the operations of our company, vendors and suppliers, supply of and demand for our products, and our liquidity as follows:
Operations
As a result of the COVID-19 pandemic, governmental authorities have implemented and are continuing to implement numerous and constantly evolving measures to try to contain the virus, such as travel bans and restrictions, limits on gatherings, quarantines, shelter-in-place orders, site closures and business shutdowns. These measures have impacted the ability of our employees, vendors, and suppliers to perform their respective responsibilities and obligations relative to the conduct of our business. We have important manufacturing operations worldwide that have been affected by the outbreak. Measures requiring business shutdowns generally exclude certain essential services, and those essential services commonly include critical infrastructure and the businesses that support that critical infrastructure. Because the animal health industry has been designated an essential business, our manufacturing and research facilities remain operational, while our employees in other company functions are working remotely. These measures have impacted and may further impact our workforce and operations, as well as those of our customers, vendors and suppliers.
Supply
We have not yet experienced any significant impacts or interruptions to our supply chain as a result of the COVID-19 pandemic. However, our suppliers may face difficulties maintaining operations in light of government-ordered restrictions and shelter-in-place mandates. Although we regularly monitor the financial health of companies in our supply chain, the financial hardship on our suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to manufacture our products, adversely affecting our operations. Freight processes relating to the shipment of our finished goods have also been disrupted and have started to result in higher shipping costs, which has negatively impacted our profitability.
Demand
The COVID-19 pandemic has adversely impacted global economic conditions. In particular, the COVID-19 pandemic has created near-term uncertainty for our channel distribution partners with respect to end customer demand and working capital. Based on these factors, in addition to a shift in tactics for demand generation with our distributors, we reduced the amount of inventory held in the channel. We anticipate that these decreases in end customer demand may impact our companion animal business, primarily in vaccines and international markets, as social distancing guidelines have decreased veterinary visits, reduced veterinary practice revenue and increased working capital considerations for all parties in our value chain. In our food animal business, demand is expected to be negatively impacted by processing plant closures and pressured producer economics, as well as an effort by dairy farmers to decrease milk production, which could impact demand for a number of our food animal products. We anticipate that decreases in demand will occur, though the extent to which our operations may be impacted by the COVID-19 pandemic will depend largely on future developments, which are highly uncertain and cannot be accurately predicted at this time.
Liquidity
Our third party distributors may face difficulties maintaining operations and normal liquidity in light of government-mandated restrictions. Due to liquidity and working capital pressure caused by the COVID-19 pandemic, our distributors are managing inventory more tightly. In response to this along with a shift in tactics for demand generation with our distributors, we decided to reduce channel inventory levels during the quarter as we tighten our approach across all facets of our distributor relationships. We expect to take similar actions going forward. These actions will allow us to improve working capital management, implement new compensation structures with our distributors and enable greater control of overall stock levels. We estimate the impact on revenues to have been
approximately $60 million through March 31, 2020, with another $80 million to $100 million of potential impact, primarily in the second quarter of 2020, as we expand this practice across our business and geographies. We continue to monitor the impacts on our customers' liquidity and therefore our ability to collect on our accounts receivable. While our allowance on these receivables factors in expected credit losses, continued disruption and declines in the global economy could result in difficulties in our ability to collect and thus require increases in our allowance for doubtful accounts.
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 of CA Disease Prevention, CA Therapeutics and FA Future Protein & Health. Since 2015, we'vewe have launched 11or acquired 14 new products, fiveincluding the additions of which were launchedEntyce™, Nocita™ and Tanovea™ in 20172019 through acquisition and 2018.business development activities. Revenue from these products contributed $92.4 million to revenue for the three months ended March 31, 2020. We continue to pursue the development of new chemical and biological molecules through our approach to innovation. Our future growth and success depends on both our pipeline of new products, including new products that we may develop through joint ventures and products that we are able to obtain through license or acquisition, and the expansion of the use of our existing products. We believe we are an industry leader in animal health research and development (R&D),R&D, with a track record of product innovation, business development and commercialization.
Productivity
Our results during the periods presented have benefited from our continued operational and productivity initiatives implemented following recent acquisitions and in response to changing market demand for antibiotics and other headwinds.
Our acquisitions within the last six years added in the aggregate $1.4 billion in revenue, 4,600 full-time employees, 12 manufacturing and eight R&D sites. In addition, from 2015 to 2019, changing market demand for antibiotics and other headwinds, such as competition with generics and innovation. Weinnovation, 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 marketing, selling, general and administrative such as rationalization of stock keeping units, reduction of contract(SG&A) functions. Our manufacturing organizations, implementation ofcost savings strategies included improving manufacturing processes and headcount through lean manufacturing principles(minimizing waste while maintaining productivity), closing of three manufacturing sites, consolidating our CMO network, strategically insourcing certain projects, and pursuing cost savings opportunities with respect to raw materials via a new procurement initiatives.process. Additional cost savings 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 general and administrative (G&A) operating expense.
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. During the ninethree months ended September 30, 2018March 31, 2020 and 2017,2019, approximately 51.1%49% and 50.6%42%, respectively, of our revenue was denominated in foreign currencies. As we operate in multiple foreign currencies, including the 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 impact our revenue, cost of goodssales and expenses, and consequently, net income. These fluctuations may also affect the ability to buy and sell our products between markets impacted by significant exchange rate variances. There has beenCurrency movements decreased revenue by 1% during the three months ended March 31, 2020. Currency movements had limited impact on our results due to currency movementsrevenue during the ninethree months ended September 30, 2018 and 2017.March 31, 2019.
Our Relationship with Lilly and Additional Standalone Costs
During the period prior to the IPO, our business operated as part of a division of Lilly. Our combined financial statements have been derived from Lilly’s consolidated financial statements and accounting records. Our combined financial statements reflect the financial position, results of operations and cash flows of the business that was 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.
Our historical results reflect an allocation of costs for certain Lilly corporate costs, 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 these agreements may be higher or lower than the costs reflected in the historical allocations. In addition, we intend to replace these services over time with ones supplied either internally by our employees or by third parties, the cost of which may be higher or lower than the historical allocations. During the three and nine months ended September 30, 2018 and 2017, corporate overhead and other allocations were $34.1 million, $105.2 million, $36.1 million and $107.8 million, respectively. See Note 14: Related Party Agreements and Transactions in our unaudited condensed 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, 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 have also 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, among others. We currently estimate these costs taken together to be in a range from $240 million to $290 million, net of potential real estate dispositions and employee benefit
changes, of which a portion will be capitalized and the remainder will be expensed.
In addition,connection with the IPO, we incurred $2.5 billion of long-term borrowings. We have estimated interest expense of approximately $99 million on an annual basis based on our historical results do not reflectborrowings as of March 31, 2020.
As a result of the impactIPO, we became subject to the reporting requirements of coststhe Securities Exchange Act of 1934, as amended, and the Sarbanes-Oxley Act. We continue to establish and expand additional procedures and practices as a standalone public company. As a result, we have incurred and expect to continue to incur as a consequence of becoming a standalone company, including incrementaladditional costs associated with being a publicly traded company. These costs include a change in compensation expense as we institute competitive compensation policies and programs as a standalone public company compared to the costs ofprior period, including internal andaudit, external audit, (including those related to Sarbanes-Oxley Act of 2002), investor relations, stock administration, stock exchange fees and regulatory compliance costs.
For the purposes of our financial statements for periods prior our IPO, our effective tax rate was computed on a separate company basis, as if we had operated as a standalone entity or a separate consolidated group in each material jurisdiction in which we operate. As a result of potential changes to our business model and due the fact that we are a standalone entity, income tax expense (benefit) included in the consolidated and combined financial statements may not be indicative of our future expected tax rate.
In connection with the IPO, we entered into $2.5 billion of long-term borrowings. Our historical results for the period prior to entering into such agreements do not reflect interest expense, which we estimate at approximately $110.0 million on an annual basis.
Asset Impairment, Restructuring and Other Special Charges
Our results have been impacted by asset impairment, restructuring and other special charges, including integration of acquired businesses, during the ninethree months ended September 30, 2018March 31, 2020 and 2017.2019. These charges primarily include severance costs resulting from actions taken to reduce our cost structure, asset impairment charges related to product rationalization and site closures, and integrationcharges and costs related to our integration efforts as a result of our acquired businesses. businesses and the pending acquisition of Bayer's animal health business, external costs directly related to acquiring businesses, including expenses for banking, legal, accounting, and other similar services, and costs to stand our organization up to be an independent company.
For more information on these charges, see Note 6:7: Asset Impairment, Restructuring and Other Special Charges in our unaudited condensed consolidated and combined financial statements.
Results of Operations
The following discussion and analysis of our results of operations should be read along with our unaudited condensed consolidated and combined financial statements and the notes thereto, which reflect the results of operations of the business transferred to us from Lilly.thereto.
| | | | Three Months Ended September 30, | | % | | Nine Months Ended September 30, | | % | | | | Three Months Ended March 31, | |
| | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change | | | | 2020 | | 2019 | | % Change |
| Revenue | $ | 761.1 |
| | $ | 697.1 |
| | 9 | % | | $ | 2,267.5 |
| | $ | 2,134.7 |
| | 6 | % | Revenue | | | $ | 657.7 | | | $ | 731.1 | | | (10) | % |
| Costs, expenses and other: | | | | | | | | | | | | Costs, expenses and other: | | |
| Cost of sales | 369.8 |
| | 376.2 |
| | (2 | )% | | 1,161.3 |
| | 1,088.9 |
| | 7 | % | Cost of sales | | | 332.7 | | | 343.8 | | | (3) | % |
| % of revenue | 49 | % | | 54 | % | | (5 | )% | | 51 | % | | 51 | % | | — | % | % of revenue | | | 51 | % | | 47 | % | | 4 | % |
| Research and development | 58.9 |
| | 61.9 |
| | (5 | )% | | 185.5 |
| | 189.7 |
| | (2 | )% | Research and development | | | 66.8 | | | 64.1 | | | 4 | % |
| % of revenue | 8 | % | | 9 | % | | (1 | )% | | 8 | % | | 9 | % | | (1 | )% | % of revenue | | | 10 | % | | 9 | % | | 1 | % |
| Marketing, selling and administrative | 179.0 |
| | 194.7 |
| | (8 | )% | | 550.1 |
| | 583.0 |
| | (6 | )% | Marketing, selling and administrative | | | 182.0 | | | 181.1 | | | — | % |
| % of revenue | 24 | % | | 28 | % | | (4 | )% | | 24 | % | | 27 | % | | (3 | )% | % of revenue | | | 28 | % | | 25 | % | | 3 | % |
| Amortization of intangible assets | 48.7 |
| | 51.6 |
| | (6 | )% | | 147.3 |
| | 161.0 |
| | (9 | )% | Amortization of intangible assets | | | 51.6 | | | 49.0 | | | 5 | % |
| % of revenue | 6 | % | | 7 | % | | (1 | )% | | 6 | % | | 8 | % | | (1 | )% | % of revenue | | | 8 | % | | 7 | % | | 1 | % |
| Asset impairment, restructuring and other special charges | 12.4 |
| | 23.7 |
| | (48 | )% | | 82.8 |
| | 189.3 |
| | (56 | )% | Asset impairment, restructuring and other special charges | | | 74.8 | | | 24.9 | | | 200 | % |
| Other - (income) expense | 13.5 |
| | (1.9 | ) | | NM |
| | 24.2 |
| | — |
| | NM |
| |
| Income (loss) before taxes | 78.8 |
| | (9.1 | ) | | NM |
| | 116.3 |
| | (77.2 | ) | | NM |
| |
| Interest expense, net of capitalized interest | | Interest expense, net of capitalized interest | | | 16.5 | | | 20.8 | | | (21) | % |
| Other - net, expense | | Other - net, expense | | | 1.1 | | | 2.6 | | | (58) | % |
| Income (loss) before income taxes | | Income (loss) before income taxes | | | (67.8) | | | 44.8 | | | NM | |
| % of revenue | 10 | % | | (1 | )% | | 11 | % | | 5 | % | | (4 | )% | | NM |
| % of revenue | | | (10) | % | | 6 | % | | NM | |
| Income tax expense | 18.6 |
| | 11.6 |
| | 60 | % | | 46.2 |
| | 72.0 |
| | (36 | )% | |
| | Income tax (benefit) expense | | Income tax (benefit) expense | | | (18.7) | | | 13.3 | | | (241) | % |
| Net income (loss) | $ | 60.2 |
| | $ | (20.7 | ) | | NM |
| | $ | 70.1 |
| | $ | (149.2 | ) | | NM |
| Net income (loss) | | | $ | (49.1) | | | $ | 31.5 | | | (256) | % |
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful
Revenue
On a global basis, our revenue within our product categories was as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Three Months Ended March 31, | | | | |
| | | | | | | 2020 | | 2019 | | % Change |
| CA Disease Prevention | | | | | | | $ | 140.3 | | | $ | 185.9 | | | (25) | % |
| CA Therapeutics | | | | | | | 65.8 | | | 81.4 | | | (19) | % |
| FA Future Protein & Health | | | | | | | 180.0 | | | 167.2 | | | 8 | % |
| FA Ruminants & Swine | | | | | | | 252.6 | | | 274.1 | | | (8) | % |
| Subtotal | | | | | | | 638.7 | | | 708.6 | | | (10) | % |
Strategic Exits(1) | | | | | | | 19.0 | | | 22.5 | | | (16) | % |
| Total | | | | | | | $ | 657.7 | | | $ | 731.1 | | | (10) | % |
|
| | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended September 30, | | % | | Nine Months Ended September 30, | | % |
| | 2018 | | 2017 | | Change | | 2018 | | 2017 | | Change |
| CA Disease Prevention | $ | 188.6 |
| | $ | 140.4 |
| | 34 | % | | $ | 603.9 |
| | $ | 519.7 |
| | 16 | % |
| CA Therapeutics | 80.5 |
| | 63.5 |
| | 27 | % | | 211.1 |
| | 181.8 |
| | 16 | % |
| FA Future Protein & Health | 162.8 |
| | 164.5 |
| | (1 | )% | | 502.1 |
| | 456.0 |
| | 10 | % |
| FA Ruminants & Swine | 301.5 |
| | 280.4 |
| | 8 | % | | 881.1 |
| | 857.3 |
| | 3 | % |
| Subtotal | 733.4 |
| | 648.8 |
| | 13 | % | | 2,198.2 |
| | 2,014.8 |
| | 9 | % |
Strategic Exits (1) | 27.7 |
| | 48.3 |
| | (42 | )% | | 69.3 |
| | 119.9 |
| | (42 | )% |
| Total | $ | 761.1 |
| | $ | 697.1 |
| | 9 | % | | $ | 2,267.5 |
| | $ | 2,134.7 |
| | 6 | % |
(1)Represents revenue from business activities we have either exited or made a strategic decision to exit.
Total revenue
Three months ended September 30, 2018March 31, 2020 vs. three months ended September 30, 2017March 31, 2019
Total revenue increased $64.0decreased $73.4 million or 9%10% for the three months ended September 30, 2018March 31, 2020 as compared to the three months ended September 30, 2017,March 31, 2019, reflecting a 4% increase due to higher realized prices10% decrease in volume and a 7% increase due to higher volumes1% unfavorable impact from foreign exchange rates, partially offset by a 2% unfavorable foreign exchange rate impact.1% increase in price.
In summary, the total revenue increasedecrease was due primarily to:
an increase
•a decrease in revenue of $49.4$44.3 million or 35%24% from CA Disease Prevention products, excluding the impact of foreign exchange rates;
an increase•a decrease in revenue of $17.5$14.7 million or 28%18% from CA Therapeutics products, excluding the impact of foreign exchange rates;
an increase•a decrease in revenue of $2.8$18.8 million or 2% from FA Future Protein & Health products, excluding the impact foreign exchange rates; and
an increase in revenue of $26.3 million or 10%7% from FA Ruminants & Swine products, excluding the impact of foreign exchange rates;
partially offset by:
•a decrease in revenue of $11.5$3.0 million or 13% from Strategic Exits, excluding the impact of foreign exchange rates; and
•a decrease in revenue of $9.5 million due to the negative impact of foreign exchange rates; andrates.
a decrease
partially offset by:
•an increase in revenue of $20.5$16.9 million or 10% from Strategic Exits,FA Future Protein & Health products, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
•CA Disease Prevention revenue decreased by $45.6 million or 25% for the quarter, driven by decreased volume and to a lesser extent an unfavorable impact from foreign exchange rates, offset by an increase in price. The volume decrease was the result of actions across brands to reduce channel inventory levels due to the impact of the COVID-19 pandemic on the companion animal market. While underlying end user demand for certain products grew in the first quarter, we took actions to reduce channel inventory levels due to the impact of the COVID-19 pandemic on the companion animal market. The decrease in revenue resulting from these actions was partially offset by an increase in direct sales, particularly in alternative channels outside vet clinics.
•CA Therapeutics revenue decreased by $15.6 million or 19% for the quarter, driven by decreased volume and to a lesser extent an unfavorable impact from foreign exchange rates. While clinic-level demand for Galliprant grew in major markets and geographic expansion continued into Latin
America in the first quarter, the volume decrease was the result of actions taken across brands to reduce channel inventory levels due to the impact of the COVID-19 pandemic on the companion animal market, partially offset by the inclusion of sales for Entyce and Nocita as a result of the acquisition of Aratana in the third quarter of 2019 and an increase in direct sales, particularly in alternative channels outside vet clinics.
•FA Future Protein & Health revenue increased by $48.2$12.8 million or 34% primarily8% for the quarter, driven by increases inincreased volume and price, partially offset by an unfavorable impact from foreign exchange rates. Growth was primarily driven by higher realized price on Trifexisstrong demand in the international poultry and a favorable comparisonaqua portfolios, in addition to prior year relatedanticipatory buying in the first quarter by direct customers in international export markets to an anticipated stock out in third quarterensure continuity of 2017 which shifted salessupply ahead of Trifexis to the second quarter of 2017. Growth was also driven by the continued uptake of Interceptor Plus and Credelio, as well as increased sales of certain vaccines from new customer agreements.potential COVID-19 pandemic disruptions.
CA Therapeutics revenue increased by $17.0 million or 27% due to volume and increased price, partially offset by the unfavorable impact of foreign exchange rates. Growth was primarily due to the re-introduction of Galliprant 100mg for dogs, continued uptake of the product and realized price increases across the category.
•FA Future ProteinRuminants & HealthSwine revenue decreased by $1.7$21.5 million or 1% due to8% for the quarter, driven by decreased volume, price, and an unfavorable impact from foreign exchange ratesrates. The decrease is driven by actions to reduce inventory levels across brands due to the impact of the COVID-19 pandemic, as well as favorable purchasing patterns in the first quarter of 2019 for Rumensin and a decline in volume,producer removal of Paylean™ to access export markets, and the continued replenishment of sterile injectable products from our contract manufacturing partner. These decreases were partially offset by increased price. Volume growth in aqua, vaccines and nutritional health products was offset by international purchasing patternsdemand in the current year for poultry which shifted sales fromChina swine market as a result of favorable producer economics and positive efforts to repopulate herds impacted by African Swine Fever in 2019, in addition to anticipatory buying in the third quarter by direct customers in international export markets to ensure continuity of 2018 to the first halfsupply ahead of 2018.potential COVID-19 pandemic disruptions.
FA Ruminants & Swine revenue increased by $21.1 million or 8% due primarily to increases in volume partially offset by the unfavorable impact of foreign exchange rates. Growth was driven mainly by U.S. and international purchasing patterns in both the current and prior year which resulted in higher sales in third quarter of 2018.
•Strategic Exits revenue decreased by $20.6$3.5 million or 42% due primarily to reduced revenue from a temporary contract manufacturing arrangement as part$19.0 million and represented 3% of the acquisition of the BI Vetmedica U.S. vaccines portfolio (BIVIVP), as well as the termination of two legacy U.S. distribution agreements acquired as part of our Novartis Animal Health acquisition.total revenue.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Total revenue increased $132.8 million or 6% for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, reflecting a 1% favorable foreign exchange rate impact, a 3% increase due to higher realized prices and a 2% increase due to higher volumes.
In summary, the total revenue increase was due primarily to:
an increase in revenue of $22.9 million due to the positive impact of foreign exchange rates;
an increase in revenue of $79.6 million or 15% from CA Disease Prevention products, excluding the impact foreign exchange rates;
an increase in revenue of $24.3 million or 13% from CA Therapeutics products, excluding the impact of foreign exchange rates;
an increase in revenue of $39.4 million or 9% from FA Future Protein & Health products, excluding the impact of foreign exchange rates;
an increase in revenue of $17.7 million or 2% from FA Ruminants & Swine, excluding the
impact of foreign exchange rates; and
partially offset by:
a decrease in revenue of $51.1 million from Strategic Exits, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
CA Disease Prevention revenue increased by $84.2 million or 16% due primarily to the continued uptake of Credelio and Interceptor Plus, as well as realized price increases primarily impacting Trifexis, Capstar and Comfortis, partially offset by competition in certain parasiticides, primarily impacting Trifexis and Comfortis.
CA Therapeutics revenue increased by $29.3 million or 16% due primarily to the continued uptake of Galliprant and Osurnia, as well as increased demand for Atopica and Onsior, partially offset by a temporary supply shortage of Percorten V used for the treatment of canine Addison’s Disease.
FA Future Protein & Health revenue increased by $46.1 million or 10% due primarily to the launch of Imvixa and the growth in poultry animal-only antibiotics and AviPro.
FA Ruminants & Swine revenue increased by $23.8 million or 3% due primarily to growth in animal-only and shared-class antibiotics, offset by competition from generic ractopamine based products.
Strategic Exits revenue decreased by $50.6 million or 42% due to reduced revenue from a temporary contract manufacturing arrangement as part of the acquisition of BIVIVP, as well as the termination in the third quarter of 2017 of a legacy U.S. distribution agreement acquired as part of our Novartis Animal Health acquisition.
Costs and Expenses and Other
Cost of sales
Three months ended September 30, 2018March 31, 2020 vs. three months ended September 30, 2017March 31, 2019
Cost of sales decreased $6.4$11.1 million in the three months ended September 30, 2018 as compared to three months ended September 30, 2017 due primarily to the mix of products sold, the results of the manufacturing productivity agenda and non-recurring costs in 2017 associated with purchase accounting charges from the acquisition of BIVIVP related to the fair value adjustments of inventory acquired that was subsequently sold, partially offset by costs related to increased volume of products sold and various cost increases.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Cost of sales increased $72.4 million in the nine months ended September 30, 2018 as compared to nine months ended September 30, 2017 primarily due to costs related to increased volume of products sold, the write-off of inventory primarily related to the suspension of activities for Imrestor and various cost increases, partially offset by non-recurring costs in 2017 associated with purchase accounting charges from the acquisition of BIVIVP related to the fair value adjustments of inventory acquired that was subsequently sold.
Research and development
Three months ended September 30, 2018 vs. months ended September 30, 2017
R&D expenses decreased $3.0 million for the three months ended September 30, 2018March 31, 2020 as compared to the three months ended September 30, 2017March 31, 2019 due primarily to normal project spend fluctuationsmanufacturing productivity improvements and restructuring savings.decreased revenue.
Nine
Cost of sales as a percent of revenues increased to 50.6% for the three months ended September 30, 2018 vs. nineMarch 31, 2020 from 47.0% for the three months ended September 30, 2017March 31, 2019, primarily due to unfavorable product and geographic mix and an unfavorable effect of foreign exchange rates on international inventories sold, partially offset by decreases in cost of sales discussed above.
R&D expenses decreased $4.2 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to site closures
Research and headcount reductions in early 2017.development
Marketing, selling and administrative
Three months ended September 30, 2018March 31, 2020 vs. three months ended September 30, 2017March 31, 2019
Marketing, selling and administrative
R&D expenses decreased $15.7increased $2.7 million for the three months ended September 30, 2018March 31, 2020 as compared to the three months ended September 30, 2017March 31, 2019, primarily due primarily to productivity initiativesadditional costs from acquired businesses in 2019, including Aratana and cost control measures across these functions.Prevtec.
Marketing, selling and administrative
Nine
Three months ended September 30, 2018March 31, 2020 vs. ninethree months ended September 30, 2017March 31, 2019
Marketing, selling and administrative expenses decreased $32.9 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to productivity initiatives and reduced direct to consumer programs.
Amortization of intangible assets
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Amortization of intangible assets decreased $2.9increased $0.9 million for the three months ended September 30 2018March 31, 2020 as compared to the three months ended September 30, 2017March 31, 2019 due to additional costs from acquired businesses during the year, primarily to the accelerationAratana, partially offset by strong expense management.
Amortization of amortization related to certain product exits in 2017.intangible assets
Nine
Three months ended September 30, 2018March 31, 2020 vs. ninethree months ended September 30, 2017March 31, 2019
Amortization of intangible assets decreased $13.7increased $2.6 million for the ninethree months ended September 30, 2018March 31, 2020 as compared to the ninethree months ended September 30, 2017March 31, 2019, primarily due primarily to the accelerationaddition of amortization related to certain product exits in 2017.of intangible assets recorded from the acquisitions of Aratana and Prevtec during 2019.
Asset impairment, restructuring and other special charges
For additional information regarding our asset impairment, restructuring and other special charges, see Note 6:7: Asset Impairment, Restructuring and Other Special Charges to our unaudited condensed consolidated and combined financial statements.
Three months ended September 30, 2018March 31, 2020 vs. three months ended September 30, 2017March 31, 2019
Asset impairment, restructuring and other special charges decreased $11.3increased $49.9 million to $74.8 million for the three months ended September 30, 2018March 31, 2020 from $24.9 million for the three months ended March 31, 2019 primarily due to higher transaction costs directly related to business acquisitions, including the pending acquisition of the animal health business of Bayer, higher integration costs of acquisitions, and costs associated with the implementation of new systems, programs, and processes due to the Separation from Lilly and in anticipation of the acquisition of the animal health business of Bayer during the three months ended March 31, 2020, as more fully described in Note 7.
Interest expense, net of capitalized interest
Three months ended March 31, 2020 vs. three months ended March 31, 2019
Interest expense, net of capitalized interest, decreased $4.3 million from $20.8 million for the three months ended March 31, 2019 to $16.5 million for the three months ended March 31, 2020 primarily as a result of the repayment of indebtedness outstanding under our existing term loan facility during the three months ended March 31, 2020.
Other - net, expense
Three months ended March 31, 2020 vs. three months ended March 31, 2019
Other - net, expense decreased $1.5 million from $2.6 million for the three months ended March 31, 2019 to $1.1 million for the three months ended March 31, 2020.
Income tax expense
Three months ended March 31, 2020 vs. three months ended March 31, 2019
Income tax expense decreased $32.0 million for the three months ended March 31, 2020 as compared to the three months ended September 30, 2017March 31, 2019 primarily due to decreased severance, integration and exit costs, partially offset by higher asset impairments.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Asset impairment, restructuring and other special charges decreased $106.5 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 primarily due to a decrease in severance, integration and exit costs, partially offset by an increase in asset impairments and a gain on disposal of a site that was previously closed as part of the acquisition and integration of Novartis Animal Health in 2017.
Income tax expense
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Income tax expense increased $7.0 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 primarily due to an increase in pretaxlower pre-tax earnings offsetdriven mainly by a decrease in the U.S. valuation allowance relatedrevenue and increased acquisition and integration costs. See Note 12: Income Taxes to utilization of prior years' net operating losses.our condensed consolidated financial statements.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Income tax expense decreased $25.8 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 primarily due to a decrease in the U.S. valuation allowance related to the utilization of prior years' net operating losses.
Liquidity and Capital Resources
We historically participated in Lilly’s centralized treasury management system, including centralized cash pooling and overall financing arrangements. We have generated and expect to continue to generate positive cash flows from operations. In connection with the IPO, we entered into various long-term debt agreements as described below.
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities.credit facilities. As a significant portion of our business is conducted outside the U.S., we hold a significant portion of cash outside of the U.S. We monitor and adjust the amount of foreign cash based on projected cash flow requirements. Our ability to use foreign cash to fund cash flow requirements in the U.S. may be impacted by local regulations and, to a lesser extent, following U.S. tax reforms, the income taxes associated with transferring cash to the U.S. As our structure evolves as a standalone company, we may change that strategy, particularly to the extent we identify tax efficient reinvestment alternatives for our foreign earnings or change our cash management strategy.
Our principal liquidity needs going forward, in addition to funds needed for the completion of the Bayer acquisition, include funding existing marketed and pipeline products, capital
expenditures, business development in our targeted areas, interest expensepayments and an anticipated dividend.payments on our amortizing notes. We believe our cash and cash equivalents on
hand, our operating cash flows and our existing financing arrangements will be sufficient to support our cash needs for the foreseeable future, including for at least the next 12 months.
Our ability to meet future funding requirements may be impacted by macroeconomic, business and financial volatility. As markets change, we will continue to monitor our liquidity position. However, a challenging economic environment or an economic downturn may impact our liquidity or ability to obtain future financing. See Forward-Looking Statements.Item 1A, "Risk Factors" for more information.
Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented:
| | | | | | | | | | | | | | | | | |
| Three Months Ended March 31, | | | | $ |
| Net cash provided by (used for): | 2020 | | 2019 | | Change |
| Operating activities | $ | 4.3 | | | $ | 8.1 | | | $ | (3.8) | |
| Investing activities | (19.6) | | | (31.0) | | | 11.4 | |
| Financing activities | 896.6 | | | (339.5) | | | 1,236.1 | |
| Effect of exchange-rate changes on cash and cash equivalents | (9.3) | | | (14.5) | | | 5.2 | |
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 872.0 | | | $ | (376.9) | | | $ | 1,248.9 | |
|
| | | | | | | | | |
| | Nine Months Ended September 30, | % |
| Net cash provided by (used in): | 2018 | | 2017 | Change |
| Operating activities | $ | 347.8 |
| | $ | 167.1 |
| 108 | % |
| Investing activities | (78.9 | ) | | (929.1 | ) | (92 | )% |
| Financing activities | 327.2 |
| | 843.5 |
| (61 | )% |
| Effect of exchange-rate changes on cash and cash equivalents | 15.4 |
| | 3.3 |
| 367 | % |
| Net increase in cash, cash equivalents and restricted cash | $ | 611.5 |
| | $ | 84.8 |
| 621 | % |
Operating activities
Our cash flow fromprovided by operating activities increaseddecreased by $180.7$3.8 million, from $167.1$8.1 million for the ninethree months ended September 30, 2017March 31, 2019 to $347.8$4.3 million for the ninethree months ended September 30, 2018.March 31, 2020. The increase isdecrease in operating cash flows was primarily attributable to a decrease in net income during the period as well as the change in deferred taxes. These decreases were partially offset by a decrease in cash used as a result of changes in operating assets and liabilities. The COVID-19 global health pandemic and related economic downturn have led to an increase in net income, which was partially offset bycustomer accounts receivable that are past due. We have extended our payment terms in the past in certain customer situations and may need to continue this practice going forward as a result of the COVID-19 global health pandemic, competitive pressures and the need for certain inventory levels at our channel distributors to avoid supply disruptions. Further extensions of customer payment terms could result in additional uses of our cash used to finance working capital. flow.
Investing activities
Our cash flow used infor investing activities decreased from $929.1by $11.4 million, to $19.6 million for the ninethree months ended September 30, 2017March 31, 2020 compared to $78.9$31.0 million for the ninethree months ended September 30, 2018. Our cash usedMarch 31, 2019. The change was primarily driven by proceeds from the settlement of the net investment hedge of $25.2 million and a decrease in investing activities for the nine months ended September 30, 2017 included $882.1 million relatednet purchases of property and equipment as compared to the acquisition of BIVIVP. This decrease wasprior year, partially offset by a netan increase in purchases of $42.6 million in capital expendituressoftware from 20172019 to 2018.2020.
Financing activities
Our cash provided by financing activities decreased from $843.5was $896.6 million for the ninethree months ended September 30, 2017 to $327.2 million for the nine months ended September 30, 2018. The cash flows in 2017 relate to net cash provided by transactions with Lilly of $844.0 millionMarch 31, 2020 as compared to cash used in transactions with Lillyfor financing activities of $247.4$339.5 million in 2018, a reduction infor the three months ended March 31, 2019. Cash provided by financing of cash flows between periods of $1.1 billion. This was offset byactivities during the net cash provided from the financing transactions related to the Separation including thethree months ended March 31, 2020 reflects proceeds from long-term debtissuances of common stock and our IPO, which was onlyTEUs during the period, partially offset by the consideration paidrepayment of indebtedness outstanding under our existing term loan facility. Cash used for financing activities during the three months ended March 31, 2019, reflected the impact of $331.5 million of payments to Lilly in connection with the Separation. The remainder of the proceeds from thelocal country asset purchases and other financing activities related to the Separation will be paid to Lilly in future periods and is reflected as restricted cash in our consolidated balance sheet.Separation.
Description of Indebtedness
During the three months ended September 30, 2018, we issued $2.0 billion
For a complete description of senior notes, entered into a $500.0 million three-year term loan,our outstanding debt as of March 31, 2020 and entered into five-year $750.0 million senior unsecured revolving credit facility. For more information,December 31, 2019, see Note 8:10: Debt into our unaudited condensed consolidated and combined financial statements.
Off Balance Sheet Arrangements
We
In connection with our pending acquisition of the animal health business of Bayer as discussed in Note 6: Acquisitions and Divestitures, in August 2019, we entered into a commitment letter that provides for financing consisting of up to $750 million in a revolving facility, $3.0 billion in a term facility, and $2.75 billion in a senior secured bridge facility. In connection with the financing commitment letter, we will incur fixed commitment fees of $40.4 million that will become due and payable upon the closing of the pending acquisition or the termination of the Purchase Agreement with Bayer. These fees have no offnot been recorded on the consolidated balance sheet arrangements that currently haveas of March 31, 2020. As a material effect or that are reasonably likelyresult of the financing secured for the acquisition through the equity and debt activity during the three months ended March 31, 2020, we no longer intend to have a material future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.use the full financing pursuant to the commitment letter. See Note 9: Equity and Note 10: Debt for more information.
Critical Accounting Policies
The preparation of financial statements in accordance with GAAP requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. There are certain of our
accounting policies that are considered critical, as these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments, often employing the use of estimates about the effects of matters that are inherently uncertain. Such policies are summarized in the Management’sItem 7, "Management's Discussion and& Analysis of Results of Financial Condition and Results of Operations, section in" of our IPO Prospectus.Annual Report on Form 10-K for the year ended December 31, 2019. There have been no significant changes in the application of our critical accounting policies during 2018.the three months ended March 31, 2020.
Contractual Obligations
See Contractual Obligations included in Item 7, "Management's Discussion & Analysis of Results of Financial Condition and Results of Operations," of our IPO Prospectus. DuringAnnual Report on Form 10-K for the nine monthsyear ended September 30, 2018, we issued $2.0 billion of senior notes, entered into a $500.0 million three-year term loan, and entered into five-year $750.0 million senior unsecured revolving credit facility. For more information, see Note 8: Debt in our unaudited condensed consolidated and combined financial statements.December 31, 2019.
Item 3. Quantitative and Qualitative Disclosures About Market Risk
Foreign Exchange Risk
We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange rates. We are primarily exposed to foreign exchange risk with respect to net assets denominated in the Euro, Swiss franc, British pound, Canadian dollar, Australian dollar and Brazilian real. As part of the TSA, Lilly maintainsmaintained a foreign currency risk management program through a central shared entity, which entersentered into derivative contracts to hedge foreign currency risk associated with forecasted transactions for the entire company, including historically for our operations. Gains and losses on derivative contracts entered into by Lilly have beenwere previously allocated to our results to the extent they were to cover exposure related to our business and offset gains and losses on underlying foreign currency exposures. Following the Separation, we intend to implementWe implemented our own foreign currency risk management program.program and assumed all hedging activities in the second quarter of 2019.
We face foreign currency exchange exposures when we enter into transactions arising from subsidiary trade and loan payables and receivables denominated in foreign currencies. We also face currency exposure that arises from translating the results of our global operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of the period. We may enter into foreign currency forward or option derivative contracts to reduce the effect of fluctuating currency exchange rates in future periods, but our historical results do not reflect the impact of any such derivatives related to our exposure to foreign currency impacts on translation.periods.
We estimate that a hypothetical 10% adverse movement in all foreign currency exchange rates related to the translation of the results of our foreign operations would decrease our net income by approximately $12.0$1.5 million for the ninethree months ended September 30, 2018.March 31, 2020.
In October 2018, we entered into a fixed interest rate, five-year, 750 million Swiss franc NIH against Swiss franc assets. The NIH generated approximately $25 million in cash and contra interest expense in 2019 ($6.1 million for the three months ended March 31, 2019). In the first quarter of 2020, the U.S. dollar strength compared to the Swiss franc allowed us to unwind and monetize approximately 75% of our Swiss franc NIH for a cash benefit of $26.7 million. We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020. In April 2020, we liquidated our remaining position for a cash benefit of $8.3 million.
Interest Risk
We
Upon extinguishment of our borrowings under the Term Credit Facility in the first quarter of 2020, our current outstanding debt balances are fixed-rate debt. While changes in interest rates currently have no impact on the interest we pay on fixed-rate debt, borrowings under our new term loan facility will be exposed to interest rate riskfluctuations based on the long-term debtLIBOR. As of March 31, 2020, we entered into in connection with our IPO. Prior to our IPO, we did not have anyheld certain interest rate exposure. Weswap agreements with a notional value of $4.05 billion that will have cash flow riskthe economic effect of modifying the variable-interest obligations associated with our $500.0the new Term Loan Facility, so that a portion of the variable-rate interest payable becomes fixed. During the three months ended March 31, 2020, we recorded a loss of $39.2 million, net of borrowings that pay interest basedtaxes on variable rates. We actively monitor our exposure and will enter into financial instrument to fix thethese interest rate based on our assessmentswaps in other comprehensive loss. The loss is primarily attributable to market conditions resulting from the COVID-19 pandemic and the resulting cut to interest rates by the U.S. Federal Reserve in the first quarter of the risk.2020. See Note 11: Financial Instruments and Fair Value for further information.
Recently Issued Accounting Pronouncements
For discussion of our new accounting standards, see Note 4: Implementation of New Financial Accounting Pronouncements to our unaudited condensed consolidated and combined financial statements.
Item 4. Controls and Procedures
(a)Evaluation of Disclosure Controls and Procedures. Under applicable SEC regulations, management of a reporting company, with the participation of the principal executive officer and principal financial officer, must periodically evaluate the company’s “disclosure controls and procedures,” which are defined generally as controls and other procedures of a reporting company designed to ensure that information required to be disclosed by the reporting company in its periodic reports filed with the SEC (such as this Form 10-Q) is recorded, processed, summarized, and reported on a timely basis.
Our management, with the participation of JeffJeffrey N. Simmons, president and chief executive officer, and Todd S. Young, executive vice president and chief financial officer, evaluated our disclosure controls and procedures as of September 30, 2018.March 31, 2020. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the disclosure controls and procedures are effective.
(b)Changes in Internal Controls. During the thirdfirst quarter of 2018,2020, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
PART II. Other Information
Item 1. Legal Proceedings
(none)
Item 1A. Risk Factors
Our material risk factors are disclosed in our IPO Prospectus. There
Other than the revisions set forth below, there have been no material changes from the risk factors previously disclosed in Part I of our IPO Prospectus.Annual Report on Form 10-K for the year ended December 31, 2019.
We have identified the following additional risk factor:
The COVID-19 pandemic has had, and is expected to continue to have, an adverse impact on our business, our future results of operations and our overall financial performance.
The recent outbreak of COVID-19 originating in Wuhan, China, in December 2019, has since rapidly increased its exposure globally. On March 11, 2020, the World Health Organization declared the outbreak a pandemic. The pandemic has impacted and may further impact the United States and the broader economies of affected countries, including negatively impacting economic growth, the proper functioning of financial and capital markets, foreign currency exchange rates and interest rates. Due to the speed with which the situation is developing, the global
breadth of its spread and the range of governmental and community reactions thereto, there is uncertainty around its duration, ultimate impact and the timing of recovery. Therefore, the pandemic could lead to an extended disruption of economic activity and the impact on our consolidated results of operations, financial position and cash flows could be material.
As a result of the adverse impact that the COVID-19 pandemic is having on our economy and the economies in the countries in which we operate, the pandemic is also affecting our operations, including our supply chain distribution systems, production levels and research and development activities. In addition, any preventive or protective actions that governments implement or that we adopt in response to the COVID-19 pandemic, such as travel restrictions, quarantines, limited operations of governmental agencies or site closures, may interfere with the ability of our employees, vendors, and suppliers to perform their respective responsibilities and obligations relative to the conduct of our business. In particular, as a result of the COVID-19 pandemic, due to the suspension of in-person interactions by our customer-facing professionals and the fact that certain vet clinics are limiting such interactions, our ability to market our products has been and may continue to be limited, which, in turn, could have an adverse effect on our ability to compete in the marketing and sales of our products. Additionally, government regulations that have been imposed in response to the COVID-19 pandemic may cause delays in the receipt of products, causing delays in our global supply chain, delaying the transportation of finished goods, disrupting our freight processes, which would result in higher shipping costs, and causing resources to be diverted that are necessary to administer certain of our products. In addition, some research and development projects could be impacted based on need for the reagents from suppliers and clinical trial activity requiring veterinary clinic access and support. Furthermore, social distancing guidelines could have an adverse impact on our research and development activities as our laboratories are not operating at full capacity.
Our customers, and therefore our business and revenues, are sensitive to negative changes in economic conditions. As a result, we anticipate declines in revenue in 2020, including in our companion animal business as social distancing guidelines have decreased veterinary visits and have reduced veterinary practice spending. In addition, there have been a number of shutdowns of processing plants as a result of COVID-19 outbreaks within their operations, and there could be more of these shutdowns, which, in turn, may lead to decreased demand for our customers’ livestock. Such shutdowns could not only lead to a decrease in demand for our products, but could also significantly impact their ability to pay for our products. In addition, an effort by dairy farmers to decrease milk production could negatively impact demand for Rumensin. We expect the negative impacts of the COVID-19 pandemic on our revenue will continue until conditions relating to the overall impact of COVID-19 on all aspects of the economy and life in general improve.
The impact of the COVID-19 pandemic on the global financial markets may reduce our ability to access capital, which could negatively impact our short-term and long-term liquidity. Additionally, our third party distributors may face difficulties maintaining operations and normal liquidity in light of government-mandated restrictions. Further, the resulting global economic downturn has negatively impacted the ability of certain of our customers to make payments on a timely basis, adversely impacting our cash flows from operations. While our liquidity has not been significantly impacted by delayed collections thus far, we do not yet know the full extent of the impact of the COVID-19 pandemic and its resulting economic impact, which could have a material adverse effect on our liquidity, capital resources, operations and business.
We are also monitoring the impact of COVID-19 on our talent recruitment and retention efforts. If members of our management and other key personnel in critical functions across our organization are unable to perform their duties or have limited availability due to COVID-19, we may not be able to execute on our business strategy and/or our operations may be negatively impacted. 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. Qualified individuals are in high demand, and we may incur significant costs to attract them, particularly at the executive level. We may face difficulty in attracting and retaining key talent for a number of reasons, including delays in the recruiting and hiring process as a result of the COVID-19 pandemic.
Our business, financial condition and results of operations could be materially adversely affected by unfavorable results in future employment litigation matters as result of COVID-19. Our employees may sue us due to possible exposure to COVID-19 while working at one of our facilities or sites. In addition, employees may challenge decisions to implement protective measures such as contact tracing on the basis of local privacy laws due to the increased collection of employee medical information. 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 paying significant damages.
Any of these negative effects resulting from litigation matters could materially adversely affect our business, financial condition or results of operations. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effect of heightening many of the other risks described in “Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2019.
The following risk factors have changed from the risk factors that were previously disclosed:
An outbreak of infectious disease carried by food animals could negatively affect the demand for, and sale and production of, our food animal products.
Sales of our food animal products could be materially adversely affected by the outbreak of disease or an outbreak carried by food animals, which could lead to the widespread death or precautionary destruction of food animals as well as the reduced consumption and demand for animal protein. In addition, outbreaks of disease carried by food animals 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 food animal products due to reduced herd or flock sizes.
In recent years, outbreaks of various diseases, including African Swine Fever, avian influenza, foot-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.
The proposed acquisition of the Bayer animal health business may not be completed on the anticipated terms and there are uncertainties and risks related to consummating the Acquisition.
In August 2019, we entered into a share purchase agreement (Purchase Agreement) to purchase the animal health business of Bayer for approximately $5.3 billion in cash and approximately $2.3 billion of our common stock, subject to certain customary adjustments. Our obligation to consummate the Acquisition is subject to satisfaction or waiver, to the extent permitted under applicable law, of a number of conditions. Among other conditions, the Acquisition is subject to antitrust approvals in certain jurisdictions. The current COVID-19 global pandemic has resulted in the closure of certain U.S. and foreign governmental agencies for an extended period of time. These closures may extend antitrust filing timelines or impact our ability to form legal entities and obtain certain permits. We cannot provide any assurance that all required antitrust clearances will be obtained, and what conditions will be imposed. Even after the reopening of governmental agencies, limited staffing at those governmental agencies or other internal limitations, or limitations on Bayer's business, may negatively impact our ability to complete the Acquisition. There can be no assurance as to the cost, scope or impact of the actions that may be required, including divestiture requirements, to obtain antitrust approval. If we are required to or otherwise decide to take such actions in order to close the Acquisition, it could be detrimental to the combined organization following the consummation of the Acquisition, including with respect to the synergies which we expect from the Acquisition. For example, in January and February 2020, we signed agreements to divest Osurnia, a treatment for otitis externa in dogs, and the U.S. rights to Capstar, an oral tablet that kills fleas in dogs and cats, and Vecoxan, a treatment for coccidiosis in calves and lambs, for an aggregate of $285 million in all cash deals, with the intent to advance our efforts to secure the necessary regulatory clearances for the Acquisition. Furthermore, these actions, or the failure to effect any additional divestitures at an acceptable price or at all, could have the effect of delaying or preventing completion of the Acquisition or imposing additional costs on or limiting the revenues or cash of the combined organization following the consummation of the Acquisition.
Even if the parties receive antitrust approvals, the applicable domestic or international regulatory authorities could take action under the antitrust laws to prevent or rescind the Acquisition, require the additional divestiture of assets or seek other remedies. Additionally, state attorneys general could seek to block or challenge the Acquisition as they deem necessary or desirable in the public interest at any time, including after completion of the Acquisition. In addition, in some circumstances, a third party could initiate a private action under antitrust laws challenging or seeking to enjoin the Acquisition, before or after it is completed. We may not prevail and may incur significant costs in defending or settling any action under the antitrust laws.
We may be unable to integrate the Bayer animal health business successfully and realize the anticipated benefits of the Acquisition.
If the Acquisition is completed, the successful integration of the Bayer animal health business and operations into those of our own and our ability to realize the expected synergies and benefits of the Transactions are subject to a number of risks and uncertainties, many of which are outside of our control. We will also be required to devote significant management attention and resources to integrating business practices, cultures and operations of each business. The risks and uncertainties relating to integrating the two businesses and realizing the anticipated cost synergies include, among other things:
•the inability to achieve the anticipated revenue, earnings, accretion and other benefits due to the impact of the COVID-19 global health pandemic;
•the challenge of integrating complex organizations, systems, operating procedures, compliance programs, technology, networks and other assets of the Bayer animal health business;
•the difficulties harmonizing differences in the business cultures of our company and the Bayer animal health business;
•the inability to combine successfully our respective businesses in a manner that permits us to achieve the cost savings, synergies and other anticipated benefits from the Acquisition;
•the inability to minimize the diversion of management attention from ongoing business concerns during the process of integrating the Bayer animal health business into our businesses;
•the inability to resolve potential conflicts that may arise relating to customer, supplier and other important relationships of our business and the Bayer animal health business;
•difficulties in retaining key management and other key employees;
•the challenge of managing the expanded operations of a significantly larger and more complex company and coordinating geographically separate organizations; and
•difficulties in fully exploring intellectual property licensed from Bayer in connection with the acquisition, given Bayer's rights as licensor of such intellectual property.
We will incur substantial expenses to consummate the proposed Acquisition but may not realize the anticipated cost synergies and other benefits to the extent expected, on the timeline expected, or at all. In addition, even if we are able to integrate the Bayer animal health business successfully, the anticipated benefits of the Acquisition may not be realized fully, or at all, or may take longer to realize than expected. Moreover, competition in the animal health industry, including competition that has negatively impacted results in the companion animal parasiticide market, may also cause us not to fully realize the anticipated benefits of the Acquisition. Given the size and significance of the Acquisition, we may encounter difficulties in the integration of the operations of the Bayer animal health business and may fail to realize the full benefits and synergies of the Acquisition, which could adversely impact our business, results of operation and financial condition.
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.
We rely on information technology systems to process, transmit and store electronic information in our day-to-day operations, including customer, employee and company data. The secure processing, maintenance and transmission of this information is critical to our operations. 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 are generally dependent upon our technology systems to operate our business in normal periods, but in the wake of the COVID-19 global pandemic, we are increasingly dependent on our information technology systems as our office workers, who are working remotely, rely on third-party applications to host a greater number of video conferences and teleconferences, 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, including, but not limited to, the use of VPN when remotely working on company matters, and other security protocols when using various video conferencing and teleconferencing applications, especially in light of the increased use of these tools due to the COVID-19 global pandemic.
We also store certain information with third parties, including the use of cloud technologies. Our information systems and those of our third-party vendors are subjected to computer viruses or other malicious codes, unauthorized access attempts, and cyber or phishing-attacks and 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 personally identifiable information, as well as technology, networks, or infrastructure. Any such breach could compromise our networks, including a breach caused by a failure by our employees, working remotely or otherwise, to use such security policies and protocols, which could result in the loss of confidential company data, or an intrusion or business interruption by hackers that are able to access the company’s network or meetings taking place via video conferencing or teleconferencing, and the information stored or in the process of being transmitted or communicated could be accessed, publicly disclosed, lost or stolen. Any such loss or misappropriation of company data or other intrusion could cause a disruption of our operations and other negative consequences, such as increased costs for security measures or remediation costs, and diversion of management attention.
Any actual or perceived access, disclosure or other loss of information or any significant breakdown, intrusion, interruption, cyber-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-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, due to a TSA with Lilly, we rely on Lilly for certain privacy, compliance, and security functions, and personnel, and may experience difficulties maintaining and implementing all policies and practices following completion of the TSA for these services.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
Use of Proceeds from Registered Securities
On September 24, 2018, we completed our IPO resulting in the issuance of 72.3 million 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 statement on Form S-1 (File No. 333-226536), which was declared effective by the SEC as of September 19, 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 19, 2018 and did not terminate before all of the securities registered in the registration statement were sold.(none)
As contemplated by the IPO Prospectus, 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.
There has been no material change in the planned use of the IPO proceeds as described in the IPO Prospectus.
Item 3. Defaults Upon Senior Securities
(none)
Item 4. Mine Safety Disclosures
(none)
Item 5. Other Information
(none)
Item 6. Exhibits
The following exhibits are either filed or furnished herewith (as applicable) or, if so indicated, incorporated by reference to the documents indicated in parentheses, which have previously been filed or furnished with the Securities and Exchange Commission.
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Exhibit Number | Description |
3.1 | AmendedExhibit Number | | Description |
| 2.1 | | | |
January 17, 2020)
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3.22.2 | Amended | | |
4.1 | Form of Certificate of Common Stock (incorporated by reference to Exhibit 4.1 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). |
4.2 | | | |
4.3 | First Supplemental Indenture,4.2 | | | |
10.1 | Registration Rights Agreement, dated August 28, 2018, between Elanco Animal Health Incorporated and Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC, as representatives of the several initial purchasers (incorporated by reference to Exhibit 4.4 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). |
10.2 | Master Separation Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on September 26, 2018).January 27, 2020) |
10.3 | Transitional Services Agreement, dated September 24, 2018, between Eli Lilly and Company and | | |
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| 10.1 | | | |
10.4 | Tax Matters Agreement, dated September 24, 2018, between Eli Lilly and Company and10.2 | | | |
10.5 | Employee Matters Agreement, dated September 24, 2018, between Eli Lilly and Company and 10.3 | | | |
10.6 | Toll Manufacturing and Supply Agreement, dated September 24, 2018, between Eli Lilly Export S.A. and Elanco UK AH Limited (incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.7 | Registration Rights Agreement, dated September 24, 2018, between Eli Lilly and Company and10.4 | | | |
10.8 | Transitional Trademark License Agreement, dated September 24, 2018, among Eli Lilly and Company, Elanco Animal Health Incorporated and Elanco US Inc. (incorporated by reference to Exhibit 10.7 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.9 | Intellectual Property and Technology License Agreement, dated September 24, 2018, among Eli Lilly and Company, Elanco Animal Health Incorporated and Elanco US Inc. (incorporated by reference to Exhibit 10.8 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.10 | Revolving Loan Credit Agreement, dated as of September 5, 2018, among Elanco Animal Health Incorporated, as borrower, JPMorgan Chase Bank, N.A., as administrative agent and the other Lenders party thereto (incorporated by reference to Exhibit 10.24 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.11 | Term Loan Credit Agreement, dated as of September 5, 2018, among Elanco Animal Health Incorporated, as borrower, JPMorgan Chase Bank, N.A., as administrative agent and the other Lenders party thereto (incorporated by reference to Exhibit 10.25 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.12 | 2018 Elanco Stock Plan (incorporated by reference to Exhibit 4.3 of Registration Statement on Form S-8 (Registration No. 333-227447) filed with the SEC on September 20, 2018). | | |
10.13 | Elanco Animal Health Incorporated Directors’ Deferral Plan (incorporated by reference to Exhibit 4.4 of Registration Statement on Form S-8 (Registration No. 333-227447) filed with the SEC on September 20, 2018). | | |
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| 31.1 | | | |
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| 31.2 | | | |
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| 32 |
| | | Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
101 | | | |
| 101 | | | Interactive Data Files.Files |
| 104 | | | Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101) |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. | | | | | | | | |
| | ELANCO ANIMAL HEALTH INCORPORATED |
| | (Registrant) |
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| Date: | May 7, 2020 | ELANCO ANIMAL HEALTH INCORPORATED/s/ Jeffrey N. Simmons |
| | (Registrant)Jeffrey N. Simmons |
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Date: | November 8, 2018 | /s/ Jeff Simmons |
| | Jeff Simmons |
| | President and Chief Executive Officer |
| Date: | November 8, 2018May 7, 2020 | /s/ James MeerTodd S. Young |
| | James MeerTodd S. Young |
| | Executive Vice President, Chief AccountingFinancial Officer |