SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBER 30, 2018MARCH 31, 2021
OR
☐ Transition Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 001-38661
Elanco Animal Health Incorporated
(Exact name of Registrant as specified in its charter)
| INDIANA | 82-5497352 | |||||||
| (State or other jurisdiction of | (I.R.S. Employer | |||||||
| incorporation or organization) | Identification No.) | |||||||
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address of principal executive offices)
Registrant’s telephone number, including area code (877) 352-6261
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common stock, no par value | ELAN | New York Stock Exchange | ||||||
| 5.00% Tangible Equity Units | ELAT | New York Stock Exchange | ||||||
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ý☒ No o☐
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.
Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||||||||||||||||||
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||||||||||||||
Emerging growth company | ☐ | ||||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o☐ No ý☒
The number of shares of common stock outstanding as of November 6, 2018May 3, 2021 were 365,625,000
472,995,963
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY
Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important risk factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions, including but not limited to the following:
•heightened competition, including from new innovation or generics;
•the impact of disruptive innovations and advances in veterinary medical practices, animal health technologies and alternatives to animal-derived protein;
•changes in regulatory restrictions on the use of antibiotics in food animals, as well as changing market demand regarding the use of antibiotics and productivity products;farm animals;
•our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;
•consolidation of our customers and distributors;
•an outbreak of infectious disease carried by farm animals;
•the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the COVID-19 global health pandemic;
•the success of our R&D, acquisitionresearch and development (R&D) and licensing efforts;
•misuse, off-label or counterfeiting use of our products;
•unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
•the impact of weather conditions and the availability of natural resources;
alternative distribution channels and the impact of global macroeconomic conditions;increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
•manufacturing problems and capacity imbalances;
•challenges to our intellectual property rights or our alleged violation of rights of others;
•risks related to our presence in foreign markets;
•breaches of our information technology systems;
•our ability to successfully integrate the businesses we acquire, including the animal health business of Bayer (Bayer Animal Health);
•effect of our substantial indebtedness on our business; and
•the effect on our business resulting from our separation from Eli Lilly and Company (Lilly).
2021 Q1 Form 10-Q | 3 | | |||||||
See “Risk Factors,” of the transactions involving the separationPart I of our business from that of Eli Lilly & Co. (Lilly) and distribution of Lilly's interest in us to its shareholders, if consummated.
2021 Q1 Form 10-Q | 4 | | |||||||
PART I. Financial InformationI
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Revenue | $ | 761.1 | $ | 697.1 | $ | 2,267.5 | $ | 2,134.7 | |||||||
| Costs, expenses and other: | |||||||||||||||
| Cost of sales | 369.8 | 376.2 | 1,161.3 | 1,088.9 | |||||||||||
| Research and development | 58.9 | 61.9 | 185.5 | 189.7 | |||||||||||
| Marketing, selling and administrative | 179.0 | 194.7 | 550.1 | 583.0 | |||||||||||
| Amortization of intangible assets | 48.7 | 51.6 | 147.3 | 161.0 | |||||||||||
| Asset impairments, restructuring and other special charges (Note 6) | 12.4 | 23.7 | 82.8 | 189.3 | |||||||||||
| Other–net, (income) expense | 13.5 | (1.9 | ) | 24.2 | — | ||||||||||
| 682.3 | 706.2 | 2,151.2 | 2,211.9 | ||||||||||||
| Income (loss) before income taxes | 78.8 | (9.1 | ) | 116.3 | (77.2 | ) | |||||||||
| Income tax expense | 18.6 | 11.6 | 46.2 | 72.0 | |||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | $ | 70.1 | $ | (149.2 | ) | |||||
| Earnings (loss) per share: | |||||||||||||||
| Basic and diluted | $ | 0.16 | $ | (0.06 | ) | $ | 0.19 | $ | (0.41 | ) | |||||
| Weighted average shares outstanding: | |||||||||||||||
| Basic and diluted | 365.6 | 365.6 | 365.6 | 365.6 | |||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | $ | 70.1 | $ | (149.2 | ) | |||||
| Other comprehensive income (loss), net of tax | 94.5 | (4.0 | ) | (9.8 | ) | 231.8 | |||||||||
| Comprehensive income (loss) | $ | 154.7 | $ | (24.7 | ) | $ | 60.3 | $ | 82.6 | ||||||
Elanco Animal Health Incorporated
Condensed Consolidated and Combined Balance SheetsStatements of Operations (Unaudited)
(Dollars in millions)millions, except per-share data)
| September 30, 2018 | December 31, 2017 | ||||||
| Assets | (Unaudited) | ||||||
| Current Assets | |||||||
| Cash and cash equivalents | $ | 300.0 | $ | 323.4 | |||
| Accounts receivable, net of allowances of $8.8 (2018) and $9.8 (2017) | 606.1 | 567.4 | |||||
| Other receivables | 30.8 | 34.5 | |||||
| Inventories (Note 7) | 1,008.7 | 1,062.3 | |||||
| Prepaid expenses and other | 123.2 | 136.1 | |||||
| Restricted cash (Note 14) | 634.9 | — | |||||
| Total current assets | 2,703.7 | 2,123.7 | |||||
| Noncurrent Assets | |||||||
| Investments (Note 9) | 14.9 | 12.3 | |||||
| Goodwill | 2,968.8 | 2,969.2 | |||||
| Other intangibles, net | 2,514.8 | 2,672.8 | |||||
| Other noncurrent assets | 100.0 | 242.0 | |||||
| Property and equipment, net of accumulated depreciation $894.5 (2018) and $834.1 (2017) | 909.3 | 920.3 | |||||
| Total assets | $ | 9,211.5 | $ | 8,940.3 | |||
| Liabilities and Equity | |||||||
| Current Liabilities | |||||||
| Accounts payable | $ | 202.7 | $ | 203.8 | |||
| Employee compensation | 81.3 | 89.3 | |||||
| Sales rebates and discounts | 147.9 | 165.5 | |||||
| Other current liabilities | 178.6 | 184.5 | |||||
| Payable to Lilly (Note 14) | 634.9 | — | |||||
| Total current liabilities | 1,245.4 | 643.1 | |||||
| Noncurrent Liabilities | |||||||
| Long-term debt (Note 8) | 2,478.5 | — | |||||
| Accrued retirement benefits | 136.0 | 139.0 | |||||
| Deferred taxes | 125.0 | 251.9 | |||||
| Other noncurrent liabilities | 89.5 | 126.0 | |||||
| Total liabilities | 4,074.4 | 1,160.0 | |||||
| Commitments and Contingencies (Note 11) | |||||||
| Equity | |||||||
| Net parent company investment | — | 8,036.9 | |||||
| Common stock, no par value, 5,000,000,000 shares authorized 365,625,000 shares issued and outstanding as of September 30, 2018 | — | — | |||||
| Additional paid-in capital | 5,347.4 | — | |||||
| Accumulated other comprehensive loss | (210.3 | ) | (256.6 | ) | |||
| Total equity | 5,137.1 | 7,780.3 | |||||
| Total liabilities and equity | $ | 9,211.5 | $ | 8,940.3 | |||
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Revenue | $ | 1,242 | $ | 658 | |||||||||||||||||||
| Costs, expenses and other: | |||||||||||||||||||||||
| Cost of sales | 569 | 333 | |||||||||||||||||||||
| Research and development | 89 | 67 | |||||||||||||||||||||
| Marketing, selling and administrative | 348 | 182 | |||||||||||||||||||||
| Amortization of intangible assets | 147 | 52 | |||||||||||||||||||||
| Asset impairment, restructuring and other special charges | 108 | 75 | |||||||||||||||||||||
| Interest expense, net of capitalized interest | 61 | 16 | |||||||||||||||||||||
| Other expense, net | 0 | 1 | |||||||||||||||||||||
| 1,322 | 726 | ||||||||||||||||||||||
| Loss before income taxes | (80) | (68) | |||||||||||||||||||||
| Income tax benefit | (19) | (19) | |||||||||||||||||||||
| Net loss | $ | (61) | $ | (49) | |||||||||||||||||||
| Loss per share: | |||||||||||||||||||||||
| Basic | $ | (0.12) | $ | (0.12) | |||||||||||||||||||
| Diluted | $ | (0.12) | $ | (0.12) | |||||||||||||||||||
| Weighted average shares outstanding: | |||||||||||||||||||||||
| Basic | 486.7 | 403.9 | |||||||||||||||||||||
| Diluted | 486.7 | 403.9 | |||||||||||||||||||||
See notes to unaudited condensed consolidated and combined financial statements.
2021 Q1 Form 10-Q | 5 | | |||||||
Elanco Animal Health Incorporated
(in millions)
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Net loss | $ | (61) | $ | (49) | |||||||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Unrealized gain (loss) on derivatives for cash flow hedges, net of taxes | 53 | (39) | |||||||||||||||||||||
| Foreign currency translation | (466) | (29) | |||||||||||||||||||||
| Defined benefit pension and retiree health benefit plans, net of taxes | 8 | (1) | |||||||||||||||||||||
| Other comprehensive loss, net of taxes | (405) | (69) | |||||||||||||||||||||
| Comprehensive loss | $ | (466) | $ | (118) | |||||||||||||||||||
See notes to condensed consolidated financial statements.
2021 Q1 Form 10-Q | 6 | | |||||||
Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions)
| March 31, 2021 | December 31, 2020 | ||||||||||
| (Unaudited) | |||||||||||
| Assets | |||||||||||
| Current Assets | |||||||||||
| Cash and cash equivalents | $ | 515 | $ | 495 | |||||||
| Accounts receivable, net of allowances of $9 (2021) and $9 (2020) | 1,028 | 872 | |||||||||
| Other receivables | 104 | 205 | |||||||||
| Inventories | 1,424 | 1,578 | |||||||||
| Prepaid expenses and other | 273 | 256 | |||||||||
| Restricted cash | 0 | 11 | |||||||||
| Total current assets | 3,344 | 3,417 | |||||||||
| Noncurrent Assets | |||||||||||
| Goodwill | 6,016 | 6,225 | |||||||||
| Other intangibles, net | 6,032 | 6,387 | |||||||||
| Other noncurrent assets | 325 | 348 | |||||||||
| Property and equipment, net of accumulated depreciation of $1,060 (2021) and $1,038 (2020) | 1,271 | 1,316 | |||||||||
| Total assets | $ | 16,988 | $ | 17,693 | |||||||
| Liabilities and Equity | |||||||||||
| Current Liabilities | |||||||||||
| Accounts payable | $ | 411 | $ | 501 | |||||||
| Employee compensation | 114 | 144 | |||||||||
| Sales rebates and discounts | 331 | 295 | |||||||||
| Current portion of long-term debt | 605 | 555 | |||||||||
| Other current liabilities | 573 | 582 | |||||||||
| Total current liabilities | 2,034 | 2,077 | |||||||||
| Noncurrent Liabilities | |||||||||||
| Long-term debt | 5,556 | 5,572 | |||||||||
| Accrued retirement benefits | 316 | 346 | |||||||||
| Deferred taxes | 828 | 900 | |||||||||
| Other noncurrent liabilities | 247 | 322 | |||||||||
| Total liabilities | 8,981 | 9,217 | |||||||||
| Commitments and Contingencies | 0 | 0 | |||||||||
| Equity | |||||||||||
| Preferred stock, no par value, 1,000,000,000 shares authorized; 0ne issued | 0 | 0 | |||||||||
| Common stock, no par value, 5,000,000,000 shares authorized, 472,968,567 and 471,921,116 shares issued and outstanding as of March 31, 2021 and December 31, 2020, respectively | 0 | 0 | |||||||||
| Additional paid-in capital | 8,647 | 8,650 | |||||||||
| Accumulated deficit | (538) | (477) | |||||||||
| Accumulated other comprehensive income (loss) | (102) | 303 | |||||||||
| Total equity | 8,007 | 8,476 | |||||||||
| Total liabilities and equity | $ | 16,988 | $ | 17,693 | |||||||
See notes to condensed consolidated financial statements.
2021 Q1 Form 10-Q | 7 | | |||||||
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)
| Common Stock | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-in Capital | Net Parent Company Investment | Foreign Currency Translation | Defined Benefit Pension and Retiree Health Benefit Plans | Total | Total Equity | |||||||||||||||||||||||
| December 31, 2016 | — | $ | — | $ | — | $ | 7,474.3 | $ | (437.3 | ) | $ | (19.6 | ) | $ | (456.9 | ) | $ | 7,017.4 | ||||||||||||
| Net loss | — | — | — | (149.2 | ) | — | — | — | (149.2 | ) | ||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | 228.1 | 3.7 | 231.8 | 231.8 | ||||||||||||||||||||||
| Transfers (to)/from Lilly, net | — | — | — | 862.7 | — | — | — | 862.7 | ||||||||||||||||||||||
| September 30, 2017 | — | $ | — | $ | — | $ | 8,187.8 | $ | (209.2 | ) | $ | (15.9 | ) | $ | (225.1 | ) | $ | 7,962.7 | ||||||||||||
| December 31, 2017 | — | $ | — | $ | — | $ | 8,036.9 | $ | (227.2 | ) | $ | (29.4 | ) | $ | (256.6 | ) | $ | 7,780.3 | ||||||||||||
| Adoption of Accounting Standards Update 2016-16 | — | — | — | (0.3 | ) | — | — | — | (0.3 | ) | ||||||||||||||||||||
| Net income | — | — | — | 70.1 | — | — | — | 70.1 | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | (20.6 | ) | 10.8 | (9.8 | ) | (9.8 | ) | |||||||||||||||||||
| Transfers (to)/from Lilly, net | — | — | — | (226.3 | ) | — | — | — | (226.3 | ) | ||||||||||||||||||||
| Separation adjustments | — | — | — | 2.2 | 56.1 | — | 56.1 | 58.3 | ||||||||||||||||||||||
| Issuance of common stock | 365.6 | — | 1,659.7 | — | — | — | — | 1,659.7 | ||||||||||||||||||||||
| Consideration to Lilly in connection with the Separation | — | — | (4,194.9 | ) | — | — | — | — | (4,194.9 | ) | ||||||||||||||||||||
| Reclassification of net parent company investment | — | — | 7,882.6 | (7,882.6 | ) | — | — | — | — | |||||||||||||||||||||
| September 30, 2018 | 365.6 | $ | — | $ | 5,347.4 | $ | — | $ | (191.7 | ) | $ | (18.6 | ) | $ | (210.3 | ) | $ | 5,137.1 | ||||||||||||
| Common Stock | Accumulated Other Comprehensive Income (Loss) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-in Capital | Retained Earnings (Accumulated Deficit) | Cash Flow Hedge Gain (Loss) | Foreign Currency Translation | Defined Benefit Pension and Retiree Health Benefit Plans | Total | Total Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2019 | 373 | $ | 0 | $ | 5,636 | $ | 84 | $ | — | $ | (199) | $ | 25 | $ | (174) | $ | 5,546 | ||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | (49) | — | — | — | — | (49) | ||||||||||||||||||||||||||||||||||||||||||||||||||
Adoption of Accounting Standards Update 2016-13 | — | — | — | (1) | — | — | — | — | (1) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive loss, net of tax | — | — | — | — | (39) | (29) | (1) | (69) | (69) | ||||||||||||||||||||||||||||||||||||||||||||||||||
Separation activities (1) | — | — | 16 | — | — | — | — | — | 16 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 11 | — | — | — | — | — | 11 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of stock under employee stock plans, net | 1 | — | (13) | — | — | — | — | — | (13) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of common stock, net of issuance costs | 25 | — | 768 | — | — | — | — | — | 768 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of tangible equity units, net of issuance costs | — | — | 452 | — | — | — | — | — | 452 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2020 | 399 | $ | 0 | $ | 6,870 | $ | 34 | $ | (39) | $ | (228) | $ | 24 | $ | (243) | $ | 6,661 | ||||||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | 472 | $ | 0 | $ | 8,650 | $ | (477) | $ | (61) | $ | 360 | $ | 4 | $ | 303 | $ | 8,476 | ||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | (61) | — | — | — | — | (61) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | 53 | (466) | 8 | (405) | (405) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 15 | — | — | — | — | — | 15 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of stock under employee stock plans, net | 1 | — | (18) | — | — | — | — | — | (18) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2021 | 473 | $ | 0 | $ | 8,647 | $ | (538) | $ | (8) | $ | (106) | $ | 12 | $ | (102) | $ | 8,007 | ||||||||||||||||||||||||||||||||||||||||||
(1)Represent amounts associated with transactions between us and Lilly, related primarily to the completion of the local country asset purchases, the finalization of assets and liabilities associated with the legal separation from Lilly, centralized cash management, and resulting impacts on deferred tax assets, that occurred subsequent to our initial public offering.
See notes to unaudited condensed consolidated and combined financial statements.
2021 Q1 Form 10-Q | 8 | | |||||||
Elanco Animal Health Incorporated
(Dollars in millions)
| Three Months Ended March 31, | |||||||||||
| 2021 | 2020 | ||||||||||
| Cash Flows from Operating Activities | |||||||||||
| Net loss | $ | (61) | $ | (49) | |||||||
| Adjustments to reconcile net loss to cash flows from operating activities: | |||||||||||
| Depreciation and amortization | 202 | 82 | |||||||||
| Change in deferred income taxes | (32) | (25) | |||||||||
| Stock-based compensation expense | 15 | 11 | |||||||||
| Asset impairment charges | 9 | 0 | |||||||||
| Gain on sale of assets | 0 | (4) | |||||||||
| Inventory fair value step-up amortization | 62 | 0 | |||||||||
| Changes in operating assets and liabilities, net of acquisitions | (183) | (10) | |||||||||
| Other non-cash operating activities, net | 10 | (1) | |||||||||
| Net Cash Provided by Operating Activities | 22 | 4 | |||||||||
| Cash Flows from Investing Activities | |||||||||||
| Net purchases of property and equipment | (18) | (13) | |||||||||
| Cash paid for acquisitions, net of cash acquired | 73 | 0 | |||||||||
| Proceeds from settlement of net investment hedges | 0 | 25 | |||||||||
| Purchases of intangible assets | (33) | 0 | |||||||||
| Purchases of software | (5) | (32) | |||||||||
| Other investing activities, net | (7) | 0 | |||||||||
| Net Cash Provided by (Used for) Investing Activities | 10 | (20) | |||||||||
| Cash Flows from Financing Activities | |||||||||||
| Repayments of borrowings | (20) | (371) | |||||||||
| Net proceeds from revolving credit facility | 50 | 0 | |||||||||
| Proceeds from issuance of long-term debt | 0 | 79 | |||||||||
| Proceeds from issuance of common stock and tangible equity units | 0 | 1,220 | |||||||||
| Debt issuance costs | 0 | (3) | |||||||||
| Other net financing transactions with Lilly | (11) | (15) | |||||||||
| Other financing activities, net | (17) | (13) | |||||||||
| Net Cash Provided by Financing Activities | 2 | 897 | |||||||||
| Effect of exchange rate changes on cash and cash equivalents | (25) | (9) | |||||||||
| Net increase in cash, cash equivalents and restricted cash | 9 | 872 | |||||||||
| Cash, cash equivalents and restricted cash at January 1 | 506 | 345 | |||||||||
| Cash, cash equivalents and restricted cash at March 31 | $ | 515 | $ | 1,217 | |||||||
| 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, | |||||||||||
| 2021 | 2020 | ||||||||||
| Cash and cash equivalents | $ | 515 | $ | 1,206 | |||||||
| Restricted cash | 0 | 11 | |||||||||
| Cash, cash equivalents and restricted cash at March 31 | $ | 515 | $ | 1,217 | |||||||
See notes to unaudited condensed consolidated and combined financial statements.
2021 Q1 Form 10-Q | 9 | | |||||||
Elanco Animal Health Incorporated
Notes to Condensed Consolidated and Combined Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share data)
Note 1. NatureBasis of BusinessPresentation and OrganizationSummary of Significant Accounting Policies
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.
We have prepared the accompanying unaudited condensed consolidated and combined financial statements in accordance with the United States (U.S.) Securities and Exchange Commission (SEC) requirements offor interim reporting. As permitted under those rules, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been condensed or omitted. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and therefore, they do not include all informationcombined financial statements and footnotes necessaryaccompanying notes for a fair presentation of financial position, results of operations, and cash flowsthe year ended December 31, 2020 included in conformityour Annual Report on Form 10-K filed with accounting principles generally accepted in the United States (GAAP). SEC on March 1, 2021.
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 significant accounting policies set forth in Note 4 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.
On August 1, 2020, we completed the previously announced acquisition of Bayer Animal Health. See Note 4: Acquisitions and Divestitures for additional information.
Note 4.2. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of an accounting standardsstandard that werewas effective January 1, 20182021 and werewas adopted on that date:
| Standard | Description | Effect on the financial statements or other significant matters | ||||||||||||
Accounting Standards Update | The amendments in this update include simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and | |||||||||||||
2021 Q1 Form 10-Q | 10 | | |||||||
The following table provides a brief description of thean accounting standard that is applicable to us but has not yet been adopted and could have a material effect on the consolidated financial statements:
adopted:
| Standard | Description | Effective Date | Effect on the financial statements or other significant matters | |||||||||||||||||||
| These standards were effective as | We are currently in the process of | |||||||||||||||||||||
Note 5.3. Revenue
Our sales rebates are based on specific agreements. 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.
The following table summarizes the activity in the sales rebates and discounts liability in the U.S., France, and the U.K.:
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Beginning balance | $ | 217 | $ | 176 | |||||||||||||||||||
| Reduction of revenue | 142 | 71 | |||||||||||||||||||||
| Payments | (106) | (87) | |||||||||||||||||||||
| Foreign currency translation adjustments | (2) | (1) | |||||||||||||||||||||
| Ending balance | $ | 251 | $ | 159 | |||||||||||||||||||
| 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, 2021 and 2020 for product shipped in previous periods were not material.
2021 Q1 Form 10-Q | 11 | | |||||||
Disaggregation of Revenue
In the first quarter of 2021, management revisited how it analyzes revenue, both internally and externally, and determined that disaggregation by major product line provides a more meaningful view of our results. Accordingly, we updated our disaggregated revenue presentation from the previous five categories (i.e., pet health disease prevention, pet health therapeutics, farm animal future protein & health, farm animal ruminants & swine, and contract manufacturing) to the following:
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Pet Health | $ | 645 | $ | 206 | |||||||||||||||||||
| Farm Animal | 578 | 433 | |||||||||||||||||||||
Contract Manufacturing (1) | 19 | 19 | |||||||||||||||||||||
| Revenue | $ | 1,242 | $ | 658 | |||||||||||||||||||
(1)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
Note 4. Acquisitions and Divestitures
Bayer Animal Health Acquisition
On August 1, 2020, we completed our previously announced acquisition of Bayer Animal Health, a provider of products intended to improve the health and well-being of pets and farm animals, in a cash and stock transaction. The transaction was accounted for as a business combination under the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The determination of estimated fair value requires 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 Bayer Animal Health are included in our condensed consolidated financial statements from the date of acquisition.
The acquisition has expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our existing product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure while expanding our direct to retailer/e-commerce presence.
Total consideration transferred to Bayer and its subsidiaries for the acquisition is summarized as follows:
Cash consideration (1) | $ | 5,058 | |||
Fair value of Elanco common stock (2) | 1,724 | ||||
Fair value of total consideration transferred (3) | $ | 6,782 | |||
(1)Includes initial cash consideration of $5,170 million less working capital and tax adjustments of $112 million.
(2)Represents the acquisition date fair value of 73 million shares of Elanco common stock at $23.64 per share. Per the terms of the stock and asset purchase agreement, the number of shares was based on 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 baseline share number of approximately $2.3 billion divided by an initial share price of $33.60).
(3)The purchase price is preliminary and subject to certain minor customary purchase price adjustments.
We recognized transaction costs related to the acquisition of Bayer Animal Health of $3 million and $20 million during the three months ended March 31, 2021 and 2020, respectively. These costs were primarily associated with financial advisory, legal and other professional services related to the acquisition and are reflected within asset impairment, restructuring and other special charges in our condensed consolidated statements of operations.
The amount of revenue attributable to Bayer Animal Health included in our condensed consolidated statement of operations for the three months ended March 31, 2021 is $559 million. Based on our current operational structure,
2021 Q1 Form 10-Q | 12 | | |||||||
we have not recorded standalone costs for Bayer Animal Health after the date of the acquisition. As a result, we are unable to accurately determine earnings or loss attributable to Bayer Animal Health since the date of acquisition.
The valuation of assets acquired and liabilities assumed has not yet been finalized as of March 31, 2021. The purchase price allocation is preliminary and subject to change, including the valuation of inventories, property and equipment, intangible assets, income taxes and goodwill, among other items. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the acquisition date. During the three months ended March 31, 2021, we recorded immaterial measurement period adjustments which were made to reflect the facts and circumstances in existence as of the acquisition date. These adjustments primarily related to changes in inventory balances and gross margin assumptions as well as minor working capital adjustments. The fair values in the table below have been updated to reflect these measurement period adjustments. Finalization of the valuation during the measurement period could result in additional changes in the amounts recorded for the acquisition date fair value.
The following table summarizes the preliminary fair value of assets acquired and liabilities assumed as of the acquisition date:
| Estimated Fair Value at August 1, 2020 | |||||
| Cash and cash equivalents | $ | 169 | |||
| Accounts receivable | 9 | ||||
| Inventories | 487 | ||||
| Prepaid expenses and other current assets | 57 | ||||
| Property and equipment | 347 | ||||
| Intangible assets: | |||||
| Acquired in-process research and development | 65 | ||||
| Marketed products | 3,930 | ||||
| Assets held for sale | 138 | ||||
| Accounts payable and accrued liabilities | (240) | ||||
| Accrued retirement benefits | (217) | ||||
| Other noncurrent assets and liabilities, net | (894) | ||||
| Total identifiable net assets | 3,851 | ||||
| Goodwill | 2,931 | ||||
| Total consideration transferred | $ | 6,782 | |||
Inventories comprised of $314 million, $79 million, $94 million in finished products, work in process, and raw materials, respectively. The preliminary estimate of fair value of finished products was determined based on net realizable value adjusted for the costs to complete the sales process, a reasonable profit allowance from the sales process, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the sales process, a reasonable profit allowance for the remaining manufacturing and sales process effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value. The net fair value step-up adjustment to inventories of $148 million has been amortized to cost of sales as the inventory is sold to customers. As of March 31, 2021, the fair value step-up adjustment has been fully amortized.
Property and equipment is mostly composed of land, buildings, equipment (including machinery, furniture and fixtures, and computer equipment), and construction in progress. The preliminary estimate of fair value of real property was determined using the sales comparison data valuation technique and the preliminary estimate of fair value of personal property was determined using the direct replacement cost method. The recorded fair value of property and equipment located at the Shawnee, Kansas site is currently equal to its net book value at the time of the acquisition, as we are in the process of gathering information to finalize our revenue disaggregated by product category:fair value assessment.
Intangible assets relate to $65 million of in-process research and development (IPR&D) and $3,930 million of marketed products. The acquired definite-lived intangible assets are being amortized over a weighted-average
| 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 | |||||||
estimated useful life of approximately 10 years on a straight-line basis. The estimated fair values of identifiable intangible assets were determined using the "income approach," which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product (including revenues, cost of sales, R&D expenses, marketing, selling and administrative expenses, and contributory asset charges), the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, and competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of intangible assets as of March 31, 2021 is based on preliminary assumptions which are subject to change as we complete our valuation procedures.
Assets held for sale include $133 million of intangible assets, consisting of marketed products and IPR&D, and $5 million of inventory related to the divestitures of Drontal™, Profender™ and other products. In order to secure the necessary regulatory clearances for the acquisition of Bayer Animal Health, we signed agreements to divest the rights to the Drontal and Profender product families within the United Kingdom and European Economic Area as well as other IPR&D. We completed the transactions, which were accounted for as asset divestitures, in the third quarter of 2020.
Accrued retirement benefits primarily relate to certain Bayer Animal Health international subsidiaries that have underfunded defined benefit pension plans. We have recorded the fair value of these plans using assumptions and accounting policies similar to those disclosed in Note 19: Retirement Benefits to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020. Upon acquisition, the excess of projected benefit obligation over the fair value of plan assets was recognized as a liability and previously existing deferred actuarial gains and losses and unrecognized service costs or benefits were eliminated.
The goodwill recognized from this acquisition represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
Pro forma financial information (unaudited)
The following table presents the estimated unaudited pro forma combined results of Elanco and Bayer Animal Health for the three months ended March 31, 2020 as if the acquisition of Bayer Animal Health had occurred on January 1, 2020:
| Revenue | $ | 1,170 | |||||||||||||||||||||
| Loss before income taxes | (67) | ||||||||||||||||||||||
The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Elanco and Bayer Animal Health. The supplemental pro forma financial information does not necessarily represent what the combined companies' revenue or results of operations would have been had the acquisition been completed on January 1, 2020, nor is it intended to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Elanco and Bayer Animal Health.
The unaudited supplemental pro forma financial information reflects primarily pro forma adjustments related to divestitures, fair value estimates for intangibles and inventory, and interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition of Bayer Animal Health. The unaudited supplemental pro forma financial information includes transaction charges associated with the acquisition. There are no material, nonrecurring pro forma adjustments directly attributable to the acquisition included in the reported pro forma revenue and loss before income taxes.
2021 Q1 Form 10-Q | 14 | | |||||||
Divestitures and Assets Held For Sale
In connection with advancing our efforts to secure the necessary regulatory clearances for our acquisition of Bayer Animal Health, we signed agreements in 2020 to divest the rights to manufacture and commercialize certain products, including currently marketed products and certain IPR&D assets. As part of those transactions, we signed an agreement to divest the worldwide rights to the legacy Elanco products Itrafungol™ and Clomicalm™ in connection with the required disposal of an early-stage IPR&D asset. We also made a payment during the three months ended March 31, 2021 and accrued for future amounts we are required to pay to the buyer of the IPR&D asset to help fund their development costs for a set period of time. The related assets met the assets held for sale criteria as of December 31, 2020. The divestiture closed during the three months ended March 31, 2021. There were no proceeds received from the disposition of these assets and the resulting immaterial impact was recorded in other expense, net in our condensed consolidated statement of operations.
Assets and liabilities considered held for sale in connection with the above divestiture were included in the respective line items on the consolidated balance sheet as follows:
| December 31, 2020 | |||||||||||
| Inventories | $ | 2 | |||||||||
| Other intangibles, net | 4 | ||||||||||
| Property and equipment, net | 0 | ||||||||||
| Deferred tax asset | 1 | ||||||||||
| Total assets held for sale | $ | 7 | |||||||||
Other intangibles, net classified as held for sale primarily consisted of marketed products.
Note 6.5. Asset Impairment, Restructuring and Other Special Charges
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, including the acquisition of Bayer Animal Health, 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 1: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
2021 Q1 Form 10-Q | 15 | | |||||||
Components of asset impairment, restructuring and other special charges including integrationare as follows:
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Restructuring charges: | |||||||||||||||||||||||
Severance and other costs (1) | $ | 26 | $ | 1 | |||||||||||||||||||
Facility exit costs (1) | 0 | 1 | |||||||||||||||||||||
| Acquisition related charges: | |||||||||||||||||||||||
Transaction and integration costs (2) | 81 | 76 | |||||||||||||||||||||
| Non-cash and other items: | |||||||||||||||||||||||
Asset impairment (3) | 9 | 0 | |||||||||||||||||||||
Asset write-down (4) | 2 | 1 | |||||||||||||||||||||
Gain on sale of fixed assets (5) | 0 | (4) | |||||||||||||||||||||
Settlements and other (6) | (10) | 0 | |||||||||||||||||||||
| Total expense | $ | 108 | $ | 75 | |||||||||||||||||||
(1)For the three months ended March 31, 2021, these charges primarily relate to a restructuring program announced and initiated in January 2021. These costs were partially offset by the reversal of severance accruals under the September 2020 program that are no longer needed. See below for further details.
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 consolidatedacquisition of Bayer Animal Health (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 | |||||||
(4)Asset write-down expenses for the three months ended March 31, 2021 resulted from adjustments recorded to write assets classified as held and used down to their current fair value. These included charges related to fixed assets in Basel, Switzerland; Cuxhaven, Germany; and Manukau, New Zealand in connection with announced restructuring programs.
Asset impairment recognized duringwrite-down expenses for the ninethree months ended September 30, 2018March 31, 2020 resulted from $19.9 million of intangible asset impairmentsadjustments recorded to write assets classified as held and $44.0 million of fixed asset impairments. The intangible asset impairmentsused down to their current fair value. These charges primarily related to revised projections of fair value due to product rationalization. The fixed asset impairments were primarily due to the decision to dispose of a manufacturing facility in the U.S. and to the suspension of commercial activities for Imrestor®.
(5)Represents a gain on the disposal from the sale of an R&D facility in Prince Edward Island, Canada.
(6)As a site that was previously closedresult of workforce reductions in connection with our September 2020 and January 2021 restructuring programs, we remeasured the impacted pension benefit obligations as of March 31, 2021, which resulted in a curtailment gain. See Note 13: Retirement Benefits for further information. This amount also includes the gain recorded on the divestiture of an early-stage IPR&D asset acquired as part of the Bayer Animal Health acquisition.
In January 2021, we announced a restructuring aligned with our ongoing efforts to improve operating efficiencies. The proposed actions are focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we intend to close R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We will also reduce duplication and optimize structures in U.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring will result in the elimination of approximately 330 positions around the world. Charges related to this initiative were approximately $41 million for the three months ended March 31, 2021. The overall project is expected to be substantially complete by the end of 2021.
In September 2020, following the closing of the Bayer Animal Health acquisition, we implemented a restructuring program designed to reduce duplication, drive efficiency and integrationoptimize our footprint in key geographies. As part of Novartis Animal Health.the restructuring plan, we have eliminated approximately 900 positions across 40 countries, primarily in the commercial and marketing functions, but also in R&D, manufacturing and quality, and back office support functions.
2021 Q1 Form 10-Q | 16 | | |||||||
During the three months ended March 31, 2021 we recorded a favorable adjustment of $13 million as a change in estimate related to this initiative, which reflects adjustments to severance accruals resulting from favorable negotiations and certain restructured employees filling open positions. The overall project is expected to be substantially complete by the end of 2021.
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, 2019 | $ | 5 | $ | 16 | $ | 21 | |||||||||||
| Charges | 1 | 1 | 2 | ||||||||||||||
| Reserve adjustments | 0 | (1) | (1) | ||||||||||||||
| Cash paid | (1) | (10) | (11) | ||||||||||||||
| Balance at March 31, 2020 | $ | 5 | $ | 6 | $ | 11 | |||||||||||
| Balance at December 31, 2020 | $ | 0 | $ | 130 | $ | 130 | |||||||||||
| Charges | 0 | 39 | 39 | ||||||||||||||
| Reserve adjustments | 0 | (13) | (13) | ||||||||||||||
| Cash paid | 0 | (38) | (38) | ||||||||||||||
| Balance at March 31, 2021 | $ | 0 | $ | 118 | $ | 118 | |||||||||||
| 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 and noncurrent liabilities on the consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next twelve months.18 months primarily due to certain country negotiations and regulations. We believe that the reserves are adequate.
Note 6. 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. FIFOmethod or the weighted average cost approximates current replacement cost.method.
Inventories consisted of the following:
| March 31, 2021 | December 31, 2020 | ||||||||||
| Finished products | $ | 613 | $ | 772 | |||||||
| Work in process | 630 | 625 | |||||||||
| Raw materials and supplies | 211 | 210 | |||||||||
| Total | 1,454 | 1,607 | |||||||||
| Decrease to LIFO cost | (30) | (29) | |||||||||
| Inventories | $ | 1,424 | $ | 1,578 | |||||||
Note 7. Equity
Common Stock Offering
On January 22, 2020, we entered into an underwriting agreement in which we agreed to sell approximately 23 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 million shares, which was exercised in full on January 23, 2020. As a result, we issued and sold a total of approximately 25 million shares of our common stock for $768 million, after issuance costs.
| 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 | |||
2021 Q1 Form 10-Q | 17 | | |||||||
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 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 ninetwo 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 ended September 30, 2018, we recognized $38.6 millionreflected in current portion of inventory write-offs in cost of sales primarilylong-term debt. Issuance costs related to the suspensionamortizing notes are reflected as a reduction of commercial activitiesthe 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 | $ | 471 | $ | 79 | $ | 550 | ||||||||||||||
| Less: Issuance costs | 19 | 3 | 22 | |||||||||||||||||
| Net proceeds | $ | 452 | $ | 76 | $ | 528 | ||||||||||||||
The senior amortizing notes have an aggregate principal amount of $79 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 Imrestor.the first installment payment of $0.6528 per amortizing note paid on May 1, 2020). Each installment constitutes a payment of interest and partial payment of principal, and in the aggregate will be equivalent to 5.00% per year with respect to the $50 stated amount per TEU.
Unless settled early at the holder’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 million shares or a maximum of 17 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 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.
2021 Q1 Form 10-Q | 18 | | |||||||
Note 8. Debt
Long-term debt as of September 30, 2018 consisted of the following:
| March 31, 2021 | December 31, 2020 | ||||||||||
| Term loan B credit facility | $ | 4,151 | $ | 4,164 | |||||||
| Revolving credit facility | 50 | 0 | |||||||||
| 3.912% Senior Notes due 2021 | 500 | 500 | |||||||||
| 4.272% Senior Notes due 2023 | 750 | 750 | |||||||||
| 4.900% Senior Notes due 2028 | 750 | 750 | |||||||||
| TEU amortizing notes | 53 | 60 | |||||||||
| Other obligations | 0 | 1 | |||||||||
| Unamortized debt issuance costs | (93) | (98) | |||||||||
| 6,161 | 6,127 | ||||||||||
| Less current portion of long-term debt | 605 | 555 | |||||||||
| Total long-term debt | $ | 5,556 | $ | 5,572 | |||||||
| 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 | ||
In connection with the acquisition of December 31, 2017 was not material.Bayer Animal Health, on August 1, 2020, we borrowed $4,275 million under a term loan B credit facility. The term loan B facility bears interest at a floating rate of LIBOR plus 175 basis points over a seven-year term.
These senior secured first lien credit facilities are secured by a variable rate plus specified margin as defined insignificant portion of our assets. They include 2 financial maintenance covenants which are solely for the agreement and is payable quarterly. There were no borrowings outstandingbenefit of lenders under the Revolving Facility at September 30, 2018.revolving credit facility. There are 0 financial maintenance covenants for the benefit of the term loan B facility. The Revolving Facilitylenders under the term loan B facility have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.
The first financial maintenance covenant for the revolving credit facility requires us to maintain a net total leverage ratio level (which is payable in full atnot subject to step-downs) as of the end of each quarter. The required level of this covenant is based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) not exceeding 7.71 to 1.00 of our pro forma adjusted EBITDA for the term.four fiscal quarters ended March 31, 2021.
The second financial maintenance covenant for the revolving credit facility withrequires us to maintain a syndicateratio 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 the term.
Senior Notes
In August 28, 2018, we issued $2.0$2 billion of senior notes (Senior Notes) in a private placement.. The Senior Notes comprised of $500.0$500 million of 3.912% Senior Notes due August 27, 2021, $750.0$750 million of 4.272% Senior Notes due August 28, 2023, and $750.0$750 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 on the respective series of Senior Notes.
2021 Q1 Form 10-Q | 19 | | |||||||
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.March 31, 2021.
TEU Amortizing Notes
On January 22, 2020, we issued $550 million in TEUs. We have entered into an agreement that requires us to use commercially reasonable efforts to causeoffered 11 million, 5.00% TEUs at the stated amount of $50 per unit, comprised of prepaid stock purchase contracts and a registrationsenior amortizing note due February 1, 2023 (the mandatory settlement date). Total cash of $528 million was received, comprised of $452 million of prepaid stock purchase contracts and $76 million of senior amortizing notes, net of issuance costs. We paid $7 million representing partial payment of principal and interest on the TEU amortizing notes during the three months ended March 31, 2021. See Note 7: Equity for further information.
Debt Extinguishment
On January 31, 2020, we repaid indebtedness outstanding under our previous term loan facility. We paid $372 million in cash, composed of $371 million of principal and $1 million of accrued interest, resulting in a debt extinguishment loss of $1 million (recognized in interest expense, net of capitalized interest in the condensed consolidated statement to become effective withof operations for 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 pursuantthree months ended March 31, 2020), primarily related to the termswrite-off of the registration rights agreement, we will be required to pay additional interest to the holders of the Senior Notes under certain circumstances.deferred debt issuance costs.
Note 9. Financial Instruments and Fair Value
Financial instruments that are potentially subject to credit risk consist principally of trade receivables. We evaluate the creditworthiness of our customers on a regular basis, monitor economic conditions, and calculate allowances for estimated credit losses on our trade receivables on a quarterly basis using an expected credit loss model. We assess whether collectability is probable at the time of sale and on an ongoing basis. 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 by 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, 2021 and December 31, 2017,2020, we had $14.9$34 million and$12.3 $33 million, respectively, of costinvestments included in other noncurrent assets on our condensed consolidated balance sheet. These include investments with readily determinable fair values, investments without readily determinable fair values, and equity method investments. Unrealized net gains and losses during the three months ended March 31, 2021 and March 31, 2020 were immaterial.
2021 Q1 Form 10-Q | 20 | | |||||||
The following table summarizes the fair value information at September 30, 2018March 31, 2021 and December 31, 20172020 for foreign exchange contract assets (liabilities), contingent consideration 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 | ||||||||||||||
| 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, 2021 | ||||||||||||||||||||||||||||||||
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 22 | $ | 0 | $ | 22 | $ | 0 | $ | 22 | ||||||||||||||||||||||
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (45) | 0 | (45) | 0 | (45) | |||||||||||||||||||||||||||
| Other noncurrent liabilities - contingent consideration | (1) | 0 | 0 | (1) | (1) | |||||||||||||||||||||||||||
| Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | (23) | 0 | (23) | 0 | (23) | |||||||||||||||||||||||||||
| Long-term debt - senior notes | (2,000) | 0 | (2,171) | 0 | (2,171) | |||||||||||||||||||||||||||
| TEU amortizing note | (53) | 0 | (49) | 0 | (49) | |||||||||||||||||||||||||||
| Term loan B | (4,151) | 0 | (4,125) | 0 | (4,125) | |||||||||||||||||||||||||||
Revolving credit facility (1) | (50) | 0 | (50) | 0 | (50) | |||||||||||||||||||||||||||
| December 31, 2020 | ||||||||||||||||||||||||||||||||
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 36 | $ | 0 | $ | 36 | $ | 0 | $ | 36 | ||||||||||||||||||||||
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (36) | 0 | (36) | 0 | (36) | |||||||||||||||||||||||||||
| Other noncurrent liabilities - contingent consideration | (1) | 0 | 0 | (1) | (1) | |||||||||||||||||||||||||||
| Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | (76) | 0 | (76) | 0 | (76) | |||||||||||||||||||||||||||
| Long-term debt - senior notes | (2,000) | 0 | (2,218) | 0 | (2,218) | |||||||||||||||||||||||||||
| TEU amortizing notes | (60) | 0 | (58) | 0 | (58) | |||||||||||||||||||||||||||
| Term loan B | (4,164) | 0 | (4,144) | 0 | (4,144) | |||||||||||||||||||||||||||
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, 2021 and December 31, 2020 related to contingent consideration associated with the acquisitions of Aratana Therapeutics, Inc. (Aratana) and Prevtec Microbia Inc. (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 million contingent upon the achievement of specific Coliprotec sales
2021 Q1 Form 10-Q | 21 | | |||||||
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.
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, Swiss franc (CHF), and Chinese yuan. 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 expense, net in the condensed consolidated statement of operations. Forward contracts generally have maturities not exceeding 12 months. At March 31, 2021 and December 31, 2020, we had outstanding foreign exchange contracts with aggregate notional amounts of $1,503 million and $1,391 million, respectively.
The amount of net gain on derivative instruments not designated as hedging instruments, recorded in other expense, net are as follows:
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
Foreign exchange forward contracts (1) | $ | 34 | $ | 28 | |||||||||||||||||||
(1)These amounts were substantially offset in other expense, net 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 was 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 was classified as Level 2). During the three months ended March 31, 2020, approximately 75% of our cross-currency swaps were liquidated for a cash benefit of $27 million (including $2 million in interest). We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020, which was fully liquidated in April 2020. Notwithstanding settlement, gains and losses within accumulated other comprehensive income (loss) will remain in accumulated other comprehensive income (loss) until either the sale or substantial liquidation of the hedged subsidiary.
Gains on the NIH, recognized within interest expense, net of capitalized interest, are as follows:
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Cross-currency interest rate swap contracts | $ | 0 | $ | 6 | |||||||||||||||||||
Over the life of the derivative, gains or losses due to spot rate fluctuations were recorded in cumulative translation adjustment in other comprehensive income (loss). The amounts of net gains on interest rate swap contracts, recorded, net of tax, in accumulated other comprehensive income (loss), are as follows:
2021 Q1 Form 10-Q | 22 | | |||||||
| Three Months Ended March 31, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
| Cross-currency interest rate swap contracts | $ | 0 | $ | 23 | |||||||||||||||||||
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 $4.1 billion notional amount, which are designated as cash flow hedges and have maturity 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 (loss). Fair value is estimated based on quoted market pricesvalues of similar liabilitieshedges and is classified as Level 2. AsAmounts recorded in accumulated other comprehensive income (loss) will be recognized in earnings in interest expense, net of Decembercapitalized interest when the hedged transaction affects earnings (i.e., when interest payments are accrued on the term loan B). During the three months ended March 31, 2017, long term debt was not material.2021 and 2020 we recorded a gain of $53 million (net of tax expense of $0 after valuation allowance) and a loss of $39 million (net of tax benefit of $11 million), respectively, on the cash flow hedges in other comprehensive loss. Over the next 12 months we expect to reclassify $28 million from accumulated other comprehensive income (loss) to interest expense, net of capitalized interest due to the amortization of net losses on the interest rate swaps. During the three months ended March 31, 2021, we reclassified $7 million of net losses into interest expense.
Note 10. Income Taxes
| Income Tax Benefit | Three Months Ended March 31, | |||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||
| Income tax benefit | $ | (19) | $ | (19) | ||||||||||||||||||||||
| Effective tax rate | 23.5 | % | 27.6 | % | ||||||||||||||||||||||
We were generally included in the tax grouping of other Lilly entities within the respective entity's tax jurisdiction; however, in certain jurisdictions, we filed separate tax returns. 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 months ended March 31, 2021, we recognized an income tax benefit of $19 million. Our effective tax rate of 23.5% differs from the statutory income tax rate primarily due to tax-exempt interest income in certain foreign jurisdictions. Income tax benefit was partially offset by a $2 million increase to the valuation allowance on our U.S. federal and state deferred tax assets during the period.
For the three months ended March 31, 2020, we recognized an income tax benefit of $19 million. The effective tax of 27.6% differs from the statutory income tax rate primarily due to a pre-tax loss mainly driven by acquisition and integration costs. In addition, a discrete income tax benefit of $2 million was recognized related to the excess tax benefits for stock-based compensation that vested in the three months ended March 31, 2020.
Note 11. Commitments and Contingencies
Legal Matters
On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco, Jeffrey Simmons and Todd Young. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco securities between September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana Therapeutics, Inc. We filed a motion to dismiss on January 13, 2021. The timing of the Court's decision is uncertain. We believe the claims made in the
2021 Q1 Form 10-Q | 23 | | |||||||
case are meritless, and we intend to vigorously defend our position. The process of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolution cannot be predicted.
On October 16, 2020, a shareholder class action lawsuit captioned Safron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives, and other individuals. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the next twelve months, the IRS examinationregistration statement on Form S-3 dated January 21, 2020 and accompanying prospectus filed in connection with Elanco’s public offering which closed on or about January 27, 2020. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of tax years 2013-2015 remains ongoing. For periods prior to the Separation, Lilly will retain the liabilities related to such IRS audit resolutions.
Claims seeking actual damages, injunctive relief, and/or restitution for the allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC arising out of the use of Seresto™, a tax matters agreement (TMA) with Lillynon-prescription flea and tick collar for cats and dogs. In March, April, and May 2021, class action lawsuits were filed in state and federal courts in the U.S. alleging that amongthe Seresto collars contain pesticides and other things, formalized our agreementingredients that can cause serious injury and death to cats and/or dogs wearing the product. The cases mention the existence of incident reports involving humans, but no plaintiff has claimed personal harm from the product. Further, a U.S. House of Representative subcommittee chair requested Elanco to produce certain documents and information related to the responsibility for historical tax positions forSeresto collar and further made a request to temporarily remove Seresto collars from the periods priormarket. We are cooperating with the subcommittee and have produced information pursuant to the Separation for jurisdictions where our business was included inrequest. In addition, as Seresto is registered with the consolidatedEnvironmental Protection Agency (EPA), we are providing information to the EPA regarding the safety profile of Seresto. All data and scientific evaluation used during the product registration process and through pharmacovigilance review supports the product’s positive safety profile and efficacy. Therefore, we believe no removal or combined tax returns of Lilly. The TMA also established a tax sharing agreement for jurisdictions where our business willrecall is warranted, nor has it been suggested by any regulatory agency. We continue to be included in Lilly's consolidated or combined tax returnsstand behind the safety profile for a periodSeresto, and it remains available to consumers globally. We continue to receive information with respect to potential litigation costs and the anticipated number of time.
We are party to various other 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 record aaccrue for certain liability if there is a claim for whichclaims to the extent that it is probable we will incur a payment will be madeloss and we can formulate a reasonable estimate of the amount is estimable. At September 30, 2018costs. As of March 31, 2021 and December 31, 2017,2020, we had no0 material 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 any claim.a significant claim other than the lawsuits noted above.
2021 Q1 Form 10-Q | 24 | | |||||||
Note 12. Geographic Information
We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both foodfarm animals and companion animals.pets. Consistent with our operational structure, our President and Chief Executive Officer (CEO), as the chief operating decision maker,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/costs/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®Baycox™, Optaflexx®Cydectin™, Denagard®Denagard™, Tylan®Maxiban™, Maxiban®Optaflexx™, Rumensin™, Tylan™, and other products for livestock and poultry, as well as Trifexis®Advantage™, Interceptor®Advantix™, Comfortis®Advocate™ (collectively referred to as the Advantage Family), Credelio™, Duramune™, Galliprant™, Interceptor™ Plus,Seresto, Trifexis™, and other products for companion animals.pets.
We have a single customer whothat accounted for 11.1%7% and 9.4%14% of revenue for the three months ended September 30, 2018March 31, 2021 and 2017, respectively, and for 11.5% and 11.9% of revenue for the nine months ended September 30, 2018 and 2017,2020, respectively. The productProduct sales with this customer resulted in accounts receivable with this customer of $79.5$75 million and $88.0$87 million as of September 30, 2018March 31, 2021 and December 31, 2017,2020, 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, | |||||||||||||||||||||||
| 2021 | 2020 | ||||||||||||||||||||||
Revenue—to unaffiliated customers (1) | |||||||||||||||||||||||
| United States | $ | 533 | $ | 300 | |||||||||||||||||||
| International | 709 | 358 | |||||||||||||||||||||
| Revenue | $ | 1,242 | $ | 658 | |||||||||||||||||||
| 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 | |||||||
| 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.
2021 Q1 Form 10-Q | 25 | | |||||||
Note 13. EarningsRetirement Benefits
The following table summarizes net periodic benefit cost relating to our defined benefit pension plans:
| Three Months Ended March 31, | ||||||||||||||
| 2021 | 2020 | |||||||||||||
| Service cost | $ | 5 | $ | 3 | ||||||||||
| Interest cost | 1 | 0 | ||||||||||||
| Expected return on plan assets | (2) | (1) | ||||||||||||
| Amortization of prior service cost | (2) | (2) | ||||||||||||
| Amortization of net actuarial loss | 1 | 1 | ||||||||||||
| Curtailments (Note 5) | (9) | 0 | ||||||||||||
| Net periodic benefit cost | $ | (6) | $ | 1 | ||||||||||
The components of net periodic benefit cost other than service cost and curtailments are included in other expense, net in the condensed consolidated statements of operations. Curtailments are included in asset impairment, restructuring and other special charges, in the condensed consolidated statements of operations.
Note 14. Loss Per Share
We have calculatedcompute basic loss per share by dividing net loss available to common shareholders by the actual weighted average number of common shares outstanding for the reporting period. Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements and the TEU prepaid stock purchase contracts (see Note 7: Equity for further discussion). Diluted earnings per share assuming 365,625,000reflects 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 were outstanding for all periods presented. This represents an aggregateis calculated using the treasury stock method. Potential common shares that would have the effect of 293,290,000increasing diluted earnings per share (or reducing loss per share) are considered to be anti-dilutive and as such, these shares of our common stock held by Lilly (which represents the 100 shares held by Lilly prior to giving 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 stockare not included in the IPO,calculation of diluted loss per share.
Basic and diluted loss per share are calculated as follows:
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| 2021 | 2020 | |||||||||||||||||||||||||
| Net loss available to common shareholders | $ | (61) | $ | (49) | ||||||||||||||||||||||
| Determination of shares: | ||||||||||||||||||||||||||
| Weighted average common shares outstanding | 486.7 | 403.9 | ||||||||||||||||||||||||
Assumed conversion of dilutive common stock equivalents (1) | 0 | 0 | ||||||||||||||||||||||||
| Diluted weighted average shares outstanding | 486.7 | 403.9 | ||||||||||||||||||||||||
Loss per share (2) | ||||||||||||||||||||||||||
| Basic | $ | (0.12) | $ | (0.12) | ||||||||||||||||||||||
| Diluted | $ | (0.12) | $ | (0.12) | ||||||||||||||||||||||
(1)During the issuance of 9,435,000 shares of our common stock sold pursuant to the underwriters’ option to purchase additional shares.
(2)Due to rounding conventions, loss per share may not recalculate precisely based on the amounts presented within this table.
2021 Q1 Form 10-Q | 26 | | |||||||
Note 15. Transactions and 2017, respectively,Agreements with Bayer
While Bayer is no longer considered a related party, we have transacted with Bayer during the net transfers (to)/from Lilly were $(226.3) million and $862.7 million, respectively. The most significant activity impactingperiod after the 2017 transferacquisition of Bayer Animal Health, including the period in which Bayer was the financing by Lillyconsidered a principal owner of 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.
For regulatory purposes in certain jurisdictions, consideration was required to be paid locally at closing in addition to amounts paid globally for the acquisition. Pursuant to the stock and asset purchase agreement, Bayer has provided a refund for payment amounts duplicated in these costs. When specific identification is not practicable, the remainder have been allocated primarily on a proportional cost method on a basis of revenue or headcount.
regions. The allocations of servicestotal amount paid to and received 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 | |||||||
2021 Q1 Form 10-Q | 27 | | |||||||
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
Founded in 1954, as part of Eli Lilly and Company, Elanco is a premier animal health company that innovates, develops, manufactures and markets products for companionpets and foodfarm animals. Headquartered in Greenfield, Indiana, we are one of the fourth largest animal health companycompanies in the world. Weworld, with pro forma combined revenue of Elanco and Bayer Animal Health of approximately $4.4 billion for the year ended December 31, 2020.
On August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our existing product portfolio and pipeline have onebeen enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure. See Note 4: Acquisitions and Divestitures to the broadest portfolioscondensed consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of pet parasiticides in the companion animal sector. Bayer Animal Health.
We offer a diverse portfolio of more than 125approximately 190 brands that make us a trusted partner to veterinarians and foodfarm animal producers in more than 90 countries. Our products are generally sold worldwide to third-party distributors, retailers, and directly to farm animal producers and veterinarians. With the acquisition of Bayer Animal Health, we have expanded our presence in retail and e-commerce channels in order to meet pet owners where they want to purchase.
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. In 2020, we renamed our four primary product categories by replacing "food animal" and "companion animal" with "farm animal" and "pet health," respectively, to better reflect the terminology used by our customers. We advance our vision bywith the following offering products in four primary categories:of portfolio solutions:
Pet Health: Our portfolio is focused on parasiticides, vaccines and therapeutics. We have one of the broadest parasiticide portfolios in the companion animalpet health sector based on indications, species and formulations, with products that protect pets from worms, fleas and ticks. CombiningOur Seresto and Advantage, Advantix, Advocate (collectively referred to as the Advantage Family) products are over-the-counter treatments for the elimination and prevention, respectively, of fleas and ticks, and complement our prescription parasiticide products, Credelio, Interceptor Plus, and Trifexis. Our vaccines portfolio with our vaccines presence, we areprovides differentiated prevention coverage for a leadernumber of important pet health risks and is available in the United States (U.S.) in the disease prevention category based on share of revenue.
2021 Q1 Form 10-Q | 28 | | |||||||
Farm Animal Future Protein & Health (FA Future Protein & Health): Our farm animal portfolio in this category, which includes vaccines, nutritional enzymesconsists of products to prevent, control and animal only antibiotics, serves the growing demand for proteintreat health challenges primarily focused on cattle (beef and includes innovative products indairy), swine, poultry, and aquaculture production, where demand for animal health(cold and warm water) production. Our products is outpacing overall industry growth. We are focused on developing functional nutritional health products that promote food animal health, includinginclude medicated feed additives, injectable antibiotics, vaccines, insecticides, and enzymes, probiotics and prebiotics. We are a leader in providing vaccines as alternatives to antibiotics to promote animal health based on share of revenue.
| Three Months Ended March 31, | ||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | ||||||||||||||||||||||||
| Revenue | $ | 1,242 | $ | 658 | ||||||||||||||||||||||
| Net loss | (61) | (49) | ||||||||||||||||||||||||
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 need 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 completedextend, which are subject to internal policies, and procedures and environmental factors beyond our control, including weather conditions and the COVID-19 global pandemic.
Key Trends and Conditions Affecting Our Results of Operations
Industry Trends
The animal health industry, which includes both farm animals and pets, is a $2.0 billion senior notes offeringgrowing industry that benefits billions of people worldwide.
As demand for animal protein grows, farm animal health is becoming increasingly important. We believe that factors influencing growth in demand for farm animal medicines and entered into a $500.0 million term loan,vaccines include:
•one in three people needing improved nutrition;
•increased global demand for protein, particularly poultry and Lilly transferredaquaculture;
•natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, driving the need for more efficient food production;
•loss of productivity due to us substantially allfarm animal disease and death;
•increased focus on food safety and food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.
Growth in farm 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 pet medicines and vaccines include:
•increased pet ownership globally;
•pets living longer; and
•increased pet spending as pets are viewed as members 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,family by any specified date or at all.owners.
2021 Q1 Form 10-Q | 29 | | |||||||
Factors Affecting Our Results of Operations
COVID-19 Pandemic
Our business has been impacted by the COVID-19 pandemic that originated in December 2019. We continue to monitor the global outbreak of COVID-19 and have worked with our customers, employees, suppliers and other stakeholders to mitigate the risks posed by its spread. The COVID-19 pandemic continues to impact the economy in the United States and globally, and has had an effect on the operations of our company, vendors and suppliers, and supply of and demand for our products as follows:
Operations
As a result of the COVID-19 pandemic, governmental authorities implemented 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 affected 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 impacted 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 continue to primarily work remotely. These measures have impacted and may further impact our workforce and operations, as well as those of our customers, vendors and suppliers.
Supply
In the first quarter of 2021, we did not experience significant impacts or interruptions to our supply chain as a result of the COVID-19 pandemic. However, as the pandemic continues, we may face supply chain disruptions due to operational difficulties experienced by our suppliers. 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 have experienced, and could continue to experience, lead time disruptions and increases in shipping costs, negatively impacting our profitability.
Demand
The COVID-19 pandemic has adversely impacted global economic conditions. In particular, the COVID-19 pandemic created significant uncertainty for our channel distribution partners with respect to end customer demand and working capital, particularly in early 2020. Based on these factors, in addition to a shift in tactics for demand generation with our distributors, in the first and second quarters of 2020, we reduced the amount of inventory held in the channel. For our pet health business, demand in our direct to retailer and e-commerce channels could be negatively impacted by economic conditions as they fluctuate.
In our farm animal business, demand has been negatively impacted by processing plant closures, resulting in a backlog of animals ready for processing, and weakened food service demand, which collectively have pressured producer economics. Processing plants have adjusted operations and have cleared most of the backlog, and demand for certain protein categories continues to recover. While the impact has been most significant for the U.S. livestock industry, particularly in the second and third quarters of 2020, the pressure has occurred globally and across species. As the pandemic has continued through the beginning of 2021, our business has been affected by lower levels of demand in certain markets due to unfavorable macroeconomic conditions and reduced food service consumption. As a result, the industry has seen pressured prices and producer profitability across species, most notably in international poultry and aqua. We anticipate that recovery of end consumer demand, particularly in the food service business as compared to prior year will continue to occur, particularly impacting our farm animal business, throughout 2021.
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 continue to manage inventory more tightly. In response to this along with a shift in tactics for demand generation with our distributors, we reduced channel inventory levels during the first half of 2020 as we tightened our approach across all facets of our distributor relationships. We estimate that this decreased our revenue by
2021 Q1 Form 10-Q | 30 | | |||||||
approximately $160 million. These actions have allowed us to improve working capital management, increase gross margin, implement new compensation structures with our distributors and enable greater control of overall stock levels. 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, disruption and declines in the global economy could result in difficulties in our ability to collect, which we have not experienced on a material basis at this time. If significant issues with collections occur, material increases in our allowance for doubtful accounts may be required.
Our Acquisition of Bayer Animal Health
We have incurred and expect to continue to incur expenses in connection with our acquisition of Bayer Animal Health including fees for professional services such as legal, accounting, consulting, and other advisory fees and expenses. Expenses incurred in 2021 primarily relate to integration activities. In addition, we have incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics and to expand administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by the former parent company of Bayer Animal Health. We anticipate that these additional costs will be partially offset by expected synergies.
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've launched 11 new products, five of which were launched in 2017 and 2018.innovation. We continue to pursue the development of new chemical and biological molecules through our approach to innovation. Our future growth and success dependsdepend on both our pipeline of new products, including new products that we 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.
Competition
We face intense competition. Principal methods of competition vary depending on the particular region, species, product category, or individual product. Some of these methods include new product development, including generic alternatives to our products, quality, price, service and promotion.
Our primary competitors include animal health medicines and vaccines companies such as Zoetis Inc.; Boehringer Ingelheim Vetmedica, Inc., the animal health division of Boehringer Ingelheim GmbH; and Merck Animal Health, the animal health division of Merck & Co., Inc. We also face competition globally from manufacturers of generic drugs, as well as from producers of nutritional health products, such as DSM Nutritional Products AG and Danisco Animal Nutrition, the animal health division of E.I. du Pont de Nemours and Company, a subsidiary of DowDuPont, Inc. There are also several new start-up companies working in the animal health area. In addition, we compete with numerous other producers of animal health products throughout the world.
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.
Prior to the acquisition of Bayer Animal Health, 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. The acquisition of Bayer Animal Health on August 1, 2020 added 3,900 full-time employees, eight manufacturing sites, and four R&D sites. In addition, from 2015 to 2020, 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 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 have resulted from reducing the number of R&D sites, SG&A savings
2021 Q1 Form 10-Q | 31 | | |||||||
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, 2021 and 2017,2020, approximately 51.1%54% and 50.6%49%, 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 had a limited impact on our results due to currency movementsrevenue during the ninethree months ended September 30, 2018March 31, 2021 and 2017.2020.
Our Relationship with Lilly and Additional Standalone Costs
All operations-focused TSAs that went into effect after our business operated2018 separation from Lilly were exited 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.
planned on March 31, 2021. We are currently investingnearly complete with investments 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$315 million to $290$335 million, net of completed and planned real estate dispositions and employee benefit changes, of which a portion will be capitalized and the remainder will be expensed.
Asset Impairment, Restructuring and Other Special Charges
During the three months ended March 31, 2021 and 2020 including in connection with the productivity initiatives described above under "Factors Affecting Our results have been impacted byResults of Operations - Productivity," we incurred charges related to asset impairment, restructuring and other special charges, including integration of acquired businesses, during the nine months ended September 30, 2018 and 2017.businesses. These charges primarily include severance costs resulting from actions taken to reduce our cost structure,costs, asset impairment charges primarily related to competitive pressures for certain pet health products, product rationalization,rationalizations, site closures and integration costs related to acquired businesses. businesses, primarily Bayer Animal Health, and costs related to the build out of processes and systems to support finance and global supply and logistics, among others, as we stand our organization up as an independent company.
For more information on these charges, see Note 6:5: Asset Impairment, Restructuring and Other Special Charges in our unauditedto the 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, | % | ||||||||||||||||||
| 2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||
| Revenue | $ | 761.1 | $ | 697.1 | 9 | % | $ | 2,267.5 | $ | 2,134.7 | 6 | % | |||||||||
| Costs, expenses and other: | |||||||||||||||||||||
| Cost of sales | 369.8 | 376.2 | (2 | )% | 1,161.3 | 1,088.9 | 7 | % | |||||||||||||
| % of revenue | 49 | % | 54 | % | (5 | )% | 51 | % | 51 | % | — | % | |||||||||
| Research and development | 58.9 | 61.9 | (5 | )% | 185.5 | 189.7 | (2 | )% | |||||||||||||
| % of revenue | 8 | % | 9 | % | (1 | )% | 8 | % | 9 | % | (1 | )% | |||||||||
| Marketing, selling and administrative | 179.0 | 194.7 | (8 | )% | 550.1 | 583.0 | (6 | )% | |||||||||||||
| % of revenue | 24 | % | 28 | % | (4 | )% | 24 | % | 27 | % | (3 | )% | |||||||||
| Amortization of intangible assets | 48.7 | 51.6 | (6 | )% | 147.3 | 161.0 | (9 | )% | |||||||||||||
| % of revenue | 6 | % | 7 | % | (1 | )% | 6 | % | 8 | % | (1 | )% | |||||||||
| Asset impairment, restructuring and other special charges | 12.4 | 23.7 | (48 | )% | 82.8 | 189.3 | (56 | )% | |||||||||||||
| 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 | |||||||||||||
| % of revenue | 10 | % | (1 | )% | 11 | % | 5 | % | (4 | )% | NM | ||||||||||
| Income tax expense | 18.6 | 11.6 | 60 | % | 46.2 | 72.0 | (36 | )% | |||||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | NM | $ | 70.1 | $ | (149.2 | ) | NM | |||||||||
2021 Q1 Form 10-Q | 32 | | |||||||
| Three Months Ended March 31, | |||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | ||||||||||||||||||||||||||||||||
| Revenue | $ | 1,242 | $ | 658 | 89 | % | |||||||||||||||||||||||||||||
| Costs, expenses and other: | |||||||||||||||||||||||||||||||||||
| Cost of sales | 569 | 333 | 71 | % | |||||||||||||||||||||||||||||||
| % of revenue | 46 | % | 51 | % | (5) | % | |||||||||||||||||||||||||||||
| Research and development | 89 | 67 | 33 | % | |||||||||||||||||||||||||||||||
| % of revenue | 7 | % | 10 | % | (2) | % | |||||||||||||||||||||||||||||
| Marketing, selling and administrative | 348 | 182 | 91 | % | |||||||||||||||||||||||||||||||
| % of revenue | 28 | % | 28 | % | — | % | |||||||||||||||||||||||||||||
| Amortization of intangible assets | 147 | 52 | 183 | % | |||||||||||||||||||||||||||||||
| % of revenue | 12 | % | 8 | % | 4 | % | |||||||||||||||||||||||||||||
| Asset impairment, restructuring and other special charges | 108 | 75 | 44 | % | |||||||||||||||||||||||||||||||
| Interest expense, net of capitalized interest | 61 | 16 | 281 | % | |||||||||||||||||||||||||||||||
| Other expense, net | — | 1 | NM | ||||||||||||||||||||||||||||||||
| Loss before income taxes | (80) | (68) | 18 | % | |||||||||||||||||||||||||||||||
| % of revenue | (6) | % | (10) | % | 4 | % | |||||||||||||||||||||||||||||
| Income tax benefit | (19) | (19) | — | % | |||||||||||||||||||||||||||||||
| Net loss | $ | (61) | $ | (49) | 24 | % | |||||||||||||||||||||||||||||
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful
Disaggregated Revenue
On a global basis, our revenue within our product categories was as follows:
| 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 | % | |||||||||
| Revenue | % of Total Revenue | Increase (Decrease) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | 2021 | 2020 | $ Change | % Change | CER (1) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 645 | $ | 206 | 52 | % | 31 | % | $ | 439 | 213 | % | 211 | % | |||||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 578 | 433 | 47 | % | 66 | % | 145 | 33 | % | 34 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 1,223 | 639 | 98 | % | 97 | % | 584 | 91 | % | 91 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
Contract Manufacturing(2) | 19 | 19 | 2 | % | 3 | % | — | — | % | — | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,242 | $ | 658 | 100 | % | 100 | % | 584 | 89 | % | 88 | % | ||||||||||||||||||||||||||||||||||||||||||||||
(1)Constant exchange rate impact.
(2)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
The detailed change in revenue by product category was as follows:
•Pet Health revenue increased by $48.2$439 million, or 34% primarily213%, for the quarter, driven by increasesan increase in volume and price, partially offset by an unfavorable impact from foreign exchange rates. Growthrevenue as a result of the addition of Bayer Animal Health product revenue of $369 million in the quarter. The increase in the legacy Elanco business was primarily driven by higher realized price on Trifexis and a favorable comparison to the prior year, related to an anticipated stock outduring which we reduced channel inventory levels with our distributors, negatively impacting revenue by approximately $60 million. Growth in third quarter of 2017 which shifted sales of Trifexis to the second quarter of 2017. Growthlegacy Elanco business was also driven by the continued uptake of Interceptor Plusattributable to higher volume in newer generation parasiticide and Credelio, as well as increased sales of certain vaccines from new customer agreements.pain products.
2021 Q1 Form 10-Q | 33 | | |||||||
•Farm Animal revenue increased by $17.0$145 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.
quarter, driven by an increase in revenue as a result of $22.9the addition of Bayer Animal Health product revenue of $174 million in the quarter. Legacy Elanco revenue declined as a result of an unfavorable comparison to the prior year, which included anticipatory buying by direct customers in international export markets to ensure continuity of supply ahead of potential COVID-19 disruptions. In addition, the decline in the current period was driven by lower levels of demand in certain markets due to the positivenegative impact of foreign exchange rates;
•Contract Manufacturing revenue remained flat at $19 million, and represented 2% of Percorten V usedtotal revenue. Contract manufacturing revenue for the treatment of canine Addison’s Disease.
Cost of inventory acquired that was subsequently sold, partially offset by costs related to increased volume of products sold and various cost increases.Sales
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Cost of sales | $ | 569 | $ | 333 | 71 | % | ||||||||||||||||||||||||||||||||
| % of revenue | 46 | % | 51 | % | ||||||||||||||||||||||||||||||||||
Cost of sales increased $72.4 million in the nine months ended September 30, 2018 as compared to nine months ended September 30, 201771%, primarily due to costs relatedthe amortization of the fair value adjustment to increased volumeinventory of products sold, the write-off of inventory primarily related$62 million due 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 relatedBayer Animal Health along with an increase in legacy Elanco sales. Excluding the amortization of the inventory fair value adjustment, cost of sales would have been approximately 41% of revenue, compared to 51% in the prior year. This decrease is due to the fair value adjustmentsinclusion of inventory acquired that was subsequently sold.Bayer Animal Health products, which have higher margins, along with continued improvements in manufacturing productivity and increases in price.
Research and development
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Research and development | $ | 89 | $ | 67 | 33 | % | ||||||||||||||||||||||||||||||||
| % of revenue | 7 | % | 10 | % | ||||||||||||||||||||||||||||||||||
R&D expenses decreased $3.0 million forincreased 33%, primarily due to the three months ended September 30, 2018 asinclusion of the Bayer Animal Health business. As a percent of revenue, research and development was 7% compared to 10% in the three months ended September 30, 2017prior year, partly due primarily to normala delay of some project spend fluctuations and restructuring savings.
Marketing, selling and administrativeadministrative
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Marketing, selling and administrative | $ | 348 | $ | 182 | 91 | % | ||||||||||||||||||||||||||||||||
| % of revenue | 28 | % | 28 | % | ||||||||||||||||||||||||||||||||||
Marketing, selling and administrative expenses decreased $15.7 millionas a percentage of revenue were flat year over year. Expenses as a percentage of revenue remained flat primarily due to a delay of planned spend for direct-to-consumer and digital advertising from the three months ended September 30, 2018 as comparedfirst quarter to the three months ended September 30, 2017second quarter resulting from a cooler early parasiticide season. Expenses increased 91% over prior year, primarily due primarily to productivity initiatives and cost control measures across these functions.
2021 Q1 Form 10-Q | 34 | | |||||||
Amortization of intangible assets
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Amortization of intangible assets | $ | 147 | $ | 52 | 183 | % | ||||||||||||||||||||||||||||||||
Amortization of intangible assets decreased $2.9increased $95 million, for the three months ended September 30 2018 as comparedprimarily due to the three months ended September 30, 2017 due primarily to the accelerationaddition of amortization related to certain product exits in 2017.
Asset impairment, restructuring and other special charges
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Asset impairment, restructuring and other special charges | $ | 108 | $ | 75 | 44 | % | ||||||||||||||||||||||||||||||||
Asset impairment, restructuring and other special charges increased $33 million, primarily due to severance associated with the restructuring program announced during the first quarter of 2021, an asset impairment charge recorded to adjust the fair value of intangible assets that were subject to product rationalization, higher integration costs of acquisitions, and costs associated with the implementation of new systems, programs, and processes due to our separation from Lilly and in connection with the acquisition of Bayer Animal Health, as more fully described in Note 5. These increases were partially offset by adjustments to severance accruals under the September 2020 program primarily as a result of restructured personnel filling open positions and favorable negotiations, and a related pension curtailment gain from the September 2020 and January 2021 programs.
For additional information regarding our asset impairment, restructuring and other special charges, see Note 6:5: Asset Impairment, Restructuring and Other Special Charges to our unauditedthe condensed consolidated and combined financial statements.
Interest expense, net of capitalized interest
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Interest expense, net of capitalized interest | $ | 61 | $ | 16 | 281 | % | ||||||||||||||||||||||||||||||||
Interest expense, net of capitalized interest, increased $45 million, primarily due to interest associated with the term loan B entered into August 1, 2020 and used to finance the Bayer Animal Health acquisition.
Other expense, net
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Other expense, net | $ | — | $ | 1 | NM | |||||||||||||||||||||||||||||||||
Other expense recorded during the three months ended September 30, 2017March 31, 2021 consisted of losses recorded in relation to divestitures. This was fully offset by up-front payments received, milestones earned, and equity issued to us in relation to a license agreement. Other expense recorded during the three months ended March 31, 2020 was primarily composed of foreign exchange losses.
Income tax benefit
| Three Months Ended March 31, | ||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2021 | 2020 | % Change | |||||||||||||||||||||||||||||||||||
| Income tax benefit | $ | (19) | $ | (19) | — | % | ||||||||||||||||||||||||||||||||
| Effective tax rate | 23.5 | % | 27.6 | % | ||||||||||||||||||||||||||||||||||
Income tax benefit was $19 million for the three months ended September 30, 2018 as comparedMarch 31, 2021 and 2020. The effective tax rates
2021 Q1 Form 10-Q | 35 | | |||||||
for both periods were impacted by net discrete tax items. See Note 10: Income Taxes to the three months ended September 30, 2017 primarily due to decreased severance, integration and exit costs, partially offset by higher asset impairments.condensed consolidated financial statements for further discussion.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities. As a significant portion of our business is conducted outside the U.S.,internationally, 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. We currently intend to indefinitely reinvest foreign earnings for continued use in our foreign operations. 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.
We believe our primary sources of liquidity needs going forwardare sufficient to fund our short-term and long-term existing and planned capital requirements, which include working capital obligations, funding existing marketed and pipeline products, capital
expenditures, business development in our targeted areas, short-term and long-term debt obligations which include principal and interest expensepayments as well as interest rate swaps, operating lease payments, purchase obligations, and an anticipated dividend. Wecosts associated with the integration of Bayer Animal Health. In addition, we have the ability to access capital markets to obtain debt refinancing for longer-term funding, if required, to service our long-term debt obligations. Further, we believe we have sufficient cash flow and liquidity to remain in compliance with 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.debt covenants.
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 - We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful" in Part I of our Annual Report on Form 10-K for the year ended December 31, 2020.
Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented:
| Nine Months Ended September 30, | % | ||||||||||||||||||||||||||||
| Net cash provided by (used in): | 2018 | 2017 | Change | ||||||||||||||||||||||||||
| (Dollars in millions) | (Dollars in millions) | Three Months Ended March 31, | |||||||||||||||||||||||||||
| Net cash provided by (used for): | Net cash provided by (used for): | 2021 | 2020 | $ Change | |||||||||||||||||||||||||
| Operating activities | $ | 347.8 | $ | 167.1 | 108 | % | Operating activities | $ | 22 | $ | 4 | $ | 18 | ||||||||||||||||
| Investing activities | (78.9 | ) | (929.1 | ) | (92 | )% | Investing activities | 10 | (20) | 30 | |||||||||||||||||||
| Financing activities | 327.2 | 843.5 | (61 | )% | Financing activities | 2 | 897 | (895) | |||||||||||||||||||||
| Effect of exchange-rate changes on cash and cash equivalents | 15.4 | 3.3 | 367 | % | Effect of exchange-rate changes on cash and cash equivalents | (25) | (9) | (16) | |||||||||||||||||||||
| Net increase in cash, cash equivalents and restricted cash | $ | 611.5 | $ | 84.8 | 621 | % | Net increase in cash, cash equivalents and restricted cash | $ | 9 | $ | 872 | $ | (863) | ||||||||||||||||
Operating activities
Our cash flow fromprovided by operating activities increased by $180.7$18 million, from $167.1to $22 million for the ninethree months ended September 30, 2017 to $347.8March 31, 2021 from $4 million for the ninethree months ended September 30, 2018.March 31, 2020. The increase is a result of an increase inwas driven by higher net income whichafter excluding amounts related to non-cash operating activities, including depreciation and amortization and inventory fair value step-up amortization. This increase was partially offset by the impact of changes in operating assets and liabilities. The COVID-19 global health pandemic and related economic downturn led to an increase in customer accounts receivable that were past due at the end of the first quarter of 2020; however, customer collections improved throughout the remainder of the year and payment terms decreased. In the past, we have extended our payment terms for distributors on occasion. Although we presently have no plans to do so in the future, it is possible that we will need to extend payment terms in certain situations 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. If so, such extensions of customer payment terms could result in additional uses of our cash used to finance working capital. flow.
2021 Q1 Form 10-Q | 36 | | |||||||
Investing activities
Our cash flow used inprovided by investing activities decreased from $929.1was $10 million for the ninethree months ended September 30, 2017March 31, 2021 as compared to $78.9cash used for investing activities of $20 million for the ninethree months ended September 30, 2018. OurMarch 31, 2020. The change was primarily driven by a decrease in the cash used in investing activities for the nine months ended September 30, 2017 included $882.1 million relatedconsideration paid to acquire Bayer Animal Health due to the acquisitionfinalization of BIVIVP. This decrease wasthe working capital adjustment during the period, partially offset by a net increasepurchases of $42.6 million in capital expenditures from 2017 to 2018.intangible assets.
Financing activities
Our cash provided by financing activities decreased from $843.5by $895 million to $2 million for the ninethree months ended September 30, 2017 to $327.2March 31, 2021 from $897 million for the ninethree months ended September 30, 2018. The cash flows in 2017 relate to net cashMarch 31, 2020. Cash provided by transactions with Lilly of $844.0 million compared to cash used in transactions with Lilly of $247.4 million in 2018, a reduction in financing of cash flows between periods of $1.1 billion. This was offset byactivities during the three months ended March 31, 2021 reflected net cash provided from the financing transactions related to the Separation including the proceeds from long-term debt and our IPO, which was onlyrevolving credit facility, partially offset by the consideration paid to Lilly in connection withrepayment of indebtedness outstanding under our term loan B credit facility. Cash provided by financing activities during the Separation. The remainder of thethree months ended March 31, 2020, reflected proceeds from issuances of common stock and TEUs during the financing related toperiod, partially offset by the Separation will be paid to Lilly in future periods and is reflected as restricted cash inrepayment of indebtedness outstanding under our consolidated balance sheet.previous term loan facility.
Description of Indebtedness
For a complete description of senior notes, entered into a $500.0 million three-year term loan,our description of our debt and entered into five-year $750.0 million senior unsecured revolvingavailable credit facility. For more information,facilities as of March 31, 2021 and December 31, 2020, see Note 8: Debt in our unauditedto the condensed consolidated and combined financial statements.
Off Balance SheetBalance-Sheet Arrangements
Other than the commitments and contingencies disclosed in Note 11: Commitments and Contingencies, we had no off balanceoff-balance sheet arrangements that currently have, a material effect or that are reasonably likely to have, a current or future material future effect on our financial condition, changes in financial condition, revenue or expenses, results of operations, liquidity, capital expenditures or capital resources.liquidity.
Contractual Obligations
Our contractual obligations and commitments as of March 31, 2021 are primarily comprised of long-term debt obligations, including interest payments, and purchase obligations. Our long-term debt obligations are comprised of our expected principal and interest obligations and our interest rate swaps. Purchase obligations consist of open purchase orders as of March 31, 2021 and contractual payment obligations with significant vendors which are noncancelable and are not contingent. These obligations are primarily short-term in nature.
Critical Accounting Policies
The preparation of financial statements in accordance with GAAP requires managementus to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. There are certainCertain of our
accounting policies that are considered critical asbecause these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments by us, often employingrequiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from our estimates could have an unfavorable effect on our financial position and results of operations. We apply estimation methodologies consistently from year to year. 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, 2020. There have been no significant changes in the application of our critical accounting policies during 2018.
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, British pound, Swiss franc, Brazilian real, Australian dollar,
2021 Q1 Form 10-Q | 37 | | |||||||
Japanese yen, Canadian dollar, Australian dollar and Brazilian real. Lilly maintains aChinese yuan.
We face foreign currency risk management program throughexchange exposures when we enter into transactions arising from subsidiary trade and loan payables and receivables denominated in foreign currencies and purchases of local subsidiaries due to local regulations as a central shared entity, which enters into derivative contracts to hedge foreign currency risk associated with forecasted transactions forresult of the entire company, including historically for our operations. Gains and losses on derivative contracts entered into by Lilly have been 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 implement our own foreign currency risk management program.
acquisition of Bayer Animal Health. 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$6 million for the ninethree months ended September 30, 2018.March 31, 2021.
Interest Risk
Borrowings under our term loan B credit facility are exposed to interest rate riskfluctuations based on the long-term debtLIBOR. As of March 31, 2021, 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 approximately $4.1 billion that have cash flow riskthe economic effect of modifying the variable-interest obligations associated with our $500.0the term loan B credit facility, so that a portion of the variable-rate interest payable becomes fixed. During the three months ended March 31, 2021, we recorded a gain of $53 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 gain is primarily attributable to an increase in the U.S. Treasury yield curve during the first quarter of 2021. See Note 9: Financial Instruments and Fair Value to the risk.condensed consolidated financial statements for further information.
Recently Issued Accounting Pronouncements
For discussion of our new accounting standards, see Note 4:2: Implementation of New Financial Accounting Pronouncements to our unauditedthe condensed consolidated and combined financial statements.
(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, 2021. 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. DuringAs of March 31, 2021, management is in the third quarterprocess of 2018,integrating the internal controls of the acquired Bayer Animal Health business into our existing operations as part of planned integration activities. In addition, we have transitioned from a Lilly solutions center to a newly established Elanco solutions center and substantially completed the implementation of our new Enterprise Resource Planning (ERP) system during the three months ended March 31, 2021. Other than the controls enhanced or implemented to integrate the Bayer Animal Health business and certain control processes that were updated to reflect our ERP implementation, there werehas been no changeschange in our internal control over financial reporting during the quarter ended March 31, 2021, that has materially affected, or areis reasonably likely to materially affect, our internal control over financial reporting. As additional transformation activities occur, we will continue to monitor and evaluate our internal control over financial reporting. Further, we have not experienced any material impact to our internal controls over financial reporting despite our accounting, finance, and legal employees working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing COVID-19 on our internal controls to minimize the impact on their design and operating effectiveness.
2021 Q1 Form 10-Q | 38 | | |||||||
PART II. Other InformationII
See Note 11: Commitments and Contingencies to the condensed consolidated financial statements for a summary of our legal proceedings.
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, 2020.
The following risk factor has been changed from the risk factor that was previously disclosed:
Unanticipated safety, quality or efficacy concerns or identified concerns associated with our products may harm our reputation and have an adverse impact on our performance.
Unanticipated safety, quality or efficacy concerns arise from time to time with respect to animal health products, whether or not scientifically or clinically supported, potentially leading to product recalls, withdrawals or suspended or declining sales, as well as product liability and other claims. Regulatory actions based on these types of safety, quality or efficacy concerns could impact all, or a significant portion, of a product’s sales.
For example, lawsuits seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been filed against us arising out of the use of Seresto, a non-prescription flea and tick collar for cats and dogs, based on reports alleging that the collar has caused injury and death to pets. Further, a U.S. House of Representative subcommittee chair requested that we produce certain documents and information related to the Seresto collar and further made a request to temporarily remove Seresto collars from the market. Similar actions relating to Seresto could be taken by regulatory agencies. If any such claims with respect to Seresto or our other products are resolved adversely to us, or if a regulatory agency determines that a recall of any of our products, including Seresto, is necessary, such action could cause harm to our reputation, reduce our product sales, result in monetary penalties and other costly remedies against us, and could therefore have a material adverse effect on our business, financial condition and results of operations.
In addition, we depend on positive perceptions of the safety, quality and efficacy of our products, and animal health products in general, by food producers, veterinarians and pet owners. Any concern as to the safety, quality or efficacy of our products, whether actual or perceived, may harm our reputation. These concerns, including those relating to Seresto, and the related harm to our reputation could materially adversely affect our business, financial condition and results of operations, regardless of whether such reports are accurate.
2021 Q1 Form 10-Q | 39 | | |||||||
(none)
(none)
(none)
2021 Q1 Form 10-Q | 40 | | |||||||
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.
| Description | |||||||||||
| 10.1 | |||||||||||
| 31.1 | |||||||||||
| 31.2 | |||||||||||
| 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 | Interactive Data | ||||||||||
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101) | ||||||||||
2021 Q1 Form 10-Q | 41 | | |||||||
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) | ||||||||
| Date: | May 7, 2021 | |||||||
| President and Chief Executive Officer | ||||||||
| Date: | /s/ | |||||||
| Executive Vice President, Chief | ||||||||
2021 Q1 Form 10-Q | 42 | | |||||||