The following table summarizes the activity in our reserves established in connection with these restructuring activities:
|
| | | | | | | |
| 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 |
|
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.
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 |
|
Long-term debt asBayer Animal Health Related Financing
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.
Revolving and Term Credit Facilities
On September 5, 2018,Simultaneously, we entered into a revolving credit agreement withfacility providing up to $750 million (with incremental capacity available if certain conditions are met) and maturing over a syndicate of banks providing for a five-year $750.0 million senior unsecuredfive-year term. The revolving credit facility (Revolving Facility). The Revolving Facility bears interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating. In February 2021, we drew down $150 million on the revolving credit facility for working capital needs. We subsequently repaid $100 million in March 2021 and the remaining $50 million in April 2021.
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.
On September 5, 2018 we also entered into a $500.0 million three-year term loan under a term
The second financial maintenance covenant for the revolving credit facility 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.
The Credit Facilities are subject to various financial and other covenants including restrictions on the level of borrowings based on a consolidated leverage ratio and a consolidated interest coverage ratio.each fiscal quarter. We were in compliance with all such covenants under the credit facility as of September 30, 2018.March 31, 2021.
Senior Notes
On
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.
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.
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 |
|
Contingent consideration liabilities relate to Galliprantitems, as well as long-term debt (including TEU amortizing notes) for which the fair value was estimated usingis disclosed on a discounted cash flow analysis and Level 3 inputs, including projections representative of a market participant view for the probability of achieving potential future payments to Aratana Therapeutics, Inc. and an estimated discount rate. The amount to be paid is dependent upon certain development, success-based regulatory, and sales-based milestones. In addition, the amount of royalties to be paid is calculated as a percentage of net sales dependent upon the timing and geography and will, therefore, vary directly with increases and decreases in net sales of Galliprant. There is no cap on the amount that may be paid pursuant to this arrangement. During the second quarter of 2018, as a result of an increase in therecurring basis:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair Value Measurements Using | | |
Financial statement line item | | Carrying Amount | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Fair Value |
March 31, 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) | |
| | | | | | | | | | |
projected cash flows related to Galliprant, we increased the fair value of the contingent consideration liabilities by $8.5 million. The additional expense was recognized in other-net (income) expense.
We have long term debt of $2.5 billion that is recorded at amortized cost in our condensed consolidated balance sheet as of September 30, 2018. (1)We consider the carrying value of the long term debt to be representative of its fair value due to the short-term nature of this instrument.
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
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:
| | | | | | | | | | | | | | | |
| | | 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
Prior to Separation
During the periods presented in the unaudited condensed consolidated and combined financial statements, our operations | | | | | | | | | | | | | | | | | | |
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 and nine months ended September 30, 2018, we incurred $18.6 million and $46.2 million, respectively, of income tax expense. For the three and nine months ended September 30, 2018, the effective tax rate of 23.6% and 39.7%, respectively, was primarily attributable to a net operating loss in the U.S. for which no tax benefit was recognized and a valuation allowance was recorded.
For the three and nine months ended September 30, 2017, despite reporting a loss before taxes of $9.1 million and $77.2 million, respectively, we incurred $11.6 million and $72.0 million of income tax expense. The tax expense recorded related primarily to income generated in certain foreign jurisdictions as no tax benefit was recorded for U.S. net operating losses.
In December 2017, the President of the U.S. signed into law the Tax Cuts and Jobs Act (2017 Tax Act), which includes significant changes to the U.S. corporate income tax system, including a reduction in the corporate income tax rate, transition to a territorial tax system, and modifications to the international tax provisions. At September 30, 2018, our accounting for the 2017 Tax Act is incomplete; however, we expect to complete our accounting by December 2018. As discussed in our combined financial statements and accompanying notes as of and for the year ended December 31, 2017 included in our IPO Prospectus, we recorded provisional adjustments for effects that we were able to reasonably estimate. Those effects included the one-time repatriation transition tax (also known as the Toll Tax), re-measurement of deferred tax assets and liabilities, unremitted earnings, executive compensation, and uncertain tax positions. At December 31, 2017, we were not able to make reasonable estimates for Global Intangible Low-Taxed Income (GILTI) deferred taxes or changes to the valuation allowances; therefore, we did not record provisional amounts. We are still evaluating the effects of the GILTI provisions and assessing our valuation allowances, and we have not yet concluded upon our accounting policy election with respect to GILTI deferred taxes or the application of intra entity transfers of inventory; therefore, the estimated annual effective tax rate reflects GILTI as a period expense. For the three and nine months ended September 30, 2018, we have not made any additional measurement-period adjustments related to provisional amounts as we are continuing to collect and analyze additional information as well as evaluate the interpretations and assumptions made. Updates to the calculations may result in material changes to the provisional adjustments recorded at December 31, 2017 and the estimated annual effective tax rate.
As part of Lilly, we are included in Lilly's U.S. tax examinations by the Internal Revenue Service (IRS).through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with the IPO, the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. The IRSU.S. examination of tax years 2013-20152016 - 2018 began in 2016. While we believe it is reasonably possible thatthe fourth quarter of 2019 and remains ongoing; therefore, the resolution of this audit could reachperiod will likely extend beyond the next 12 months.
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
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.
Impact of Separation
InElanco common stock or 5.00% TEUs issued in connection with the Separation,public offering. This case is currently stayed in deference to Hunter v. Elanco Animal Health Inc. We believe the claims made in the case are meritless, and we entered intointend 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.
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.
Based on the TMA, Lilly retained the tax benefitscases, and liabilities associated with all periods prior to the Separation date for any jurisdiction where we were included in a consolidated or combined tax return. The financial statements for periods prior to Separation included certain deferred tax assets related to tax credit and net operating loss carryovers that resulted from our tax expense being calculated on a separate return basis that will not transfer to us either because they were used by Lilly or are retained by Lilly and reflected certain tax liabilities that will be retained by Lilly. We recorded an adjustmenttaking appropriate steps to our consolidated balance sheet at the date of Separation to reflect our tax positions based on the TMA. This resulted in a decrease in tax liabilities by $31.2 million asdefend these tax liabilities will be retained by Lilly.class action lawsuits.
At September 30, 2018, we have net operating losses for international tax purposes of approximately $190 million which will expire between 2022 and 2028. These net operating losses are partially reserved. Deferred tax assets related to state net operating losses are $6.2 million. The state net operating losses will generally expire between 2035 and 2037.
Note 11. Contingencies
We are party to various 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.
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.
(2) Long-lived assets consist of property and equipment, net, and certain noncurrent assets.
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.
Note 14. Related Party Agreements and Transactions
Separation-Related Agreements with Lilly
As described in Note 1, in connection with the Separation Lilly transferred to us substantially all of its animal health businesses in exchange for approximately $4.2 billion. This is reflected as consideration to Lilly in our statement of equity. In addition, we entered into a master separation agreement and a transitional services agreement with Lilly.
Master Separation Agreement (MSA)
As stated in Note 1, Lilly transferred to us at the time of Separation, through a series of transactions, the businesses that will continue as part of Elanco. For a certain portion of our operations, the legal transfer of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries. Under the MSA entered into with Lilly, we are responsible for the business activities conducted by Lilly on our behalf and are subject to the risks and entitled to the benefits generated by these operations and assets. As a result, the related assets and liabilities and results of operations have been reported in our unaudited condensed consolidated and combined financial statements. The total net assets associated with these jurisdictions are $84.5 million and the annual profits are insignificant. Upon Separation, we retained $275.0 million, which is reflected as restricted cash, that will be used to fund the purchase of these operations from Lilly at the time of the local country closing and have an offsetting payable to Lilly. If the amount of local purchases is less than $275.0 million, we are required to repay the remaining amount to Lilly.
In addition, based on the MSA, we are required to distribute to Lilly any amount of cash in excess of $300.0 million held at September 30, 2018. As a result, we have reflected an additional $359.9 million of restricted cash on our balance sheet with an offsetting payable to Lilly at September 30, 2018.
Transitional Services Agreement (TSA)
Historically, Lilly has provided us significant shared services and resources related to corporate functions such as executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations, which we refer to collectively as the "Lilly Services." Under the terms of the TSA, we will be able to use Lilly Services for a fixed term established on a service-by-service basis. We will pay Lilly mutually agreed-upon fees for the Lilly Services provided under the TSA, which will be based on Lilly's cost (including third-party costs) of providing the Lilly Services throughthree months ended March 31, 2021 and subject2020, we reported a net loss. Therefore, dilutive common stock equivalents are not assumed to have been issued since their effect is anti-dilutive. As a mark-up of 7% thereafter, with additional inflation-based escalation beginning January 1, 2020. The fees under the TSA become payable for all periods beginning after October 1, 2018.
We also entered into a TMA, an employee matters agreement, a toll manufacturingresult, basic and supply agreement and a registration rights agreement with Lilly in connection with the Separation.
Transactions with Lilly Prior to Separation
We did not historically operate as a standalone business and had various relationships with Lilly whereby Lilly provided services to us.
Transfers to/from Lilly, net
As discussed in the basis of presentation, net parent company investment is primarily impacted by contributions from Lilly whichdiluted weighted average shares are the result of treasury activity andsame, causing diluted net funding provided by or distributedloss per share to Lilly.be equivalent to basic net loss per share. For the three months ended September 30, 2018March 31, 2021 and 2017, respectively, the net transfers (to)/from Lilly were $(116.8)2020, approximately 1.6 million and $38.1 million. For1.8 million, respectively, of potential common shares were excluded from the nine months ended September 30, 2018calculation of diluted earnings per share because their effect was anti-dilutive.
(2)Due to rounding conventions, loss per share may not recalculate precisely based on the amounts presented within this table.
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.
Corporate Overhead and Other Allocations
Lilly provides us certain services, including executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. We provide Lilly certain servicesElanco. These transactions primarily related to local country asset purchases and various transitional services agreements (TSAs), contract manufacturing support. Our financial statements reflect an allocation ofarrangements, and certain lease agreements to ensure business continuity after the acquisition.
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 |
|
We provide Lilly certain services related to manufacturing support. Allocations of manufacturing support from us to Lilly of $1.3 million and $1.5 million forBayer during the three months ended September 30, 2018 and 2017, respectively, as well as $3.7 million and $4.5 millionMarch 31, 2021 for the nine months ended September 30, 2018 and 2017, respectively, reduced the cost of sales in the unaudited condensed consolidated and combined statements of operations.
The financial information herein may not necessarily reflect our consolidated financial position, results of operations and cash flows in the future or what they wouldthese local country asset purchases was approximately $16 million. All local country asset purchases have been if we had been a separate, standalone entity during the periods presented. Management believes that the methods used to allocate expenses are reasonable.completed as of March 31, 2021.
Stock-based Compensation
Our employees participate in Lilly stock-based compensation plans, the costs of which have been allocated to us and recorded in cost of sales, research and development, and marketing, selling and administrative expenses in the unaudited condensed consolidated and combined statements of operations. The costs of such plans related to our employees were $6.9 million and $6.2 million for the three months ended September 30, 2018 and 2017, respectively, as well as $20.2 million and $18.7 million for the nine months ended September 30, 2018 and 2017, respectively.
Retirement Benefits
Our employees participate in defined benefit pension and other post retirement plans sponsored by Lilly, the costs and benefits of which have been recorded in the unaudited condensed consolidated and combined statement of operations in cost of sales, research and development, and marketing, selling and administrative expenses. For the three and nine months ended September 30, 2018, the benefit of such plans related to our employees was $1.6 million and $0.3 million, respectively, and for the three and nine months ended September 30, 2017 the costs of such plans related to our employees were $1.7 million and $5.1 million, respectively.
Centralized Cash Management
Lilly uses a centralized approach to cash management and financing of operations. Until Separation, the majority of our business was party to Lilly’s cash pooling arrangements to maximize Lilly's availability of cash for general operating and investing purposes. Under these cash pooling arrangements, cash balances were swept regularly from our accounts. Cash transfers to and from Lilly’s cash concentration accounts and the resulting balances at the end of each reporting period were reflected in net parent company investment in the condensed consolidated and combined balance sheets.
Debt
Lilly’s third-party debt and the related interest expense have not been allocated to us for any of the periods presented as we were not the legal obligor of the debt and Lilly borrowings were not directly attributable to our business.
Commercial Operations
We sell certain products to and receives certain goods and services from a customer/vendor, whose chairman and Chief Executive Officer is a member of Lilly's Board of Directors. These product sales resulted in revenue of $4.2 million and $6.6 million for the three months ended September 30, 2018 and 2017, respectively, and of $16.4 million and $17.8 million for the nine months ended September 30, 2018 and 2017, respectively. The product sales resulted in accounts receivable of $1.9 million and $2.0 million at September 30, 2018 and December 31, 2017, respectively. The purchase of goods and services resulted in cost of sales and operating expenses of $1.4 million and $1.1 million for the three months ended September 30, 2018 and 2017, respectively, as well as $3.3 million and $5.3 million September 30, 2018 and 2017, respectively. The purchase of goods and services resulted in accounts payable of $0.4 million and $0.3 million at September 30, 2018 and December 31, 2017, respectively.
ItemITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of OperationsMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tables present dollars in millions, except per-share data)
The management’s discussion and analysis of financial condition and results of operations (MD&A) is intended to assist the reader in understanding and assessing significant changes and trends related to our results of operations and financial position. This discussion and analysis should be read in conjunction with the unaudited condensed consolidated and combined financial statements and accompanying footnotes in Item 1 of Part I of this Quarterly Report on Form 10-Q. Certain statements in this Item 2 of Part I of this Quarterly Report on Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements"Statements," Item 1A, "Risk Factors," of Part II of this Quarterly Report on Form 10-Q, and inItem 1A, “Risk Factors” included inFactors,” of Part I of our final prospectus relating to our initial public offering filedAnnual Report on September 21, 2018 (IPO Prospectus),Form 10-K for the year ended December 31, 2020, may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements.
Overview
Founded in 1954, as part of Eli Lilly and Company, 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:
Companion Animal Disease Prevention (CA Disease Prevention)
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.
Companion Animal Therapeutics (CA Therapeutics): WeU.S. only. In therapeutics, we have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprant™ product is one of the fastest growing osteoarthritis treatments in the U.S. We alsoAdditionally, we have treatmentsproducts that offer treatment for otitis (ear infections) with Claro™, as well as treatments for certain cardiovascular and dermatology indications.
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.
Food Animal Ruminants & Swine (FA Ruminants & Swine):among others. We have developed a wide range of foodfarm animal products, including Rumensin and Baytril™, both of which are used extensively in ruminantruminants (e.g., cattle, sheep and goats) and swine production. In poultry, our Maxiban product, is a valuable offering for the control and prevention of intestinal disease.
On September 24, 2018, we completed an initial public offering resulting in the issuance of 72.3 million shares our common stock (IPO), which represented approximately 19.8%A summary of our total outstanding shares. Our common stock began trading on the New York Stock Exchange under the symbol "ELAN" on September 20, 2018. Prior to2021 revenue and in connectionnet loss compared with the IPO,same period in 2020 is as follows:
| | | | | | | | | | | | | | | | | | |
| | | | 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.
For the three months ended September 30, 2018 and 2017, our revenue was $761.1 million and $697.1 million,
respectively. For the three months ended September 30, 2018 and 2017, our net income (loss) was $60.2 million and $(20.7) million, respectively.
For the nine months ended September 30, 2018 and 2017, our revenue was $2,267.5 million and $2,134.7 million, respectively, For the nine months ended September 30, 2018 and 2017 our net income (loss) was $70.1 million and $(149.2) million, respectively.
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
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
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
During the period prior to the IPO,
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.
Our historical results reflect an allocation of costs for certain Lilly corporate costs, including, among others, executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. These allocations are not necessarily indicative of the expenses we may incur as a standalone public company. Although we entered into certain agreements with Lilly in connection with the IPO and the Separation, the amount and composition of our expenses may vary from historical levels since the fees charged for the services under these agreements may be higher or lower than the costs reflected in the historical allocations. In addition, we intend to replace these services over time with ones supplied either internally by our employees or by third parties, the cost of which may be higher or lower than the historical allocations. During the three and nine months ended September 30, 2018 and 2017, corporate overhead and other allocations were $34.1 million, $105.2 million, $36.1 million and $107.8 million, respectively. See Note 14: Related Party Agreements and Transactions in our unaudited condensed consolidated and combined financial statements.
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.
In addition, our historical results do not reflect the impact of costs we have incurred and expect to continue to incur as a consequence of becoming a standalone company, including incremental costs associated with being a publicly traded company. These costs include a change in compensation expense as we institute competitive compensation policies and programs as a standalone public company, the costs of internal and external audit (including those related to Sarbanes-Oxley Act of 2002), investor relations, stock administration, stock exchange fees and regulatory compliance costs.
For the purposes of our financial statements for periods prior our IPO, our effective tax rate was computed on a separate company basis, as if we had operated as a standalone entity or a separate consolidated group in each material jurisdiction in which we operate. As a result of potential changes to our business model and due the fact that we are a standalone entity, income tax expense (benefit) included in the consolidated and combined financial statements may not be indicative of our future expected tax rate.
In connection with the IPO, we entered into $2.5 billion of long-term borrowings. Our historical results for the period prior to entering into such agreements do not reflect interest expense, which we estimate at approximately $110.0 million on an annual basis.
Asset Impairment, Restructuring and Other Special Charges
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 |
|
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | 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 | % |
(1) Represents revenue from business activities we have either exited or made a strategic decision to exit.
Total revenue
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Total revenue increased $64.0 million or 9% for the three months ended September 30, 2018March 31 is summarized as compared to the three months ended September 30, 2017, reflecting a 4% increase due to higher realized prices and a 7% increase due to higher volumes partially offset by a 2% unfavorable foreignfollows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | 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.
In summary, the total(CER) is defined as revenue increase was due primarily to:
an increase in revenue of $49.4 million or 35% from CA Disease Prevention products,growth excluding the impact of foreign exchange. The calculation assumes the same foreign currency exchange rates;rates that were in effect for the comparable prior-year period were used in translation of the current period results. We believe this metric provides a useful comparison to previous periods.
(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.
anTotal revenue increased $584 million to $1,242 million comprised of $683 million from the legacy Elanco portfolio and $559 million from the legacy Bayer Animal Health portfolio. This 89% increase reflects a 86% increase in revenue of $17.5 million or 28%volume, a 2% increase in price, and a limited favorable impact from CA Therapeutics products, excluding the impact of foreign exchange rates;rates.
an increase in revenue of $2.8 million or 2% from FA Future Protein & Health products, excluding the impact foreign exchange rates; and
an increase in revenue of $26.3 million or 10% from FA Ruminants & Swine products, excluding the impact of foreign exchange rates;
partially offset by:
a decrease in revenue of $11.5 million due to the negative impact of foreign exchange rates; and
a decrease in revenue of $20.5 million from Strategic Exits, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
CA Disease Prevention
•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.
•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.
FA Future Protein & Health revenue decreased by $1.7 million or 1% due to unfavorable impact from foreign exchange rates and a decline in volume, partially offset by increased price. Volume growth in aqua, vaccines and nutritional health products was offset by international purchasing patterns in the current year for poultry which shifted sales from the third quarter of 2018 to the first half of 2018.
FA Ruminants & Swine revenue increased by $21.1 million or 8% due primarily to increases in volume partially offset by the unfavorable impact of foreign exchange rates. Growth was driven mainly by U.S. and international purchasing patterns in both the current and prior year which resulted in higher sales in third quarter of 2018.
Strategic Exits revenue decreased by $20.6 million or 42% due primarily to reduced revenue from a temporary contract manufacturing arrangement as part of the acquisition of the BI Vetmedica U.S. vaccines portfolio (BIVIVP)33%, as well as the termination of two legacy U.S. distribution agreements acquired as part of our Novartis Animal Health acquisition.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Total revenue increased $132.8 million or 6% for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, reflecting a 1% favorable foreign exchange rate impact, a 3% increase due to higher realized prices and a 2% increase due to higher volumes.
In summary, the total revenue increase was due primarily to:
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;
an increase in revenue of $79.6 million or 15% from CA Disease Prevention products, excluding the impact foreign exchange rates;
an increase in revenue of $24.3 million or 13% from CA Therapeutics products, excluding the impact of foreign exchange rates;
an increase in revenue of $39.4 million or 9% from FA Future Protein & Health products, excluding the impact of foreign exchange rates;
an increase in revenue of $17.7 million or 2% from FA Ruminants & Swine, excluding the
impact of foreign exchange rates;COVID-19 pandemic on poultry and
partially offset by:
a decrease in revenue of $51.1 million from Strategic Exits, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
CA Disease Prevention revenue increased by $84.2 million or 16% due primarily to the continued uptake of Credelio aqua consumption, production, and Interceptor Plus,profitability as well as realized price increases primarily impacting Trifexis, Capstar and Comfortis, partiallygeneric competition, partly offset by competition in certain parasiticides, primarily impacting Trifexis and Comfortis.
CA Therapeutics revenue increased by $29.3 million or 16% due primarily to the continued uptake of Galliprant and Osurnia, as well as increased demand for Atopicain China and Onsior, partially offset by a temporary supply shortageprice growth.
•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.
FA Future Protein & Health revenue increased by $46.1period includes $16 million or 10% due primarily to the launch of Imvixa and the growth in poultry animal-only antibiotics and AviPro.
FA Ruminants & Swine revenue increased by $23.8 million or 3% due primarily to growth in animal-only and shared-class antibiotics, offset by competition from generic ractopamine based products.
Strategic Exits revenue decreased by $50.6 million or 42% due to reduced revenue from a temporary contract manufacturing arrangement as part of the acquisition of BIVIVP, as well as the termination in the third quarter of 2017 of a legacy U.S. distribution agreement acquired as part of our Novartis Animal Health acquisition.
Costs and Expenses and Other
Cost of sales
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Cost of sales decreased $6.4 million in the three months ended September 30, 2018 as compared to three months ended September 30, 2017 due primarily to the mix of products sold, the results of the manufacturing productivity agenda and non-recurring costs in 2017 associated with purchase accounting chargesresulting from the acquisition of BIVIVP related to the fair value adjustmentsBayer Animal Health.
Cost of inventory acquired that was subsequently sold, partially offset by costs related to increased volume of products sold and various cost increases.Sales
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | 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 September 30, 2018 vs. months ended September 30, 2017 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | 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.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
R&D expenses decreased $4.2 million forfrom the nine months ended September 30, 2018 as comparedfirst quarter to the nine months ended September 30, 2017 due primarily to site closures and headcount reductions in early 2017.second quarter.
Marketing, selling and administrativeadministrative
Three months ended September 30, 2018 vs. three months ended September 30, 2017 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | 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.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Marketing, selling and administrative expenses decreased $32.9 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to productivity initiativesacquisition of Bayer Animal Health and reduced direct to consumer programs.increased information technology spending.
Amortization of intangible assets
Three months ended September 30, 2018 vs. three months ended September 30, 2017 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | 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.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Amortization of intangible assets decreased $13.7 million forrecorded from the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to the accelerationacquisition of amortization related to certain product exits in 2017.Bayer Animal Health.
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.
Three months ended September 30, 2018 vs.
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.
Asset impairment, restructuring and other special charges decreased $11.3
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
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.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Asset impairment, restructuring and other special charges decreased $106.5 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 primarily due to a decrease in severance, integration and exit costs, partially offset by an increase in asset impairments and a gain on disposal of a site that was previously closed as part of the acquisition and integration of Novartis Animal Health in 2017.
Income tax expense
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Income tax expense increased $7.0 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 primarily due to an increase in pretax earnings offset by a decrease in the U.S. valuation allowance related to utilization of prior years' net operating losses.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Income tax expense decreased $25.8 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 primarily due to a decrease in the U.S. valuation allowance related to the utilization of prior years' net operating losses.
Liquidity and Capital Resources
We historically participated in Lilly’s centralized treasury management system, including centralized cash pooling and overall financing arrangements. We have generated and expect to continue to generate positive cash flows from operations. In connection with the IPO, we entered into various long-term debt agreements as described below.
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities. 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.
Our principal
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.
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
During the three months ended September 30, 2018, we issued $2.0 billion
For a complete description of senior notes, entered into a $500.0 million three-year term loan,our 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
We have
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.
Contractual Obligations
See Contractual Obligations included in our IPO Prospectus. During the ninethree months ended September 30, 2018, we issued $2.0 billion of senior notes, entered into a $500.0 million three-year term loan, and entered into five-year $750.0 million senior unsecured revolving credit facility. For more information, see Note 8: Debt in our unaudited condensed consolidated and combined financial statements.March 31, 2021.
ItemITEM 3. Quantitative and Qualitative Disclosures About Market RiskQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange rates. We are primarily exposed to foreign exchange risk with respect to net assets denominated in the Euro, British pound, Swiss franc, Brazilian real, Australian dollar,
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
We
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.
ItemITEM 4. Controls and ProceduresCONTROLS AND PROCEDURES
(a)Evaluation of Disclosure Controls and Procedures. Under applicable SEC regulations, management of a reporting company, with the participation of the principal executive officer and principal financial officer, must periodically evaluate the company’s “disclosure controls and procedures,” which are defined generally as controls and other procedures of a reporting company designed to ensure that information required to be disclosed by the reporting company in its periodic reports filed with the SEC (such as this Form 10-Q) is recorded, processed, summarized, and reported on a timely basis.
Our management, with the participation of JeffJeffrey N. Simmons, president and chief executive officer, and Todd S. Young, executive vice president and chief financial officer, evaluated our disclosure controls and procedures as of September 30, 2018.March 31, 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.
PART II. Other InformationII
ItemITEM 1. Legal ProceedingsLEGAL PROCEEDINGS
See Note 11: Commitments and Contingencies to the condensed consolidated financial statements for a summary of our legal proceedings.
ItemITEM 1A. Risk FactorsRISK FACTORS
Our material risk factors are disclosed in our IPO Prospectus. There
Other than the revisions set forth below, there have been no material changes from the risk factors previously disclosed in Part I of our IPO Prospectus.Annual Report on Form 10-K for the year ended December 31, 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.
ItemITEM 2. Unregistered Sales of Equity Securities and Use of ProceedsUNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Use of Proceeds from Registered SecuritiesOn September 24, 2018, we completed our IPO resulting in the issuance of 72.3 million shares of our common stock at a price to the public of $24.00 per share, which number of shares included the underwriters’ exercise in full of their option to purchase up to an additional 9.4 million shares of common stock at the IPO price, less underwriting discounts. The 72.3 million shares of our common stock sold in the IPO represent approximately 19.8% of our outstanding shares, while Lilly continues to own approximately 80.2% of our outstanding shares. The shares sold in the offering were registered under the Securities Act pursuant to a registration statement on Form S-1 (File No. 333-226536), which was declared effective by the SEC as of September 19, 2018. The aggregate offering price of our common stock registered and sold under the registration statement was approximately $1,736.0 million (including the shares issued pursuant to the underwriters’ option to purchase additional shares). Our proceeds from the IPO were approximately $1,659.7 million, after deducting underwriting discounts and commissions of approximately $76.4 million. Goldman, Sachs & Co. LLC, J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC served as joint book-running managers and as representatives of the underwriters for the IPO. The offering commenced on September 19, 2018 and did not terminate before all of the securities registered in the registration statement were sold.
As contemplated by the IPO Prospectus, we have paid, or will pay, to Lilly approximately $4.2 billion in connection with the Separation, which includes the net proceeds from the IPO. A portion of the aggregate payment to Lilly is currently retained by us and is reflected on our balance sheet as restricted cash.(none)
There has been no material change in the planned use of the IPO proceeds as described in the IPO Prospectus.
ItemITEM 3. Defaults Upon Senior SecuritiesDEFAULTS UPON SENIOR SECURITIES
(none)
ItemITEM 4. Mine Safety DisclosuresMINE SAFETY DISCLOSURES
(none)
ItemITEM 5. Other InformationOTHER INFORMATION
(none)
ItemITEM 6. ExhibitsEXHIBITS
The following exhibits are either filed or furnished herewith (as applicable) or, if so indicated, incorporated by reference to the documents indicated in parentheses, which have previously been filed or furnished with the Securities and Exchange Commission.
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Exhibit Number | Description |
3.1 | Amended and Restated Articles of IncorporationExhibit Number | | Description |
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| 10.1 | | | |
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3.210.2 | Amended and Restated Bylaws | | |
4.1 | Form of Certificate of Common Stock (incorporated by reference to Exhibit 4.1 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). |
4.210.3 | Indenture, dated August 28, 2018, between | | |
4.3 | First Supplemental Indenture, dated August 28, 2018, between Elanco Animal Health Incorporated and Deutsche Bank Trust Company Americas, as trustee (incorporated by reference to Exhibit 4.3 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.1 | Registration Rights Agreement, dated August 28, 2018, between Elanco Animal Health Incorporated and Goldman Sachs & Co. LLC, J.P. Morgan Securities LLC and Morgan Stanley & Co. LLC, as representatives of the several initial purchasers (incorporated by reference to Exhibit 4.4 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.2 | Master Separation Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.1 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.3 | Transitional Services Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.2 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.4 | Tax Matters Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.3 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.5 | Employee Matters Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.4 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.6 | Toll Manufacturing and Supply Agreement, dated September 24, 2018, between Eli Lilly Export S.A. and Elanco UK AH Limited (incorporated by reference to Exhibit 10.5 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.7 | Registration Rights Agreement, dated September 24, 2018, between Eli Lilly and Company and Elanco Animal Health Incorporated (incorporated by reference to Exhibit 10.6 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.8 | Transitional Trademark License Agreement, dated September 24, 2018, among Eli Lilly and Company, Elanco Animal Health Incorporated and Elanco US Inc. (incorporated by reference to Exhibit 10.7 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.9 | Intellectual Property and Technology License Agreement, dated September 24, 2018, among Eli Lilly and Company, Elanco Animal Health Incorporated and Elanco US Inc. (incorporated by reference to Exhibit 10.8 of the Current Report on Form 8-K filed with the SEC on September 26, 2018). | | |
10.10 | Revolving Loan Credit Agreement, dated as of September 5, 2018, among Elanco Animal Health Incorporated, as borrower, JPMorgan Chase Bank, N.A., as administrative agent and the other Lenders party thereto (incorporated by reference to Exhibit 10.24 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.11 | Term Loan Credit Agreement, dated as of September 5, 2018, among Elanco Animal Health Incorporated, as borrower, JPMorgan Chase Bank, N.A., as administrative agent and the other Lenders party thereto (incorporated by reference to Exhibit 10.25 of Amendment No. 2 to Registration Statement on Form S-1 (Registration No. 333-226536) filed with the SEC on September 6, 2018). | | |
10.12 | 2018 Elanco Stock Plan (incorporated by reference to Exhibit 4.3 of Registration Statement on Form S-8 (Registration No. 333-227447) filed with the SEC on September 20, 2018). | | |
10.13 | Elanco Animal Health Incorporated Directors’ Deferral Plan (incorporated by reference to Exhibit 4.4 of Registration Statement on Form S-8 (Registration No. 333-227447) filed with the SEC on September 20, 2018). | | |
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| 32 |
| | | Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). |
101 | | | |
| 101 | | | Interactive Data Files.Files |
| 104 | | | Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101) |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized. | | | | | | | | |
| | ELANCO ANIMAL HEALTH INCORPORATED |
| | (Registrant) |
| | |
Date: | May 7, 2021 | ELANCO ANIMAL HEALTH INCORPORATED/s/ Jeffrey N. Simmons |
| | (Registrant)Jeffrey N. Simmons |
| | |
Date: | November 8, 2018 | /s/ Jeff Simmons |
| | Jeff Simmons |
| | President and Chief Executive Officer |
Date: | November 8, 2018May 7, 2021 | /s/ James MeerTodd S. Young |
| | James MeerTodd S. Young |
| | Executive Vice President, Chief AccountingFinancial Officer |