UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED SEPTEMBERJUNE 30, 20182022
OR
☐ Transition Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 001-38661
Elanco Animal Health Incorporated
(Exact name of Registrant as specified in its charter)
| INDIANA | 82-5497352 | |||||||
| (State or other jurisdiction of | (I.R.S. Employer | |||||||
| incorporation or organization) | Identification No.) | |||||||
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address of principal executive offices)
Registrant’s telephone number, including area code (877) 352-6261
Securities registered pursuant to Section 12(b) of the Act:
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered | ||||||
| Common stock, no par value | ELAN | New York Stock Exchange | ||||||
| 5.00% Tangible Equity Units | ELAT | New York Stock Exchange | ||||||
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files).
Yes ý☒ No o☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer | ☒ | Accelerated filer | ☐ | ||||||||||||||||||||
Non-accelerated filer | ☐ | Smaller reporting company | ☐ | ||||||||||||||||||||
Emerging growth company | ☐ | ||||||||||||||||||||||
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. o☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes o☐ No ý☒
The number of shares of common stock outstanding as of November 6, 2018 were 365,625,000
August 3, 2022 was 474,113,647.
ELANCO ANIMAL HEALTH INCORPORATED
TABLE OF CONTENTS
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FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY
Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important risk factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions, including but not limited to the following:
•heightened competition, including from new innovation or generics;
•the impact of disruptive innovations and advances in veterinary medical practices, animal health technologies and alternatives to animal-derived protein;
•changes in regulatory restrictions on the use of antibiotics in food animals, as well as changing market demand regarding the use of antibiotics and productivity products;farm animals;
•our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;
•consolidation of our customers and distributors;
•an outbreak of infectious disease carried by farm animals;
•the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the COVID-19 global health pandemic;
•the potential impact on our business and global economic conditions resulting from the conflict involving Russia and Ukraine;
•the success of our R&D acquisition and licensing efforts;
•misuse, off-label or counterfeiting use of our products;
•unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
•fluctuations in our business results due to seasonality and other factors;
•the impact of weather conditions and the availability of natural resources;
•risks related to currency rate fluctuations;
•our dependence on the success of tariffs or trade disputes;our top products;
•the impact of global macroeconomic conditions;customer exposure to rising costs and reduced customer income;
•the lack of availability or significant increases in the cost of raw materials;
•use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
•risks related to the write-down of goodwill or identifiable intangible assets;
•risks related to the evaluation of animals;
•manufacturing problems and capacity imbalances;
2022 Q2 Form 10-Q | 3 | | |||||||
•the impact of litigation, regulatory investigations, and other legal matters and the risk that our insurance policies may be insufficient to protect us from the impact of such matters;
•actions by regulatory bodies, including as a result of their interpretation of studies on product safety;
•risks related to tax expense or exposure;
•risks related to environmental, health and safety laws and regulations;
•risks related to our presence in foreign markets;
•challenges to our intellectual property rights or our alleged violation of rights of others;
•our dependence on sophisticated information technology and infrastructure and the impact of breaches of our information technology systems;
•the impact of increased regulation or decreased financial support related to farm animals;
•adverse effects of labor disputes, strikes, work stoppages, and the loss of key personnel or highly skilled employees;
•risks related to underfunded pension plan liabilities;
•our ability to complete acquisitions and successfully integrate the businesses we acquire, including KindredBio and the animal health business of Bayer (Bayer Animal Health);
•the effect of our substantial indebtedness on our business, including restrictions in our debt agreements that will limit our operating flexibility; and
•risks related to certain governance provisions in our constituent documents.
See Item 1A, “Risk Factors,” of the transactions involving the separationPart I of our business from that of Eli Lilly & Co. (Lilly) and distribution of Lilly's interest in us to its shareholders, if consummated.
2022 Q2 Form 10-Q | 4 | | |||||||
Table of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should be viewed as historical data.Contents
PART I. Financial InformationI
ITEM 1. Financial StatementsFINANCIAL STATEMENTS
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Revenue | $ | 761.1 | $ | 697.1 | $ | 2,267.5 | $ | 2,134.7 | |||||||
| Costs, expenses and other: | |||||||||||||||
| Cost of sales | 369.8 | 376.2 | 1,161.3 | 1,088.9 | |||||||||||
| Research and development | 58.9 | 61.9 | 185.5 | 189.7 | |||||||||||
| Marketing, selling and administrative | 179.0 | 194.7 | 550.1 | 583.0 | |||||||||||
| Amortization of intangible assets | 48.7 | 51.6 | 147.3 | 161.0 | |||||||||||
| Asset impairments, restructuring and other special charges (Note 6) | 12.4 | 23.7 | 82.8 | 189.3 | |||||||||||
| Other–net, (income) expense | 13.5 | (1.9 | ) | 24.2 | — | ||||||||||
| 682.3 | 706.2 | 2,151.2 | 2,211.9 | ||||||||||||
| Income (loss) before income taxes | 78.8 | (9.1 | ) | 116.3 | (77.2 | ) | |||||||||
| Income tax expense | 18.6 | 11.6 | 46.2 | 72.0 | |||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | $ | 70.1 | $ | (149.2 | ) | |||||
| Earnings (loss) per share: | |||||||||||||||
| Basic and diluted | $ | 0.16 | $ | (0.06 | ) | $ | 0.19 | $ | (0.41 | ) | |||||
| Weighted average shares outstanding: | |||||||||||||||
| Basic and diluted | 365.6 | 365.6 | 365.6 | 365.6 | |||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | $ | 70.1 | $ | (149.2 | ) | |||||
| Other comprehensive income (loss), net of tax | 94.5 | (4.0 | ) | (9.8 | ) | 231.8 | |||||||||
| Comprehensive income (loss) | $ | 154.7 | $ | (24.7 | ) | $ | 60.3 | $ | 82.6 | ||||||
Elanco Animal Health Incorporated
Condensed Consolidated and Combined Balance SheetsStatements of Operations (Unaudited)
(Dollars in millions)
| September 30, 2018 | December 31, 2017 | ||||||
| Assets | (Unaudited) | ||||||
| Current Assets | |||||||
| Cash and cash equivalents | $ | 300.0 | $ | 323.4 | |||
| Accounts receivable, net of allowances of $8.8 (2018) and $9.8 (2017) | 606.1 | 567.4 | |||||
| Other receivables | 30.8 | 34.5 | |||||
| Inventories (Note 7) | 1,008.7 | 1,062.3 | |||||
| Prepaid expenses and other | 123.2 | 136.1 | |||||
| Restricted cash (Note 14) | 634.9 | — | |||||
| Total current assets | 2,703.7 | 2,123.7 | |||||
| Noncurrent Assets | |||||||
| Investments (Note 9) | 14.9 | 12.3 | |||||
| Goodwill | 2,968.8 | 2,969.2 | |||||
| Other intangibles, net | 2,514.8 | 2,672.8 | |||||
| Other noncurrent assets | 100.0 | 242.0 | |||||
| Property and equipment, net of accumulated depreciation $894.5 (2018) and $834.1 (2017) | 909.3 | 920.3 | |||||
| Total assets | $ | 9,211.5 | $ | 8,940.3 | |||
| Liabilities and Equity | |||||||
| Current Liabilities | |||||||
| Accounts payable | $ | 202.7 | $ | 203.8 | |||
| Employee compensation | 81.3 | 89.3 | |||||
| Sales rebates and discounts | 147.9 | 165.5 | |||||
| Other current liabilities | 178.6 | 184.5 | |||||
| Payable to Lilly (Note 14) | 634.9 | — | |||||
| Total current liabilities | 1,245.4 | 643.1 | |||||
| Noncurrent Liabilities | |||||||
| Long-term debt (Note 8) | 2,478.5 | — | |||||
| Accrued retirement benefits | 136.0 | 139.0 | |||||
| Deferred taxes | 125.0 | 251.9 | |||||
| Other noncurrent liabilities | 89.5 | 126.0 | |||||
| Total liabilities | 4,074.4 | 1,160.0 | |||||
| Commitments and Contingencies (Note 11) | |||||||
| Equity | |||||||
| Net parent company investment | — | 8,036.9 | |||||
| Common stock, no par value, 5,000,000,000 shares authorized 365,625,000 shares issued and outstanding as of September 30, 2018 | — | — | |||||
| Additional paid-in capital | 5,347.4 | — | |||||
| Accumulated other comprehensive loss | (210.3 | ) | (256.6 | ) | |||
| Total equity | 5,137.1 | 7,780.3 | |||||
| Total liabilities and equity | $ | 9,211.5 | $ | 8,940.3 | |||
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Revenue | $ | 1,177 | $ | 1,279 | $ | 2,402 | $ | 2,521 | |||||||||||||||
| Costs, expenses and other: | |||||||||||||||||||||||
| Cost of sales | 484 | 551 | 993 | 1,120 | |||||||||||||||||||
| Research and development | 82 | 94 | 163 | 183 | |||||||||||||||||||
| Marketing, selling and administrative | 343 | 385 | 663 | 733 | |||||||||||||||||||
| Amortization of intangible assets | 133 | 129 | 270 | 276 | |||||||||||||||||||
| Asset impairment, restructuring and other special charges | 86 | 299 | 132 | 407 | |||||||||||||||||||
| Interest expense, net of capitalized interest | 67 | 60 | 119 | 121 | |||||||||||||||||||
| Other (income) expense, net | — | (3) | 9 | (3) | |||||||||||||||||||
| 1,195 | 1,515 | 2,349 | 2,837 | ||||||||||||||||||||
| Income (loss) before income taxes | (18) | (236) | 53 | (316) | |||||||||||||||||||
| Income tax expense (benefit) | 4 | (26) | 27 | (45) | |||||||||||||||||||
| Net income (loss) | $ | (22) | $ | (210) | $ | 26 | $ | (271) | |||||||||||||||
| Earnings (loss) per share: | |||||||||||||||||||||||
| Basic | $ | (0.04) | $ | (0.43) | $ | 0.05 | $ | (0.56) | |||||||||||||||
| Diluted | $ | (0.04) | $ | (0.43) | $ | 0.05 | $ | (0.56) | |||||||||||||||
| Weighted average shares outstanding: | |||||||||||||||||||||||
| Basic | 488.4 | 487.3 | 488.2 | 487.0 | |||||||||||||||||||
| Diluted | 488.4 | 487.3 | 492.1 | 487.0 | |||||||||||||||||||
See notes to unaudited condensed consolidated and combined financial statements.
2022 Q2 Form 10-Q | 5 | | |||||||
Elanco Animal Health Incorporated
(in millions)
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Net income (loss) | $ | (22) | $ | (210) | $ | 26 | $ | (271) | |||||||||||||||
| Other comprehensive income (loss): | |||||||||||||||||||||||
| Cash flow hedges, net of taxes | 8 | (5) | 117 | 48 | |||||||||||||||||||
| Foreign currency translation | (470) | 169 | (555) | (297) | |||||||||||||||||||
| Defined benefit pension and retiree health benefit plans, net of taxes | (1) | 3 | (2) | 11 | |||||||||||||||||||
| Other comprehensive income (loss), net of taxes | (463) | 167 | (440) | (238) | |||||||||||||||||||
| Comprehensive loss | $ | (485) | $ | (43) | $ | (414) | $ | (509) | |||||||||||||||
See notes to condensed consolidated financial statements.
2022 Q2 Form 10-Q | 6 | | |||||||
Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions, except share data)
| June 30, 2022 | December 31, 2021 | ||||||||||
| (Unaudited) | |||||||||||
| Assets | |||||||||||
| Current Assets | |||||||||||
| Cash and cash equivalents | $ | 507 | $ | 638 | |||||||
| Accounts receivable, net of allowances of $10 (2022) and $12 (2021) | 916 | 833 | |||||||||
| Other receivables | 212 | 195 | |||||||||
| Inventories | 1,334 | 1,373 | |||||||||
| Prepaid expenses and other | 338 | 237 | |||||||||
| Total current assets | 3,307 | 3,276 | |||||||||
| Noncurrent Assets | |||||||||||
| Goodwill | 5,898 | 6,172 | |||||||||
| Other intangibles, net | 5,059 | 5,587 | |||||||||
| Other noncurrent assets | 376 | 387 | |||||||||
| Property and equipment, net of accumulated depreciation of $688 (2022) and $1,041 (2021) | 961 | 1,061 | |||||||||
| Total assets | $ | 15,601 | $ | 16,483 | |||||||
| Liabilities and Equity | |||||||||||
| Current Liabilities | |||||||||||
| Accounts payable | $ | 386 | $ | 418 | |||||||
| Employee compensation | 113 | 185 | |||||||||
| Sales rebates and discounts | 284 | 316 | |||||||||
| Current portion of long-term debt | 56 | 294 | |||||||||
| Other current liabilities | 499 | 430 | |||||||||
| Total current liabilities | 1,338 | 1,643 | |||||||||
| Noncurrent Liabilities | |||||||||||
| Long-term debt | 6,007 | 6,025 | |||||||||
| Accrued retirement benefits | 254 | 271 | |||||||||
| Deferred taxes | 620 | 745 | |||||||||
| Other noncurrent liabilities | 242 | 261 | |||||||||
| Total liabilities | 8,461 | 8,945 | |||||||||
| Commitments and Contingencies | 0 | 0 | |||||||||
| Equity | |||||||||||
| Preferred stock, no par value, 1,000,000,000 shares authorized; none issued | — | — | |||||||||
| Common stock, no par value, 5,000,000,000 shares authorized, 474,097,334 and 473,119,786 shares issued and outstanding as of June 30, 2022 and December 31, 2021, respectively | — | — | |||||||||
| Additional paid-in capital | 8,712 | 8,696 | |||||||||
| Accumulated deficit | (923) | (949) | |||||||||
| Accumulated other comprehensive loss | (649) | (209) | |||||||||
| Total equity | 7,140 | 7,538 | |||||||||
| Total liabilities and equity | $ | 15,601 | $ | 16,483 | |||||||
See notes to condensed consolidated financial statements.
2022 Q2 Form 10-Q | 7 | | |||||||
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)
| Common Stock | Accumulated Other Comprehensive Income (Loss) | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-in Capital | Accumulated Deficit | Cash Flow Hedge Gain (Loss) | Foreign Currency Translation | Defined Benefit Pension and Retiree Health Benefit Plans | Total | Total Equity | |||||||||||||||||||||||||||||||||||||||||||||||||||
| December 31, 2020 | 471.9 | $ | — | $ | 8,650 | $ | (477) | $ | (61) | $ | 360 | $ | 4 | $ | 303 | $ | 8,476 | ||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | (61) | — | — | — | — | (61) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | 53 | (466) | 8 | (405) | (405) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 15 | — | — | — | — | — | 15 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of stock under employee stock plans, net | 1.1 | — | (18) | — | — | — | — | — | (18) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2021 | 473.0 | — | 8,647 | (538) | (8) | (106) | 12 | (102) | 8,007 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | (210) | — | — | — | — | (210) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | (5) | 169 | 3 | 167 | 167 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 16 | — | — | — | — | — | 16 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| June 30, 2021 | 473.0 | $ | — | $ | 8,663 | $ | (748) | $ | (13) | $ | 63 | $ | 15 | $ | 65 | $ | 7,980 | ||||||||||||||||||||||||||||||||||||||||||
| Common Stock | Accumulated Other Comprehensive Income (Loss) | |||||||||||||||||||||||||||||
| Shares | Amount | Additional Paid-in Capital | Net Parent Company Investment | Foreign Currency Translation | Defined Benefit Pension and Retiree Health Benefit Plans | Total | Total Equity | |||||||||||||||||||||||
| December 31, 2016 | — | $ | — | $ | — | $ | 7,474.3 | $ | (437.3 | ) | $ | (19.6 | ) | $ | (456.9 | ) | $ | 7,017.4 | ||||||||||||
| Net loss | — | — | — | (149.2 | ) | — | — | — | (149.2 | ) | ||||||||||||||||||||
| Other comprehensive income, net of tax | — | — | — | — | 228.1 | 3.7 | 231.8 | 231.8 | ||||||||||||||||||||||
| Transfers (to)/from Lilly, net | — | — | — | 862.7 | — | — | — | 862.7 | ||||||||||||||||||||||
| September 30, 2017 | — | $ | — | $ | — | $ | 8,187.8 | $ | (209.2 | ) | $ | (15.9 | ) | $ | (225.1 | ) | $ | 7,962.7 | ||||||||||||
| December 31, 2017 | — | $ | — | $ | — | $ | 8,036.9 | $ | (227.2 | ) | $ | (29.4 | ) | $ | (256.6 | ) | $ | 7,780.3 | ||||||||||||
| Adoption of Accounting Standards Update 2016-16 | — | — | — | (0.3 | ) | — | — | — | (0.3 | ) | ||||||||||||||||||||
| Net income | — | — | — | 70.1 | — | — | — | 70.1 | ||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | (20.6 | ) | 10.8 | (9.8 | ) | (9.8 | ) | |||||||||||||||||||
| Transfers (to)/from Lilly, net | — | — | — | (226.3 | ) | — | — | — | (226.3 | ) | ||||||||||||||||||||
| Separation adjustments | — | — | — | 2.2 | 56.1 | — | 56.1 | 58.3 | ||||||||||||||||||||||
| Issuance of common stock | 365.6 | — | 1,659.7 | — | — | — | — | 1,659.7 | ||||||||||||||||||||||
| Consideration to Lilly in connection with the Separation | — | — | (4,194.9 | ) | — | — | — | — | (4,194.9 | ) | ||||||||||||||||||||
| Reclassification of net parent company investment | — | — | 7,882.6 | (7,882.6 | ) | — | — | — | — | |||||||||||||||||||||
| September 30, 2018 | 365.6 | $ | — | $ | 5,347.4 | $ | — | $ | (191.7 | ) | $ | (18.6 | ) | $ | (210.3 | ) | $ | 5,137.1 | ||||||||||||
| December 31, 2021 | 473.1 | $ | — | $ | 8,696 | $ | (949) | $ | 25 | $ | (253) | $ | 19 | $ | (209) | $ | 7,538 | ||||||||||||||||||||||||||||||||||||||||||
| Net income | — | — | — | 48 | — | — | — | — | 48 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | 109 | (85) | (1) | 23 | 23 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 14 | — | — | — | — | — | 14 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of stock under employee stock plans, net | 1.0 | — | (11) | — | — | — | — | — | (11) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| March 31, 2022 | 474.1 | — | 8,699 | (901) | 134 | (338) | 18 | (186) | 7,612 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Net loss | — | — | — | (22) | — | — | — | — | (22) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Other comprehensive income (loss), net of tax | — | — | — | — | 8 | (470) | (1) | (463) | (463) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Stock compensation | — | — | 17 | — | — | — | — | — | 17 | ||||||||||||||||||||||||||||||||||||||||||||||||||
| Issuance of stock under employee stock plans, net | — | — | (4) | — | — | — | — | — | (4) | ||||||||||||||||||||||||||||||||||||||||||||||||||
| June 30, 2022 | 474.1 | $ | — | $ | 8,712 | $ | (923) | $ | 142 | $ | (808) | $ | 17 | $ | (649) | $ | 7,140 | ||||||||||||||||||||||||||||||||||||||||||
See notes to unaudited condensed consolidated and combined financial statements.
2022 Q2 Form 10-Q | 8 | | |||||||
Elanco Animal Health Incorporated
(Dollars in millions)
| Nine Months Ended September 30, | |||||||
| 2018 | 2017 | ||||||
| Cash Flows from Operating Activities | |||||||
| Net income (loss) | $ | 70.1 | $ | (149.2 | ) | ||
| Adjustments to Reconcile Net Income (Loss) to Cash Flows from Operating Activities: | |||||||
| Depreciation and amortization | 222.3 | 231.3 | |||||
| Change in deferred income taxes | 12.6 | (7.0 | ) | ||||
| Stock-based compensation expense | 20.2 | 18.7 | |||||
| Asset impairment charges | 102.5 | 43.8 | |||||
| Gain on sale of assets | — | (16.0 | ) | ||||
| Other changes in operating assets and liabilities, net of acquisitions and divestitures | (83.4 | ) | 42.7 | ||||
| Other non-cash operating activities, net | 3.5 | 2.8 | |||||
| Net Cash Provided by Operating Activities | 347.8 | 167.1 | |||||
| Cash Flows from Investing Activities | |||||||
| Net purchases of property and equipment | (74.3 | ) | (31.7 | ) | |||
| Cash paid for acquisitions, net of cash acquired | — | (882.1 | ) | ||||
| Other investing activities, net | (4.6 | ) | (15.3 | ) | |||
| Net Cash Used for Investing Activities | (78.9 | ) | (929.1 | ) | |||
| Cash Flows from Financing Activities | |||||||
| Proceeds from issuance of long-term debt (Note 8) | 2,477.7 | — | |||||
| Proceeds from issuance of common stock (Note 1) | 1,659.7 | — | |||||
| Consideration paid to Lilly in connection with the Separation (Note 1) | (3,559.1 | ) | — | ||||
| Other financing activities, net | (3.7 | ) | (0.5 | ) | |||
| Other net transactions with Lilly | (247.4 | ) | 844.0 | ||||
| Net Cash Provided by Financing Activities | 327.2 | 843.5 | |||||
| Effect of exchange rate changes on cash and cash equivalents | 15.4 | 3.3 | |||||
| Net increase in cash, cash equivalents and restricted cash | 611.5 | 84.8 | |||||
| Cash, cash equivalents and restricted cash at January 1 | 323.4 | 258.8 | |||||
| Cash, cash equivalents and restricted cash at September 30 | $ | 934.9 | $ | 343.6 | |||
| September 30, | |||||||
| 2018 | 2017 | ||||||
| Cash and cash equivalents | $ | 300.0 | $ | 343.6 | |||
| Restricted cash (Note 14) | 634.9 | — | |||||
| Cash, cash equivalents and restricted cash at September 30 | $ | 934.9 | $ | 343.6 | |||
| Six Months Ended June 30, | |||||||||||
| 2022 | 2021 | ||||||||||
| Cash Flows from Operating Activities | |||||||||||
| Net income (loss) | $ | 26 | $ | (271) | |||||||
| Adjustments to reconcile net income (loss) to cash flows from operating activities: | |||||||||||
| Depreciation and amortization | 347 | 372 | |||||||||
| Deferred income taxes | (40) | (114) | |||||||||
| Stock-based compensation expense | 31 | 31 | |||||||||
| Asset impairment and write-down charges | 87 | 278 | |||||||||
| Loss on sale of assets | 1 | 2 | |||||||||
| Gain on divestiture | (3) | — | |||||||||
| Inventory fair value step-up amortization | — | 63 | |||||||||
| Loss on extinguishment of debt | 17 | — | |||||||||
| Proceeds from interest rate swap settlements | 132 | — | |||||||||
| Changes in operating assets and liabilities | (369) | (190) | |||||||||
| Other non-cash operating activities, net | 21 | — | |||||||||
| Net Cash Provided by Operating Activities | 250 | 171 | |||||||||
| Cash Flows from Investing Activities | |||||||||||
| Net purchases of property and equipment | (45) | (35) | |||||||||
| Cash paid for acquisitions, net of cash acquired | — | 73 | |||||||||
| Purchases of intangible assets | (1) | (34) | |||||||||
| Purchases of software | (13) | (12) | |||||||||
| Other investing activities, net | (7) | (7) | |||||||||
| Net Cash Used for Investing Activities | (66) | (15) | |||||||||
| Cash Flows from Financing Activities | |||||||||||
| Proceeds from issuance of long-term debt | 425 | — | |||||||||
| Proceeds from revolving credit facility | 563 | 150 | |||||||||
| Repayments of long-term borrowings | (528) | (37) | |||||||||
| Repayments of revolving credit facility | (738) | (150) | |||||||||
| Debt issuance costs | (1) | — | |||||||||
| Other net financing transactions with Lilly | — | (11) | |||||||||
| Other financing activities, net | (17) | (17) | |||||||||
| Net Cash Used for Financing Activities | (296) | (65) | |||||||||
| Effect of exchange rate changes on cash and cash equivalents | (19) | (17) | |||||||||
| Net increase (decrease) in cash and cash equivalents | (131) | 74 | |||||||||
| Cash and cash equivalents at January 1 | 638 | 506 | |||||||||
| Cash and cash equivalents at June 30 | $ | 507 | $ | 580 | |||||||
See notes to unaudited condensed consolidated and combined financial statements.
2022 Q2 Form 10-Q | 9 | | |||||||
Elanco Animal Health Incorporated
Notes to Condensed Consolidated and Combined Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share and per-unit data)
Note 1. Nature of Business and OrganizationBackground
Elanco Parent was formedincorporated in 2018, as a wholly-owned subsidiary of Lilly, to serve as the ultimate parent company of substantially all of the animal health businesses of Lilly.
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
We have prepared the accompanying unaudited condensed consolidated and combined financial statements in accordance with the U.S. Securities and Exchange Commission (SEC) requirements offor interim reporting. As permitted under those rules, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been condensed or omitted. The information included in this Form 10-Q should be read in conjunction with our consolidated financial statements and therefore, they doaccompanying notes for the year ended December 31, 2021 included in our Form 10-K filed with the SEC on February 28, 2022. In addition, results for interim periods should not include all information and footnotes necessarybe considered indicative of results for a fair presentation of financial position, results of operations, and cash flows in conformity with accounting principles generally accepted inany other interim period or for the United States (GAAP). full year ending December 31, 2022 or any other future period.
In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for a fair presentation of the results of operations for the periods shown. In preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates.
Certain reclassifications of prior year information have been made to prior periodsconform to the current year's presentation.
The significant accounting policies set forth in Note 3 to the unaudited condensed consolidated and combined financial statements and accompanying notes to conform with current presentation. In addition, during the period ended September 30, 2018, certain combined balance sheet amounts related to the prior year have been revised to correct the sales rebates and discounts liability, which did not correctly reflect an accrual for rebates related to product held in the wholesalers' pipeline. In accordance with Securities and Exchange Commission Staff Accounting Bulletin No. 99, Materiality, and Accounting Standards Codification (ASC) 250, Presentation of Financial Statements, we assessed the materiality of this correction and concluded that the accrualour Annual Report on Form 10-K for the rebate related to product held in the wholesalers' pipeline was not material to prior periods, and therefore, amendments of previously filed reports are not required.
Note 4.3. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of an accounting standardsstandard that werewas effective January 1, 20182022 and werewas adopted on that date:
| Standard | Description | Effect on the financial statements or other significant matters | ||||||||||||
| The amendments in this update require annual disclosure of transactions with | ||||||||||||||
2022 Q2 Form 10-Q | 10 | | |||||||
The following table provides a brief description of thean accounting standard that is applicable to us but has not yet been adopted and could have a material effect on the consolidated financial statements:
adopted:
| Standard | Description | Effective Date | Effect on the financial statements or other significant matters | |||||||||||||||||||||
| Adoption of the guidance is optional and effective as | Our current | |||||||||||||||||||||||
Note 5.4. Revenue
Our sales rebates and discounts are based on specific agreementsagreements. The most significant of our sales rebate and discount programs in terms of accrual and payment amounts, percentage of our products that are sold via these programs, and level of judgment required in estimating the appropriate transaction price, relate to our programs in the U.S., France and the majority relate to sales in the U.S.United Kingdom (U.K.). As of SeptemberJune 30, 20182022 and 2017,2021, the aggregate liability for sales rebates and discounts in the U.S. representsfor these countries represented approximately 70%77% and 71%, respectively, of our total liability with the next largest country representing approximately 8% and 6%73%, respectively, of our total liability.
The following table summarizes the activity in theour global sales rebates and discounts liability in the U.S.:liability:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Beginning balance | $ | 295 | $ | 331 | $ | 316 | $ | 295 | |||||||||||||||
| Reduction of revenue | 176 | 178 | 355 | 367 | |||||||||||||||||||
| Payments | (187) | (206) | (387) | (359) | |||||||||||||||||||
| Ending balance | $ | 284 | $ | 303 | $ | 284 | $ | 303 | |||||||||||||||
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Beginning balance | $ | 99.1 | $ | 118.7 | $ | 114.8 | $ | 116.1 | |||||||
| Reduction of revenue | 53.5 | 48.6 | 154.2 | 184.9 | |||||||||||
| Payments | (49.1 | ) | (49.6 | ) | (165.5 | ) | (183.3 | ) | |||||||
| Ending balance | $ | 103.5 | $ | 117.7 | $ | 103.5 | $ | 117.7 | |||||||
Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three and ninesix months ended SeptemberJune 30, 20182022 and 2021 for product shipped in previous periods were not material.
2022 Q2 Form 10-Q | 11 | | |||||||
Disaggregation of Revenue
The following table summarizes our revenue disaggregated by product category:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Pet Health | $ | 612 | $ | 685 | $ | 1,251 | $ | 1,330 | |||||||||||||||
| Farm Animal: | |||||||||||||||||||||||
| Cattle | 248 | 224 | 495 | 485 | |||||||||||||||||||
| Poultry | 174 | 186 | 353 | 357 | |||||||||||||||||||
| Swine | 89 | 113 | 189 | 236 | |||||||||||||||||||
| Aqua | 42 | 44 | 85 | 67 | |||||||||||||||||||
| Total Farm Animal | 553 | 567 | 1,122 | 1,145 | |||||||||||||||||||
Contract Manufacturing (1) | 12 | 27 | 29 | 46 | |||||||||||||||||||
| Revenue | $ | 1,177 | $ | 1,279 | $ | 2,402 | $ | 2,521 | |||||||||||||||
(1)Represents revenue from arrangements in which we manufacture products on behalf of a third party, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
Note 5. Acquisitions, Divestitures and Other Arrangements
KindredBio Acquisition
On August 27, 2021, we acquired KindredBio, a publicly traded biopharmaceutical company that develops innovative biologics focused on saving and improving the lives of pets. The acquisition further accelerates our pet health expansion, particularly by expanding our presence in dermatology.
The transaction was accounted for as a business combination under the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The determination of estimated fair value requires management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of the acquisition is included in our condensed consolidated financial statements from the date of acquisition.
In connection with the merger agreement, we acquired all outstanding stock of KindredBio for $9.25 per share, or an aggregate cash purchase consideration of $444 million. We utilized our revolving credit facility and cash on hand to finance the acquisition.
On May 5, 2021, we signed an agreement with KindredBio to acquire exclusive global rights to KIND-030, a monoclonal antibody that is being developed for the treatment and prevention of canine parvovirus. We calculated the fair value of the liability associated with that agreement using an income approach leveraging the estimated sales royalty, sales milestone and technical milestone payments avoided, and settled the $29 million liability upon the closing of our acquisition of KindredBio.
Revenue and loss from KindredBio included in our condensed consolidated statements of operations for the three and six months ended June 30, 2022 were immaterial.
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Companion Animal Disease Prevention | $ | 188.6 | $ | 140.4 | $ | 603.9 | $ | 519.7 | |||||||
| Companion Animal Therapeutics | 80.5 | 63.5 | 211.1 | 181.8 | |||||||||||
| Companion Animal Other | 27.7 | 48.3 | 69.3 | 119.9 | |||||||||||
| Food Animal Future Protein & Health | 162.8 | 164.5 | 502.1 | 456.0 | |||||||||||
| Food Animal Ruminants & Swine | 301.5 | 280.4 | 881.1 | 857.3 | |||||||||||
| Revenue | $ | 761.1 | $ | 697.1 | $ | 2,267.5 | $ | 2,134.7 | |||||||
2022 Q2 Form 10-Q | 12 | | |||||||
The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
| Estimated Fair Value at August 27, 2021 | |||||
| Cash and cash equivalents | $ | 31 | |||
| Other net working capital | 12 | ||||
| Property and equipment | 33 | ||||
| Intangible assets, primarily acquired in-process research and development (IPR&D) | 333 | ||||
| Deferred income taxes, net | (26) | ||||
| Total identifiable net assets | 383 | ||||
| Goodwill | 32 | ||||
| Settlement of liability related to previous license agreement | 29 | ||||
| Total consideration transferred | $ | 444 | |||
The accounting for this acquisition is substantially complete, with the exception of the finalization of tax-related amounts and minor working capital adjustments. The measurement period adjustments recorded during 2022, which were made to reflect the facts and circumstances in existence as of the acquisition date, primarily related to changes in the estimated fair value of acquired IPR&D and minor tax and working capital adjustments. The net impact of these adjustments was not material. Finalization of the valuation during the measurement period could result in a change in the amounts recorded for the acquisition date fair value. The completion of the valuation will occur no later than one year from the acquisition date.
Property and equipment is mostly comprised of land, buildings, equipment (including laboratory equipment, furniture and fixtures, and computer equipment), and construction in progress. The estimated fair value of real and personal property was determined using the sales comparison data valuation technique, to the extent that market data for similar assets was available. When market pricing data was not available for a given asset or asset class, the direct replacement cost method was used.
The estimated fair values of acquired IPR&D were determined using the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset (including revenues, cost of sales, R&D expenses, marketing, selling and administrative expenses, and contributory asset charges), the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, and competitive trends impacting the asset and each cash flow stream, as well as other factors.
The goodwill recognized from this acquisition is primarily attributable to KindredBio's assembled workforce and expected synergies. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
2022 Q2 Form 10-Q | 13 | | |||||||
Divestitures
Microbiome R&D platform carve-out
In April 2022, we signed an agreement to transfer assets associated with our microbiome R&D platform to a newly created, independent biopharmaceutical company, BiomEdit, focused on developing solutions for animal and human health. As part of the agreement, we retain a non-voting, minority stake in the company. Assets transferred include intellectual property and laboratory equipment. The book values of those assets were not material. In addition, we have entered into transitional services agreements with the company for certain services. We have determined that the disposal of the related net assets does not qualify for reporting as a discontinued operation because it does not represent a strategic shift that has or will have a major effect on our operations and financial results. During the three and six months ended June 30, 2022, we recorded a gain on the disposal of approximately $3 million. While there is no certainty that additional equity in BiomEdit will be sold, the sale of additional Series A equity by the company during 2022 could result in additional gains.
Shawnee and Speke
During 2021, as part of our strategy to optimize our manufacturing footprint, we announced an agreement with TriRx Pharmaceuticals (TriRx) to sell our manufacturing sites in Shawnee, Kansas (Shawnee) and Speke, U.K. (Speke), including the planned transfer of approximately 600 employees. In connection with these arrangements, we also entered into long-term manufacturing and supply agreements, under which TriRx will manufacture existing Elanco products at both sites upon the closing of the transactions. On August 1, 2021, we completed the sale of our Shawnee site and expect to receive gross cash proceeds of $51 million over a period of three years based on the terms of the agreement, beginning in the second half of 2022. On February 1, 2022, we completed the sale of our Speke site and expect to receive gross cash proceeds of $29 million over a period of one year commencing 12 months from the closing date. Receivables for the expected cash proceeds are included in other receivables and other noncurrent assets on our condensed consolidated balance sheets. Upon closing, we recorded a contract asset of $55 million for the favorable supply agreement, which is included in prepaid expenses and other and other noncurrent assets on our condensed consolidated balance sheets. The related assets for Speke were classified as held for sale as of December 31, 2021. The divestitures did not represent a strategic shift that has or will have a major effect on our operations and financial results, and therefore do not qualify for reporting as a discontinued operation. See Note 6: Asset Impairment, Restructuring and Other Special Charges for further information.
Assets Held For Sale
Assets and liabilities considered held for sale in connection with the above divestitures were included in the respective line items on our condensed consolidated balance sheets as follows:
| December 31, 2021 | |||||||||||
| Inventories | $ | 31 | |||||||||
| Property and equipment, net | 50 | ||||||||||
| Total assets held for sale | $ | 81 | |||||||||
2022 Q2 Form 10-Q | 14 | | |||||||
BexCaFe Arrangement
On June 9, 2022, we signed a license agreement with BexCaFe, LLC (BexCaFe) for the development and commercialization of products related to an oral treatment intended to reduce glucose levels in diabetic cats. BexCaFe held the rights to the compound through a license agreement with similar terms and conditions. We will incur all development and regulatory costs associated with the products. Based on the guidance in Accounting Standards Codification (ASC) 810, Consolidation, we determined that BexCaFe represents a variable interest entity and that we are the primary beneficiary of BexCaFe because the terms of the license give us the power to direct the activities that most significantly impact the entity’s economic performance. As a result, we consolidated BexCaFe, a development-stage company with no employees that did not meet the definition of a business, as of the date we signed the license agreement. Upon initial consolidation of BexCaFe, we measured an IPR&D asset at its fair value of $59 million and recorded liabilities totaling $59 million, which include contingent consideration of $49 million based on the fair value of estimated future milestone payments and sales royalties owed under the license agreement. These liabilities are included in other current liabilities and other noncurrent liabilities on our condensed consolidated balance sheet as of June 30, 2022. The fair value of the contingent payments was calculated based on an income approach, with payments adjusted for probability of success and then discounted to a present value. There is no minimum payout due on the contingent consideration and the maximum payout is unlimited. Since BexCaFe did not meet the definition of a business, no goodwill was recorded and immediately after initial consolidation, we expensed the IPR&D asset because we concluded that it did not have an alternative future use. This amount is included in asset impairment, restructuring, and other special charges in our condensed consolidated statements of operations for the three and six months ended June 30, 2022.
Subsequent to the effective date of the license agreement, our condensed consolidated financial statements include the assets, liabilities, operating results and cash flows of BexCaFe. Based on the guidance in ASC 810, income and expense between us and BexCaFe have been eliminated against the income or expense included in the financial statements of BexCaFe. The resulting amounts after the effect of these eliminations were included in our condensed consolidated financial statements for the three and six months ended June 30, 2022 and were not material.
Note 6. Asset Impairment, Restructuring and Other Special Charges
In recent years, we have incurred substantial costs associated with restructuring programs and cost-reduction initiatives designed to achieve a flexible and competitive cost structure. As discussed further below, restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions, including the acquisition of Bayer Animal Health, we have also incurred costs associated with executing transactions and integrating acquired operations, which may include expenditures for banking, legal, accounting, and other similar services. In addition, we have incurred costs to stand up our organization as an independent company. All operating functions can be impacted by these actions; therefore, non-cash expenses associated with our tangible and intangible assets can be incurred as a result of revised fair value projections and/or determinations to no longer utilize certain assets in the business on an ongoing basis.
For finite-lived intangible assets and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 2: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
2021 Restructuring Programs
In 2021, we announced 2 separate restructuring programs to improve operating efficiencies.
2022 Q2 Form 10-Q | 15 | | |||||||
The actions proposed in January 2021 focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we closed our R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We have historically participatedalso reduced duplication and optimized structures in Lilly's cost-reduction initiatives. Our totalU.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring resulted in the elimination of approximately 315 positions around the world. Activities related to this initiative resulted in net charges relatedof $3 million and $44 million for the three and six months ended June 30, 2021, respectively, primarily consisting of severance costs and other non-cash charges. Restructuring charges under this program were substantially complete at the end of 2021.
The program announced in November 2021 included initiatives to consolidate certain international commercial operations into one organization, integrate our centralized global marketing organization into country level commercial organizations, transform and simplify our R&D organizational structure, and other organizational adjustments. In connection with the proposed restructuring, we eliminated 380 positions. During the three and six months ended June 30, 2022, we recorded adjustments of $2 million and $9 million, respectively, to reduce severance accruals resulting from final negotiations and certain restructured employees filling open positions. Restructuring charges under this program were substantially complete as of June 30, 2022; however, we may continue to make adjustments to our severance accruals to reflect changes in estimates resulting from ongoing negotiations.
Components of asset impairment, restructuring and other special charges including integrationare as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Restructuring charges (credits): | |||||||||||||||||||||||
Severance and other costs (1) | $ | (2) | $ | 1 | $ | (9) | $ | 28 | |||||||||||||||
| Facility exit costs | 1 | — | 2 | — | |||||||||||||||||||
| Acquisition related charges: | |||||||||||||||||||||||
Transaction and integration costs (2) | 26 | 30 | 50 | 111 | |||||||||||||||||||
| Non-cash and other items: | |||||||||||||||||||||||
Asset impairment (3) | 59 | 4 | 59 | 13 | |||||||||||||||||||
Asset write-down (4) | — | 267 | 28 | 269 | |||||||||||||||||||
| Net periodic benefit cost (credits) (Note 14) | — | (8) | — | (17) | |||||||||||||||||||
Settlements and other (5) | 2 | 5 | 2 | 3 | |||||||||||||||||||
| Total expense | $ | 86 | $ | 299 | $ | 132 | $ | 407 | |||||||||||||||
(1)2022 credits primarily related to adjustments resulting from the reversal of severance accruals associated with the November 2021 program. For the three and six months ended June 30, 2021, charges mainly represent employee termination costs for the restructuring program announced and initiated in January 2021, partially offset by $1 million and $14 million, respectively, for the reversal of severance accruals associated with a restructuring program announced and initiated in 2020.
(2)Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services. Integration costs represent internal and external incremental costs directly related to integrating acquired businesses, inincluding the unaudited condensed consolidatedacquisitions of KindredBio and combined statements of operations consisted of the following:
| Three Months Ended September 30, | Nine Months Ended September 30, | ||||||||||||||
| 2018 | 2017 | 2018 | 2017 | ||||||||||||
| Cash expense: | |||||||||||||||
| Severance | $ | (0.2 | ) | $ | 5.8 | $ | (2.8 | ) | $ | 62.1 | |||||
| Integration and other | 4.9 | 6.4 | 10.5 | 75.1 | |||||||||||
| Exit costs | 1.5 | 11.5 | 11.2 | 24.3 | |||||||||||
| Total cash expense | 6.2 | 23.7 | 18.9 | 161.5 | |||||||||||
| Non-cash expense | |||||||||||||||
| Asset impairment | 6.2 | — | 63.9 | 43.8 | |||||||||||
| Total non-cash expense | 6.2 | — | 63.9 | 43.8 | |||||||||||
| Gain on sale of fixed assets | — | — | — | (16.0 | ) | ||||||||||
| Total | $ | 12.4 | $ | 23.7 | $ | 82.8 | $ | 189.3 | |||||||
(3)2022 includes a charge of $59 million related to the expensing of an IPR&D asset with no alternative future use licensed from BexCaFe during the second quarter. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. 2021 represents the impact of adjustments to fair value of property and equipment, IPR&D assets, and marketed products that were subject to product rationalization.
(4)2022 includes the finalization of the write-down charge upon the final sale of the Speke manufacturing site. 2021 represents adjustments recorded to write down assets classified as held for sale to an amount equal to fair value less costs to sell. These charges related to our integration effortsShawnee and Speke manufacturing sites. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. Also included are charges recorded to write down assets in Belford Roxo, Brazil; Basel, Switzerland; Cuxhaven, Germany; and Manukau, New Zealand that were classified as held and used to their current fair value. These charges were recorded in connection with announced restructuring programs.
2022 Q2 Form 10-Q | 16 | | |||||||
(5)2022 includes a result$2 million measurement period adjustment to the charge associated with the settlement of a liability for future royalty and milestone payments triggered in connection with our acquisition of KindredBio. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. For the three and six months ended June 30, 2021, charges mainly represent accounting and advisory fees related to the planned sale of our acquired businesses.
The following table summarizes the activity in our reserves established in connection with these restructuring activities:
| Severance | |||||||||||||||||
| Balance at December 31, 2020 | $ | 130 | |||||||||||||||
| Charges | 42 | ||||||||||||||||
| Reserve adjustments | (14) | ||||||||||||||||
| Cash paid | (70) | ||||||||||||||||
| Balance at June 30, 2021 | $ | 88 | |||||||||||||||
| Balance at December 31, 2021 | $ | 126 | |||||||||||||||
| Reserve adjustments | (9) | ||||||||||||||||
| Cash paid | (63) | ||||||||||||||||
| Balance at June 30, 2022 | $ | 54 | |||||||||||||||
| Exit costs | Severance | Total | |||||||||
| Balance at December 31, 2016 | $ | 11.5 | $ | 26.6 | $ | 38.1 | |||||
| Charges | 24.3 | 62.1 | 86.4 | ||||||||
| Cash paid | (7.6 | ) | (61.8 | ) | (69.4 | ) | |||||
| Balance at September 30, 2017 | $ | 28.2 | $ | 26.9 | $ | 55.1 | |||||
| Balance at December 31, 2017 | $ | 34.9 | $ | 43.1 | $ | 78.0 | |||||
| Charges | 11.2 | (2.8 | ) | 8.4 | |||||||
| Separation adjustment | (5.9 | ) | — | (5.9 | ) | ||||||
| Cash paid | (10.9 | ) | (22.6 | ) | (33.5 | ) | |||||
| Balance at September 30, 2018 | $ | 29.3 | $ | 17.7 | $ | 47.0 | |||||
These reserves are included in other current and noncurrent liabilities on our condensed consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next twelve months.12 months primarily due to certain country negotiations and regulations. We believe that the reserves are adequate.
Note 7. Inventories
We state all inventories at the lower of cost or market.net realizable value. We use the last-in, first-out (LIFO) method for a portion of our inventories located in the continental U.S. Other inventories are valued by the first-in, first-out (FIFO) method. FIFOmethod or the weighted average cost approximates current replacement cost.method.
Inventories consisted of the following:
| June 30, 2022 | December 31, 2021 | ||||||||||
| Finished products | $ | 618 | $ | 598 | |||||||
| Work in process | 545 | 565 | |||||||||
| Raw materials and supplies | 222 | 256 | |||||||||
| Total | 1,385 | 1,419 | |||||||||
| Decrease to LIFO cost | (51) | (46) | |||||||||
| Inventories | $ | 1,334 | $ | 1,373 | |||||||
Note 8. Equity
| 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 | |||
On January 22, 2020, we 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 nine months ended September 30, 2018, we recognized $38.6 milliontwo 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 inventory write-offsissuance costs in costadditional paid-in capital. The value allocated to the senior amortizing notes is reflected in current portion of sales primarilylong-term debt on the condensed consolidated balance sheets. 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.
2022 Q2 Form 10-Q | 17 | | |||||||
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. The entire additional 3 million shares are included in diluted weighted average shares outstanding if the applicable market value is at or below $32.00 and the impact is not anti-dilutive.
2022 Q2 Form 10-Q | 18 | | |||||||
Note 8.9. Debt
Long-term debt as of September 30, 2018 consisted of the following:
| June 30, 2022 | December 31, 2021 | ||||||||||
Incremental Term Facility due 2025 (1) | $ | 175 | $ | — | |||||||
| Incremental Term Facility due 2028 | 496 | 499 | |||||||||
Incremental Term Facility due 2029 (2) | 250 | — | |||||||||
| Term Loan B | 4,027 | 4,118 | |||||||||
| Revolving Credit Facility | 75 | 250 | |||||||||
4.272% Senior Notes due 2023 (3) | 344 | 750 | |||||||||
| 4.900% Senior Notes due 2028 | 750 | 750 | |||||||||
| TEU Amortizing Notes | 20 | 34 | |||||||||
| Unamortized debt issuance costs | (74) | (82) | |||||||||
| 6,063 | 6,319 | ||||||||||
| Less current portion of long-term debt | 56 | 294 | |||||||||
| Total long-term debt | $ | 6,007 | $ | 6,025 | |||||||
| 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 | ||
(2)In April 2022, we also entered into an incremental assumption agreement with Farm Credit Mid-America, PCA supplementing and amending our existing credit agreement dated August 1, 2020 relating to our senior secured credit facility. The incremental assumption agreement provides for a $500.0 million three-yearnew incremental term loan under a term credit facility with a syndicatean aggregate principal amount of banks (the Term Facility and collectively with the Revolving Facility, the Credit Facilities.)$250 million maturing on April 19, 2029. The Term Facilitynew incremental term facility bears interest at Term SOFR, including a variable ratecredit spread adjustment, plus margin as defined in Term Facility (3.50% at September 30, 2018)175 basis points and is payable quarterly.in quarterly installments of principal and interest with a final balloon payment due on April 19, 2029. The Term Facility is payableproceeds were used to repay a portion of our outstanding obligations under our revolving credit facility.
(3)In April 2022, we completed a tender offer and retired $406 million in full at the endaggregate principal amount of the term.
We were in compliance with all suchof our debt covenants under the indenture governing the Senior Notes as of SeptemberJune 30, 2018.2022.
Note 9.10. 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 itshad investments without readily determinable fair value.
2022 Q2 Form 10-Q | 19 | | |||||||
The following table summarizes the fair value information at SeptemberJune 30, 20182022 and December 31, 20172021 for contingent consideration liabilitiesforeign exchange contract assets (liabilities), investments, and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items:
| Fair Value Measurements Using | |||||||||||||||||||
| Financial statement line item | Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Fair Value | ||||||||||||||
| September 30, 2018 | |||||||||||||||||||
| Other current liabilities- contingent consideration | $ | 17.4 | $ | — | $ | — | $ | 17.4 | $ | 17.4 | |||||||||
| Other noncurrent liabilities- contingent consideration | 41.4 | — | — | 41.4 | 41.4 | ||||||||||||||
| December 31, 2017 | |||||||||||||||||||
| Other current liabilities- contingent consideration | 1.3 | — | — | 1.3 | 1.3 | ||||||||||||||
| Other noncurrent liabilities- contingent consideration | 45.2 | — | — | 45.2 | 45.2 | ||||||||||||||
| Fair Value Measurements Using | ||||||||||||||||||||||||||||||||
| Financial statement line item | Carrying Amount | Quoted Prices in Active Markets for Identical Assets (Level 1) | Significant Other Observable Inputs (Level 2) | Significant Unobservable Inputs (Level 3) | Fair Value | |||||||||||||||||||||||||||
| June 30, 2022 | ||||||||||||||||||||||||||||||||
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 48 | $ | — | $ | 48 | $ | — | $ | 48 | ||||||||||||||||||||||
| Prepaid expense and other - forward-starting interest rate contracts designated as cash flow hedges | 18 | — | 18 | — | 18 | |||||||||||||||||||||||||||
| Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges | 4 | — | 4 | 0 | 4 | |||||||||||||||||||||||||||
| Other noncurrent assets - investments | 9 | 9 | — | — | 9 | |||||||||||||||||||||||||||
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (48) | — | (48) | — | (48) | |||||||||||||||||||||||||||
| Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | (3) | — | (3) | — | (3) | |||||||||||||||||||||||||||
| Long-term debt, including current portion | (6,137) | — | (5,892) | — | (5,892) | |||||||||||||||||||||||||||
| December 31, 2021 | ||||||||||||||||||||||||||||||||
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 19 | $ | — | $ | 19 | $ | — | $ | 19 | ||||||||||||||||||||||
| Other noncurrent assets - investments | 13 | 13 | — | — | 13 | |||||||||||||||||||||||||||
| Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges | 8 | — | 8 | — | 8 | |||||||||||||||||||||||||||
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | (20) | — | (20) | — | (20) | |||||||||||||||||||||||||||
| Long-term debt, including current portion | (6,401) | — | (6,518) | — | (6,518) | |||||||||||||||||||||||||||
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.
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 value was estimated using a discountedvalues or cash flow analysis and Level 3 inputs, including projections representativeflows 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,underlying exposures. Derivative cash flows, with the amount of royalties to be paid is calculated as a percentageexception of net sales dependent uponinvestment hedges, are principally classified in the timing and geography and will, therefore, vary directlyoperating activities section of the condensed consolidated statements of cash flows, consistent 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 the
2022 Q2 Form 10-Q | 20 | | |||||||
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 Euro, British pound, Swiss franc, Brazilian real, Australian dollar, Japanese yen, Canadian dollar, 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 statements of operations. Forward contracts generally have maturities not exceeding 12 months. At June 30, 2022 and December 31, 2021, we increasedhad outstanding foreign exchange contracts with aggregate notional amounts of $1,085 million and $1,212 million, respectively.
The amount of net gains (losses) on derivative instruments not designated as hedging instruments, recorded in other (income) expense, net were as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
Foreign exchange forward contracts (1) | $ | (7) | $ | 7 | $ | (15) | $ | (27) | |||||||||||||||
(1)These amounts were substantially offset in other (income) expense, net by the effect of changing exchange rates on the underlying foreign currency exposures.
Derivatives designated as hedges
We are subject to interest rate risk with regard to our existing floating-rate debt, and we utilize interest rate swap contracts to mitigate the variability in cash flows by effectively converting the floating-rate debt into fixed-rate debt. We recognize any differences between the variable interest rate payments and the fixed interest rate settlements with the swap counterparties as an adjustment to interest expense, net of capitalized interest over the life of the swaps. We have designated these swaps as cash flow hedges and record them at fair value on the condensed consolidated balance sheets. Changes in the fair value of the contingent consideration liabilities by $8.5 million. The additional expense washedges are recognized in other-net (income) expense.
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Forward-starting interest rate swaps | $ | 8 | $ | (5) | $ | 117 | $ | 48 | |||||||||||||||
During the periods presentedthree months ended June 30, 2022 and 2021, net gains (losses) on cash flow hedges recorded in other comprehensive income (loss) included an unrealized gain of $33 million and an unrealized loss of $5 million, respectively, related to mark-to-market adjustments. During the unaudited condensed consolidatedsix months ended June 30, 2022 and combined financial statements,2021, net gains (losses) on cash flow hedges recorded in other comprehensive income (loss) included unrealized gains of $143 million and $48 million, respectively, related to mark-to-market adjustments.
In April 2022, we took advantage of market opportunities to restructure our operations were generally includedinterest rate swap portfolio. We unwound the existing swaps and simultaneously entered into new agreements with the same notional amounts and covering the same tenors. As a result, we received a cash settlement of $132 million. This gain was initially recognized in accumulated other comprehensive loss and will be reclassified to interest expense, net of capitalized interest over the tax groupingperiod during which the related interest payments will be made.
2022 Q2 Form 10-Q | 21 | | |||||||
Additionally, as a result of the April 2022 interest rate swap settlement, other Lilly entities within the respective entity's tax jurisdiction; however, in certain jurisdictions, we filed separate tax returns. Prior to the Separation, thecomprehensive income tax expense included in these financial statements has been calculated using the separate return basis as if Elanco filed separate tax returns.
During the three months ended June 30, 2022 and 2021, we incurred $18.6reclassified $7 million of net losses into interest expense, net of capitalized interest in our condensed consolidated statements of operations. During the six months ended June 30, 2022 and 2021, we reclassified $10 million and $46.2$14 million, respectively, of income taxnet losses into interest expense. ForOver the three and ninenext 12 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.
Note 11. Income Taxes
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Income tax expense (benefit) | $ | 4 | $ | (26) | $ | 27 | $ | (45) | ||||||||||||||||||
| Effective tax rate | (22.5) | % | 11.1 | % | 50.7 | % | 14.2 | % | ||||||||||||||||||
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.
For the three and six months ended June 30, 2022, we recognized income tax expense of $4 million and $27 million, respectively. Our effective tax rate of (22.5)% and 50.7%, respectively, differs from the statutory income tax rate largely due to changes in the earnings mix between periods resulting in projected losses in the U.S. The U.S. federal and state losses are subject to valuation allowances. The income tax expense was partially offset by the $17 million income tax benefit reclassified from accumulated other comprehensive loss due to the termination of interest rate swaps during the period.
For the three and six months ended June 30, 2021, we recognized an income tax benefit of $26 million and $45 million, respectively. Our effective tax rate of 11.1% and 14.2%, respectively, differs from the statutory income tax rate primarily because the U.S. federal and state jurisdictions were currently generating losses that were subject to valuation allowances.
Note 12. 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 and certain executives. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint adding additional claims against Elanco, certain executives, and other individuals. 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. 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.
2022 Q2 Form 10-Q | 22 | | |||||||
On October 16, 2020, a shareholder class action lawsuit captioned Saffron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives, and other individuals. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the next twelve months, the IRS examinationregistration statement on Form S-3 dated January 21, 2020 and accompanying prospectus filed in connection with Elanco’s public offering which closed on or about January 27, 2020. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of tax years 2013-2015 remains ongoing. For periods prior to the Separation, Lilly will retain the liabilities related to such IRS audit resolutions.
Claims seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC, along with other Elanco and Bayer entities, arising out of the use of Seresto™, a tax matters agreement (TMA) with Lillynon-prescription flea and tick collar for cats and dogs. During 2021, putative class action lawsuits were filed in federal courts in the U.S. alleging that among other things, formalized our agreementthe Seresto collars contain pesticides 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. In August 2021, the lawsuits were consolidated by the Judicial Panel on Multidistrict Litigation, and the cases were transferred to the Northern District of Illinois. We are vigorously defending these lawsuits.
Further, in March 2021, a U.S. House of Representatives subcommittee chair requested that Elanco produce certain documents and information related to the responsibility for historical tax positions forSeresto collar and further made a request to temporarily recall Seresto collars from the periods priormarket. On June 15, 2022, the subcommittee held a hearing at which our President and Chief Executive Officer (CEO) testified. During and after the hearing, the subcommittee chair repeated his request that Elanco voluntarily recall the collars and also requested that the Environmental Protection Agency (EPA) commence administrative proceedings that would allow the EPA to remove Seresto from the market.
Seresto is a pesticide registered with the EPA. A non-profit organization submitted a petition to the SeparationEPA requesting that the agency take action to cancel Seresto’s pesticide registration and suspend the registration pending cancellation. The EPA is considering this petition and asked for jurisdictions where our business was included inpublic comment. We submitted a comment to the consolidatedEPA supporting the safety profile of Seresto. 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, recall, or combined tax returnscancellation of Lilly. The TMA also established a tax sharing agreement for jurisdictions where our business willthe pesticide registration 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 period of time.Seresto, and it remains available to consumers globally.
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 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 Septembercosts. As of June 30, 20182022 and December 31, 2017,2021, we had no 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.
Regulatory Matters
On July 1, 2021, we received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We have cooperated in providing documents and information to the SEC and will continue to do so. Management believes that its actions were appropriate.
Other Commitments
As of June 30, 2022, we have a lease commitment that has not yet commenced for our new corporate headquarters in Indianapolis, Indiana. Total minimum lease payments are estimated to be approximately $310 million over a term of 25 years, excluding extensions. Final lease payments may vary depending on the actual cost of certain construction activities. Lease commencement is expected in 2024.
2022 Q2 Form 10-Q | 23 | | |||||||
The land for our new corporate headquarters is located in a Tax Increment Finance District, and the project is, in part, funded through Tax Incremental Financing (TIF) through an incentive agreement between us and the City of Indianapolis. The agreement provides for an estimated total incentive of $64 million to be funded by the City of Indianapolis in connection with the future tax increment revenue generated from the developed property. In December 2021, as part of a funding and development agreement entered into between us and the developer, we made a commitment to use the expected TIF proceeds towards the cost of developing and constructing the headquarters. In exchange, the developer reimbursed us up to the $64 million commitment in 2021. We expect to refund approximately $15 million to the developer within the next 12 months, and this amount is included in other current liabilities on our condensed consolidated balance sheet as of June 30, 2022. As a result, it is our expectation that our future lease payments will be reduced. The remaining accrued incentive is included in other noncurrent liabilities on our condensed consolidated balance sheets and will be amortized over the lease term beginning at the commencement date and offset future rent expense.
Note 12.13. Geographic Information
We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both food animalspets and companionfarm animals. Consistent with our operational structure, our President and Chief Executive Officer (CEO),CEO, as the chief operating decision maker, makes resource allocation and business process decisions globally across our consolidated business. Strategic decisions are managed globally with global functional leaders responsible for determining significant cost/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®AviPro™, Optaflexx®Baytril™, Denagard®Cydectin™, Tylan®Catosal™, Maxiban®Denagard™, Maxiban™, Rumensin™, Pulmotil™, 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% and 9.4%10% of revenue for the three months ended SeptemberJune 30, 20182022 and 2017, respectively,2021, and for 11.5%10% and 11.9%8% of revenue for the ninesix months ended SeptemberJune 30, 20182022 and 2017,2021, respectively. The productProduct sales with this customer resulted in accounts receivable with this customer of $79.5$78 million and $88.0$74 million as of SeptemberJune 30, 20182022 and December 31, 2017,2021, 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 June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Revenue | |||||||||||||||||||||||
| United States | $ | 539 | $ | 581 | $ | 1,061 | $ | 1,114 | |||||||||||||||
| International | 638 | 698 | 1,341 | 1,407 | |||||||||||||||||||
| Revenue | $ | 1,177 | $ | 1,279 | $ | 2,402 | $ | 2,521 | |||||||||||||||
| 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 | |||
2022 Q2 Form 10-Q | 24 | | |||||||
Note 14. Retirement Benefits
The following table summarizes net periodic benefit cost (income) relating to the countries based on the locationour defined benefit pension plans:
| Three Months Ended June 30, | Six Months Ended June 30, | ||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||
| Service cost | $ | 3 | $ | 5 | $ | 7 | $ | 10 | |||||||||||||||
| Interest cost | 1 | — | 2 | 1 | |||||||||||||||||||
| Expected return on plan assets | (1) | (1) | (3) | (3) | |||||||||||||||||||
| Amortization of prior service cost | (1) | (2) | (2) | (4) | |||||||||||||||||||
| Amortization of net actuarial loss | — | — | — | 1 | |||||||||||||||||||
| Net curtailments and settlements (Note 6) | — | (8) | — | (17) | |||||||||||||||||||
| Net periodic benefit cost (income) | $ | 2 | $ | (6) | $ | 4 | $ | (12) | |||||||||||||||
The components of the customer.net periodic benefit cost (income) other than service cost and net curtailments and settlements are included in other (income) expense, net in our condensed consolidated statements of operations. Net curtailments and settlements are included in asset impairment, restructuring and other special charges in our condensed consolidated statements of operations.
Note 13.15. Earnings (Loss) Per Share
We have calculatedcompute basic earnings (loss) per share by dividing net income (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 8: 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 allis calculated using the treasury stock method. Potential common shares that would have the effect of increasing diluted earnings per share (or reducing loss per share) are considered to be anti-dilutive and as such, these shares are not included in the calculation of diluted earnings (loss) per share.
Basic and diluted earnings (loss) per share are calculated as follows:
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| 2022 | 2021 | 2022 | 2021 | |||||||||||||||||||||||
| Net income (loss) available to common shareholders | $ | (22) | $ | (210) | $ | 26 | $ | (271) | ||||||||||||||||||
| Determination of shares: | ||||||||||||||||||||||||||
| Weighted average common shares outstanding | 488.4 | 487.3 | 488.2 | 487.0 | ||||||||||||||||||||||
Assumed conversion of dilutive common stock equivalents (1) | — | — | 3.9 | — | ||||||||||||||||||||||
| Diluted weighted average shares outstanding | 488.4 | 487.3 | 492.1 | 487.0 | ||||||||||||||||||||||
Earnings (loss) per share (2) | ||||||||||||||||||||||||||
| Basic | $ | (0.04) | $ | (0.43) | $ | 0.05 | $ | (0.56) | ||||||||||||||||||
| Diluted | $ | (0.04) | $ | (0.43) | $ | 0.05 | $ | (0.56) | ||||||||||||||||||
(1)For periods presented. This represents an aggregate of 293,290,000 shares of ourwith a reported net loss, dilutive common stock held by Lilly (which represents the 100 shares held by Lilly priorequivalents are not assumed to givinghave been issued since their effect to the 2,932,900-for-1 stock split that occurred on September 19, 2018), the issuance of 62,900,000 shares of our common stock in the IPO, and the issuance of 9,435,000 shares of our common stock sold pursuant to the underwriters’ option to purchase additional shares.
(2)Due to rounding conventions, earnings (loss) per share may not recalculate precisely based on the financing by Lilly 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.amounts presented within this table.
| 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 | |||||||
2022 Q2 Form 10-Q | 25 | | |||||||
Table of manufacturing support from us to Lilly of $1.3 million and $1.5 million for the three months ended September 30, 2018 and 2017, respectively, as well as $3.7 million and $4.5 million for the nine months ended September 30, 2018 and 2017, respectively, reduced the cost of sales in the unaudited condensed consolidated and combined statements of operations.Contents
Overview
Elanco is a premierglobal animal health company that innovates, develops manufactures and markets products for companionpets and food animals. Headquartered in Greenfield, Indiana, we are the fourth largest animal health company in the world. We have one of the broadest portfolios of pet parasiticides in the companion animal sector. We offer a diverse portfolio of more than 125 brands that make us a trusted partner to veterinarians and food animal producersfarm animals in more than 90 countries.
With a heritage dating back to 1954, we rigorously innovate to improve the health of animals and to benefit our customers while fostering an inclusive, cause-driven culture for our employees. We operate our business in a single segment directed at fulfilling our vision of enriching the lives of people through food, - making protein more accessible and affordable, - and through pet companionship, - helping pets live longer, healthier lives.
On August 27, 2021, we acquired KindredBio, a biopharmaceutical company that develops innovative biologics focused on saving and improving the lives of pets. We had previously signed an agreement with KindredBio in the second quarter of 2021 to acquire exclusive global rights to KIND-030, a monoclonal antibody in development for the treatment and prevention of canine parvovirus. The acquisition of KindredBio further accelerates our opportunity for expansion in pet health, notably by expanding our research efforts in dermatology. See Note 5: Acquisitions, Divestitures and Other Arrangements to the condensed consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of KindredBio.
On August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure.
We offer a diverse portfolio of approximately 200 brands that make us a trusted partner to pet owners, veterinarians and farm animal producers. Our products are generally sold worldwide to third-party distributors and independent 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 food and companionship enriching life – all to advance the health of animals, people and the planet. We advance our vision by offering products in fourthese two primary categories:
Pet Health: Our pet health 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 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.
2022 Q2 Form 10-Q | 26 | | |||||||
Farm Animal Future Protein & Health (FA Future Protein & Health): Our farm animal portfolio in this category, which includes vaccines, nutritional enzymesconsists of products designed to prevent, control and animal only antibiotics, serves the growing demand for proteintreat health challenges primarily focused on cattle (beef and includes innovative products indairy), swine, poultry, and aquaculture production, where demand for animal health(cold and warm water) production. Our products is outpacing overall industry growth. We are focused on developing functional nutritional health products that promote food animal health, includinginclude medicated feed additives, injectable antibiotics, vaccines, insecticides, and enzymes, probiotics and prebiotics. We are a leader in providing vaccines as alternatives to antibiotics to promote animal health based on share of revenue.
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | 2022 | 2021 | ||||||||||||||||||||||
| Revenue | $ | 1,177 | $ | 1,279 | $ | 2,402 | $ | 2,521 | ||||||||||||||||||
| Net income (loss) | (22) | (210) | 26 | (271) | ||||||||||||||||||||||
Increases or decreases in inventory levels at our channel distributors can positively or negatively impact our quarterly and $(20.7) million, respectively.annual revenue results, leading to variations in revenues. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the need for certain inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, payment terms we extend, which are subject to internal policies, and 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 pets and farm animals, is a growing industry that benefits billions of people worldwide.
We believe that factors influencing growth in demand for pet medicines and vaccines include:
•increased pet ownership globally;
•pets living longer; and
•increased pet spending as pets are viewed as members of the nine months ended September 30, 2018family by owners.
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 2017, our revenue was $2,267.5 millionvaccines include:
•two in three people needing improved nutrition;
•increased global demand for protein, particularly poultry and $2,134.7 million, respectively, Foraquaculture;
•natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, driving the nine months ended September 30, 2018need for more efficient food production;
•loss of productivity due to farm animal disease and 2017 our net income (loss) was $70.1 milliondeath;
•increased focus on food safety and $(149.2) million, respectively.food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.
Growth in 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.
2022 Q2 Form 10-Q | 27 | | |||||||
Factors Affecting Our Results of Operations
Russia-Ukraine Conflict
In February 2022, Russia commenced military action against Ukraine. In response, the U.S. and certain other countries imposed and continue to impose significant sanctions and export controls against Russia, Belarus and certain individuals and entities connected to Russian or Belarusian political, business, and financial organizations. The U.S. and certain other countries could impose further sanctions, trade restrictions, and other retaliatory actions if the conflict continues or worsens. The broader consequences of the conflict, including related inflationary pressures, geopolitical tensions, additional retaliatory actions taken by the U.S. and other countries, and any counter retaliatory actions by Russia or Belarus in response, including, for example, potential cyberattacks or the disruption of energy and commodity exports, are likely to cause regional instability and could materially adversely affect global trade, currency exchange rates, regional economies and the global economy. The situation remains uncertain and it is difficult to predict the impact that the conflict and actions taken in response to the conflict will have on our business; however, they could increase our costs, disrupt our supply chain, reduce our sales and earnings, or otherwise adversely affect our business and results of operations.
As a global animal health leader, we have an obligation to support the health of animals and people. At the center of that work is ensuring access and availability of food. At this time, we are limiting our business in Russia to only the essential products that support these needs, while complying with all imposed sanctions. We do not manufacture products or source any materials from companies in Russia for use in our products, nor do we conduct business with the Russian government. During the six months ended June 30, 2022, revenue to Russian and Ukrainian customers represented approximately 1% of our consolidated revenue. Assets held in Russia as of June 30, 2022 represented less than 1% of our consolidated assets.
COVID-19 Pandemic and Resulting Operating Environment
We continue to closely monitor the impact of the COVID-19 pandemic, including its variants, and the related economic effects on all aspects of our business, including impacts on our operations, supply chain, and customer demand. The extent to which the COVID-19 pandemic may impact our financial condition and results of operations remains uncertain and is dependent on developments that are out of our control, including measures being taken by authorities to mitigate against the spread of COVID-19, such as the recent lockdowns in China, the emergence of new variants and the availability and successful administration of effective vaccines. We cannot predict the impact that the ongoing COVID-19 pandemic will have on our employees, customers, vendors and suppliers; however, the COVID-19 pandemic has had and may continue to have an adverse impact on our business if these parties continue to experience negative effects.
While the situation surrounding the COVID-19 pandemic remains fluid, the effects have disrupted the global supply chain across all modes of transportation, which in turn has resulted in less reliable transportation schedules and increased freight costs. This disruption, combined with increased demand for key raw materials, including those used in COVID-19 vaccine manufacturing, and labor constraints has also impacted our suppliers, resulting in shortages of raw materials or components required to manufacture our products. We continue to work closely with suppliers and freight partners to mitigate impacts to our operations and customers, including the addition of new transportation routes and targeted increases of certain safety stocks. Although we regularly monitor the financial health of companies in our supply chain, prolonged financial hardship on our suppliers and labor shortages could continue to disrupt our ability to obtain key raw materials, adversely affecting our operations. The global industry freight environment has experienced, and could continue to experience, lead time disruptions and increases in shipping costs, negatively impacting our profitability.
Our Acquisition of Bayer Animal Health and KindredBio
We have incurred and expect to continue to incur expenses in connection with our acquisitions of Bayer Animal Health and KindredBio, including fees for professional services such as legal, accounting, consulting, and other advisory fees and expenses. Expenses incurred in 2021 and thus far in 2022 are primarily related to integration activities. In addition, we have incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics and to expand administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by the former parent company of Bayer Animal Health. We anticipate that these additional costs will be partially offset by expected synergies.
2022 Q2 Form 10-Q | 28 | | |||||||
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, and 12 manufacturing and eight R&D sites. The acquisitions of Bayer Animal Health on August 1, 2020 and KindredBio on August 27, 2021 added 3,950 full-time employees, 10 manufacturing sites, and five R&D sites (before company-wide restructuring activities initiated in 2020 and 2021). In addition, from 2015 to 2021, 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 and administrative such as rationalization of stock keeping units, reduction of contractfunctions. Our manufacturing organizations, implementation ofcost savings strategies included improving manufacturing processes and headcount through lean manufacturing principles(minimizing waste while maintaining productivity), closing and procurement initiatives.selling manufacturing sites, consolidating our CMO network, strategically insourcing certain projects, and pursuing cost savings opportunities through alternate sources of supply. Additional cost savings have resulted from reducing the number of R&D sites, sales force consolidation and reducing discretionary and other general and administrative operating expenses.
Seasonality
The results of our pet health business may fluctuate due to seasonality. For example, based upon historical results, approximately 70% and 60% of total annual revenue contributed by our higher-margin parasiticide products Seresto and Advantage Family, respectively, has occurred during the first half of the year, which is reflective of the flea and tick season in the Northern Hemisphere. Therefore, a period-to-period comparison of our historical results may not be meaningful and fluctuations in total revenue for our pet health products are not necessarily an indication of future performance.
2022 Q2 Form 10-Q | 29 | | |||||||
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 ninesix months ended SeptemberJune 30, 20182022 and 2017,2021, approximately 51.1%52% and 50.6%51%, respectively, of our revenue was denominated in foreign currencies. As we operate in multiple foreign currencies, including the Euro, British pound, Swiss franc, Brazilian real, Australian dollar, Japanese yen, Canadian dollar, Chinese yuan, and other currencies, changes in those currencies relative to the U.S. dollar impact our revenue, cost of goodssales and expenses, and consequently, net income. These fluctuations may also affect the ability to buy and sell our products between markets impacted by significant exchange rate variances. There has beenCurrency movements decreased revenue by 4% during the six months ended June 30, 2022. Currency movements had a limited impact on our results due to currency movementsrevenue during the ninesix months ended SeptemberJune 30, 2018 and 2017.2021.
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 June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Three Months Ended September 30, | % | Nine Months Ended September 30, | % | |||||||||||||||||||||||||||||||||||||||||||||||||||||
| 2018 | 2017 | Change | 2018 | 2017 | Change | |||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | |||||||||||||||||||||||||||||||||||||||||||||||||
| Revenue | $ | 761.1 | $ | 697.1 | 9 | % | $ | 2,267.5 | $ | 2,134.7 | 6 | % | Revenue | $ | 1,177 | $ | 1,279 | (8) | % | $ | 2,402 | $ | 2,521 | (5) | % | |||||||||||||||||||||||||||||||
| Costs, expenses and other: | Costs, expenses and other: | |||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Cost of sales | 369.8 | 376.2 | (2 | )% | 1,161.3 | 1,088.9 | 7 | % | Cost of sales | 484 | 551 | (12) | % | 993 | 1,120 | (11) | % | |||||||||||||||||||||||||||||||||||||||
| % of revenue | 49 | % | 54 | % | (5 | )% | 51 | % | 51 | % | — | % | % of revenue | 41 | % | 43 | % | (2) | % | 41 | % | 44 | % | (3) | % | |||||||||||||||||||||||||||||||
| Research and development | 58.9 | 61.9 | (5 | )% | 185.5 | 189.7 | (2 | )% | Research and development | 82 | 94 | (13) | % | 163 | 183 | (11) | % | |||||||||||||||||||||||||||||||||||||||
| % of revenue | 8 | % | 9 | % | (1 | )% | 8 | % | 9 | % | (1 | )% | % of revenue | 7 | % | 7 | % | — | % | 7 | % | 7 | % | — | % | |||||||||||||||||||||||||||||||
| Marketing, selling and administrative | 179.0 | 194.7 | (8 | )% | 550.1 | 583.0 | (6 | )% | Marketing, selling and administrative | 343 | 385 | (11) | % | 663 | 733 | (10) | % | |||||||||||||||||||||||||||||||||||||||
| % of revenue | 24 | % | 28 | % | (4 | )% | 24 | % | 27 | % | (3 | )% | % of revenue | 29 | % | 30 | % | (1) | % | 28 | % | 29 | % | (1) | % | |||||||||||||||||||||||||||||||
| Amortization of intangible assets | 48.7 | 51.6 | (6 | )% | 147.3 | 161.0 | (9 | )% | Amortization of intangible assets | 133 | 129 | 3 | % | 270 | 276 | (2) | % | |||||||||||||||||||||||||||||||||||||||
| % of revenue | 6 | % | 7 | % | (1 | )% | 6 | % | 8 | % | (1 | )% | % of revenue | 11 | % | 10 | % | 1 | % | 11 | % | 11 | % | — | % | |||||||||||||||||||||||||||||||
| Asset impairment, restructuring and other special charges | 12.4 | 23.7 | (48 | )% | 82.8 | 189.3 | (56 | )% | Asset impairment, restructuring and other special charges | 86 | 299 | (71) | % | 132 | 407 | (68) | % | |||||||||||||||||||||||||||||||||||||||
| Other - (income) expense | 13.5 | (1.9 | ) | NM | 24.2 | — | NM | |||||||||||||||||||||||||||||||||||||||||||||||||
| Income (loss) before taxes | 78.8 | (9.1 | ) | NM | 116.3 | (77.2 | ) | NM | ||||||||||||||||||||||||||||||||||||||||||||||||
| Interest expense, net of capitalized interest | Interest expense, net of capitalized interest | 67 | 60 | 12 | % | 119 | 121 | (2) | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Other (income) expense, net | Other (income) expense, net | — | (3) | NM | 9 | (3) | NM | |||||||||||||||||||||||||||||||||||||||||||||||||
| Income (loss) before income taxes | Income (loss) before income taxes | (18) | (236) | 92 | % | 53 | (316) | 117 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| % of revenue | 10 | % | (1 | )% | 11 | % | 5 | % | (4 | )% | NM | % of revenue | (2) | % | (18) | % | 16 | % | 2 | % | (13) | % | 15 | % | ||||||||||||||||||||||||||||||||
| Income tax expense | 18.6 | 11.6 | 60 | % | 46.2 | 72.0 | (36 | )% | ||||||||||||||||||||||||||||||||||||||||||||||||
| Income tax expense (benefit) | Income tax expense (benefit) | 4 | (26) | 115 | % | 27 | (45) | 160 | % | |||||||||||||||||||||||||||||||||||||||||||||||
| Net income (loss) | $ | 60.2 | $ | (20.7 | ) | NM | $ | 70.1 | $ | (149.2 | ) | NM | Net income (loss) | $ | (22) | $ | (210) | 90 | % | $ | 26 | $ | (271) | 110 | % | |||||||||||||||||||||||||||||||
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful
2022 Q2 Form 10-Q | 30 | | |||||||
Disaggregated Revenue
On a global basis, our revenue within ourby product categories was as follows:
| Three Months Ended September 30, | % | Nine Months Ended September 30, | % | ||||||||||||||||||
| 2018 | 2017 | Change | 2018 | 2017 | Change | ||||||||||||||||
| CA Disease Prevention | $ | 188.6 | $ | 140.4 | 34 | % | $ | 603.9 | $ | 519.7 | 16 | % | |||||||||
| CA Therapeutics | 80.5 | 63.5 | 27 | % | 211.1 | 181.8 | 16 | % | |||||||||||||
| FA Future Protein & Health | 162.8 | 164.5 | (1 | )% | 502.1 | 456.0 | 10 | % | |||||||||||||
| FA Ruminants & Swine | 301.5 | 280.4 | 8 | % | 881.1 | 857.3 | 3 | % | |||||||||||||
| Subtotal | 733.4 | 648.8 | 13 | % | 2,198.2 | 2,014.8 | 9 | % | |||||||||||||
Strategic Exits (1) | 27.7 | 48.3 | (42 | )% | 69.3 | 119.9 | (42 | )% | |||||||||||||
| Total | $ | 761.1 | $ | 697.1 | 9 | % | $ | 2,267.5 | $ | 2,134.7 | 6 | % | |||||||||
| Revenue | % of Total Revenue | Increase (Decrease) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | 2022 | 2021 | $ Change | % Change | CER (1) | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 612 | $ | 685 | 52 | % | 54 | % | $ | (73) | (11) | % | (7) | % | |||||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 553 | 567 | 47 | % | 44 | % | (14) | (2) | % | 3 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 1,165 | 1,252 | 99 | % | 98 | % | (87) | (7) | % | (3) | % | ||||||||||||||||||||||||||||||||||||||||||||||||
Contract Manufacturing (2) | 12 | 27 | 1 | % | 2 | % | (15) | (56) | % | (53) | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,177 | $ | 1,279 | 100 | % | 100 | % | (102) | (8) | % | (4) | % | ||||||||||||||||||||||||||||||||||||||||||||||
Note: Numbers may not add due to higher realized prices and a 7% increase due to higher volumes partially offset by a 2% unfavorable foreignrounding
(1)Constant exchange rate impact.
(2)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
On a global basis, the effect of price, foreign exchange rates and volumes on changes in revenue for the three months ended June 30, 2022 and 2021 was as follows:
Three months ended June 30, 2022 (Dollars in millions) | Revenue | Price | FX Rate | Volume | Total | CER | ||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 612 | 1% | (4)% | (8)% | (11)% | (7)% | |||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 553 | 2% | (5)% | 1% | (2)% | 3% | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 1,165 | 1% | (4)% | (4)% | (7)% | (3)% | ||||||||||||||||||||||||||||||||||||||||||||
| Contract Manufacturing | 12 | —% | (2)% | (53)% | (56)% | (53)% | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,177 | 1% | (4)% | (5)% | (8)% | (4)% | |||||||||||||||||||||||||||||||||||||||||||
Three months ended June 30, 2021 (Dollars in millions) | Revenue | Price | FX Rate | Volume (1) | Total | CER | ||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 685 | 6% | 3% | 161% | 170% | 167% | |||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 567 | —% | 6% | 73% | 79% | 73% | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 1,252 | 2% | 5% | 112% | 120% | 115% | ||||||||||||||||||||||||||||||||||||||||||||
| Contract Manufacturing | 27 | —% | —% | 69% | 69% | 69% | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 1,279 | 2% | 5% | 111% | 118% | 114% | |||||||||||||||||||||||||||||||||||||||||||
Note: Numbers may not add due to rounding
(1)Impact of 2021 revenue from Bayer Animal Health is reflected in volume.
2022 Q2 Form 10-Q | 31 | | |||||||
On a global basis, our revenue by product category for the six months ended June 30, 2022 and 2021 is summarized as follows:
| Revenue | % of Total Revenue | Increase (Decrease) | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | 2022 | 2021 | $ Change | % Change | CER | ||||||||||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 1,251 | $ | 1,330 | 52 | % | 53 | % | $ | (79) | (6) | % | (3) | % | |||||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 1,122 | 1,145 | 47 | % | 45 | % | (23) | (2) | % | 2 | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 2,373 | 2,475 | 99 | % | 98 | % | (102) | (4) | % | — | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Contract Manufacturing | 29 | 46 | 1 | % | 2 | % | (17) | (37) | % | (34) | % | ||||||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 2,402 | $ | 2,521 | 100 | % | 100 | % | (119) | (5) | % | (1) | % | ||||||||||||||||||||||||||||||||||||||||||||||
Note: Numbers may not add due to rounding
On a global basis, the effect of price, foreign exchange rates and volumes on changes in revenue for the six months ended June 30, 2022 and 2021 was as follows:
Six months ended June 30, 2022 (Dollars in millions) | Revenue | Price | FX Rate | Volume | Total | CER | ||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 1,251 | 1% | (3)% | (4)% | (6)% | (3)% | |||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 1,122 | 1% | (4)% | —% | (2)% | 2% | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 2,373 | 1% | (4)% | (2)% | (4)% | —% | ||||||||||||||||||||||||||||||||||||||||||||
| Contract Manufacturing | 29 | —% | (2)% | (34)% | (37)% | (34)% | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 2,402 | 1% | (4)% | (2)% | (5)% | (1)% | |||||||||||||||||||||||||||||||||||||||||||
Six months ended June 30, 2021 (Dollars in millions) | Revenue | Price | FX Rate | Volume (1) | Total | CER | ||||||||||||||||||||||||||||||||||||||||||||
| Pet Health | $ | 1,330 | 4% | 2% | 183% | 189% | 187% | |||||||||||||||||||||||||||||||||||||||||||
| Farm Animal | 1,145 | 1% | 3% | 49% | 53% | 50% | ||||||||||||||||||||||||||||||||||||||||||||
| Subtotal | 2,475 | 2% | 2% | 100% | 105% | 102% | ||||||||||||||||||||||||||||||||||||||||||||
| Contract Manufacturing | 46 | —% | —% | 31% | 31% | 31% | ||||||||||||||||||||||||||||||||||||||||||||
| Total | $ | 2,521 | 2% | 2% | 98% | 103% | 100% | |||||||||||||||||||||||||||||||||||||||||||
Note: Numbers may not add due to rounding
(1)Impact of 2021 revenue from Bayer Animal Health is reflected in volume.
Revenue
Pet Health revenue decreased by $73 million, or 11%, for the three months ended June 30, 2022, driven by a decrease in volume and an unfavorable impact from foreign exchange rates, partially offset by an increase in price. On a constant currency basis, the decrease of 7% was primarily attributable to lower volumes in U.S. parasiticides, driven by declines in older generation products, supply chain disruptions for certain products and increased competition.
Pet Health revenue of $17.5decreased by $79 million, or 28%6%, for the six months ended June 30, 2022, driven by a decrease in volume and an unfavorable impact from CA Therapeuticsforeign exchange rates, partially offset by an increase in price. On a constant currency basis, the decrease of 3% was primarily attributable to lower volumes in U.S. parasiticides, driven by declines in older generation products, excludingsupply chain disruptions for certain products and increased competition.
Farm Animal revenue decreased by $14 million, or 2%, for the three months ended June 30, 2022, driven by an unfavorable impact from foreign exchange rates, partially offset by increases in price and volume. On a constant currency basis, growth was driven by increased demand for ruminant products internationally, most notably sheep products, and certain customer programs that shifted sales expected in the third quarter of 2022 into the second quarter of 2022, partially offset by a continued decline in demand in the swine market, particularly in China, which began in the second half of 2021, as well as increased competition in the European swine market.
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Farm Animal revenue decreased by $23 million, or 2%, for the six months ended June 30, 2022, driven by an unfavorable impact from foreign exchange rates, partially offset by an increase in price. On a constant currency basis, growth was driven by improved producer demand and innovation in poultry and strong aqua demand during the first quarter of 2022. Growth was also favorably impacted by increased demand for ruminant products internationally, most notably sheep products, and certain customer programs that shifted sales expected in the third quarter of 2022 into the second quarter of 2022. These increases were partially offset by a continued decline in demand in the swine market, particularly in China, which began in the second half of 2021, as well as the impact of generic competition on price for certain cattle brands and increased competition in the European swine market.
Cost of Sales
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Cost of sales | $ | 484 | $ | 551 | (12) | % | $ | 993 | $ | 1,120 | (11) | % | ||||||||||||||||||||||||||
| % of revenue | 41 | % | 43 | % | 41 | % | 44 | % | ||||||||||||||||||||||||||||||
Cost of sales as a percentage of revenue decreased for the three months ended June 30, 2022, primarily due to improvements in manufacturing productivity, price, and the effect of foreign exchange rates on international inventories sold, partially offset by unfavorable product mix and inflationary impacts on input costs, freight and conversion costs.
Cost of sales as a percentage of revenue decreased for the six months ended June 30, 2022, primarily due to amortization of the fair value adjustment of $63 million recorded from the acquisition of Bayer Animal Health in the first half of 2021, price, improvements in manufacturing productivity and the effect of foreign exchange rates on international inventories sold, partially offset by unfavorable product mix and inflationary impacts on input costs, freight and conversion costs. Excluding the $63 million fair value adjustment for the six months ended June 30, 2021, cost of sales as a percentage of revenue would have been approximately 42%.
Research and Development
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Research and development | $ | 82 | $ | 94 | (13) | % | $ | 163 | $ | 183 | (11) | % | ||||||||||||||||||||||||||
| % of revenue | 7 | % | 7 | % | 7 | % | 7 | % | ||||||||||||||||||||||||||||||
R&D expenses decreased $12 million and $20 million for the three and six months ended June 30, 2022, respectively. R&D expenses were favorably impacted by cost savings realized as a result of 2021 restructuring activities, lower professional service costs due the rationalization of certain R&D projects, and the impact of foreign exchange rates;exchange.
Marketing, Selling and Administrative
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Marketing, selling and administrative | $ | 343 | $ | 385 | (11) | % | $ | 663 | $ | 733 | (10) | % | ||||||||||||||||||||||||||
| % of revenue | 29 | % | 30 | % | 28 | % | 29 | % | ||||||||||||||||||||||||||||||
Marketing, selling and administrative expenses decreased $42 million and $70 million for the three and six months ended June 30, 2022, respectively, primarily driven by disciplined cost management across the business, cost savings realized as a result of 2021 restructuring activities, changes in revenue of $2.8 million or 2% from FA Future Protein & Health products, excluding the impact foreign exchange rates;our promotional programs which resulted in a decrease in marketing expense, and
2022 Q2 Form 10-Q | 33 | | |||||||
Amortization of Intangible Assets
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Amortization of intangible assets | $ | 133 | $ | 129 | 3 | % | $ | 270 | $ | 276 | (2) | % | ||||||||||||||||||||||||||
Amortization of intangible assets increased $4 million for the three months ended June 30, 2022, primarily due to the negative impacttiming of foreign exchange rates; and
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Asset impairment, restructuring and other special charges | $ | 86 | $ | 299 | (71) | % | $ | 132 | $ | 407 | (68) | % | ||||||||||||||||||||||||||
For additional information regarding our asset impairment, restructuring and other special charges, see Note 6: Asset Impairment, Restructuring and Other Special Charges to our unauditedthe condensed consolidated and combined financial statements.
Asset impairment, restructuring and other special charges decreased $11.3$213 million for the three months ended SeptemberJune 30, 2018 as compared2022, primarily due to a $265 million charge recorded during the three months ended SeptemberJune 30, 2017 primarily2021 to write down assets at our Shawnee and Speke manufacturing sites that were classified as held for sale to an amount equal to fair value less costs to sell, as well as a period over period decrease in overall acquisition-related charges, which include transaction costs related to acquisitions and costs associated with the implementation of new systems, programs, and processes due to decreased severance,both our separation from Lilly and the integration and exit costs,of Bayer Animal Health. These decreases were partially offset by highera one-time charge of $59 million related to the expensing of an IPR&D asset impairments.
Asset impairment, restructuring and other special charges decreased $106.5$275 million for the ninesix months ended SeptemberJune 30, 2018 as compared to the nine months ended September 30, 20172022, primarily due to a $265 million charge recorded during the six months ended June 30, 2021 to write down assets at our Shawnee and Speke manufacturing sites that were classified as held for sale to an amount equal to fair value less costs to sell, as well as a period over period decrease in severance charges and overall acquisition-related charges, which include transaction costs related to acquisitions and costs associated with the implementation of new systems, programs, and processes due to both our separation from Lilly and the integration of Bayer Animal Health. See Note 6: Asset Impairment, Restructuring and exit costs,Other Special Charges for further discussion. These decreases were partially offset by an increase ina $28 million asset impairmentswrite-down charge recorded upon the final sale of our Speke manufacturing site and a gain on disposalone-time charge of a site that was previously closed as part$59 million related to the expensing of an IPR&D asset licensed from BexCaFe during the acquisition and integration of Novartis Animal Health in 2017.
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Interest Expense, Net of Capitalized Interest
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Interest expense, net of capitalized interest | $ | 67 | $ | 60 | 12 | % | $ | 119 | $ | 121 | (2) | % | ||||||||||||||||||||||||||
Interest expense, net of capitalized interest increased $7.0$7 million for the three months ended SeptemberJune 30, 2018 as compared2022, primarily due to a $17 million debt extinguishment loss recorded upon the retirement of a portion of the aggregate principal on our 4.272% Senior Notes due August 28, 2023 during the period and higher interest on variable-rate debt due to increases in rates, partially offset by the favorable impact of refinancing at lower interest rates and a lower average debt balance.
Interest expense, net of capitalized interest decreased $2 million for the six months ended June 30, 2022, primarily due to the favorable impact of refinancing at lower interest rates, partially offset by a $17 million debt extinguishment loss recorded upon the retirement of a portion of the aggregate principal on our 4.272% Senior Notes due August 28, 2023 during the three months ended SeptemberJune 30, 2017 primarily2022 and higher interest on variable-rate debt due to an increaseincreases in pretax earningsrates.
Other (Income) Expense, Net
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Other (income) expense, net | $ | — | $ | (3) | NM | $ | 9 | $ | (3) | NM | ||||||||||||||||||||||||||||
Other expense recorded during the three months ended June 30, 2022 primarily consisted of mark-to-market adjustments on equity investments and foreign exchange losses. These amounts were fully offset by a decrease in the U.S. valuation allowancegain recognized on the disposal of our microbiome R&D platform, as well as certain components of net periodic benefit cost. See Note 14: Retirement Benefits to the condensed consolidated financial statements for further discussion related to utilization of prior years' net operating losses.
Other expense recorded during the six months ended SeptemberJune 30, 20172022 primarily consisted of mark-to-market adjustments on equity investments and foreign exchange losses, partially offset by the gain recognized on the disposal of our microbiome R&D platform, as well as certain components of net periodic benefit cost. See Note 14: Retirement Benefits to the condensed consolidated financial statements for further discussion related to net periodic benefit cost (income) recorded during the period. Other income recorded during the six months ended June 30, 2021 consisted of certain components of net periodic benefit income, an up-front payment received in relation to an asset assignment agreement, and up-front payments received, milestones earned, and equity issued to us in relation to a license agreement. This income was partially offset by losses recorded in relation to divestitures and foreign exchange losses.
Income Tax Expense (Benefit)
| Three Months Ended June 30, | Six Months Ended June 30, | |||||||||||||||||||||||||||||||||||||
| (Dollars in millions) | 2022 | 2021 | % Change | 2022 | 2021 | % Change | ||||||||||||||||||||||||||||||||
| Income tax expense (benefit) | $ | 4 | $ | (26) | (115) | % | $ | 27 | $ | (45) | (160) | % | ||||||||||||||||||||||||||
| Effective tax rate | (22.5) | % | 11.1 | % | 50.7 | % | 14.2 | % | ||||||||||||||||||||||||||||||
Income tax expense decreased $25.8 millionincreased for the ninethree and six months ended SeptemberJune 30, 2018 as compared2022, primarily due changes in earnings mix which caused the U.S. federal and state jurisdictions to generate losses which are subject to valuation allowances. The effective tax rate decreased for the three months ended June 30, 2022 driven by the change in U.S. valuation allowances and the income tax benefit due to the ninetermination of interest rate swaps. The effective tax rate for the six months ended SeptemberJune 30, 2017 primarily2022 increased due to a decreaseadjustments in jurisdictional earnings mix, slightly offset by the U.S. valuation allowance relatedincome tax benefit due to the utilizationtermination of prior years' net operating losses.interest rate swaps. See Note 11: Income Taxes to the condensed consolidated financial statements.
2022 Q2 Form 10-Q | 35 | | |||||||
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities.credit facilities. As a significant portion of our business is conducted outside the U.S.,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 intend to indefinitely reinvest foreign earnings for continued use in our foreign operations. As our structure evolves as a standalone company, we may change that strategy, particularly to the extent we identify tax efficient reinvestment alternatives for our foreign earnings or change our cash management strategy.
We believe our primary sources of liquidity needs going forwardare sufficient to fund our short-term and long-term existing and planned capital requirements, which include working capital obligations, funding existing marketed and pipeline products, capital
expenditures, business development in our targeted areas, short-term and long-term debt obligations which include principal and interest expensepayments as well as interest rate swaps, operating lease payments, purchase obligations, and an anticipated dividend. Wecosts associated with the integrations of Bayer Animal Health and KindredBio. 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 Form 10-K for the year ended December 31, 2021.
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) | Six Months Ended June 30, | |||||||||||||||||||||||||||
| Net cash provided by (used for): | Net cash provided by (used for): | 2022 | 2021 | $ Change | |||||||||||||||||||||||||
| Operating activities | $ | 347.8 | $ | 167.1 | 108 | % | Operating activities | $ | 250 | $ | 171 | $ | 79 | ||||||||||||||||
| Investing activities | (78.9 | ) | (929.1 | ) | (92 | )% | Investing activities | (66) | (15) | (51) | |||||||||||||||||||
| Financing activities | 327.2 | 843.5 | (61 | )% | Financing activities | (296) | (65) | (231) | |||||||||||||||||||||
| 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 | (19) | (17) | (2) | |||||||||||||||||||||
| Net increase in cash, cash equivalents and restricted cash | $ | 611.5 | $ | 84.8 | 621 | % | |||||||||||||||||||||||
| Net increase (decrease) in cash and cash equivalents | Net increase (decrease) in cash and cash equivalents | $ | (131) | $ | 74 | $ | (205) | ||||||||||||||||||||||
Operating activities
Cash provided by operating activities increased by $180.7$79 million from $167.1to $250 million for the ninesix months ended SeptemberJune 30, 2017 to $347.82022 from $171 million for the ninesix months ended SeptemberJune 30, 2018. The increase is a result of2021, primarily due to an increase in net income which wasafter adjusting for non-cash items as well as proceeds of $132 million from interest rate swap settlements. These increases were partially offset by changes in operating assets and liabilities, particularly changes in inventories, other assets, and accounts payable and other liabilities as compared to the prior year. 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.
2022 Q2 Form 10-Q | 36 | | |||||||
Investing activities
Our cash flow used infor investing activities decreased from $929.1was $66 million for the ninesix months ended SeptemberJune 30, 20172022 as compared to $78.9$15 million for the ninesix months ended SeptemberJune 30, 2018. Our2021. The change was primarily driven by cash used in investing activities forreceived during the ninesix months ended SeptemberJune 30, 2017 included $882.1 million related to2021 as a result of the finalization of the working capital adjustment for the acquisition of BIVIVP. This decrease wasBayer Animal Health as well as an increase in cash used for net purchases of property and equipment in the current period, partially offset by a net increaseyear over year decrease in cash used for purchases of $42.6 million in capital expenditures from 2017 to 2018.intangible assets.
Financing activities
Our cash provided byused for financing activities decreased from $843.5was $296 million for the ninesix months ended SeptemberJune 30, 2017 to $327.2 million for the nine months ended September 30, 2018. The cash flows in 2017 relate to net cash provided by transactions with Lilly of $844.0 million2022 as compared to cash used in transactions with Lillyfor financing activities of $247.4$65 million in 2018, a reduction infor the six months ended June 30, 2021. Cash used for financing activities during the six months ended June 30, 2022 primarily reflected the tender offer completed during the period as well as net repayments on our revolving credit facility and the repayment of cash flows between periods of $1.1 billion. This was offset by the net cash provided from the financing transactions related to the Separation including the proceeds from long-term debt andindebtedness outstanding under our IPO, which was onlyterm loan B credit facility, partially offset by proceeds from our newly issued incremental term facilities. Cash used for financing activities during the considerationsix months ended June 30, 2021 primarily reflected the repayment of indebtedness outstanding under our term loan B credit facility and cash paid to Lilly in connection with the Separation. The remainder of the proceeds from the financing related to the Separation will be paid to Lilly in future periods and is reflected as restricted cash in our consolidated balance sheet.local country asset purchases.
Description of Indebtedness
For a complete description of our existing debt and available credit facilities as of June 30, 2018, we issued $2.0 billion of senior notes, entered into a $500.0 million three-year term loan,2022 and entered into five-year $750.0 million senior unsecured revolving credit facility. For more information,December 31, 2021, see Note 8:9: Debt within Item 8, “Financial Statements and Supplementary Data,” of Part II of our Form 10-K for the year ended December 31, 2021. New developments are discussed in Note 9: Debt of this Form 10-Q.
Contractual Obligations
Our contractual obligations and commitments as of June 30, 2022 are primarily comprised of long-term debt obligations, operating leases, and purchase obligations. Our long-term debt obligations are comprised of our unaudited condensed consolidatedexpected principal and combined financial statements.interest obligations and our interest rate swaps. Purchase obligations consist of open purchase orders as of June 30, 2022 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 and Estimates
The preparation of financial statements in accordance with U.S. 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.Form 10-K for the year ended December 31, 2021. There have been no significant changes in the application of our critical accounting policies during 2018.
2022 Q2 Form 10-Q | 37 | | |||||||
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 through a central shared entity, which entersexchange exposures when we enter into derivative contracts to hedgetransactions arising from subsidiary trade and loan payables and receivables denominated in foreign currency risk associated with forecasted transactions for the entire company, including historically for our operations. Gains and losses on derivative contracts entered into by Lilly have 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.
currencies. We also face currency exposure that arises from translating the results of our global operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of the period. We may enter into foreign currency forward or option derivative contracts to reduce the effect of fluctuating currency exchange rates in future periods, but our historical results do not reflect the impact of any such derivatives related to our exposure to foreign currency impacts on translation.periods.
We estimate that a hypothetical 10% adverse movement in all foreign currency exchange rates related to the translation of the results of our foreign operations would decrease our net income by approximately $12.0$10 million for the ninesix months ended SeptemberJune 30, 2018.2022.
We generally identify hyperinflationary markets as those markets whose cumulative inflation rate over a three-year period exceeds 100%. We have concluded that our Argentina subsidiary is operating in a hyperinflationary market. As a result, beginning in the second quarter of 2018, the functional currency of our Argentina subsidiary changed from the local currency to the U.S. dollar. During the six months ended June 30, 2022, revenue in Argentina represented less than 1% of our consolidated revenue. Assets held in Argentina as of June 30, 2022 represented less than 1% of our consolidated assets.
During the first quarter of 2022, Turkey’s three-year cumulative inflation rate exceeded 100%, and we concluded that Turkey became a hyperinflationary economy for accounting purposes. As of April 1, 2022, we applied hyperinflationary accounting for our subsidiary in Turkey and changed its functional currency from the Turkish lira to the U.S. dollar. During the six months ended June 30, 2022, revenue in Turkey represented less than 1% of our consolidated revenue. Assets held in Turkey as of June 30, 2022 represented less than 1% of our consolidated assets.
While the hyperinflationary conditions did not have a material impact on our business during the six months ended June 30, 2022, in the future, we may incur larger currency devaluations, which could have a material adverse impact on our results of operations.
Interest Risk
Our variable-rate debt is exposed to interest rate riskfluctuations based on the long-term debtLIBOR and Term SOFR. As of June 30, 2022, 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 $3,050 million that have cash flow risk associated withthe economic effect of modifying our $500.0variable-interest so that a portion of the variable-rate interest payable becomes fixed. During the six months ended June 30, 2022, we recorded a gain of $117 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 assessment ofswaps in other comprehensive income (loss). See Note 10: Financial Instruments and Fair Value to the risk.
ITEM 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.
2022 Q2 Form 10-Q | 38 | | |||||||
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 SeptemberJune 30, 2018.2022. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the disclosure controls and procedures are effective.
(b)Changes in Internal Controls. During the thirdsecond quarter of 2018,2022, there were no changes in our internal control over financial reporting that materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.
2022 Q2 Form 10-Q | 39 | | |||||||
PART II. Other InformationII
ITEM 1. Legal ProceedingsLEGAL PROCEEDINGS
See Note 12: Commitments and Contingencies to the condensed consolidated financial statements for a summary of our legal proceedings, which is incorporated herein by reference.
ITEM 1A. Risk FactorsRISK FACTORS
Our material risk factors are discloseddocumented in Item 1A of Part I of our IPO Prospectus.Form 10-K for the year ended December 31, 2021, which is incorporated herein by reference. There have been no material changes from the risk factors previously disclosed in our IPO Prospectus.the Form 10-K.
ITEM 2. Unregistered Sales of Equity Securities and Use of ProceedsUNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(none)
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(none)
ITEM 4. MINE SAFETY DISCLOSURES
(none)
ITEM 5. OTHER INFORMATION
(none)
2022 Q2 Form 10-Q | 40 | | |||||||
ITEM 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.
| Exhibit Number | Description | ||||||||||
| 3.1 | |||||||||||
| 3.2 | |||||||||||
| 10.1 | |||||||||||
| Section 302 Certification of the Chief Executive Officer pursuant to Rule 13a-14(a) of the Securities Exchange Act of 1934, as adopted pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |||||||||||
| 31.2 | |||||||||||
| 32 | |||||||||||
| Certification of the Chief Executive Officer and the Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith). | |||||||||||
| 101 | Interactive Data Files. | ||||||||||
| 104 | Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101). | ||||||||||
2022 Q2 Form 10-Q | 41 | | |||||||
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
| ELANCO ANIMAL HEALTH INCORPORATED | ||||||||
| (Registrant) | ||||||||
| Date: | August 8, 2022 | |||||||
| President and Chief Executive Officer | ||||||||
| Date: | /s/ | |||||||
| Executive Vice President, Chief | ||||||||
2022 Q2 Form 10-Q | 42 | | |||||||