Note 1. Nature of Business and OrganizationBackground
Note 2. Basis of Presentation and Summary of Significant Accounting Policies
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.
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Companion Animal Disease Prevention | $ | 188.6 |
| | $ | 140.4 |
| | $ | 603.9 |
| | $ | 519.7 |
|
Companion Animal Therapeutics | 80.5 |
| | 63.5 |
| | 211.1 |
| | 181.8 |
|
Companion Animal Other | 27.7 |
| | 48.3 |
| | 69.3 |
| | 119.9 |
|
Food Animal Future Protein & Health | 162.8 |
| | 164.5 |
| | 502.1 |
| | 456.0 |
|
Food Animal Ruminants & Swine | 301.5 |
| | 280.4 |
| | 881.1 |
| | 857.3 |
|
Revenue | $ | 761.1 |
| | $ | 697.1 |
| | $ | 2,267.5 |
| | $ | 2,134.7 |
|
The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
| | | | | |
Estimated Fair Value at 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.
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 | |
| | | |
| | | |
| | | |
| | | |
| | | |
| | | |
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.
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 |
|
Severance costs represent costs incurredBayer Animal Health (e.g., expenditures for consulting, system and process integration, and product transfers), as a result of actions taken to reduce our cost structure.
Integration and other costs primarily representwell as independent company stand-up costs related to the implementation of new systems, programs, and processes.
(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.
(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.
Exit costs primarily represent contract termination costsShawnee and reserves for costs related to facilities which we have exited.
Asset impairment recognized during the nine months ended September 30, 2018 resulted from $19.9 million of intangible asset impairments and $44.0 million of fixed asset impairments. The intangible asset impairments primarily related to revised projections of fair value due to product rationalization. The fixed asset impairments were primarily due to the decision to dispose of aSpeke manufacturing facility in the U.S. and to the suspension of commercial activities for Imrestor®.
Asset impairment recognized during the nine months ended September 30, 2017 resulted primarily from intangible asset impairments related to revised projections of fair value due to product rationalization and to a lessor extent competitive pressures. The fair value measurements utilized to determine the intangible asset impairments in 2018 and 2017 represent Level 3 fair value measurements.
Gain on sale of fixed assets for the nine months ended September 30, 2017 representssites, partially offset by a gain recorded on the disposaldivestiture of a site that was previously closedan early-stage IPR&D asset acquired as part of the acquisition and integration of NovartisBayer Animal Health.Health acquisition.
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 |
|
DuringTangible Equity Unit (TEU) Offering
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.
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.
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 |
|
Long-term debt as of December 31, 2017 was not material.
Revolving and Term Credit Facilities
On September 5, 2018,(1)In June 2022, we entered into a revolvingan incremental assumption agreement with Bank of America, N.A. supplementing and amending our existing credit agreement with a syndicate of banks providingdated August 1, 2020 relating to our senior secured credit facility. The incremental assumption agreement provides for a five-year $750.0 million senior unsecured revolving creditnew incremental term facility (Revolving Facility).with an aggregate principal amount of $175 million. The Revolving Facilitynew incremental term facility bears interest at the Secured Overnight Financing Rate (Term SOFR), including a variable ratecredit spread adjustment, plus specified margin as defined in the agreement175 basis points and is payable quarterly. There were no borrowings outstanding under the Revolving Facility at September 30, 2018. The Revolving Facility is payable in full at the endon June 30, 2025. The proceeds were used to repay a portion of the term.our outstanding obligations under our revolving credit facility.
On September 5, 2018
(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.
The Credit Facilities are subject to various financial and other covenants including restrictions on the level of borrowings based on a consolidated leverage ratio and a consolidated interest coverage ratio. We were in compliance with all such covenants as of September 30, 2018.
Senior Notes
On August 28, 2018, we issued $2.0 billion of senior notes (Senior Notes) in a private placement. The Senior Notes comprised of $500.0 million of 3.912% Senior Notes due August 27, 2021, $750.0 million ofour 4.272% Senior Notes due August 28, 2023, and $750.0resulting in a debt extinguishment loss of approximately $17 million recognized in interest expense, net of 4.900% Senior Notes due August 28, 2028.capitalized interest in the condensed consolidated statements of operations. The interest rate payable on each series of Senior Notes is subject to adjustment if Moody's Investor Services, Inc. or Standard & Poor's Financial Services LLC downgrades, or subsequently upgrades, its ratings on the respective series of Senior Notes.repayment was funded with proceeds received from a draw under our revolving credit facility.
The indenture that governs the Senior Notes contains covenants, including limitations on our ability, and certain of our subsidiaries, to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets, in addition, to other customary terms.
We were in compliance with all suchof our debt covenants under the indenture governing the Senior Notes as of SeptemberJune 30, 2018.2022.
We have entered into an agreement that requires us to use commercially reasonable efforts to cause a registration statement to become effective with the SEC by August 28, 2019, relating to an offer to exchange the Senior Notes for registered Senior Notes having substantially identical terms, or, in certain cases, to register the Senior Notes for resale. If we do not register or exchange the Senior Notes pursuant to the terms of the registration rights agreement, we will be required to pay additional interest to the holders of the Senior Notes under certain circumstances.
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.
As of September 30, 2018 and December 31, 2017, we had $14.9 million and$12.3 million, respectively, of costvalues and equity method investments.investments included in other noncurrent assets on our condensed consolidated balance sheets totaling $31 million and $22 million as of June 30, 2022 and December 31, 2021, respectively. Unrealized net gains and losses on our investments for the three and six months ended June 30, 2022 and 2021 were immaterial.
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 |
|
Contingent consideration liabilities relate to Galliprantitems, as well as long-term debt (including TEU amortizing notes) for which fair value is disclosed on a recurring basis:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Fair Value Measurements Using | | |
Financial statement line item | | Carrying Amount | | Quoted Prices in Active Markets for Identical Assets (Level 1) | | Significant Other Observable Inputs (Level 2) | | Significant Unobservable Inputs (Level 3) | | Fair Value |
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
projected cashunderlying hedged item. Cash flows related to Galliprant,net investment hedges are classified in the investing activities section of the consolidated statements of cash flows. Our outstanding positions are discussed below.
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.
We have long term debt of $2.5 billion that is recorded at amortized cost in our condensed consolidated balance sheet as of September 30, 2018. We consider the carryingother comprehensive income (loss). Fair value of the long term debt to be representative of its fair value as of September 30, 2018. The fair value of this long term debt is estimated based on quoted market pricesvalues of similar liabilitieshedges and is classified as Level 2. AsOur outstanding forward-starting interest rate swaps have maturities ranging between 2022 and 2025 with aggregate notional amounts of $3,050 million and $3,800 million as of June 30, 2022 and December 31, 2017, long term debt was not material.2021, respectively.
Note 10. Income TaxesThe amounts of net gains (losses) on cash flow hedges recorded, net of tax, in other comprehensive income (loss), are as follows:
Prior to Separation
| | | | | | | | | | | | | | | | | | | | | | | |
| 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.
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.
For(loss) for the three and ninesix months ended SeptemberJune 30, 2018,2022 included a $17 million reclassification of stranded tax benefit from accumulated other comprehensive loss, based on our policy to reclassify income tax effects from accumulated other comprehensive loss using the portfolio approach, as well as $8 million of reclassification of unrealized gains. Other than the reclassification of the stranded tax benefit, there was no tax effect recorded in relation to our cash flow hedges for the three and six months ended June 30, 2022 and 2021 after the application of the U.S. valuation allowance. See Note 11: Income Taxes for further discussion.
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.
For the three and nine months ended September 30, 2017, despite reporting a loss before taxes of $9.1 million and $77.2 million, respectively, we incurred $11.6 million and $72.0 million of income tax expense. The tax expense recorded related primarily to income generated in certain foreign jurisdictions as no tax benefit was recorded for U.S. net operating losses.
In December 2017, the President of the U.S. signed into law the Tax Cuts and Jobs Act (2017 Tax Act), which includes significant changes to the U.S. corporate income tax system, including a reduction in the corporate income tax rate, transition to a territorial tax system, and modifications to the international tax provisions. At September 30, 2018, our accounting for the 2017 Tax Act is incomplete; however, we expect to complete our accounting by December 2018. As discussed in our combined financial statements and accompanying notes asreclassify a gain of and for the year ended December 31, 2017 included in our IPO Prospectus, we recorded provisional adjustments for effects that we were able to reasonably estimate. Those effects included the one-time repatriation transition tax (also known as the Toll Tax), re-measurement of deferred tax assets and liabilities, unremitted earnings, executive compensation, and uncertain tax positions. At December 31, 2017, we were not able to make reasonable estimates for Global Intangible Low-Taxed Income (GILTI) deferred taxes or changes$72 million, which includes $53 million relating to the valuation allowances; therefore, we did not record provisional amounts. interest rate swap settlement, to interest expense, net of capitalized interest.
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.
As part of Lilly, we arewere included in Lilly's U.S. tax examinations by the Internal Revenue Service (IRS).through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with our initial public offering (IPO), the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. The IRSU.S. examination of tax years 2013-20152016 to 2018 began in 2016. While we believe it is reasonably possible thatthe fourth quarter of 2019 and remains ongoing. The resolution of this audit could reachperiod will likely extend beyond the next 12 months.
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.
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.
Impact of Separation
InElanco common stock or 5.00% TEUs issued in connection with the Separation, we entered intopublic offering. This case is currently stayed in deference to Hunter v. Elanco Animal Health Inc.
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.
Based on the TMA, Lilly retained the tax benefits and liabilities associated with all periods prior to the Separation date for any jurisdiction where we were included in a consolidated or combined tax return. The financial statements for periods prior to Separation included certain deferred tax assets related to tax credit and net operating loss carryovers that resulted from our tax expense being calculated on a separate return basis that will not transfer to us either because they were used by Lilly or are retained by Lilly and reflected certain tax liabilities that will be retained by Lilly. We recorded an adjustment to our consolidated balance sheet at the date of Separation to reflect our tax positions based on the TMA. This resulted in a decrease in tax liabilities by $31.2 million as these tax liabilities will be retained by Lilly.
At September 30, 2018, we have net operating losses for international tax purposes of approximately $190 million which will expire between 2022 and 2028. These net operating losses are partially reserved. Deferred tax assets related to state net operating losses are $6.2 million. The state net operating losses will generally expire between 2035 and 2037.
Note 11. Contingencies
We are party to various other legal actions in the normal course of business. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality. We record aaccrue for 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.
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 |
|
(1) Revenue is attributed
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.
(2) Long-lived assets consist of property and equipment, net, and certain noncurrent assets.
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.
Note 14. Related Party Agreements and Transactions
Separation-Related Agreements with Lilly
As described in Note 1, in connection with the Separation Lilly transferred to us substantially all of its animal health businesses in exchange for approximately $4.2 billion. This is reflected as consideration to Lilly in our statement of equity. In addition, we entered into a master separation agreement and a transitional services agreement with Lilly.
Master Separation Agreement (MSA)
As stated in Note 1, Lilly transferred to us at the time of Separation, through a series of transactions, the businesses that will continue as part of Elanco. For a certain portion of our operations, the legal transfer of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries. Under the MSA entered into with Lilly, we are responsible for the business activities conducted by Lilly on our behalf and are subject to the risks and entitled to the benefits generated by these operations and assets.anti-dilutive. As a result, the related assetsbasic and liabilities and results of operations have been reported in our unaudited condensed consolidated and combined financial statements. The total net assets associated with these jurisdictions are $84.5 million and the annual profits are insignificant. Upon Separation, we retained $275.0 million, which is reflected as restricted cash, that will be used to fund the purchase of these operations from Lilly at the time of the local country closing and have an offsetting payable to Lilly. If the amount of local purchases is less than $275.0 million, we are required to repay the remaining amount to Lilly.
In addition, based on the MSA, we are required to distribute to Lilly any amount of cash in excess of $300.0 million held at September 30, 2018. As a result, we have reflected an additional $359.9 million of restricted cash on our balance sheet with an offsetting payable to Lilly at September 30, 2018.
Transitional Services Agreement (TSA)
Historically, Lilly has provided us significant shared services and resources related to corporate functions such as executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations, which we refer to collectively as the "Lilly Services." Under the terms of the TSA, we will be able to use Lilly Services for a fixed term established on a service-by-service basis. We will pay Lilly mutually agreed-upon fees for the Lilly Services provided under the TSA, which will be based on Lilly's cost (including third-party costs) of providing the Lilly Services through March 31, 2021, and subject to a mark-up of 7% thereafter, with additional inflation-based escalation beginning January 1, 2020. The fees under the TSA become payable for all periods beginning after October 1, 2018.
We also entered into a TMA, an employee matters agreement, a toll manufacturing and supply agreement and a registration rights agreement with Lilly in connection with the Separation.
Transactions with Lilly Prior to Separation
We did not historically operate as a standalone business and had various relationships with Lilly whereby Lilly provided services to us.
Transfers to/from Lilly, net
As discussed in the basis of presentation, net parent company investment is primarily impacted by contributions from Lilly whichdiluted weighted average shares are the result of treasury activity andsame, causing diluted net funding provided by or distributedloss per share to Lilly.be equivalent to basic net loss per share. For the three months ended SeptemberJune 30, 20182022 and 2017, respectively, the net transfers (to)/from Lilly were $(116.8)2021, approximately 3.2 million and $38.1 million.4.2 million, respectively, of potential common shares were excluded from the calculation of diluted earnings (loss) per share because their effect was anti-dilutive. For the ninesix months ended SeptemberJune 30, 20182022 and 2017, respectively, the net transfers (to)/from Lilly were $(226.3)2021, approximately 1.6 million and $862.74.3 million, respectively. The most significant activity impactingrespectively, of potential common shares were excluded from the 2017 transfercalculation of diluted earnings (loss) per share because their effect was anti-dilutive.
(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.
Corporate Overhead and Other Allocations
Lilly provides us certain services, including executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. We provide Lilly certain services related to manufacturing support. Our financial statements reflect an allocation of these costs. When specific identification is not practicable, the remainder have been allocated primarily on a proportional cost method on a basis of revenue or headcount.
The allocations of services from Lilly to us were reflected as follows in the unaudited condensed consolidated and combined statements of operations:
|
| | | | | | | | | | | | | | | |
| Three Months Ended September 30, | | Nine Months Ended September 30, |
| 2018 | | 2017 | | 2018 | | 2017 |
Cost of sales | $ | 7.0 |
| | $ | 7.7 |
| | $ | 21.8 |
| | $ | 23.0 |
|
Research and development | 0.7 |
| | 0.7 |
| | 2.2 |
| | 2.1 |
|
Marketing, selling and administrative | 26.4 |
| | 27.7 |
| | 81.2 |
| | 82.7 |
|
Total | $ | 34.1 |
| | $ | 36.1 |
| | $ | 105.2 |
| | $ | 107.8 |
|
We provide Lilly certain services related to manufacturing support. Allocations
The financial information herein may not necessarily reflect our consolidated financial position, results of operations and cash flows in the future or what they would have been if we had been a separate, standalone entity during the periods presented. Management believes that the methods used to allocate expenses are reasonable.ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONSStock-based Compensation
Our employees participate in Lilly stock-based compensation plans, the costs of which have been allocated to us and recorded in cost of sales, research and development, and marketing, selling and administrative expenses in the unaudited condensed consolidated and combined statements of operations. The costs of such plans related to our employees were $6.9 million and $6.2 million for the three months ended September 30, 2018 and 2017, respectively, as well as $20.2 million and $18.7 million for the nine months ended September 30, 2018 and 2017, respectively.
Retirement Benefits
Our employees participate in defined benefit pension and other post retirement plans sponsored by Lilly, the costs and benefits of which have been recorded in the unaudited condensed consolidated and combined statement of operations in cost of sales, research and development, and marketing, selling and administrative expenses. For the three and nine months ended September 30, 2018, the benefit of such plans related to our employees was $1.6 million and $0.3 million, respectively, and for the three and nine months ended September 30, 2017 the costs of such plans related to our employees were $1.7 million and $5.1 million, respectively.
Centralized Cash Management
Lilly uses a centralized approach to cash management and financing of operations. Until Separation, the majority of our business was party to Lilly’s cash pooling arrangements to maximize Lilly's availability of cash for general operating and investing purposes. Under these cash pooling arrangements, cash balances were swept regularly from our accounts. Cash transfers to and from Lilly’s cash concentration accounts and the resulting balances at the end of each reporting period were reflected in net parent company investment in the condensed consolidated and combined balance sheets.
Debt
Lilly’s third-party debt and the related interest expense have not been allocated to us for any of the periods presented as we were not the legal obligor of the debt and Lilly borrowings were not directly attributable to our business.
Commercial Operations
We sell certain products to and receives certain goods and services from a customer/vendor, whose chairman and Chief Executive Officer is a member of Lilly's Board of Directors. These product sales resulted in revenue of $4.2 million and $6.6 million for the three months ended September 30, 2018 and 2017, respectively, and of $16.4 million and $17.8 million for the nine months ended September 30, 2018 and 2017, respectively. The product sales resulted in accounts receivable of $1.9 million and $2.0 million at September 30, 2018 and December 31, 2017, respectively. The purchase of goods and services resulted in cost of sales and operating expenses of $1.4 million and $1.1 million for the three months ended September 30, 2018 and 2017, respectively, as well as $3.3 million and $5.3 million September 30, 2018 and 2017, respectively. The purchase of goods and services resulted in accounts payable of $0.4 million and $0.3 million at September 30, 2018 and December 31, 2017, respectively.
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tables present dollars in millions, except per-share data)
The management’s discussion and analysis of financial condition and results of operations
(MD&A) is intended to assist the reader in understanding and assessing significant changes and trends related to our results of operations and financial position. This discussion and analysis should be read in conjunction with the
unaudited condensed consolidated
and combined financial statements and accompanying footnotes in Item 1 of Part I of this
Quarterly Report on Form 10-Q. Certain statements in this Item 2 of Part I of this
Quarterly Report on Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements"
of this Form 10-Q, in Item 1A, "Risk Factors" of Part II of this Form 10-Q, and in
Item 1A, “Risk Factors”
included inof Part I of our
final prospectus relating to our initial public offering filed on September 21, 2018 (IPO Prospectus),Form 10-K for the year ended December 31, 2021, may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements. Further, due to the seasonality of our pet health sales, interim results are not necessarily an appropriate base from which to project annual results.
Overview
Founded in 1954 as part of Eli Lilly and Company,
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:
Companion Animal Disease Prevention (CA Disease Prevention):
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.
Companion Animal Therapeutics (CA Therapeutics): WeU.S. only. In therapeutics, we have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprantproduct is one of the fastest growing osteoarthritis treatments in the U.S. We alsoAdditionally, we have treatmentsproducts that offer treatment for otitis (ear infections) with Claro, as well as treatments for certain cardiovascular and dermatology indications.
Farm Animal Future Protein & Health (FA Future Protein & Health): Our farm animal portfolio in this category, which includes vaccines, nutritional enzymesconsists of products 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.
Food Animal Ruminants & Swine (FA Ruminants & Swine):among others. We have developed a wide range of foodfarm animal products, including Rumensin and Baytril, both of which are used extensively in ruminantruminants (e.g., cattle, sheep and goats). In poultry, our Maxiban product, is a valuable offering for the control and swine production.prevention of intestinal disease.
On September 24, 2018, we completed an initial public offering resulting in the issuance of 72.3 million shares our common stock (IPO), which represented approximately 19.8%A summary of our total outstanding shares. Our common stock began trading on the New York Stock Exchange under the symbol "ELAN" on September 20, 2018. Prior to2022 revenue and in connection with the IPO, we completed a $2.0 billion senior notes offering and entered into a $500.0 million term loan, and Lilly transferred to us substantially all of the assets and liabilities of their animal health business. Lilly continues to own the remaining 80.2% of our outstanding shares. Lilly has informed us that it may make a tax-free distribution to its shareholders of all or a portion of its remaining equity interest in us, which may include one or more distributions effected as a dividend to all Lilly shareholders, one or more distributions in exchange for Lilly shares or other securities, or any combination thereof. We refer to any such potential distribution as the Distribution. Lilly has no obligation to pursue or consummate any further dispositions of its ownership interest in us, including through the Distribution, by any specified date or at all.
For the three months ended September 30, 2018 and 2017, our revenue was $761.1 million and $697.1 million,
respectively. For the three months ended September 30, 2018 and 2017, our net income (loss) was $60.2 millioncompared with the same period in 2021 is as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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.
For
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.
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.
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.
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.
Our Relationship with Lilly and Additional Standalone Costs
During the period prior to the IPO, our business operated as part of a division of Lilly. Our combined financial statements have been derived from Lilly’s consolidated financial statements and accounting records. Our combined financial statements reflect the financial position, results of operations and cash flows of the business that was transferred at the time of the Separation and do not purport to reflect what the results of operations, comprehensive income/(loss), financial position, equity or cash flows would have been had we operated as an independent, publicly traded company during the periods presented.
Our historical results reflect an allocation of costs for certain Lilly corporate costs, including, among others, executive oversight, treasury, legal, finance, human resources, tax, internal audit, financial reporting, information technology and investor relations. These allocations are not necessarily indicative of the expenses we may incur as a standalone public company. Although we entered into certain agreements with Lilly in connection with the IPO and the Separation, the amount and composition of our expenses may vary from historical levels since the fees charged for the services under these agreements may be higher or lower than the costs reflected in the historical allocations. In addition, we intend to replace these services over time with ones supplied either internally by our employees or by third parties, the cost of which may be higher or lower than the historical allocations. During the three and nine months ended September 30, 2018 and 2017, corporate overhead and other allocations were $34.1 million, $105.2 million, $36.1 million and $107.8 million, respectively. See Note 14: Related Party Agreements and Transactions in our unaudited condensed consolidated and combined financial statements.
We are currently investing in expanding our own administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources and manufacturing, to replace services previously provided by Lilly. Because of initial stand up costs and overlaps with services previously provided by Lilly, we have incurred and expect to continue to incur certain temporary, duplicative expenses in connection with the
Separation. We have also incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics, among others. We currently estimate these costs taken together to be in a range from $240 million to $290 million, of which a portion will be capitalized and the remainder will be expensed.
In addition, our historical results do not reflect the impact of costs we have incurred and expect to continue to incur as a consequence of becoming a standalone company, including incremental costs associated with being a publicly traded company. These costs include a change in compensation expense as we institute competitive compensation policies and programs as a standalone public company, the costs of internal and external audit (including those related to Sarbanes-Oxley Act of 2002), investor relations, stock administration, stock exchange fees and regulatory compliance costs.
For the purposes of our financial statements for periods prior our IPO, our effective tax rate was computed on a separate company basis, as if we had operated as a standalone entity or a separate consolidated group in each material jurisdiction in which we operate. As a result of potential changes to our business model and due the fact that we are a standalone entity, income tax expense (benefit) included in the consolidated and combined financial statements may not be indicative of our future expected tax rate.
In connection with the IPO, we entered into $2.5 billion of long-term borrowings. Our historical results for the period prior to entering into such agreements do not reflect interest expense, which we estimate at approximately $110.0 million on an annual basis.
Asset Impairment, Restructuring and Other Special Charges
Our results have been impacted by asset impairment, restructuring and other special charges, including integration of acquired businesses, during the nine months ended September 30, 2018 and 2017. These charges primarily include severance costs resulting from actions taken to reduce our cost structure, asset impairment charges related to product rationalization, site closures, and integration costs related to acquired businesses. For more information on these charges, see Note 6: Asset Impairment, Restructuring and Other Special Charges in our unaudited condensed consolidated and combined financial statements.
Results of Operations
The following discussion and analysis of our results of operations should be read along with our unaudited condensed consolidated and combined financial statements and the notes thereto, which reflect the results of operations of the business transferred to us from Lilly.thereto.
| | | | | | | | | | | | | | | | Three Months Ended 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
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 | % |
(1) Represents revenue from business activities we have either exited or made a strategic decision to exit.
Total revenue
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Total revenue increased $64.0 million or 9%category for the three months ended SeptemberJune 30, 20182022 and 2021 is summarized as compared to the three months ended September 30, 2017, reflecting a 4% increasefollows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | 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.
In summary, the total(CER), a non-GAAP measure, is defined as revenue increase was due primarily to:
an increase in revenue of $49.4 million or 35% from CA Disease Prevention products,growth excluding the impact of foreign exchange. The calculation assumes the same foreign currency exchange rates;rates that were in effect for the comparable prior-year period were used in translation of the current period results. We believe this metric provides a useful comparison to previous periods.
(2)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
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.
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.
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.
an increase
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
an increase in revenue of $26.3 million or 10% from FA Ruminants & Swine products, excluding the impact of foreign exchange rates;exchange. These decreases more than offset the impact of inflation during the periods.
partially offset by:
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
a decreasefinalizing the valuation of intangible assets acquired from the Bayer Animal Health acquisition in revenue of $20.5 million from Strategic Exits, excludingthe prior year, partially offset by the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
CA Disease Prevention revenue increased by $48.2Amortization of intangible assets decreased $6 million or 34% primarily driven by increases in volume and price, partially offset by an unfavorable impact from foreign exchange rates. Growth was primarily driven by higher realized price on Trifexis and a favorable comparison to prior year related to an anticipated stock out in third quarter of 2017 which shifted sales of Trifexis tofor the second quarter of 2017. Growth was also driven by the continued uptake of Interceptor Plus and Credelio, as well as increased sales of certain vaccines from new customer agreements.
CA Therapeutics revenue increased by $17.0 million or 27% due to volume and increased price, partially offset by the unfavorable impact of foreign exchange rates. Growth wassix months ended June 30, 2022, primarily due to the re-introductiontiming of Galliprant 100mg for dogs, continued uptakefinalizing the valuation of intangible assets acquired from the product and realized price increases across the category.
FA Future Protein &Bayer Animal Health revenue decreased by $1.7 million or 1% due to unfavorable impact from foreign exchange rates and a decline in volume, partially offset by increased price. Volume growth in aqua, vaccines and nutritional health products was offset by international purchasing patternsacquisition in the current year for poultry which shifted sales from the third quarter of 2018 to the first half of 2018.
FA Ruminants & Swine revenue increased by $21.1 million or 8% due primarily to increases in volume partially offset by the unfavorable impact of foreign exchange rates. Growth was driven mainly by U.S. and international purchasing patterns in both the current and prior year, which resulted in higher sales in third quarter of 2018.
Strategic Exits revenue decreased by $20.6 million or 42% due primarily to reduced revenue from a temporary contract manufacturing arrangement as part of the acquisition of the BI Vetmedica U.S. vaccines portfolio (BIVIVP), as well as the termination of two legacy U.S. distribution agreements acquired as part of our Novartis Animal Health acquisition.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Total revenue increased $132.8 million or 6% for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017, reflecting a 1% favorable foreign exchange rate impact, a 3% increase due to higher realized prices and a 2% increase due to higher volumes.
In summary, the total revenue increase was due primarily to:
an increase in revenue of $22.9 million due to the positive impact of foreign exchange rates;
an increase in revenue of $79.6 million or 15% from CA Disease Prevention products, excluding the impact foreign exchange rates;
an increase in revenue of $24.3 million or 13% from CA Therapeutics products, excluding the impact of foreign exchange rates;
an increase in revenue of $39.4 million or 9% from FA Future Protein & Health products, excluding the impact of foreign exchange rates;
an increase in revenue of $17.7 million or 2% from FA Ruminants & Swine, excluding the
impact of foreign exchange rates; and
partially offset by:
a decrease in revenue of $51.1 million from Strategic Exits, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
CA Disease Prevention revenue increased by $84.2 million or 16% due primarily to the continued uptake of Credelio and Interceptor Plus, as well as realized price increases primarily impacting Trifexis, Capstar and Comfortis, partially offset by competition in certain parasiticides, primarily impacting Trifexis and Comfortis.
CA Therapeutics revenue increased by $29.3 million or 16% due primarily to the continued uptake of Galliprant and Osurnia, as well as increased demand for Atopica and Onsior, partially offset by a temporary supply shortage of Percorten V used for the treatment of canine Addison’s Disease.
FA Future Protein & Health revenue increased by $46.1 million or 10% due primarily to the launch of Imvixa and the growth in poultry animal-only antibiotics and AviPro.
FA Ruminants & Swine revenue increased by $23.8 million or 3% due primarily to growth in animal-only and shared-class antibiotics, offset by competition from generic ractopamine based products.
Strategic Exits revenue decreased by $50.6 million or 42% due to reduced revenue from a temporary contract manufacturing arrangement as part of the acquisition of BIVIVP, as well as the termination in the third quarter of 2017 of a legacy U.S. distribution agreement acquired as part of our Novartis Animal Health acquisition.
Costs and ExpensesAsset Impairment, Restructuring and Other Special Charges
Cost of sales | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | 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) | % |
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Cost of sales decreased $6.4 million in the three months ended September 30, 2018 as compared to three months ended September 30, 2017 due primarily to the mix of products sold, the results of the manufacturing productivity agenda and non-recurring costs in 2017 associated with purchase accounting charges from the acquisition of BIVIVP related to the fair value adjustments of inventory acquired that was subsequently sold, partially offset by costs related to increased volume of products sold and various cost increases.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Cost of sales increased $72.4 million in the nine months ended September 30, 2018 as compared to nine months ended September 30, 2017 primarily due to costs related to increased volume of products sold, the write-off of inventory primarily related to the suspension of activities for Imrestor and various cost increases, partially offset by non-recurring costs in 2017 associated with purchase accounting charges from the acquisition of BIVIVP related to the fair value adjustments of inventory acquired that was subsequently sold.
Research and development
Three months ended September 30, 2018 vs. months ended September 30, 2017
R&D expenses decreased $3.0 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 due primarily to normal project spend fluctuations and restructuring savings.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
R&D expenses decreased $4.2 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to site closures and headcount reductions in early 2017.
Marketing, selling and administrative
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Marketing, selling and administrative expenses decreased $15.7 million for the three months ended September 30, 2018 as compared to the three months ended September 30, 2017 due primarily to productivity initiatives and cost control measures across these functions.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Marketing, selling and administrative expenses decreased $32.9 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to productivity initiatives and reduced direct to consumer programs.
Amortization of intangible assets
Three months ended September 30, 2018 vs. three months ended September 30, 2017
Amortization of intangible assets decreased $2.9 million for the three months ended September 30 2018 as compared to the three months ended September 30, 2017 due primarily to the acceleration of amortization related to certain product exits in 2017.
Nine months ended September 30, 2018 vs. nine months ended September 30, 2017
Amortization of intangible assets decreased $13.7 million for the nine months ended September 30, 2018 as compared to the nine months ended September 30, 2017 due primarily to the acceleration of amortization related to certain product exits in 2017.
Asset impairment, restructuring and other special charges
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.
Three months ended September 30, 2018 vs. three months ended September 30, 2017
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.
Ninelicensed from BexCaFe during the three months ended SeptemberJune 30, 2018 vs. nine months ended September 30, 20172022. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion.
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.
Income tax expense
Threesix months ended SeptemberJune 30, 2018 vs. three months ended September 30, 20172022. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion.
Income tax
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.
Nineperiodic benefit cost (income) recorded during the period. Other income recorded during the three months ended SeptemberJune 30, 2018 vs. nine2021 consisted of certain components of net periodic benefit income and an up-front payment received in relation to an asset assignment agreement, partially offset by foreign exchange 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.
Liquidity and Capital Resources
We historically participated in Lilly’s centralized treasury management system, including centralized cash pooling and overall financing arrangements. We have generated and expect to continue to generate positive cash flows from operations. In connection with the IPO, we entered into various long-term debt agreements as described below.
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our Credit Facilities.credit facilities. As a significant portion of our business is conducted outside the U.S.,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.
Our principal
We believe our primary sources of liquidity needs going forwardare sufficient to fund our short-term and long-term existing and planned capital requirements, which include working capital obligations, funding existing marketed and pipeline products, capital
expenditures, business development in our targeted areas, short-term and long-term debt obligations which include principal and interest expensepayments as well as interest rate swaps, operating lease payments, purchase obligations, and an anticipated dividend. Wecosts associated with the 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) | |
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 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.
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.