SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒ Quarterly Report Under Section 13 or 15(d) of the
Securities Exchange Act of 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2020MARCH 31, 2021
OR
☐ Transition Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 001-38661
Elanco Animal Health Incorporated
(Exact name of Registrant as specified in its charter)
| | | | | | | | |
| INDIANA | | 82-5497352 |
| (State or other jurisdiction of | | (I.R.S. Employer |
| incorporation or organization) | | Identification No.) |
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address of principal executive offices)
Registrant’s telephone number, including area code (877) 352-6261
Securities registered pursuant to Section 12(b) of the Act:
| | | | | | | | |
| Title of each class | Trading Symbol(s) | Name of each exchange on which registered |
| Common stock, no par value | ELAN | New York Stock Exchange |
| 5.00% Tangible Equity Units | ELAT | New York Stock Exchange |
Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐
Indicate by check mark whether the Registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
| | | | | | | | | | | | | | | | | | | | | | | |
| Large accelerated filer | ☒ | | | | | Accelerated filer | ☐ |
| Non-accelerated filer | ☐ | | | | | Smaller reporting company | ☐ |
| | | | | | Emerging growth company | ☐ |
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☐
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes ☐ No ☒
The number of shares of common stock outstanding as of July 27, 2020May 3, 2021 were 398,902,384472,995,963
Elanco Animal Health IncorporatedELANCO ANIMAL HEALTH INCORPORATED
FormFORM 10-Q
For the Quarter Ended June 30, 2020FOR THE QUARTER ENDEDMARCH 31, 2021
Table of ContentsTABLE OF CONTENTS
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PART I. Financial Information1 | | | | |
| Item 1. | | Financial Statements | | |
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| Item 2. | | | | |
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Liquidity and Capital ResourcesItem 3. | | | | |
| Item 4. | | | | |
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| Item 1. | | | | |
| Item 1A. | | | | |
| Item 2. | | | | |
| Item 3. | | | | |
| Item 4. | | | | |
| Item 5. | | | | |
| Item 6. | | | | |
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PART II. Other Information | | | | |
Item 1. | | Legal Proceedings | | |
Item 1A. | | Risk Factors | | |
Item 2. | | Unregistered Sales of Equity Securities and Use of Proceeds | | |
Item 3. | | Defaults Upon Senior Securities | | |
Item 4. | | Mine Safety Disclosures | | |
Item 5. | | Other Information | | |
Item 6. | | Exhibits | | |
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Signatures | | | | |
Forward-Looking StatementsFORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY
This Quarterly Report on Form 10-Q includes forward-looking statements within the meaning of the federal securities laws. This quarterly report contains forward-looking statements, including, without limitation, statements concerning the impact on our businessElanco Animal Health Incorporated and its subsidiaries (collectively, Elanco, the Company, we, us or our) caused by the acquisitionintegration of the animal health business of Bayer Aktiengesellschaft (Bayer), expected synergies and our cost savings, product launches, independent company stand-up costs and timing, expectations relating to human capital resources, the coronavirus (COVID-19) global pandemic, estimated "stand up" costs,reduction of debt, expectations relating to liquidity and sources of capital, our estimated interest expense,expected compliance with debt covenants, our industry and our operations, performance and financial condition, and including in particular, statements relating to our business, growth strategies, distribution strategies, product development efforts and future expenses.
Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important risk factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions, including but not limited to the following:
•heightened competition, including from innovation or generics;
•the impact of disruptive innovations and advances in veterinary medical practices, animal health technologies and alternatives to animal-derived protein;
•changes in regulatory restrictions on the use of antibiotics in foodfarm animals;
•the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the coronavirus (COVID-19) global health pandemic;
•our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;
•consolidation of our customers and distributors;
•an outbreak of infectious disease carried by foodfarm animals;
•the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the COVID-19 global health pandemic;
•the success of our research and development (R&D) and licensing efforts;
•our ability to complete acquisitions and successfully integrate the businesses we acquire, including the animal health business of Bayer Aktiengesellschaft (Bayer);
•the impact of the COVID-19 global health pandemic on our ability to achieve the anticipated revenue, earnings, accretion and other benefits associated with the acquisition of the animal health business of Bayer;
•misuse, off-label or counterfeiting use of our products;
•unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
•the impact of weather conditions and the availability of natural resources;
•disruption in our supply chain due to manufacturing issues experienced by our contract manufacturers;
•use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in higherfluctuation in our revenues;
•manufacturing problems and capacity imbalances;
•challenges to our intellectual property rights or lower inventory levels held by them in advanceour alleged violation of or trailing actual customer demand, which could lead to variations in quarterly revenue results;rights of others;
•risks related to our presence in emergingforeign markets;
•changes in United States (U.S.) foreign trade policy, impositionbreaches of tariffs or trade disputes;our information technology systems;
•our ability to successfully integrate the impactbusinesses we acquire, including the animal health business of global macroeconomic conditions;Bayer (Bayer Animal Health);
•effect of our substantial indebtedness on our business; and
•the effect on our business resulting from our separation from Eli Lilly and Company (Lilly), including the various costs associated with transition to a standalone entity, including the ability to stand up our enterprise resource planning (ERP) system and other information technology systems..
See “Risk Factors,” of Part I of our Annual Report on Form 10-K for the year ended December 31, 20192020 filed with the Securities and Exchange Commission (SEC) and Item 1A, "Risk Factors," of Part II of our Quarterly Report on Form 10-Q for the period ended March 31, 2020 and Part II of this Quarterly Report on Form 10-Q, for a further description of these and other factors. Although we have attempted to identify important risk factors, there may be other risk factors not presently known to us or that we presently believe are not material that could cause actual results and developments to differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. If any of these risks materialize, or if any of the above assumptions underlying forward-looking statements prove incorrect, actual results and developments may differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. For the reasons described above, we caution you against relying on any forward-looking statements, which should also be read in conjunction with the other cautionary statements that are included elsewhere in this quarterly report. Any forward-looking statement made by us in this quarterly report speaks only as of the date hereof. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update or to revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should be viewed as historical data.
PART I. Financial InformationI
ItemITEM 1. Financial StatementsFINANCIAL STATEMENTS
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Operations (Unaudited)
(Dollars and shares in millions, except per-share data)
| | | | Three Months Ended June 30, | | | Six Months Ended June 30, | | | | Three Months Ended March 31, |
| | | 2020 | | 2019 | | 2020 | | 2019 | | | 2021 | | 2020 |
| Revenue | Revenue | $ | 586.3 | | | $ | 781.6 | | | $ | 1,244.0 | | | $ | 1,512.7 | | Revenue | | $ | 1,242 | | | $ | 658 | |
| Costs, expenses and other: | Costs, expenses and other: | | Costs, expenses and other: | | |
| Cost of sales | Cost of sales | 295.9 | | | 356.0 | | | 628.6 | | | 699.8 | | Cost of sales | | 569 | | | 333 | |
| Research and development | Research and development | 59.4 | | | 68.8 | | | 126.2 | | | 132.9 | | Research and development | | 89 | | | 67 | |
| Marketing, selling and administrative | Marketing, selling and administrative | 162.8 | | | 200.9 | | | 344.8 | | | 382.0 | | Marketing, selling and administrative | | 348 | | | 182 | |
| Amortization of intangible assets | Amortization of intangible assets | 49.0 | | | 49.3 | | | 100.6 | | | 98.3 | | Amortization of intangible assets | | 147 | | | 52 | |
| Asset impairment, restructuring and other special charges (Note 7) | 119.4 | | | 31.8 | | | 194.2 | | | 56.7 | | |
| Asset impairment, restructuring and other special charges | | Asset impairment, restructuring and other special charges | | 108 | | | 75 | |
| Interest expense, net of capitalized interest | Interest expense, net of capitalized interest | 24.8 | | | 20.7 | | | 41.3 | | | 41.5 | | Interest expense, net of capitalized interest | | 61 | | | 16 | |
| Other–net, (income) expense | (47.9) | | | 3.9 | | | (46.8) | | | 6.5 | | |
| Other expense, net | | Other expense, net | | 0 | | | 1 | |
| | 663.4 | | | 731.4 | | | 1,388.9 | | | 1,417.7 | | | | 1,322 | | | 726 | |
| Income (loss) before income taxes | (77.1) | | | 50.2 | | | (144.9) | | | 95.0 | | |
| Income tax (benefit) expense | (23.9) | | | 14.3 | | | (42.6) | | | 27.6 | | |
| Net income (loss) | $ | (53.2) | | | $ | 35.9 | | | $ | (102.3) | | | $ | 67.4 | | |
| Loss before income taxes | | Loss before income taxes | | (80) | | | (68) | |
| Income tax benefit | | Income tax benefit | | (19) | | | (19) | |
| Net loss | | Net loss | | $ | (61) | | | $ | (49) | |
| | Earnings (loss) per share: | | |
| Loss per share: | | Loss per share: | | |
| Basic | Basic | $ | (0.13) | | | $ | 0.10 | | | $ | (0.25) | | | $ | 0.18 | | Basic | | $ | (0.12) | | | $ | (0.12) | |
| Diluted | Diluted | $ | (0.13) | | | $ | 0.10 | | | $ | (0.25) | | | $ | 0.18 | | Diluted | | $ | (0.12) | | | $ | (0.12) | |
| Weighted average shares outstanding: | Weighted average shares outstanding: | | Weighted average shares outstanding: | | |
| Basic | Basic | 413.2 | | 365.7 | | 408.5 | | 365.7 | Basic | | 486.7 | | | 403.9 | |
| Diluted | Diluted | 413.2 | | 367.0 | | 408.5 | | 366.5 | Diluted | | 486.7 | | | 403.9 | |
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See notes to condensed consolidated financial statements.
Elanco Animal Health IncorporatedCondensed Consolidated Statements of Comprehensive Income (Loss)Loss (Unaudited)
Elanco Animal Health Incorporated
(Dollars in millions)
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| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
| Net income (loss) | $ | (53.2) | | | $ | 35.9 | | | $ | (102.3) | | | $ | 67.4 | |
| Other comprehensive income (loss): | | | | | | | |
| Unrealized loss on derivatives for cash flow hedges, net of taxes | (20.7) | | | — | | | (59.9) | | | — | |
| Foreign currency translation | 49.6 | | | 35.4 | | | 20.3 | | | 5.2 | |
| Defined benefit pension and retiree health benefit plans, net of taxes | (1.1) | | | 0.2 | | | (1.5) | | | 2.2 | |
| Other comprehensive income (loss), net of tax | 27.8 | | | 35.6 | | | (41.1) | | | 7.4 | |
| Comprehensive income (loss) | $ | (25.4) | | | $ | 71.5 | | | $ | (143.4) | | | $ | 74.8 | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
| Net loss | | | | | $ | (61) | | | $ | (49) | |
| Other comprehensive income (loss): | | | | | | | |
| Unrealized gain (loss) on derivatives for cash flow hedges, net of taxes | | | | | 53 | | | (39) | |
| Foreign currency translation | | | | | (466) | | | (29) | |
| Defined benefit pension and retiree health benefit plans, net of taxes | | | | | 8 | | | (1) | |
| Other comprehensive loss, net of taxes | | | | | (405) | | | (69) | |
| Comprehensive loss | | | | | $ | (466) | | | $ | (118) | |
See notes to condensed consolidated financial statements.
Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(Dollars in millions)
| | | | | | | | | | | |
| June 30,
2020 | | December 31, 2019 |
| (Unaudited) | | |
| Assets | | | |
| Current Assets | | | |
| Cash and cash equivalents | $ | 1,391.1 | | | $ | 334.0 | |
| Accounts receivable, net of allowances of $7.3 (2020) and $6.2 (2019) | 543.9 | | | 816.9 | |
| Other receivables | 72.9 | | | 73.0 | |
| Inventories (Note 8) | 1,065.3 | | | 1,050.7 | |
| Prepaid expenses and other | 107.4 | | | 87.4 | |
| | | |
| Restricted cash (Note 17) | 10.7 | | | 11.1 | |
| Total current assets | 3,191.3 | | | 2,373.1 | |
| Noncurrent Assets | | | |
| | | |
| Goodwill | 3,044.0 | | | 2,989.6 | |
| Other intangibles, net | 2,432.7 | | | 2,482.8 | |
| Other noncurrent assets | 283.9 | | | 185.0 | |
| Property and equipment, net of accumulated depreciation of $942.1 (2020) and $930.5 (2019) | 924.1 | | | 955.3 | |
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| Total assets | $ | 9,876.0 | | | $ | 8,985.8 | |
| Liabilities and Equity | | | |
| Current Liabilities | | | |
| Accounts payable | $ | 242.5 | | | $ | 222.6 | |
| Employee compensation | 57.2 | | | 99.6 | |
| Sales rebates and discounts | 164.0 | | | 211.0 | |
| Current portion of long-term debt (Note 10) | 25.9 | | | 24.5 | |
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| Other current liabilities | 321.7 | | | 244.4 | |
| Payable to Lilly (Note 17) | 24.1 | | | 16.4 | |
| Total current liabilities | 835.4 | | | 818.5 | |
| Noncurrent Liabilities | | | |
| Long-term debt (Note 10) | 2,030.4 | | | 2,330.5 | |
| Accrued retirement benefits | 83.9 | | | 82.5 | |
| Deferred taxes | 65.5 | | | 100.8 | |
| Other noncurrent liabilities | 208.9 | | | 106.6 | |
| Total liabilities | 3,224.1 | | | 3,438.9 | |
| Commitments and Contingencies (Note 14) | — | | | — | |
| Equity | | | |
| | | |
| Preferred stock, no par value, 1,000,000,000 shares authorized; 0ne issued | — | | | — | |
| Common stock, no par value, 5,000,000,000 shares authorized, 398,899,013 and 373,011,513 shares issued and outstanding as of June 30, 2020 and December 31, 2019, respectively | — | | | — | |
| Additional paid-in capital | 6,886.1 | | | 5,636.3 | |
| Retained earnings (accumulated deficit) | (19.4) | | | 84.3 | |
| Accumulated other comprehensive loss | (214.8) | | | (173.7) | |
| Total equity | 6,651.9 | | | 5,546.9 | |
| Total liabilities and equity | $ | 9,876.0 | | | $ | 8,985.8 | |
| | | | | | | | | | | |
| March 31, 2021 | | December 31, 2020 |
| (Unaudited) | | |
| Assets | | | |
| Current Assets | | | |
| Cash and cash equivalents | $ | 515 | | | $ | 495 | |
| Accounts receivable, net of allowances of $9 (2021) and $9 (2020) | 1,028 | | | 872 | |
| Other receivables | 104 | | | 205 | |
| Inventories | 1,424 | | | 1,578 | |
| Prepaid expenses and other | 273 | | | 256 | |
| | | |
| Restricted cash | 0 | | | 11 | |
| Total current assets | 3,344 | | | 3,417 | |
| Noncurrent Assets | | | |
| | | |
| Goodwill | 6,016 | | | 6,225 | |
| Other intangibles, net | 6,032 | | | 6,387 | |
| Other noncurrent assets | 325 | | | 348 | |
| Property and equipment, net of accumulated depreciation of $1,060 (2021) and $1,038 (2020) | 1,271 | | | 1,316 | |
| | | |
| Total assets | $ | 16,988 | | | $ | 17,693 | |
| Liabilities and Equity | | | |
| Current Liabilities | | | |
| Accounts payable | $ | 411 | | | $ | 501 | |
| Employee compensation | 114 | | | 144 | |
| Sales rebates and discounts | 331 | | | 295 | |
| Current portion of long-term debt | 605 | | | 555 | |
| | | |
| Other current liabilities | 573 | | | 582 | |
| | | |
| Total current liabilities | 2,034 | | | 2,077 | |
| Noncurrent Liabilities | | | |
| Long-term debt | 5,556 | | | 5,572 | |
| Accrued retirement benefits | 316 | | | 346 | |
| Deferred taxes | 828 | | | 900 | |
| Other noncurrent liabilities | 247 | | | 322 | |
| Total liabilities | 8,981 | | | 9,217 | |
| Commitments and Contingencies | 0 | | | 0 | |
| Equity | | | |
| | | |
| Preferred stock, no par value, 1,000,000,000 shares authorized; 0ne issued | 0 | | | 0 | |
| Common stock, no par value, 5,000,000,000 shares authorized, 472,968,567 and 471,921,116 shares issued and outstanding as of March 31, 2021 and December 31, 2020, respectively | 0 | | | 0 | |
| Additional paid-in capital | 8,647 | | | 8,650 | |
| Accumulated deficit | (538) | | | (477) | |
| Accumulated other comprehensive income (loss) | (102) | | | 303 | |
| Total equity | 8,007 | | | 8,476 | |
| Total liabilities and equity | $ | 16,988 | | | $ | 17,693 | |
See notes to condensed consolidated financial statements.
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)
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| Common Stock | | | | | | | | | | Accumulated Other Comprehensive Income (Loss) | | | | | | | | |
| Shares | | Amount | | Additional Paid-in Capital | | | | Retained Earnings (Accumulated Deficit) | | Cash Flow Hedge Gain (Loss) | | Foreign Currency Translation | | Defined Benefit Pension and Retiree Health Benefit Plans | | Total | | Total Equity |
| December 31, 2018 | 365.6 | | | $ | — | | | $ | 5,403.3 | | | | | $ | 16.4 | | | $ | — | | | $ | (218.2) | | | $ | (4.0) | | | $ | (222.2) | | | $ | 5,197.5 | |
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| Net income | — | | | — | | | — | | | | | 31.5 | | | — | | | — | | | — | | | — | | | 31.5 | |
| Other comprehensive income (loss), net of tax | — | | | — | | | — | | | | | — | | | — | | | (30.2) | | | 2.0 | | | (28.2) | | | (28.2) | |
Separation activities(1) | — | | | — | | | (7.0) | | | | | — | | | — | | | — | | | — | | | — | | | (7.0) | |
| Stock compensation | — | | | — | | | 2.4 | | | | | — | | | — | | | — | | | — | | | — | | | 2.4 | |
| Issuance of stock under employee stock plans, net | 0.1 | | | — | | | — | | | | | — | | | — | | | — | | | — | | | — | | | — | |
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| March 31, 2019 | 365.7 | | | — | | | 5,398.7 | | | | | 47.9 | | | — | | | (248.4) | | | (2.0) | | | (250.4) | | | 5,196.2 | |
| Net income | — | | | — | | | — | | | | | 35.9 | | | — | | | — | | | — | | | — | | | 35.9 | |
| Other comprehensive income, net of tax | — | | | — | | | — | | | | | — | | | — | | | 35.4 | | | 0.2 | | | 35.6 | | | 35.6 | |
Separation activities(1) | — | | | — | | | (18.4) | | | | | — | | | — | | | — | | | — | | | — | | | (18.4) | |
| Stock compensation | — | | | — | | | 14.3 | | | | | — | | | — | | | — | | | — | | | — | | | 14.3 | |
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| Other | — | | | — | | | 1.9 | | | | | — | | | — | | | — | | | — | | | — | | | 1.9 | |
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| June 30, 2019 | 365.7 | | | $ | — | | | $ | 5,396.5 | | | | | $ | 83.8 | | | $ | — | | | $ | (213.0) | | | $ | (1.8) | | | $ | (214.8) | | | $ | 5,265.5 | |
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| Common Stock | | | | | | | | Accumulated Other Comprehensive Income (Loss) | | |
| Shares | | Amount | | Additional Paid-in Capital | | | | Retained Earnings (Accumulated Deficit) | | Cash Flow Hedge Gain (Loss) | | Foreign Currency Translation | | Defined Benefit Pension and Retiree Health Benefit Plans | | Total | | Total Equity |
| December 31, 2019 | 373 | | | $ | 0 | | | $ | 5,636 | | | | | $ | 84 | | | $ | — | | | $ | (199) | | | $ | 25 | | | $ | (174) | | | $ | 5,546 | |
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| Net loss | — | | | — | | | — | | | | | (49) | | | — | | | — | | | — | | | — | | | (49) | |
Adoption of Accounting Standards Update 2016-13 | — | | | — | | | — | | | | | (1) | | | — | | | — | | | — | | | — | | | (1) | |
| Other comprehensive loss, net of tax | — | | | — | | | — | | | | | — | | | (39) | | | (29) | | | (1) | | | (69) | | | (69) | |
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Separation activities (1) | — | | | — | | | 16 | | | | | — | | | — | | | — | | | — | | | — | | | 16 | |
| Stock compensation | — | | | — | | | 11 | | | | | — | | | — | | | — | | | — | | | — | | | 11 | |
| Issuance of stock under employee stock plans, net | 1 | | | — | | | (13) | | | | | — | | | — | | | — | | | — | | | — | | | (13) | |
| Issuance of common stock, net of issuance costs | 25 | | | — | | | 768 | | | | | — | | | — | | | — | | | — | | | — | | | 768 | |
| Issuance of tangible equity units, net of issuance costs | — | | | — | | | 452 | | | | | — | | | — | | | — | | | — | | | — | | | 452 | |
| March 31, 2020 | 399 | | | $ | 0 | | | $ | 6,870 | | | | | $ | 34 | | | $ | (39) | | | $ | (228) | | | $ | 24 | | | $ | (243) | | | $ | 6,661 | |
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| December 31, 2019 | 373.0 | | | $ | — | | | $ | 5,636.3 | | | | | $ | 84.3 | | | $ | — | | | $ | (198.4) | | | $ | 24.7 | | | $ | (173.7) | | | $ | 5,546.9 | |
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| Net loss | — | | | — | | | — | | | | | (49.1) | | | — | | | — | | | — | | | — | | | (49.1) | |
Adoption of Accounting Standards Update 2016-13(2) | — | | | — | | | — | | | | | (1.4) | | | — | | | — | | | — | | | — | | | (1.4) | |
| Other comprehensive loss, net of tax | — | | | — | | | — | | | | | — | | | (39.2) | | | (29.3) | | | (0.4) | | | (68.9) | | | (68.9) | |
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Separation activities(1) | — | | | — | | | 15.8 | | | | | — | | | — | | | — | | | — | | | — | | | 15.8 | |
| Stock compensation | — | | | — | | | 11.1 | | | | | — | | | — | | | — | | | — | | | — | | | 11.1 | |
| Issuance of stock under employee stock plans, net | 0.8 | | | — | | | (12.8) | | | | | — | | | — | | | — | | | — | | | — | | | (12.8) | |
Issuance of common stock, net of issuance costs(3) | 25.0 | | | — | | | 767.5 | | | | | — | | | — | | | — | | | — | | | — | | | 767.5 | |
Issuance of tangible equity units, net of issuance costs(3) | — | | | — | | | 452.4 | | | | | — | | | — | | | — | | | — | | | — | | | 452.4 | |
| March 31, 2020 | 398.8 | | | — | | | 6,870.3 | | | | | 33.8 | | | (39.2) | | | (227.7) | | | 24.3 | | | (242.6) | | | 6,661.5 | |
| Net loss | — | | | — | | | ��� | | | | | (53.2) | | | — | | | — | | | — | | | — | | | (53.2) | |
| Other comprehensive income (loss), net of tax | — | | | — | | | — | | | | | — | | | (20.7) | | | 49.6 | | | (1.1) | | | 27.8 | | | 27.8 | |
Separation activities (1) | — | | | — | | | 8.8 | | | | | — | | | — | | | — | | | — | | | — | | | 8.8 | |
| Stock compensation | — | | | — | | | 8.3 | | | | | — | | | — | | | — | | | — | | | — | | | 8.3 | |
| Issuance of stock under employee stock plans, net | 0.1 | | | — | | | (1.0) | | | | | — | | | — | | | — | | | — | | | — | | | (1.0) | |
| Other | — | | | — | | | (0.3) | | | | | — | | | — | | | — | | | — | | | | | (0.3) | |
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| June 30, 2020 | 398.9 | | | $ | — | | | $ | 6,886.1 | | | | | $ | (19.4) | | | $ | (59.9) | | | $ | (178.1) | | | $ | 23.2 | | | $ | (214.8) | | | $ | 6,651.9 | |
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| December 31, 2020 | 472 | | | $ | 0 | | | $ | 8,650 | | | | | $ | (477) | | | $ | (61) | | | $ | 360 | | | $ | 4 | | | $ | 303 | | | $ | 8,476 | |
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| Net loss | — | | | — | | | — | | | | | (61) | | | — | | | — | | | — | | | — | | | (61) | |
| Other comprehensive income (loss), net of tax | — | | | — | | | — | | | | | — | | | 53 | | | (466) | | | 8 | | | (405) | | | (405) | |
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| Stock compensation | — | | | — | | | 15 | | | | | — | | | — | | | — | | | — | | | — | | | 15 | |
| Issuance of stock under employee stock plans, net | 1 | | | — | | | (18) | | | | | — | | | — | | | — | | | — | | | — | | | (18) | |
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| March 31, 2021 | 473 | | | $ | 0 | | | $ | 8,647 | | | | | $ | (538) | | | $ | (8) | | | $ | (106) | | | $ | 12 | | | $ | (102) | | | $ | 8,007 | |
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(1) See Note 17: Related Party AgreementsRepresent amounts associated with transactions between us and Transactions for further discussion.
(2) See Note 4: ImplementationLilly, related primarily to the completion of New Financial Accounting Pronouncements for further discussion.
(3) See Note 9: Equity for further discussion.the local country asset purchases, the finalization of assets and liabilities associated with the legal separation from Lilly, centralized cash management, and resulting impacts on deferred tax assets, that occurred subsequent to our initial public offering.
See notes to condensed consolidated financial statements.
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)
| | | Six Months Ended June 30, | | | Three Months Ended March 31, |
| | | 2020 | | 2019 | | 2021 | | 2020 |
| Cash Flows from Operating Activities | Cash Flows from Operating Activities | | | Cash Flows from Operating Activities | |
| Net income (loss) | $ | (102.3) | | | $ | 67.4 | | |
| Adjustments to reconcile net income (loss) to cash flows from operating activities: | | |
| Net loss | | Net loss | $ | (61) | | | $ | (49) | |
| Adjustments to reconcile net loss to cash flows from operating activities: | | Adjustments to reconcile net loss to cash flows from operating activities: | |
| Depreciation and amortization | Depreciation and amortization | 162.4 | | | 152.4 | | Depreciation and amortization | 202 | | | 82 | |
| Change in deferred income taxes | Change in deferred income taxes | (78.4) | | | 40.3 | | Change in deferred income taxes | (32) | | | (25) | |
| Stock-based compensation expense | Stock-based compensation expense | 19.4 | | | 21.9 | | Stock-based compensation expense | 15 | | | 11 | |
| Asset impairment charges | Asset impairment charges | 3.5 | | | 4.0 | | Asset impairment charges | 9 | | | 0 | |
| Gain on sale of assets | Gain on sale of assets | (51.3) | | | — | | Gain on sale of assets | 0 | | | (4) | |
| | Changes in operating assets and liabilities | 205.7 | | | (205.2) | | |
| Inventory fair value step-up amortization | | Inventory fair value step-up amortization | 62 | | | 0 | |
| Changes in operating assets and liabilities, net of acquisitions | | Changes in operating assets and liabilities, net of acquisitions | (183) | | | (10) | |
| | Other non-cash operating activities, net | Other non-cash operating activities, net | 4.6 | | | (22.6) | | Other non-cash operating activities, net | 10 | | | (1) | |
| Net Cash Provided by Operating Activities | Net Cash Provided by Operating Activities | 163.6 | | | 58.2 | | Net Cash Provided by Operating Activities | 22 | | | 4 | |
| Cash Flows from Investing Activities | Cash Flows from Investing Activities | | Cash Flows from Investing Activities | |
| | Net proceeds from sale (purchases) of property and equipment | 19.2 | | | (51.8) | | |
| | Proceeds from settlement of net investment hedges (Note 11) | 32.7 | | | — | | |
| | Net purchases of property and equipment | | Net purchases of property and equipment | (18) | | | (13) | |
| Cash paid for acquisitions, net of cash acquired | | Cash paid for acquisitions, net of cash acquired | 73 | | | 0 | |
| Proceeds from settlement of net investment hedges | | Proceeds from settlement of net investment hedges | 0 | | | 25 | |
| Purchases of intangible assets | | Purchases of intangible assets | (33) | | | 0 | |
| Purchases of software | Purchases of software | (59.6) | | | (22.9) | | Purchases of software | (5) | | | (32) | |
| Other investing activities, net | Other investing activities, net | (1.3) | | | (2.8) | | Other investing activities, net | (7) | | | 0 | |
| Net Cash Used for Investing Activities | (9.0) | | | (77.5) | | |
| Net Cash Provided by (Used for) Investing Activities | | Net Cash Provided by (Used for) Investing Activities | 10 | | | (20) | |
| Cash Flows from Financing Activities | Cash Flows from Financing Activities | | Cash Flows from Financing Activities | |
| Repayments of borrowings (Note 10) | (377.8) | | | (65.0) | | |
| Proceeds from issuance of long-term debt (Note 10) | 79.2 | | | — | | |
| Repayments of borrowings | | Repayments of borrowings | (20) | | | (371) | |
| Net proceeds from revolving credit facility | | Net proceeds from revolving credit facility | 50 | | | 0 | |
| Proceeds from issuance of long-term debt | | Proceeds from issuance of long-term debt | 0 | | | 79 | |
| | Proceeds from issuance of common stock and tangible equity units (Note 9) | 1,219.9 | | | — | | |
| Proceeds from issuance of common stock and tangible equity units | | Proceeds from issuance of common stock and tangible equity units | 0 | | | 1,220 | |
| Debt issuance costs | Debt issuance costs | (3.2) | | | — | | Debt issuance costs | 0 | | | (3) | |
| | Consideration paid to Lilly in connection with the Separation (Note 1) | — | | | (191.2) | | |
| | | Other net financing transactions with Lilly | Other net financing transactions with Lilly | — | | | 5.0 | | Other net financing transactions with Lilly | (11) | | | (15) | |
| Other financing activities, net | Other financing activities, net | (14.2) | | | 1.4 | | Other financing activities, net | (17) | | | (13) | |
| Net Cash Provided by (Used for) Financing Activities | 903.9 | | | (249.8) | | |
| Net Cash Provided by Financing Activities | | Net Cash Provided by Financing Activities | 2 | | | 897 | |
| Effect of exchange rate changes on cash and cash equivalents | Effect of exchange rate changes on cash and cash equivalents | (1.8) | | | (11.8) | | Effect of exchange rate changes on cash and cash equivalents | (25) | | | (9) | |
| Net increase (decrease) in cash, cash equivalents and restricted cash | 1,056.7 | | | (280.9) | | |
| Net increase in cash, cash equivalents and restricted cash | | Net increase in cash, cash equivalents and restricted cash | 9 | | | 872 | |
| Cash, cash equivalents and restricted cash at January 1 | Cash, cash equivalents and restricted cash at January 1 | 345.1 | | | 677.5 | | Cash, cash equivalents and restricted cash at January 1 | 506 | | | 345 | |
| Cash, cash equivalents and restricted cash at June 30 | $ | 1,401.8 | | | $ | 396.6 | | |
| Cash, cash equivalents and restricted cash at March 31 | | Cash, cash equivalents and restricted cash at March 31 | $ | 515 | | | $ | 1,217 | |
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| June 30, | | |
| 2020 | | 2019 |
| Cash and cash equivalents | $ | 1,391.1 | | | $ | 385.1 | |
| Restricted cash (Note 17) | 10.7 | | | 11.5 | |
| Cash, cash equivalents and restricted cash at June 30 | $ | 1,401.8 | | | $ | 396.6 | |
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| March 31, |
| 2021 | | 2020 |
| Cash and cash equivalents | $ | 515 | | | $ | 1,206 | |
| Restricted cash | 0 | | | 11 | |
| Cash, cash equivalents and restricted cash at March 31 | $ | 515 | | | $ | 1,217 | |
See notes to condensed consolidated financial statements.
Elanco Animal Health Incorporated
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share data)
Note 1. Nature of Business and Organization
Nature of Business
Elanco Animal Health Incorporated (Elanco Parent) and its subsidiaries (collectively, Elanco, the Company, we, us or our) was formed as a wholly-owned subsidiary of Eli Lilly and Company (Lilly). Elanco is a global animal health company that innovates, develops, manufactures and markets products for companion and food animals. We offer a diverse portfolio of more than 125 brands to veterinarians and food animal producers in more than 90 countries.
Organization
Elanco Parent was formed in May 2018, as a wholly-owned subsidiary of Lilly, to serve as the ultimate parent company of substantially all of the animal health businesses of Lilly.
On September 24, 2018, Elanco Parent completed an initial public offering (IPO) resulting in the issuance of 72.3 million shares of its common stock (including shares issued pursuant to the underwriters’ option to purchase additional shares), which represented 19.8% of the outstanding shares, at $24 per share resulting in total net proceeds, after underwriting discounts and commissions, of $1.7 billion. In connection with the completion of the IPO, through a series of equity and other transactions, Lilly transferred to Elanco Parent the animal health businesses that form its business. In exchange, Elanco Parent has paid to Lilly approximately $4.2 billion, which included the net proceeds from the IPO, the net proceeds from the debt offering completed by Elanco Parent in August 2018 and the term loan facility entered into by Elanco Parent in September 2018 (see Note 10: Debt). These transactions are collectively referred to herein as the Separation.
On February 8, 2019, Lilly announced an exchange offer whereby Lilly shareholders could exchange all or a portion of Lilly common stock for shares of Elanco common stock owned by Lilly. The disposition of Elanco shares was completed on March 11, 2019, and resulted in the full separation of Elanco along with the disposal of Lilly's entire ownership and voting interest in Elanco.
Note 2.1. Basis of Presentation and Summary of Significant Accounting Policies
Elanco was formed as a wholly-owned subsidiary of Eli Lilly and Company (Lilly). Elanco Parent was formed in May 2018 to serve as the ultimate parent company of substantially all of the animal health businesses of Lilly. In September 2018, Elanco Parent completed an initial public offering (IPO). In connection with the completion of the IPO, through a series of equity and other transactions, Lilly transferred to Elanco Parent the animal health businesses that form its business. The disposition of Elanco shares by Lilly was completed in March 2019, which resulted in the full separation of Elanco.
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the United States (U.S.) Securities and Exchange Commission (SEC) requirements offor interim reporting. As permitted under those rules, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been condensed or omitted. The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and therefore, they do not include all informationcombined financial statements and footnotes necessaryaccompanying notes for a fair presentation of financial position, results of operations, and cash flowsthe year ended December 31, 2020 included in conformityour Annual Report on Form 10-K filed with accounting principles generally accepted in the United States (GAAP). SEC on March 1, 2021.
In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for a fair presentation of the results of operations for the periods shown. In preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates. The accounts of all wholly owned and controlled subsidiaries are included in the condensed consolidated financial statements and all intercompany balances and transactions have been eliminated.
Certain reclassifications have been made to prior periods in the condensed consolidated financial statements and accompanying notes to conform with current presentation.
The information included in this Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and combined financial statements and accompanying notes for the year ended December 31, 2019 included in our Annual Report on Form 10-K filed with the Securities and Exchange Commission (SEC) on February 28, 2020.
Our income taxes in 2019 and thereafter reflect the results on a stand-alone basis independent of Lilly, except for the period during which we were included in a combined tax return with Lilly until full separation. The income tax amounts in the financial statements have been calculated based on a separate return methodology and presented as if our operations were separate taxpayers in the respective jurisdictions. We file income tax returns in the U.S. federal jurisdiction and various state, local and non-U.S. jurisdictions.
The significant accounting policies set forth in Note 4 to the consolidated and combined financial statements in our Annual Report on Form 10-K for the year ended December 31, 20192020 appropriately represent, in all material respects, the current status of our accounting policies, except as it relates to the adoption of the standardsstandard that werewas effective January 1, 20202021 as described in Note 4:2: Implementation of New Financial Accounting Pronouncements,Pronouncements.
On August 1, 2020, we completed the previously announced acquisition of Bayer Animal Health. See Note 4: Acquisitions and are incorporated herein by reference.Divestitures for additional information.
Note 3. Impact of Separation
In connection with the Separation, we issued $2.0 billion aggregate principal amount of senior notes in a private placement, and we also entered into a $750.0 million senior unsecured revolving credit facility and $500.0 million senior unsecured term credit facility. In connection with the Separation, we entered into various agreements with Lilly, including a master separation agreement, a tax matters agreement and the transitional services agreement (TSA).
In addition to the agreements referenced above, we entered into several other related party transactions with Lilly before and at the time of the Separation. For additional information regarding our ongoing agreements, as well as certain activities while Lilly was a related party, see Note 17: Related Party Agreements and Transactions.
Note 4.2. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of an accounting standardsstandard that werewas effective January 1, 20202021 and werewas adopted on that date:
| | | | | | | | | | | | | | |
| Standard | | Description | | Effect on the financial statements or other significant matters |
Accounting Standards Update 2016-13,(ASU) 2019-12, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial InstrumentsSimplifying the Accounting for Income Taxes | | This standard modifiesThe amendments in this update include simplifications related to accounting for income taxes including removing certain exceptions related to the impairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses on certain types of financial instruments, including trade receivables. | | We adoptedfor intraperiod tax allocation and the standard using the modified retrospective approach. The impact of adoption included the first-time recognition of expected credit losses (i.e., bad debt expense) on current receivablesdeferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that are not past due, which resultedresult in a decreasestep-up in retained earningsthe tax basis of $1.4 million. Recognition of this allowance and other impacts of adoption were not material to the consolidated financial statements. |
Accounting Standards Update 2018-15, Intangibles - Goodwill and Other Internal-Use Software (Subtopic 350-40): Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement that is a Service Contract
| | This guidance aligns the requirements for capitalizing implementation costs incurred in a cloud-based hosting arrangement that is a service contract with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software.goodwill. | | We implemented the guidance on a prospective basis. The adoption of this guidance did not have a significantmaterial impact on theour consolidated financial statements. |
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The following table provides a brief description of an accounting standardsstandard that is applicable to us that havebut has not yet been adopted:
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| Standard | | Description | | Effective Date | | Effect on the financial statements or other significant matters |
Accounting Standards Update 2019-12, Simplifying the Accounting for Income Taxes
| | The amendments in this update simplify the accounting for income taxes by removing certain exceptions and clarifying certain requirements regarding franchise taxes, goodwill, consolidated tax expenses, and annual effective tax rate calculations.
| | This standard is effective January 1, 2021, with early adoption permitted. We intend to adopt this standard on that date. | | We are currently evaluating the effect of this standard on our consolidated financial statements. |
Accounting Standards UpdateASU 2020-04, Reference rate reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial ReportingReporting; ASU 2021-01, Reference Rate Reform (Topic 848): Scope
| | This updateASU 2020-04 provides optional expedients and exceptions for applying U.S. GAAP to contracts, hedging relationships, and other transactions affected by reference rate reform if certain criteria are met. ASU 2021-01 clarifies the scope of Topic 848 so that derivatives affected by the discounting transition are explicitly eligible for certain optional expedients and exceptions. | | This standard can be applied immediately, but early adoption is only availableThese standards were effective as of March 12, 2020 through December 31, 2022.2022 and adoption is permitted at any time during the period on a prospective basis. | | We are currently in the process of evaluating the impact of the London Interbank Offered Rate (LIBOR) on our existing contracts butand may elect optional expedients in future periods as reference rate reform activities occur. We do not expect that this updatethese updates will have a material impact on our consolidated financial statements. |
Note 5.3. Revenue
Our sales rebates and discounts are based on specific agreementsagreements. The most significant of our sales rebate programs in terms of accrual and payment amounts, percentage of our products that are sold via these programs, and level of judgment required in estimating the appropriate transaction price, relate to our programs in the U.S., France and the majority relate to sales in the U.S.United Kingdom (U.K.). As of June 30,March 31, 2021 and 2020, and 2019, the aggregate liability for sales rebates for these countries represented approximately 76% and discounts in the U.S. represents approximately 74% and 75%82%, respectively, of our total liability with the next largest country representing approximately 7%4% and 5%6%, respectively, of our total liability.
The following table summarizes the activity in the sales rebates and discounts liability in the U.S., France, and the U.K.:
| | | Three Months Ended June 30, | | | Six Months Ended June 30, | | | | Three Months Ended March 31, |
| | 2020 | | 2019 | | 2020 | | 2019 | | | 2021 | | 2020 |
| Beginning balance | Beginning balance | $ | 137.6 | | | $ | 120.0 | | | $ | 150.4 | | | $ | 118.5 | | Beginning balance | | $ | 217 | | | $ | 176 | |
| | Reduction of revenue | Reduction of revenue | 65.1 | | | 80.6 | | | 125.6 | | | 146.3 | | Reduction of revenue | | 142 | | | 71 | |
| Payments | Payments | (80.7) | | | (68.5) | | | (154.0) | | | (132.7) | | Payments | | (106) | | | (87) | |
| Foreign currency translation adjustments | | Foreign currency translation adjustments | | (2) | | | (1) | |
| Ending balance | Ending balance | $ | 122.0 | | | $ | 132.1 | | | $ | 122.0 | | | $ | 132.1 | | Ending balance | | $ | 251 | | | $ | 159 | |
Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three and six months ended June 30,March 31, 2021 and 2020 and 2019 for product shipped in previous periods were not material.
Actual global product returns were approximately 1.5%1% and less than 0.1%2% of net revenue for the three months ended June 30,March 31, 2021 and 2020, and 2019, respectively. Actual product returns were approximately 1.6% and 0.2% of net revenue for the six months ended June 30, 2020 and 2019, respectively.
Disaggregation of Revenue
The following table summarizesIn the first quarter of 2021, management revisited how it analyzes revenue, both internally and externally, and determined that disaggregation by major product line provides a more meaningful view of our results. Accordingly, we updated our disaggregated revenue disaggregated by product category:presentation from the previous five categories (i.e., pet health disease prevention, pet health therapeutics, farm animal future protein & health, farm animal ruminants & swine, and contract manufacturing) to the following:
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| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
| Companion Animal Disease Prevention | $ | 176.3 | | | $ | 223.4 | | | $ | 316.6 | | | $ | 409.3 | |
| Companion Animal Therapeutics | 78.0 | | | 83.4 | | | 143.8 | | | 164.8 | |
| Food Animal Future Protein & Health | 157.9 | | | 175.8 | | | 337.9 | | | 343.0 | |
| Food Animal Ruminants & Swine | 158.2 | | | 271.5 | | | 410.8 | | | 545.6 | |
Strategic Exits(1) | 15.9 | | | 27.5 | | | 34.9 | | | 50.0 | |
| Revenue | $ | 586.3 | | | $ | 781.6 | | | $ | 1,244.0 | | | $ | 1,512.7 | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
| | | | | | | |
| | | | | | | |
| Pet Health | | | | | $ | 645 | | | $ | 206 | |
| | | | | | | |
| | | | | | | |
| Farm Animal | | | | | 578 | | | 433 | |
Contract Manufacturing (1) | | | | | 19 | | | 19 | |
| Revenue | | | | | $ | 1,242 | | | $ | 658 | |
(1)Represents revenue from business activitiesarrangements in which we have either exited or madeact as a strategic decisioncontract manufacturer, including supply agreements associated with divestitures of products related to exit.the acquisition of Bayer Animal Health.
Note 6.4. Acquisitions and Divestitures
2019 AcquisitionsBayer Animal Health Acquisition
During 2019,On August 1, 2020, we completed our previously announced acquisition of Bayer Animal Health, a provider of products intended to improve the acquisitionshealth and well-being of all outstanding shares of Aratana Therapeutics, Inc. (Aratana)pets and Prevtec Microbia Inc. (Prevtec). These transactions werefarm animals, in a cash and stock transaction. The transaction was accounted for as a business combinationscombination under the acquisition method of accounting. Under thisThe acquisition method therequires, among other things, that assets acquired and liabilities assumed were recordedin a business combination be recognized at their respective fair values as of the acquisition date in our condensed consolidated financial statements.date. The determination of estimated fair value requiredrequires management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of these acquisitionsBayer Animal Health are included in our condensed consolidated financial statements from the datesdate of acquisition.
Aratana Therapeutics, Inc.
On July 18, 2019, we acquired Aratana, a pet therapeutics company focused on innovative therapies for dogs and cats, for stock and cash-based contingent value rights. Aratana is the creator of the canine osteoarthritis medicine,Galliprant™, the rights to which we acquired in 2016. The acquisition enhanceshas expanded our presence in the areas of appetite stimulants in dogs, pain relief in dogs and cats, and treatments of other conditions in the U.S. and internationally. In connection with the acquisition, we issued approximately 7.2 million shares with a value of $238.0 million to Aratana shareholders, based on our stock price on the last trading day immediately prior to the closing date. The purchase consideration also included up to $12 million in contingent value rights, which represent the rights of Aratana shareholders to receive a contingent payment of $0.25 per share in cash upon the achievement of a specified milestone as outlined in the merger agreement. We calculated an immaterial fair value for the contingent value rights using the Monte Carlo simulation model.
Contingent consideration liabilities that we previously recorded for future royalty and milestone payments in relation to the 2016 acquisition of rights to Galliprant were settled upon the closing of our acquisition of Aratana.The liabilities were valued at $84.7 million as of the acquisition date using the Monte Carlo simulation model.The resulting $7.5 million loss upon settlement was recorded in other - net, (income) expense in the consolidated and combined statement of operations for the year ended December 31, 2019.
The following table summarizes the amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
| | | | | |
Estimated Fair Value at July 18, 2019 | |
Cash and cash equivalents | $ | 26.4 | |
Inventories | 10.3 | |
Acquired in-process research and development | 31.9 | |
Marketed products (1)
| 36.7 | |
Other intangible assets (1)
| 13.2 | |
Other assets and liabilities - net | 4.1 | |
Total identifiable net assets | 122.6 | |
Goodwill (2)
| 30.7 | |
Settlement of existing contingent consideration liabilities | 84.7 | |
Total consideration transferred | $ | 238.0 | |
(1)These intangible assets, which are being amortized on a straight-line basis over their estimated useful lives, are expected to have a weighted average useful life of approximately 12.5 years.
(2)The goodwill recognized from this acquisition is attributable primarily to expected synergies from combining the operations of Aratana with our legacy business. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
The accounting for this acquisition is complete. A $19.1 million measurement period adjustment was recorded to establish a deferred tax liability for the preexisting Galliprant contingent consideration liability during the three and six months ended June 30, 2020.
We issued 0.1 million shares and recorded $3.6 million of stock-based compensation expense for the vesting of Aratana equity awards that was accelerated upon the closing of the acquisition during 2019.
Had Aratana been acquired on January 1, 2018, the unaudited pro forma combined revenues and income before income taxes of Elanco and Aratana would have been $1,520.6 million and $82.3 million, respectively, for the six months ended June 30, 2019.
Prevtec Microbia Inc.
On July 31, 2019, we acquired Prevtec in a cash transaction for approximately $60.3 million, inclusive of certain post-closing adjustments. Prevtec is a Canadian biotechnology company specializing in the development of vaccines intended to help prevent bacterial diseases in food animals. The acquisition allows us to expand on our previous distribution arrangement for Coliprotec™and is consistent with our efforts to explore innovative antibiotic alternatives.
The purchase consideration included up to $16.3 million in additional cash consideration, contingent upon the achievement of specific sales milestones by December 31, 2021. We recorded a $4.7 million liability on the condensed consolidated balance sheet as of the acquisition date based on the fair value of the contingent consideration as calculated using the Monte Carlo simulation model.
A previously existing $0.7 million receivable owed from Prevtec to Elanco Animal Health UK Limited was settled upon the closing of our acquisition of Prevtec.The resulting immaterial gain upon settlement was recorded in other - net, (income) expense in the consolidated and combined statement of operations for the year ended December 31, 2019.
The following table summarizes the amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
| | | | | |
Estimated Fair Value at July 31, 2019 | |
Cash and cash equivalents | $ | 0.9 | |
Property and equipment | 0.5 | |
Acquired in-process research and development | 2.8 | |
Marketed products (1)
| 58.9 | |
Other intangible assets | 1.1 | |
Other assets and liabilities - net | (9.3) | |
Total identifiable net assets | 54.9 | |
| |
Goodwill (2)
| 10.1 | |
Total consideration transferred | $ | 65.0 | |
(1)These intangible assets, which are being amortized on a straight-line basis over their estimated useful lives, are expected to have a weighted average useful life of 10 years.
(2)The goodwill recognized from this acquisition is attributable primarily to expected synergies from combining the operations of Prevtec with our legacy business and future unidentified projects and products. The goodwill associated with this acquisition is not deductible for tax purposes.
The accounting for this acquisition is complete. An immaterial measurement period adjustment to deferred taxes was recorded during the three and six months ended June 30, 2020.
Pending Acquisition
Bayer Animal Health Business
On August 19, 2019, we entered into a Share and Asset Purchase Agreement (Purchase Agreement) with Bayer, a German corporation, to acquire Bayer's animalpet health business. Bayer's animal health business is a provider of products intended to improve the health and well-being of pets and farm animals. This acquisition is expected to expand our Companion Animal product category, advancing our planned intentional portfolio mix transformation and creating a better balance between our Food Animalfarm animal and Companion Animalpet health product categories. PursuantOur existing product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure while expanding our direct to retailer/e-commerce presence.
Total consideration transferred to Bayer and its subsidiaries for the Purchase Agreementacquisition is summarized as follows:
| | | | | |
Cash consideration (1) | $ | 5,058 | |
Fair value of Elanco common stock (2) | 1,724 | |
Fair value of total consideration transferred (3) | $ | 6,782 | |
(1)Includes initial cash consideration of $5,170 million less working capital and subject totax adjustments of $112 million.
(2)Represents the satisfactionacquisition date fair value of certain customary closing conditions, including the absence of any law or order enjoining or otherwise prohibiting the transaction in specified jurisdictions, we will purchase Bayer’s animal health business for $5.3 billion in cash and73 million shares of ourElanco common stock equal toat $23.64 per share. Per the terms of the stock and asset purchase agreement, the number of shares was based on approximately $2.3 billion divided by the 20-day volume-weighted average stock price as of the last day of trading before the closing of the acquisition (but subject to a 7.5% symmetrical collar centered on the volume-weighted averagebaseline share number of approximately $2.3 billion divided by an initial share price for the 30 trading days ended August 6, 2019 of $33.60).
(3)The transactionpurchase price is expectedpreliminary and subject to close in August 2020. See Note 14: Commitments and Contingencies for discussion regarding certain commitments related to this transaction.minor customary purchase price adjustments.
DivestituresWe recognized transaction costs related to the acquisition of Bayer Animal Health of $3 million and $20 million during the three months ended March 31, 2021 and 2020, respectively. These costs were primarily associated with financial advisory, legal and other professional services related to the acquisition and are reflected within asset impairment, restructuring and other special charges in our condensed consolidated statements of operations.
The amount of revenue attributable to Bayer Animal Health included in our condensed consolidated statement of operations for the three months ended March 31, 2021 is $559 million. Based on our current operational structure,
we have not recorded standalone costs for Bayer Animal Health after the date of the acquisition. As a result, we are unable to accurately determine earnings or loss attributable to Bayer Animal Health since the date of acquisition.
The valuation of assets acquired and liabilities assumed has not yet been finalized as of March 31, 2021. The purchase price allocation is preliminary and subject to change, including the valuation of inventories, property and equipment, intangible assets, income taxes and goodwill, among other items. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the acquisition date. During the three months ended March 31, 2021, we recorded immaterial measurement period adjustments which were made to reflect the facts and circumstances in existence as of the acquisition date. These adjustments primarily related to changes in inventory balances and gross margin assumptions as well as minor working capital adjustments. The fair values in the table below have been updated to reflect these measurement period adjustments. Finalization of the valuation during the measurement period could result in additional changes in the amounts recorded for the acquisition date fair value.
The following table summarizes the preliminary fair value of assets acquired and liabilities assumed as of the acquisition date:
| | | | | |
| Estimated Fair Value at August 1, 2020 | |
| Cash and cash equivalents | $ | 169 | |
| Accounts receivable | 9 | |
| Inventories | 487 | |
| Prepaid expenses and other current assets | 57 | |
| Property and equipment | 347 | |
| |
| |
| |
| |
| Intangible assets: | |
| Acquired in-process research and development | 65 | |
| Marketed products | 3,930 | |
| Assets held for sale | 138 | |
| Accounts payable and accrued liabilities | (240) | |
| Accrued retirement benefits | (217) | |
| Other noncurrent assets and liabilities, net | (894) | |
| Total identifiable net assets | 3,851 | |
| Goodwill | 2,931 | |
| Total consideration transferred | $ | 6,782 | |
Inventories comprised of $314 million, $79 million, $94 million in finished products, work in process, and raw materials, respectively. The preliminary estimate of fair value of finished products was determined based on net realizable value adjusted for the costs to complete the sales process, a reasonable profit allowance from the sales process, and estimated holding costs. The preliminary estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the sales process, a reasonable profit allowance for the remaining manufacturing and sales process effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value. The net fair value step-up adjustment to inventories of $148 million has been amortized to cost of sales as the inventory is sold to customers. As of March 31, 2021, the fair value step-up adjustment has been fully amortized.
Property and equipment is mostly composed of land, buildings, equipment (including machinery, furniture and fixtures, and computer equipment), and construction in progress. The preliminary estimate of fair value of real property was determined using the sales comparison data valuation technique and the preliminary estimate of fair value of personal property was determined using the direct replacement cost method. The recorded fair value of property and equipment located at the Shawnee, Kansas site is currently equal to its net book value at the time of the acquisition, as we are in the process of gathering information to finalize our fair value assessment.
Intangible assets relate to $65 million of in-process research and development (IPR&D) and $3,930 million of marketed products. The acquired definite-lived intangible assets are being amortized over a weighted-average
estimated useful life of approximately 10 years on a straight-line basis. The estimated fair values of identifiable intangible assets were determined using the "income approach," which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset or product (including revenues, cost of sales, R&D expenses, marketing, selling and administrative expenses, and contributory asset charges), the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, and competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of intangible assets as of March 31, 2021 is based on preliminary assumptions which are subject to change as we complete our valuation procedures.
Assets held for sale include $133 million of intangible assets, consisting of marketed products and IPR&D, and $5 million of inventory related to the divestitures of Drontal™, Profender™ and other products. In January 2020,order to secure the necessary regulatory clearances for the acquisition of Bayer Animal Health, we signed agreements to divest the worldwide rights to the Osurnia™Drontal and Profender product families within the U.S.United Kingdom and European Economic Area as well as other IPR&D. We completed the transactions, which were accounted for as asset divestitures, in the third quarter of 2020.
Accrued retirement benefits primarily relate to certain Bayer Animal Health international subsidiaries that have underfunded defined benefit pension plans. We have recorded the fair value of these plans using assumptions and accounting policies similar to those disclosed in Note 19: Retirement Benefits to the consolidated financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020. Upon acquisition, the excess of projected benefit obligation over the fair value of plan assets was recognized as a liability and previously existing deferred actuarial gains and losses and unrecognized service costs or benefits were eliminated.
The goodwill recognized from this acquisition represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
Pro forma financial information (unaudited)
The following table presents the estimated unaudited pro forma combined results of Elanco and Bayer Animal Health for the three months ended March 31, 2020 as if the acquisition of Bayer Animal Health had occurred on January 1, 2020:
| | | | | | | | | | | |
| | | | | |
| | | | | | | |
| Revenue | | | | | | | $ | 1,170 | |
| Loss before income taxes | | | | | | | (67) | |
The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Elanco and Bayer Animal Health. The supplemental pro forma financial information does not necessarily represent what the combined companies' revenue or results of operations would have been had the acquisition been completed on January 1, 2020, nor is it intended to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Elanco and Bayer Animal Health.
The unaudited supplemental pro forma financial information reflects primarily pro forma adjustments related to divestitures, fair value estimates for intangibles and inventory, and interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition of Bayer Animal Health. The unaudited supplemental pro forma financial information includes transaction charges associated with the acquisition. There are no material, nonrecurring pro forma adjustments directly attributable to the acquisition included in the reported pro forma revenue and loss before income taxes.
Divestitures and Assets Held For Sale
In connection with advancing our efforts to secure the necessary regulatory clearances for our acquisition of Bayer Animal Health, we signed agreements in 2020 to divest the rights to Capstar™,manufacture and in February 2020,commercialize certain products, including currently marketed products and certain IPR&D assets. As part of those transactions, we signed an agreement to divest the worldwide rights to the legacy Elanco products Vecoxan™, Itrafungolfor an aggregate of $285 million in all cash transactions. The agreements were signed with the intent to advance our efforts to secure the necessary regulatory clearances for the pending acquisition of the Bayer animal health business. The closing of these transactions is contingent on us entering into consent decrees with certain agencies™ and Clomicalm™ in connection with the pending acquisition as well as customary closing conditions. On July 27, 2020,required disposal of an early-stage IPR&D asset. We also made a payment during the three months ended March 31, 2021 and accrued for future amounts we completedare required to pay to the salebuyer of our remaining interest in Osurnia. Cash proceeds from the sale were approximately $141.6 million. The divestituresIPR&D asset to help fund their development costs for a set period of Capstar and Vecoxan, along with certain other immaterial divestitures, are expected to close contemporaneously with our acquisition of Bayer's animal health business.
time. The related assets for all 3 divestitures met the assets held for sale criteria as of June 30, 2020 and the assets for the Osurnia and Capstar divestitures met the assets held for sale criteria as of December 31, 2019. No adjustments2020. The divestiture closed during the three months ended March 31, 2021. There were required to recordno proceeds received from the disposition of these assets atand the lower of their carrying amounts or fair values less costs to sell on theresulting immaterial impact was recorded in other expense, net in our condensed consolidated balance sheet. statement of operations.
Assets and liabilities considered held for sale in connection with the divestituresabove divestiture were included in the respective line items on the consolidated balance sheet as follows:
| | | | | | | | | | | |
| June 30, 2020 | | December 31, 2019 |
| Inventories | $ | 7.0 | | | $ | 10.6 | |
| Other intangibles, net | 100.0 | | | 61.2 | |
| Property and equipment, net | 0.2 | | | 0.2 | |
| Total assets held for sale | $ | 107.2 | | | $ | 72.0 | |
| | | |
| Deferred taxes | $ | (3.4) | | | $ | (1.4) | |
| Total liabilities held for sale | $ | (3.4) | | | $ | (1.4) | |
| | | | | | | |
| | | December 31, 2020 |
| Inventories | | | $ | 2 | |
| Other intangibles, net | | | 4 | |
| Property and equipment, net | | | 0 | |
| Deferred tax asset | | | 1 | |
| Total assets held for sale | | | $ | 7 | |
| | | |
| | | |
| | | |
Other intangibles, net classified as held for sale primarily consistconsisted of marketed products. We determined that the disposal of these net assets does not qualify for reporting as a discontinued operation because it does not represent a strategic shift that has or will have a major effect on our operations and financial results.
Note 7.5. 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. Restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions, andincluding the pending acquisition of Bayer's animal health business,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 asset and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 2:1: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
Components of asset impairment, restructuring and other special charges are as follows:
| | | Three Months Ended June 30, | | | Six Months Ended June 30, | | | | Three Months Ended March 31, |
| | 2020 | | 2019 | | 2020 | | 2019 | | | 2021 | | 2020 |
| Restructuring charges: | Restructuring charges: | | | | | | | | Restructuring charges: | | | | |
Severance and other costs (1) | Severance and other costs (1) | $ | 0.6 | | | $ | (1.3) | | | $ | 1.0 | | | $ | (0.8) | | Severance and other costs (1) | | $ | 26 | | | $ | 1 | |
Facility exit costs | Facility exit costs | 0.1 | | | — | | | 0.7 | | | — | | Facility exit costs | | 0 | | | 1 | |
| | Acquisition related charges: | Acquisition related charges: | | Acquisition related charges: | | |
Transaction and integration costs (2) | Transaction and integration costs (2) | 111.1 | | | 33.1 | | | 187.4 | | | 53.5 | | Transaction and integration costs (2) | | 81 | | | 76 | |
| | Non-cash and other items: | Non-cash and other items: | | Non-cash and other items: | | |
Asset impairment (3) (4) | 3.5 | | | — | | | 3.5 | | | 4.0 | | |
Asset impairment (3) | | Asset impairment (3) | | 9 | | | 0 | |
Asset write-down (5)(4) | Asset write-down (5)(4) | 1.0 | | | — | | | 2.3 | | | — | | Asset write-down (5)(4) | | 2 | | | 1 | |
Gain on sale of fixed assets (6)(5) | Gain on sale of fixed assets (6)(5) | — | | | — | | | (3.8) | | | — | | Gain on sale of fixed assets (6)(5) | | 0 | | | (4) | |
Settlements and other (7)(6) | Settlements and other (7)(6) | 3.1 | | | — | | | 3.1 | | | — | | Settlements and other (7)(6) | | (10) | | | 0 | |
| | Total expense | Total expense | $ | 119.4 | | | $ | 31.8 | | | $ | 194.2 | | | $ | 56.7 | | Total expense | | $ | 108 | | | $ | 75 | |
(1)For the three and six months ended June 30,March 31, 2021, these charges primarily relate to a restructuring program announced and initiated in January 2021. These costs were partially offset by the reversal of severance accruals under the September 2020 program that are no longer needed. See below for further details.
For the three months ended March 31, 2020, these charges primarily relatedrelate to the announced 2019 program to streamline operations in Speke, England as well as the remaining costs to close the Larchwood, Iowa facility.
(2)Transaction costs represent external costs directly related to acquiring businesses and primarily include expenditures for banking, legal, accounting and other similar services. Integration costs represent internal and external incremental costs directly related to integrating acquired businesses, including the pending acquisition of Bayer's animal health businessBayer Animal Health (e.g., expenditures for consulting, system and process integration, and product transfers), as well as stand-up costs related to the implementation of new systems, programs, and processes due to the Separation from Lilly.processes.
(3)Asset impairment charges for the three and six months ended June 30, 2020 related to the impairment of an in-process research and development asset resulting from a reassessment of geographic viability.
(4)Asset impairment charges for the six months ended June 30, 2019March 31, 2021 related to an adjustment to fair value of intangible assets that were subject to product rationalization.
(5)(4)Asset write-down expenses for the three and six months ended June 30,March 31, 2021 resulted from adjustments recorded to write assets classified as held and used down to their current fair value. These included charges related to fixed assets in Basel, Switzerland; Cuxhaven, Germany; and Manukau, New Zealand in connection with announced restructuring programs.
Asset write-down expenses for the three months ended March 31, 2020 resulted from adjustments recorded to write assets classified as held and used down to their current fair value. These charges primarily related to fixed assets in Wusi, China in connection with the announced 2019 program to streamline operations.
(6)(5)Represents a gain on the disposal from the sale of an R&D facility in Prince Edward Island, Canada,Canada.
(6)As a result of workforce reductions in connection with our September 2020 and January 2021 restructuring programs, we remeasured the impacted pension benefit obligations as of March 31, 2021, which was written down duringresulted in a curtailment gain. See Note 13: Retirement Benefits for further information. This amount also includes the gain recorded on the divestiture of an early-stage IPR&D asset acquired as part of the Bayer Animal Health acquisition.
In January 2021, we announced a restructuring aligned with our ongoing efforts to improve operating efficiencies. The proposed actions are focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we intend to close R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We will also reduce duplication and optimize structures in U.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring will result in the elimination of approximately 330 positions around the world. Charges related to this initiative were approximately $41 million for the three months ended March 31, 2021. The overall project is expected to be substantially complete by the end of 2021.
In September 30, 2019 as2020, following the closing of the Bayer Animal Health acquisition, we implemented a restructuring program designed to reduce duplication, drive efficiency and optimize our footprint in key geographies. As part of the announced 2019 programrestructuring plan, we have eliminated approximately 900 positions across 40 countries, primarily in the commercial and marketing functions, but also in R&D, manufacturing and quality, and back office support functions.
During the three months ended March 31, 2021 we recorded a favorable adjustment of $13 million as a change in estimate related to streamline operations.
(7)Charge primarily relatesthis initiative, which reflects adjustments to a non-recurring litigation settlement for a matter that originated priorseverance accruals resulting from favorable negotiations and certain restructured employees filling open positions. The overall project is expected to be substantially complete by the Separation.end of 2021.
The following table summarizes the activity in our reserves established in connection with restructuring activities:
| | Facility exit costs | | Severance | | Total | |
| Balance at December 31, 2018 | $ | 9.3 | | | $ | 35.1 | | | $ | 44.4 | | |
| Charges | — | | | 2.5 | | | 2.5 | | |
| Reserve adjustments | — | | | (3.3) | | | (3.3) | | |
| Cash paid | (1.7) | | | (13.8) | | | (15.5) | | |
| Balance at June 30, 2019 | $ | 7.6 | | | $ | 20.5 | | | $ | 28.1 | | |
| | | | | | | | Facility exit costs | | Severance | | Total |
| Balance at December 31, 2019 | Balance at December 31, 2019 | $ | 5.4 | | | $ | 15.5 | | | $ | 20.9 | | Balance at December 31, 2019 | $ | 5 | | | $ | 16 | | | $ | 21 | |
| Charges | Charges | 0.7 | | | 1.7 | | | 2.4 | | Charges | 1 | | | 1 | | | 2 | |
| Reserve adjustments | Reserve adjustments | — | | | (0.7) | | | (0.7) | | Reserve adjustments | 0 | | | (1) | | | (1) | |
| Cash paid | Cash paid | (1.2) | | | (12.6) | | | (13.8) | | Cash paid | (1) | | | (10) | | | (11) | |
| Balance at June 30, 2020 | $ | 4.9 | | | $ | 3.9 | | | $ | 8.8 | | |
| Balance at March 31, 2020 | | Balance at March 31, 2020 | $ | 5 | | | $ | 6 | | | $ | 11 | |
| | Balance at December 31, 2020 | | Balance at December 31, 2020 | $ | 0 | | | $ | 130 | | | $ | 130 | |
| | Charges | | Charges | 0 | | | 39 | | | 39 | |
| Reserve adjustments | | Reserve adjustments | 0 | | | (13) | | | (13) | |
| Cash paid | | Cash paid | 0 | | | (38) | | | (38) | |
| Balance at March 31, 2021 | | Balance at March 31, 2021 | $ | 0 | | | $ | 118 | | | $ | 118 | |
These reserves are included in other current and noncurrent liabilities on the consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next twelve months.18 months primarily due to certain country negotiations and regulations. We believe that the reserves are adequate.
Note 8.6. Inventories
We state all inventories at the lower of cost or 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, 2020 | | December 31, 2019 | | March 31, 2021 | | December 31, 2020 |
| Finished products | Finished products | $ | 439.5 | | | $ | 402.9 | | Finished products | $ | 613 | | | $ | 772 | |
| Work in process | Work in process | 575.4 | | | 603.2 | | Work in process | 630 | | | 625 | |
| Raw materials and supplies | Raw materials and supplies | 84.1 | | | 83.9 | | Raw materials and supplies | 211 | | | 210 | |
| Total (approximates replacement cost) | 1,099.0 | | | 1,090.0 | | |
| Total | | Total | 1,454 | | | 1,607 | |
| Decrease to LIFO cost | Decrease to LIFO cost | (33.7) | | | (39.3) | | Decrease to LIFO cost | (30) | | | (29) | |
| Inventories | Inventories | $ | 1,065.3 | | | $ | 1,050.7 | | Inventories | $ | 1,424 | | | $ | 1,578 | |
Note 9.7. Equity
Common Stock Offering
On January 22, 2020, we entered into an underwriting agreement in which we agreed to sell approximately 22.723 million shares of our common stock at a public offering price of $32.00 per share. In connection with the offering, we granted the underwriters an option to purchase up to an additional 2.32 million shares, which was exercised in full on January 23, 2020. As a result, we issued and sold a total of approximately 25.025 million shares of our common stock for $767.5$768 million, after issuance costs.
Tangible Equity Unit (TEU) Offering
On January 22, 2020, we also completed our offering of 11 million, 5.00% TEUs. Total proceeds, net of issuance costs, were $528.5$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 two components. The prepaid stock is considered a freestanding financial instrument, indexed to Elanco common stock, and meets the conditions for equity classification.
The value allocated to the prepaid stock is reflected net of issuance costs in additional paid-in capital. The value allocated to the senior amortizing notes is reflected in long-term debt on the consolidated balance sheet, with payments expected in the next twelve months reflected in current portion of long-term debt. Issuance costs related to the amortizing notes are reflected as a reduction of the carrying amount and will be amortized through the maturity date using the effective interest rate method.
The proceeds from the issuance were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
| | | Equity Component | | Debt Component | | Total | | Equity Component | | Debt Component | | Total |
| Fair value per unit | Fair value per unit | | $ | 42.80 | | | $ | 7.20 | | | $ | 50.00 | | Fair value per unit | | $ | 42.80 | | | $ | 7.20 | | | $ | 50.00 | |
| | Gross proceeds | Gross proceeds | | $ | 470.8 | | | $ | 79.2 | | | $ | 550.0 | | Gross proceeds | | $ | 471 | | | $ | 79 | | | $ | 550 | |
| Less: Issuance costs | Less: Issuance costs | | 18.4 | | | 3.1 | | | 21.5 | | Less: Issuance costs | | 19 | | | 3 | | | 22 | |
| Net proceeds | Net proceeds | | $ | 452.4 | | | $ | 76.1 | | | $ | 528.5 | | Net proceeds | | $ | 452 | | | $ | 76 | | | $ | 528 | |
The senior amortizing notes have an aggregate principal amount of $79.2$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 the first installment payment of $0.6528 per amortizing note duepaid 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 14.314 million shares or a maximum of 17.217 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 14.314 million minimum shares are included in the calculation of basic weighted average shares outstanding. The difference between the minimum and maximum shares represents potentially dilutive securities, which are included in the calculation of diluted weighted average shares outstanding on a pro rata basis to the extent that the average applicable market value is higher than $32.00 but is less than $38.40 during the period.
Note 10.8. Debt
Long-term debt consisted of the following:
| | | June 30, 2020 | | December 31, 2019 | | March 31, 2021 | | December 31, 2020 |
| | Term credit facility | $ | — | | | $ | 371.4 | | |
| Term loan B credit facility | | Term loan B credit facility | $ | 4,151 | | | $ | 4,164 | |
| Revolving credit facility | | Revolving credit facility | 50 | | | 0 | |
| 3.912% Senior Notes due 2021 | 3.912% Senior Notes due 2021 | 500.0 | | | 500.0 | | 3.912% Senior Notes due 2021 | 500 | | | 500 | |
| 4.272% Senior Notes due 2023 | 4.272% Senior Notes due 2023 | 750.0 | | | 750.0 | | 4.272% Senior Notes due 2023 | 750 | | | 750 | |
| 4.900% Senior Notes due 2028 | 4.900% Senior Notes due 2028 | 750.0 | | | 750.0 | | 4.900% Senior Notes due 2028 | 750 | | | 750 | |
| TEU amortizing notes | TEU amortizing notes | 72.6 | | | — | | TEU amortizing notes | 53 | | | 60 | |
| Other obligations | Other obligations | 0.3 | | | 0.4 | | Other obligations | 0 | | | 1 | |
| Unamortized debt issuance costs | Unamortized debt issuance costs | (16.6) | | | (16.8) | | Unamortized debt issuance costs | (93) | | | (98) | |
| | Total debt | 2,056.3 | | | 2,355.0 | | |
| | | 6,161 | | | 6,127 | |
| Less current portion of long-term debt | Less current portion of long-term debt | 25.9 | | | 24.5 | | Less current portion of long-term debt | 605 | | | 555 | |
| Total long-term debt | Total long-term debt | $ | 2,030.4 | | | $ | 2,330.5 | | Total long-term debt | $ | 5,556 | | | $ | 5,572 | |
Bayer Animal Health Related Financing
In connection with the acquisition of Bayer Animal Health, on August 1, 2020, we borrowed $4,275 million under a term loan B credit facility. The term loan B facility bears interest at a floating rate of LIBOR plus 175 basis points over a seven-year term.
Simultaneously, we entered into a revolving credit facility providing up to $750 million (with incremental capacity available if certain conditions are met) and maturing over a five-year term. The revolving credit facility bears interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating. In February 2021, we drew down $150 million on the revolving credit facility for working capital needs. We subsequently repaid $100 million in March 2021 and the remaining $50 million in April 2021.
These senior secured first lien credit facilities are secured by a significant portion of our assets. They include 2 financial maintenance covenants which are solely for the benefit of lenders under the revolving credit facility. There are 0 financial maintenance covenants for the benefit of the term loan B facility. The lenders under the term loan B facility have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.
The first financial maintenance covenant for the revolving credit facility requires us to maintain a net total leverage ratio level (which is not subject to step-downs) as of the end of each quarter. The required level of this covenant is based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) not exceeding 7.71 to 1.00 of our pro forma adjusted EBITDA for the four fiscal quarters ended March 31, 2021.
The second financial maintenance covenant for the revolving credit facility requires us to maintain a ratio of pro forma adjusted EBITDA to cash interest expense of no less than 2.00 to 1.00, tested as of the end of each fiscal quarter. We were in compliance with all covenants under the credit facility as of March 31, 2021.
Senior Notes
In August 2018, we issued $2 billion of senior notes (Senior Notes). The Senior Notes comprised of $500 million of 3.912% Senior Notes due August 27, 2021, $750 million of 4.272% Senior Notes due August 28, 2023, and $750 million of 4.900% Senior Notes due August 28, 2028. The interest rate payable on each series of Senior Notes is subject to adjustment if Moody's Investor Services, Inc. or Standard & Poor's Financial Services LLC downgrades, or subsequently upgrades, its ratings on the respective series of Senior Notes.
The indenture that governs the Senior Notes contains covenants, including limitations on our ability, and certain of our subsidiaries, to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets, in addition, to other customary terms. We were in compliance with all such covenants under the indenture governing the Senior Notes as of March 31, 2021.
TEU Amortizing Notes
On January 22, 2020, we issued $550 million in TEUs. We offered 11 million, 5.00% TEUs at the stated amount of $50 per unit, comprised of prepaid stock purchase contracts and a senior amortizing note due February 1, 2023 (the mandatory settlement date). Total cash of $528.5$528 million was received, comprised of $452.4$452 million of prepaid stock purchase contracts and $76.1$76 million of senior amortizing notes, net of issuance costs. We paid $7.2$7 million representing partial payment of principal and interest on the TEU amortizing notes during the sixthree months ended June 30, 2020.March 31, 2021. See Note 9:7: Equity for further information.
Term LoanDebt Extinguishment
On January 31, 2020, we repaid indebtedness outstanding under our existingprevious term loan facility. We paid $372.4$372 million in cash, composed of $371.4$371 million of principal and $1.0$1 million of accrued interest, resulting in a debt extinguishment loss of $0.8$1 million (recognized in interest expense, net of capitalized interest in the condensed consolidated statement of operations for the sixthree months ended June 30,March 31, 2020), primarily related to the write-off of deferred debt issuance costs.
New Credit Facility
On February 4, 2020, we successfully priced our senior secured credit facilities, consisting of the following:
•Term loan B facility with an aggregate principal amount of $4,275.0 million and a maturity of seven years.
•Revolving credit facility providing up to $750.0 million and a maturity of five years.
The term loan B facility was priced at par at LIBOR plus 175 basis points, and the revolving loan facility is expected to bear interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating.
We intend to use the proceeds from the equity and debt activities to finance the cash portion of the pending acquisition of Bayer's animal health business and to pay related fees and expenses. As a result, we have obtained substantially all of the financing necessary to consummate the acquisition and do not currently intend to pursue any additional financing previously provided under the commitment letter obtained in August 2019 (see Note 14: Commitments and Contingencies). We expect to execute the debt agreements upon closing the acquisition of Bayer's animal health business.
The senior secured credit facilities are expected to include two financial maintenance covenants which are solely for the benefit of lenders under the revolving credit facility and no financial maintenance covenant for the benefit of the term loan B facility. The lenders under the term loan B facility will have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.
We expect the first financial maintenance covenant for the revolving credit facility to be a requirement to maintain a certain pro forma net total leverage ratio level (which will not be subject to step-downs) as of the end of each quarter, beginning with the fiscal quarter ending September 30, 2020 (assuming the closing of the acquisition of Bayer's animal health business occurs in early August 2020). The required level of this covenant will be based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) equal to 65% of our pro forma adjusted EBITDA for the four fiscal quarters ending June 30, 2020 (assuming the closing of the acquisition of Bayer's animal health business occurs in early August 2020).
The second financial maintenance covenant for the revolving credit facility is expected to be a requirement to maintain a ratio of pro forma adjusted EBITDA to cash interest expense of no less than 2.00 to 1.00, tested as of the end of each fiscal quarter, beginning with the fiscal quarter ending September 30, 2020 (assuming the closing of the acquisition of Bayer's animal health business occurs in early August 2020).
Deferred financing costs of approximately $27.3 million, consisting of legal, accounting and other fees relating to our new credit facility, are capitalized within other noncurrent assets on the condensed consolidated balance sheet as of June 30, 2020. We expect to defer an additional $35.8 million in arrangement fees upon executing the debt agreements, which will be offset against the debt proceeds. Deferred financing costs will be recorded as a contra-liability and presented net against long-term debt on the condensed consolidated balance sheet at the time of issuance.
Note 11.9. Financial Instruments and Fair Value
Financial instruments that are potentially subject to credit risk consist principally of trade receivables. We evaluate the creditworthiness of our customers on a regular basis, monitor economic conditions, and calculate allowances for estimated credit losses on our trade receivables on a quarterly basis using an expected credit loss model. We assess whether collectability is probable at the time of sale and on an ongoing basis. Collateral is generally not required. The risk associated with this concentration is mitigated by our ongoing credit-review procedures.
A large portion of our cash is held inby a few major financial institutions. We monitor the exposure with these institutions and do not expect any of these institutions to fail to meet their obligations. All highly liquid investments with a maturity of three months or less from the date of purchase are considered to be cash equivalents. The cost of these investments approximates fair value. We also consider the carrying value of restricted cash balances to be representative of its fair value.
As of June 30, 2020March 31, 2021 and December 31, 2019,2020, we had $19.6$34 million and $18.8$33 million, respectively, primarily related to equity methodof investments included in other noncurrent assets onon our condensed consolidated balance sheet. These include investments with readily determinable fair values, investments without readily determinable fair values, and equity method investments. Unrealized net gains and losses during the three months ended March 31, 2021 and March 31, 2020 were immaterial.
The following table summarizes the fair value information at June 30, 2020March 31, 2021 and December 31, 20192020 for foreign exchange contract assets (liabilities), contingent consideration liabilities, net investment hedge assets (liabilities) and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items, as well as long-term debt (including TEU amortizing notes) for which fair value is disclosed on a recurring basis:
| | | | | | Fair Value Measurements Using | | | | | | | | Fair Value Measurements Using | | |
| Financial statement line item | 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 | 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, 2020 | | | | | | | | | | |
| March 31, 2021 | | March 31, 2021 | | | | | | | | | | |
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 14.6 | | | $ | — | | | $ | 14.6 | | | $ | — | | | $ | 14.6 | | Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | | $ | 22 | | | $ | 0 | | | $ | 22 | | | $ | 0 | | | $ | 22 | |
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | Other current liabilities - foreign exchange contracts not designated as hedging instruments | (17.1) | | | — | | | (17.1) | | | — | | | (17.1) | | Other current liabilities - foreign exchange contracts not designated as hedging instruments | | (45) | | | 0 | | | (45) | | | 0 | | | (45) | |
| Other noncurrent liabilities - contingent consideration | Other noncurrent liabilities - contingent consideration | (2.6) | | | — | | | — | | | (2.6) | | | (2.6) | | Other noncurrent liabilities - contingent consideration | | (1) | | | 0 | | | 0 | | | (1) | | | (1) | |
| | Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | (77.3) | | | — | | | (77.3) | | | — | | | (77.3) | | Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | | (23) | | | 0 | | | (23) | | | 0 | | | (23) | |
| Long-term debt - senior notes | Long-term debt - senior notes | (2,000.0) | | | — | | | (2,137.0) | | | — | | | (2,137.0) | | Long-term debt - senior notes | | (2,000) | | | 0 | | | (2,171) | | | 0 | | | (2,171) | |
| TEU amortizing note (1) | TEU amortizing note (1) | (72.6) | | | — | | | (72.6) | | | — | | | (72.6) | | TEU amortizing note (1) | | (53) | | | 0 | | | (49) | | | 0 | | | (49) | |
| December 31, 2019 | | |
| Term loan B | | Term loan B | | (4,151) | | | 0 | | | (4,125) | | | 0 | | | (4,125) | |
Revolving credit facility (1) | | Revolving credit facility (1) | | (50) | | | 0 | | | (50) | | | 0 | | | (50) | |
| December 31, 2020 | | December 31, 2020 | |
| Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | $ | 0.8 | | | $ | — | | | $ | 0.8 | | | $ | — | | | $ | 0.8 | | Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments | | $ | 36 | | | $ | 0 | | | $ | 36 | | | $ | 0 | | | $ | 36 | |
| Other current liabilities - foreign exchange contracts not designated as hedging instruments | Other current liabilities - foreign exchange contracts not designated as hedging instruments | (1.1) | | | — | | | (1.1) | | | — | | | (1.1) | | Other current liabilities - foreign exchange contracts not designated as hedging instruments | | (36) | | | 0 | | | (36) | | | 0 | | | (36) | |
| Other noncurrent liabilities - contingent consideration | Other noncurrent liabilities - contingent consideration | (4.7) | | | — | | | — | | | (4.7) | | | (4.7) | | Other noncurrent liabilities - contingent consideration | | (1) | | | 0 | | | 0 | | | (1) | | | (1) | |
| Other noncurrent assets - cross currency interest rate contracts designated as net investment hedges | 2.3 | | | — | | | 2.3 | | | — | | | 2.3 | | |
| Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | | Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges | | (76) | | | 0 | | | (76) | | | 0 | | | (76) | |
| | Long-term debt - senior notes | Long-term debt - senior notes | (2,000.0) | | | — | | | (2,120.6) | | | — | | | (2,120.6) | | Long-term debt - senior notes | | (2,000) | | | 0 | | | (2,218) | | | 0 | | | (2,218) | |
Long-term debt - term credit facility (1) | (371.4) | | | — | | | (371.4) | | | — | | | (371.4) | | |
| TEU amortizing notes | | TEU amortizing notes | | (60) | | | 0 | | | (58) | | | 0 | | | (58) | |
| Term loan B | | Term loan B | | (4,164) | | | 0 | | | (4,144) | | | 0 | | | (4,144) | |
|
(1)We consider the carrying value to be representative of its fair value.value due to the short-term nature of this instrument.
We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities.
Contingent consideration liabilities as of June 30, 2020March 31, 2021 and December 31, 20192020 related to contingent consideration associated with the acquisitions of Aratana Therapeutics, Inc. (Aratana) and Prevtec Microbia Inc. (Prevtec) during 2019. For Aratana, we will pay up to $12 million in contingent value rights that are dependent on the achievement of a specified milestone as outlined in the merger agreement. For Prevtec, based on the terms of the purchase agreement, we will pay up to $16.3$16 million contingent upon the achievement of specific Coliprotec sales
milestones by December 31, 2021. The fair value of both contingent consideration liabilities was estimated using the Monte Carlo simulation model and Level 3 inputs including historical revenue, discount rate, asset volatility, and revenue volatility. During the three months ended June 30, 2020, primarily as a result of a decrease in forecasted revenues related to Coliprotec, we decreased the fair value of the contingent consideration liability associated with the Prevtec acquisition by $2.1 million, and recognized the gain in other – net, (income) expense in the condensed consolidated statement of operations. See Note 6: Acquisitions and Divestitures for further discussion.
Derivative Instruments and Hedging Activities
We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures.
Derivatives Not Designated as Hedges
We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. These derivative financial instruments primarily offset exposures in the British pound, Canadian dollar, Euro, Japanese yen, and Swiss franc (CHF)., 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 (income) expense in the condensed consolidated income statement.statement of operations. Forward contracts generally have maturities not exceeding 12 months. At June 30, 2020March 31, 2021 and December 31, 2019,2020, we had outstanding foreign exchange contracts with aggregate notional amounts of $910.3$1,503 million and $861.2$1,391 million, respectively.
The amount of net gain/(loss)gain on derivative instruments not designated as hedging instruments, recorded in other -expense, net (income) expense are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
Foreign exchange forward contracts (1) | $ | (6.3) | | | $ | 6.7 | | | $ | 21.7 | | | $ | (1.3) | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
Foreign exchange forward contracts (1) | | | | | $ | 34 | | | $ | 28 | |
(1)These amounts were substantially offset in other –expense, net (income) expense by the effect of changing exchange rates on the underlying foreign currency exposures.
Derivatives Designated as Hedges
In October 2018, as a means of mitigating the impact of currency fluctuations on our operations in Switzerland, we entered into a five-year cross-currency fixed interest rate swap with a 750 million CHF notional amount, which was designated as a net investment hedge (NIH) against CHF denominated assets (the fair value of which was estimated based on quoted market values of similar hedges and was classified as Level 2). During the sixthree months ended June 30,March 31, 2020, we fullyapproximately 75% of our cross-currency swaps were liquidated our cross currency interest rate swaps for a cash benefit of $35.1$27 million (including $2.4$2 million in interest). We had an approximately 190 million CHF notional remaining on our NIH as of March 31, 2020, which was fully liquidated in April 2020. Notwithstanding settlement, gains and losses within accumulated other comprehensive lossincome (loss) will remain in accumulated other comprehensive lossincome (loss) until either the sale or substantial liquidation of the hedged subsidiary.
Gains on the NIH, recognized within interest expense, net of capitalized interest, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
| Cross-currency interest rate swap contracts | $ | 0.1 | | | $ | 6.1 | | | $ | 6.2 | | | $ | 12.2 | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
| Cross-currency interest rate swap contracts | | | | | $ | 0 | | | $ | 6 | |
Over the life of the derivative, gains or losses due to spot rate fluctuations were recorded in cumulative translation adjustment in other comprehensive income.income (loss). The amounts of net gains on interest rate swap contracts, recorded, net of tax, in accumulated other comprehensive income/income (loss), are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
| Cross-currency interest rate swap contracts | $ | 0.7 | | | $ | 6.8 | | | $ | 24.0 | | | $ | 5.4 | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
| Cross-currency interest rate swap contracts | | | | | $ | 0 | | | $ | 23 | |
Separately, in March 2020, as a means of mitigating variability in cash flows associated with the anticipated term loan B issuance, we executed forward-starting interest rate swaps with a $4.05$4.1 billion notional amount, which are designated as cash flow hedges and have settlementmaturity dates ranging between 2022 and 2025. These instruments effectively convert floating-rate debt to fixed-rate debt. The cash flow hedges are recorded at fair value on our condensed consolidated balance sheet, while changes in the fair value of the hedge are recognized in other comprehensive income.income (loss). Fair value is estimated based on quoted market values of similar hedges and is classified as Level 2. Amounts recorded in accumulated other comprehensive lossincome (loss) will be recognized in earnings in interest expense, net of capitalized interest when the hedged transaction affects earnings (i.e., when interest payments are accrued on the term loan B). During the three and six months ended June 30,March 31, 2021 and 2020 we recorded a gain of $53 million (net of tax expense of $0 after valuation allowance) and a loss of $20.7$39 million (net of tax benefit of $6.0 million) and $59.9 million (net of tax benefit of $17.4$11 million), respectively, on the cash flow hedges in other comprehensive loss. Over the next 12 months we expect to reclassify $21.0$28 million from accumulated other comprehensive lossincome (loss) to interest expense, net of capitalized interest due to the amortization of net losses on the interest rate swaps. During the three months ended March 31, 2021, we reclassified $7 million of net losses into interest expense.
Note 12. Leases
Australia Sale-Leaseback
On June 26, 2020, our wholly-owned subsidiary, Elanco Australasia PTY LTD, sold land and an R&D facility located in New South Wales, Australia, for aggregate proceeds of $55.1 million, and leased the property back for an initial term of 15 years through a sale-leaseback transaction. Under the terms of the purchase and sale agreement, we determined that control of the assets was relinquished to the buyer-lessor. Therefore, we recognized a pre-tax gain on the sale of $45.6 million in other - net, (income) expense in the condensed consolidated statement of operations during the three months ended June 30, 2020. Operating lease right-of-use assets and liabilities include the present value of $27.8 million for the associated lease payments, which are presented in other noncurrent assets and other noncurrent liabilities and other current liabilities on the condensed consolidated balance sheet as of June 30, 2020.
Note 13.10. Income Taxes
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| Provision for Taxes on Income | | Three Months Ended June 30, | | | | Six Months Ended June 30, | | |
| | 2020 | | 2019 | | 2020 | | 2019 |
| Income tax (benefit) expense | | $ | (23.9) | | | $ | 14.3 | | | $ | (42.6) | | | $ | 27.6 | |
| Effective tax rate | | 30.9 | % | | 28.5 | % | | 29.4 | % | | 29.0 | % |
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Our income taxes for the three and six months ended June 30, 2020 and 2019, respectively, reflect the results on a stand-alone basis independent of Lilly, except for the period during which we were included in a combined tax return until full separation. In the jurisdictions in which we were included in a combined tax return, our income taxes were determined based on the tax matters agreement between us and Lilly. Prior to the Separation, the income tax
expense included in these financial statements has been calculated using the separate return basis as if Elanco filed separate tax returns.
In 2017, the U.S. enacted the Tax Cuts and Jobs Act (2017 Tax Act), which significantly revised U.S. tax law. Guidance related to the 2017 Tax Act, including Notices, Proposed Regulations, and Final Regulations, has been issued, and we expect additional guidance will be issued in 2020. This additional guidance could materially impact our assumptions and estimates used to record our U.S. federal and state income tax expense resulting from the 2017 Tax Act. | | | | | | | | | | | | | | | | | | |
| Income Tax Benefit | | | | Three Months Ended March 31, |
| | | | | | 2021 | | 2020 |
| Income tax benefit | | | | | | $ | (19) | | | $ | (19) | |
| Effective tax rate | | | | | | 23.5 | % | | 27.6 | % |
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We arewere included in Lilly's U.S. tax examinations by the Internal Revenue Service through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with the IPO, the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. During the fourth quarter of 2019, the IRS began itsThe U.S. examination of tax years 2016 - 2018. Because the examination is still2018 began in the early stagesfourth quarter of information gathering,2019 and remains ongoing; therefore, the resolution of thethis audit period will likely extend beyond the next 12 months.
For the three and six months ended June 30, 2020,March 31, 2021, we recognized an income tax benefit of $23.9 million and $42.6 million, respectively. For the three and six months ended June 30, 2020, our$19 million. Our effective tax rate of 30.9% and 29.4%, respectively,23.5% differs from the statutory income tax rate primarily due to changestax-exempt interest income in certain foreign jurisdictions. Income tax benefit was partially offset by a $2 million increase to the expected geographical mix of profitsvaluation allowance on our U.S. federal and state deferred tax assets during the impact of U.S. tax on non-U.S. earnings as a result of U.S. tax reform.period.
For the three and six months ended June 30, 2019,March 31, 2020, we incurred $14.3 million and $27.6 million, respectively, ofrecognized an income tax expense. For the three and six months ended June 30, 2019, ourbenefit of $19 million. The effective tax rate of 28.5% and 29.0%, respectively,27.6% differs from the statutory income tax rate primarily due to a one-time foreign exchange gain on the transferpre-tax loss mainly driven by acquisition and integration costs. In addition, a discrete income tax benefit of assets upon separation in addition$2 million was recognized related to the impact of state income taxes.excess tax benefits for stock-based compensation that vested in the three months ended March 31, 2020.
Note 14.11. Commitments and Contingencies
Legal mattersMatters
On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco, Jeffrey Simmons and Todd Young. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco securities between January 10, 2020September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana Therapeutics, Inc. We filed a motion to dismiss on January 13, 2021. The timing of the Court's decision is uncertain. We believe the claims made in the
case are meritless, and we intend to vigorously defend our position. The process of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolution cannot be predicted.
On October 16, 2020, a shareholder class action lawsuit captioned Safron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives, and other individuals. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the registration 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 Courtlawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco common stock or 5.00% TEUs issued in connection with the public offering. This case is currently considering lead plaintiff motions.stayed in deference to Hunter v. Elanco Animal Health Inc. 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.
Claims seeking actual damages, injunctive relief, and/or restitution for the allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC arising out of the use of Seresto™, a non-prescription flea and tick collar for cats and dogs. In March, April, and May 2021, class action lawsuits were filed in state and federal courts in the U.S. alleging that the Seresto collars contain pesticides and other ingredients that can cause serious injury and death to cats and/or dogs wearing the product. The cases mention the existence of incident reports involving humans, but no plaintiff has claimed personal harm from the product. Further, a U.S. House of Representative subcommittee chair requested Elanco to produce certain documents and information related to the Seresto collar and further made a request to temporarily remove Seresto collars from the market. We are cooperating with the subcommittee and have produced information pursuant to the request. In addition, as Seresto is registered with the Environmental Protection Agency (EPA), we are providing information to the EPA regarding the safety profile of Seresto. All data and scientific evaluation used during the product registration process and through pharmacovigilance review supports the product’s positive safety profile and efficacy. Therefore, we believe no removal or recall is warranted, nor has it been suggested by any regulatory agency. We continue to stand behind the safety profile for Seresto, and it remains available to consumers globally. We continue to receive information with respect to potential litigation costs and the anticipated number of cases, and we will be taking appropriate steps to defend these class action lawsuits.
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 accrue for certain liability claims to the extent that it is probable we will incur a loss and we can formulate a reasonable estimate of their costs and there is a reasonable probability of incurring significant costs or expenses.the costs. As of June 30, 2020March 31, 2021 and December 31, 2019,2020, we had 0 material liabilities established related to litigation as there were no significant claims which were probable and estimable. We have not historically had any significant litigation expense and are not currently subject to a significant claim other than the lawsuitlawsuits noted above.
Bayer Animal Health acquisition fees
In connection with our pending acquisition of the animal health business of Bayer as discussed in Note 6: Acquisitions and Divestitures, in August 2019, we entered into a commitment letter that provides for financing consisting of up to $750 million in a revolving facility, $3.0 billion in a term facility and $2.75 billion in a senior secured bridge facility. In connection with the financing commitment letter, we will incur fixed commitment fees of $40.4 million that will become due and payable upon the closing of the pending acquisition or the termination of the Purchase Agreement with Bayer. In addition, we expect to incur approximately $22.5 million in advisory fees that are contingent upon closing the pending acquisition. These fees have not been recorded on the condensed consolidated balance sheet as of June 30, 2020. As a result of the financing secured for the acquisition through the equity and debt activity during the first quarter of 2020, we no longer intend to use the full financing pursuant to the commitment letter. See Note 9: Equity and Note 10: Debt for more information.
Note 15.12. Geographic Information
We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both foodfarm animals and companion animals.pets. Consistent with our operational structure, our President and Chief Executive Officer (CEO), as the chief operating decision maker,Chief Operating Decision Maker, makes resource allocation and business process decisions globally across our consolidated business. Strategic decisions are managed globally with global functional leaders responsible for determining significant cost/costs/investments and with regional leaders responsible for overseeing the execution of the global strategy. Our global research and development organization is responsible for development of new products. Our manufacturing organization is responsible for the manufacturing and supply of products and for the optimization of our supply chain. Regional leaders are responsible for the distribution and sale of our products and for local direct costs. The business is also supported by global corporate staff functions. Managing and allocating resources at the global corporate level enables our CEO to assess the overall level of resources available and how to best deploy these resources across functions, product types, regional commercial organizations and research and development projects in line with our overarching long-term corporate-wide strategic goals, rather than on a product or geographic basis. Consistent with this decision-making process, our CEO uses consolidated, single-segment financial information for purposes of evaluating performance, allocating resources, setting incentive compensation targets, as well as forecasting future period financial results.
Our products include Rumensin™Baycox™, Optaflexx™Cydectin™, Denagard™, Maxiban™, Optaflexx™, Rumensin™, Tylan™,Maxiban™ and other products for livestock and poultry, as well as Trifexis™Advantage™, Advantix™, Advocate™ (collectively referred to as the Advantage Family), Credelio™, Duramune™,Galliprant™, Interceptor™ Plus,Seresto, Trifexis™,Comfortis™, Galliprant and other products for companion animals.pets.
We have a single customer that accounted for 10.4%7% and 12.5%14% of revenue for the three months ended June 30,March 31, 2021 and 2020, and 2019, respectively, and for 12.1% and 12.2% of revenue for the six months ended June 30, 2020 and 2019, respectively. The productProduct sales with this customer resulted in accounts receivable with this customer of $50.0$75 million and $90.5$87 million as of June 30, 2020March 31, 2021 and December 31, 2019,2020, respectively.
We are exposed to the risk of changes in social, political and economic conditions inherent in foreign operations and our results of operations and the value of our 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, | | |
| 2020 | | 2019 | | 2020 | | 2019 |
Revenue—to unaffiliated customers (1) | | | | | | | |
| United States | $ | 248.1 | | | $ | 395.0 | | | $ | 548.0 | | | $ | 778.9 | |
| International | 338.2 | | | 386.6 | | | 696.0 | | | 733.8 | |
| | | | | | | |
| | | | | | | |
| Revenue | $ | 586.3 | | | $ | 781.6 | | | $ | 1,244.0 | | | $ | 1,512.7 | |
| | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| | | | | 2021 | | 2020 |
Revenue—to unaffiliated customers (1) | | | | | | | |
| United States | | | | | $ | 533 | | | $ | 300 | |
| International | | | | | 709 | | | 358 | |
| | | | | | | |
| | | | | | | |
| Revenue | | | | | $ | 1,242 | | | $ | 658 | |
| | | | | | | | | | | |
| June 30, 2020 | | December 31, 2019 |
Long-lived assets (2) | | | |
| United States | $ | 737.5 | | | $ | 709.8 | |
| United Kingdom | 186.9 | | | 192.6 | |
| | | |
| Other foreign countries | 262.4 | | | 244.7 | |
| Long-lived assets | $ | 1,186.8 | | | $ | 1,147.1 | |
(1)Revenue is attributed to the countries based on the location of the customer.
(2)Long-lived assets consist
Note 13. Retirement Benefits
The following table summarizes net periodic benefit cost relating to our defined benefit pension plans:
| | | | | | | | | | | | | | |
| | Three Months Ended March 31, |
| | 2021 | | 2020 |
| Service cost | | $ | 5 | | | $ | 3 | |
| Interest cost | | 1 | | | 0 | |
| Expected return on plan assets | | (2) | | | (1) | |
| Amortization of prior service cost | | (2) | | | (2) | |
| Amortization of net actuarial loss | | 1 | | | 1 | |
| Curtailments (Note 5) | | (9) | | | 0 | |
| Net periodic benefit cost | | $ | (6) | | | $ | 1 | |
The components of propertynet periodic benefit cost other than service cost and equipment,curtailments are included in other expense, net in the condensed consolidated statements of operations. Curtailments are included in asset impairment, restructuring and certain noncurrent assets, including right-of-use assets.other special charges, in the condensed consolidated statements of operations.
Note 16. Earnings Per Share
Basic Earnings14. Loss Per Share
We compute basic earnings (loss)loss per share by dividing net earnings (loss)loss available to common shareholders by the actual weighted average number of common shares outstanding for the reporting period. For the three and six months ended June 30, 2020, weighted average number of common shares outstanding used to calculate basic earnings per share includes the impact of approximately 25.0 million shares and 14.3 million shares, respectively, relating to the common stock issued in connection with the January 2020 common stock offering and the shares of common stock issuable at the minimum settlement rate under the TEU prepaid stock purchase contracts. See Note 9: Equity for further discussion.
Diluted Earnings Per Share
Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements and the TEU prepaid stock purchase contracts.contracts (see Note 7: Equity for further discussion). Diluted earnings per share reflects the potential dilution that could occur if holders of the unvested equity awards and unsettled TEUs converted their holdings into common stock. The weighted average number of potentially dilutive shares outstanding is calculated using the treasury stock method.
Weighted average diluted shares outstanding included common stock equivalents of 1.3 million and 0.8 million for the three and six months ended June 30, 2019, respectively.
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 earningsloss per share.
Basic and diluted loss per share are calculated as follows:
| | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| | | | | | 2021 | | 2020 |
| Net loss available to common shareholders | | | | | | $ | (61) | | | $ | (49) | |
| Determination of shares: | | | | | | | | |
| Weighted average common shares outstanding | | | | | | 486.7 | | | 403.9 |
Assumed conversion of dilutive common stock equivalents (1) | | | | | | 0 | | | 0 | |
| Diluted weighted average shares outstanding | | | | | | 486.7 | | | 403.9 |
Loss per share (2) | | | | | | | | |
| Basic | | | | | | $ | (0.12) | | | $ | (0.12) | |
| Diluted | | | | | | $ | (0.12) | | | $ | (0.12) | |
(1)During the three and six months ended June 30,March 31, 2021 and 2020, we reported a net loss. Therefore, dilutive common sharesstock equivalents are not assumed to have been issued since their effect is anti-dilutive. As a result, basic and diluted weighted average shares are the same, causing diluted net loss per share to be equivalent to basic net loss per share.
For the three and six months ended June 30, 2019,March 31, 2021 and 2020, approximately 0.11.6 million sharesand 1.8 million, respectively, of potential common shares were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive.
(2)Due to rounding conventions, loss per share may not recalculate precisely based on the amounts presented within this table.
Note 17. Related Party Agreements and Transactions
Transactions with Lilly Subsequent to Separation and Related to the Separation
Amounts due from/(due to) Lilly in connection with the Separation and agreed upon services were as follows:
| | | | | | | | | | | |
| June 30, 2020 | | December 31, 2019 |
| TSA | $ | (10.9) | | | $ | 10.5 | |
| Other activities | (2.5) | | | (15.8) | |
| Local country asset purchases | (10.7) | | | (11.1) | |
| Total payable to Lilly | $ | (24.1) | | | $ | (16.4) | |
Note 15. Transactions and Agreements with Bayer
While Bayer is no longer considered a related party, we have transacted with Bayer during the period after the acquisition of Bayer Animal Health, including the period in which Bayer was considered a principal owner of Elanco. These transactions primarily related to local country asset purchases and various transitional services agreements (TSAs), contract manufacturing arrangements, and certain lease agreements to ensure business continuity after the acquisition.
For regulatory purposes in certain jurisdictions, consideration was required to be paid locally at closing in addition to amounts paid globally for the acquisition. Pursuant to the stock and asset purchase agreement, Bayer has provided a refund for payment amounts duplicated in these regions. The total amount paid to and received from Bayer during the three months ended March 31, 2021 for these local country asset purchases was approximately $16 million. All local country asset purchases have been completed as of March 31, 2021.
As described in Note 1, we completed an IPO in September 2018 and Lilly fully divested all ownership of Elanco in March 2019. In connection with the Separation, we entered into various agreements with Lilly related to the form of our separation and certain ongoing activities that will continue for a period of time. These included, among others, a master separation agreement (MSA), a TSA and a tax matters agreement. In addition, there was a portion of our operations for which the legal transfer of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries.
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 are able to use Lilly Services for a fixed term established on a service-by-service basis. We pay Lilly mutually agreed-upon fees for the Lilly Services provided under the TSA, which are 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, 2022. The fees under the TSA became payable for all periods beginning after October 1, 2018.
Separation Activities
Subsequent to our IPO, there continue to be transactions between us and Lilly related primarily to the completion of the local country asset purchases and finalization of assets and liabilities associated with the legal separation from Lilly, combined income tax returns and the impact of the tax matters agreement, historical Lilly retirement benefits, and centralized cash management. The most significant of these activities includes the finalization of the local country valuation of business and the resulting impact on deferred tax assets and the impact of combined tax returns.
Other Activities
We continue to share certain services and back office functions with Lilly, which in certain instances result in Lilly paying costs for Elanco (e.g., utilities, local country operating costs, etc.) that are then passed through to Elanco for reimbursement. These amounts are included in cash flows from operating activities in our consolidated statements of cash flows. In addition, we operate through a single treasury settlement process and prior to the local country asset purchases (as described below) continued to transact through Lilly's processes in certain instances. As a result of these activities, there were certain amounts of financing that occurred between Lilly and Elanco during the six months ended June 30, 2019 and 2020. These amounts are included in cash flows from financing activities in our condensed consolidated statements of cash flows.
Local Country Asset Purchases
The legal transfer of certain of our net assets did not occur prior to the Separation due to certain regulatory requirements in each of these countries. The related assets, liabilities, and results of operations have been reported in our condensed consolidated financial statements, as we are responsible for the business activities conducted by Lilly on our behalf and are subject to the risks and entitled to the benefits generated by these operations and assets under the terms of the MSA. We held restricted cash, and the associated payable to Lilly, at the date of Separation to fund the acquisition of these assets. As of June 30, 2020, the majority of these assets have been legally acquired and the remainder are expected to be purchased during 2020. Restricted cash and Payable to Lilly of $10.7 million are recorded on the condensed consolidated balance sheet for the remainder of the assets expected to be purchased by the end of 2020.
| | | | | | | | |
| 2021 Q1 Form 10-Q | 27
Transactions with Lilly Prior to Full Separation
Prior to the IPO, we did not operate as a standalone business and had various relationships with Lilly whereby Lilly provided services to us. The impact on our historical combined financial statements includes the following:
Stock-based Compensation
Prior to full separation, our employees participated in Lilly stock-based compensation plans, the costs of which were allocated to us and recorded in cost of sales, research and development, and marketing, selling and administrative expenses in the condensed consolidated statements of operations. The costs of such plans related to our employees were $5.1 million for the six months endedJune 30, 2019.
| |
ItemITEM 2. Management’s Discussion and Analysis of Financial Condition and Results of OperationsMANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Management’s Discussion and Analysis of Financial Condition and Results of Operations
(Tables present dollars in millions, except per-share data)
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 condensed consolidated 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," Item 1A, "Risk Factors," of Part II of this Quarterly Report on Form 10-Q, and Item 1A, “Risk Factors,” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2019,2020, may cause our actual results, financial position, and cash generated from operations to differ materially from these forward-looking statements.
Overview
Founded in 1954, as part of Eli Lilly and Company (Lilly), Elanco is a premier animal health company that innovates, develops, manufactures and markets products for companionpets and foodfarm animals. Headquartered in Greenfield, Indiana, we are one of the fourth largest animal health companycompanies in the world, with pro forma combined revenue of $3,071.0 millionElanco and Bayer Animal Health of approximately $4.4 billion for the year ended December 31, 2019. Globally, we are #1 in medicinal feed additives, #2 in poultry, and #3 in other pharmaceuticals, which are mainly companion animal therapeutics, measured by 2019 revenue, according to Vetnosis.2020.
WeOn August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our existing product portfolio and pipeline have onebeen enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure. See Note 4: Acquisitions and Divestitures to the broadest portfolioscondensed consolidated financial statements for additional information on the acquisition. Subsequent to the acquisition date, our consolidated financial statements include the assets, liabilities, operating results and cash flows of pet parasiticides in the companion animal sector. Bayer Animal Health.
We offer a diverse portfolio of more than 125approximately 190 brands that make us a trusted partner to veterinarians and foodfarm animal producers in more than 90 countries.
On September 24, 2018, Our products are generally sold worldwide to third-party distributors, retailers, and directly to farm animal producers and veterinarians. With the acquisition of Bayer Animal Health, we completedhave expanded our initial public offering (IPO), pursuantpresence in retail and e-commerce channels in order to which we issued and sold 19.8% of our total outstanding shares. On September 20, 2018, our common stock began trading on the New York Stock Exchange (NYSE) under the symbol “ELAN.” On September 24, 2018, immediately preceding the completion of the IPO, Lilly transferredmeet pet owners where they want to us substantially all of its animal health businesses in exchange for (i) all of the net proceeds (approximately $1,659.7 million) we received from the sale of our common stock in the IPO, including the net proceeds we received as a result of the exercise in full of the underwriters’ option to purchase additional shares, (ii) all of the net proceeds (approximately $2,000 million) we received from the issuance of our senior notes; and (iii) all of the net proceeds ($498.6 million) we received from the entry into our term loan facility. In addition, immediately prior to the completion of the IPO, we entered into certain agreements with Lilly that provide a framework for our ongoing relationship with them.
On February 8, 2019, Lilly announced an exchange offer whereby Lilly shareholders could exchange all or a portion of Lilly common stock for shares of Elanco common stock owned by Lilly. On that date, we filed a Registration Statement on Form S-4 with the SEC in connection with that exchange offer. The disposition of Elanco shares was completed on March 11, 2019, and resulted in the full separation of Elanco along with the disposal of Lilly's entire ownership and voting interest in Elanco.purchase.
We operate our business in a single segment directed at fulfilling our vision of enriching the lives of people through food, making protein more accessible and affordable and through pet companionship, helping pets live longer, healthier lives. In 2020, we renamed our four primary product categories by replacing "food animal" and "companion animal" with "farm animal" and "pet health," respectively, to better reflect the terminology used by our customers. We advance our vision bywith the following offering products in four primary categories:of portfolio solutions:
Companion Animal Disease Prevention (CA Disease Prevention)Pet Health: Our portfolio is focused on parasiticides, vaccines and therapeutics. We have one of the broadest parasiticide portfolios in the companion animalpet health sector based on indications, species and formulations, with products that protect pets from worms, fleas and ticks. CombiningOur Seresto and Advantage, Advantix, Advocate (collectively referred to as the Advantage Family) products are over-the-counter treatments for the elimination and prevention, respectively, of fleas and ticks, and complement our prescription parasiticide products, Credelio, Interceptor Plus, and Trifexis. Our vaccines portfolio with our vaccines presence, we areprovides differentiated prevention coverage for a leadernumber of important pet health risks and is available in the U.S. in the disease prevention category based on share of revenue.
Companion Animal Therapeutics (CA Therapeutics): Weonly. In therapeutics, we have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprant™ Galliprant™ product is one of the fastest growing osteoarthritis treatments in the U.S. We alsoAdditionally, we have treatmentsproducts that offer treatment for otitis (ear infections) with Claro™, as well as treatments for certain cardiovascular and dermatology indications.
FoodFarm Animal Future Protein & Health (FA Future Protein & Health): Our farm animal portfolio in this category, which includes vaccines, nutritional enzymesconsists of products to prevent, control and animal only antibiotics, serves the growing demand for proteintreat health challenges primarily focused on cattle (beef and includes innovative products indairy), swine, poultry, and aquaculture production, where demand for animal health(cold and warm water) production. Our products is outpacing overall industry growth. We are focused on developing functional nutritional health products that promote food animal health, includinginclude medicated feed additives, injectable antibiotics, vaccines, insecticides, and enzymes, probiotics and prebiotics. We are a leader in providing vaccines as alternatives to antibiotics to promote animal health based on share of revenue.
Food Animal Ruminants & Swine (FA Ruminants & Swine):among others. We have developed a wide range of foodfarm animal products, including Rumensin and Baytril™, both of which are used extensively in ruminantruminants (e.g., cattle, sheep and goats) and swine production. In poultry, our Maxiban product, is a valuable offering for the control and prevention of intestinal disease.
A summary of our 20202021 revenue and net incomeloss compared with the same period in 20192020 is as follows:
| | | Three Months Ended June 30, | | | Six Months Ended June 30, | | | | Three Months Ended March 31, |
| 2020 | | 2019 | | 2020 | | 2019 | |
| (Dollars in millions) | | (Dollars in millions) | | | 2021 | | 2020 |
| Revenue | Revenue | $ | 586.3 | | | $ | 781.6 | | | $ | 1,244.0 | | | $ | 1,512.7 | | Revenue | | | $ | 1,242 | | | $ | 658 | |
| Net income (loss) | (53.2) | | | 35.9 | | | (102.3) | | | 67.4 | | |
| Net loss | | Net loss | | | (61) | | | (49) | |
Increases or decreases in inventory levels at our channel distributors can positively or negatively impact our quarterly and annual revenue results, leading to variations in quarterly revenues. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the need for certain inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, payment terms we extend, which are subject to internal policies, and procedures and environmental factors beyond our control, including weather conditions and the COVID-19 global pandemic.
Key Trends and Conditions Affecting Our Results of Operations
Industry Trends
The animal health industry, which includes both foodfarm animals and companion animals,pets, is a growing industry that benefits billions of people worldwide.
As demand for animal protein grows, foodfarm animal health is becoming increasingly important. We believe that factors influencing growth in demand for foodfarm animal medicines and vaccines include:
•one in three people needing improved nutrition;
•increased global demand for protein, particularly poultry and aquaculture;
•natural resource constraints, such as scarcity of arable land, fresh water and increased competition for cultivated land, driving the need for more efficient food production;
•loss of productivity due to foodfarm animal disease and death;
•increased focus on food safety and food security; and
•human population growth, increased standards of living, particularly in many emerging markets, and increased urbanization.
Growth in foodfarm animal nutritional health products (enzymes, probiotics and prebiotics) is influenced, among other factors, by demand for antibiotic alternatives that can promote animal health and increase productivity.
We believe that factors influencing growth in demand for companion animalpet medicines and vaccines include:
•increased pet ownership globally;
•pets living longer; and
•increased pet spending as pets are viewed as members of the family by owners.
Factors Affecting Our Results of Operations
COVID-19 Pandemic
The outbreak ofOur business has been impacted by the COVID-19 originating in Wuhan, China,pandemic that originated in December 2019 has since rapidly increased its exposure globally. On March 11, 2020, the World Health Organization declared the outbreak a pandemic.2019. We continue to monitor the global outbreak of COVID-19 and are workinghave worked with our customers, employees, suppliers and other stakeholders to mitigate the risks posed by its spread. The COVID-19 pandemic is affectingcontinues to impact the economy in the United States and globally, and has had an effect on the operations of our company, vendors and suppliers, and supply of and demand for our products as follows:
Operations
As a result of the COVID-19 pandemic, governmental authorities have implemented and are continuing to implement numerous and constantly evolving measures to try to contain the virus, such as travel bans and restrictions, limits on gatherings, quarantines, shelter-in-place orders, site closures and business shutdowns. These measures have affected the ability of our employees, vendors, and suppliers to perform their respective responsibilities and obligations relative to the conduct of our business. We have important manufacturing operations worldwide that have been impacted by the outbreak. Measures requiring business shutdowns generally exclude certain essential services, and those essential services commonly include critical infrastructure and the businesses that support that critical infrastructure. Because the animal health industry has been designated an essential business, our manufacturing and research facilities remain operational, while our employees in other company functions arecontinue to primarily workingwork remotely. These measures have impacted and may further impact our workforce and operations, as well as those of our customers, vendors and suppliers.
Supply
In the secondfirst quarter of 2021, we havedid not experienced anyexperience significant impacts or interruptions to our supply chain as a result of the COVID-19 pandemic. However, as the pandemic continues, we may face supply chain disruptions due to operational difficulties experienced by our suppliers in light of government-ordered restrictions and shelter-in-place mandates.suppliers. Although we regularly monitor the financial health of companies in our supply chain, the financial hardship on our suppliers caused by the COVID-19 pandemic could cause a disruption in our ability to obtain raw materials or components required to manufacture our products, adversely affecting our operations. Freight processes relatinghave experienced, and could continue to the shipment of our finished goods have been disruptedexperience, lead time disruptions and have resultedincreases in higher shipping costs, which has negatively impactedimpacting our profitability.
Demand
The COVID-19 pandemic has adversely impacted global economic conditions. In particular, the COVID-19 pandemic has created near-termsignificant uncertainty for our channel distribution partners with respect to end customer demand and working capital.capital, particularly in early 2020. Based on these factors, in addition to a shift in tactics for demand generation with our distributors, in the first and second quarters of 2020, we reduced the amount of inventory held in the channel. We anticipate that decreasesFor our pet health business, demand in end customer demand may impact our companion animal business, primarily in clinically administered pharmaceutical products suchdirect to retailer and e-commerce channels could be negatively impacted by economic conditions as vaccines, and in international markets, as social distancing guidelines have decreased veterinary visits, reduced veterinary practice revenue and increased working capital considerations for all parties in the value chain. they fluctuate.
In our foodfarm animal business, demand has been negatively impacted by processing plant closures, resulting in a backlog of animals ready for processing, and weakened food service demand, which collectively have pressured producer economics, as well as an effort by dairy farmers to decrease milk production, which could impacteconomics. Processing plants have adjusted operations and have cleared most of the backlog, and demand for a number of our food animal products.certain protein categories continues to recover. While the impact ishas been most significant for the U.S. livestock industry, particularly in the second and third quarters of 2020, the pressure has occurred globally and across species. As the pandemic has continued through the beginning of 2021, our business has been affected by lower levels of demand in certain markets due to unfavorable macroeconomic conditions and reduced food service consumption. As a result, the industry has seen pressured prices and producer profitability across species, most notably in international poultry and aqua. We anticipate that decreasesrecovery of end consumer demand, particularly in demandthe food service business as compared to prior year will continue to occur, particularly in the foodimpacting our farm animal business, throughout the rest of the year.2021.
Our third party distributors may face difficulties maintaining operations and normal liquidity in light of government-mandated restrictions. Due to liquidity and working capital pressure caused by the COVID-19 pandemic, our distributors are managingcontinue to manage inventory more tightly. In response to this along with a shift in tactics for demand generation with our distributors, we reduced channel inventory levels during the first half of 2020 as we tightentightened our approach across all facets of our distributor relationships. We estimate that this decreased our revenue by
approximately $160 million. These actions have allowed us to improve working capital management, increase gross margin, implement new compensation structures with our distributors and enable greater control of overall stock levels. We continue to monitor the impacts on our customers' liquidity and therefore our ability to collect on our
accounts receivable. While our allowance on these receivables factors in expected credit losses, continued disruption and declines in the global economy could result in difficulties in our ability to collect, which we have not experienced on a material basis at this time. If significant issues with collections occur, material increases in our allowance for doubtful accounts may be required.
Our Acquisition of Bayer Animal Health
We have incurred and expect to continue to incur expenses in connection with our acquisition of Bayer Animal Health including fees for professional services such as legal, accounting, consulting, and other advisory fees and expenses. Expenses incurred in 2021 primarily relate to integration activities. In addition, we have incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics and to expand administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by the former parent company of Bayer Animal Health. We anticipate that these additional costs will be partially offset by expected synergies.
Product Development and New Product Launches
A key element of our targeted value creation strategy is to drive growth through portfolio development and product innovation, primarily in our three targeted growth categories of CA Disease Prevention, CA Therapeutics and FA Future Protein & Health. Since 2015, we have launched or acquired 14 new products, including the additions of Entyce™, Nocita™ and Tanovea™ in 2019 through acquisition and business development activities. Revenue from these products contributed $215.2 million to revenue for the six months ended June 30, 2020.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, including the acquisition of Bayer's animal health business, and the expansion of the use of our existing products. We believe we are an industry leader in animal health 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 operational and productivity initiatives implemented following recent acquisitions and in response to changing market demand for antibiotics and other headwinds.
OurPrior to the acquisition of Bayer Animal Health, our acquisitions within the last six years added in the aggregate $1.4 billion in revenue, 4,600 full-time employees, 12 manufacturing and eight R&D sites. The acquisition of Bayer Animal Health on August 1, 2020 added 3,900 full-time employees, eight manufacturing sites, and four R&D sites. In addition, from 2015 to 2019,2020, changing market demand for antibiotics and other headwinds, such as competition with generics and innovation, 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 selling, general and administrative (SG&A) functions. Our manufacturing cost savings strategies included improving manufacturing processes and headcount through lean manufacturing (minimizing waste while maintaining productivity), closing of three manufacturing sites, consolidating our CMO network, strategically insourcing certain projects, and pursuing cost savings opportunities with respect to raw materials via a new procurement process. Additional cost savings have resulted from reducing the number of R&D sites, from 16 to nine, SG&A savings
from sales force consolidation, and reducing discretionary and other general and administrative (G&A) operating expense.
Foreign Exchange Rates
Significant portions of our revenue and costs are exposed to changes in foreign exchange rates. Our products are sold in more than 90 countries and, as a result, our revenue is influenced by changes in foreign exchange rates. During the sixthree months ended June 30,March 31, 2021 and 2020, approximately 54% and 2019, approximately 49% and 42%, respectively, of our revenue was denominated in foreign currencies. As we operate in multiple foreign currencies, including the Euro, British pound, Swiss franc, Brazilian real, Australian dollar, Japanese yen, Canadian dollar, Chinese yuan, and other currencies, changes in those currencies relative to the U.S. dollar impact our revenue, cost of sales 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. Currency movements decreased revenue by 2% during the six months ended June 30, 2020. Currency movements had a limited impact on revenue during the sixthree months ended June 30, 2019.March 31, 2021 and 2020.
Our Relationship with Lilly and Additional Standalone Costs
All operations-focused TSAs that went into effect after our 2018 separation from Lilly were exited as planned on March 31, 2021. We are currently investingnearly complete with investments in expanding our own administrative functions, including, but not limited to, information technology, facilities management, distribution, human resources, and manufacturing, to replace services previously provided by Lilly. Because of initial stand up costs and overlaps with services previously provided by Lilly, we have incurred and expect to continue to incur certain temporary, duplicative expenses in connection with the Separation. We have also incurred and expect to continue to incur costs related to the build out of processes and systems to support finance and global supply and logistics, among others. We currently estimate these costs taken together to be in a range from $240$315 million to $290$335 million, net of potentialcompleted and planned real estate dispositions and employee benefit changes, of which a portion will be capitalized and the remainder will be expensed.
In connection with the IPO, we incurred $2.5 billion of long-term borrowings. We have estimated interest expense of approximately $99 million on an annual basis based on our borrowings as of June 30, 2020.
As a result of the IPO, we became subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, and the Sarbanes-Oxley Act. We continue to establish and expand additional procedures and practices as a standalone public company. As a result, we continue to incur additional costs as a standalone public company compared to the prior period, including internal audit, external audit, investor relations, stock administration, stock exchange fees and regulatory compliance costs.
Asset Impairment, Restructuring and Other Special Charges
During the three months ended March 31, 2021 and 2020 including in connection with the productivity initiatives described above under "Factors Affecting Our results have been impacted byResults of Operations - Productivity," we incurred charges related to asset impairment, restructuring and other special charges, including integration of acquired businesses, during the three and six months ended June 30, 2020 and 2019.businesses. These charges primarily include severance costs resulting from actions taken to reduce our cost structure,costs, asset impairment charges primarily related to competitive pressures for certain pet health products, product rationalization andrationalizations, site closures and chargesintegration costs related to acquired businesses, primarily Bayer Animal Health, and costs related to our integration effortsthe build out of processes and systems to support finance and global supply and logistics, among others, as a result of our acquired businesses and the pending acquisition of Bayer's animal health business, external costs directly related to acquiring businesses, including expenses for banking, legal, accounting, and other similar services, and costs towe stand our organization up to beas an independent company.
For more information on these charges, see Note 7:5: Asset Impairment, Restructuring and Other Special Charges in ourto the condensed consolidated financial statements.
Results of Operations
The following discussion and analysis of our results of operations should be read along with our condensed consolidated financial statements and the notes thereto.
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | | | Six Months Ended June 30, | | | | |
| 2020 | | 2019 | | % Change | | 2020 | | 2019 | | % Change |
| Revenue | $ | 586.3 | | | $ | 781.6 | | | (25) | % | | $ | 1,244.0 | | | $ | 1,512.7 | | | (18) | % |
| Costs, expenses and other: | | | | | | | | | | | |
| Cost of sales | 295.9 | | | 356.0 | | | (17) | % | | 628.6 | | | 699.8 | | | (10) | % |
| % of revenue | 50 | % | | 46 | % | | 4 | % | | 51 | % | | 46 | % | | 5 | % |
| Research and development | 59.4 | | | 68.8 | | | (14) | % | | 126.2 | | | 132.9 | | | (5) | % |
| % of revenue | 10 | % | | 9 | % | | 1 | % | | 10 | % | | 9 | % | | 1 | % |
| Marketing, selling and administrative | 162.8 | | | 200.9 | | | (19) | % | | 344.8 | | | 382.0 | | | (10) | % |
| % of revenue | 28 | % | | 26 | % | | 2 | % | | 28 | % | | 25 | % | | 3 | % |
| Amortization of intangible assets | 49.0 | | | 49.3 | | | (1) | % | | 100.6 | | | 98.3 | | | 2 | % |
| % of revenue | 8 | % | | 6 | % | | 2 | % | | 8 | % | | 6 | % | | 2 | % |
| Asset impairment, restructuring and other special charges | 119.4 | | | 31.8 | | | 275 | % | | 194.2 | | | 56.7 | | | 243 | % |
| Interest expense, net of capitalized interest | 24.8 | | | 20.7 | | | 20 | % | | 41.3 | | | 41.5 | | | — | % |
| Other - net, (income) expense | (47.9) | | | 3.9 | | | NM | | (46.8) | | | 6.5 | | | NM |
| Income (loss) before income taxes | (77.1) | | | 50.2 | | | NM | | (144.9) | | | 95.0 | | | NM |
| % of revenue | (13) | % | | 6 | % | | (19) | % | | (12) | % | | 6 | % | | (18) | % |
| | | | | | | | | | | |
| Income tax (benefit) expense | (23.9) | | | 14.3 | | | (267) | % | | (42.6) | | | 27.6 | | | (254) | % |
| Net income (loss) | $ | (53.2) | | | $ | 35.9 | | | NM | | $ | (102.3) | | | $ | 67.4 | | | NM |
| | | | | | | | | | | | | | | | | | | | | | | | | |
| | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | 2021 | | 2020 | | % Change |
| Revenue | | | | | | | $ | 1,242 | | | $ | 658 | | | 89 | % |
| Costs, expenses and other: | | | | | | | | | | | |
| Cost of sales | | | | | | | 569 | | | 333 | | | 71 | % |
| % of revenue | | | | | | | 46 | % | | 51 | % | | (5) | % |
| Research and development | | | | | | | 89 | | | 67 | | | 33 | % |
| % of revenue | | | | | | | 7 | % | | 10 | % | | (2) | % |
| Marketing, selling and administrative | | | | | | | 348 | | | 182 | | | 91 | % |
| % of revenue | | | | | | | 28 | % | | 28 | % | | — | % |
| Amortization of intangible assets | | | | | | | 147 | | | 52 | | | 183 | % |
| % of revenue | | | | | | | 12 | % | | 8 | % | | 4 | % |
| Asset impairment, restructuring and other special charges | | | | | | | 108 | | | 75 | | | 44 | % |
| Interest expense, net of capitalized interest | | | | | | | 61 | | | 16 | | | 281 | % |
| Other expense, net | | | | | | | — | | | 1 | | | NM |
| Loss before income taxes | | | | | | | (80) | | | (68) | | | 18 | % |
| % of revenue | | | | | | | (6) | % | | (10) | % | | 4 | % |
| | | | | | | | | | | |
| Income tax benefit | | | | | | | (19) | | | (19) | | | — | % |
| Net loss | | | | | | | $ | (61) | | | $ | (49) | | | 24 | % |
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful
Disaggregated Revenue
On a global basis, our revenue within our product categories wasfor the three months ended March 31 is summarized as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended June 30, | | | | | | Six Months Ended June 30, | | | | |
| 2020 | | 2019 | | % Change | | 2020 | | 2019 | | % Change |
| CA Disease Prevention | $ | 176.3 | | | $ | 223.4 | | | (21) | % | | $ | 316.6 | | | $ | 409.3 | | | (23) | % |
| CA Therapeutics | 78.0 | | | 83.4 | | | (6) | % | | 143.8 | | | 164.8 | | | (13) | % |
| FA Future Protein & Health | 157.9 | | | 175.8 | | | (10) | % | | 337.9 | | | 343.0 | | | (1) | % |
| FA Ruminants & Swine | 158.2 | | | 271.5 | | | (42) | % | | 410.8 | | | 545.6 | | | (25) | % |
| Subtotal | 570.4 | | | 754.1 | | | (24) | % | | 1,209.1 | | | 1,462.7 | | | (17) | % |
Strategic Exits(1) | 15.9 | | | 27.5 | | | (42) | % | | 34.9 | | | 50.0 | | | (30) | % |
| Total | $ | 586.3 | | | $ | 781.6 | | | (25) | % | | $ | 1,244.0 | | | $ | 1,512.7 | | | (18) | % |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | | | | Revenue | | % of Total Revenue | | Increase (Decrease) |
| (Dollars in millions) | | | | | | | 2021 | | 2020 | | 2021 | | 2020 | | $ Change | | % Change | | CER (1) |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Pet Health | | | | | | | $ | 645 | | | $ | 206 | | | 52 | % | | 31 | % | | $ | 439 | | 213 | % | | 211 | % |
| | | | | | | | | | | | | | | | | | | |
| | | | | | | | | | | | | | | | | | | |
| Farm Animal | | | | | | | 578 | | | 433 | | | 47 | % | | 66 | % | | 145 | | 33 | % | | 34 | % |
| Subtotal | | | | | | | 1,223 | | | 639 | | | 98 | % | | 97 | % | | 584 | | 91 | % | | 91 | % |
Contract Manufacturing(2) | | | | | | | 19 | | | 19 | | | 2 | % | | 3 | % | | — | | — | % | | — | % |
| Total | | | | | | | $ | 1,242 | | | $ | 658 | | | 100 | % | | 100 | % | | 584 | | 89 | % | | 88 | % |
(1)Constant exchange rate (CER) is defined as revenue growth excluding the impact of foreign exchange. The calculation assumes the same foreign currency exchange 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 business activitiesarrangements in which we have either exited or madeact as a strategic decisioncontract manufacturer, including supply agreements associated with divestitures of products related to exit.the acquisition of Bayer Animal Health.
Total revenue
Three months ended June 30, 2020 vs. three months ended June 30, 2019
Total revenue decreased $195.3 increased $584 million or 25%, reflectingto $1,242 million comprised of $683 million from the legacy Elanco portfolio and $559 million from the legacy Bayer Animal Health portfolio. This 89% increase reflects a 25% decrease86% increase in volume, a 2% increase in price, and a 2% unfavorablelimited favorable impact from foreign exchange rates, partially offset by a 2% increase in price.
In summary, the total revenue decrease was due primarily to:
•a decrease in revenue of $45.2 million or 20% from CA Disease Prevention products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $4.4 million or 5% from CA Therapeutics products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $11.0 million or 6% from FA Future Protein & Health products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $107.9 million or 40% from FA Ruminants & Swine products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $11.0 million or 40% from Strategic Exits, excluding the impact of foreign exchange rates; and
•a decrease in revenue of $15.8 million due to the negative impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
•CA Disease PreventionPet Health revenue decreasedincreased by $47.1$439 million, or 21%213%, for the quarter, driven by decreased volume across all products and to a significantly lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decline was the result of actions taken across brands to reduce channel inventory levels as well as decreased demand in veterinary productsrevenue as a result of the COVID-19 pandemic, primarilyaddition of Bayer Animal Health product revenue of $369 million in U.S. vaccines and international markets. Underlying end user demand forthe quarter. The increase in the legacy Elanco business was driven by a favorable comparison to the prior year, during which we reduced channel inventory levels with our distributors, negatively impacting revenue by approximately $60 million. Growth in the legacy Elanco business was also attributable to higher volume in newer generation parasiticide products grew during the quarter as compared to the prior year.and pain products.
•CA TherapeuticsFarm Animal revenue decreasedincreased by $5.4$145 million, or 6%33%, for the quarter, driven by decreased volume and to a lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decline was the result of actions taken across brands to reduce channel inventory levels as well as decreased demand in veterinary productsrevenue as a result of the COVID-19 pandemic, primarily in veterinarian-administered products and international markets, offset by continued growthaddition of Galliprant globally and in alternative channels, as well as the inclusionBayer Animal Health product revenue of sales for Entyce and Nocita from the acquisition of Aratana$174 million in the third quarterquarter. Legacy Elanco revenue declined as a result of 2019.
•FA Future Protein & Health revenue decreased by $17.9 million or 10% for the quarter, driven by decreased volume and to a lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decline was driven by lower demand due to impacts of the COVID-19 pandemic on global protein markets and the subsequent impact of anticipatory buying that occurred in the first quarter of 2020 by direct customers in international export markets, partially offset by continued growth in our aqua portfolio.
•FA Ruminants & Swine revenue decreased by $113.3 million or 42% for the quarter, driven by decreased volume and to a significantly lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decrease was driven by lower demand duecomparison to the impact of the COVID-19 pandemic on global protein markets, primarily Optaflexx, the subsequent impact ofprior year, which included anticipatory buying by direct customers in international export markets and actions taken across brands to reduce channel inventoryensure continuity of supply ahead of potential COVID-19 disruptions. In addition, the decline in the current period was driven by lower levels primarily for Rumensin. Additionally, volume was impacted by generic competition for Rumensin andtrade pressure affecting Paylean™. These decreases were partially offset by increasedof demand in China's swine market as a result of favorable producer economics and positive efforts to repopulate herds impacted by African Swine Fever in 2019.
•Strategic Exits revenue decreased by $11.6 million to $15.9 million and represented 3% of total revenue.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
Total revenue decreased $268.7 million or 18%, reflecting a 18% decrease in volume and a 2% unfavorable impact from foreign exchange rates, partially offset by a 2% increase in price.
In summary, the total revenue decrease was due primarily to:
•a decrease in revenue of $89.5 million or 22% from CA Disease Prevention products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $19.1 million or 12% from CA Therapeutics products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $126.8 million or 23% from FA Ruminants & Swine products, excluding the impact of foreign exchange rates;
•a decrease in revenue of $14.0 million or 28% from Strategic Exits, excluding the impact of foreign exchange rates; and
•a decrease in revenue of $25.2 millioncertain markets due to the negative impact of foreign exchange rates.
partially offset by:
•an increase in revenue of $5.9 million or 2% from FA Future Protein & Health products, excluding the impact of foreign exchange rates.
The detailed change in revenue by product category was as follows:
•CA Disease Prevention revenue decreased by $92.7 million or 23%, driven by decreased volume and to a significantly lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decline was the result of actions taken across brands to reduce channel inventory levels and decreased demand in veterinary products as a result of the COVID-19 pandemic, primarily in U.S. vaccines and international markets. Underlying end user demand for our newer generation parasiticide products grew during the year. These decreases were partially offset by an increase in direct sales, particularly in alternative channels outside vet clinics.
•CA Therapeutics revenue decreased by $21.0 million or 13%, driven by decreased volume and to a lesser extent an unfavorable impact from foreign exchange rates, partially offset by an increase in price. The volume decline was the result of actions taken across brands to reduce channel inventory levels and decreased demand in veterinary products as a result of the COVID-19
pandemic, primarily in veterinarian-administered products and international markets, partially offset by the inclusion of sales for Entyce and Nocita from the acquisition of Aratana in the third quarter of 2019.
•FA Future Protein & Health revenue decreased by $5.1 million or 1%, driven primarily by an unfavorable impact from foreign exchange rates and to a lesser extent volume, partially offset by an increase in price. The volume decline was driven by decreased demand due to impacts of the COVID-19 pandemic on global protein markets, partially offset by continued growth in ourpoultry and aqua consumption, production, and poultry vaccine portfolios.
•FA Ruminants & Swine revenue decreased by $134.8 million or 25%, driven by decreased volume and to a significantly lesser extent an unfavorable impact from foreign exchange rates. The volume decrease was driven by decreased demand due to the impact of the COVID-19 pandemic on global protein markets, primarily Optaflexx, and actions taken across brands to reduce channel inventory levels, primarily for Rumensin. Additionally, volume was impacted byprofitability as well as generic competition, for Rumensin andtrade pressure affecting Paylean. These decreases were partiallypartly offset by increased demand in China's swine market as a result of favorable producer economicsChina and positive efforts to repopulate herds impacted by African Swine Fever in 2019.
•Strategic ExitsContract Manufacturing revenue decreased by $15.1 million to $34.9remained flat at $19 million, and represented 3%2% of total revenue.
Costs and Expenses and Other
Cost of salesSales
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Cost of sales | | | | | | | | $ | 569 | | | $ | 333 | | | 71 | % |
| % of revenue | | | | | | | | 46 | % | | 51 | % | | |
Cost of sales decreased $60.1 million primarily due to manufacturing productivity improvements and decreased revenue.
Cost of sales as a percent of revenues increased to 50.5% from 45.5%71%, primarily due to unfavorable product and geographic mix and unfavorable leveragethe amortization of fixed manufacturing costs across a lower revenue base, partially offset by continued improvementsthe fair value adjustment to inventory of $62 million due to the acquisition of Bayer Animal Health along with an increase in manufacturing productivity and increases in price.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
Costlegacy Elanco sales. Excluding the amortization of the inventory fair value adjustment, cost of sales decreased $71.2 million due primarilywould have been approximately 41% of revenue, compared to manufacturing productivity improvements and decreased revenue.
Cost of sales as a percent of revenues increased to 50.5% from 46.3%, primarily51% in the prior year. This decrease is due to unfavorable product and geographic mix, unfavorable leveragethe inclusion of fixed manufacturing costs across a lower revenue base, partially offset byBayer Animal Health products, which have higher margins, along with continued improvements in manufacturing productivity and increases in price.
Research and development
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Research and development | | | | | | | | $ | 89 | | | $ | 67 | | | 33 | % |
| % of revenue | | | | | | | | 7 | % | | 10 | % | | |
R&D expenses decreased $9.4 million,increased 33%, primarily due to strong expense management, adjustmentsthe inclusion of the Bayer Animal Health business. As a percent of revenue, research and development was 7% compared to variable pay, and delayed project spending.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
R&D expenses decreased 6.7 million, primarily10% in the prior year, partly due to strong expense management, adjustmentsa delay of some project spend from the first quarter to variable pay, and delayed project spending.
Marketing, selling and administrative
administrativ
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Marketing, selling and administrative | | | | | | | | $ | 348 | | | $ | 182 | | | 91 | % |
| % of revenue | | | | | | | | 28 | % | | 28 | % | | |
Marketing, selling and administrative expenses decreased $38.1 million,as a percentage of revenue were flat year over year. Expenses as a percentage of revenue remained flat primarily due to disciplined cost management acrossa delay of planned spend for direct-to-consumer and digital advertising from the business as we have movedfirst quarter to the second quarter resulting from a cooler early parasiticide season. Expenses increased 91% over prior year, primarily to virtual operations due to the COVID-19 pandemic, adjustments to variable pay,acquisition of Bayer Animal Health and delayed projectincreased information technology spending.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
Marketing, selling and administrative expenses decreased $37.2 million, due to disciplined cost management across the business as we have moved primarily to virtual operations due to the COVID-19 pandemic, adjustments to variable pay, and delayed project spending, partially offset by additional costs from acquired businesses in 2019, including Aratana and Prevtec.
Amortization of intangible assets
Three months ended June 30, 2020 vs. three months ended June 30, 2019
Amortization of intangible assets decreased $0.3 million, primarily due to an adjustment to amortization recorded on assets classified as held for sale, partially offset by the addition of amortization of intangible assets recorded from the acquisitions of Aratana and Prevtec during 2019.
Six months ended June 30, 2020 vs. six months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Amortization of intangible assets | | | | | | | | $ | 147 | | | $ | 52 | | 183 | % |
Amortization of intangible assets increased $2.3$95 million, primarily due to the addition of amortization of intangible assets recorded from the acquisitionsacquisition of Aratana and Prevtec during 2019.Bayer Animal Health.
Asset impairment, restructuring and other special charges
For additional information regarding our asset impairment, restructuring and other special charges, see Note 7: Asset Impairment, Restructuring and Other Special Charges to our condensed consolidated financial statements. | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Asset impairment, restructuring and other special charges | | | | | | | | $ | 108 | | | $ | 75 | | 44 | % |
Three months ended June 30, 2020 vs. three months ended June 30, 2019
Asset impairment, restructuring and other special charges increased $87.6 million to $119.4 million from $31.8$33 million, primarily due to higher transaction costs directly relatedseverance associated with the restructuring program announced during the first quarter of 2021, an asset impairment charge recorded to business acquisitions, includingadjust the pending acquisitionfair value of the animal health business of Bayer,intangible assets that were subject to product rationalization, higher integration costs of acquisitions, and costs associated with the implementation of new systems, programs, and processes due to the Separationour separation from Lilly and in anticipation ofconnection with the acquisition of the animal health business of Bayer Animal Health, as more fully described in Note 7.5. These increases were partially offset by adjustments to severance accruals under the September 2020 program primarily as a result of restructured personnel filling open positions and favorable negotiations, and a related pension curtailment gain from the September 2020 and January 2021 programs.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
AssetFor additional information regarding our asset impairment, restructuring and other special charges, increased $137.5 million to $194.2 million from $56.7 million, primarily due to higher transaction costs directly related to business acquisitions, including the pending acquisition of the animal health business of Bayer, higher integration costs of acquisitions,see Note 5: Asset Impairment, Restructuring and costs associated with the implementation of new systems, programs, and processes dueOther Special Charges to the Separation from Lilly and in anticipation of the acquisition of the animal health business of Bayer, as more fully described in Note 7.condensed consolidated financial statements.
Interest expense, net of capitalized interest
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Interest expense, net of capitalized interest | | | | | | | | $ | 61 | | | $ | 16 | | 281 | % |
Interest expense, net of capitalized interest, increased $4.1 million from $20.7 million to $24.8$45 million, primarily as a result of offsetting gains from the net investment hedge recorded in the second quarter of 2019 that did not recur in the second quarter of 2020 due to its liquidation.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
Interest expense, net of capitalized interest decreased $0.2 million from $41.5 million to $41.3 million, primarily as a result ofassociated with the repayment of indebtedness outstanding under our existing term loan facility duringB entered into August 1, 2020 and used to finance the first quarter of 2020.Bayer Animal Health acquisition.
Other -expense, net (income) expense
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Other expense, net | | | | | | | | $ | — | | | $ | 1 | | NM |
Other - net, (income) expense changed by $51.8 million from expense of $3.9 million to income of $47.9 million, primarily as a result ofrecorded during the gain on the sale of land and buildings in New South Wales, Australia. See Note 12: Leases for further discussion.
Sixthree months ended June 30, 2020 vs. sixMarch 31, 2021 consisted of losses recorded in relation to divestitures. This was fully offset by up-front payments received, milestones earned, and equity issued to us in relation to a license agreement. Other expense recorded during the three months ended June 30, 2019
Other - net, (income) expense changed by $53.3 million from expenseMarch 31, 2020 was primarily composed of $6.5 million to income of $46.8 million, primarily as a result of a gain on the sale of land and buildings in New South Wales, Australia. See Note 12: Leases for further discussion.foreign exchange losses.
Income tax expensebenefit
Three months ended June 30, 2020 vs. three months ended June 30, 2019 | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | | Three Months Ended March 31, |
| (Dollars in millions) | | | | | | | | 2021 | | 2020 | | % Change |
| Income tax benefit | | | | | | | | $ | (19) | | | $ | (19) | | — | % |
| Effective tax rate | | | | | | | | 23.5 | % | | 27.6 | % | | |
Income tax expense decreased $38.2benefit was $19 million primarily due to lower pre-tax earnings driven mainlyfor the three months ended March 31, 2021 and 2020. The effective tax rates
for both periods were impacted by a decrease in revenue and increased acquisition and integration costs.net discrete tax items. See Note 13:10: Income Taxes to ourthe condensed consolidated financial statements.
Six months ended June 30, 2020 vs. six months ended June 30, 2019
Income tax expense decreased $70.2 million, primarily due to lower pre-tax earnings driven mainly by a decrease in revenue and increased acquisition and integration costs. See Note 13: Income Taxes to our condensed consolidated financial statements.statements for further discussion.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from operations and funds available under our credit facilities.Credit Facilities. As a significant portion of our business is conducted outside the U.S.,internationally, we hold a significant portion of cash outside of the U.S. We monitor and adjust the amount of foreign cash based on projected cash flow requirements. Our ability to use foreign cash to fund cash flow requirements in the U.S. may be impacted by local regulations and, to a lesser extent, following U.S. tax reforms, the income taxes associated with transferring cash to the U.S. We currently intend to indefinitely reinvest foreign earnings for continued use in our foreign operations. As our structure evolves as a standalone company, we may change that strategy, particularly to the extent we identify tax efficient reinvestment alternatives for our foreign earnings or change our cash management strategy.
Our principalWe believe our primary sources of liquidity needs going forward, in additionare sufficient to funds needed for the completion of the Bayer acquisition,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 payments as well as interest rate swaps, operating lease payments, purchase obligations, and payments oncosts associated with the integration of Bayer Animal Health. In addition, we have the ability to access capital markets to obtain debt refinancing for longer-term funding, if required, to service our amortizing notes. Welong-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 Item 1A, "Risk Factors""Item 1A. Risk Factors - We may not be able to generate sufficient cash to service all of our indebtedness and may be forced to take other actions to satisfy our obligations under our indebtedness, which may not be successful" in Part I of our Annual Report on Form 10-K for more information.the year ended December 31, 2020.
Cash Flows
The following table provides a summary of cash flows from operating, investing and financing activities for the periods presented:
| | | | | | | | | | | | | | | | | |
| Six Months Ended June 30, | | | | $ |
| Net cash provided by (used for): | 2020 | | 2019 | | Change |
| Operating activities | $ | 163.6 | | | $ | 58.2 | | | $ | 105.4 | |
| Investing activities | (9.0) | | | (77.5) | | | 68.5 | |
| Financing activities | 903.9 | | | (249.8) | | | 1,153.7 | |
| Effect of exchange-rate changes on cash and cash equivalents | (1.8) | | | (11.8) | | | 10.0 | |
| Net increase (decrease) in cash, cash equivalents and restricted cash | $ | 1,056.7 | | | $ | (280.9) | | | $ | 1,337.6 | |
| | | | | | | | | | | | | | | | | | | | |
| (Dollars in millions) | | Three Months Ended March 31, |
| Net cash provided by (used for): | | 2021 | | 2020 | | $ Change |
| Operating activities | | $ | 22 | | | $ | 4 | | | $ | 18 | |
| Investing activities | | 10 | | | (20) | | | 30 | |
| Financing activities | | 2 | | | 897 | | | (895) | |
| Effect of exchange-rate changes on cash and cash equivalents | | (25) | | | (9) | | | (16) | |
| Net increase in cash, cash equivalents and restricted cash | | $ | 9 | | | $ | 872 | | | $ | (863) | |
Operating activities
Our cash provided by operating activities increased by $105.4$18 million, from $58.2to $22 million for the sixthree months ended June 30, 2019 to $163.6March 31, 2021 from $4 million for the sixthree months ended June 30,March 31, 2020. The increase inwas driven by higher net income after excluding amounts related to non-cash operating cash flowsactivities, including depreciation and amortization and inventory fair value step-up amortization. This increase was primarily attributable to decreases in accounts receivable and increases in accounts payable and other current liabilities, partially offset by increasesthe impact of changes in inventoryoperating assets and prepaid expenses and a decrease in net income, adjusted for non-cash items.liabilities. The COVID-19 global health pandemic and related economic downturn led to an increase in customer accounts receivable that were past due at the end of the first quarter of 2020; however, customer collections improved inthroughout the second quarterremainder of the year and payment terms decreased. WeIn the past, we have extended our payment terms for distributors on occasion. Although we presently have no plans to do so in the past in certain customer situations and whilefuture, it is possible that we do not intendwill need to extend payment terms in the future, we may need to implement this practice in the futurecertain situations as a result of the COVID-19 global health pandemic, competitive pressures and the need for certain inventory levels at our channel distributors to avoid supply disruptions. ExtensionsIf so, such extensions of customer payment terms could result in additional uses of our cash flow.
Investing activities
Our cash provided by investing activities was $10 million for the three months ended March 31, 2021 as compared to cash used for investing activities decreased by $68.5 million, to $9.0of $20 million for the sixthree months ended June 30, 2020 compared to $77.5 million for the six months ended June 30, 2019.March 31, 2020. The change was primarily driven by net proceeds froma decrease in the sale of property and equipment of $19.2 million in 2020 (mostly relatedcash consideration paid to acquire Bayer Animal Health due to the Australia land and facility sale) as compared to net purchasesfinalization of property and equipment of $51.8 million in 2019,the working capital adjustment during the period, partially offset by an increase in purchases of software from 2019 to 2020.intangible assets.
Financing activities
Our cash provided by financing activities was $903.9decreased by $895 million to $2 million for the sixthree months ended June 30, 2020 as compared to cash used for financing activities of $249.8March 31, 2021 from $897 million for the sixthree months ended June 30, 2019.March 31, 2020. Cash provided by financing activities during the sixthree months ended June 30,March 31, 2021 reflected net proceeds from our revolving credit facility, partially offset by the repayment of indebtedness outstanding under our term loan B credit facility. Cash provided by financing activities during the three months ended March 31, 2020, reflectsreflected proceeds from issuances of common stock and TEUs during the period, partially offset by the repayment of indebtedness outstanding under our existingprevious term loan facility. Cash used for financing activities during the six months ended June 30, 2019, reflected the impact of $186.2 million of net cash consideration to Lilly in connection with local country asset purchases and other financing activities related to the Separation.
Description of Indebtedness
For a complete description of our outstandingdescription of our debt and available credit facilities as of June 30, 2020March 31, 2021 and December 31, 2019,2020, see Note 10:8: Debt to ourthe condensed consolidated financial statements.
Off Balance SheetBalance-Sheet Arrangements
In connection with our pending acquisition ofOther than the animal health business of Bayer as discussedcommitments and contingencies disclosed in Note 6: Acquisitions11: Commitments and Divestitures, in August 2019,Contingencies, we entered intohad no off-balance sheet arrangements that have, or are reasonably likely to have, a commitment letter that provides for financing consistingcurrent or future material effect on our financial condition, results of up to $750 million in a revolving facility, $3.0 billion in a term facility,operations, or liquidity.
Contractual Obligations
Our contractual obligations and $2.75 billion in a senior secured bridge facility. In connection with the financing commitment letter, we will incur fixed commitment fees of $40.4 million that will become due and payable upon the closing of the pending acquisition or the termination of the Purchase Agreement with Bayer. In addition, we expect to incur approximately $22.5 million in advisory fees that are contingent upon closing the pending acquisition. These fees have not been recorded on the consolidated balance sheetcommitments as of June 30, 2020. As a resultMarch 31, 2021 are primarily comprised of the financing secured for the acquisition through the equitylong-term debt obligations, including interest payments, and purchase obligations. Our long-term debt activity during the first quarterobligations are comprised of 2020, we no longer intend to use the full financing pursuant to the commitment letter. See Note 9: Equityour expected principal and Note 10: Debt for more information.interest obligations and our interest rate swaps. Purchase obligations consist of open purchase orders as of March 31, 2021 and contractual payment obligations with significant vendors which are noncancelable and are not contingent. These obligations are primarily short-term in nature.
Critical Accounting Policies
The preparation of financial statements in accordance with GAAP requires managementus to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses. There are certainCertain of our accounting policies that are considered critical asbecause these policies are the most important to the depiction of our financial statements and require significant, difficult or complex judgments by us, often employingrequiring the use of estimates about the effects of matters that are inherently uncertain. Actual results that differ from our estimates could have an unfavorable effect on our financial position and results of operations. We apply estimation methodologies consistently from year to year. Such policies are summarized in Item 7, "Management's Discussion & Analysis of Results of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended December 31, 2019.2020. There have been no significant changes in the application of our critical accounting policies during the sixthree months ended June 30, 2020.March 31, 2021.
Contractual Obligations
See Contractual Obligations included in Item 7, "Management's Discussion & Analysis of Results of Financial Condition and Results of Operations," of our Annual Report on Form 10-K for the year ended December 31, 2019.
ItemITEM 3. Quantitative and Qualitative Disclosures About Market RiskQUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Foreign Exchange Risk
We operate on a global basis and are exposed to the risk that our earnings, cash flows and equity could be adversely impacted by fluctuations in foreign exchange rates. We are primarily exposed to foreign exchange risk with respect to net assets denominated in the Euro, British pound, Swiss franc, British pound,Brazilian real, Australian dollar,
Japanese yen, Canadian dollar, Australian dollar and Brazilian real. As part of the TSA, Lilly maintained a foreign currency risk management program through a central shared entity, which entered into derivative contracts to hedge foreign currency risk associated with forecasted transactions for the entire company, including historically for our operations. Gains and losses on derivative contracts entered into by Lilly were previously allocated to our results to the extent they were to cover exposure related to our business and offset gains and losses on underlying foreign currency exposures. We implemented our own foreign currency risk management program and assumed all hedging activities in the second quarter of 2019.Chinese yuan.
We face foreign currency exchange exposures when we enter into transactions arising from subsidiary trade and loan payables and receivables denominated in foreign currencies.currencies and purchases of local subsidiaries due to local regulations as a result of the acquisition of Bayer Animal Health. We also face currency exposure that arises from translating the results of our global operations to the U.S. dollar at exchange rates that have fluctuated from the beginning of the period. We may enter into foreign currency forward or option derivative contracts to reduce the effect of fluctuating currency exchange rates in future periods.
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 $2.4$6 million for the sixthree months ended June 30, 2020.March 31, 2021.
Interest Risk
Upon extinguishment of our borrowings under the Term Credit Facility in the first quarter of 2020, our current outstanding debt balances are fixed-rate debt. While changes in interest rates currently have no impact on the interest we pay on fixed-rate debt, borrowingsBorrowings under our new term loan B credit facility will beare exposed to interest rate
fluctuations based on LIBOR. As of June 30, 2020,March 31, 2021, we held certain interest rate swap agreements with a notional value of $4.05approximately $4.1 billion that will have the economic effect of modifying the variable-interest obligations associated with the new Term Loan Facility,term loan B credit facility, so that a portion of the variable-rate interest payable becomes fixed. During the sixthree months ended June 30, 2020,March 31, 2021, we recorded a lossgain of $59.9$53 million, net of taxes on these interest rate swaps in other comprehensive loss. The lossgain is primarily attributable to market conditions resulting from the COVID-19 pandemic and the resulting cut to interest rates byan increase in the U.S. Federal Reserve inTreasury yield curve during the first quarter of 2020.2021. See Note 11:9: Financial Instruments and Fair Value to the condensed consolidated financial statements for further information.
Recently Issued Accounting Pronouncements
For discussion of our new accounting standards, see Note 4:2: Implementation of New Financial Accounting Pronouncements to ourthe condensed consolidated financial statements.
ItemITEM 4. Controls and ProceduresCONTROLS AND PROCEDURES
(a)Evaluation of Disclosure Controls and Procedures. Under applicable SEC regulations, management of a reporting company, with the participation of the principal executive officer and principal financial officer, must periodically evaluate the company’s “disclosure controls and procedures,” which are defined generally as controls and other procedures of a reporting company designed to ensure that information required to be disclosed by the reporting company in its periodic reports filed with the SEC (such as this Form 10-Q) is recorded, processed, summarized, and reported on a timely basis.
Our management, with the participation of Jeffrey N. Simmons, president and chief executive officer, and Todd S. Young, executive vice president and chief financial officer, evaluated our disclosure controls and procedures as of June 30, 2020.March 31, 2021. Based on this evaluation, the chief executive officer and the chief financial officer concluded that the disclosure controls and procedures are effective.
(b)Changes in Internal Controls. DuringAs of March 31, 2021, management is in the second quarterprocess of 2020,integrating the internal controls of the acquired Bayer Animal Health business into our existing operations as part of planned integration activities. In addition, we have transitioned from a Lilly solutions center to a newly established Elanco solutions center and substantially completed the implementation of our new Enterprise Resource Planning (ERP) system during the three months ended March 31, 2021. Other than the controls enhanced or implemented to integrate the Bayer Animal Health business and certain control processes that were updated to reflect our ERP implementation, there werehas been no changeschange in our internal control over financial reporting during the quarter ended March 31, 2021, that has materially affected, or areis reasonably likely to materially affect, our internal control over financial reporting. As additional transformation activities occur, we will continue to monitor and evaluate our internal control over financial reporting. Further, we have not experienced any material impact to our internal controls over financial reporting despite our accounting, finance, and legal employees working remotely due to the COVID-19 pandemic. We are continually monitoring and assessing COVID-19 on our internal controls to minimize the impact on their design and operating effectiveness.
PART II. Other Information
PART II
ItemITEM 1. Legal ProceedingsLEGAL PROCEEDINGS
See Note 14:11: Commitments and Contingencies to ourthe condensed consolidated financial statements for a summary of our legal proceedings.
ItemITEM 1A. Risk FactorsRISK FACTORS
Other than the revisions set forth below, there have been no material changes from the risk factors disclosed in Part I of our Annual Report on Form 10-K for the year ended December 31, 2019.
We have identified the following additional risk factor which has been updated from the version presented in our Quarterly Report on Form 10-Q for the quarter ended March 31, 2020:2020.
The COVID-19 pandemicfollowing risk factor has had,been changed from the risk factor that was previously disclosed:
Unanticipated safety, quality or efficacy concerns or identified concerns associated with our products may harm our reputation and is expected to continue to have an adverse impact on our business, our future results of operations and our overall financial performance.
The outbreakUnanticipated safety, quality or efficacy concerns arise from time to time with respect to animal health products, whether or not scientifically or clinically supported, potentially leading to product recalls, withdrawals or suspended or declining sales, as well as product liability and other claims. Regulatory actions based on these types of COVID-19 originating in Wuhan, China, in December 2019, has since rapidly increased its exposure globally. On March 11, 2020, the World Health Organization declared the outbreaksafety, quality or efficacy concerns could impact all, or a pandemic. The pandemic has impacted and may further impact the United States and the broader economiessignificant portion, of affected countries, including negatively impacting economic growth, the proper functioning of financial and capital markets, foreign currency exchange rates and interest rates. Due to the speed with which the situation is developing, the global breadth of its spread and the range of governmental and community reactions thereto, there is uncertainty around its duration, ultimate impact and the timing of recovery. Therefore, the pandemic could lead to an extended disruption of economic activity and the impact on our consolidated results of operations, financial position and cash flows could be material.
As a resultFor example, lawsuits seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been filed against us arising out of the adverse impactuse of Seresto, a non-prescription flea and tick collar for cats and dogs, based on reports alleging that the COVID-19 pandemic is having on our economycollar has caused injury and the economies in the countries in which we operate, the pandemic is also affecting our operations, including our supply chain distribution systems, production levels and research and development activities. In addition, any preventive or protective actions that governments implement ordeath to pets. Further, a U.S. House of Representative subcommittee chair requested that we adopt in responseproduce certain documents and information related to the COVID-19 pandemic,Seresto collar and further made a request to temporarily remove Seresto collars from the market. Similar actions relating to Seresto could be taken by regulatory agencies. If any such as travel restrictions, quarantines, limited operationsclaims with respect to Seresto or our other products are resolved adversely to us, or if a regulatory agency determines that a recall of governmental agencies or site closures, may interfere with the abilityany of our employees, vendors, and suppliersproducts, including Seresto, is necessary, such action could cause harm to perform their respective responsibilities and obligations relative to the conduct of our business. In particular, as a result of the COVID-19 pandemic, due to the suspension of in-person interactions byreputation, reduce our customer-facing professionals and the fact that certain vet clinics are limiting such interactions, our ability to market our products has been and may continue to be limited, which, in turn, could have an adverse effect on our ability to compete in the marketing andproduct sales, of our products. Additionally, government regulations that have been imposed in response to the COVID-19 pandemic may cause delays in the receipt of products, causing delays in our global supply chain, delaying the transportation of finished goods, disrupting our freight processes, which would result in higher shipping costs, and causing resources to be diverted that are necessary to administer certain of our products. In addition, some research and development projects could be impacted based on need for the reagents from suppliers and clinical trial activity requiring veterinary clinic access and support. Furthermore, social distancing guidelines could have an adverse impact on our research and development activities as our laboratories are not operating at full capacity.
Our customers, and therefore our business and revenues, are sensitive to negative changes in economic conditions. As a result, we have experienced declines in revenue in 2020, including in our companion animal business as social distancing guidelines have decreased veterinary visits and have reduced veterinary practice spending. In addition, there have been a number of shutdowns of processing plants as a result of COVID-19 outbreaks within their operations, and there could be more of these shutdowns, which, in turn, have led and may lead to a further decrease in demand for our customers’ livestock. Such shutdowns could not only lead to a decrease in demand for our products, but could also significantly impact their ability to pay for our products. In addition, an effort by dairy farmers to decrease milk production could negatively impact demand for Rumensin. We expect the negative impacts of the COVID-19 pandemic on our revenue will continue until conditions relating to the overall impact of COVID-19 on all aspects of the economy and life in general improve.
The impact of the COVID-19 pandemic on the global financial markets may reduce our ability to access capital, which could negatively impact our short-term and long-term liquidity. Additionally, our suppliers and third party distributors may face difficulties maintaining operations and normal liquidity in light of government-mandated restrictions. Further, the resulting global economic downturn may negatively impact the ability of certain of our customers to make payments on a timely basis, adversely impacting our cash flows from operations. While our liquidity has not been significantly impacted by delayed collections thus far, we do not yet know the full extent of the impact of the COVID-19 pandemic and its resulting economic impact, which could have a material adverse effect on our liquidity, capital resources, operations and business.
We are also monitoring the impact of COVID-19 on our talent recruitment and retention efforts. If members of our managementmonetary penalties and other key personnel in critical functions across our organization are unable to perform their duties or have limited availability due to COVID-19, we may not be able to execute on our business strategy and/or our operations may be negatively impacted. The loss or limited availability of the services of one or more of our executive officers or other key personnel, or our inability to recruitcostly remedies against us, and retain qualified executive officers or other key personnel in the future, could at least temporarily,therefore have a material adverse effect on our business, financial condition and results of operations. Qualified individuals are in high demand, and we may incur significant costs to attract them, particularly at the executive level. We may face difficulty in attracting and retaining key talent for a number of reasons, including delays in the recruiting and hiring process as a result of the COVID-19 pandemic.
Our business, financial conditionIn addition, we depend on positive perceptions of the safety, quality and results of operations could be materially adversely affected by unfavorable results in future employment litigation matters as result of COVID-19. Our employees may sue us due to possible exposure to COVID-19 while working at oneefficacy of our facilities or sites. In addition, employees may challenge decisions to implement protective measures suchproducts, and animal health products in general, by food producers, veterinarians and pet owners. Any concern as contact tracing on the basis of local privacy laws due to the increased collectionsafety, quality or efficacy of employee medical information. Litigation matters, regardless of their meritsour products, whether actual or their ultimate outcomes, are costly, divert management’s attentionperceived, may harm our reputation. These concerns, including those relating to Seresto, and may materially adversely affectthe related harm to our reputation and demand for our products. We cannot predict with certainty the eventual outcome of pending or future litigation matters. An adverse outcome of litigation or legal matters could result in us being responsible for paying significant damages. Any of these negative effects resulting from litigation matters could materially adversely affect our business, financial condition orand results of operations. To the extent the COVID-19 pandemic adversely affects our business and financial results, it may also have the effectoperations, regardless of heightening many of the other risks described in “Item 1A. Risk Factors” and elsewhere in our Annual Report on Form 10-K for the year ended December 31, 2019.
| | | | | | | | |
| 2021 Q1 Form 10-Q | 39 The following risk factors have changed from the risk factors that were disclosed in our Annual Report on Form 10-K for the year ended December 31, 2019:
An outbreak of infectious disease carried by food animals could negatively affect the demand for, and sale and production of, our food animal products.
Sales of our food animal products could be materially adversely affected by the outbreak of disease or an outbreak carried by food animals, which could lead to the widespread death or precautionary destruction of food animals as well as the reduced consumption and demand for animal protein. In addition, outbreaks of disease carried by food animals may reduce regional or global sales of particular animal-derived food products or result in reduced exports of such products, either due to heightened export restrictions or import prohibitions, which may reduce demand for our food animal products due to reduced herd or flock sizes.
In recent years, outbreaks of various diseases, including African Swine Fever, avian influenza, foot-and-mouth disease, bovine spongiform encephalopathy (otherwise known as BSE or “mad cow” disease) and porcine epidemic diarrhea virus (otherwise known as PEDV) have negatively impacted sales of our animal health products. The discovery of additional cases of any of these, or new, diseases may result in additional restrictions on animal protein, reduced herd or flock sizes, or reduced demand for animal protein, any of which may have a material adverse effect on our business, financial condition and results of operations. In addition, the outbreak of any highly contagious disease near our main production sites could require us to immediately halt production of our products at such sites or force us to incur substantial expenses in procuring raw materials or products elsewhere.
We may be unable to integrate the Bayer animal health business successfully and realize the anticipated benefits of the Acquisition.
If the Acquisition is completed, the successful integration of the Bayer animal health business and operations into those of our own and our ability to realize the expected synergies and benefits of the Transaction is subject to a number of risks and uncertainties, many of which are outside of our control. We will also be required to devote significant management attention and resources to integrating business practices, cultures and operations of each business. The risks and uncertainties relating to integrating the two businesses and realizing the anticipated cost synergies include, among other things:
•the inability to achieve the anticipated revenue, earnings, accretion and other benefits due to the impact of the COVID-19 global health pandemic;
•the challenge of integrating complex organizations, systems, operating procedures, compliance programs, technology, networks and other assets of the Bayer animal health business;
•the difficulties harmonizing differences in the business cultures of our company and the Bayer animal health business;
•the inability to combine successfully our respective businesses in a manner that permits us to achieve the cost savings, synergies and other anticipated benefits from the Acquisition;
•the inability to minimize the diversion of management attention from ongoing business concerns during the process of integrating the Bayer animal health business into our businesses;
•the inability to resolve potential conflicts that may arise relating to customer, supplier and other important relationships of our business and the Bayer animal health business;
•difficulties in retaining key management and other key employees;
•the challenge of managing the expanded operations of a significantly larger and more complex company and coordinating geographically separate organizations; and
•difficulties in fully exploring intellectual property licensed from Bayer in connection with the acquisition, given Bayer's rights as licensor of such intellectual property.
We will incur substantial expenses to consummate the proposed Acquisition but may not realize the anticipated cost synergies and other benefits to the extent expected, on the timeline expected, or at all. In addition, even if we are able to integrate the Bayer animal health business successfully, the anticipated benefits of the Acquisition may not be realized fully, or at all, or may take longer to realize than expected. Moreover, competition in the animal health industry, including competition that has negatively impacted results in the companion animal parasiticide market, may also cause us not to fully realize the anticipated benefits of the Acquisition. Given the size and significance of the Acquisition, we may encounter difficulties in the integration of the operations of the Bayer animal health business and may fail to realize the full benefits and synergies of the Acquisition, which could adversely impact our business, results of operation and financial condition.
Breaches of our information technology systems or improper disclosure of confidential company or personal data, or a failure to comply with privacy laws, regulations and our contractual obligations concerning data privacy or the security of certain information could have a material adverse effect on our reputation and operations.
We rely on information technology systems to process, transmit and store electronic information in our day-to-day operations, including customer, employee and company data. The secure processing, maintenance and transmission of this information is critical to our operations. In addition, the legal environment surrounding information security, storage, use, processing, transmission, maintenance, disclosure and privacy is demanding with the frequent imposition of new and changing regulatory requirements.
We are generally dependent upon our technology systems to operate our business in normal periods, but in the wake of the COVID-19 global pandemic, we are increasingly dependent on our information technology systems as our office workers, who are working remotely, rely on third-party applications to host a greater number of video conferences and teleconferences, and are processing information through our network via their home networks, which may be less secure.As such, our ability to effectively manage our business depends on the security, reliability and adequacy of our technology systems and data and the ability of our employees to follow our cyber security policies and protocols, including, but not limited to, the use of VPN when remotely working on company matters, and other security protocols when using various video conferencing and teleconferencing applications, especially in light of the increased use of these tools due to the COVID-19 global pandemic.
We also store certain information with third parties, including the use of cloud technologies. Our information systems and those of our third-party vendors are subjected to computer viruses or other malicious codes, unauthorized access attempts, and cyber or phishing-attacks and also are vulnerable to an increasing threat of continually evolving cybersecurity risks and external hazards, as well as improper or inadvertent staff behavior, all of which could expose confidential company and personally identifiable information, as well as technology, networks, or infrastructure. Any such breach could compromise our networks, including a breach caused by a failure by our employees, working remotely or otherwise, to use such security policies and protocols, which could result in the loss of confidential company data, or an intrusion or business interruption by hackers that are able to access the company’s network or meetings taking place via video conferencing or teleconferencing, and the information stored or in the process of being transmitted or communicated could be accessed, publicly disclosed, lost or stolen. Any such loss or misappropriation of company data or other intrusion could cause a disruption of our operations and other negative consequences, such as increased costs for security measures or remediation costs, and diversion of management attention.
Any actual or perceived access, disclosure or other loss of information or any significant breakdown, intrusion, interruption, cyber-attack or corruption of customer, employee or company data or our failure to comply with federal, state, local and foreign privacy laws or contractual obligations with customers, vendors, payment processors and other third parties, could result in legal claims or proceedings, liability under laws or contracts that protect the privacy of personal information, regulatory penalties, disruption of our operations, and damage to our reputation, all of which could materially adversely affect our business, revenue and competitive position. While we will continue to implement additional protective measures to reduce the risk of and detect cyber-incidents, cyber-attacks are becoming more sophisticated and frequent, and the techniques used in such attacks change rapidly. Our protective measures may not protect us against attacks and such attacks could have a significant impact on our business and reputation. In addition, due to a TSA with Lilly, we rely on Lilly for certain privacy, compliance, and security functions, and personnel, and may experience difficulties maintaining and implementing all policies and practices following completion of the TSA for these services.
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ItemITEM 2. Unregistered Sales of Equity Securities and Use of ProceedsUNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
(none)
ItemITEM 3. Defaults Upon Senior SecuritiesDEFAULTS UPON SENIOR SECURITIES
(none)
ItemITEM 4. Mine Safety DisclosuresMINE SAFETY DISCLOSURES
(none)
ItemITEM 5. Other InformationOTHER INFORMATION
(none)
ItemITEM 6. ExhibitsEXHIBITS
The following exhibits are either filed or furnished herewith (as applicable) or, if so indicated, incorporated by reference to the documents indicated in parentheses, which have previously been filed or furnished with the Securities and Exchange Commission.
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| 31.1 | | | |
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| 31.2 | | | |
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| 32 | | | |
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| 101 | | | Interactive Data Files |
| 104 | | | Cover Page Interactive Data File (formatted as Inline XBRL document and included in Exhibit 101) |
Signatures
Pursuant to the requirements of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned thereunto duly authorized.
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| | ELANCO ANIMAL HEALTH INCORPORATED |
| | (Registrant) |
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| Date: | July 30, 2020May 7, 2021 | /s/ Jeffrey N. Simmons |
| | Jeffrey N. Simmons |
| | President and Chief Executive Officer |
| Date: | July 30, 2020May 7, 2021 | /s/ Todd S. Young |
| | Todd S. Young |
| | Executive Vice President, Chief Financial Officer |
