ELAN Elanco Animal Health Incorporated

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Washington, D.C. 20549

Form 10-Q

☒ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

☐ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Transition Period from _________ to _______

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

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

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 (or for such shorter period that the registrant was required to file such reports), 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 May 4, 2023 was 492,550,481.

FOR THE QUARTER ENDED MARCH 31, 2023

TABLE OF CONTENTS

PART 1

Item 1.

FINANCIAL STATEMENTS

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)

4

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (UNAUDITED)

5

CONDENSED CONSOLIDATED BALANCE SHEETS

6

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY (UNAUDITED)

7

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)

8

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)

9

Item 2.

MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

OVERVIEW

24

RESULTS OF OPERATIONS

28

SUMMARY OF CHANGES

30

LIQUIDITY AND CAPITAL RESOURCES

32

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK

34

Item 4.

CONTROLS AND PROCEDURES

35

PART II

Item 1.

LEGAL PROCEEDINGS

36

Item 1A.

RISK FACTORS

36

Item 2.

UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

37

Item 3.

DEFAULTS UPON SENIOR SECURITIES

37

Item 4.

MINE SAFETY DISCLOSURES

37

Item 5.

OTHER INFORMATION

37

Item 6.

EXHIBITS

38

SIGNATURES

39

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 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 farm animals;

•our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;

•consolidation of our customers and distributors;

•an outbreak of infectious disease carried by farm animals;

•demand, supply and operational challenges associated with the effects of a human disease outbreak, epidemic, pandemic or other widespread public health concern;

•the potential impact on our business and global economic conditions resulting from the conflict involving Russia and Ukraine;

•the success of our research and development (R&D) and licensing efforts;

•misuse, off-label or counterfeiting use of our products;

•unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;

•fluctuations in our business results due to seasonality and other factors;

•the impact of weather conditions, including those related to climate change, and the availability of natural resources;

•risks related to the modification of foreign trade policy;

•risks related to currency exchange rate fluctuations;

•our dependence on the success of our top products;

•the impact of customer exposure to rising costs and reduced customer income;

•the lack of availability or significant increases in the cost of raw materials;

•the impact of increased or decreased sales into our distribution channels resulting in fluctuation in our revenues;

•risks related to the write-down of goodwill or identifiable intangible assets;

•risks related to the evaluation of animals;

•manufacturing problems and capacity imbalances;

•the impact of litigation, regulatory investigations and other legal matters, including the risk to our reputation and the risk that our insurance policies may be insufficient to protect us from the impact of such matters;

•actions by regulatory bodies, including as a result of their interpretation of studies on product safety;

•risks related to tax expense or exposure;

•risks related to environmental, health and safety laws and regulations;

•risks related to our presence in foreign markets;

•challenges to our intellectual property rights or our alleged violation of rights of others;

•our dependence on sophisticated information technology and infrastructure and the impact of breaches of our information technology systems;

•the impact of increased regulation or decreased financial support related to farm animals;

•adverse effects of labor disputes, strikes, work stoppages and the loss of key personnel or highly skilled employees;

•risks related to underfunded pension plan liabilities;

•our ability to complete acquisitions and successfully integrate the businesses we acquire, including Kindred Biosciences, Inc. (KindredBio) and the animal health business of Bayer Aktiengesellschaft (Bayer Animal Health) and specifically the impact of the integration of ERP systems in April 2023 and related sales order processing blackout periods and their impact on revenue in the second quarter of 2023;

•the effect of our substantial indebtedness on our business, including restrictions in our debt agreements that will limit our operating flexibility;

•risks related to certain governance provisions in our constituent documents; and

•any failure to maintain an effective system of disclosure controls and internal control over financial reporting, including arising from an identified material weakness.

ITEM 1. FINANCIAL STATEMENTS

(in millions, except per-share data)

			Three Months Ended March 31,
			2023						2022
Revenue			$	1,257					$	1,226
Costs, expenses and other:
Cost of sales			494						509
Research and development			81						81
Marketing, selling and administrative			327						323
Amortization of intangible assets			134						137
Asset impairment, restructuring and other special charges			40						40
Interest expense, net of capitalized interest			64						52
Other expense, net			9						9
			1,149						1,151
Income before income taxes			108						75
Income tax expense			5						24
Net income			$	103					$	51
Earnings per share:
Basic			$	0.21					$	0.10
Diluted			$	0.21					$	0.10
Weighted average shares outstanding:
Basic			491.1						488.0
Diluted			492.8						492.2

See notes to condensed consolidated financial statements.

(in millions)

			Three Months Ended March 31,
			2023						2022
Net income			$	103					$	51
Other comprehensive income (loss):
Cash flow hedges, net of taxes			(48)						109
Foreign currency translation			130						(85)
Defined benefit pension and retiree health benefit plans, net of taxes			—						(1)
Other comprehensive income, net of taxes			82						23
Comprehensive income			$	185					$	74

See notes to condensed consolidated financial statements.

(in millions, except share data)

			March 31, 2023						December 31, 2022
			(Unaudited)
Assets
Current Assets
Cash and cash equivalents			$	318					$	345
Accounts receivable, net of allowances of $15 (2023) and $13 (2022)			1,051						797
Other receivables			213						205
Inventories			1,596						1,538
Prepaid expenses and other			370						394
Total current assets			3,548						3,279
Noncurrent Assets
Goodwill			6,061						5,993
Other intangibles, net			4,791						4,842
Other noncurrent assets			369						378
Property and equipment, net of accumulated depreciation of $744 (2023) and $723 (2022)			1,000						999
Total assets			$	15,769					$	15,491
Liabilities and Equity
Current Liabilities
Accounts payable			$	381					$	390
Employee compensation			110						146
Sales rebates and discounts			329						324
Current portion of long-term debt			381						388
Other current liabilities			377						454
Total current liabilities			1,578						1,702
Noncurrent Liabilities
Long-term debt			5,639						5,448
Accrued retirement benefits			164						161
Deferred taxes			663						662
Other noncurrent liabilities			245						229
Total liabilities			8,289						8,202
Commitments and Contingencies
Equity
Preferred stock, no par value, 1,000,000,000 shares authorized; none issued			—						—
Common stock, no par value, 5,000,000,000 shares authorized, 492,418,216 and 474,237,738 shares issued and outstanding as of March 31, 2023 and December 31, 2022, respectively			—						—
Additional paid-in capital			8,744						8,738
Accumulated deficit			(954)						(1,057)
Accumulated other comprehensive loss			(310)						(392)
Total equity			7,480						7,289
Total liabilities and equity			$	15,769					$	15,491

See notes to condensed consolidated financial statements.

			Common Stock																														Accumulated Other Comprehensive Loss
			Shares						Amount						Additional Paid-in Capital												Accumulated Deficit						Cash Flow Hedge						Foreign Currency Translation						Defined Benefit Pension and Retiree Health Benefit Plans						Total						Total Equity
December 31, 2021			473.1						$	—					$	8,696											$	(979)					$	25					$	(253)					$	19					$	(209)					$	7,508
Net income			—						—						—												51						—						—						—						—						51
Other comprehensive income (loss), net of tax			—						—						—												—						109						(85)						(1)						23						23
Stock-based compensation			—						—						14												—						—						—						—						—						14
Issuance of stock under employee stock plans, net			1.0						—						(11)												—						—						—						—						—						(11)
March 31, 2022			474.1						$	—					$	8,699											$	(928)					$	134					$	(338)					$	18					$	(186)					$	7,585

December 31, 2022			474.2						$	—					$	8,738											$	(1,057)					$	182					$	(672)					$	98					$	(392)					$	7,289
Net income			—						—						—												103						—						—						—						—						103
Other comprehensive income (loss), net of tax			—						—						—												—						(48)						130						—						82						82
Stock-based compensation			—						—						11												—						—						—						—						—						11
Issuance of stock under employee stock plans, net			0.9						—						(6)												—						—						—						—						—						(6)
Issuance of stock under employee stock purchase plan, net			0.1						—						1												—						—						—						—						—						1
Conversion of tangible equity units (TEUs) into common stock			17.2						—						—												—						—						—						—						—						—
March 31, 2023			492.4						$	—					$	8,744											$	(954)					$	134					$	(542)					$	98					$	(310)					$	7,480

See notes to condensed consolidated financial statements.

Elanco Animal Health Incorporated

(Dollars in millions)

			Three Months Ended March 31,
			2023						2022
Cash Flows from Operating Activities
Net income			$	103					$	51
Adjustments to reconcile net income to cash flows from operating activities:
Depreciation and amortization			173						176
Deferred income taxes			2						(7)
Stock-based compensation expense			12						14
Asset impairment and write-down charges			—						22
Loss on sale of assets			1						1
Inventory fair value step-up amortization			1						—
Changes in operating assets and liabilities, net of acquisitions			(439)						(332)
Other non-cash operating activities, net			2						13
Net Cash Used for Operating Activities			(145)						(62)
Cash Flows from Investing Activities
Net purchases of property and equipment			(20)						(19)
Cash paid for acquisitions			(16)						—
Purchases of intangible assets			(14)						—
Purchases of software			(4)						(7)
Other investing activities, net			(1)						(3)
Net Cash Used for Investing Activities			(55)						(29)
Cash Flows from Financing Activities
Proceeds from revolving credit facility			200						63
Repayments of long-term borrowings			(19)						(89)
Repayments of revolving credit facility			—						(163)
Other financing activities, net			(7)						(11)
Net Cash Provided by (Used for) Financing Activities			174						(200)
Effect of exchange rate changes on cash and cash equivalents			(1)						(5)
Net decrease in cash and cash equivalents			(27)						(296)
Cash and cash equivalents at January 1			345						638
Cash and cash equivalents at March 31			$	318					$	342

Elanco Animal Health Incorporated

(Tables present dollars and shares in millions, except per-share and per-unit data)

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the SEC requirements for interim reporting. As permitted under those rules, certain information and footnote disclosures normally included in annual financial statements prepared in accordance with generally accepted accounting principles in the U.S. (GAAP) have been condensed or omitted. The information included in this Form 10-Q should be read in conjunction with our consolidated financial statements and accompanying notes for the year ended December 31, 2022 included in our 2022 Form 10-K. In addition, results for interim periods should not be considered indicative of results for any other interim period or for the full year ending December 31, 2023 or any other future period.

The significant accounting policies set forth in Note 4 to the consolidated financial statements in our 2022 Form 10-K appropriately represent, in all material respects, the current status of our accounting policies.

In connection with the preparation of our financial statements as of and for the year ended December 31, 2022, a cumulative error was identified and corrected relating to the valuation allowance for taxes for a Southeast Asia affiliate. While immaterial to prior years, correcting this cumulative error in 2022 would have caused the 2022 financial statements to be materially misstated. In conjunction with making these corrections, we made other adjustments to the prior years to revise uncorrected errors. The appropriate revisions to our historical condensed consolidated financial statements and the notes thereto are reflected herein. Further information is included in Note 2 and Note 21 to the consolidated financial statements in our 2022 Form 10-K.

The following table provides a brief description of an accounting standard that was recently adopted:

Standard

Description

Effective Date

Effect on the Financial Statements or Other Significant Matters

ASU 2020-04, Reference Rate Reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting; ASU 2021-01, Reference Rate Reform (Topic 848): Scope; ASU 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848

ASU 2020-04 provides optional expedients and exceptions for applying 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. ASU 2022-06 extends the period of time entities can utilize the reference rate reform relief guidance under ASU 2020-04 from December 31, 2022 to December 31, 2024.

Adoption of the guidance is optional and effective as of March 12, 2020 through December 31, 2024. Adoption is permitted at any time during the period on a prospective basis.

Effective April 1, 2023, and in accordance with the provisions outlined in our underlying credit agreements, we have transitioned the reference rate used in our credit facilities from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (Term SOFR). The change did not have a material impact on our condensed consolidated financial statements.

The following table summarizes the activity in our global sales rebates and discounts liability:

			Three Months Ended March 31,
			2023						2022
Beginning balance			$	324					$	319
Reduction of revenue			209						219
Payments			(204)						(241)
Ending balance			$	329					$	297

Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three months ended March 31, 2023 and 2022 for product shipped in previous periods were not material.

The following table summarizes our revenue disaggregated by product category:

			Three Months Ended March 31,
			2023						2022
Pet Health			$	675					$	640
Farm Animal:
Cattle			248						247
Poultry			183						180
Swine			102						99
Aqua			40						43
Total Farm Animal			573						569
Contract Manufacturing (1)			9						17
Revenue			$	1,257					$	1,226

(1)Represents revenue from arrangements in which we manufacture products on behalf of a third party.

Up-front cash consideration						$	16
Deferred cash consideration due January 4, 2024						5
Fair value of contingent consideration						35
Total purchase consideration						$	56

Estimated Fair Value at January 3, 2023
Inventory			$	3
Intangible assets:
Marketed products			28
Acquired in-process research and development (IPR&D)			9
Other intangible assets			15
Total identifiable assets			55
Goodwill (1)			1
Total consideration transferred			$	56

(1)The goodwill recognized from this acquisition is primarily attributable to NutriQuest's assembled workforce and expected synergies. The goodwill associated with this acquisition is deductible for tax purposes.

In June 2022, we signed a license agreement with BexCaFe, LLC (BexCaFe) for the development and commercialization of products related to Bexacat, an oral treatment intended to reduce glucose levels in diabetic cats. BexCaFe held the rights to the compound through a license agreement with similar terms and conditions. We will incur all development and regulatory costs associated with the products. Based on the guidance in Accounting Standards Codification (ASC) 810, Consolidation, we determined that BexCaFe represents a variable interest entity and that we are the primary beneficiary of BexCaFe because the terms of the license give us the power to direct the activities that most significantly impact the entity’s economic performance. As a result, we consolidated BexCaFe, a development-stage company with no employees that did not meet the definition of a business, as of the date we signed the license agreement. Upon initial consolidation of BexCaFe, we measured an IPR&D asset at its fair value of $59 million and recorded liabilities totaling $59 million, which included contingent consideration of $49 million based on the fair value of estimated future milestone payments and sales royalties owed under the license agreement. The initial fair value of the contingent payments was calculated based on an income approach, with payments adjusted for probability of success and then discounted to a present value. There is no minimum payout due on the contingent consideration and the maximum payout related to sales royalties is unlimited. Since BexCaFe did not meet the definition of a business, no goodwill was recorded and immediately after initial consolidation, we expensed the IPR&D asset because we concluded that it did not have an alternative future use.

During the three months ended March 31, 2023, we paid $13 million to BexCaFe in connection with development/regulatory milestones achieved upon U.S. FDA approval of the original new animal drug application for Bexacat in December 2022. Remaining contingent consideration liabilities of $36 million are included in other current liabilities and other noncurrent liabilities on our condensed consolidated balance sheet as of March 31, 2023.

For finite-lived intangible assets and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 2: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.

Components of asset impairment, restructuring and other special charges are as follows:

			Three Months Ended March 31,
			2023						2022
Restructuring charges (credits):
Severance and other costs (1)			$	—					$	(7)
Facility exit costs			—						1
Acquisition related charges:
Transaction and integration costs (2)			40						24
Non-cash and other items:
Asset write-down (3)			—						22
Total expense			$	40					$	40

(1)2022 credits primarily relate to adjustments resulting from the reversal of severance accruals associated with 2021 restructuring programs resulting from final negotiations and certain restructured employees filling open positions.

(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 acquisition of Bayer Animal Health (e.g., expenditures for consulting, system and process integration and product transfers), as well as independent company stand-up costs related to the implementation of new systems, programs and processes.

(3)2022 includes the finalization of the write-down charge upon the final sale of the Speke site. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion.

									Severance
Balance at December 31, 2021									$	126
Reserve adjustments									(7)
Cash paid									(42)
Foreign currency translation adjustments									(1)
Balance at March 31, 2022									$	76
Balance at December 31, 2022									$	36
Cash paid									(24)
Foreign currency translation adjustments									—
Balance at March 31, 2023									$	12

Inventories consisted of the following:

			March 31, 2023						December 31, 2022
Finished products			$	749					$	725
Work in process			605						605
Raw materials and supplies			299						266
Total			1,653						1,596
Decrease to LIFO cost			(57)						(58)
Inventories			$	1,596					$	1,538

Long-term debt consisted of the following:

			March 31, 2023						December 31, 2022
Incremental Term Facility due 2025			$	175					$	175
Incremental Term Facility due 2028			492						494
Incremental Term Facility due 2029			249						249
Term Loan B due 2027			3,870						3,881
Revolving Credit Facility (1)			200						—
4.272% Senior Notes due 2023			344						344
4.900% Senior Notes due 2028			750						750
TEU Amortizing Notes due 2023 (2)			—						7
Unamortized debt issuance costs			(60)						(64)
			6,020						5,836
Less current portion of long-term debt			381						388
Total long-term debt			$	5,639					$	5,448

(1)During the three months ended March 31, 2023, we drew on our revolving credit facility to fund working capital needs.

(2)The TEU amortizing notes matured on February 1, 2023.

We had investments without readily determinable fair values and equity method investments included in other noncurrent assets on our condensed consolidated balance sheets totaling $27 million as of March 31, 2023 and December 31, 2022. Unrealized net gains and losses on our investments for the three months ended March 31, 2023 and 2022 were immaterial.

The following table summarizes the fair value information at March 31, 2023 and December 31, 2022 for foreign exchange contract assets (liabilities), investments, contingent consideration 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
Financial statement line item						Carrying Amount						Quoted Prices in Active Markets for Identical Assets (Level 1)						Significant Other Observable Inputs (Level 2)						Significant Unobservable Inputs (Level 3)						Fair Value
March 31, 2023
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments						$	28					$	—					$	28					$	—					$	28
Prepaid expense and other - forward-starting interest rate contracts designated as cash flow hedges						8						—						8						—						8
Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges						3						—						3												3
Other noncurrent assets - investments						6						6						—						—						6
Other current liabilities - foreign exchange contracts not designated as hedging instruments						(25)						—						(25)						—						(25)
Other current liabilities - contingent consideration						(23)						—						—						(23)						(23)
Other noncurrent liabilities - contingent consideration						(12)						—						—						(12)						(12)
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges						(9)						—						(9)						—						(9)
Long-term debt, including current portion						(6,080)						—						(5,891)						—						(5,891)
December 31, 2022
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments						$	76					$	—					$	76					$	—					$	76
Prepaid expenses and other - forward-starting interest rate contracts designated as cash flow hedges						14						—						14						—						14
Other noncurrent assets - forward-starting interest rate contracts designated as cash flow hedges						10						—						10						—						10
Other noncurrent assets - investments						7						7						—						—						7
Other current liabilities - foreign exchange contracts not designated as hedging instruments						(64)						—						(64)						—						(64)
Long-term debt, including current portion						(5,900)						—						(5,711)						—						(5,711)

			Three Months Ended March 31,
			2023						2022
Foreign exchange forward contracts (1)			$	2					$	(8)

(1)These amounts were substantially offset in other expense, net by the effect of changing exchange rates on the underlying foreign currency exposures.

			Three Months Ended March 31,
			2023						2022
Forward-starting interest rate swaps			$	(48)					$	109

						Three Months Ended March 31,
						2023						2022
Income tax expense						$	5					$	24
Effective tax rate						4.4		%				31.6		%

On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco and certain executives. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint adding additional claims against Elanco, certain executives and other individuals. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco securities between September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana. We filed a motion to dismiss on January 13, 2021. On August 17, 2022, the Court issued an order granting our motion to dismiss the case without prejudice. On October 14, 2022, the plaintiffs filed a motion for leave to amend the complaint. We filed an opposition to the plaintiffs' motion on December 7, 2022. We believe the claims made in the case are meritless, and we intend to vigorously defend our position.

On October 16, 2020, a shareholder class action lawsuit captioned Saffron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives and other individuals and entities. 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 lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco common stock or 5.00% TEUs issued in connection with the public offering. From February 2021 to August 2022, this case was stayed in deference to Hunter v. Elanco Animal Health Inc. On October 24, 2022, we filed a motion to dismiss. The plaintiffs filed their opposition to the motion to dismiss on December 23, 2022. We believe the claims made in the case are meritless, and we intend to vigorously defend our position.

Claims seeking actual damages, injunctive relief and/or restitution for allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC, along with other Elanco and Bayer entities, arising out of the use of Seresto™, a non-prescription flea and tick collar for cats and dogs. During 2021, putative class action lawsuits were filed in federal courts in the U.S. alleging that the Seresto collars contain pesticides that can cause serious injury and death to cats and/or dogs wearing the product. The cases mention the existence of incident reports involving humans, but no plaintiff has claimed personal harm from the product. In August 2021, the lawsuits were consolidated by the Judicial Panel on Multidistrict Litigation, and the cases were transferred to the Northern District of Illinois. We are vigorously defending these lawsuits. In January 2023, a lawsuit seeking damages for alleged negligence, breach of statutory regulations, breach of statutory duties and deceptive marketing was filed in Israel against Elanco among other parties, arising out of the use of Seresto and Foresto™, a flea and tick collar for cats and dogs that is marketed and sold in Europe and in Israel. We intend to defend our position vigorously.

Further, in March 2021, a member of the U.S. House of Representatives who was serving as a subcommittee chair requested that Elanco produce certain documents and information related to the Seresto collar and further made a request to temporarily recall Seresto collars from the market. On June 15, 2022, the subcommittee held a hearing at which our CEO testified. During and after the hearing, the subcommittee chair repeated his request that Elanco voluntarily recall the collars and also requested that the Environmental Protection Agency (EPA) commence administrative proceedings that would allow the EPA to remove Seresto from the market.

Seresto is a pesticide registered with the EPA. In April 2021, a non-profit organization submitted a petition to the EPA requesting that the agency take action to cancel Seresto’s pesticide registration and suspend the registration pending cancellation. In response to the EPA's request for comments from the public on the petition, we submitted a comment to the EPA supporting the safety profile of Seresto and have since engaged in discussions with the EPA. Data and scientific evaluation used during the product registration process and through pharmacovigilance review supports the product’s positive safety profile and efficacy. We believe no removal, recall, or cancellation of the pesticide registration 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.

In the third quarter of 2019, Tevra Brands, LLC (Tevra) filed a complaint in the U.S. District Court of the Northern District of California, alleging that Bayer Animal Health (acquired by us in August 2020) had been involved in unlawful exclusive dealing and tying of its flea and tick products Advantage, Advantix and Seresto and maintained a monopoly in the market. The complaint was amended in March 2020 and then dismissed in September 2020 with leave to amend. A second amended complaint was filed in March 2021 and realleges claims of unlawful exclusive dealing related to Advantage and Advantix and monopoly maintenance. A motion to dismiss the second amended complaint was denied in January 2022. Tevra’s demands include both actual and treble damages. The trial is scheduled in July 2024. We intend to defend our position vigorously.

Our products include AviPro™, Baytril™, Catosal™, Clynav™, Cydectin™, Denagard™, Maxiban™, Rumensin™, Pulmotil™ and other products for livestock, poultry and aquaculture, as well as Advantage™, Advantix™, Advocate™ (with several brands collectively referred to as the Advantage Family), Credelio™, TruCan™, Galliprant™, Interceptor™ Plus, Seresto, Trifexis™ and other products for pets.

			Three Months Ended March 31,
			2023						2022
Revenue
United States			$	543					$	522
International			714						704
Revenue			$	1,257					$	1,226

Basic and diluted earnings per share are calculated as follows:

						Three Months Ended March 31,
						2023						2022
Net income available to common shareholders						$	103					$	51
Determination of shares:
Basic weighted average common shares outstanding (1)						491.1						488.0
Assumed conversion of dilutive common stock equivalents (2)						1.7						4.2
Diluted weighted average shares outstanding						492.8						492.2
Earnings per share (3)
Basic						$	0.21					$	0.10
Diluted						$	0.21					$	0.10

(1)The TEU prepaid stock purchase contracts were convertible into a minimum of 14.3 million shares or a maximum of 17.2 million shares. The minimum 14.3 million shares were included in the calculation of basic weighted average shares from January 22, 2020 to February 1, 2023. The 17.2 million shares that were ultimately issued were included in the calculation of basic weighted average shares after the settlement date, from February 1, 2023 to March 31, 2023.

(2)For the three months ended March 31, 2023 and 2022, approximately 1.4 million and 0.1 million, respectively, of potential common shares were excluded from the calculation of diluted loss per share because their effect was anti-dilutive.

(3)Due to rounding conventions, loss per share may not recalculate precisely based on the amounts presented within this table.

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Management’s discussion and analysis of financial condition and results of operations (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 Form 10-Q. Certain statements in this Item 2 of Part I of this Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements" of this Form 10-Q, in Item 1A, "Risk Factors" of Part II of this Form 10-Q, and in Item 1A, “Risk Factors” of Part I of our 2022 Form 10-K, may cause our actual results, financial position and cash generated from operations to differ materially from these forward-looking statements. Further, due to the seasonality of our pet health sales, interim results are not necessarily an appropriate base from which to project annual results.

Pet Health: Our pet health portfolio is focused on parasiticides, vaccines and therapeutics. We have one of the broadest parasiticide portfolios in the pet health sector based on indications, species and formulations, with products that protect pets from worms, fleas and ticks. Our Seresto and Advantage Family products are over-the-counter treatments for the elimination and prevention, respectively, of fleas and ticks, and complement our prescription parasiticide products, Credelio, Interceptor Plus and Trifexis. Our vaccines portfolio provides differentiated prevention coverage for a number of important pet health risks and is available in the U.S. only. In therapeutics, we have a broad pain and osteoarthritis portfolio across species, modes of action, indications and disease stages. Pet owners are increasingly treating osteoarthritis in their pets, and our Galliprant product is one of the fastest growing osteoarthritis treatments in the U.S. Additionally, we have products that offer treatment for otitis (ear infections) with Claro, as well as treatments for certain cardiovascular and dermatology indications.

Farm Animal: Our farm animal portfolio consists of products designed to prevent, control and treat health challenges primarily focused on cattle (beef and dairy), swine, poultry and aquaculture (cold and warm water) production. Our products include medicated feed additives, injectable antibiotics, vaccines, insecticides and enzymes, among others. We have a wide range of farm animal products, including Rumensin and Baytril, both of which are used extensively in ruminants (e.g., cattle, sheep and goats). In poultry, our Maxiban product, is a valuable offering for the control and prevention of intestinal disease.

A summary of our 2023 revenue and net income compared with the same period in 2022 is as follows:

						Three Months Ended March 31,
(Dollars in millions)						2023						2022
Revenue						$	1,257					$	1,226
Net income						103						51

•increased pet ownership globally;

•pets living longer; and

•owners sharing a unique and loving bond with their pets.

•two 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 farm 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.

Global Macroeconomic Environment

Our operations are conducted globally, and we are exposed to and are impacted by various global macroeconomic factors. We face continuing market and operating challenges across the globe due to, among other factors, the Russia-Ukraine conflict, supply chain disruptions, higher interest rates and inflationary pressures. Continued evolution of these conditions has led to economic slowdowns in certain countries and/or regions. It has also led to volatility in consumer behavior, which has reduced demand due to consumption decreases and retailer destocking, particularly impacting our parasiticide products. We expect these global macroeconomic pressures to continue in 2023.

While there has been an overall improvement in the conditions related to the COVID-19 pandemic in 2023 as compared to 2022, we may continue to experience geographical variations. In 2022, our operations were adversely impacted by the COVID-19 related lockdowns in China, which were lifted late in the year. The extent to which the COVID-19 pandemic may continue to impact our financial condition and results of operations remains uncertain.

We face intense competition globally. Competition may vary depending on the particular region, species, product category or individual product. We compete principally on the basis of product quality, price, cost-effectiveness, promotional effectiveness, new product development and product differentiation. Certain products, both existing and new products that we introduce, may compete with other branded or generic products already on the market or that are later developed by competitors. When competitors introduce new products with ease-of-use, therapeutic or cost advantages, our products may become subject to decreased sales and/or price reductions.

Our acquisitions in the six years prior to the acquisition of Bayer Animal Health added, in the aggregate, $1.4 billion in revenue, 4,600 full-time employees and 12 manufacturing and eight R&D sites. The acquisitions of Bayer Animal Health on August 1, 2020 and KindredBio on August 27, 2021 added 3,950 full-time employees, 10 manufacturing sites and five R&D sites (before company-wide restructuring activities initiated in 2020 and 2021). In addition, from 2015 to 2022, 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 marketing, selling and administrative functions. Our manufacturing cost savings strategies included improving manufacturing processes and headcount through lean manufacturing (minimizing waste while maintaining productivity), closing and selling manufacturing sites, consolidating our CMO network, strategically insourcing certain projects and pursuing cost savings opportunities through alternate sources of supply. Additional cost savings have resulted from reducing the number of R&D sites, sales force consolidation and reducing discretionary and other general and administrative operating expenses.

While many of our products are sold consistently throughout the year, we do experience seasonality in our pet health business due to increased demand for certain parasiticide product offerings in the first half of the year. For example, based upon historical results, approximately 75% and 60% of total annual revenue contributed by our higher-margin parasiticide products Seresto and Advantage Family, respectively, has occurred during the first half of the year, which is reflective of the flea and tick season in the Northern Hemisphere. Therefore, a period-to-period comparison of our historical results may not be meaningful and fluctuations in total revenue for our pet health products are not necessarily an indication of future performance.

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 March 31,
(Dollars in millions)			2023						2022						% Change
Revenue			$	1,257					$	1,226					3		%
Costs, expenses and other:
Cost of sales			494						509						(3)		%
% of revenue			39		%				42		%				(3)		%
Research and development			81						81						—		%
% of revenue			6		%				7		%				(1)		%
Marketing, selling and administrative			327						323						1		%
% of revenue			26		%				26		%				—		%
Amortization of intangible assets			134						137						(2)		%
% of revenue			11		%				11		%				—		%
Asset impairment, restructuring and other special charges			40						40						—		%
Interest expense, net of capitalized interest			64						52						23		%
Other expense, net			9						9						—		%
Income before income taxes			108						75						44		%
% of revenue			9		%				6		%				3		%
Income tax expense			5						24						(79)		%
Net income			$	103					$	51					102		%