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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
☒
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended March 31, 2023
OR
☐
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)
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INDIANA
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82-5497352 |
(State or other jurisdiction of |
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(I.R.S. Employer |
incorporation or organization) |
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Identification No.) |
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address and zip code of principal executive offices)
Registrant’s telephone number, including area code
(877) 352-6261
Securities registered pursuant to Section 12(b) of the Act:
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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.
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Large accelerated filer
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☒ |
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Accelerated filer
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☐ |
Non-accelerated filer
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☐ |
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Smaller reporting company
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☐ |
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Emerging growth company
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☐ |
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.
ELANCO ANIMAL HEALTH INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED
MARCH 31, 2023
TABLE OF CONTENTS
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Item 1.
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Item 2.
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Item 3. |
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Item 4. |
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Item 1.
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Item 1A.
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Item 2.
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Item 3. |
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Item 4. |
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Item 5. |
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Item 6.
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FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY
This Quarterly Report on Form 10-Q (Form 10-Q) includes
forward-looking statements within the meaning of the federal
securities laws. These forward-looking statements include, without
limitation, statements concerning the impact on Elanco Animal
Health Incorporated and its subsidiaries (collectively, Elanco, the
Company, we, us or our) caused by the integration of business
acquisitions, expected synergies and cost savings, product
launches, global macroeconomic conditions, expectations relating to
liquidity and sources of capital, our expected compliance with debt
covenants, cost savings, expenses and reserves relating to
restructuring actions, 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 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.
See Item 1A, “Risk Factors,” of Part I of our Annual Report on Form
10-K for the year ended December 31, 2022 filed with the
United States (U.S.) Securities and Exchange Commission (SEC)
(2022
Form 10-K),
and Part II of this 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. 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.
PART I
ITEM 1. FINANCIAL STATEMENTS
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Operations
(Unaudited)
(in millions, except per-share data)
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Three Months Ended March 31, |
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2023 |
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2022 |
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Revenue |
$ |
1,257 |
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$ |
1,226 |
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Costs, expenses and other: |
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Cost of sales |
494 |
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509 |
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Research and development |
81 |
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81 |
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Marketing, selling and administrative |
327 |
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323 |
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Amortization of intangible assets
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134 |
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137 |
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Asset impairment, restructuring and other special
charges
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40 |
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40 |
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Interest expense, net of capitalized interest |
64 |
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52 |
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Other expense, net |
9 |
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9 |
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1,149 |
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1,151 |
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Income before income taxes |
108 |
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75 |
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Income tax expense |
5 |
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24 |
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Net income |
$ |
103 |
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$ |
51 |
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Earnings per share: |
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Basic |
$ |
0.21 |
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$ |
0.10 |
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Diluted |
$ |
0.21 |
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$ |
0.10 |
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Weighted average shares outstanding: |
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Basic |
491.1 |
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488.0 |
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Diluted |
492.8 |
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492.2 |
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See notes to condensed consolidated financial
statements.
Elanco Animal Health Incorporated
Condensed Consolidated Statements of Comprehensive Income
(Unaudited)
(in millions)
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Three Months Ended March 31, |
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2023 |
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2022 |
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Net income |
$ |
103 |
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$ |
51 |
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Other comprehensive income (loss): |
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Cash flow hedges, net of taxes |
(48) |
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109 |
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Foreign currency translation |
130 |
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(85) |
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Defined benefit pension and retiree health benefit plans, net of
taxes |
— |
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(1) |
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Other comprehensive income, net of taxes |
82 |
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23 |
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Comprehensive income |
$ |
185 |
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$ |
74 |
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See notes to condensed consolidated financial
statements.
Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions, except share data)
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March 31, 2023 |
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December 31, 2022 |
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(Unaudited) |
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Assets |
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Current Assets |
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Cash and cash equivalents |
$ |
318 |
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$ |
345 |
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Accounts receivable, net of allowances of $15 (2023) and $13
(2022)
|
1,051 |
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797 |
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Other receivables |
213 |
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205 |
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Inventories |
1,596 |
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1,538 |
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Prepaid expenses and other |
370 |
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394 |
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Total current assets |
3,548 |
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3,279 |
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Noncurrent Assets |
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Goodwill |
6,061 |
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5,993 |
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Other intangibles, net |
4,791 |
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4,842 |
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Other noncurrent assets |
369 |
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378 |
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Property and equipment, net of accumulated depreciation of $744
(2023) and $723 (2022)
|
1,000 |
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999 |
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Total assets |
$ |
15,769 |
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$ |
15,491 |
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Liabilities and Equity |
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Current Liabilities |
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Accounts payable |
$ |
381 |
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$ |
390 |
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Employee compensation |
110 |
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146 |
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Sales rebates and discounts |
329 |
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324 |
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Current portion of long-term debt |
381 |
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388 |
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Other current liabilities |
377 |
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454 |
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Total current liabilities |
1,578 |
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1,702 |
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Noncurrent Liabilities |
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Long-term debt |
5,639 |
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5,448 |
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Accrued retirement benefits |
164 |
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161 |
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Deferred taxes |
663 |
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662 |
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Other noncurrent liabilities |
245 |
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229 |
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Total liabilities |
8,289 |
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8,202 |
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Commitments and Contingencies |
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Equity |
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Preferred stock, no par value, 1,000,000,000 shares authorized;
none issued
|
— |
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— |
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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
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— |
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— |
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Additional paid-in capital |
8,744 |
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8,738 |
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Accumulated deficit |
(954) |
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(1,057) |
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Accumulated other comprehensive loss |
(310) |
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(392) |
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Total equity |
7,480 |
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7,289 |
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Total liabilities and equity |
$ |
15,769 |
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$ |
15,491 |
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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 |
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Accumulated Other Comprehensive Loss |
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Shares |
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Amount |
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Additional Paid-in Capital |
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Accumulated Deficit |
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Cash Flow Hedge |
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Foreign Currency Translation |
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Defined Benefit Pension and Retiree Health Benefit
Plans |
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Total |
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Total Equity |
December 31, 2021
|
473.1 |
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$ |
— |
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$ |
8,696 |
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$ |
(979) |
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$ |
25 |
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|
$ |
(253) |
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$ |
19 |
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$ |
(209) |
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$ |
7,508 |
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Net income |
— |
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|
— |
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— |
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|
51 |
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|
— |
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— |
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— |
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— |
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51 |
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Other comprehensive income (loss), net of tax |
— |
|
|
— |
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|
— |
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|
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— |
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|
109 |
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(85) |
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(1) |
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23 |
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23 |
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Stock-based compensation |
— |
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— |
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14 |
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— |
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— |
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— |
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— |
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— |
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14 |
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Issuance of stock under employee stock plans, net |
1.0 |
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— |
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(11) |
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— |
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|
— |
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|
— |
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— |
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— |
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(11) |
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March 31, 2022 |
474.1 |
|
|
$ |
— |
|
|
$ |
8,699 |
|
|
|
|
$ |
(928) |
|
|
$ |
134 |
|
|
$ |
(338) |
|
|
$ |
18 |
|
|
$ |
(186) |
|
|
$ |
7,585 |
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December 31, 2022
|
474.2 |
|
|
$ |
— |
|
|
$ |
8,738 |
|
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|
|
$ |
(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
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(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 |
|
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
and per-unit data)
Note 1. Background
Elanco is a global animal health company that innovates, develops,
manufactures and markets products for pets and farm animals. We
offer a portfolio of approximately 200 brands to pet owners,
veterinarians and farm animal producers in more than 90 countries.
Our products are generally sold worldwide directly to wholesalers,
distributors and independent retailers. Certain products are also
sold directly to farm animal producers and veterinarians. We have a
diversified business of products across species consisting of: dogs
and cats (collectively, pet health) and cattle, poultry, swine and
aqua (collectively, farm animal).
Elanco was incorporated in Indiana on September 18, 2018, and prior
to that was a business unit of Eli Lilly and Company
(Lilly).
Note 2. Basis of Presentation and Summary of Significant Accounting
Policies
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.
In our opinion, the financial statements reflect all adjustments
(including those that are normal and recurring) that are necessary
for fair presentation of the results of operations for the periods
shown. In preparing financial statements in conformity with GAAP,
we must make estimates and assumptions that affect the reported
amounts of assets, liabilities, revenue, expenses and related
disclosures at the date of the financial statements and during the
reporting period. Actual results could differ from those estimates.
Certain reclassifications of prior year information have been made
to conform to the current year's presentation.
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.
Revision of Previously Issued Consolidated Financial
Statements
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.
Note 3. Implementation of New Financial Accounting
Pronouncements
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.
|
Note 4. Revenue
Our sales rebates and discounts are based on specific agreements.
The most significant of our sales rebate and discount programs in
terms of accrual and payment amounts, percentage of our products
that are sold via these programs and level of judgment required in
estimating the appropriate transaction price, relate to our
programs in the U.S., France and the United Kingdom (U.K.). As of
March 31, 2023 and 2022, the aggregate liability for sales rebates
and discounts for these countries represented approximately 76% and
74%, respectively, of our total liability.
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.
Actual global product returns were less than 1% of net revenue for
the three months ended March 31, 2023 and 2022.
Disaggregation of Revenue
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.
Note 5. Acquisitions, Divestitures and Other
Arrangements
NutriQuest U.S. Acquisition
On January 3, 2023, we acquired certain U.S. marketed products,
pipeline products, inventory and an assembled workforce from
NutriQuest, LLC (NutriQuest). NutriQuest is a provider of swine,
poultry and cattle nutritional health products to animal producers.
The acquisition allows us to expand our existing nutritional health
offerings and furthers our efforts to explore innovative antibiotic
alternatives.
The composition of the purchase price is as follows:
|
|
|
|
|
|
|
|
|
Up-front cash consideration |
|
$ |
16 |
|
Deferred cash consideration due January 4, 2024 |
|
5 |
|
Fair value of contingent consideration |
|
35 |
|
Total purchase consideration |
|
$ |
56 |
|
Contingent consideration includes up to $85 million of cash
consideration payable if specific development, sales and geographic
expansion milestones are achieved. We recorded a $35 million
liability on the condensed consolidated balance sheet as of the
acquisition date based on the fair value of the contingent
consideration. See Note 10: Financial Instruments and Fair Value
for further information.
The transaction was accounted for as a business combination under
the acquisition method of accounting. The acquisition method
requires, among other things, that assets acquired and liabilities
assumed in a business combination be recognized at their fair
values as of the acquisition date. The determination of estimated
fair value requires management to make significant estimates and
assumptions. The excess of the purchase price over the fair value
of the acquired assets has been recorded as goodwill. The results
of operations of the acquisition are included in our condensed
consolidated financial statements from the date of
acquisition.
Revenue and income from NutriQuest included in our condensed
consolidated statements of operations for the three months ended
March 31, 2023 were immaterial.
The following table summarizes the preliminary amounts recognized
for assets acquired as of the acquisition date:
|
|
|
|
|
|
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.
Other intangible assets consist of customer relationships and trade
names. The acquired definite-lived intangible assets are being
amortized over a weighted-average estimated useful life of
approximately 12 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 accounting for this acquisition has not been finalized as of
March 31, 2023. The purchase price allocation is preliminary and
subject to change, including the valuation of the contingent
consideration and intangible assets. The final determination of
these amounts will be completed as soon as possible but no later
than one year from the acquisition date.
Pending Acquisition
NutriQuest Brazil
On January 22, 2023, we entered into an asset purchase agreement to
acquire inventory and distribution rights for certain marketed
products and certain other assets of NutriQuest Nutricao Animal
Ltda (NutriQuest Brazil). Pursuant to the terms and conditions set
forth in the asset purchase agreement, total consideration is
$24 million to be paid in two installments, subject to certain
post-closing adjustments. The transaction is expected to close
within the next six months. We anticipate that this transaction
will be accounted for as a business combination under the
acquisition method of accounting.
Divestitures
Microbiome R&D platform carve-out
In April 2022, we signed an agreement to transfer assets associated
with our microbiome R&D platform to a newly created,
independent biopharmaceutical company, BiomEdit, focused on
developing solutions for animal and human health. As part of the
agreement, we retained a non-voting, minority stake in the company.
In addition, we entered into transitional services agreements with
the company for certain services. Assets transferred included
intellectual property and laboratory equipment. The book values of
those assets were not material. We recorded a gain on disposal of
the assets of approximately $3 million during the year ended
December 31, 2022. We determined that the disposal of the related
net assets does not qualify for reporting as a discontinued
operation because it does not represent a strategic shift that has
or will have a major effect on our operations and financial
results. During the three months ended March 31, 2023, we recorded
an immaterial gain in other expense, net in our condensed
consolidated statements of operations in connection with the sale
of additional equity by BiomEdit.
Shawnee and Speke
During 2021, as part of our strategy to optimize our manufacturing
footprint, we announced an agreement with TriRx Pharmaceuticals
(TriRx) to sell our manufacturing sites in Shawnee, Kansas
(Shawnee) and Speke, U.K. (Speke), including the transfer of
approximately 600 employees. In connection with these arrangements,
we also entered into long-term manufacturing and supply agreements,
under which TriRx began manufacturing existing Elanco products at
both sites upon the closing of the transactions. On August 1, 2021
and February 1, 2022, we completed the sales of our Shawnee and
Speke sites, respectively. Upon closing the sale of the Speke site,
we recorded a contract asset of $55 million for the favorable
supply agreement, which is included in prepaid expenses and other
and other noncurrent assets on our condensed consolidated balance
sheets. Our fair value assessment for the favorable supply
agreement was estimated using a combined income and market approach
which incorporated Level 3 inputs. The divestitures did not
represent a strategic shift that has or will have a major effect on
our operations and financial results, and therefore do not qualify
for reporting as discontinued operations. See Note 6: Asset
Impairment, Restructuring and Other Special Charges for further
information.
Based on the terms of the agreements, we expect to receive
aggregate gross cash proceeds of $78 million from the sales of
Shawnee and Speke over a period of three years which began in the
second half of 2022. Through March 31, 2023, we have received cash
proceeds totaling $13 million. In May 2023, we entered into
amendments to the agreements which effectively restructured the
payment schedule related to the remaining amount owed. Under the
terms of the amendments, we expect to receive the remaining cash
proceeds upon the earlier of the date on which certain conditions
are met or in equal installments over a twelve-month period
beginning January 31, 2024. At this time, we believe amounts owed
by TriRx are collectible and we will continue to assess
collectibility. Further, we have rights to certain collateral in
the event of a default and we continue to monitor the value of this
collateral.
BexCaFe Arrangement
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.
Subsequent to the effective date of the license agreement, our
consolidated financial statements include the assets, liabilities,
operating results and cash flows of BexCaFe. Based on the guidance
in ASC 810, income and expense between us and BexCaFe have been
eliminated against the income or expense included in the financial
statements of BexCaFe. The resulting amounts after the effect of
these eliminations were included in our condensed consolidated
financial statements for the three months ended March 31, 2023 and
were not material.
Note 6. Asset Impairment, Restructuring and Other Special
Charges
In recent years, we have incurred substantial costs associated with
restructuring programs and cost-reduction initiatives designed to
achieve a flexible and competitive cost structure. As discussed
further below, restructuring activities primarily include charges
associated with facility rationalization and workforce reductions.
In connection with our recent acquisitions, including the
acquisition of Bayer Animal Health, we have also incurred costs
associated with executing transactions and integrating acquired
operations, which may include expenditures for banking, legal,
accounting and other similar services. In addition, we have
incurred costs to stand up our organization as an independent
company. All operating functions can be impacted by these actions;
therefore, non-cash expenses associated with our tangible and
intangible assets can be incurred as a result of revised fair value
projections and/or determinations to no longer utilize certain
assets in the business on an ongoing basis.
For finite-lived intangible assets and other long-lived assets,
whenever impairment indicators are present, we calculate the
undiscounted value of projected cash flows associated with the
asset, or group of assets, and compare it to the carrying amount.
If the carrying amount is greater, we record an impairment loss for
the excess of book value over fair value. Determinations of fair
value can result from a complex series of judgments and rely on
estimates and assumptions. See Note 2: Basis of Presentation and
Summary of Significant Accounting Policies for discussion regarding
estimates and assumptions.
Components of asset impairment, restructuring and other special
charges are as follows:
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
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.
The following table summarizes the activity in our reserves
established in connection with restructuring
activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
|
|
|
These reserves relate to certain restructuring programs initiated
in 2021 and are included in other current and noncurrent
liabilities on our condensed consolidated balance sheets based on
the timing of when the obligations are expected to be paid, which
can vary due to certain country negotiations and regulations. As of
March 31, 2023, we expect to pay approximately $7 million over
the next 12 months. We believe that the reserves are
adequate.
Note 7. 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 or the weighted
average cost method.
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 |
|
Note 8. Equity
Tangible Equity Unit (TEU) Offering
In January 2020, we issued 11 million in TEUs at the stated
amount of $50 per unit. Total proceeds, net of issuance costs, were
$528 million. The gross proceeds and deferred finance costs
from the issuance of the TEUs were allocated 86% to equity (prepaid
stock purchase contracts) and 14% to debt (TEU amortizing notes)
based on the relative fair value of the respective components of
each TEU. See Note 9: Debt for additional information on the TEU
amortizing notes.
The TEU prepaid stock purchase contracts were converted into shares
of our common stock on February 1, 2023. Holders of our TEUs
received 1.5625 shares of our common stock based on the maximum
settlement rate for the applicable market value being below $32.00.
In total, we issued approximately 17 million shares to holders
in connection with the settlement.
Note 9. Debt
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 were in compliance with all of our debt covenants as of March
31, 2023.
Note 10. Financial Instruments and Fair Value
Financial instruments that are potentially subject to credit risk
consist principally of trade receivables. We evaluate the
creditworthiness of our customers on a regular basis, monitor
economic conditions and calculate allowances for estimated credit
losses on our trade receivables on a quarterly basis using an
expected credit loss model. We assess whether collectability is
probable at the time of sale and on an ongoing basis. Collateral is
generally not required. The risk associated with this concentration
is mitigated by our ongoing credit-review procedures.
A large portion of our cash is held by a few major financial
institutions. We monitor the exposure with these institutions and
do not expect any of these institutions to fail to meet their
obligations. All highly liquid investments with a maturity of three
months or less from the date of purchase are considered to be cash
equivalents. The cost of these investments approximates fair
value.
We 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:
|
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|
|
|
|
|
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|
|
|
|
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|
|
|
|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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 totaling $35 million as
of March 31, 2023 related to contingent consideration associated
with our acquisition of certain assets of NutriQuest during the
first quarter of 2023. We may pay up to $85 million in cash
consideration which is contingent upon the achievement of specified
sales, approval and geographic expansion milestones as outlined in
the asset purchase agreement. The fair values of the contingent
consideration liabilities were estimated using the Monte Carlo
simulation model and a probability weighted expected return method.
Both methods use significant inputs that are not observable in the
market, representing Level 3 inputs, including those relating to
revenue forecasts, discount rates, and volatility. See Note 5:
Acquisitions, Divestitures and Other Arrangements 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.
Derivative cash flows, with the exception of net investment hedges,
are principally classified in the operating activities section of
the condensed consolidated statements of cash flows, consistent
with the underlying hedged item. Cash flows related to net
investment hedges are classified in the investing activities
section of the consolidated statements of cash flows. Further, we
do not offset derivative assets and liabilities on the condensed
consolidated balance sheets. Our outstanding positions are
discussed below.
Derivatives not designated as hedges
We may enter into foreign exchange forward or option contracts to
reduce the effect of fluctuating currency exchange rates. These
derivative financial instruments primarily offset exposures in the
Euro, British pound, Swiss franc, Brazilian real, Australian
dollar, Japanese yen, Canadian dollar and Chinese yuan. Foreign
currency derivatives used for hedging are put in place using the
same or like currencies and duration as the underlying exposures
and are recorded at fair value with the gain or loss recognized in
other expense, net in the condensed consolidated statements of
operations. Forward contracts generally have maturities not
exceeding 12 months. As of March 31, 2023 and December 31,
2022, we had outstanding foreign exchange contracts with aggregate
notional amounts of $912 million and $784 million,
respectively.
The amount of net gains (losses) on derivative instruments not
designated as hedging instruments, recorded in other expense, net
were as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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.
Derivatives designated as hedges
We are subject to interest rate risk with regard to our existing
floating-rate debt, and we utilize interest rate swap contracts to
mitigate the variability in cash flows by effectively converting
the floating-rate debt into fixed-rate debt. We recognize any
differences between the variable interest rate payments and the
fixed interest rate settlements with the swap counterparties as an
adjustment to interest expense, net of capitalized interest over
the life of the swaps. We have designated our interest rate swaps
as cash flow hedges and record them at fair value on the condensed
consolidated balance sheets. Changes in the fair value of the
hedges are recognized in other comprehensive income (loss). Fair
value is estimated based on quoted market values of similar hedges
and is classified as Level 2. Our outstanding forward-starting
interest rate swaps have maturities ranging between 2023 and 2025
with aggregate notional amounts of $3,050 million as of March
31, 2023 and December 31, 2022. In March 2023, we entered into
new interest rate swap agreements with a combined notional amount
of $1,000 million, which become effective on October 1, 2023
following the maturity of certain current swaps with the same
combined notional amount. The transaction effectively extends the
maturity from 2023 to 2025 and will result in a change of the
weighted average fixed rate from 4.4% to 4.1% on the effective
date.
The amounts of net gains (losses) on cash flow hedges recorded, net
of tax, in other comprehensive income, are as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
2022 |
|
|
|
|
Forward-starting interest rate swaps |
$ |
(48) |
|
|
$ |
109 |
|
|
|
|
|
During the three months ended March 31, 2023 and 2022, activity on
cash flow hedges recorded in other comprehensive income included
losses of $21 million and gains of $109 million,
respectively, related to mark-to-market adjustments. There was no
tax effect for the three months ended March 31, 2023 and 2022 after
the application of the U.S. valuation allowance. See Note 11:
Income Taxes for further discussion.
In April 2022 and September 2022, we took advantage of market
opportunities to restructure our interest rate swap portfolio. We
unwound the existing swaps and simultaneously entered into new
agreements with the same notional amounts and covering the same
tenors. As a result, we received cash settlements of
$132 million and $75 million in the respective periods.
These gains were initially recognized in accumulated other
comprehensive loss and are reclassified to interest expense, net of
capitalized interest over the period during which the related
interest payments are made. During the three months ended March 31,
2023, we reclassified $27 million of gains relating to our
terminated interest rate swaps from accumulated other comprehensive
loss to interest expense, net of capitalized interest.
During the three months ended March 31, 2023 and 2022, we
reclassified $4 million and $3 million, respectively, of
net losses into interest expense. Over the next 12 months, we
expect to reclassify a gain of $87 million, which includes
$75 million relating to the interest rate swap settlements, to
interest expense, net of capitalized interest.
Note 11. Income Taxes
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
|
2023 |
|
2022 |
|
|
|
|
Income tax expense |
|
$ |
5 |
|
|
$ |
24 |
|
|
|
|
|
Effective tax rate |
|
4.4 |
% |
|
31.6 |
% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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|
|
We were 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 our initial public offering (IPO), the potential
liabilities or potential refunds attributable to pre-IPO periods in
which Elanco was included in a Lilly consolidated or combined tax
return remain with Lilly. The U.S. examination of tax years 2016 to
2018 began in the fourth quarter of 2019 and remains ongoing. It is
possible that the examination of these tax years could conclude
within the next 12 months. Final resolution of certain matters is
dependent upon several factors, including the potential for formal
administrative proceedings.
For the three months ended March 31, 2023, we recognized income tax
expense of $5 million. Our effective tax rate of 4.4% differs from
the statutory income tax rate due to jurisdictional earnings mix of
projected income in lower tax jurisdictions, partially offset by
losses in the U.S. and a Southeast Asia affiliate for which there
is no tax benefit as valuation allowances have been established in
those countries.
For the three months ended March 31, 2022, we recognized income tax
expense of $24 million. Our effective tax rate of 31.6% differs
from the statutory income tax rate largely due to certain research
and experimentation costs being capitalized beginning January 1,
2022, as provided under the Tax Cuts and Jobs Act. This increased
the expected profits in jurisdictions with higher statutory tax
rates as well as expected U.S. international tax inclusions, which
are partially offset by utilization of net operating losses and
valuation allowance release in the U.S.
Note 12. Commitments and Contingencies
Legal Matters
We are party to various legal actions that arise in the normal
course of business. The most significant matters are described
below. Loss contingency provisions are recorded when it is deemed
probable that we will incur a loss and we can formulate a
reasonable estimate of that loss. For the litigation matters
discussed below for which a loss is reasonably possible, we are
unable to estimate the possible loss or range of loss, if any. The
process of resolving these matters is inherently uncertain and may
develop over an extended period of time; therefore, at this time,
the ultimate resolutions cannot be predicted. As of March 31, 2023
and December 31, 2022, we had no material liabilities
established related to litigation as there were no significant
claims which were probable and estimable.
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.
Regulatory Matters
On July 1, 2021, we received a subpoena from the SEC relating to
our channel inventory and sales practices prior to mid-2020. We
have cooperated in providing documents and information to the SEC
and will continue to do so. Management believes that its actions
were appropriate. At this stage, we are unable to estimate the
range of any potential loss associated with this
matter.
Other Commitments
As of March 31, 2023, we have a lease commitment that has not yet
commenced for our new corporate headquarters in Indianapolis,
Indiana. Total minimum lease payments are estimated to be
approximately $378 million over a term of 25 years, excluding
extensions. Final lease payments may vary depending on the actual
cost of certain construction activities. Lease commencement is
expected in 2025.
The land for our new corporate headquarters is located in a Tax
Increment Finance District, and the project is, in part, funded
through Tax Incremental Financing (TIF) through an incentive
agreement between us and the City of Indianapolis. The agreement
provides for an estimated total incentive of $64 million to be
funded by the City of Indianapolis in connection with the future
tax increment revenue generated from the developed property. In
December 2021, as part of a funding and development agreement
entered into between us and the developer, we made a commitment to
use the expected TIF proceeds towards the cost of developing and
constructing the headquarters. In exchange, the developer
reimbursed us up to the $64 million commitment in 2021. During
2022, we refunded approximately $15 million of the TIF
proceeds to the developer. As a result, it is our expectation that
our future lease payments will be reduced. The remaining accrued
incentive is included in other noncurrent liabilities on our
condensed consolidated balance sheets and will be amortized over
the lease term beginning on the commencement date and offset future
rent expense.
Note 13. Geographic Information
We operate as a single operating segment engaged in the
development, manufacturing, marketing and sales of animal health
products worldwide for both pets and farm animals. Consistent with
our operational structure, our CEO, as the chief operating decision
maker, makes resource allocation and business process decisions
globally across our consolidated business. Strategic decisions are
managed globally with global functional leaders responsible for
determining significant 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
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.
We have a single customer that accounted for 9% and 10% of revenue
for the three months ended March 31, 2023 and 2022, respectively.
Product sales with this customer resulted in accounts receivable of
$66 million and $73 million as of March 31, 2023 and
December 31, 2022, 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:
|
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|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
|
2023 |
|
2022 |
|
|
|
|
Revenue
|
|
|
|
|
|
|
|
United States |
$ |
543 |
|
|
$ |
522 |
|
|
|
|
|
International |
714 |
|
|
704 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
$ |
1,257 |
|
|
$ |
1,226 |
|
|
|
|
|
Note 14. Earnings Per Share
We compute basic earnings (loss) per share by dividing net income
(loss) available to common shareholders by the actual weighted
average number of common shares outstanding for the reporting
period. Elanco has variable common stock equivalents relating to
certain equity awards in stock-based compensation arrangements. We
also had variable common stock equivalents related to the TEU
prepaid stock purchase contracts during the three months ended
March 31, 2022 and in the first quarter of 2023 through the
settlement date of February 1, 2023 (see Note 8: Equity for further
discussion). Diluted earnings per share reflects the potential
dilution that could occur if holders of the unvested equity awards
converted their holdings into common stock and that could have
occurred if holders of unsettled TEUs had converted their holdings
into common stock prior to the February 1, 2023 settlement date.
The weighted average number of potentially dilutive shares
outstanding is calculated using the treasury stock method.
Potential common shares that would have the effect of increasing
diluted earnings per share (or reducing loss per share) are
considered to be anti-dilutive and as such, these shares
are not included in the calculation of diluted earnings (loss) per
share.
Basic and diluted earnings per share are calculated as
follows:
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|
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
Introduction
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.
Overview
Elanco is a global animal health company that develops products for
pets and farm animals in more than 90 countries. With a heritage
dating back to 1954, we rigorously innovate to improve the health
of animals and to benefit our customers while fostering an
inclusive, cause-driven culture for our employees. We operate our
business in a single segment directed at fulfilling our vision of
enriching the lives of people through food, making protein more
accessible and affordable, and through pet companionship, helping
pets live longer, healthier lives. We advance our vision by
offering products in two primary categories: pet health and farm
animal.
We offer a diverse portfolio of approximately 200 brands that make
us a trusted partner to pet owners, veterinarians and farm animal
producers. Our products are generally sold worldwide to third-party
distributors and independent retailers, and directly to farm animal
producers and veterinarians. With the acquisition of Bayer Animal
Health in 2020, we expanded our presence in retail and e-commerce
channels, allowing our customers to shop where and how they
want.
We operate our business in a single segment directed at fulfilling
our vision of food and companionship enriching life – all to
advance the health of animals, people and the planet. We advance
our vision by offering products in these two primary
categories:
Pet Health:
Our pet health portfolio is focused on parasiticides, vaccines and
therapeutics. We have one of the broadest parasiticide portfolios
in the 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 |
|
|
|
|
|
As a global company, significant portions of our revenue and
expenses are recorded in currencies other than the U.S. dollar.
Accordingly, in any period, our reported revenue, expenses and
resulting earnings (loss) are impacted by changes in the exchange
rates of those currencies relative to the U.S. dollar.
Increases or decreases in inventory levels in our distribution
channels can positively or negatively impact our quarterly and
annual revenue results, leading to variations in revenue. 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, blackout shipping periods due to system downtime,
implementations and integrations, and procedures and environmental
factors beyond our control, including weather conditions and the
COVID-19 global pandemic.
Key Trends and Conditions Affecting Our Results of
Operations
Industry Trends
The animal health industry, which includes both pets and farm
animals, is a growing industry that benefits billions of people
worldwide.
We believe that factors influencing growth in demand for pet
medicines and vaccines include:
•increased
pet ownership globally;
•pets
living longer; and
•owners
sharing a unique and loving bond with their pets.
As demand for animal protein grows, farm animal health is becoming
increasingly important. We believe that factors influencing growth
in demand for farm animal medicines and vaccines
include:
•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.
Growth in farm animal nutritional health products (enzymes,
probiotics and prebiotics) is influenced, among other factors, by
demand for antibiotic alternatives that can promote animal health
and increase productivity.
Factors Affecting Our Results of Operations
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.
As a global animal health leader, we have an obligation to support
the health of animals and people. At the center of that work is
ensuring access and availability of food and avoiding the spread of
disease. At this time, we are limiting our business in Russia to
only the essential products that support these needs, while
complying with all imposed sanctions. We do not currently
manufacture products or source any materials from companies in
Russia for use in our products, but to continue to support the
health of animals and people, we may in the future source products
in Russia because of new laws requiring products sold in Russia to
be produced there as well. We do not conduct business with the
Russian government. During the three months ended March 31, 2023,
revenue to Russian and Ukrainian customers represented
approximately 1% of our consolidated revenue. Assets held in Russia
as of March 31, 2023 represented less than 1% of our consolidated
assets.
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.
Revision of Prior Period Financial Statements Primarily Relating to
Tax Valuation Allowance Adjustment
In connection with the preparation of our financial statements as
of and for the year ended December 31, 2022, a cumulative error was
identified 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. As a result of
having to make the revisions related to this error, we made other
immaterial revisions to our 2022 unaudited interim consolidated
financial statements. All of the revisions are reflected throughout
this Form 10-Q. See Note 2: Basis of Presentation and Summary of
Significant Accounting Policies to the condensed consolidated
financial statements for additional information.
Acquisitions of Bayer Animal Health and KindredBio
We have incurred expenses in connection with our acquisitions of
Bayer Animal Health and KindredBio, including fees for professional
services such as legal, accounting, consulting and other advisory
fees and expenses. Expenses incurred in 2023 and 2022 are primarily
related to integration activities. In addition, we have incurred
and expect to continue to incur costs related to the build out of
processes and systems to support finance and global supply and
logistics and to expand administrative functions, including, but
not limited to, information technology, facilities management,
distribution, human resources and manufacturing, to replace
services previously provided by the former parent company of Bayer
Animal Health. We anticipate that these additional costs will be
partially offset by expected synergies. The ERP system integration
of legacy Bayer Animal Health to the Elanco system is expected to
be completed in the second quarter of 2023. In connection with the
integration of the two systems, we specified to our customers
periods of time during which product could not be shipped and
increased our inventories during the fourth quarter of 2022 to
ensure that our product remained available to customers. We believe
certain customers modified purchasing habits due to the ERP system
integration, causing a shift of revenue from the second quarter to
the first quarter of 2023 of approximately $90 million to $110
million based on our high-level estimates. In addition, we extended
payment terms related to approximately $35 million of revenue in
the first quarter of 2023 in certain international markets, driven
by the duration of the aforementioned blackout
periods.
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. We
continue to pursue the development of new chemical and biological
molecules through our approach to innovation. Our future growth and
success depend on both our pipeline of new products, including new
products that we develop internally and may develop through joint
ventures and products that we are able to obtain through licenses
or acquisitions, 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 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 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.
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.
Seasonality
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.
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 three months ended
March 31, 2023 and 2022, approximately 53% and 54%, 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 3% during the
three months ended March 31, 2023 and 2022.
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.
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
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 |
% |
|
|
|
|
|
|
Certain amounts and percentages may reflect rounding
adjustments.
Disaggregated Revenue
On a global basis, our revenue by product category for the three
months ended March 31, 2023 and 2022 is summarized as
follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue |
|
% of Total Revenue |
|
Increase (Decrease) |
(Dollars in millions) |
|
|
|
|
|
|
2023 |
|
2022 |
|
2023 |
|
2022 |
|
$ Change |
|
% Change |
|
CER
(1)
|
Pet Health |
|
|
|
|
|
|
$ |
675 |
|
|
$ |
640 |
|
|
54 |
% |
|
52 |
% |
|
$ |
35 |
|
5 |
% |
|
8 |
% |
Farm Animal |
|
|
|
|
|
|
573 |
|
|
569 |
|
|
46 |
% |
|
46 |
% |
|
4 |
|
1 |
% |
|
5 |
% |
Subtotal |
|
|
|
|
|
|
1,248 |
|
|
1,209 |
|
|
99 |
% |
|
99 |
% |
|
39 |
|
3 |
% |
|
7 |
% |
Contract Manufacturing
(2)
|
|
|
|
|
|
|
9 |
|
|
17 |
|
|
1 |
% |
|
1 |
% |
|
(8) |
|
(47) |
% |
|
(41) |
% |
Total |
|
|
|
|
|
|
$ |
1,257 |
|
|
$ |
1,226 |
|
|
100 |
% |
|
100 |
% |
|
31 |
|
3 |
% |
|
6 |
% |
Note: Numbers may not add due to rounding
(1)Constant
exchange rate (CER), a non-GAAP measure, 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 arrangements in which we manufacture products on
behalf of a third party.
On a global basis, the effect of price, foreign exchange rates and
volume on changes in revenue for the three months ended March 31,
2023 and 2022 was as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, 2023
(Dollars in millions)
|
|
|
|
|
|
Revenue |
|
Price |
|
FX Rate |
|
Volume |
|
Total |
|
CER |
Pet Health |
|
|
|
|
|
$ |
675 |
|
|
5% |
|
(3)% |
|
3% |
|
5% |
|
8% |
Farm Animal |
|
|
|
|
|
573 |
|
|
5% |
|
(4)% |
|
—% |
|
1% |
|
5% |
Subtotal |
|
|
|
|
|
1,248 |
|
|
5% |
|
(3)% |
|
2% |
|
3% |
|
7% |
Contract Manufacturing |
|
|
|
|
|
9 |
|
|
—% |
|
(7)% |
|
(41)% |
|
(47)% |
|
(41)% |
Total |
|
|
|
|
|
$ |
1,257 |
|
|
5% |
|
(3)% |
|
1% |
|
3% |
|
6% |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three months ended March 31, 2022
(Dollars in millions)
|
|
|
|
|
|
Revenue |
|
Price |
|
FX Rate |
|
Volume |
|
Total |
|
CER |
Pet Health |
|
|
|
|
|
$ |
640 |
|
|
2% |
|
(3)% |
|
—% |
|
(1)% |
|
2% |
Farm Animal |
|
|
|
|
|
569 |
|
|
1% |
|
(3)% |
|
—% |
|
(2)% |
|
1% |
Subtotal |
|
|
|
|
|
1,209 |
|
|
2% |
|
(3)% |
|
—% |
|
(1)% |
|
2% |
Contract Manufacturing |
|
|
|
|
|
17 |
|
|
—% |
|
(3)% |
|
(8)% |
|
(11)% |
|
(8)% |
Total |
|
|
|
|
|
$ |
1,226 |
|
|
2% |
|
(3)% |
|
—% |
|
(1)% |
|
2% |
Note: Numbers may not add due to rounding
Revenue
Pet Health revenue increased $35 million, or 5%, for the three
months ended March 31, 2023, driven by increases in price and
volume, partially offset by an unfavorable impact from foreign
exchange rates. Revenue increased an estimated $65 million to $80
million over prior year due to the modification of certain
customers' purchasing habits of legacy Bayer Animal Health products
in anticipation of our ERP system integration. Excluding the impact
of this shift in revenue from the second quarter to the first
quarter and on a constant currency basis, the decrease in revenue
was primarily attributable to the impact of a supply disruption in
vaccines, a decline in sales of certain parasiticide products and
declines in retail products primarily in Europe, partially offset
by price increases and innovation revenue.
Farm Animal revenue increased by $4 million, or 1%, for the
three months ended March 31, 2023, driven by an increase in price,
partially offset by an unfavorable impact from foreign exchange
rates. Revenue increased an estimated $25 million to $30 million
over prior year due to the modification of certain customers'
purchasing habits of legacy Bayer Animal Health products in
anticipation of our ERP system integration. Excluding the impact of
this shift in revenue from the second quarter to the first quarter
and on a constant currency basis, the year over year change was
primarily attributable to increased demand in Europe and Asia,
primarily in poultry, innovation revenue and price increases,
offset by a decrease in demand for poultry products in the U.S.,
generic competition, timing of aqua purchases in the prior year and
supply disruptions of cattle vaccines in the U.S.
Cost of Sales
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Cost of sales |
|
$ |
494 |
|
|
$ |
509 |
|
|
(3) |
% |
|
|
|
|
|
|
% of revenue |
|
39 |
% |
|
42 |
% |
|
|
|
|
|
|
|
|
Cost of sales as a percentage of revenue decreased for the three
months ended March 31, 2023, primarily due to due to the
modification of certain customers' purchasing habits of legacy
Bayer Animal Health products in anticipation of our ERP system
integration, which primarily related to Pet Health products which
have higher margins, as well as product price increases and
improvements in manufacturing productivity, partially offset by
inflationary impacts on input costs and conversion
costs.
Research and Development
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Research and development |
|
$ |
81 |
|
|
$ |
81 |
|
|
— |
% |
|
|
|
|
|
|
% of revenue |
|
6 |
% |
|
7 |
% |
|
|
|
|
|
|
|
|
R&D expenses were flat for the three months ended March 31,
2023 and decreased slightly as a percentage of
revenue.
Marketing, Selling and Administrative
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Marketing, selling and administrative |
|
$ |
327 |
|
|
$ |
323 |
|
|
1 |
% |
|
|
|
|
|
|
% of revenue |
|
26 |
% |
|
26 |
% |
|
|
|
|
|
|
|
|
Marketing, selling and administrative expenses increased
$4 million for the three months ended March 31, 2023,
primarily driven by increases in employee compensation costs,
travel and meeting expenses and spend related to consulting
services, partially offset by the impact of foreign exchange
rates.
Amortization of Intangible Assets
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Amortization of intangible assets |
|
$ |
134 |
|
|
$ |
137 |
|
|
(2) |
% |
|
|
|
|
|
|
Amortization of intangible assets decreased $3 million for the
three months ended March 31, 2023, primarily due to the impact of
foreign exchange rates, partially offset by the addition of
amortization of intangible assets recorded from the acquisition of
certain assets of NutriQuest during the period.
Asset Impairment, Restructuring and Other Special
Charges
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Asset impairment, restructuring and other special
charges |
|
$ |
40 |
|
|
$ |
40 |
|
|
— |
% |
|
|
|
|
|
|
For additional information regarding our asset impairment,
restructuring and other special charges, see Note 6: Asset
Impairment, Restructuring and Other Special Charges to the
condensed consolidated financial statements.
Asset impairment, restructuring and other special charges were flat
in the three months ended March 31, 2023 as compared to the prior
year. Amounts recorded during the three months ended March 31, 2023
primarily represented costs associated with the implementation of
new systems, programs, and processes due to the integration of
Bayer Animal Health.
Interest Expense, Net of Capitalized Interest
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Interest expense, net of capitalized interest |
|
$ |
64 |
|
|
$ |
52 |
|
|
23 |
% |
|
|
|
|
|
|
Interest expense, net of capitalized interest increased
$12 million for the three months ended March 31, 2023,
primarily due to higher interest on variable-rate debt due to rate
increases.
Other Expense, Net
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Other expense, net |
|
$ |
9 |
|
|
$ |
9 |
|
|
— |
% |
|
|
|
|
|
|
Other expense recorded during the three months ended March 31, 2023
primarily consisted of foreign exchange losses and mark-to-market
adjustments on equity investments, partially offset by certain
components of net periodic benefit cost, a gain recorded in
connection with the sale of additional equity by BiomEdit, and
milestones earned and equity issued to us in relation to a license
agreement. Other expense recorded during the three months ended
March 31, 2022 primarily consisted of mark-to-market adjustments on
equity investments and foreign exchange losses, partially offset by
certain components of net periodic benefit cost.
Income Tax Expense
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended March 31, |
|
|
(Dollars in millions) |
|
2023 |
|
2022 |
|
% Change |
|
|
|
|
|
|
Income tax expense |
|
$ |
5 |
|
|
$ |
24 |
|
|
(79) |
% |
|
|
|
|
|
|
Effective tax rate |
|
4.4 |
% |
|
31.6 |
% |
|
|
|
|
|
|
|
|
Income tax expense decreased $19 million for the three months ended
March 31, 2023. The effective tax rate decreased for the three
months ended March 31, 2023 as compared to the prior year and
differs from the statutory income tax rate largely due to
jurisdictional earnings mix of projected income in lower tax
jurisdictions, partially offset by losses in the U.S. and a
Southeast Asia affiliate, for which there is no tax benefit as
valuation allowances have been established in those countries, and
refinements in the calculation of required capitalization of
certain R&D expenses. See Note 11: Income Taxes to the
condensed consolidated financial statements.
Liquidity and Capital Resources
Our primary sources of liquidity are cash on hand, cash flows from
operations and funds available under our credit facilities. As a
significant portion of our business is conducted internationally,
we hold a significant portion of cash outside of the U.S. We
monitor and adjust the amount of foreign cash based on projected
cash flow requirements. Our ability to use foreign cash to fund
cash flow requirements in the U.S. may be impacted by local
regulations and, to a lesser extent, following U.S. tax reforms,
the income taxes associated with transferring cash to the U.S. We
intend to indefinitely reinvest foreign earnings for continued use
in our foreign operations. As our business evolves, we may change
that strategy, particularly to the extent we identify tax efficient
reinvestment alternatives for our foreign earnings or change our
cash management strategy.
We believe our primary sources of liquidity are sufficient to fund
our short-term and long-term existing and planned capital
requirements, which include working capital obligations, funding
existing marketed and pipeline products, capital expenditures,
business development in our targeted areas, short-term and
long-term debt obligations, which include principal and interest
payments, as well as interest rate swaps, operating lease payments,
purchase obligations and costs associated with the integrations of
Bayer Animal Health. In addition, we have the ability to access
capital markets to obtain debt refinancing for longer-term funding,
if required, to service our long-term debt obligations. Further, we
believe we have sufficient cash flow and liquidity to remain in
compliance with our 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 - 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
2022 Form 10-K.
Cash Flows
The following table provides a summary of cash flows from
operating, investing and financing activities for the periods
presented:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
(Dollars in millions) |
|
Three Months Ended March 31, |
Net cash provided by (used for): |
|
2023 |
|
2022 |
|
$ Change |
Operating activities |
|
$ |
(145) |
|
|
$ |
(62) |
|
|
$ |
(83) |
|
Investing activities |
|
(55) |
|
|
(29) |
|
|
(26) |
|
Financing activities |
|
174 |
|
|
(200) |
|
|
374 |
|
Effect of exchange-rate changes on cash and cash
equivalents |
|
(1) |
|
|
(5) |
|
|
4 |
|
Net decrease in cash and cash equivalents |
|
$ |
(27) |
|
|
$ |
(296) |
|
|
$ |
269 |
|
Operating activities
Cash used for operating activities increased $83 million to $145
million for the three months ended March 31, 2023 from $62 million
for the three months ended March 31, 2022, primarily due to a
decrease in cash resulting from changes in operating assets and
liabilities, particularly accounts receivable and
inventories.
In the past, we have extended our payment terms for distributors on
occasion. Specifically, due to the ERP system integration scheduled
to be completed in the second quarter of 2023, we increased
inventories on hand and extended payment terms on sales totaling
$35 million for some customers during the first quarter of
2023 to ensure that our product was available for a period of time
during which there were no shipments. Although we presently have no
plans to do so in the future, it is also possible that we will need
to extend payment terms in certain situations, for example, as a
result of the COVID-19 global health pandemic, competitive
pressures, macroeconomic factors and the need for certain inventory
levels in our distribution channels to avoid supply disruptions. If
so, such extensions of customer payment terms could result in
additional uses of our cash flow.
Investing activities
Cash used for investing activities was $55 million for the three
months ended March 31, 2023 as compared to $29 million for the
three months ended March 31, 2022. The increase was primarily
driven by cash paid for the acquisition of certain assets of
NutriQuest during the three months ended March 31, 2023 as well as
a year over year increase in cash paid for intangible assets,
partially offset by a year over year decrease in cash used for
purchases of software.
Financing activities
Cash provided by financing activities was $174 million for the
three months ended March 31, 2023 as compared to cash used for
financing activities of $200 million for the three months ended
March 31, 2022. Cash provided by financing activities during the
three months ended March 31, 2023 primarily reflected proceeds from
our revolving credit facility, partially offset by the repayment of
indebtedness outstanding under our long-term borrowings. Cash used
for financing activities during the three months ended March 31,
2022 reflected the repayment of indebtedness outstanding under our
Term Loan B credit facility and net repayments on our revolving
credit facility.
Description of Indebtedness
For a complete description of our existing debt and available
credit facilities as of March 31, 2023 and December 31, 2022,
see Note 10: Debt within Item 8, “Financial Statements and
Supplementary Data,” of Part II of our
2022 Form 10-K.
New developments are discussed in Note 9: Debt of this Form
10-Q.
Contractual Obligations
Our contractual obligations and commitments as of March 31, 2023
are primarily comprised of long-term debt obligations, operating
leases and purchase obligations. Our long-term debt obligations are
comprised of our expected principal and interest obligations.
Purchase obligations consist of open purchase orders as of March
31, 2023 and contractual payment obligations with significant
vendors which are noncancelable and are not contingent. These
obligations are primarily short-term in nature. See Note 12:
Commitments and Contingencies to the condensed consolidated
financial statements for further discussion regarding the
contractual obligations related to our new corporate headquarters
in Indianapolis, Indiana.
Critical Accounting Policies and Estimates
The preparation of financial statements in accordance with U.S.
GAAP requires us to make estimates and judgments that affect the
reported amounts of assets, liabilities, revenues and expenses.
Certain of our accounting policies are considered critical because
these policies are the most important to the depiction of our
financial statements and require significant, difficult or complex
judgments by us, often requiring 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
2022 Form 10-K.
There have been no significant changes or developments in the
application of our critical accounting policies during the three
months ended March 31, 2023.
Goodwill Impairment Testing
We evaluate goodwill for impairment on an annual basis and when
certain qualitative impairment indicators are present that would
more likely than not reduce the fair value of our single reporting
unit below its carrying amount.
In the third quarter of 2022, a significant change in our market
capitalization relative to our book value, among other factors,
triggered a goodwill impairment review. Based on our qualitative
assessment, we concluded that it was more likely than not that the
fair value of our single reporting unit was less than its carrying
value, and therefore, we were required to perform a quantitative
goodwill impairment test, which involved comparing the estimated
fair value of our single reporting unit with its carrying value,
including goodwill. We estimated the fair value of our single
reporting unit using a combination of the income and market
approach.
Significant management judgment is required in estimating our
reporting unit’s fair value and in the creation of forecasts of
future operating results that are used in the discounted cash flow
method of valuation. These include, but are not limited to,
estimates and assumptions regarding (1) our future cash flows,
revenue, and other profitability measures, (2) the long-term growth
rate of our business, and (3) the determination of our
weighted-average cost of capital, which is a factor in determining
the discount rate. We make these judgments based on our historical
experience, relevant market size, historical pricing of similar
products, and expected industry trends. These assumptions are
subject to change in future periods because of, among other things,
additional information, financial information based on further
historical experience, changes in competition, our investment
decisions, volatility in foreign currency exchange rates, results
of research and development, and changes in macroeconomic
conditions, including rising interest rates and inflation. A change
in these assumptions or the use of alternative estimates and
assumptions could have a significant impact on the estimated fair
value and may expose us to goodwill impairment losses.
As a result of our quantitative assessment, we estimated that the
fair value of our single reporting unit exceeded the carrying
amount by more than 20% as of September 30, 2022 and, therefore, no
impairment existed with respect to our goodwill. Given the further
decline in our market capitalization relative to our book value, we
reevaluated our impairment testing from a qualitative perspective
as of March 31, 2023. There was no change to our previous
conclusion that no impairment exists, primarily due to decreases in
interest rates impacting our cost of capital and improvements in
certain drivers of our fair value.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET
RISK
Foreign Exchange Risk
We operate on a global basis and are exposed to the risk that our
earnings, cash flows and equity could be adversely impacted by
fluctuations in foreign exchange rates. We are primarily exposed to
foreign exchange risk with respect to net assets denominated in the
Euro, British pound, Swiss franc, Brazilian real, Australian
dollar, Japanese yen, Canadian dollar and 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. 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 $7 million for the three months ended March 31,
2023.
We generally identify hyperinflationary markets as those markets
whose cumulative inflation rate over a three-year period exceeds
100%. We have concluded that our Argentina subsidiary is operating
in a hyperinflationary market. As a result, beginning in the second
quarter of 2018, the functional currency of our Argentina
subsidiary changed from the local currency to the U.S. dollar.
During the three months ended March 31, 2023, revenue in Argentina
represented less than 1% of our consolidated revenue. Assets held
in Argentina as of March 31, 2023 represented less than 1% of our
consolidated assets.
During the first quarter of 2022, Turkey’s three-year cumulative
inflation rate exceeded 100%, and we concluded that Turkey became a
hyperinflationary economy for accounting purposes.
As of April 1, 2022, we applied hyperinflationary accounting for
our subsidiary in Turkey and changed its functional currency from
the Turkish lira to the U.S. dollar. During the three months ended
March 31, 2023, revenue in Turkey represented less than 1% of our
consolidated revenue. Assets held in Turkey as of March 31, 2023
represented less than 1% of our consolidated assets.
While the hyperinflationary conditions did not have a material
impact on our business during the three months ended March 31,
2023, in the future, we may incur larger currency devaluations,
which could have a material adverse impact on our results of
operations.
Interest Risk
During the first quarter of 2023, our variable-rate debt was
subject to fluctuations in interest rates based on both LIBOR and
Term SOFR. However, effective April 1, 2023, we transitioned the
reference rate used in our credit facilities, and as a result, our
variable-rate debt is now exclusively indexed to Term SOFR. As of
March 31, 2023, we held certain interest rate swap agreements with
a notional value of $3,050 million that have the economic
effect of modifying our variable interest such that a portion of
the variable-rate interest payable becomes fixed. As of March 31,
2023, $4,144 million and $1,936 million of our total
long-term debt, including the current portion, is fixed-rate debt
(including variable-rate converted to fixed-rate through the use of
interest rate swaps) and unhedged variable-rate debt, respectively.
During the three months ended March 31, 2023, we recorded a loss of
$48 million, net of taxes on these interest rate swaps in
other comprehensive income. See Note 10: Financial Instruments and
Fair Value to the condensed consolidated financial statements for
further information.
ITEM 4. CONTROLS 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 March 31, 2023. As
disclosed in Item 9A of Part II of our
2022 Form 10-K,
management concluded that a material weakness existed as of
December 31, 2022 resulting from the ineffective review of the
annual income tax provision, including the valuation allowance
related to deferred tax assets. We are in the process of
identifying all issues contributing to the material weakness and
developing a remediation plan. The implementation of this
remediation plan will require, at a minimum, the effective
operation of certain quarterly and annual controls. Therefore, the
material weakness cannot be fully remediated until we assess the
effectiveness of our internal control over financial reporting for
the year ending December 31, 2023. Based on this evaluation, the
chief executive officer and the chief financial officer concluded
that, as of the end of the period covered by this report, our
disclosure controls and procedures remained
ineffective.
(b)Changes
in Internal Controls.
During the first quarter of 2023, there were no changes in our
internal control over financial reporting that materially affected,
or are reasonably likely to materially affect, our internal control
over financial reporting other than the aforementioned material
weakness.
PART II
ITEM 1. LEGAL PROCEEDINGS
See Note 12: Commitments and Contingencies to the condensed
consolidated financial statements for a summary of our legal
proceedings, which is incorporated herein by
reference.
Our risk factors are documented in Item 1A of Part I of our
2022 Form 10-K,
which is incorporated herein by reference. Other than the revisions
set forth below, there have been no material changes from the risk
factors previously disclosed in the
2022 Form 10-K.
The following risk factors have been changed from the risk factors
that were previously disclosed:
Unanticipated safety, quality or efficacy concerns or identified
concerns associated with our products may harm our reputation and
have an adverse impact on our performance.
Unanticipated safety, quality or efficacy concerns arise from time
to time with respect to animal health products, whether or not
scientifically or clinically supported, potentially leading to
product recalls, withdrawals or suspended or reduced sales, as well
as product liability and other claims. Regulatory actions based on
these types of safety, quality or efficacy concerns could impact
all, or a significant portion, of a product’s sales.
For example, lawsuits seeking actual damages, injunctive relief,
and/or restitution for allegedly deceptive marketing have been
filed against us arising out of the use of
Seresto,
a non-prescription flea and tick collar for cats and dogs, based on
media reports alleging that the collar has caused injury and death
to pets. Further, in 2021, the U.S. House of Representatives'
then-subcommittee chair requested that we produce certain documents
and information related to the
Seresto
collar, made a request to temporarily remove
Seresto
collars from the market and, during a hearing at which our
President and Chief Executive Officer (CEO) testified, again called
for removal of the collars from the market. We do not anticipate
that the collars will be removed from the market by the EPA or any
other regulatory agencies or that any potential or agreed upon
brand stewardship actions will have meaningful commercial impact on
the
Seresto
brand. However, if any similar claims with respect to our other
products are resolved adversely to us, or if a regulatory agency
determines that a recall or cancellation of registrations of any of
our products is necessary, such action could cause harm to our
reputation, reduce our product sales, result in monetary penalties
and other costly remedies against us, and could therefore have a
material adverse effect on our business, financial condition and
results of operations.
In addition, we depend on positive perceptions of the safety,
quality and efficacy of our products, and animal health products in
general, by food producers, veterinarians and pet owners. Any
concern as to the safety, quality or efficacy of our products,
whether actual or perceived, may harm our reputation. These
concerns, including those relating to
Seresto,
and the related harm to our reputation could materially adversely
affect our business, financial condition and results of operations,
regardless of whether such reports are accurate.
Changes in our credit rating could increase our interest expense
and restrict our access to, and negatively impact the terms of,
current or future financings or trade credit.
Credit rating agencies continually revise their ratings for the
companies that they follow, including us. Credit rating agencies
also evaluate our industry as a whole and may change their credit
ratings for us based on their overall view of our industry. We
cannot be sure that credit rating agencies will maintain their
ratings on us and certain of our debt. The acquisition of Bayer
Animal Health had a negative impact on our credit ratings, leading
to higher borrowing expenses. Additionally, S&P, Moody's and
Fitch downgraded our credit ratings in February, March and April
2023, respectively. Because the ratings of certain of our senior
unsecured notes have been downgraded, we are required to pay
additional interest under the senior unsecured notes. Any further
downgrades could result in requirements to pay additional interest
under the senior unsecured notes. Moreover, any decision to
downgrade our ratings could restrict our access to, and negatively
impact the terms of, current or future financings and trade credit
extended by our suppliers of raw materials or other
vendors.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF
PROCEEDS
(none)
ITEM 3. DEFAULTS UPON SENIOR SECURITIES
(none)
ITEM 4. MINE SAFETY DISCLOSURES
(none)
ITEM 5. OTHER INFORMATION
(none)
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 |
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Interactive Data Files. |
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104 |
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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 |
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(Registrant) |
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Date: |
May 9, 2023 |
/s/ Jeffrey N. Simmons |
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Jeffrey N. Simmons |
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President and Chief Executive Officer |
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(Principal Executive Officer) |
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Date: |
May 9, 2023 |
/s/ Todd S. Young |
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Todd S. Young |
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Executive Vice President, Chief Financial Officer |
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(Principal Financial Officer) |
Elanco Animal Health (NYSE:ELAN)
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