Notes to Condensed Consolidated Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share and per-unit data)
Note 1. Basis of Presentation and Summary of Significant Accounting Policies
Elanco Animal Health Incorporated (Elanco Parent) and its subsidiaries (collectively, Elanco, the Company, we, us, or our) is a premier animal health company that innovates, develops, manufactures and markets products for pets and farm animals.
Elanco was originally a wholly owned subsidiary of Eli Lilly and Company (Lilly). Elanco Parent, formed as the ultimate parent company of substantially all of the animal health businesses of Lilly, completed an initial public offering (IPO) in September 2018 and Lilly completed the disposition of all of its ownership interest in Elanco in March 2019.
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the United States (U.S.) Securities and Exchange Commission (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 Quarterly Report on Form 10-Q should be read in conjunction with our consolidated and combined financial statements and accompanying notes for the year ended December 31, 2020 included in our Annual Report on Form 10-K filed with the SEC on March 1, 2021. 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, 2021 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.
The significant accounting policies set forth in Note 4 to the consolidated and combined financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020 appropriately represent, in all material respects, the current status of our accounting policies, except as it relates to the adoption of the standard that was effective January 1, 2021 as described in Note 2: Implementation of New Financial Accounting Pronouncements.
On August 1, 2020 and August 27, 2021 we completed the acquisitions of Bayer Animal Health and KindredBio, respectively. See Note 4: Acquisitions and Divestitures for additional information.
Note 2. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of an accounting standard that was effective January 1, 2021 and was adopted on that date:
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Standard
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Description
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Effect on the financial statements or other significant matters
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Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes
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The amendments in this update include simplifications related to accounting for income taxes including removing certain exceptions related to the approach for intraperiod tax allocation and the recognition of deferred tax liabilities for outside basis differences. The standard also clarifies the accounting for transactions that result in a step-up in the tax basis of goodwill.
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The adoption of this guidance did not have a material impact on our consolidated financial statements.
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The following table provides a brief description of an accounting standard that is applicable to us but has not yet been adopted:
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Standard
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Description
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Effective Date
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Effect on the financial statements or other significant matters
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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
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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.
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These standards were effective as of March 12, 2020 through December 31, 2022 and adoption is permitted at any time during the period on a prospective basis.
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We are currently in the process of evaluating the impact of the London Interbank Offered Rate (LIBOR) on our existing contracts and may elect optional expedients in future periods as reference rate reform activities occur. We do not expect that these updates will have a material impact on our consolidated financial statements.
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Note 3. Revenue
Our sales rebates are based on specific agreements. The most significant of our sales rebate programs in terms of accrual and payment amounts, percentage of our products that are sold via these programs, and level of judgment required in estimating the appropriate transaction price, relate to our programs in the U.S., France and the United Kingdom (U.K.). As of September 30, 2021 and 2020, the aggregate liability for sales rebates for these countries represented approximately 72% and 74%, respectively, of our total liability.
The following table summarizes the activity in our global sales rebates liability:
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2021
|
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2020
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2021
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2020
|
Beginning balance
|
$
|
303
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$
|
164
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$
|
295
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$
|
211
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Bayer Animal Health at acquisition
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—
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|
|
78
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—
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|
|
78
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Reduction of revenue
|
163
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|
|
145
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|
|
516
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|
|
316
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Payments
|
(150)
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|
(108)
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(495)
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|
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(326)
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Ending balance
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$
|
316
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$
|
279
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$
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316
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$
|
279
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Adjustments to revenue recognized as a result of changes in estimates for the judgments described above during the three and nine months ended September 30, 2021 and 2020 for product shipped in previous periods were not material.
Actual global product returns were approximately 2% and less than 1% of net revenue for the three months ended September 30, 2021 and 2020, respectively. Actual global product returns were approximately 1% of net revenue for the nine months ended September 30, 2021 and 2020.
Disaggregation of Revenue
In the first quarter of 2021, management revisited how it analyzes revenue, both internally and externally, and determined that disaggregation by major product line provides a more meaningful view of our results. Accordingly, we updated our disaggregated revenue presentation from the previous five categories (i.e., pet health disease prevention, pet health therapeutics, farm animal future protein & health, farm animal ruminants & swine, and contract manufacturing) to the following:
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Three Months Ended September 30,
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Nine Months Ended September 30,
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2021
|
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2020
|
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2021
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2020
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Pet Health
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$
|
527
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|
$
|
401
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|
$
|
1,857
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$
|
861
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Farm Animal
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583
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473
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1,728
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|
1,222
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Contract Manufacturing (1)
|
21
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|
|
16
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|
|
67
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|
|
51
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Revenue
|
$
|
1,131
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|
|
$
|
890
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|
|
$
|
3,652
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|
$
|
2,134
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(1)Represents revenue from arrangements in which we act as a contract manufacturer, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.
Note 4. Acquisitions and Divestitures
During 2021 and 2020, we completed the acquisitions of KindredBio and Bayer Animal Health, respectively. These transactions were accounted for as business combinations under the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The determination of estimated fair value requires management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of these acquisitions are included in our condensed consolidated financial statements from the dates of acquisition.
KindredBio Acquisition
On August 27, 2021, we acquired KindredBio, a publicly traded biopharmaceutical company that develops innovative biologics focused on saving and improving the lives of pets. The acquisition further accelerates our pet health expansion, particularly by expanding our presence in dermatology. In connection with the merger agreement, we acquired all outstanding stock of KindredBio for $9.25 per share, or an aggregate cash purchase consideration of $444 million. We utilized our revolving credit facility and cash on hand to finance the acquisition. Refer to Note 8: Debt for further details.
During the three months ended June 30, 2021, we signed an agreement with KindredBio to acquire exclusive global rights to KIND-030, a monoclonal antibody that is being developed for the treatment and prevention of canine parvovirus. We calculated the fair value of the liability associated with that agreement using an income approach leveraging the estimated sales royalty, sales milestone and technical milestone payments avoided, and the $26 million liability was settled upon the closing of our acquisition of KindredBio. Refer to Note 5: Asset Impairment, Restructuring and Other Special Charges for further discussion.
We incurred transaction costs in connection with the KindredBio acquisition of $4 million and $6 million during the three and nine months ended September 30, 2021, respectively. Transaction costs were primarily associated with legal and other professional services related to the acquisition and are reflected within asset impairment, restructuring and other special charges in our condensed consolidated statements of operations.
Revenue and loss from KindredBio included in our condensed consolidated statements of operations since the date of acquisition for the three and nine months ended September 30, 2021 were immaterial.
The valuation of assets acquired and liabilities assumed has not yet been finalized as of September 30, 2021. The purchase price allocation is preliminary and subject to change, including the valuation of property and equipment, intangible assets, income taxes and goodwill. The amounts recognized will be finalized as the information necessary to complete the analysis is obtained, but no later than one year after the acquisition date.
The following table summarizes the preliminary amounts recognized for assets acquired and liabilities assumed as of the acquisition date:
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Estimated Fair Value at August 27, 2021
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Cash and cash equivalents
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$
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31
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Other net working capital
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1
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Property and equipment
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26
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Intangible assets, primarily acquired in-process research and development
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352
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Deferred income taxes
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(22)
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Total identifiable net assets
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388
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Goodwill
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30
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Settlement of liability related to previous license agreement
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26
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Total consideration transferred
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$
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444
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Property and equipment is mostly composed of land, buildings, equipment (including laboratory equipment, furniture and fixtures, and computer equipment), and construction in progress. The fair value of property and equipment is currently equal to its net book value at the time of the acquisition, as we are in the process of gathering information to complete our fair value assessment.
The preliminary estimated fair values of acquired in-process research and development (IPR&D) were determined using the income approach, which is a valuation technique that provides an estimate of the fair value of an asset based on market participant expectations of the cash flows an asset would generate over its remaining useful life. Some of the significant assumptions inherent in the development of these asset valuations include the estimated net cash flows for each year for each asset (including revenues, cost of sales, R&D expenses, marketing, selling and administrative expenses, and contributory asset charges), the appropriate discount rate necessary to measure the risk inherent in each future cash flow stream, the life cycle of each asset, the potential regulatory and commercial success risk, and competitive trends impacting the asset and each cash flow stream, as well as other factors. The fair value of acquired IPR&D as of September 30, 2021 is based on preliminary assumptions which are subject to change as we complete our valuation procedures.
The goodwill recognized from this acquisition is attributable primarily to KindredBio's assembled workforce. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
Bayer Animal Health Acquisition
On August 1, 2020, we completed the acquisition of Bayer Animal Health. The acquisition has expanded our pet health product category, advancing our planned portfolio mix transformation and creating a better balance between our farm animal and pet health product categories. Our product portfolio and pipeline have been enhanced by the addition of Bayer Animal Health, which complements our commercial operations and international infrastructure while expanding our direct to retailer/e-commerce presence.
Total consideration transferred to Bayer and its subsidiaries for the acquisition is summarized as follows:
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Cash consideration (1)
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$
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5,054
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Fair value of Elanco common stock (2)
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1,724
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Fair value of total consideration transferred
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$
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6,778
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(1)Includes initial cash consideration of $5,170 million less working capital and tax adjustments of $116 million.
(2)Represents the acquisition date fair value of 73 million shares of Elanco common stock at $23.64 per share. Per the terms of the stock and asset purchase agreement, the number of shares was based on approximately $2.3 billion divided by the 20-day volume-weighted average stock price as of the last day of trading before the closing of the acquisition (but subject to a 7.5% symmetrical collar centered on the baseline share number of approximately $2.3 billion divided by an initial share price of $33.60).
We recognized transaction costs related to the acquisition of Bayer Animal Health of $3 million and $93 million during the nine months ended September 30, 2021 and 2020, respectively. Transaction costs for the three months ended September 30, 2020 were $35 million. Transaction costs were primarily associated with financial advisory, legal and other professional services related to the acquisition and are reflected within asset impairment, restructuring and other special charges in our condensed consolidated statements of operations.
The amount of revenue attributable to Bayer Animal Health included in our condensed consolidated statements of operations for the three and nine months ended September 30, 2021 is $421 million and $1,509 million, respectively. Bayer Animal Health revenues were $196 million for both the three and nine months ended September 30, 2020. Based on our current operational structure, we have not recorded standalone costs for Bayer Animal Health after the date of the acquisition. As a result, we are unable to accurately determine earnings or loss attributable to Bayer Animal Health since the date of acquisition.
The following table summarizes the fair value of assets acquired and liabilities assumed as of the acquisition date:
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Estimated Fair Value at August 1, 2020
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|
Cash and cash equivalents
|
$
|
169
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|
Accounts receivable
|
10
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|
Inventories
|
487
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|
Prepaid expenses and other current assets
|
60
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|
Property and equipment
|
315
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|
|
|
|
|
|
|
|
|
Intangible assets:
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|
Acquired in-process research and development
|
65
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|
Marketed products
|
3,740
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|
Assets held for sale
|
138
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|
Accounts payable and accrued liabilities
|
(237)
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|
Accrued retirement benefits
|
(220)
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|
Other noncurrent assets and liabilities, net
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(878)
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|
Total identifiable net assets
|
3,649
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|
Goodwill
|
3,129
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|
Total consideration transferred
|
$
|
6,778
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|
The valuation of assets acquired and liabilities assumed was finalized during the second quarter of 2021. The measurement period adjustments recorded during 2021, which were made to reflect the facts and circumstances in existence as of the acquisition date, primarily related to the finalization of our fair value assessment of property and equipment located at the Shawnee, Kansas site (Shawnee), revised cash flow assumptions for marketed products, adjustments related to changes in inventory balances and gross margin assumptions, tax adjustments, and minor working capital adjustments. These adjustments resulted in a decrease to marketed products intangible assets of $210 million, a decrease to property and equipment of $32 million, a net decrease to working capital accounts and other non-current assets and liabilities of $14 million, and an increase to goodwill of $207 million.
Inventories comprised of $311 million, $81 million, $95 million in finished products, work in process, and raw materials, respectively. The estimate of fair value of finished products was determined based on net realizable value adjusted for the costs to complete the sales process, a reasonable profit allowance from the sales process, and estimated holding costs. The estimate of fair value of work in process was determined based on net realizable value adjusted for costs to complete the manufacturing process, costs of the sales process, a reasonable profit allowance for the remaining manufacturing and sales process effort, and an estimate of holding costs. The fair value of raw materials was determined to approximate book value. The net fair value step-up adjustment to inventories of $152 million has been amortized to cost of sales as the inventory is sold to customers. As of September 30, 2021, the fair value step-up adjustment has been fully amortized.
Property and equipment is mostly composed of land, buildings, equipment (including machinery, furniture and fixtures, and computer equipment), and construction in progress. The estimated fair value of real property was
determined using the sales comparison data valuation technique and personal property was determined using the direct replacement cost method. The estimated fair value of property and equipment located at the Shawnee, Kansas site was determined using the income approach.
Intangible assets relate to $65 million of IPR&D and $3,740 million of marketed products. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of approximately 10 years on a straight-line basis. The estimated fair values of identifiable intangible assets were determined using the income approach. 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.
Assets held for sale include $133 million of intangible assets, consisting of marketed products and IPR&D, and $5 million of inventory related to the divestitures of Drontal™, Profender™ and other products. See the Divestitures section below for further details.
Accrued retirement benefits primarily relate to certain Bayer Animal Health international subsidiaries that have underfunded defined benefit pension plans. We have recorded the fair value of these plans using assumptions and accounting policies similar to those disclosed in Note 19: Retirement Benefits to the consolidated and combined financial statements in our Annual Report on Form 10-K for the year ended December 31, 2020. Upon acquisition, the excess of projected benefit obligation over the fair value of plan assets was recognized as a liability and previously existing deferred actuarial gains and losses and unrecognized service costs or benefits were eliminated.
The goodwill recognized from this acquisition represents the value of additional growth platforms and an expanded revenue base as well as anticipated operational synergies and cost savings from the creation of a single combined global organization. The majority of goodwill associated with this acquisition is not deductible for tax purposes.
Pro forma financial information (unaudited)
The following table presents the estimated unaudited pro forma combined results of Elanco and Bayer Animal Health as if the acquisition of Bayer Animal Health had occurred on January 1, 2020:
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Three Months Ended September 30, 2020
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|
Nine Months Ended September 30, 2020
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Revenue
|
|
|
$
|
1,069
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|
|
|
|
$
|
3,308
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|
Loss before income taxes
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|
|
(227)
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|
|
|
|
(392)
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|
The supplemental pro forma financial information has been prepared using the acquisition method of accounting and is based on the historical financial information of Elanco and Bayer Animal Health. The supplemental pro forma financial information does not necessarily represent what the combined companies' revenue or results of operations would have been had the acquisition been completed on January 1, 2020, nor is it intended to be a projection of future operating results of the combined company. It also does not reflect any operating efficiencies or potential cost savings that might be achieved from synergies of combining Elanco and Bayer Animal Health.
The unaudited supplemental pro forma financial information reflects primarily pro forma adjustments related to divestitures; fair value estimates for property and equipment, intangibles and inventory; interest expense and amortization of debt issuance costs for the debt issuance to finance the acquisition of Bayer Animal Health. The unaudited supplemental pro forma financial information includes transaction charges associated with the acquisition. There are no material, nonrecurring pro forma adjustments directly attributable to the acquisition included in the reported pro forma revenue and loss before income taxes.
Divestitures
Shawnee and Speke divestitures
In the second quarter of 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 and Speke, U.K. (Speke), including the planned transfer of approximately 600 employees. In connection with these arrangements, we also entered into long-term manufacturing and supply agreements, under which TriRx will manufacture existing Elanco products at both sites upon the closing of the transactions. During the nine months ended September 30, 2021, we recorded a $271 million pre-tax charge to reduce the carrying value of the disposal groups to an amount equal to fair value less costs to sell in asset impairment, restructuring, and other special charges in our condensed consolidated statements of operations. Our fair value less costs to sell assessment includes the fair value of the favorable manufacturing and supply agreements, estimated using a combined income and market approach which incorporated Level 3 inputs. On August 1, 2021, we completed the sale of our Shawnee site and expect to receive gross cash proceeds of $51 million over a period of three years based on the terms of the agreement. This activity is considered non-cash investing activity within our condensed consolidated statements of cash flows for the nine months ended September 30, 2021. We expect to close the Speke transaction in the first quarter of 2022; therefore, the related assets are classified as held for sale as of September 30, 2021. See Note 5: Asset Impairment, Restructuring and Other Special Charges for further information.
Elanco and Bayer Animal Health product divestitures
In connection with advancing our efforts to secure the necessary regulatory clearances for our acquisition of Bayer Animal Health, we signed agreements in 2020 to divest the rights to manufacture and commercialize certain legacy Elanco products. In 2020, we signed agreements to divest the worldwide rights to Osurnia™ and Vecoxan™ and the U.S. rights to Capstar. In July 2020, we completed these sales, along with certain other immaterial divestitures. The transactions were accounted for as asset divestitures.
In 2020, we also signed an agreement to divest the worldwide rights to the legacy Elanco products Itrafungol™ and Clomicalm™ in connection with the required disposal of an early-stage IPR&D asset. We also made a payment during the nine months ended September 30, 2021 and accrued for future amounts we are required to pay to the buyer of the IPR&D asset to help fund their development costs for a set period of time. The divestiture closed during the nine months ended September 30, 2021. There were no proceeds received from the disposition of these assets and the resulting immaterial impact was recorded in other (income) expense, net in our condensed consolidated statements of operations. The related assets met the assets held for sale criteria as of December 31, 2020.
To allow the Bayer Animal Health acquisition to close on a timely basis, we signed agreements to divest the rights to the legacy Bayer Animal Health products Drontal and Profender within the U.K. and European Economic Area as well as other IPR&D. We completed the transactions, which were accounted for as asset divestitures, in August 2020. Drontal, Profender, and the IPR&D rights were acquired as part of the Bayer Animal Health acquisition. The related assets were classified as held for sale on the balance sheet as of the acquisition date and measured at fair value at the time of the acquisition; therefore, no gains were recognized on the sales. During the three months ended September 2020, a loss of $7 million was recorded on the sale of IPR&D as recognition of the potential income from the divestiture was constrained by revenue accounting standards.
There were additional marketed and pipeline products that we were required to dispose of in order to comply with regulatory requirements. These divestitures did not have a material effect on our operations, cash flows or financial position.
During the three and nine months ended September 30, 2020, we received gross cash proceeds of $435 million and recognized pre-tax gains of $156 million (net of transaction costs of $13 million) relating to the product divestitures described above. Pre-tax gains were included in other (income) expense, net in our condensed consolidated statements of operations.
Assets Held For Sale
Assets and liabilities considered held for sale in connection with the above divestitures were included in the respective line items on our condensed consolidated balance sheets as follows:
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|
September 30, 2021
|
|
December 31, 2020
|
Inventories
|
$
|
38
|
|
|
$
|
2
|
|
Other intangibles, net
|
—
|
|
|
4
|
|
Property and equipment, net
|
55
|
|
|
—
|
|
Deferred tax asset
|
—
|
|
|
1
|
|
|
|
|
|
Total assets held for sale
|
$
|
93
|
|
|
$
|
7
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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|
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|
Other intangibles, net classified as held for sale primarily consisted of marketed products.
Microbiome R&D platform carve-out
On October 5, 2021, we announced our intention to carve out our microbiome R&D platform, aiming to create a privately funded, independent, biopharmaceutical company focused on developing solutions for animal and human health. We are exploring structures with both strategic and financial sponsors, and may retain a minority stake in this new entity. The potential carve-out is expected to be completed by the end of the first quarter of 2022 and assets transferred are not expected to be material. 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.
Note 5. Asset Impairment, Restructuring and Other Special Charges
In recent years, we have incurred substantial costs associated with restructuring programs and cost-reduction initiatives designed to achieve a flexible and competitive cost structure. Restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions, including the acquisitions of Bayer Animal Health and KindredBio, we have also incurred costs associated with executing transactions and integrating acquired operations, which may include expenditures for banking, legal, accounting, and other similar services. In addition, we have incurred costs to stand up our organization as an independent company. All operating functions can be impacted by these actions; therefore, non-cash expenses associated with our tangible and intangible assets can be incurred as a result of revised fair value projections and/or determinations to no longer utilize certain assets in the business on an ongoing basis.
For finite-lived intangible asset and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 1: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
Components of asset impairment, restructuring and other special charges are as follows:
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Restructuring charges:
|
|
|
|
|
|
|
|
Severance and other costs (1)
|
$
|
(2)
|
|
|
$
|
130
|
|
|
$
|
26
|
|
|
$
|
131
|
|
Facility exit costs (1)
|
—
|
|
|
—
|
|
|
—
|
|
|
1
|
|
|
|
|
|
|
|
|
|
Acquisition related charges:
|
|
|
|
|
|
|
|
Transaction and integration costs (2)
|
30
|
|
|
131
|
|
|
141
|
|
|
318
|
|
|
|
|
|
|
|
|
|
Non-cash and other items:
|
|
|
|
|
|
|
|
Asset impairment (3)
|
50
|
|
|
—
|
|
|
63
|
|
|
4
|
|
Asset write-down (4)
|
6
|
|
|
1
|
|
|
275
|
|
|
3
|
|
Gain on sale of fixed assets (5)
|
—
|
|
|
—
|
|
|
—
|
|
|
(4)
|
|
Settlements and other (6)
|
27
|
|
|
—
|
|
|
13
|
|
|
3
|
|
|
|
|
|
|
|
|
|
Total expense
|
$
|
111
|
|
|
$
|
262
|
|
|
$
|
518
|
|
|
$
|
456
|
|
(1)For the nine months ended September 30, 2021, these charges primarily related to a restructuring program announced and initiated in January 2021. These costs were partially offset by the reversal of severance accruals associated with the January 2021 and September 2020 programs during the period. See below for further details.
For the three and nine months ended September 30, 2020, these charges primarily related to a restructuring program announced and initiated in September 2020. See below for further details.
(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 acquisitions of KindredBio and 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)Asset impairment charges for the three and nine months ended September 30, 2021 related to adjustments to the fair value of IPR&D assets that were subject to product rationalization. The asset impairment charge during the three months ended September 30, 2021 reflects a decision by management to terminate an IPR&D project and fully impair the related asset, which is associated with a farm animal parasiticide. The decision was prompted by unfavorable efficacy results observed during the quarter.
Asset impairment charges for the nine months ended September 30, 2020 related to the impairment of an IPR&D asset resulting from product rationalization and a reassessment of geographic viability.
(4)Asset write-down expenses for the nine months ended September 30, 2021 include the initial adjustments recorded to write down the Shawnee and Speke assets classified as held for sale as of June 30, 2021 to an amount equal to estimated fair value less costs to sell, as well as adjustments to values of assets sold in relation to the Shawnee manufacturing site sold on August 1, 2021 and assets classified as held for sale in relation to the future sale of the Speke manufacturing site during the three months ended September 30, 2021. See Note 4: Acquisitions and Divestitures for further discussion. Other charges for the nine months ended September 30, 2021 include adjustments recorded to write down assets in Belford Roxo, Brazil; Basel, Switzerland; Cuxhaven, Germany; and Manukau, New Zealand that were classified as held and used to their current fair value. These charges were recorded in connection with the January 2021 and September 2020 restructuring programs.
Asset write-down expenses for the three and nine months ended September 30, 2020 resulted from adjustments recorded to write down assets classified as held and used to their current fair value. These charges primarily related to fixed assets in Wusi, China in connection with the announced 2019 program to streamline operations.
(5)Represents a gain on the disposal from the sale of an R&D facility in Prince Edward Island, Canada.
(6)Settlements and other expenses for the three and nine months ended September 30, 2021 include a charge associated with the settlement of a liability for future royalty and milestone payments triggered in connection with our acquisition of KindredBio as discussed further in Note 4: Acquisitions and Divestitures, accounting and advisory fees related to the sale of our manufacturing site in Shawnee, and an $8 million charge related to a litigation settlement for a matter that originated prior to our acquisition of Bayer Animal Health, partially offset by net curtailment and settlement gains from the remeasurement of our pension benefit obligation as a result of workforce reductions in connection with our September 2020 and January 2021 restructuring programs. See Note 13: Retirement Benefits for further information. The amount for the nine months ended September 30, 2021 also includes the gain recorded on the divestiture of an early-stage IPR&D asset acquired as part of the Bayer Animal Health acquisition.
Settlements and other expenses for the three and nine months ended September 30, 2020 relate to a non-recurring litigation settlement for a matter that originated prior to our separation from Lilly.
In January 2021, we announced a restructuring aligned with our ongoing efforts to improve operating efficiencies. The proposed actions focused on streamlining processes and delivering increased efficiency in functional areas, while improving the productivity of our investments in innovation. As part of the restructuring plan, we closed our R&D sites in Manukau, New Zealand and Cuxhaven, Germany. We have also reduced duplication and optimized structures in U.S. operations, marketing, manufacturing and quality central functions, and administrative areas. The restructuring resulted in the elimination of approximately 330 positions around the world. Activities related to this initiative resulted in favorable adjustments of $1 million and charges of $44 million during the three and nine months ended September 30, 2021, respectively. The favorable adjustments reflect a change in estimate resulting from ongoing negotiations. Initiatives under this program are expected to be substantially completed by the end of 2021.
In September 2020, following the closing of the Bayer Animal Health acquisition, we implemented a restructuring program designed to reduce duplication, drive efficiency and optimize our footprint in key geographies. As part of the restructuring plan, we have eliminated approximately 900 positions across 40 countries, primarily in the commercial and marketing functions, but also in R&D, manufacturing and quality, and back office support functions. During the three and nine months ended September 30, 2021 we recorded favorable adjustments of $1 million and $15 million, respectively, as a change in estimate related to this initiative, which reflects adjustments to severance accruals resulting from favorable negotiations and certain restructured employees filling open positions. Initiatives under this program are expected to be substantially completed by the end of 2021.
The following table summarizes the activity in our reserves established in connection with restructuring activities:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Facility exit costs
|
|
Severance
|
|
Total
|
Balance at December 31, 2019
|
$
|
5
|
|
|
$
|
16
|
|
|
$
|
21
|
|
Charges
|
1
|
|
|
132
|
|
|
133
|
|
Reserve adjustments
|
—
|
|
|
(1)
|
|
|
(1)
|
|
Cash paid
|
(1)
|
|
|
(15)
|
|
|
(16)
|
|
Balance at September 30, 2020
|
$
|
5
|
|
|
$
|
132
|
|
|
$
|
137
|
|
|
|
|
|
|
|
Balance at December 31, 2020
|
$
|
—
|
|
|
$
|
130
|
|
|
$
|
130
|
|
|
|
|
|
|
|
Charges
|
—
|
|
|
41
|
|
|
41
|
|
Reserve adjustments
|
—
|
|
|
(15)
|
|
|
(15)
|
|
Cash paid
|
—
|
|
|
(95)
|
|
|
(95)
|
|
Balance at September 30, 2021
|
$
|
—
|
|
|
$
|
61
|
|
|
$
|
61
|
|
These reserves are included in other current and noncurrent liabilities on our condensed consolidated balance sheets. Substantially all of the reserves are expected to be paid in the next 15 months primarily due to certain country negotiations and regulations. We believe that the reserves are adequate.
Note 6. Inventories
We state all inventories at the lower of cost or net realizable value. We use the last-in, first-out (LIFO) method for a portion of our inventories located in the continental U.S. Other inventories are valued by the first-in, first-out (FIFO) method or the weighted average cost method.
Inventories consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2021
|
|
December 31, 2020
|
Finished products
|
$
|
595
|
|
|
$
|
772
|
|
Work in process
|
576
|
|
|
625
|
|
Raw materials and supplies
|
255
|
|
|
210
|
|
Total
|
1,426
|
|
|
1,607
|
|
Decrease to LIFO cost
|
(43)
|
|
|
(29)
|
|
Inventories
|
$
|
1,383
|
|
|
$
|
1,578
|
|
Note 7. Equity
Common Stock Offering
On January 22, 2020, we entered into an underwriting agreement in which we agreed to sell approximately 23 million shares of our common stock at a public offering price of $32.00 per share. In connection with the offering, we granted the underwriters an option to purchase up to an additional 2 million shares, which was exercised in full on January 23, 2020. As a result, we issued and sold a total of approximately 25 million shares of our common stock for $768 million, after issuance costs.
Tangible Equity Unit (TEU) Offering
On January 22, 2020, we also completed our offering of 11 million, 5.00% TEUs. Total proceeds, net of issuance costs, were $528 million. Each TEU, which has a stated amount of $50, is comprised of a prepaid stock purchase contract (prepaid stock) and a senior amortizing note due February 1, 2023. Subsequent to issuance, each TEU may be legally separated into the two components. The prepaid stock is considered a freestanding financial instrument, indexed to Elanco common stock, and meets the conditions for equity classification.
The value allocated to the prepaid stock is reflected net of issuance costs in additional paid-in capital. The value allocated to the senior amortizing notes is reflected in long-term debt on the condensed consolidated balance sheets, with payments expected in the next twelve months reflected in current portion of long-term debt. Issuance costs related to the amortizing notes are reflected as a reduction of the carrying amount and will be amortized through the maturity date using the effective interest rate method.
The proceeds from the issuance were allocated to equity and debt based on the relative fair value of the respective components of each TEU as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Equity Component
|
|
Debt Component
|
|
Total
|
Fair value per unit
|
|
$
|
42.80
|
|
|
$
|
7.20
|
|
|
$
|
50.00
|
|
|
|
|
|
|
|
|
Gross proceeds
|
|
$
|
471
|
|
|
$
|
79
|
|
|
$
|
550
|
|
Less: Issuance costs
|
|
19
|
|
|
3
|
|
|
22
|
|
Net proceeds
|
|
$
|
452
|
|
|
$
|
76
|
|
|
$
|
528
|
|
The senior amortizing notes have an aggregate principal amount of $79 million and bear interest at 2.75% per year. On each February 1, May 1, August 1, and November 1 until the maturity date, we will pay equal quarterly cash installments of $0.6250 per each amortizing note with an initial principal amount of $7.2007 (except for the first installment payment of $0.6528 per amortizing note paid on May 1, 2020). Each installment constitutes a payment of interest and partial payment of principal, and in the aggregate will be equivalent to 5.00% per year with respect to the $50 stated amount per TEU.
Unless settled early at the holder’s or our election, each prepaid stock purchase contract will automatically settle on February 1, 2023 (the mandatory settlement date) for a number of shares of common stock per contract based on the average of the volume-weighted average trading prices during the 20 consecutive trading day period beginning on, and including the 21st scheduled trading day immediately preceding February 1, 2023 (applicable market value) with reference to the following settlement rates:
|
|
|
|
|
|
|
|
|
Applicable Market Value
|
|
Common Stock Issued
|
Equal to or greater than $38.40
|
|
1.3021 shares (minimum settlement rate)
|
Less than $38.40, but greater than $32.00
|
|
$50 divided by applicable market value
|
Less than or equal to $32.00
|
|
1.5625 (maximum settlement rate)
|
The prepaid stock purchase contracts are mandatorily convertible into a minimum of 14 million shares or a maximum of 17 million shares of our common stock on the mandatory settlement date (unless redeemed by us or settled earlier at the unit holder's option). The 14 million minimum shares are included in the calculation of basic weighted average shares outstanding. The difference between the minimum and maximum shares represents potentially dilutive securities, which are included in the calculation of diluted weighted average shares outstanding on a pro rata basis to the extent that the average applicable market value is higher than $32.00 but is less than $38.40 during the period.
Note 8. Debt
Long-term debt consisted of the following:
|
|
|
|
|
|
|
|
|
|
|
|
|
September 30, 2021
|
|
December 31, 2020
|
Incremental Term Facility
|
$
|
500
|
|
|
$
|
—
|
|
Term Loan B
|
4,129
|
|
|
4,164
|
|
Revolving Credit Facility
|
250
|
|
|
—
|
|
3.912% Senior Notes due 2021
|
—
|
|
|
500
|
|
4.272% Senior Notes due 2023
|
750
|
|
|
750
|
|
4.900% Senior Notes due 2028
|
750
|
|
|
750
|
|
TEU Amortizing Notes
|
40
|
|
|
60
|
|
Other obligations
|
—
|
|
|
1
|
|
Unamortized debt issuance costs
|
(85)
|
|
|
(98)
|
|
|
6,334
|
|
|
6,127
|
|
Less current portion of long-term debt
|
61
|
|
|
555
|
|
Total long-term debt
|
$
|
6,273
|
|
|
$
|
5,572
|
|
Farm Credit Agreement
On August 12, 2021, we entered into a new debt financing arrangement with Farm Credit Mid-America, PCA (Farm Credit) for a $500 million credit facility, consisting of a senior secured term loan (Incremental Term Facility) to retire our existing Senior Notes due August 27, 2021. The Incremental Term Facility bears interest at a floating rate of LIBOR plus 175 basis points and is payable in quarterly installments with a final balloon payment due on August 12, 2028. The terms of the Incremental Term Facility, including pledged collateral and financial maintenance covenants, are generally consistent with the terms of our existing term loan B credit facility (Term Loan B) and revolving credit facility.
Bayer Animal Health Related Financing
In connection with the acquisition of Bayer Animal Health, on August 1, 2020, we borrowed $4,275 million under a Term Loan B facility. The Term Loan B bears interest at a floating rate of LIBOR plus 175 basis points and is payable in quarterly installments through August 1, 2027.
Simultaneously, we entered into a revolving credit facility providing up to $750 million (with incremental capacity available if certain conditions are met) and maturing over a five-year term. The revolving credit facility bears interest at LIBOR plus an applicable margin ranging between 1.50% and 2.25% per annum based on our corporate family rating or corporate credit rating. In February 2021, we drew down $150 million on the revolving credit facility for working capital needs. We subsequently repaid $100 million in March 2021 and the remaining $50 million in April 2021. In August 2021, we drew down $350 million on the revolving credit facility to partially fund the acquisition of KindredBio. We subsequently repaid $100 million in September 2021.
These senior secured first lien credit facilities are secured by a significant portion of our assets. They include two financial maintenance covenants which are solely for the benefit of lenders under the revolving credit facility. There are no financial maintenance covenants for the benefit of the Term Loan B facility. The lenders under the Term Loan B facility have no enforcement rights with respect to the financial maintenance covenants for the revolving credit facility.
The first financial maintenance covenant for the revolving credit facility requires us to maintain a net total leverage ratio level (which is not subject to step-downs) as of the end of each quarter. The required level of this covenant is based on closing date pro forma net leverage and pro forma adjusted earnings before interest, taxes, depreciation and amortization (EBITDA) not exceeding 7.71 to 1.00 of our pro forma adjusted EBITDA for the four fiscal quarters ended September 30, 2021.
The second financial maintenance covenant for the revolving credit facility requires us to maintain a ratio of pro forma adjusted EBITDA to cash interest expense of no less than 2.00 to 1.00, tested as of the end of each fiscal quarter. We were in compliance with all covenants under the credit facility as of September 30, 2021.
Senior Notes
In August 2018, we issued $2 billion of senior notes (Senior Notes). The Senior Notes comprised of $500 million of 3.912% Senior Notes due August 27, 2021, which were fully repaid as part of the Farm Credit refinancing, $750 million of 4.272% Senior Notes due August 28, 2023, and $750 million of 4.900% Senior Notes due August 28, 2028. The interest rate payable on each series of Senior Notes is subject to adjustment if Moody's Investor Services, Inc. or Standard & Poor's Financial Services LLC downgrades, or subsequently upgrades, its ratings on the respective series of Senior Notes.
The indenture that governs the Senior Notes contains covenants that limit our, and certain of our subsidiaries' ability, to incur liens or engage in sale-leaseback transactions. The indenture also contains restrictions on our ability to consolidate, merge or sell substantially all of our assets, in addition, to other customary terms. We were in compliance with all such covenants under the indenture governing the Senior Notes as of September 30, 2021.
TEU Amortizing Notes
On January 22, 2020, we issued $550 million in TEUs. We offered 11 million, 5.00% TEUs at the stated amount of $50 per unit, comprised of prepaid stock purchase contracts and a senior amortizing note due February 1, 2023 (the mandatory settlement date). Total cash of $528 million was received, comprised of $452 million of prepaid stock purchase contracts and $76 million of senior amortizing notes, net of issuance costs. During the three and nine months ended September 30, 2021, we paid $7 million and $21 million, respectively, representing partial payment of principal and interest on the TEU amortizing notes. See Note 7: Equity for further information.
Debt Extinguishment
On January 31, 2020, we repaid indebtedness outstanding under our previous term loan facility. We paid $372 million in cash, composed of $371 million of principal and $1 million of accrued interest, resulting in a debt extinguishment loss of $1 million (recognized in interest expense, net of capitalized interest in our condensed consolidated statements of operations for the nine months ended September 30, 2020), primarily related to the write-off of deferred debt issuance costs.
On September 25, 2020, we made a repayment of principal of $100 million on the indebtedness outstanding under our Term Loan B. The repayment was accounted for as a partial debt extinguishment and resulted in a debt extinguishment loss of $2 million (recognized in interest expense, net of capitalized interest in the condensed consolidated statements of operations for the three and nine months ended September 30, 2020), primarily related to the write-off of deferred debt issuance costs.
Note 9. Financial Instruments and Fair Value
Financial instruments that are potentially subject to credit risk consist principally of trade receivables. We evaluate the creditworthiness of our customers on a regular basis, monitor economic conditions, and calculate allowances for estimated credit losses on our trade receivables on a quarterly basis using an expected credit loss model. We assess whether collectability is probable at the time of sale and on an ongoing basis. Collateral is generally not required. The risk associated with this concentration is mitigated by our ongoing credit-review procedures.
A large portion of our cash is held by a few major financial institutions. We monitor the exposure with these institutions and do not expect any of these institutions to fail to meet their obligations. All highly liquid investments with a maturity of three months or less from the date of purchase are considered to be cash equivalents. The cost of these investments approximates fair value. We also consider the carrying value of restricted cash balances to be representative of its 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 $21 million and $24 million as of September 30, 2021 and December 31, 2020, respectively. Unrealized net gains and losses on our investments for the three and nine months ended September 30, 2021 and 2020 were immaterial.
The following table summarizes the fair value information at September 30, 2021 and December 31, 2020 for foreign exchange contract assets (liabilities), investments, contingent consideration liabilities, and cash flow hedge assets (liabilities) measured at fair value on a recurring basis in the respective balance sheet line items, as well as long-term debt (including TEU amortizing notes) for which fair value is disclosed on a recurring basis:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Fair Value Measurements Using
|
|
|
Financial statement line item
|
|
Carrying
Amount
|
|
Quoted Prices in Active Markets for Identical Assets
(Level 1)
|
|
Significant
Other Observable Inputs
(Level 2)
|
|
Significant
Unobservable
Inputs
(Level 3)
|
|
Fair
Value
|
September 30, 2021
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments
|
|
$
|
30
|
|
|
$
|
—
|
|
|
$
|
30
|
|
|
$
|
—
|
|
|
$
|
30
|
|
Other noncurrent assets - investments
|
|
15
|
|
|
15
|
|
|
—
|
|
|
—
|
|
|
15
|
|
Other current liabilities - foreign exchange contracts not designated as hedging instruments
|
|
(30)
|
|
|
—
|
|
|
(30)
|
|
|
—
|
|
|
(30)
|
|
Other current liabilities - contingent consideration
|
|
(1)
|
|
|
—
|
|
|
—
|
|
|
(1)
|
|
|
(1)
|
|
|
|
|
|
|
|
|
|
|
|
|
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges
|
|
(24)
|
|
|
—
|
|
|
(24)
|
|
|
—
|
|
|
(24)
|
|
Long-term debt, including current portion
|
|
(6,419)
|
|
|
—
|
|
|
(6,551)
|
|
|
—
|
|
|
(6,551)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
December 31, 2020
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Prepaid expenses and other - foreign exchange contracts not designated as hedging instruments
|
|
$
|
36
|
|
|
$
|
—
|
|
|
$
|
36
|
|
|
$
|
—
|
|
|
$
|
36
|
|
Other noncurrent assets - investments
|
|
9
|
|
|
9
|
|
|
—
|
|
|
—
|
|
|
9
|
|
Other current liabilities - foreign exchange contracts not designated as hedging instruments
|
|
(36)
|
|
|
—
|
|
|
(36)
|
|
|
—
|
|
|
(36)
|
|
Other noncurrent liabilities - contingent consideration
|
|
(1)
|
|
|
—
|
|
|
—
|
|
|
(1)
|
|
|
(1)
|
|
Other noncurrent liabilities - forward-starting interest rate contracts designated as cash flow hedges
|
|
(76)
|
|
|
—
|
|
|
(76)
|
|
|
—
|
|
|
(76)
|
|
|
|
|
|
|
|
|
|
|
|
|
Long-term debt, including current portion
|
|
(6,225)
|
|
|
—
|
|
|
(6,420)
|
|
|
—
|
|
|
(6,420)
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities.
Contingent consideration liabilities as of September 30, 2021 and December 31, 2020 related to contingent consideration associated with the acquisitions of Aratana Therapeutics, Inc. (Aratana) and Prevtec Microbia Inc. (Prevtec) during 2019. For Aratana, we will pay up to $12 million in contingent value rights that are dependent on the achievement of a specified milestone by December 31, 2021 as outlined in the merger agreement. For Prevtec, based on the terms of the purchase agreement, we will pay up to $16 million contingent upon the achievement of specific Coliprotec sales milestones by December 31, 2021. The fair value of both contingent consideration liabilities was estimated using the Monte Carlo simulation model and Level 3 inputs including historical revenue, discount rate, asset volatility, and revenue volatility.
Derivative Instruments and Hedging Activities
We are exposed to market risks, such as changes in foreign currency exchange rates and interest rates. To manage the volatility related to these exposures, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at inception. Additionally, we assess, both at inception and at least quarterly thereafter, whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures.
Derivatives Not Designated as Hedges
We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. These derivative financial instruments primarily offset exposures in the British pound, Canadian dollar, Euro, Japanese yen, Swiss franc (CHF), and Chinese yuan. Foreign currency derivatives used for hedging are put in place using the same or like currencies and duration as the underlying exposures and are recorded at fair value with the gain or loss recognized in other (income) expense, net in the condensed consolidated statements of operations. Forward contracts generally have maturities not exceeding 12 months. At September 30, 2021 and December 31, 2020, we had outstanding foreign exchange contracts with aggregate notional amounts of $1,417 million and $1,391 million, respectively.
The amounts of net gain (loss) on derivative instruments not designated as hedging instruments, recorded in other (income) expense, net are as follows:
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|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Foreign exchange forward contracts (1)
|
$
|
(2)
|
|
|
$
|
(2)
|
|
|
$
|
(29)
|
|
|
$
|
19
|
|
(1)These amounts were substantially offset in other (income) expense, net by the effect of changing exchange rates on the underlying foreign currency exposures.
Derivatives Designated as Hedges
In October 2018, as a means of mitigating the impact of currency fluctuations on our operations in Switzerland, we entered into a five-year cross-currency fixed interest rate swap with a 750 million CHF notional amount, which was designated as a net investment hedge (NIH) against CHF denominated assets (the fair value of which was estimated based on quoted market values of similar hedges and was classified as Level 2). During the nine months ended September 30, 2020 we fully liquidated our cross currency interest rate swaps for a cash benefit of $35 million (including $2 million in interest). Notwithstanding settlement, gains and losses within accumulated other comprehensive income (loss) will remain in accumulated other comprehensive income (loss) until either the sale or substantial liquidation of the hedged subsidiary.
Gains on the NIH, recognized within interest expense, net of capitalized interest, are as follows:
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|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Cross-currency interest rate swap contracts
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
6
|
|
Over the life of the derivative, gains or losses due to spot rate fluctuations were recorded in cumulative translation adjustment in other comprehensive income (loss). The amounts of net gains on interest rate swap contracts, recorded, net of tax, in accumulated other comprehensive income (loss), are as follows:
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|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Cross-currency interest rate swap contracts
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
—
|
|
|
$
|
24
|
|
Separately, in March 2020, as a means of mitigating variability in cash flows associated with the anticipated Term Loan B issuance, we executed forward-starting interest rate swaps with a $4.1 billion notional amount, which are designated as cash flow hedges and have maturity dates ranging between 2022 and 2025. These instruments effectively convert floating-rate debt to fixed-rate debt. The cash flow hedges are recorded at fair value on our condensed consolidated balance sheets, while changes in the fair value of the hedge 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. Amounts recorded in accumulated other comprehensive income (loss) are recognized in earnings in interest expense, net of capitalized interest when the hedged transaction affects earnings (i.e., as interest payments are accrued on the Term Loan B).
The amounts of net gains (losses) on cash flow hedges, recorded, net of tax, in accumulated other comprehensive income (loss), are as follows:
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|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Forward-starting interest rate swaps, net of tax benefit of $0, $2, $0 and $20, respectively
|
$
|
4
|
|
|
$
|
(7)
|
|
|
$
|
52
|
|
|
$
|
(67)
|
|
There was no tax effect for the three and nine months ended September 30, 2021 after the application of the U.S. valuation allowance. See Note 10: Income Taxes for further discussion. Over the next 12 months we expect to reclassify $26 million from accumulated other comprehensive income (loss) to interest expense, net of capitalized interest due to the amortization of net losses on the interest rate swaps. During the three and nine months ended September 30, 2021, we reclassified $8 million and $22 million, respectively, of net losses into interest expense.
Note 10. Income Taxes
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|
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|
|
|
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|
|
|
|
Income Tax Benefit
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Income tax benefit
|
|
$
|
(26)
|
|
|
$
|
(74)
|
|
|
$
|
(71)
|
|
|
$
|
(117)
|
|
Effective tax rate
|
|
20.0
|
%
|
|
35.4
|
%
|
|
15.9
|
%
|
|
32.9
|
%
|
|
|
|
|
|
|
|
|
|
|
|
|
|
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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 the IPO, the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. The U.S. examination of tax years 2016 - 2018 began in the fourth quarter of 2019 and remains ongoing; therefore, the resolution of this audit period will likely extend beyond the next 12 months.
For the three and nine months ended September 30, 2021, we recognized an income tax benefit of $26 million and $71 million, respectively. For the three months ended September 30, 2021, our effective tax rate of 20.0% differs from the statutory income tax rate primarily due to preliminary accounting for the acquisition of KindredBio, which caused a partial release of the U.S. federal valuation allowance, as well as profits being located in jurisdictions with higher statutory tax rates. For the nine months ended September 30, 2021, our effective tax rate of 15.9% differs from the statutory income tax rate primarily because the U.S. federal and state jurisdictions are currently generating losses that are subject to valuation allowances.
For the three and nine months ended September 30, 2020, we recognized an income tax benefit of $74 million and $117 million, respectively. For the three and nine months ended September 30, 2020, our effective tax rate of 35.4% and 32.9%, respectively, differs from the statutory income tax rate primarily due to the release of foreign valuation allowances as a result of gains on divestitures. Additionally, the state tax benefit is a result of U.S. pre-tax losses and the foreign tax benefit is due to losses in jurisdictions with tax rates higher than U.S. statutory rates.
Note 11. Commitments and Contingencies
Legal Matters
On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco, Jeffrey Simmons and Todd Young. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco securities between September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana. We filed a motion to dismiss on January 13, 2021. The timing of the Court's decision is uncertain. We believe the claims made in the case are meritless, and we intend to vigorously defend our position. The process of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolution cannot be predicted.
On October 16, 2020, a shareholder class action lawsuit captioned Safron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives, and other individuals. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the registration statement on Form S-3 dated January 21, 2020 and accompanying prospectus filed in connection with Elanco’s public offering which closed on or about January 27, 2020. The 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. This case is currently stayed in deference to Hunter v. Elanco Animal Health Inc.
Claims seeking actual damages, injunctive relief, and/or restitution for allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC, along with other Elanco and Bayer entities, arising out of the use of Seresto™, a non-prescription flea and tick collar for cats and dogs. During the nine months ended September 30, 2021, putative class action lawsuits were filed in state and federal courts in the U.S. alleging that the Seresto collars contain pesticides and other ingredients that can cause serious injury and death to cats and/or dogs wearing the product. The cases mention the existence of incident reports involving humans, but no plaintiff has claimed personal harm from the product. One plaintiff filed a petition before the Judicial Panel on Multidistrict Litigation (JPML). The hearing on the JPML petition took place on July 29, 2021, and a decision was reached to consolidate and transfer all pending lawsuits to the federal court in the Northern District of Illinois. We continue to receive information with respect to potential litigation costs, and we will be taking appropriate steps to defend these class action lawsuits.
Further, a U.S. House of Representative 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. We are continuing to cooperate with the subcommittee and have produced information pursuant to the request.
Seresto is a pesticide registered with the Environmental Protection Agency (EPA). 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. The EPA is considering this petition and asked for public comment. We submitted a comment to the EPA supporting the safety profile of Seresto. All data and scientific evaluation used during the product registration process and through pharmacovigilance review supports the product’s positive safety profile and efficacy. Therefore, we believe no removal, 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.
We are party to various other legal actions in the normal course of business. In determining whether a pending matter is significant for financial reporting and disclosure purposes, we consider both quantitative and qualitative factors in order to assess materiality. We accrue for liability claims to the extent that it is probable we will incur a loss and we can formulate a reasonable estimate of the costs. As of September 30, 2021 and December 31, 2020, we had no material liabilities established related to litigation as there were no significant claims which were probable and estimable. We are not currently subject to a significant claim other than the lawsuits noted above.
Regulatory Matters
On July 1, 2021, we received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We have cooperated in providing documents and information to the SEC and will continue to do so. Management believes that its actions were appropriate.
Note 12. Geographic Information
We operate as a single operating segment engaged in the development, manufacturing, marketing and sales of animal health products worldwide for both farm animals and pets. Consistent with our operational structure, our President and Chief Executive Officer (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 Baycox™, Cydectin™, Denagard™, Maxiban™, Optaflexx™, Rumensin™, Tylan™, and other products for livestock and poultry, as well as Advantage™, Advantix™, Advocate™ (collectively referred to as the Advantage Family), Credelio™, Duramune™, Galliprant™, Interceptor™ Plus, Seresto, Trifexis™, and other products for pets.
We have a single customer that accounted for 11% and 12% of revenue for the three months ended September 30, 2021 and 2020, respectively, and 9% and 12% of revenue for the nine months ended September 30, 2021 and 2020, respectively. Product sales with this customer resulted in accounts receivable of $80 million and $87 million as of September 30, 2021 and December 31, 2020, respectively.
We are exposed to the risk of changes in social, political and economic conditions inherent in foreign operations and our results of operations and the value of our foreign assets are affected by fluctuations in foreign currency exchange rates.
Selected geographic area information was as follows:
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Revenue
|
|
|
|
|
|
|
|
United States
|
$
|
507
|
|
|
$
|
422
|
|
|
$
|
1,621
|
|
|
$
|
970
|
|
International
|
624
|
|
|
468
|
|
|
2,031
|
|
|
1,164
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Revenue
|
$
|
1,131
|
|
|
$
|
890
|
|
|
$
|
3,652
|
|
|
$
|
2,134
|
|
Note 13. Retirement Benefits
The following table summarizes net periodic benefit cost (income) relating to our defined benefit pension plans:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Service cost
|
$
|
4
|
|
|
$
|
3
|
|
|
$
|
14
|
|
|
$
|
8
|
|
Interest cost
|
1
|
|
|
—
|
|
|
2
|
|
|
1
|
|
Expected return on plan assets
|
(2)
|
|
|
(2)
|
|
|
(5)
|
|
|
(4)
|
|
Amortization of prior service cost
|
(1)
|
|
|
(2)
|
|
|
(5)
|
|
|
(6)
|
|
Amortization of net actuarial loss
|
—
|
|
|
1
|
|
|
1
|
|
|
2
|
|
Net curtailments and settlements (Note 5)
|
(9)
|
|
|
—
|
|
|
(26)
|
|
|
—
|
|
Net periodic benefit cost (income)
|
$
|
(7)
|
|
|
$
|
—
|
|
|
$
|
(19)
|
|
|
$
|
1
|
|
The components of net periodic benefit cost other than service cost and net curtailments and settlements are included in other (income) expense, net in our condensed consolidated statements of operations. Net curtailments and settlements are included in asset impairment, restructuring and other special charges, in our condensed consolidated statements of operations.
Note 14. Loss Per Share
We compute basic loss per share by dividing net loss available to common shareholders by the actual weighted average number of common shares outstanding for the reporting period. Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements and the TEU prepaid stock purchase contracts (see Note 7: Equity for further discussion). Diluted earnings per share reflects the potential dilution that could occur if holders of the unvested equity awards and unsettled TEUs converted their holdings into common stock. The weighted average number of potentially dilutive shares outstanding is calculated using the treasury stock method. 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 loss per share.
Basic and diluted loss per share are calculated as follows:
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months Ended September 30,
|
|
Nine Months Ended September 30,
|
|
|
2021
|
|
2020
|
|
2021
|
|
2020
|
Net loss available to common shareholders
|
|
$
|
(104)
|
|
|
$
|
(135)
|
|
|
$
|
(375)
|
|
|
$
|
(237)
|
|
Determination of shares:
|
|
|
|
|
|
|
|
|
Weighted average common shares outstanding
|
|
487.3
|
|
|
462.4
|
|
487.1
|
|
|
426.5
|
Assumed conversion of dilutive common stock equivalents (1)
|
|
—
|
|
|
—
|
|
|
—
|
|
|
—
|
|
Diluted weighted average shares outstanding
|
|
487.3
|
|
|
462.4
|
|
487.1
|
|
|
426.5
|
Loss per share (2)
|
|
|
|
|
|
|
|
|
Basic
|
|
$
|
(0.21)
|
|
|
$
|
(0.29)
|
|
|
$
|
(0.77)
|
|
|
$
|
(0.56)
|
|
Diluted
|
|
$
|
(0.21)
|
|
|
$
|
(0.29)
|
|
|
$
|
(0.77)
|
|
|
$
|
(0.56)
|
|
(1)During the three and nine months ended September 30, 2021 and 2020, we reported a net loss. Therefore, dilutive common stock equivalents are not assumed to have been issued since their effect is anti-dilutive. As a result, basic and diluted weighted average shares are the same, causing diluted net loss per share to be equivalent to basic net loss per share. For the three months ended September 30, 2021 and 2020, approximately 1.7 million and 1.6 million, respectively, of potential common shares were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive. For the nine months ended September 30, 2021 and 2020, approximately 1.6 million and 1.9 million, respectively, of potential common shares were excluded from the calculation of diluted earnings per share because their effect was anti-dilutive.
(2)Due to rounding conventions, loss per share may not recalculate precisely based on the amounts presented within this table.
Note 15. Transactions and Agreements with Bayer
While Bayer is no longer considered a related party, we have transacted with Bayer during the period after the acquisition of Bayer Animal Health, including the period in which Bayer was considered a principal owner of Elanco. These transactions primarily related to local country asset purchases and various transitional services agreements (TSAs), contract manufacturing arrangements, and certain lease agreements to ensure business continuity after the acquisition.
For regulatory purposes in certain jurisdictions, consideration was required to be paid locally at closing in addition to amounts paid globally for the acquisition. Pursuant to the stock and asset purchase agreement, Bayer has provided a refund for payment amounts duplicated in these regions. The total amount paid to and received from Bayer during the nine months ended September 30, 2021 for these local country asset purchases was approximately $16 million. All local country asset purchases have been completed as of September 30, 2021.