Elanco Animal Health Inc. — Q1 2019 Form 10-Q
Reporting period: Three months ended March 31, 2019; comparisons are with the three months ended March 31, 2018. Elanco is a global animal-health company operating in more than 90 countries. Lilly completed its full divestiture of Elanco on March 11, 2019. The prior-period statements are combined results from when Elanco was part of Lilly, so they may not be directly comparable with results as an independent public company.
Financial performance
| Metric | Q1 2019 | Q1 2018 |
|---|---|---|
| Revenue | $731.1 million | $736.2 million |
| Gross profit / gross margin | $387.3 million / approximately 53% | $376.2 million / approximately 51% |
| Income before tax | $44.8 million | $77.5 million |
| Net income | $31.5 million | $72.7 million |
| Diluted EPS | $0.09 | $0.25 |
| Operating cash flow | $5.6 million | $47.0 million |
| Capital expenditures | $28.0 million | $32.7 million |
Revenue declined 1% year over year: 2% higher volume was more than offset by a 3% unfavorable foreign-exchange impact, with no overall price impact. Cost of sales fell 5%, improving gross margin by about 2 percentage points. Net income declined as higher special charges, new interest expense and a higher effective tax rate more than offset the gross-margin improvement. Asset impairment, restructuring and other special charges were $24.9 million, versus $2.4 million; integration costs, including standalone-company setup, were the main driver. Interest expense was $20.8 million, compared with none in Q1 2018. The effective tax rate was 29.7%, versus 6.2%, primarily reflecting different one-time and valuation-allowance effects.
Revenue mix and material changes
- Companion Animal Disease Prevention: $185.9 million, down 8%, with declines in older parasiticides and vaccines partly offset by growth in Credelio and Interceptor Plus.
- Companion Animal Therapeutics: $81.4 million, up 31%, primarily on Galliprant and Atopica sales; Galliprant backorders were resolved and the product launched in additional European markets.
- Food Animal Future Protein & Health: $167.2 million, essentially flat; aqua and poultry vaccine growth was offset by foreign exchange and purchasing timing.
- Food Animal Ruminants & Swine: $274.1 million, down 3%; management cited softer international swine antibiotic demand, including effects from African Swine Fever and antimicrobial policies.
- U.S. revenue was $383.9 million, up from $360.0 million; international revenue was $347.2 million, down from $376.2 million.
Liquidity, debt and cash
At March 31, 2019, cash and cash equivalents were $272.1 million and restricted cash was $28.5 million. Current assets were $2.278 billion and current liabilities were $708.2 million. Total debt was $2.466 billion, including a $485.0 million variable-rate term facility and senior notes due 2021, 2023 and 2028; the company also had a $750 million revolving credit facility. Cash, cash equivalents and restricted cash decreased $376.9 million during the quarter. Financing cash outflows included $175.1 million of separation consideration paid to Lilly and other Lilly-related financing flows. Management said $156.4 million of net financing outflows with Lilly was expected to be repaid in Q2 2019.
Operating cash flow fell to $5.6 million, principally due to lower net income and working-capital movements, including higher receivables and lower payables. Management stated that cash, operating cash flow and financing arrangements were expected to cover needs for at least the next 12 months. The company estimated annual interest expense of approximately $85 million.
Outlook, risks and unusual items
- No specific revenue or earnings guidance is stated in the provided filing text. Elanco estimated total standalone setup costs of $240 million to $290 million, net of potential real-estate dispositions; some costs will be capitalized and the remainder expensed. The company expected temporary duplicate expenses as it replaces Lilly-provided services.
- Elanco remained party to transition and other arrangements with Lilly. Fees under the transition services agreement are based on Lilly’s cost through March 31, 2021, then include a 7% markup, with inflation-based escalation beginning in 2022.
- Foreign-exchange exposure is significant: about 42% of Q1 2019 revenue was denominated in foreign currencies. Management estimated that a hypothetical 10% adverse movement in relevant currencies would reduce quarterly net income by approximately $11.9 million. A Swiss-franc net-investment hedge has potential significant settlement exposure in 2023.
- Other cited risks include competition and generics, product safety or efficacy concerns, regulation of antibiotics in food animals, animal-disease outbreaks, customer and distributor consolidation, emerging-market and macroeconomic conditions, tariffs and trade disputes, and execution of standalone operations and acquisitions. The filing also discusses uncertainty around Brexit and potential effects on product approvals, trade and currencies.
- On April 26, 2019, Elanco agreed to acquire Aratana Therapeutics. The proposed consideration included 0.1481 Elanco shares and a contingent value right per Aratana share, with a maximum aggregate contingent payment of approximately $12 million. Closing was expected mid-2019, subject to customary conditions and approvals.
- The company reported no significant probable and estimable litigation liabilities and no material off-balance-sheet arrangements. It adopted the new lease standard on January 1, 2019, recording $84.9 million of right-of-use assets and $85.3 million of lease liabilities.
Facts investors should verify
- Whether revenue and margins sustain improvement after currency effects and category-level declines, particularly in disease prevention and international food animal markets.
- How much of the $240 million to $290 million standalone setup-cost estimate is expensed, when costs are incurred, and whether the expected savings and transition away from Lilly services materialize.
- Q2 repayment and settlement of the $156.4 million Lilly-related financing outflow, as well as liquidity and working-capital trends.
- Debt-service capacity, variable-rate exposure and actual interest expense versus the approximately $85 million annual estimate.
- Completion, dilution, integration costs and anticipated benefits of the Aratana acquisition.
- Potential foreign-exchange effects, the 2023 Swiss-franc hedge settlement exposure, and developments affecting Brexit-related regulatory and market risks.