Elanco Animal Health Inc. — Q3 2020 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2020. Elanco is a global animal-health company serving pet and farm-animal markets. Results include Bayer Animal Health from its August 1, 2020 acquisition date.
Financial performance
| Metric | Q3 2020 | Q3 2019 | Nine months 2020 | Nine months 2019 |
|---|---|---|---|---|
| Revenue | $889.6 million | $771.3 million | $2,133.6 million | $2,284.0 million |
| Net income (loss) | $(135.0) million | $10.0 million | $(237.3) million | $77.4 million |
| Diluted EPS | $(0.29) | $0.03 | $(0.56) | $0.21 |
| Operating cash flow | Not stated separately | Not stated separately | $51.9 million | $97.8 million |
- Q3 revenue rose 15%, including $195.6 million from Bayer Animal Health; the company attributed the increase to 14% volume growth and 2% price growth, partly offset by foreign exchange.
- Nine-month revenue fell 7%, reflecting lower volume and unfavorable currency effects, partly offset by price. Farm Animal Ruminants & Swine revenue declined 13%; Pet Health Disease Prevention was nearly flat.
- Q3 gross margin was approximately 50% of revenue, versus 53% in Q3 2019. For the first nine months, it was approximately 50%, versus 54%. Bayer inventory fair-value step-up amortization added about $33.1 million to cost of sales; excluding it, cost of sales was approximately 45.9% of Q3 revenue and 48.6% year to date.
- Cash and cash equivalents were $659.9 million at September 30, 2020, versus $334.0 million at year-end 2019. Net operating cash flow was positive, while investing cash outflow of $4.71 billion was driven primarily by the Bayer acquisition.
- Total debt was $6.14 billion, including $553.6 million current and $5.59 billion long-term, compared with $2.36 billion at December 31, 2019. Management estimated annual interest expense of approximately $210 million based on September debt levels.
- Total assets were $17.24 billion and total equity was $8.34 billion at September 30, 2020. Inventory increased to $1.60 billion from $1.05 billion at year-end.
Material changes and unusual items
- Elanco acquired Bayer Animal Health for preliminary total consideration of $6.89 billion: $5.17 billion cash and approximately 72.9 million Elanco shares. The acquisition expanded pet-health offerings and international and direct-to-retailer/e-commerce reach; purchase accounting remained preliminary.
- Q3 asset impairment, restructuring and other special charges were $262.2 million, versus $77.2 million a year earlier; nine-month charges were $456.4 million, versus $133.9 million. They included acquisition/integration costs and restructuring charges.
- Other income included $156.4 million of pretax gains, net of transaction costs, from product divestitures. The nine-month period also included a $45.6 million gain on an Australian sale-leaseback. These gains helped offset operating costs but did not prevent a net loss.
- Q3 interest expense increased to $48.1 million from $18.7 million, mainly due to acquisition financing. Cost growth also reflected Bayer-related amortization, higher marketing and administrative expenses, and the inventory step-up.
- Q3 revenue grew in Pet Health Disease Prevention (+43%) and Farm Animal Ruminants & Swine (+10%), but Farm Animal Future Protein & Health declined 6%. Bayer contributed to growth in the quarter, so reported comparisons are not fully like-for-like.
Outlook, risks and contingencies
- Management said cash, operating cash flows and financing arrangements should cover expected needs for at least the next 12 months, and reported compliance with credit-facility covenants at September 30. The filing provides no clear numerical earnings or revenue guidance; management expected pandemic-related demand pressure, particularly in farm animal markets, to continue through year-end.
- A post-acquisition restructuring targets approximately 900 positions in 40 countries. Expected total charges are $190–$210 million through 2021, primarily severance; $131.6 million of severance reserves remained at quarter-end.
- Estimated standalone-company transition costs were revised to $280–$320 million, net of completed and potential real-estate dispositions and employee-benefit changes. Management cited added IT deployment and site-transition costs.
- COVID-19 risks include weaker demand tied to veterinary visits, food-service consumption and producer economics; possible supplier, freight and distribution disruption; and customer collection or liquidity pressure. Elanco reported no significant COVID-related supply-chain interruption in Q3 and no material collection issues at that time.
- Risks also include acquisition integration and synergy delivery, competition and generic products, foreign exchange and floating-rate debt, and dependence on transitional services from Bayer. Two shareholder class actions allege misleading disclosures concerning supply chain, inventory, revenue, projections or distributor relationships. The company said it intended to defend the claims; outcomes were uncertain, and no material litigation liabilities were recorded.
- One customer represented 11.7% of Q3 revenue and 11.9% of nine-month revenue in 2020.
Important facts for investors to verify
- How much of future revenue and earnings growth comes from Bayer, and whether integration synergies offset acquisition-related costs and higher debt service.
- Progress on restructuring, including actual cash costs, timing of the 900 planned position reductions, and the $190–$210 million charge estimate.
- Whether channel inventory reductions, COVID-related demand pressure and customer collections improve or further affect revenue and operating cash flow.
- Debt repayment capacity, floating-rate exposure, covenant headroom and the accuracy of the estimated annual interest burden.
- Final Bayer purchase-price allocation, including acquired intangible values, goodwill and inventory step-up amortization, and developments in the shareholder lawsuits.