Elanco Animal Health Inc. — Q3 2019 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2019. Elanco is a global animal-health company serving companion- and food-animal markets. The 2018 comparative results are combined historical results from before the company’s separation from Lilly; 2019 results are consolidated, with some transition effects affecting comparability.
Financial performance
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $771.3 million | $761.1 million | $2,284.0 million | $2,267.5 million |
| Income before tax | $(12.5) million | $78.8 million | $82.5 million | $116.3 million |
| Income tax (benefit) expense | $(22.5) million | $18.6 million | $5.1 million | $46.2 million |
| Net income | $10.0 million | $60.2 million | $77.4 million | $70.1 million |
| Diluted EPS | $0.03 | $0.20 | $0.21 | $0.24 |
| Operating cash flow | Not separately stated | Not separately stated | $97.8 million | $347.8 million |
Margins and expenses: Cost of sales was 47% of revenue in Q3 versus 49% a year earlier, and 46% for the nine-month period versus 51%. Gross margin therefore improved on this measure, primarily reflecting manufacturing productivity. Special charges rose to $77.2 million in Q3 and $133.9 million for nine months, largely from acquisition and integration activity, separation-related systems work, restructuring, impairments and asset write-downs. Interest expense was $18.7 million in Q3 and $60.2 million for nine months.
Cash, debt and liquidity: September 30 cash and cash equivalents were $309.2 million, with $11.1 million restricted cash. Total debt was $2,360.1 million, including $24.5 million current debt; long-term debt was $2,335.6 million. Current assets were $2,310.4 million and current liabilities $741.5 million. Operating cash flow fell $250.0 million year over year, primarily due to increases in receivables, inventories and other assets and lower other liabilities. Investing used $160.5 million; financing used $298.6 million. Management said available cash, operating cash flow and financing arrangements should support needs for at least the next 12 months.
Changes and operating trends
- Revenue grew 1% in both Q3 and the first nine months. For nine months, growth reflected higher volume and price, partly offset by a 2% unfavorable foreign-exchange effect.
- Q3 category revenue: Companion Animal Disease Prevention $207.6 million (+10%); Companion Animal Therapeutics $87.6 million (+9%); Food Animal Future Protein & Health $191.5 million (+18%); Food Animal Ruminants & Swine $266.2 million (−12%). Strategic-exit revenue was $18.4 million.
- Growth in companion-animal products and Future Protein & Health was offset by weakness in Ruminants & Swine. Management cited African swine fever in Asia, supply disruption for certain injectable cattle products, lower U.S. Paylean use, distributor purchasing changes, and Australian drought. Q3 Future Protein & Health benefited from certain one-time sales and favorable prior-year comparisons.
- Nine-month net income increased to $77.4 million from $70.1 million despite lower pretax income, reflecting lower tax expense. Q3 pretax loss compared with prior-year pretax income; the quarter included a $22.5 million tax benefit.
- Aratana and Prevtec were acquired during Q3. Aratana added $3.8 million of revenue in the quarter; the filing does not provide a comparable standalone revenue contribution for Prevtec.
Outlook, transactions and risks
- No formal revenue or earnings guidance is provided in the filing. Management estimated annual interest expense of approximately $85 million based on debt outstanding at September 30, 2019, and estimated standalone “stand up” costs of $240 million to $290 million, net of potential real-estate dispositions and employee-benefit changes; part may be capitalized.
- Elanco agreed to acquire Bayer’s animal-health business for $5.3 billion cash and approximately $2.3 billion in Elanco stock, subject to customary adjustments and closing conditions, including antitrust approvals. Closing was not expected before July 1, 2020. Financing commitments included a $750 million revolving facility, $3.0 billion term facility and $2.75 billion bridge facility. A $40.4 million commitment fee would become payable upon closing or termination of the purchase agreement.
- In September, Elanco initiated restructuring across multiple locations and functions, including exiting R&D operations in Prince Edward Island, ceasing certain Wusi, China manufacturing, and streamlining operations in Speke, England. Substantial completion was expected by September 2020.
- Key risks include acquisition approval, financing, integration and leverage; dilution from shares to be issued to Bayer; generic competition and product patent expirations; foreign-exchange and interest-rate exposure; distributor inventory and payment-term effects on cash flow; supply disruptions; animal disease and weather; regulatory restrictions; and Brexit-related uncertainty. One customer accounted for 15.9% of Q3 revenue.
- Management reported disclosure controls and procedures were effective as of September 30, 2019, with no material change in internal control over financial reporting during the quarter. No significant litigation liability was recorded.
Investor verification priorities
- Track whether category growth—particularly companion-animal and Future Protein & Health—can offset continuing Ruminants & Swine weakness.
- Verify operating cash-flow recovery and working-capital trends, especially receivables, inventory and customer payment terms.
- Assess the timing, approvals, financing terms, final consideration and integration costs of the Bayer transaction, including the expected debt burden and share dilution.
- Monitor the scale and duration of separation, acquisition, restructuring and impairment charges against management’s estimated standalone costs.
- Review the sustainability of reported earnings and tax effects, including the Brazil tax-audit benefit and other unusual items.