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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT UNDER SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2022
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from _________ to _______
COMMISSION FILE NUMBER 001-38661
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Elanco Animal Health Incorporated
(Exact name of Registrant as specified in its charter)
INDIANA
 82-5497352
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification No.)
2500 INNOVATION WAY, GREENFIELD, INDIANA 46140
(Address and zip code of principal executive offices)

Registrant’s telephone number, including area code (877352-6261
Securities registered pursuant to Section 12(b) of the Act:
Title of each classTrading Symbol(s)Name of each exchange on which registered
Common stock, no par valueELANNew York Stock Exchange
5.00% Tangible Equity UnitsELATNew York Stock Exchange
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes No
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of a “large accelerated filer,” “accelerated filer,” “smaller reporting company” and "emerging growth company" in Rule 12b-2 of the Exchange Act.
Large accelerated filer
Accelerated filer
Non-accelerated filer
Smaller reporting company
Emerging growth company



If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act.
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
Yes No
The number of shares of common stock outstanding as of November 3, 2022 was 474,205,430.
2022 Q3 Form 10-Q | 2
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ELANCO ANIMAL HEALTH INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2022
TABLE OF CONTENTS
Item 1.
Item 2.
Item 3.
Item 4.
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

2022 Q3 Form 10-Q | 3
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FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY

This Quarterly Report on Form 10-Q (Form 10-Q) includes forward-looking statements within the meaning of the federal securities laws. These forward-looking statements, include, without limitation, statements concerning the impact on Elanco Animal Health Incorporated and its subsidiaries (collectively, Elanco, the Company, we, us or our) caused by the integration of Kindred Biosciences, Inc. (KindredBio) and the animal health business of Bayer Aktiengesellschaft (Bayer), expected synergies and cost savings, product launches, the coronavirus (COVID-19) global pandemic, conflict involving Russia and Ukraine and the potential impact on our business and global economic conditions, reduction of debt, expectations relating to liquidity and sources of capital, our expected compliance with debt covenants, cost savings, expenses, and reserves relating to restructuring actions, our industry and our operations, performance and financial condition, and including, in particular, statements relating to our business, growth strategies, distribution strategies, product development efforts and future expenses.

Forward-looking statements are based on our current expectations and assumptions regarding our business, the economy and other future conditions. Because forward-looking statements relate to the future, by their nature, they are subject to inherent uncertainties, risks and changes in circumstances that are difficult to predict. As a result, our actual results may differ materially from those contemplated by the forward-looking statements. Important risk factors that could cause actual results to differ materially from those in the forward-looking statements include regional, national, or global political, economic, business, competitive, market, and regulatory conditions, including but not limited to the following:
heightened competition, including from generics;
the impact of disruptive innovations and advances in veterinary medical practices, animal health technologies and alternatives to animal-derived protein;
changes in regulatory restrictions on the use of antibiotics in farm animals;
our ability to implement our business strategies or achieve targeted cost efficiencies and gross margin improvements;
consolidation of our customers and distributors;
an outbreak of infectious disease carried by farm animals;
the impact on our operations, the supply chain, customer demand, and our liquidity as a result of the COVID-19 global health pandemic;
the potential impact on our business and global economic conditions resulting from the conflict involving Russia and Ukraine;
the success of our R&D and licensing efforts;
misuse, off-label or counterfeiting use of our products;
unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
fluctuations in our business results due to seasonality and other factors;
the impact of weather conditions and the availability of natural resources;
risks related to the modification of foreign trade policy;
risks related to currency rate fluctuations;
our dependence on the success of our top products;
the impact of customer exposure to rising costs and reduced customer income;
the lack of availability or significant increases in the cost of raw materials;
use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
risks related to the write-down of goodwill or identifiable intangible assets;
risks related to the evaluation of animals;
manufacturing problems and capacity imbalances;
2022 Q3 Form 10-Q | 4
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the impact of litigation, regulatory investigations, and other legal matters, including the risk to our reputation and the risk that our insurance policies may be insufficient to protect us from the impact of such matters;
actions by regulatory bodies, including as a result of their interpretation of studies on product safety;
risks related to tax expense or exposure;
risks related to environmental, health and safety laws and regulations;
risks related to our presence in foreign markets;
challenges to our intellectual property rights or our alleged violation of rights of others;
our dependence on sophisticated information technology and infrastructure and the impact of breaches of our information technology systems;
the impact of increased regulation or decreased financial support related to farm animals;
adverse effects of labor disputes, strikes, work stoppages, and the loss of key personnel or highly skilled employees;
risks related to underfunded pension plan liabilities;
our ability to complete acquisitions and successfully integrate the businesses we acquire, including KindredBio and the animal health business of Bayer (Bayer Animal Health);
the effect of our substantial indebtedness on our business, including restrictions in our debt agreements that will limit our operating flexibility; and
risks related to certain governance provisions in our constituent documents.
See Item 1A, “Risk Factors,” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2021 filed with the United States (U.S.) Securities and Exchange Commission (SEC) (2021 Form 10-K), and Part II of this Form 10-Q, for a further description of these and other factors. Although we have attempted to identify important risk factors, there may be other risk factors not presently known to us or that we presently believe are not material that could cause actual results and developments to differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. If any of these risks materialize, or if any of the assumptions underlying forward-looking statements prove incorrect, actual results and developments may differ materially from those made in or suggested by the forward-looking statements contained in this quarterly report. We caution you against relying on any forward-looking statements, which should also be read in conjunction with the other cautionary statements that are included elsewhere in this quarterly report. Any forward-looking statement made by us in this quarterly report speaks only as of the date hereof. Factors or events that could cause our actual results to differ may emerge from time to time, and it is not possible for us to predict all of them. We undertake no obligation to publicly update or to revise any forward-looking statement, whether as a result of new information, future developments or otherwise, except as may be required by law.


2022 Q3 Form 10-Q | 5
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PART I

ITEM 1. FINANCIAL STATEMENTS

Elanco Animal Health Incorporated
Condensed Consolidated Statements of Operations (Unaudited)
(in millions, except per-share data)
 Three Months Ended September 30,Nine Months Ended September 30,
 2022202120222021
Revenue$1,028 $1,131 $3,430 $3,652 
Costs, expenses and other:
Cost of sales472 502 1,465 1,622 
Research and development78 94 241 277 
Marketing, selling and administrative298 342 961 1,075 
Amortization of intangible assets
128 141 398 417 
Asset impairment, restructuring and other special charges
26 111 158 518 
Interest expense, net of capitalized interest60 60 179 181 
Other expense, net8 11 17 8 
1,070 1,261 3,419 4,098 
Income (loss) before income taxes(42)(130)11 (446)
Income tax expense (benefit)7 (26)34 (71)
Net loss$(49)$(104)$(23)$(375)
Loss per share:
Basic $(0.10)$(0.21)$(0.05)$(0.77)
Diluted$(0.10)$(0.21)$(0.05)$(0.77)
Weighted average shares outstanding:
Basic488.4 487.3 488.3 487.1 
Diluted488.4 487.3 488.3 487.1 
See notes to condensed consolidated financial statements.
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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(in millions)
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
Net loss$(49)$(104)$(23)$(375)
Other comprehensive income (loss):
Cash flow hedges, net of taxes62 4 179 52 
Foreign currency translation(418)(209)(973)(506)
Defined benefit pension and retiree health benefit plans, net of taxes(2)(6)(4)5 
Other comprehensive loss, net of taxes(358)(211)(798)(449)
Comprehensive loss$(407)$(315)$(821)$(824)
See notes to condensed consolidated financial statements.

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Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions, except share data)
September 30, 2022December 31, 2021
(Unaudited)
Assets 
Current Assets
Cash and cash equivalents$460 $638 
Accounts receivable, net of allowances of $10 (2022) and $12 (2021)
804 833 
Other receivables224 195 
Inventories1,340 1,373 
Prepaid expenses and other326 237 
Total current assets3,154 3,276 
Noncurrent Assets
Goodwill5,716 6,172 
Other intangibles, net4,766 5,587 
Other noncurrent assets376 387 
Property and equipment, net of accumulated depreciation of $696 (2022) and $1,041 (2021)
936 1,061 
Total assets$14,948 $16,483 
Liabilities and Equity
Current Liabilities
Accounts payable$350 $418 
Employee compensation136 185 
Sales rebates and discounts298 316 
Current portion of long-term debt394 294 
Other current liabilities435 430 
Total current liabilities1,613 1,643 
Noncurrent Liabilities
Long-term debt5,507 6,025 
Accrued retirement benefits 240 271 
Deferred taxes618 745 
Other noncurrent liabilities225 261 
Total liabilities8,203 8,945 
Commitments and Contingencies
Equity
Preferred stock, no par value, 1,000,000,000 shares authorized; none issued
  
Common stock, no par value, 5,000,000,000 shares authorized, 474,124,115 and 473,119,786 shares issued and outstanding as of September 30, 2022 and December 31, 2021, respectively
  
Additional paid-in capital8,724 8,696 
Accumulated deficit(972)(949)
Accumulated other comprehensive loss(1,007)(209)
Total equity6,745 7,538 
Total liabilities and equity$14,948 $16,483 
See notes to condensed consolidated financial statements.
2022 Q3 Form 10-Q | 8
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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)
Common StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional Paid-in CapitalAccumulated DeficitCash Flow Hedge Gain (Loss)Foreign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2020
471.9 $ $8,650 $(477)$(61)$360 $4 $303 $8,476 
Net loss— — — (61)— — — — (61)
Other comprehensive income (loss), net of tax— — — — 53 (466)8 (405)(405)
Stock compensation — — 15 — — — — — 15 
Issuance of stock under employee stock plans, net1.1 — (18)— — — — — (18)
March 31, 2021473.0  8,647 (538)(8)(106)12 (102)8,007 
Net loss— — — (210)— — — — (210)
Other comprehensive income (loss), net of tax— — — — (5)169 3 167 167 
Stock compensation— — 16 — — — — — 16 
June 30, 2021473.0  8,663 (748)(13)63 15 65 7,980 
Net loss— — — (104)— — — — (104)
Other comprehensive income (loss), net of tax— — — — 4 (209)(6)(211)(211)
Stock compensation— — 17 — — — — — 17 
September 30, 2021473.0 $ $8,680 $(852)$(9)$(146)$9 $(146)$7,682 
December 31, 2021
473.1 $ $8,696 $(949)$25 $(253)$19 $(209)$7,538 
Net income— — — 48 — — — — 48 
Other comprehensive income (loss), net of tax— — — — 109 (85)(1)23 23 
Stock compensation— — 14 — — — — — 14 
Issuance of stock under employee stock plans, net1.0 — (11)— — — — — (11)
March 31, 2022474.1  8,699 (901)134 (338)18 (186)7,612 
Net loss— — — (22)— — — — (22)
Other comprehensive income (loss), net of tax— — — — 8 (470)(1)(463)(463)
Stock compensation— — 17 — — — — — 17 
Issuance of stock under employee stock plans, net— — (4)— — — — — (4)
June 30, 2022474.1  8,712 (923)142 (808)17 (649)7,140 
Net loss— — — (49)— — — — (49)
Other comprehensive income (loss), net of tax— — — — 62 (418)(2)(358)(358)
Stock compensation— — 13 — — — — — 13 
Issuance of stock under employee stock plans, net— — (1)— — — — (1)
September 30, 2022474.1 $ $8,724 $(972)$204 $(1,226)$15 $(1,007)$6,745 

See notes to condensed consolidated financial statements.
2022 Q3 Form 10-Q | 9
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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)
Nine Months Ended September 30,
 20222021
Cash Flows from Operating Activities
Net loss$(23)$(375)
Adjustments to reconcile net loss to cash flows from operating activities:
Depreciation and amortization514 542 
Deferred income taxes(36)(119)
Stock-based compensation expense44 48 
Asset impairment and write-down charges87 334 
Loss on sale of assets3  
Loss (gain) on divestiture(3)2 
Inventory fair value step-up amortization 64 
Loss on extinguishment of debt19  
Proceeds from interest rate swap settlements207  
Changes in operating assets and liabilities, net of acquisitions
(384)(243)
Other non-cash operating activities, net11 7 
Net Cash Provided by Operating Activities439 260 
Cash Flows from Investing Activities
Net purchases of property and equipment(71)(60)
Cash paid for acquisitions, net of cash acquired (342)
Proceeds from site divestitures11  
Purchases of intangible assets(11)(35)
Purchases of software(23)(11)
Other investing activities, net(9)(8)
Net Cash Used for Investing Activities(103)(456)
Cash Flows from Financing Activities
Proceeds from issuance of long-term debt425 500 
Proceeds from revolving credit facility563 500 
Repayments of long-term borrowings(607)(555)
Repayments of revolving credit facility(813)(250)
Debt issuance costs(2)(1)
Early redemption and tender premiums paid(14) 
Other net financing transactions with Lilly  (11)
Other financing activities, net(17)(17)
Net Cash (Used for) Provided by Financing Activities(465)166 
Effect of exchange rate changes on cash and cash equivalents(49)(23)
Net decrease in cash and cash equivalents(178)(53)
Cash and cash equivalents at January 1638 506 
Cash and cash equivalents at September 30$460 $453 

See notes to condensed consolidated financial statements.
2022 Q3 Form 10-Q | 10
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Elanco Animal Health Incorporated
Notes to Condensed Consolidated Financial Statements (Unaudited)
(Tables present dollars and shares in millions, except per-share and per-unit data)

Note 1. Background

Elanco is a global animal health company that innovates, develops, manufactures and markets products for pets and farm animals. We offer a portfolio of approximately 200 brands to pet owners, veterinarians and farm animal producers in more than 90 countries. Our products are generally sold worldwide directly to wholesalers, distributors, and independent retailers. Certain products are also sold directly to farm animal producers and veterinarians. We have a diversified business of products across species consisting of: dogs and cats (collectively, pet health) and cattle, poultry, swine and aqua (collectively, farm animal).

Elanco was incorporated in Indiana on September 18, 2018, and prior to that was a business unit of Eli Lilly and Company (Lilly).

Note 2. Basis of Presentation and Summary of Significant Accounting Policies

We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the 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 Form 10-Q should be read in conjunction with our consolidated financial statements and accompanying notes for the year ended December 31, 2021 included in our Form 10-K filed with the SEC on February 28, 2022 (2021 Form 10-K). In addition, results for interim periods should not be considered indicative of results for any other interim period or for the full year ending December 31, 2022 or any other future period.

In our opinion, the financial statements reflect all adjustments (including those that are normal and recurring) that are necessary for fair presentation of the results of operations for the periods shown. In preparing financial statements in conformity with GAAP, we must make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expenses, and related disclosures at the date of the financial statements and during the reporting period. Actual results could differ from those estimates. Certain reclassifications of prior year information have been made to conform to the current year's presentation.

The significant accounting policies set forth in Note 3 to the consolidated financial statements in our 2021 Form 10-K appropriately represent, in all material respects, the current status of our accounting policies, except as it relates to goodwill and the adoption of the standard that was effective January 1, 2022 as described in Note 3: Implementation of New Financial Accounting Pronouncements.

Goodwill

Goodwill is recorded as the difference, if any, between the aggregate consideration paid for an acquisition and the fair value of the net tangible and intangible assets acquired. We evaluate goodwill for impairment at least annually and when certain qualitative impairment indicators are present. When required, a comparison of fair value to the carrying amount of our single reporting unit is performed to determine the amount of any impairment. We begin by assessing qualitative factors to determine whether it is more likely than not that the fair value of our single reporting unit is less than its carrying value. Based on that qualitative assessment, if we conclude that it is more likely than not that the fair value of our single reporting unit is less than its carrying value, we conduct a quantitative goodwill impairment test, which involves comparing the estimated fair value of our single reporting unit with its carrying value, including goodwill. We estimate the fair value of our single reporting unit using a combination of the income and market approach. If the carrying value of the reporting unit exceeds its estimated fair value, we recognize an impairment loss for the difference.

During the third quarter of 2022, a significant change in our market capitalization relative to our book value, among other factors, triggered a quantitative goodwill impairment test. As of September 30, 2022, our single reporting unit was tested for impairment using the quantitative approach described above, resulting in an estimated fair value that exceeded the carrying amount by more than 20%. Therefore, no impairment existed with respect to our goodwill.
2022 Q3 Form 10-Q | 11
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Note 3. Implementation of New Financial Accounting Pronouncements

The following table provides a brief description of an accounting standard that was effective January 1, 2022 and was adopted on that date:
StandardDescriptionEffect on the financial statements or other significant matters
ASU 2021-10, Government Assistance (Topic 832)
The amendments in this update require annual disclosure of transactions with governments that are accounted for by applying a grant or contribution model. The new pronouncement requires entities to provide information about the nature, terms and conditions associated with the transactions and the financial statement line items affected.The adoption of this guidance did not have a material impact on our consolidated financial statements.

The following table provides a brief description of an accounting standard that is applicable to us but has not yet been adopted:
StandardDescriptionEffective DateEffect on the financial statements or other significant matters
ASU 2020-04, Reference rate reform (Topic 848) - Facilitation of the Effects of Reference Rate Reform on Financial Reporting; ASU 2021-01, Reference Rate Reform (Topic 848): Scope
ASU 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.Adoption of the guidance is optional and effective as of March 12, 2020 through December 31, 2022. Adoption is permitted at any time during the period on a prospective basis.
Our current credit facilities reference London Inter-Bank Offered Rate (LIBOR) as a benchmark rate. The underlying credit agreements include provisions which outline criteria for establishing a consistent replacement benchmark rate in the event that LIBOR is discontinued. Therefore, it is unlikely that we will need to adopt this optional guidance. However, we will continue to evaluate the impact as reference rate reform activities occur.

Note 4. Revenue

Our sales rebates and discounts are based on specific agreements. The most significant of our sales rebate and discount programs in terms of accrual and payment amounts, percentage of our products that are sold via these programs, and level of judgment required in estimating the appropriate transaction price, relate to our programs in the U.S., France and the United Kingdom (U.K.). As of September 30, 2022 and 2021, the aggregate liability for sales rebates and discounts for these countries represented approximately 76% and 72%, respectively, of our total liability.

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The following table summarizes the activity in our global sales rebates and discounts liability:
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
Beginning balance$284 $303 $316 $295 
Reduction of revenue169 163 524 516 
Payments(143)(146)(525)(489)
Foreign currency translation adjustments(12)(4)(17)(6)
Ending balance$298 $316 $298 $316 

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, 2022 and 2021 for product shipped in previous periods were not material.

Actual global product returns were approximately 1% and 2% of net revenue for the three months ended September 30, 2022 and 2021, respectively. Actual global product returns were approximately 1% of net revenue for the nine months ended September 30, 2022 and 2021.

Disaggregation of Revenue

The following table summarizes our revenue disaggregated by product category:
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
Pet Health$471 $527 $1,722 $1,857 
Farm Animal:
Cattle227 250 722 735 
Poultry176 179 529 536 
Swine95 110 284 346 
Aqua47 44 132 111 
Total Farm Animal545 583 1,667 1,728 
Contract Manufacturing (1)
12 21 41 67 
Revenue$1,028 $1,131 $3,430 $3,652 
(1)Represents revenue from arrangements in which we manufacture products on behalf of a third party, including supply agreements associated with divestitures of products related to the acquisition of Bayer Animal Health.

Note 5. Acquisitions, Divestitures and Other Arrangements

KindredBio Acquisition

On August 27, 2021, we acquired KindredBio, a publicly traded biopharmaceutical company that developed 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.

The transaction was accounted for as a business combination under the acquisition method of accounting. The acquisition method requires, among other things, that assets acquired and liabilities assumed in a business combination be recognized at their fair values as of the acquisition date. The determination of estimated fair value requires management to make significant estimates and assumptions. The excess of the purchase price over the fair value of the acquired net assets, where applicable, has been recorded as goodwill. The results of operations of the acquisition are included in our condensed consolidated financial statements from the date of acquisition.

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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.

On May 5, 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 settled the $29 million liability upon the closing of our acquisition of KindredBio.

Revenue and loss from KindredBio included in our condensed consolidated statements of operations for the three and nine months ended September 30, 2022 were immaterial.

The following table summarizes the fair value of assets acquired and liabilities assumed as of the acquisition date:

Estimated Fair Value at August 27, 2021
Cash and cash equivalents$31 
Other net working capital13 
Property and equipment33 
Intangible assets, primarily acquired in-process research and development (IPR&D)333 
Deferred income taxes, net(30)
Total identifiable net assets380 
Goodwill35 
Settlement of liability related to previous license agreement29 
Total consideration transferred$444 

The valuation of assets acquired and liabilities assumed was finalized during the third quarter of 2022. The measurement period adjustments recorded during 2022, which were made to reflect the facts and circumstances in existence as of the acquisition date, primarily related to changes in the estimated fair value of acquired IPR&D and minor tax and working capital adjustments. The net impact of these adjustments was not material.

Property and equipment is mostly comprised of land, buildings, equipment (including laboratory equipment, furniture and fixtures, and computer equipment), and construction in progress. The estimated fair value of real and personal property was determined using the sales comparison data valuation technique, to the extent that market data for similar assets was available. When market pricing data was not available for a given asset or asset class, the direct replacement cost method was used.

The estimated fair values of acquired 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 goodwill recognized from this acquisition is primarily attributable to KindredBio's assembled workforce and expected synergies. The majority of goodwill associated with this acquisition is not deductible for tax purposes.


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Divestitures

Microbiome R&D platform carve-out

In April 2022, we signed an agreement to transfer assets associated with our microbiome R&D platform to a newly created, independent biopharmaceutical company, BiomEdit, focused on developing solutions for animal and human health. As part of the agreement, we retain a non-voting, minority stake in the company. Assets transferred include intellectual property and laboratory equipment. The book values of those assets were not material. In addition, we have entered into transitional services agreements with the company for certain services. We have determined that the disposal of the related net assets does not qualify for reporting as a discontinued operation because it does not represent a strategic shift that has or will have a major effect on our operations and financial results. During the nine months ended September 30, 2022, we recorded a gain on the disposal of approximately $3 million.

Shawnee and Speke

During 2021, as part of our strategy to optimize our manufacturing footprint, we announced an agreement with TriRx Pharmaceuticals (TriRx) to sell our manufacturing sites in Shawnee, Kansas (Shawnee) and Speke, U.K. (Speke), including the 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. On August 1, 2021 and February 1, 2022, we completed the sales of our Shawnee and Speke sites, respectively. Upon closing the sale of the Speke site, we recorded a contract asset of $55 million for the favorable supply agreement, which is included in prepaid expenses and other and other noncurrent assets on our condensed consolidated balance sheets. The divestitures did not represent a strategic shift that has or will have a major effect on our operations and financial results, and therefore do not qualify for reporting as discontinued operations. See Note 6: Asset Impairment, Restructuring and Other Special Charges for further information.

Based on the terms of the agreements, we expect to receive aggregate gross cash proceeds of $78 million from the sales of Shawnee and Speke over a period of three years beginning in the second half of 2022. During the three months ended September 30, 2022, we received cash proceeds of $11 million. Receivables for the remaining expected cash proceeds are included in other receivables and other noncurrent assets on our condensed consolidated balance sheets.

Assets Held For Sale

Assets considered held for sale in connection with the Speke divestiture were included in the respective line items on our condensed consolidated balance sheets as follows:
December 31, 2021
Inventories$31 
Property and equipment, net50 
Total assets held for sale$81 
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BexCaFe Arrangement

On June 9, 2022, we signed a license agreement with BexCaFe, LLC (BexCaFe) for the development and commercialization of products related to Bexacat, an oral treatment intended to reduce glucose levels in diabetic cats. BexCaFe held the rights to the compound through a license agreement with similar terms and conditions. We will incur all development and regulatory costs associated with the products. Based on the guidance in Accounting Standards Codification (ASC) 810, Consolidation, we determined that BexCaFe represents a variable interest entity and that we are the primary beneficiary of BexCaFe because the terms of the license give us the power to direct the activities that most significantly impact the entity’s economic performance. As a result, we consolidated BexCaFe, a development-stage company with no employees that did not meet the definition of a business, as of the date we signed the license agreement. Upon initial consolidation of BexCaFe, we measured an IPR&D asset at its fair value of $59 million and recorded liabilities totaling $59 million, which included contingent consideration of $49 million based on the fair value of estimated future milestone payments and sales royalties owed under the license agreement. The initial fair value of the contingent payments was calculated based on an income approach, with payments adjusted for probability of success and then discounted to a present value. There is no minimum payout due on the contingent consideration and the maximum payout is unlimited. Since BexCaFe did not meet the definition of a business, no goodwill was recorded and immediately after initial consolidation, we expensed the IPR&D asset because we concluded that it did not have an alternative future use. This amount is included in asset impairment, restructuring, and other special charges in our condensed consolidated statement of operations for the nine months ended September 30, 2022.

We paid $10 million to BexCaFe under the terms of this agreement during the three months ended September 30, 2022. Contingent consideration liabilities of $49 million are included in other current liabilities and other noncurrent liabilities on our condensed consolidated balance sheet as of September 30, 2022.

Subsequent to the effective date of the license agreement, our condensed consolidated financial statements include the assets, liabilities, operating results and cash flows of BexCaFe. Based on the guidance in ASC 810, income and expense between us and BexCaFe have been eliminated against the income or expense included in the financial statements of BexCaFe. The resulting amounts after the effect of these eliminations were included in our condensed consolidated financial statements for the three and nine months ended September 30, 2022 and were not material.

Note 6. Asset Impairment, Restructuring and Other Special Charges

In recent years, we have incurred substantial costs associated with restructuring programs and cost-reduction initiatives designed to achieve a flexible and competitive cost structure. As discussed further below, restructuring activities primarily include charges associated with facility rationalization and workforce reductions. In connection with our recent acquisitions, including the acquisition of Bayer Animal Health, we have also incurred costs associated with executing transactions and integrating acquired operations, which may include expenditures for banking, legal, accounting, and other similar services. In addition, we have incurred costs to stand up our organization as an independent company. All operating functions can be impacted by these actions; therefore, non-cash expenses associated with our tangible and intangible assets can be incurred as a result of revised fair value projections and/or determinations to no longer utilize certain assets in the business on an ongoing basis.

For finite-lived intangible assets and other long-lived assets, whenever impairment indicators are present, we calculate the undiscounted value of projected cash flows associated with the asset, or group of assets, and compare it to the carrying amount. If the carrying amount is greater, we record an impairment loss for the excess of book value over fair value. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions. See Note 2: Basis of Presentation and Summary of Significant Accounting Policies for discussion regarding estimates and assumptions.
2021 Restructuring Programs

In 2021, we announced two separate restructuring programs to improve operating efficiencies.

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The actions proposed in January 2021 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 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 315 positions around the world. Activities related to this initiative resulted in adjustments of $1 million to reduce severance accruals and net charges of $44 million for the three and nine months ended September 30, 2021, respectively. The adjustments reflect a change in estimate resulting from negotiations. Restructuring charges under this program were substantially complete at the end of 2021.

The program announced in November 2021 included initiatives to consolidate certain international commercial operations into one organization, integrate our centralized global marketing organization into country level commercial organizations, transform and simplify our R&D organizational structure, and other organizational adjustments. In connection with the proposed restructuring, we eliminated 380 positions. During the nine months ended September 30, 2022, we recorded adjustments of $9 million to reduce severance accruals resulting from final negotiations and certain restructured employees filling open positions. Restructuring charges under this program were substantially complete as of September 30, 2022; however, we may continue to make adjustments to our severance accruals to reflect changes in estimates resulting from ongoing negotiations.

Components of asset impairment, restructuring and other special charges are as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2022202120222021
Restructuring charges (credits):
Severance and other costs (1)
$ $(2)$(9)$26 
Facility exit costs  2  
Acquisition related charges:
Transaction and integration costs (2)
27 30 77 141 
Non-cash and other items:
Asset impairment (3)
 50 59 63 
Asset write-down (4)
(1)6 27 275 
Net periodic benefit income (Note 14) (9) (26)
Settlements and other (5)
 36 2 39 
Total expense$26 $111 $158 $518 
(1)2022 credits primarily relate to adjustments resulting from the reversal of severance accruals associated with the November 2021 program. For the nine months ended September 30, 2021, charges primarily related to the 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.
(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)2022 includes a charge of $59 million related to the expensing of an IPR&D asset with no alternative future use licensed from BexCaFe during the second quarter. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. 2021 amounts represent the impact of adjustments to the fair value of certain 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 was associated with a farm animal parasiticide. The decision was prompted by unfavorable efficacy results observed during the quarter.
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(4)2022 amounts primarily include the finalization of the write-down charge upon the final sale of the Speke manufacturing site. Asset write-down charges recorded in 2021 included 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 Speke manufacturing site during the three months ended September 30, 2021. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. Also included are charges 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 announced restructuring programs.
(5)Amounts recorded during the nine months ended September 30, 2022 represent a $2 million measurement period adjustment to the charge associated with the settlement of a liability for future royalty and milestone payments triggered in connection with our acquisition of KindredBio. See Note 5: Acquisitions, Divestitures and Other Arrangements for further discussion. Amounts recorded during the three and nine months ended September 30, 2021 include the initial charge associated with the settlement of the liability for future royalty and milestone payments triggered in connection with our acquisition of KindredBio, 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. 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.

The following table summarizes the activity in our reserves established in connection with restructuring activities:
Severance
Balance at December 31, 2020$130 
Charges41 
Reserve adjustments(15)
Cash paid(94)
Foreign currency translation adjustments(1)
Balance at September 30, 2021$61 
Balance at December 31, 2021$126 
Reserve adjustments(9)
Cash paid(71)
Foreign currency translation adjustments(5)
Balance at September 30, 2022$41 
These reserves are included in other current liabilities and other noncurrent liabilities on our condensed consolidated balance sheets based on the timing of when the obligations are expected to be paid, which can vary due to certain country negotiations and regulations. As of September 30, 2022, we expect to pay approximately $34 million over the next 12 months. We believe that the reserves are adequate.

Note 7. Inventories

We state all inventories at the lower of cost or net realizable value. We use the last-in, first-out (LIFO) method for a portion of our inventories located in the continental U.S. Other inventories are valued by the first-in, first-out (FIFO) method or the weighted average cost method.

Inventories consisted of the following:
September 30, 2022December 31, 2021
Finished products$612 $598 
Work in process542 565 
Raw materials and supplies240 256 
Total1,394 1,419 
Decrease to LIFO cost(54)(46)
Inventories$1,340 $1,373 

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Note 8. Equity

Tangible Equity Unit (TEU) Offering

On January 22, 2020, we 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 current portion of long-term debt on the condensed consolidated balance sheets. 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 ComponentDebt ComponentTotal
Fair value per unit$42.80 $7.20 $50.00 
Gross proceeds$471 $79 $550 
Less: Issuance costs19 3 22 
Net proceeds$452 $76 $528 

The senior amortizing notes have an aggregate principal amount of $