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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, 2021
OR
Transition Report Pursuant To Section 13 or 15(d) of the
Securities Exchange Act of 1934
COMMISSION FILE NUMBER 001-38661
elan-20210930_g1.jpg
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 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 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 1, 2021 were 473,098,643




ELANCO ANIMAL HEALTH INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2021
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.

2021 Q3 Form 10-Q | 2
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FORWARD-LOOKING STATEMENTS AND RISK FACTOR SUMMARY

This Quarterly Report on 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, expectations relating to the potential carve-out of the microbiome research and development (R&D) platform, the sales of manufacturing facilities, product launches, independent company stand-up costs and timing, the coronavirus (COVID-19) global pandemic, 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 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 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;
the impact of weather conditions and the availability of natural resources;
use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
manufacturing problems and capacity imbalances;
challenges to our intellectual property rights or our alleged violation of rights of others;
risks related to our presence in foreign markets;
breaches of our information technology systems;
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 terms, timing or structure of any separation of the microbiome R&D platform, including whether it will be consummated at all, and whether the operational and strategic benefits of such transaction can be achieved, including whether the uncertainty of announcing the separation initiative will have adverse impacts on the employees, customers and suppliers related to the platform;
the effect of our substantial indebtedness on our business;
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the uncertainties inherent in research relating to product safety and additional analyses of existing safety data;
actions by regulatory bodies, including as a result of their interpretation of studies on product safety;
unfavorable publicity resulting from media reports on our products;
public acceptance of our products;
fluctuations in our business results due to seasonality and other factors; and
the impact of litigation, regulatory investigations, and other legal matters.
See Item 1A, “Risk Factors,” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2020 filed with the Securities and Exchange Commission (SEC), and Item 1A, "Risk Factors," of Part II of our Quarterly Reports on Form 10-Q for the periods ended June 30, 2021 and March 31, 2021 and Part II of this Quarterly Report on 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.


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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,
 2021202020212020
Revenue$1,131 $890 $3,652 $2,134 
Costs, expenses and other:
Cost of sales502 442 1,622 1,071 
Research and development94 88 277 214 
Marketing, selling and administrative342 278 1,075 623 
Amortization of intangible assets
141 96 417 197 
Asset impairment, restructuring and other special charges
111 262 518 456 
Interest expense, net of capitalized interest60 48 181 89 
Other (income) expense, net11 (115)8 (162)
1,261 1,099 4,098 2,488 
Loss before income taxes(130)(209)(446)(354)
Income tax benefit(26)(74)(71)(117)
Net loss$(104)$(135)$(375)$(237)
Loss per share:
Basic $(0.21)$(0.29)$(0.77)$(0.56)
Diluted$(0.21)$(0.29)$(0.77)$(0.56)
Weighted average shares outstanding:
Basic487.3 462.4 487.1 426.5 
Diluted487.3 462.4 487.1 426.5 
See notes to condensed consolidated financial statements.
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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Comprehensive Loss (Unaudited)
(in millions)
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Net loss$(104)$(135)$(375)$(237)
Other comprehensive income (loss):
Unrealized gain (loss) on derivatives for cash flow hedges, net of taxes4 (7)52 (67)
Foreign currency translation(209)101 (506)121 
Defined benefit pension and retiree health benefit plans, net of taxes(6)(1)5 (2)
Other comprehensive income (loss), net of taxes(211)93 (449)52 
Comprehensive loss$(315)$(42)$(824)$(185)
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, 2021December 31, 2020
(Unaudited)
Assets 
Current Assets
Cash and cash equivalents$453 $495 
Accounts receivable, net of allowances of $11 (2021) and $9 (2020)
924 872 
Other receivables158 205 
Inventories1,383 1,578 
Prepaid expenses and other242 256 
Restricted cash 11 
Total current assets3,160 3,417 
Noncurrent Assets
Goodwill6,191 6,225 
Other intangibles, net5,816 6,387 
Other noncurrent assets357 348 
Property and equipment, net of accumulated depreciation of $1,050 (2021) and $1,038 (2020)
1,041 1,316 
Total assets$16,565 $17,693 
Liabilities and Equity
Current Liabilities
Accounts payable$436 $501 
Employee compensation159 144 
Sales rebates and discounts316 295 
Current portion of long-term debt61 555 
Other current liabilities390 582 
Total current liabilities1,362 2,077 
Noncurrent Liabilities
Long-term debt6,273 5,572 
Accrued retirement benefits 302 346 
Deferred taxes726 900 
Other noncurrent liabilities220 322 
Total liabilities8,883 9,217 
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, 473,033,625 and 471,921,116 shares issued and outstanding as of September 30, 2021 and December 31, 2020, respectively
  
Additional paid-in capital8,680 8,650 
Accumulated deficit(852)(477)
Accumulated other comprehensive income (loss)(146)303 
Total equity7,682 8,476 
Total liabilities and equity$16,565 $17,693 
See notes to condensed consolidated financial statements.
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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 CapitalRetained Earnings (Accumulated Deficit)Cash Flow Hedge Gain (Loss)Foreign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2019373.0 $ $5,636 $84 $— $(199)$25 $(174)$5,546 
Net loss— — — (49)— — — — (49)
Adoption of Accounting Standards Update 2016-13
— — — (1)— — — — (1)
Other comprehensive loss, net of tax— — — — (39)(29)(1)(69)(69)
Separation activities (1)
— — 16 — — — — — 16 
Stock compensation — — 11 — — — — — 11 
Issuance of stock under employee stock plans, net0.8 — (13)— — — — — (13)
Issuance of common stock, net of issuance costs25.0 — 768 — — — — — 768 
Issuance of tangible equity units, net of issuance costs— — 452 — — — — — 452 
March 31, 2020398.8  6,870 34 (39)(228)24 (243)6,661 
Net loss— — — (53)— — — — (53)
Other comprehensive income (loss), net of tax— — — — (21)50 (1)28 28 
Separation activities (1)
— — 9 — — — — — 9 
Stock compensation— — 8 — — — — — 8 
Issuance of stock under employee stock plans, net0.1 — (1)— — — — — (1)
June 30, 2020398.9  6,886 (19)(60)(178)23 (215)6,652 
Net loss— — — (135)— — — — (135)
Other comprehensive income (loss), net of tax— — — — (7)101 (1)93 93 
Stock compensation— — 11 — — — — — 11 
Issuance of stock under employee stock plans, net0.1 — 0 — — — — — 0 
Issuance of stock to Bayer for acquisition, net of issuance costs72.9 — 1,723 — — — — — 1,723 
September 30, 2020471.9 $ $8,620 $(154)$(67)$(77)$22 $(122)$8,344 
(1)Represent amounts associated with transactions between us and Eli Lilly and Company (Lilly), related primarily to the completion of the local country asset purchases, the finalization of assets and liabilities associated with the legal separation from Lilly, centralized cash management, and resulting impacts on deferred tax assets, that occurred subsequent to our initial public offering.

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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited), Continued
(Dollars and shares in millions)
Common StockAccumulated Other Comprehensive Income (Loss)
SharesAmountAdditional Paid-in CapitalRetained Earnings (Accumulated Deficit)Cash Flow Hedge Gain (Loss)Foreign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2020471.9 $ $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 

See notes to condensed consolidated financial statements.
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Elanco Animal Health Incorporated
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)
Nine Months Ended September 30,
 20212020
Cash Flows from Operating Activities
Net loss$(375)$(237)
Adjustments to reconcile net loss to cash flows from operating activities:
Depreciation and amortization542 295 
Change in deferred income taxes(119)(160)
Stock-based compensation expense48 31 
Asset impairment and write-down charges334 5 
Gain on sale of assets— (51)
Loss (gain) on divestitures2 (170)
Inventory fair value step-up amortization64 33 
Changes in operating assets and liabilities, net of acquisitions
(243)291 
Other non-cash operating activities, net7 15 
Net Cash Provided by Operating Activities260 52 
Cash Flows from Investing Activities
Net purchases of property and equipment(60)(16)
Cash paid for acquisitions, net of cash acquired(342)(5,001)
Proceeds from settlement of net investment hedges 33 
Proceeds from product divestitures 435 
Purchases of intangible assets(35) 
Purchases of software(11)(148)
Other investing activities, net(8)(8)
Net Cash Used for Investing Activities(456)(4,705)
Cash Flows from Financing Activities
Repayments of borrowings(555)(684)
Net proceeds from revolving credit facility250  
Proceeds from issuance of long-term debt500 4,554 
Proceeds from issuance of common stock and tangible equity units 1,220 
Debt issuance costs(1)(103)
Other net financing transactions with Lilly (11) 
Other financing activities, net(17)(15)
Net Cash Provided by Financing Activities166 4,972 
Effect of exchange rate changes on cash and cash equivalents(23)7 
Net increase (decrease) in cash, cash equivalents and restricted cash(53)326 
Cash, cash equivalents and restricted cash at January 1506 345 
Cash, cash equivalents and restricted cash at September 30$453 $671 
September 30,
20212020
Cash and cash equivalents$453 $660 
Restricted cash 11 
Cash, cash equivalents and restricted cash at September 30$453 $671 
See notes to condensed consolidated financial statements.
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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. 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:
StandardDescriptionEffect on the financial statements or other significant matters
Accounting Standards Update (ASU) 2019-12, Simplifying the Accounting for Income Taxes
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. 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:
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.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.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.

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:
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Beginning balance$303 $164 $295 $211 
Bayer Animal Health at acquisition 78  78 
Reduction of revenue163 145 516 316 
Payments(150)(108)(495)(326)
Ending balance$316 $279 $316 $279 

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.

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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:
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
Pet Health$527 $401 $1,857 $861 
Farm Animal583 473 1,728 1,222 
Contract Manufacturing (1)
21 16 67 51 
Revenue$1,131 $890 $3,652 $2,134 
(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.

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The following table summarizes the preliminary amounts recognized for 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 capital1 
Property and equipment26 
Intangible assets, primarily acquired in-process research and development352 
Deferred income taxes(22)
Total identifiable net assets388 
Goodwill30 
Settlement of liability related to previous license agreement26 
Total consideration transferred$444 

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:

Cash consideration (1)
$5,054 
Fair value of Elanco common stock (2)
1,724 
Fair value of total consideration transferred$6,778 
(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).

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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:

Estimated Fair Value at August 1, 2020
Cash and cash equivalents$169 
Accounts receivable10 
Inventories487 
Prepaid expenses and other current assets60 
Property and equipment315 
Intangible assets:
Acquired in-process research and development 65 
Marketed products3,740 
Assets held for sale138 
Accounts payable and accrued liabilities(237)
Accrued retirement benefits(220)
Other noncurrent assets and liabilities, net (878)
Total identifiable net assets3,649 
Goodwill3,129 
Total consideration transferred$6,778 

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
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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:
Three Months Ended September 30, 2020Nine Months Ended September 30, 2020
Revenue$1,069 $3,308 
Loss before income taxes
(227)(392)

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.


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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.

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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:
September 30, 2021December 31, 2020
Inventories$38 $2 
Other intangibles, net 4 
Property and equipment, net55  
Deferred tax asset 1 
Total assets held for sale$93 $7 

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.

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Components of asset impairment, restructuring and other special charges are as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2021202020212020
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: