10-Q 1 elan-20230930.htm 10-Q FOR THE PERIOD ENDED SEPTEMBER 30, 2023 elan-20230930
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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2023
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
2015-Elanco-logo.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 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
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 2, 2023 was 492,798,113.



ELANCO ANIMAL HEALTH INCORPORATED
FORM 10-Q
FOR THE QUARTER ENDED SEPTEMBER 30, 2023
TABLE OF CONTENTS
PART 1. Financial Information
Item 1.
Item 2.
Item 3.
Item 4.
PART II. Other Information
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.

2023 Q3 Form 10-Q | 1

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 business acquisitions, expected synergies and cost savings, product launches, global macroeconomic conditions, 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;
demand, supply and operational challenges associated with the effects of a human disease outbreak, epidemic, pandemic or other widespread public health concern;
the potential impact on our business and global economic conditions resulting from regional conflicts;
the success of our research and development (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, including those related to climate change, and the availability of natural resources;
risks related to the modification of foreign trade policy;
risks related to currency exchange 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;
the impact of increased or decreased sales into our distribution channels resulting in fluctuations 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;
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;
2023 Q3 Form 10-Q | 2

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;
risks related to the use of machine learning and artificial intelligence by us and our competitors;
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 Kindred Biosciences, Inc. (KindredBio) and the animal health business of Bayer Aktiengesellschaft (Bayer Animal Health);
the effect of our substantial indebtedness on our business, including restrictions in our debt agreements that limit our operating flexibility, changes in our credit ratings that lead to higher borrowing expenses and may restrict access to credit and changes in interest rates that may adversely affect earnings and cash flows;
risks related to certain governance provisions in our constituent documents; and
any failure to maintain an effective system of disclosure controls and internal control over financial reporting, including arising from an identified material weakness.
See Item 1A, “Risk Factors,” of Part I of our Annual Report on Form 10-K for the year ended December 31, 2022 filed with the United States (U.S.) Securities and Exchange Commission (SEC) (2022 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 above 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.


2023 Q3 Form 10-Q | 3

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,
 2023202220232022
Revenue$1,068 $1,026 $3,382 $3,426 
Costs, expenses and other:
Cost of sales487 472 1,415 1,465 
Research and development86 78 248 241 
Marketing, selling and administrative313 298 993 963 
Amortization of intangible assets
140 128 410 398 
Asset impairment, restructuring and other special charges
16 26 91 152 
Goodwill impairment1,042  1,042  
Interest expense, net of capitalized interest72 60 210 179 
Other expense, net9 8 41 11 
2,165 1,070 4,450 3,409 
(Loss) income before income taxes(1,097)(44)(1,068)17 
Income tax (benefit) expense(1)21 22 41 
Net loss$(1,096)$(65)$(1,090)$(24)
Loss per share:
Basic $(2.22)$(0.13)$(2.21)$(0.05)
Diluted$(2.22)$(0.13)$(2.21)$(0.05)
Weighted-average shares outstanding:
Basic492.7 488.4 492.1 488.3 
Diluted492.7 488.4 492.1 488.3 

See accompanying notes to condensed consolidated financial statements.
2023 Q3 Form 10-Q | 4

Elanco Animal Health Incorporated
Condensed Consolidated Statements of Comprehensive Income (Loss) (Unaudited)
(in millions)
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Net loss$(1,096)$(65)$(1,090)$(24)
Other comprehensive loss:
Cash flow hedges, net of taxes 62 (19)179 
Foreign currency translation, net of taxes(197)(418)(65)(973)
Defined benefit pension and retiree health benefit plans, net of taxes(4)(2)(6)(4)
Other comprehensive loss, net of taxes(201)(358)(90)(798)
Comprehensive loss$(1,297)$(423)$(1,180)$(822)

See accompanying notes to condensed consolidated financial statements.

2023 Q3 Form 10-Q | 5

Elanco Animal Health Incorporated
Condensed Consolidated Balance Sheets
(in millions, except share data)
September 30, 2023December 31, 2022
(Unaudited)
Assets 
Current Assets
Cash and cash equivalents$369 $345 
Accounts receivable, net
911 797 
Other receivables224 205 
Inventories1,690 1,538 
Prepaid expenses and other371 394 
Total current assets3,565 3,279 
Noncurrent Assets
Goodwill4,902 5,993 
Other intangibles, net4,475 4,842 
Other noncurrent assets410 378 
Property and equipment, net
992 999 
Total assets$14,344 $15,491 
Liabilities and Equity
Current Liabilities
Accounts payable$296 $390 
Sales rebates and discounts356 324 
Current portion of long-term debt39 388 
Other current liabilities574 600 
Total current liabilities1,265 1,702 
Noncurrent Liabilities
Long-term debt5,870 5,448 
Deferred taxes643 662 
Other noncurrent liabilities432 390 
Total liabilities8,210 8,202 
Commitments and Contingencies
Equity
Common stock, no par value, 5,000,000,000 shares authorized, 492,683,420 and 474,237,738 shares issued and outstanding as of September 30, 2023 and December 31, 2022, respectively
  
Additional paid-in capital8,763 8,738 
Accumulated deficit(2,147)(1,057)
Accumulated other comprehensive loss(482)(392)
Total equity6,134 7,289 
Total liabilities and equity$14,344 $15,491 

See accompanying notes to condensed consolidated financial statements.
2023 Q3 Form 10-Q | 6

Elanco Animal Health Incorporated
Condensed Consolidated Statements of Equity (Unaudited)
(Dollars and shares in millions)
Common StockAccumulated Other Comprehensive Loss
SharesAmountAdditional Paid-in CapitalAccumulated DeficitCash Flow HedgeForeign Currency TranslationDefined Benefit Pension and Retiree Health Benefit PlansTotalTotal Equity
December 31, 2021
473.1 $ $8,696 $(979)$25 $(253)$19 $(209)$7,508 
Net income— — — 51 — — — — 51 
Other comprehensive income (loss), net of tax— — — — 109 (85)(1)23 23 
Stock-based compensation activity, net1.0 — 3 — — — — — 3 
March 31, 2022474.1  8,699 (928)134 (338)18 (186)7,585 
Net loss— — — (10)— — — — (10)
Other comprehensive income (loss), net of tax— — — — 8 (470)(1)(463)(463)
Stock-based compensation activity, net— — 13 — — — — — 13 
June 30, 2022474.1  8,712 (938)142 (808)17 (649)7,125 
Net loss— — — (65)— — — — (65)
Other comprehensive income (loss), net of tax— — — — 62 (418)(2)(358)(358)
Stock-based compensation activity, net— — 12 — — — — — 12 
September 30, 2022474.1 $ $8,724 $(1,003)$204 $(1,226)$15 $(1,007)$6,714 
December 31, 2022
474.2 $ $8,738 $(1,057)$182 $(672)$98 $(392)$7,289 
Net income— — — 103 — — — — 103 
Other comprehensive income (loss), net of tax— — — — (48)130 — 82 82 
Stock-based compensation activity, net1.0 — 6 — — — — — 6 
Conversion of tangible equity units (TEUs) into common stock17.2 — — — — — — — — 
March 31, 2023492.4  8,744 (954)134 (542)98 (310)7,480 
Net loss— — — (97)— — — — (97)
Other comprehensive income (loss), net of tax— — — — 29 2 (2)29 29 
Stock-based compensation activity, net0.2 — 8 — — — — — 8 
June 30, 2023492.6  8,752 (1,051)163 (540)96 (281)7,420 
Net loss— — — (1,096)— — — — (1,096)
Other comprehensive income (loss), net of tax— — — — — (197)(4)(201)(201)
Stock-based compensation activity, net0.1 — 11 — — — — — 11 
September 30, 2023492.7 $ $8,763 $(2,147)$163 $(737)$92 $(482)$6,134 

See accompanying notes to condensed consolidated financial statements.
2023 Q3 Form 10-Q | 7

Elanco Animal Health Incorporated
Condensed Consolidated Statements of Cash Flows (Unaudited)
(Dollars in millions)
Nine Months Ended September 30,
 20232022
Cash Flows from Operating Activities
Net loss$(1,090)$(24)
Adjustments to reconcile net loss to cash flows from operating activities:
Depreciation and amortization523 514 
Goodwill impairment 1,042  
Stock-based compensation expense31 44 
Asset impairment and write-down charges5 81 
Proceeds from interest rate swap settlements57 207 
Changes in operating assets and liabilities, net of acquisitions
(446)(385)
Other non-cash operating activities, net(8)2 
Net Cash Provided by Operating Activities114 439 
Cash Flows from Investing Activities
Net purchases of property and equipment and software(99)(94)
Cash paid for acquisitions(19) 
Purchases of intangible assets(14)(11)
Other investing activities, net(2)2 
Net Cash Used for Investing Activities(134)(103)
Cash Flows from Financing Activities
Proceeds from Revolving Credit Facility350 563 
Repayments of Revolving Credit Facility(53)(813)
Proceeds from Securitization Facility250  
Repayments of Securitization Facility(97) 
Proceeds from issuance of long-term debt 425 
Repayments of long-term borrowings(388)(607)
Other financing activities, net(6)(33)
Net Cash Provided by (Used for) Financing Activities56 (465)
Effect of exchange rate changes on cash and cash equivalents(12)(49)
Net increase (decrease) in cash and cash equivalents24 (178)
Cash and cash equivalents – beginning of period345 638 
Cash and cash equivalents – end of period$369 $460 

See accompanying notes to condensed consolidated financial statements.
2023 Q3 Form 10-Q | 8

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
We have prepared the accompanying unaudited condensed consolidated financial statements in accordance with the 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, 2022 included in our 2022 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, 2023 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 4 to the consolidated financial statements in our 2022 Form 10-K appropriately represent, in all material respects, the current status of our accounting policies.
Revision of Previously Issued Consolidated Financial Statements
In connection with the preparation of our financial statements as of and for the year ended December 31, 2022, a cumulative error was identified and corrected relating to the valuation allowance for taxes for a Southeast Asia affiliate. While immaterial to prior years, correcting this cumulative error in 2022 would have caused the 2022 financial statements to be materially misstated. In conjunction with making these corrections, we made other adjustments to the prior years to revise uncorrected errors. The appropriate revisions to our historical condensed consolidated financial statements and the notes thereto are reflected herein. Further information is included in Note 2 and Note 21 to the consolidated financial statements in our 2022 Form 10-K.

Note 2. Implementation of New Financial Accounting Pronouncements
The following table provides a brief description of an accounting standard that was adopted during the nine months ended September 30, 2023:
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 2022-06, Reference Rate Reform (Topic 848): Deferral of the Sunset Date of Topic 848
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. ASU 2022-06 extends the period of time entities can utilize the reference rate reform relief guidance under ASU 2020-04 from December 31, 2022 to December 31, 2024.Adoption of the guidance is optional and effective as of March 12, 2020 through December 31, 2024. Adoption is permitted at any time during the period on a prospective basis.
Effective April 1, 2023, and in accordance with the provisions outlined in our underlying credit agreements, we have transitioned the reference rate used in our credit facilities from the London Interbank Offered Rate (LIBOR) to the Secured Overnight Financing Rate (Term SOFR). The change did not have a material impact on our condensed consolidated financial statements.

Note 3. Revenue
We recognize revenue primarily from product sales to customers. Revenue from sales of products is recognized at the point where the customer obtains control of the goods and we satisfy our performance obligations, which is
2023 Q3 Form 10-Q | 9

generally once the goods have been shipped and the customer has assumed title. For contract manufacturing organization (CMO) arrangements, we recognize revenue over time or at a point in time depending on our evaluation of when the customer obtains control of the promised goods or services.
We have a single customer that accounted for approximately 10% and 11% of revenue for the nine months ended September 30, 2023 and 2022, respectively. Product sales with this customer resulted in accounts receivable of $96 million and $73 million at September 30, 2023 and December 31, 2022, respectively.
Provisions for sales rebates and discounts are recorded as a reduction to revenue in the period the related sales are recognized and are based on specific agreements. In determining the appropriate accrual amount, we consider our historical experience with similar incentive programs, current sales data and estimates of inventory levels at our channel distributors. The following table summarizes the activity in our global sales rebates and discounts liability:
Nine Months Ended September 30,
20232022
Beginning balance$324 $319 
Reduction of revenue558 524 
Payments(522)(521)
Foreign currency translation adjustments(4)(18)
Ending balance$356 $304 
Adjustments to revenue recognized as a result of changes in estimates during the nine months ended September 30, 2023 and 2022 for product shipped in previous periods were not material. Actual global product returns were approximately 1% of net revenue for the nine months ended September 30, 2023 and 2022.
Disaggregation of Revenue
The following table summarizes our revenue disaggregated by product category:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Pet Health$495 $469 $1,688 $1,718 
Farm Animal:
Cattle242 227 700 722 
Poultry184 176 545 529 
Swine93 95 284 284 
Aqua42 47 132 132 
Total Farm Animal561 545 1,661 1,667 
Contract Manufacturing (1)
12 12 33 41 
Revenue$1,068 $1,026 $3,382 $3,426 
(1)Represents revenue from arrangements in which we manufacture products on behalf of a third party.
The following table summarizes our revenue disaggregated by geographic area:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
United States$479 $475 $1,522 $1,536 
International589 551 1,860 1,890 
Revenue$1,068 $1,026 $3,382 $3,426 

Note 4. Acquisitions, Divestitures and Other Arrangements
NutriQuest U.S. Acquisition
On January 3, 2023, we acquired certain U.S. marketed products, pipeline products, inventory and an assembled workforce from NutriQuest, LLC (NutriQuest). NutriQuest is a provider of swine, poultry and cattle nutritional health products to animal producers. The acquisition allows us to expand our existing nutritional health offerings and furthers our efforts to explore innovative antibiotic alternatives.

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The composition of the purchase price was as follows:
Up-front cash consideration$16 
Deferred cash consideration due January 4, 20245 
Fair value of contingent consideration37 
Total purchase consideration$58 
The NutriQuest acquisition 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, with the excess of the purchase price over the fair value of the acquired assets recorded as goodwill. The determination of estimated fair value requires management to make significant estimates and assumptions. Contingent consideration for this acquisition includes up to $85 million of cash consideration payable if specific development, sales and geographic expansion milestones are achieved, as outlined in the asset purchase agreement. The initial fair value of this contingent consideration liability of $37 million was estimated at the acquisition date using a Monte Carlo simulation model, which represented a Level 3 measurement under the fair value measurement hierarchy (see Note 10. Fair Value for further information).
The following table summarizes the preliminary amounts recognized for assets acquired as of the acquisition date:
Inventories$3 
Intangible assets:
Marketed products29 
Acquired in-process research and development (IPR&D)10 
Other intangible assets15 
Total identifiable assets57 
Goodwill1 
Total consideration transferred$58 
Other intangible assets consist of customer relationships and trade names. The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of approximately 12 years on a straight-line basis. The estimated fair values of identifiable intangible assets 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 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.
The accounting for this acquisition has not been finalized as of September 30, 2023. The purchase price allocation is preliminary and subject to change, including the valuation of the contingent consideration and intangible assets. The final determination of these amounts will be completed as soon as possible but no later than one year from the acquisition date. Revenue attributable to the NutriQuest acquisition for the nine months ended September 30, 2023, was approximately $16 million.
NutriQuest Brazil Acquisition
On August 1, 2023, we acquired certain assets including inventory and distribution rights for certain marketed products from NutriQuest Nutricao Animal Ltda (NutriQuest Brazil) for total purchase consideration of $19 million. The composition of the purchase price included cash paid on the closing date of approximately $3 million, with consideration payable through 2026 valued at approximately $16 million, a portion of which is contingent upon the continuation of certain terms and conditions set forth in the asset purchase agreement. The NutriQuest Brazil acquisition was accounted for as a business combination under the acquisition method of accounting.
The following table summarizes the preliminary amounts recognized for assets acquired as of the acquisition date:
Inventories$3 
Definite-lived intangible assets15 
Total identifiable assets18 
Goodwill1 
Total consideration transferred$19 
2023 Q3 Form 10-Q | 11

The acquired definite-lived intangible assets are being amortized over a weighted-average estimated useful life of approximately nine years on a straight-line basis. The estimated fair values of identifiable intangible assets were determined using the income approach. The purchase price allocation for this acquisition is preliminary as of September 30, 2023, and subject to change, including the valuation of the intangible assets. The final determination of these amounts will be completed as soon as possible but no later than one year from the acquisition date. Neither revenue nor income before taxes included within our condensed consolidated statements of operations from NutriQuest Brazil were material for the three and nine months ended September 30, 2023.
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 retained a non-voting, minority stake in the company. In addition, we entered into transitional services agreements with the company for certain services. Assets transferred included intellectual property and laboratory equipment. The book values of those assets were not material. We recorded a gain on disposal of the assets of approximately $3 million during the year ended December 31, 2022.
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 transfer of approximately 600 employees. In connection with these arrangements, we also entered into long-term manufacturing and supply agreements, under which TriRx began manufacturing 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 was included in prepaid expenses and other and other noncurrent assets on our condensed consolidated balance sheets.
Based on the terms of the agreements and cash proceeds received to date, as of September 30, 2023, we had a net receivable balance from TriRx of $73 million from the sales of Shawnee and Speke, which was included within other receivables on the condensed consolidated balance sheets. In May 2023, we entered into amendments to the agreements which effectively restructured the payment schedule related to the remaining amount owed. Under the terms of the amendments we expect to receive approximately $67 million of this receivable balance upon the earlier of the date on which certain conditions are met or in equal installments over a twelve-month period beginning January 31, 2024, with the remainder due within the next 12 months. We continue to assess the collectibility of these receivables from TriRx and continue to believe amounts owed are collectible. Further, we have rights to certain collateral in the event of a default and we continue to monitor the value of this collateral.
BexCaFe Arrangement
In June 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. There is no minimum payout due on the contingent consideration and the maximum payout related to sales royalties 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.
During the nine months ended September 30, 2023, we paid $13 million to BexCaFe in connection with development/regulatory milestones achieved upon U.S. Food and Drug Administration (FDA) approval of the original new animal drug application for Bexacat in December 2022. Remaining contingent consideration liabilities of $35 million were included in other current liabilities and other noncurrent liabilities on our condensed consolidated balance sheet as of September 30, 2023.


2023 Q3 Form 10-Q | 12

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 recent acquisitions, including the acquisition of Bayer Animal Health, we have also incurred costs associated with executing transactions and integrating acquired operations. 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 impairment charges 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. Determinations of fair value can result from a complex series of judgments and rely on estimates and assumptions.
Components of asset impairment, restructuring and other special charges were as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Restructuring charges (credits)(1)
$ $ $ $(7)
Acquisition related charges(2)
11 27 86 77 
Asset impairments and other items (3)
5 (1)5 82 
Total expense$16 $26 $91 $152 
(1)Restructuring credits in 2022 related to adjustments resulting from the reversal of severance accruals associated with 2021 restructuring programs, resulting from final negotiations and certain restructured employees filling open positions.
(2)Acquisition related charges included transaction costs directly related to acquiring businesses, such as expenditures for banking, legal, accounting, consulting and other similar services, integration charges inclusive of system and process integration and product transfers, and independent company stand-up costs related to the implementation of new systems, programs and processes.
(3)Asset impairments during the third quarter of 2023 primarily related to the write-down of certain indefinite-lived intangible assets due to increases in the relevant discount rates. Asset impairments during 2022 included a charge of $59 million related to the write-off of an IPR&D asset with no alternative future use licensed from BexCaFe and a $22 million charge related to the finalization of the write-down upon sale of the Speke site (see Note 4. Acquisitions, Divestitures and Other Arrangements for further discussion on each of these items).
The changes in our restructuring reserves during the nine months ended September 30, 2023, were as follows:
Balance at December 31, 2022$36 
Cash paid(29)
Balance at September 30, 2023$7 
These reserves were included within 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-specific negotiations and regulations.

Note 6. Inventories
Inventories are stated at the lower of cost and 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, 2023December 31, 2022
Finished products$831 $783 
Work in process772 683 
Raw materials and supplies145 130 
Total1,748 1,596 
Decrease to LIFO cost(58)(58)
Inventories$1,690 $1,538 

Note 7. Equity
Tangible Equity Unit (TEU) Offering
In January 2020, we issued 11 million in TEUs at the stated amount of $50 per unit. Total proceeds, net of issuance costs, were $528 million. The gross proceeds and deferred finance costs from the issuance of the TEUs were allocated 86% to equity (prepaid stock purchase contracts) and 14% to debt (TEU amortizing notes) based on the
2023 Q3 Form 10-Q | 13

relative fair value of the respective components of each TEU. The TEU prepaid stock purchase contracts were converted into shares of our common stock on February 1, 2023. Holders of our TEUs received 1.5625 shares of our common stock based on the maximum settlement rate for the applicable market value being below $32.00. In total, we issued approximately 17 million shares to holders in connection with the settlement.

Note 8. Debt
Long-term debt consisted of the following:
September 30, 2023December 31, 2022
Incremental Term Facility due 2025$175 $175 
Incremental Term Facility due 2028490 494 
Incremental Term Facility due 2029247 249 
Term Loan B due 20273,849 3,881 
Revolving Credit Facility (1)
297  
Securitization Facility (2)
153  
4.272% Senior Notes due 2023 (3)
 344 
4.900% Senior Notes due 2028 (4)
750 750 
TEU Amortizing Notes due 2023 (5)
 7 
Unamortized debt issuance costs(52)(64)
5,909 5,836 
Less current portion of long-term debt39 388 
Total long-term debt$5,870 $5,448 
(1)During the nine months ended September 30, 2023, we drew $350 million on our Revolving Credit Facility (subsequently repaying $53 million), both to fund working capital needs and to partially fund the repayment of the 4.272% Senior Notes due 2023 (see below for further information). Our Revolving Credit Facility provides up to $750 million in borrowing capacity (with incremental capacity if certain conditions are met), bears interest at Term SOFR plus 2.10% and matures in August 2025.
(2)In August 2023, we entered into a new secured term facility that is secured and collateralized by our U.S. Net Eligible Receivables Balance (see below for further information).
(3)We redeemed the 4.272% Senior Notes due 2023 in full in August 2023 (see below for further information).
(4)Subsequent to issuance in August 2018, the 4.900% Senior Notes due 2028 have been subject to interest rate increases related to credit rating agency downgrades. As of September 30, 2023, these notes bear interest at a rate of 6.650%.
(5)The TEU Amortizing Notes due 2023 matured on February 1, 2023 (see Note 7. Equity for further information).
2023 Financing
On August 3, 2023, we entered into a new secured term facility (the "Securitization Facility") that is secured and collateralized by our U.S. accounts receivable subject to certain adjustments (defined as the Net Eligible Receivables Balance within the applicable agreement). Of the maximum borrowing capacity under the Securitization Facility of $300 million, $250 million was drawn on August 3, 2023, based on our borrowing capacity on that date. Our borrowing capacity under the Securitization Facility is subject to fluctuation monthly based on the level of our borrowing base as reported to the lender, which is correlated to our U.S. Net Eligible Receivables Balances. The Securitization Facility requires monthly interest payments over its three-year term at a variable rate based on Term SOFR plus 125 basis points. The full, outstanding balance of the Securitization Facility is due on July 31, 2026. During the three months ended September 30, 2023, we utilized the proceeds from the Securitization Facility, in addition to a $100 million draw on our Revolving Credit Facility, to redeem in full the 4.272% Senior Notes due 2023. The early redemption of the 4.272% Senior Notes due 2023 satisfied all obligations and commitments thereunder. Subsequent to our initial $250 million draw on the Securitization Facility, $97 million was repaid, resulting in a balance of $153 million outstanding as of September 30, 2023. The Securitization Facility includes various covenants specific to the underlying composition of our U.S. accounts receivables portfolio.
As of September 30, 2023, approximately 76% of our long-term indebtedness bears interest at a fixed rate, including variable-rate converted to fixed-rate through the use of interest rate swaps (see Note 9. Financial Instruments for further information). We were in compliance with all of our debt covenants as of September 30, 2023.

Note 9. Financial Instruments
To manage our exposure to market risks, such as changes in foreign currency exchange rates and interest rates, we have entered into various derivative transactions. We formally assess, designate and document, as a hedge of an underlying exposure, each qualifying derivative instrument that will be accounted for as an accounting hedge at
2023 Q3 Form 10-Q | 14

inception. We also assess at least quarterly thereafter whether the financial instruments used in the hedging transaction are effective at offsetting changes in either the fair values or cash flows of the underlying exposures. Derivative cash flows are principally classified in the operating activities section of the condensed consolidated statements of cash flows, consistent with the underlying hedged item. Further, we do not offset derivative assets and liabilities on the condensed consolidated balance sheets. Our outstanding positions are discussed below.
Derivatives not designated as hedges
We may enter into foreign exchange forward or option contracts to reduce the effect of fluctuating currency exchange rates. Foreign currency derivatives used for hedging are put in place using the same or like currencies and duration as the underlying exposures and are recorded at fair value with the gain or loss recognized in other expense, net in the condensed consolidated statements of operations. Forward contracts generally have maturities not exceeding 12 months. As of September 30, 2023 and December 31, 2022, we had outstanding foreign exchange contracts with aggregate notional amounts of $864 million and $784 million, respectively.
The amounts of net gains (losses) on derivative instruments not designated as hedging instruments, recorded in other expense, net were as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Foreign exchange forward contracts (1)
$1 $(5)$2 $(20)
(1)These amounts were substantially offset in other expense, net by the effect of changing exchange rates on the underlying foreign currency exposures.
Derivatives designated as hedges
To manage our exposure to variable interest rate risk, we utilize interest rate swap contracts to effectively convert our variable-rate debt into fixed-rate debt. We recognize any differences between the variable interest rate payments and the fixed interest rate settlements with the swap counterparties as an adjustment to interest expense, net of capitalized interest over the life of the swaps. We have designated our interest rate swaps as cash flow hedges and record them at fair value on the condensed consolidated balance sheets. Changes in the fair value of the hedges are recognized in other comprehensive income (loss). Fair value is estimated based on quoted market values of similar hedges and is classified as Level 2 in the fair value hierarchy (see Note 10. Fair Value for further information).
Our outstanding forward-starting interest rate swaps had maturities ranging between 2023 and 2028, with aggregate notional amounts of $3,800 million and $3,050 million as of September 30, 2023 and December 31, 2022, respectively. In March 2023, we entered into new interest rate swap agreements with a combined notional amount of $1,000 million, which became effective on October 1, 2023, following the maturity of certain swaps with the same combined notional amount. Additionally, on May 1, 2023, we entered into new interest rate swap agreements with a combined notional amount of $750 million, which became effective on June 1, 2023, and mature in August 2028. Also, in September 2023, we took advantage of market opportunities to further restructure our interest rate swap portfolio (see below for further details). As of September 30, 2023, when factoring in the $3,800 million of variable rate debt converted to fixed-rate through the use of interest rate swaps (excluding the expected future reclassifications to interest expense, net of capitalized interest related to past interest rate swap settlements), the weighted-average effective interest rate on our outstanding indebtedness was 6.34%.
Additionally, as a means of mitigating the impact of currency fluctuations on our operations in Switzerland, we entered into a series of cross-currency fixed interest rate swaps in September 2023 with a 1 billion CHF notional amount with tenors in 2027. These instruments were determined to be, and were designated as, effective economic hedges of net investments in our CHF denominated net assets. The fair values of these instruments were estimated based on quoted market values of similar hedges and is classified as Level 2 in the fair value hierarchy. Over the life of these instruments, gains or losses due to spot rate fluctuations will be recorded as cumulative translation adjustments, as a component of other comprehensive income (loss). Gains and losses within accumulated other comprehensive income (loss) will remain in accumulated other comprehensive income (loss) until either the sale or substantial liquidation of the hedged subsidiary.
The amounts of gains (losses) on derivatives designated as cash flow hedges and net investment hedges, net of tax, recorded in other comprehensive loss were as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Forward-starting interest rate swaps$ $62 $(19)$179 
Cross-currency fixed interest rate swaps9  9  
2023 Q3 Form 10-Q | 15

During the three months ended September 30, 2023 and 2022, activity on cash flow hedges recorded in other comprehensive loss included gains of $24 million and a gain of $75 million, net of tax, respectively, related to mark-to-market adjustments. During the nine months ended September 30, 2023 and 2022, activity on cash flow hedges recorded in other comprehensive loss included gains of $57 million and $218 million, net of tax, respectively, related to mark-to-market adjustments.
As noted above, in September 2023, we took advantage of market opportunities to restructure $3,050 million of our interest rate swap portfolio by unwinding existing swaps and simultaneously entering into new agreements with the same notional amounts and tenors extending through 2026. As a result, we received cash settlements of $57 million in the aggregate. Also, in April 2022 and September 2022, we settled certain existing interest rate swaps and simultaneously entered into new agreements with the same notional amount and covering the same tenor. As a result, we received cash settlements of $207 million in the aggregate. The cash proceeds from these interest rate swap settlements were included in net cash from operating activities in the condensed consolidated statements of cash flows for the nine months ended September 30, 2023 and 2022.
During the three months ended September 30, 2023 and 2022, we reclassified $35 million and $11 million of net gains, respectively, into interest expense, net of capitalized interest. During the nine months ended September 30, 2023 and 2022, we reclassified $94 million of net gains and $10 million of net losses, respectively, into interest expense, net of capitalized interest. Over the next 12 months, we expect to reclassify a gain of $120 million to interest expense, net of capitalized interest related to our derivatives designated as hedges.

Note 10. Fair Value
Fair value is defined as the exchange price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Fair value measurements are based on a framework that utilizes the inputs market participants use to determine the fair value of an asset or liability and establishes a fair value hierarchy to prioritize those inputs. Level 1 fair value measurements are based on quoted prices in active markets for identical assets or liabilities. We determine our Level 2 fair value measurements based on a market approach using quoted market values or significant other observable inputs for identical or comparable assets or liabilities. Our Level 3 fair value measurements, which include the value of contingent consideration as of September 30, 2023, are based on unobservable inputs based on little or no market activity.
The following table summarizes the fair value information at September 30, 2023 and December 31, 2022 for assets and liabilities measured at fair value on a recurring basis in the respective balance sheet line items, as well as long-term debt, for which fair value is disclosed on a recurring basis:
2023 Q3 Form 10-Q | 16

  Fair Value Measurements Using 
Financial statement line itemCarrying
Amount
Quoted Prices in Active Markets for Identical Assets
(Level 1)
Significant
Other Observable Inputs
(Level 2)
Significant
Unobservable
Inputs
(Level 3)
Fair
Value
September 30, 2023
Recurring fair value measurements
Prepaid expenses and other - derivative instruments$64 $ $64 $ $64 
Other noncurrent assets - derivative instruments32  32  32 
Other noncurrent assets - investments with readily determinable fair value8 8   8 
Other current liabilities - derivative instruments(61) (61) (61)
Other current liabilities - contingent consideration(16)  (16)(16)
Other noncurrent liabilities - contingent consideration(33)  (33)(33)
Financial instruments not carried at fair value
Long-term debt, including current portion(5,961) (5,877) (5,877)
December 31, 2022
Recurring fair value measurements
Prepaid expenses and other - derivative instruments$90 $ $90 $ $90 
Other noncurrent assets - derivative instruments10  10  10 
Other noncurrent assets - investments with readily determinable fair value7 7   7 
Other current liabilities - derivative instruments(64) (64) (64)
Financial instruments not carried at fair value
Long-term debt, including current portion(5,900) (5,711) (5,711)
We also had investments without readily determinable fair values and equity method investments, which were classified as other noncurrent assets on our condensed consolidated balance sheets totaling $28 million and $27 million as of September 30, 2023 and December 31, 2022, respectively. These investments are not recorded at fair value on a recurring basis, and as such, are not included in the fair value table above.
Of the total value of the contingent consideration liabilities at September 30, 2023, $42 million related to our acquisition of certain assets from NutriQuest during the first quarter of 2023 (see Note 4. Acquisitions, Divestitures and Other Arrangements for further information). We may pay up to $85 million in cash consideration related to this acquisition, which is contingent upon the achievement of specific development, sales and geographic expansion milestones, as outlined in the asset purchase agreement. The fair values of these liabilities at September 30, 2023, were estimated using the Monte Carlo simulation model, consisting of Level 3 inputs not observable in the market, including estimates relating to revenue forecasts, discount rates and volatility.

Note 11. Goodwill
The following table summarizes the changes in the carrying amount of goodwill:
Balance as of December 31, 2022$5,993 
     Additions related to acquisitions2 
     Impairment charge(1,042)
     Foreign currency translation adjustments(51)
Balance as of September 30, 2023$4,902 
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. Goodwill is not amortized, but is reviewed for
2023 Q3 Form 10-Q | 17

impairment at least annually on October 1, or more frequently if 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.
Given the sharp increase in long-term treasury rates in the third quarter of 2023, we assessed our long-lived assets for impairment, concluding that qualitative impairment indicators (i.e., a triggering event) existed as of September 30, 2023, for certain indefinite-lived assets, including goodwill. Accordingly, we performed an interim quantitative goodwill impairment test, which resulted in a $1,042 million pre-tax impairment charge. The fair value of our single reporting unit was determined using the income approach, based on a discounted cash flow model. Significant management judgment was required in estimating our reporting unit’s fair value, including, but not limited to, estimates and assumptions regarding future cash flows, revenue growth and other profitability measures such as gross margin and EBITDA margin; and the determination of an appropriate discount rate. We made these judgments based on historical experience, relevant market size, historical pricing and expected industry trends. While we believe our estimates and assumptions underlying the September 30, 2023, interim goodwill impairment test were reasonable in view of all available information, future changes in our discount rate, whether driven by increases in long-term treasury rates or other factors, or future changes in other significant assumptions or the use of alternative estimates and assumptions, could have a significant impact on the estimated fair value of our reporting unit, exposing us to further goodwill impairment losses.

Note 12. Income Taxes
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Income tax (benefit) expense$(1)$21 $22 $41 
Effective tax rate0.2 %(47.7)%(2.0)%234.3 %
For the three and nine months ended September 30, 2023, we recognized an income tax benefit of $1 million and income tax expense of $22 million, respectively. Our effective tax rates of 0.2% and (2.0)%, respectively, differ from the statutory income tax rates primarily due to the recognition of a goodwill impairment charge that was non-deductible in most of the impacted jurisdictions.
For the three and nine months ended September 30, 2022, we recognized income tax expense of $21 million and $41 million, respectively. Our effective tax rates of (47.7)% and 234.3%, respectively, differ from the statutory income tax rate primarily due to the mix of earnings between periods resulting in projected losses in the U.S. and for various other foreign affiliates for which there was no tax benefit, as valuation allowances had been established in those jurisdictions. Income tax expense for the nine months ended September 30, 2022, included a $17 million income tax benefit reclassified from accumulated other comprehensive loss due to the termination of interest rates swaps.
We were included in Eli Lilly and Company's (Lilly's) U.S. tax examinations by the Internal Revenue Service through the full separation date of March 11, 2019. Pursuant to the tax matters agreement we executed with Lilly in connection with our initial public offering (IPO), the potential liabilities or potential refunds attributable to pre-IPO periods in which Elanco was included in a Lilly consolidated or combined tax return remain with Lilly. The U.S. examination of tax years 2016 to 2018 began in 2019 and remains ongoing.

Note 13. Commitments and Contingencies
Legal Matters
We are party to various legal actions that arise in the normal course of business. The most significant matters are described below. Loss contingency provisions are recorded when it is deemed probable that we will incur a loss and we can formulate a reasonable estimate of that loss.
Seresto Class Action Lawsuits and EPA Safety Review
Claims seeking actual damages, injunctive relief and/or restitution for allegedly deceptive marketing have been made against Elanco Animal Health Inc. and Bayer HealthCare LLC, along with other Elanco and Bayer entities, arising out of the use of Seresto™, a non-prescription flea and tick collar for cats and dogs. During 2021, putative class action lawsuits were filed in federal courts in the U.S. alleging that the Seresto collars contain pesticides that can cause serious injury and death to cats and/or dogs wearing the product. In August 2021, the lawsuits were consolidated by the Judicial Panel on Multidistrict Litigation, and the cases were transferred to the Northern District of Illinois. In June 2023, the parties agreed on the monetary terms of a potential settlement of the consolidated class action lawsuits, and as a result, a charge of $15 million was recorded during the three months ended June 30, 2023. The parties must still reach agreement on non-monetary terms, and any settlement, if reached, is subject to approval by the court, and likely will be subject to other conditions. This $15 million provision was included within other noncurrent liabilities on our condensed consolidated balance sheet as of September 30, 2023.
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Also, in January 2023, a lawsuit seeking damages for alleged negligence, breach of statutory regulations, breach of statutory duties and deceptive marketing was filed in Israel against Elanco and other parties, arising out of the use of Seresto and Foresto™ flea and tick collars for cats and dogs that are marketed and sold in Europe and in Israel. We intend to defend our position vigorously, and as of the date of this filing, we are unable to estimate the probability of loss or range of loss, if any.
Seresto is a pesticide registered with the U.S. Environmental Protection Agency (the EPA). In April 2021, a non-profit organization submitted a petition to the EPA requesting that the agency take action to cancel Seresto’s pesticide registration and suspend the registration pending cancellation. In response to the EPA's request for comments from the public on the petition, we submitted a comment to the EPA supporting the safety profile of Seresto and engaged in discussions with the EPA. On July 13, 2023, the EPA announced their completion of a comprehensive, multi-year review, with support from the FDA, of the Seresto flea and tick collar and confirmed the continued registration of the collar, denying the citizen's petition. As part of the EPA’s scientific review process, the agency analyzed incident data including third-party assessments and compared data to other EPA registered pet products. Based on comprehensive data from the review, the EPA concluded that Seresto continues to meet all the EPA’s standards for registration under the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA), which ensures that products do not pose unreasonable risk of harm.
Additional Legal Matters
For the litigation matters discussed below we either believe loss is not probable or are unable to estimate the possible loss or range of loss, if any. The process of resolving these matters is inherently uncertain and may develop over an extended period of time; therefore, at this time, the ultimate resolutions cannot be predicted. As of September 30, 2023 and December 31, 2022, we had no material liabilities established related to the litigation matters mentioned below.
On May 20, 2020, a shareholder class action lawsuit captioned Hunter v. Elanco Animal Health Inc., et al. was filed in the United States District Court for the Southern District of Indiana (the Court) against Elanco and certain executives. On September 3, 2020, the Court appointed a lead plaintiff, and on November 9, 2020, the lead plaintiff filed an amended complaint adding additional claims against Elanco, certain executives and other individuals. The lawsuit alleged, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s supply chain, inventory, revenue and projections. The lawsuit sought unspecified monetary damages and purports to represent purchasers of Elanco securities between September 30, 2018 and May 6, 2020, and purchasers of Elanco common stock issued in connection with Elanco's acquisition of Aratana. On January 13, 2021, we filed a motion to dismiss, and on August 17, 2022, the Court issued an order granting our motion to dismiss the case without prejudice. On October 14, 2022, the plaintiffs filed a motion for leave to amend the complaint. On December 7, 2022, we filed an opposition to the plaintiffs' motion, and on September 27, 2023, the Court denied the plaintiffs' motion for leave, issuing final judgment in favor of Elanco. On October 25, 2023, the plaintiffs filed a notice of appeal to the United Stated Court of Appeals for the Seventh Circuit. We continue to believe the claims made in the case are meritless, and we intend to continue to vigorously defend our position.
On October 16, 2020, a shareholder class action lawsuit captioned Saffron Capital Corporation v. Elanco Animal Health Inc., et al. was filed in the Marion Superior Court of Indiana against Elanco, certain executives and other individuals and entities. On December 23, 2020, the plaintiffs filed an amended complaint adding an additional plaintiff. The lawsuit alleges, in part, that Elanco and certain of its executives made materially false and/or misleading statements and/or failed to disclose certain facts about Elanco’s relationships with third party distributors and revenue attributable to those distributors within the registration statement on Form S-3 dated January 21, 2020 and accompanying prospectus filed in connection with Elanco’s public offering which closed on or about January 27, 2020. The lawsuit seeks unspecified monetary damages and purports to represent purchasers of Elanco common stock or TEUs issued in connection with the public offering. From February 2021 to August 2022, this case was stayed in deference to Hunter v. Elanco Animal Health Inc. On October 24, 2022, we filed a motion to dismiss. On December 23, 2022, the plaintiffs filed their opposition to the motion to dismiss. Prior to the ruling on the motion to dismiss, on June 8, 2023, the plaintiffs filed a motion for leave to file a second amended complaint, which is now the operative complaint. We filed a motion to dismiss the complaint on August 7, 2023, to which the plaintiff filed their opposition on October 13, 2023. We continue to believe the claims made in the case are meritless, and we intend to vigorously defend our position.
In the third quarter of 2019, Tevra Brands, LLC (Tevra) filed a complaint in the U.S. District Court of the Northern District of California, alleging that Bayer Animal Health (acquired by us in August 2020) had been involved in unlawful, exclusive dealing and tying of its flea and tick products Advantage, Advantix and Seresto and maintained a monopoly in the market. The complaint was amended in March 2020 and then dismissed in September 2020 with leave to amend. A second amended complaint was filed in March 2021 and realleges claims of unlawful exclusive
2023 Q3 Form 10-Q | 19

dealing related to Advantage and Advantix and monopoly maintenance. A motion to dismiss the second amended complaint was denied in January 2022. Tevra’s demands include both actual and treble damages. The trial is scheduled for July 2024. We intend to defend our position vigorously.
Regulatory Matters
On July 1, 2021, we received a subpoena from the SEC relating to our channel inventory and sales practices prior to mid-2020. We have cooperated in providing documents and information to the SEC and will continue to do so. We have recently engaged in discussions with the SEC about a possible resolution or settlement of potential disclosure claims, but there can be no assurance that a resolution or settlement will be reached. Management continues to believe that its actions were appropriate. We are unable to estimate the range of any reasonably possible loss associated with this matter.
Other Commitments
As of September 30, 2023, we had a lease commitment that has not yet commenced for our new corporate headquarters in Indianapolis, Indiana. Total minimum lease payments are estimated to be approximately $378 million over a term of 25 years, excluding extensions. Final lease payments may vary depending on the actual cost of certain construction activities. Lease commencement is expected in 2025.
The land for our new corporate headquarters is located in a Tax Increment Finance District, and the project is, in part, funded through Tax Incremental Financing (TIF) through an incentive agreement between us and the City of Indianapolis. The agreement provides for an estimated total incentive of $64 million to be funded by the City of Indianapolis in connection with the future tax increment revenue generated from the developed property. In December 2021, as part of a funding and development agreement entered into between us and the developer, we made a commitment to use the expected TIF proceeds towards the cost of developing and constructing the headquarters. In exchange, the developer reimbursed us up to the $64 million commitment in 2021. During 2022, we refunded approximately $15 million of the TIF proceeds to the developer. As a result, it is our expectation that our future lease payments will be reduced. The remaining accrued incentive was included in other noncurrent liabilities on our condensed consolidated balance sheets and will be amortized over the lease term beginning on the commencement date and offset future rent expense.

Note 14. Earnings Per Share
We compute basic earnings (loss) per share by dividing net income (loss) available to common shareholders by the actual weighted-average number of common shares outstanding for the reporting period. Elanco has variable common stock equivalents relating to certain equity awards in stock-based compensation arrangements. We also had variable common stock equivalents related to the TEU prepaid stock purchase contracts during the three and nine months ended September 30, 2022, and in the first quarter of 2023 through the settlement date of February 1, 2023 (see Note 7. Equity for further discussion). Diluted earnings per share reflects the potential dilution that could occur if holders of the unvested equity awards converted their holdings into common stock and that could have occurred if holders of unsettled TEUs had converted their holdings into common stock prior to the February 1, 2023 settlement date. The weighted-average number of potentially dilutive shares outstanding was calculated using the treasury stock method. Potential common shares that would have the effect of increasing diluted earnings per share (or reducing loss per share) were considered to be anti-dilutive and as such, these shares were not included in the calculation of diluted loss per share.
Basic and diluted weighted-average shares outstanding were as follows:
Three Months Ended September 30,Nine Months Ended September 30,
2023202220232022
Determination of shares:
Basic weighted-average common shares outstanding (1)
492.7 488.4492.1 488.3
Assumed conversion of dilutive common stock equivalents (2)
    
Diluted weighted-average shares outstanding492.7 488.4492.1 488.3
(1)The TEU prepaid stock purchase contracts were convertible into a minimum of 14.3 million shares or a maximum of 17.2 million shares. The minimum 14.3 million shares were included in the calculation of basic weighted-average shares from January 22, 2020 to February 1, 2023. The 17.2 million shares that were ultimately issued were included in the calculation of basic weighted-average shares subsequent to the settlement date of February 1, 2023.
(2)For the three months ended September 30, 2023 and 2022, approximately 2.7 million and 4.4 million, respectively, of potential common shares were excluded from the calculation of diluted loss per share because their effect was anti-dilutive. For the nine months ended September 30, 2023 and 2022, approximately 2.7 million and 2.6 million, respectively, of potential common shares were excluded from the calculation of diluted loss per share because their effect was anti-dilutive.
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ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

Introduction
Management’s discussion and analysis of financial condition and results of operations (MD&A) is intended to assist the reader in understanding and assessing significant changes and trends related to our results of operations and financial position. This discussion and analysis should be read in conjunction with the condensed consolidated financial statements and accompanying footnotes in Item 1 of Part I of this Form 10-Q. Certain statements in this Item 2 of Part I of this Form 10-Q constitute forward-looking statements. Various risks and uncertainties, including those discussed in "Forward-Looking Statements" of this Form 10-Q, in Item 1A, "Risk Factors" of Part II of this Form 10-Q, and in Item 1A, “Risk Factors” of Part I of our 2022 Form 10-K, may cause our actual results, financial position and cash generated from operations to differ materially from these forward-looking statements. Further, due to the seasonality of our pet health sales, interim results are not necessarily an appropriate base from which to project annual results.
Business Overview
Elanco is a global animal health company that develops products for pets and farm animals in more than 90 countries. With a heritage dating back to 1954, we rigorously innovate to improve the health of animals and to benefit our customers while fostering an inclusive, cause-driven culture for our employees. We operate our business in a single segment directed at fulfilling our vision of enriching the lives of people through food, making protein more accessible and affordable, and through pet companionship, helping pets live longer, healthier lives. We advance our vision by offering products in the Pet Health and Farm Animal product categories.
We offer a diverse portfolio of approximately 200 brands that make us a trusted partner to pet owners, veterinarians and farm animal producers. Our products are generally sold worldwide to third-party distributors and independent retailers and directly to farm animal producers and veterinarians. With the acquisition of Bayer Animal Health in 2020, we expanded our presence in retail and e-commerce channels, allowing our customers to shop where and how they want.
Key Trends and Factors Affecting Our Results of Operations
Acquisition and Integration Activity: To date in 2023, we have acquired certain U.S. marketed products, pipeline products, inventory and an assembled workforce from NutriQuest, LLC (NutriQuest) and certain assets including inventory and distribution rights for certain marketed products from NutriQuest Nutricao Animal Ltda (NutriQuest Brazil). Additionally, as previously disclosed, in April 2023, we successfully completed the integration of the Bayer Animal Health business into Elanco's Enterprise Resource Planning (ERP) system. During the nine months ended September 30, 2023, we incurred costs totaling $86 million related to integration activities, including the build out of processes and systems to support our global organization. We anticipate some additional costs through early 2024 as we finalize these integration activities.
Macroeconomic Factors: Our operations are exposed to and are impacted by various global macroeconomic factors. We face continuing market and operating challenges across the globe due to, among other factors, the Russia-Ukraine conflict, conditions related to the COVID-19 pandemic, supply chain disruption, higher interest rates and inflationary pressures. Continued evolution of these conditions has led to economic slowdowns in certain countries and/or regions and volatility in consumer behavior. Additionally, as discussed in more detail below, the continued rise in interest rates throughout the year, specifically in long-term treasury rates in the third quarter, led to a $1,042 million pre-tax impairment charge as of September 30, 2023. We anticipate global macroeconomic pressures to continue beyond 2023.
Russia-Ukraine Conflict: As a global animal health leader, we have an obligation to support the health of animals and people. At the center of that work is ensuring access and availability of food and avoiding the spread of disease. At this time, we are limiting our business in Russia to only the essential products that support these needs, while complying with all imposed sanctions. We do not currently manufacture products in Russia, but we continue to support the health of animals and people in the country. We have entered into an agreement pursuant to which we will supply raw material inventories to an entity in Russia that will manufacture its own products, which we will then distribute, because of new laws requiring products sold in Russia to be produced there as well. We do not conduct business with the Russian government. During the nine months ended September 30, 2023, revenue from Russian and Ukrainian customers represented approximately 1% of our consolidated revenue. Assets held in Russia as of September 30, 2023, represented less than 1% of our consolidated assets.
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Seasonality: While many of our products are sold consistently throughout the year, we do experience seasonality in our pet health business due to increased demand for certain parasiticide product offerings in the first half of the year. For example, based upon historical results, approximately 75% and 60% of total annual revenue contributed by our higher-margin parasiticide products Seresto and Advantage Family, respectively, typically occurs during the first half of the year, which is reflective of the flea and tick season in the Northern Hemisphere.
Product Development and Regulatory Update
A key element of our targeted value creation strategy is to drive growth through portfolio development and product innovation. We continue to pursue the development of new chemical and biological molecules through our approach to innovation. Our future growth and success depend on both our pipeline of new products, including new products that we develop internally and may develop with partners and products that we are able to obtain through licenses or acquisitions, and the life cycle management of our existing products. We believe we are an industry leader in animal health R&D, with a track record of successful product innovation, business development and commercialization. For example, in July 2023, we launched our canine parvovirus monoclonal antibody in the U.S. after receiving conditional approval from the U.S. Department of Agriculture. This product is the first and only approved therapeutic solution to treat canine parvovirus, one of the most contagious and deadly viruses a dog can contract.
Seresto: On July 13, 2023, the EPA announced its completion of a comprehensive, multi-year review, with support from the FDA, of the Seresto flea and tick collar and confirmed the continued registration of the collar. As part of the EPA’s scientific review process, the agency analyzed incident data including third-party assessments and compared data to other EPA-registered pet products. Based on comprehensive data from the study, the EPA concluded that Seresto continues to meet all the EPA’s standards for registration under the Federal Insecticide, Fungicide and Rodenticide Act (FIFRA), which ensures that products do not pose an unreasonable risk of harm. We believe the EPA's conclusions align with those of authorities worldwide, with Seresto being approved for use in more than 80 countries and supported by veterinary professionals around the globe. The robust scientific evidence continues to support Seresto's safe use.
Goodwill Impairment Charge
Given the sharp increase in long-term treasury rates in the third quarter of 2023, we assessed our long-lived assets for impairment, concluding that qualitative impairment indicators (i.e., a triggering event) existed as of September 30, 2023, for certain indefinite-lived assets, including goodwill. Accordingly, we performed an interim quantitative goodwill impairment test. Significant management judgment was required in estimating our reporting unit’s fair value and in the creation of forecasts of future operating results that were used in the discounted cash flow method of valuation. These included, but were not limited to, estimates and assumptions regarding our future cash flows, revenue growth and other profitability measures such as gross margin and EBITDA margin; and the determination of an appropriate discount rate. We made these significant judgments based on our historical experience, relevant market size, historical pricing and expected industry trends.
Due principally to the sharp increase in long-term treasury rates in the third quarter of 2023, which led to an increased discount rate assumption relative to prior interim assessments, our quantitative test resulted in a $1,042 million pre-tax impairment charge. While we believe the estimates and assumptions underlying our goodwill impairment test were reasonable in view of all available information, future changes in our discount rate assumption, whether driven by increases in long-term treasury rates or other factors, or future changes in other significant assumptions or the use of alternative estimates and assumptions, could have a significant impact on our reporting unit's estimated fair value and may expose us to further goodwill impairment losses. For additional information regarding this goodwill impairment, see Note 11. Goodwill to the condensed consolidated financial statements.

Results of Operations
The following discussion and analysis of our results of operations should be read along with our condensed consolidated financial statements and the notes thereto.
Revision of Prior Period Financial Statements Primarily Relating to Tax Valuation Allowance Adjustment
In connection with the preparation of our financial statements as of and for the year ended December 31, 2022, a cumulative error was identified relating to the valuation allowance for taxes for a Southeast Asia affiliate. While immaterial to prior years, correcting this cumulative error in 2022 would have caused the 2022 financial statements to be materially misstated. As a result of having to make the revisions related to this error, we made other immaterial revisions to our 2022 unaudited interim consolidated financial statements. All of the revisions have been reflected throughout this Form 10-Q.

2023 Q3 Form 10-Q | 22

Three Months Ended September 30,Nine Months Ended September 30,
(Dollars in millions)20232022% Change20232022% Change
Revenue $1,068 $1,026 %$3,382 $3,426 (1)%
Costs, expenses and other:
Cost of sales487 472 %1,415 1,465 (3)%
% of revenue46 %46 %— %42 %43 %(1)%
Research and development86 78 10 %248 241 %
% of revenue%%— %%%— %
Marketing, selling and administrative313 298 %993 963 %
% of revenue29 %29 %— %29 %28 %%
Amortization of intangible assets140 128 %410 398 %
% of revenue13 %12 %%12 %12 %%
Asset impairment, restructuring and other special charges16 26 (38)%91 152 (40)%
Goodwill impairment1,042 — 100 %1,042 — 100 %
Interest expense, net of capitalized interest72 60 20 %210 179 17 %
Other expense, net13 %41 11 NM
(Loss) income before income taxes(1,097)(44)NM(1,068)17 NM
% of revenue(103)%(4)%NM(32)%— %NM
Income tax (benefit) expense(1)21 NM22 41 NM
Net loss$(1,096)$(65)NM$(1,090)$(24)NM
Certain amounts and percentages may reflect rounding adjustments.
NM - Not meaningful
Revenue
As a global company, our products are sold in more than 90 countries, and as a result, significant portions of our revenue and expenses are recorded in currencies other than the U.S. dollar. As a result, our revenue is influenced by changes in foreign exchange rates. During the nine months ended September 30, 2023 and 2022, approximately 51% of our revenue was denominated in foreign currencies. Foreign currency movements decreased revenue by 1% and 2% for the three and nine months ended September 30, 2023, respectively, compared to the same periods in 2022.
Further, increases or decreases in inventory levels in our distribution channels can positively or negatively impact our quarterly revenue results, leading to variations in revenue. This can be a result of various factors, such as end customer demand, new customer contracts, heightened and generic competition, the need for certain inventory levels, our ability to renew distribution contracts with expected terms, our ability to implement commercial strategies, regulatory restrictions, unexpected customer behavior, proactive measures taken by us in response to shifting market dynamics, payment terms we extend, which are subject to internal policies, blackout shipping periods due to system downtime, implementations and integrations and procedures and environmental factors beyond our control.
On a global basis, our revenue by product category for the three and nine months ended September 30, 2023 and 2022 is summarized as follows:
Three Months Ended September 30,
Revenue% of Total RevenueIncrease (Decrease)
(Dollars in millions)2023202220232022$ Change% Change
CC (1)
Pet Health$495 $469 46 %46 %$26%%
Farm Animal561 545 53 %53 %16%%
Subtotal1,056 1,014 99 %99 %42%%
Contract Manufacturing (2)
12 12 %%— %(2)%
Total$1,068