Elanco Animal Health Reports Second Quarter 2022 Results

• Second Quarter 2022 Financial Results
  • Revenue of $1,177 million
  • Reported Net Loss of $22 million, Adjusted Net Income of $177 million
  • Adjusted EBITDA of $300 million or 25.5% of Revenue
  • Reported EPS of $(0.04), Adjusted EPS of $0.36
• Updating full year 2022 guidance to reflect current assumptions related to economic, environmental and company-specific factors impacting the business, expecting:
  • Revenue of $4,465 to $4,550 million
  • Reported diluted EPS of $(0.10) to $(0.03), Adjusted EPS of $1.06 to $1.13
  • Reported Net Loss of $(48) to $(15) million, Adjusted EBITDA of $1,060 to $1,100 million
• Providing financial guidance for the third quarter 2022, expecting:
  • Revenue of $1,010 to $1,060 million
  • Reported diluted EPS of $(0.12) to $(0.06), Adjusted EPS of $0.12 to $0.18
  • Reported Net Loss of $(61) to $(32) million, Adjusted EBITDA of $175 to $215 million
• Remain committed to achieve 60% adjusted gross margin and 31% adjusted EBITDA margin targets; extending timeline to achieve primarily due to significantly higher inflation, global macro uncertainties, and revenue mix changes.
• Net leverage ratio decreased to 5.3x adjusted EBITDA; Reduction to ~5.0x adjusted EBITDA expected by year-end 2022.

Elanco Animal Health Incorporated (NYSE: ELAN) today reported financial results for the second quarter of 2022, provided guidance for the third quarter of 2022, and updated guidance for the full year 2022.

“Our relentless efforts to drive operational efficiency from our company-wide productivity agenda allowed us to grow adjusted EBITDA and adjusted EPS despite topline pressures in the quarter,” said Jeff Simmons, Elanco president and chief executive officer. “Our global teams are executing on items within our control while continuing to weather the many macro challenges that are creating headwinds to our business. While we are reducing our revenue expectations for the full year primarily based on these macro factors, we expect to deliver improved margins that will enable us to grow full year adjusted EBITDA and adjusted EPS compared to 2021.”

“Looking ahead, our innovation engine is building momentum and we are delighted with the pace of development of our late-stage pipeline. In July, we launched Zorbium, a feline pain product in the U.S., and are seeing a strong start. Within the next two to four months, we expect to make regulatory submissions for two differentiated Pet Health products, a parasiticide and a dermatology product, both with the potential to be blockbusters. We believe that our broad spectrum parasiticide product has crossed the so-called 'heartworm threshold', an important step on the path to approval and commercial success. And finally, we in-licensed a first-in-class feline diabetes product with FDA approval expected with the next 12 months. As our product development pipeline continues to progress and mature, our prospects for accelerated revenue growth improve.”

Financial Highlights

In the second quarter of 2022, revenue was $1,177 million, a decrease of 8% on a reported basis, or a decrease of 4% excluding the unfavorable impact of foreign exchange rates, compared with the second quarter of 2021.

Pet Health revenue was $612 million, a decrease of 11% on a reported basis or a decrease of 7% excluding the unfavorable impact from foreign exchange rates, with a 1% increase from price in the quarter as executed list price increases were partially offset by rebate and in-store marketing programs, primarily in the U.S. retail business. The Advantage^® Family of products contributed $137 million, representing a 7% decline on a reported basis, or a 3% decline excluding the unfavorable impact of foreign exchange rates. Seresto contributed $113 million, representing a 12% decline on a reported basis, or a 6% decline excluding the unfavorable impact for foreign exchange rates. For the second quarter excluding the unfavorable impact of foreign exchange rates, declines in older generation parasiticide products, supply chain disruption in the U.S. for certain retail products, and lower demand for Seresto was partially offset by growth in the Credelio franchise globally.

Farm Animal revenue was $553 million, a decrease of 2% on a reported basis or an increase of 3% excluding the unfavorable impact from foreign exchange rates, with a 2% increase from price. Excluding the unfavorable impact of foreign exchange rates, increased demand for ruminant products internationally, notably sheep products, and the timing of generic defense programs for Rumensin shifting sales expected in the third quarter of 2022 into the second quarter was partially offset by pressured economics for swine and poultry producers in China and a decline for swine in Europe.

Contract Manufacturing revenue was $12 million, a decrease of 56% or 53% when excluding the unfavorable impact from foreign exchange rates.

Reported and adjusted gross profit was $693 million, or 58.9% of revenue in the second quarter of 2022. Gross profit as a percent of revenue improved 200 bps on a reported basis and 190 bps on an adjusted basis, primarily driven by continued improvements in manufacturing productivity and price, and the effect of foreign exchange rates on international inventories sold, partially offset by inflation on input costs, freight and conversion costs and unfavorable mix from lower Pet Health revenue.

Total operating expense was $425 million for the second quarter of 2022. Marketing, selling and administrative expenses decreased 11% to $343 million, and research and development expenses decreased 13% to $82 million. The decrease in total operating expenses was primarily driven by the disciplined execution of recent strategic actions and the benefit of a stronger U.S. dollar more than offsetting cost inflation and continued investment in key strategic priorities, including the R&D pipeline.

Asset impairment, restructuring, and other special charges was $86 million in the second quarter of 2022, compared to $299 million in the second quarter of 2021. Charges recorded in the second quarter of 2022 primarily related to a $59 million charge recorded for IPR&D related to the feline diabetes care asset Elanco licensed during the quarter and costs associated with the implementation of new systems, programs, and processes due to the integration of Bayer Animal Health. We continue to expect the integration to be completed by mid-2023.

Reported net interest expense increased to $67 million in the second quarter of 2022 from $60 million in the second quarter of 2021, primarily due to a debt extinguishment loss recorded upon the retirement of a portion of the company's senior notes and the impact of rate increases on variable rate debt. Adjusted net interest expense was $50 million, or a decline of $10 million compared to the second quarter of 2021 primarily driven by the repayment of the company's $500 million bond in August of 2021.

The reported effective tax rate decreased to negative 22.5% in the second quarter of 2022 compared to 11.1% in the second quarter of 2021, primarily driven by the jurisdictional location of Elanco profits and a benefit from a cash interest rate swap settlement. The adjusted effective tax rate decreased from 29.6% in the second quarter of 2021 to 18.0% in the second quarter of 2022, primarily driven by the jurisdictional location of Elanco profits and discrete items which increased tax expense in the second quarter of 2021 and decreased tax expense in the second quarter of 2022.

Net loss for the second quarter of 2022 was $22 million and $(0.04) per diluted share on a reported basis, compared with a net loss of $210 million and $(0.43) per diluted share for the same period in 2021. On an adjusted basis, net income for the second quarter of 2022 was $177 million, a 31% increase as compared to the second quarter of 2021, or $0.36 per diluted share, a 29% increase compared with the same period in 2021.

Adjusted EBITDA was $300 million in the second quarter of 2022, an increase of 3% compared to the second quarter of 2021. Adjusted EBITDA as a percent of revenue was 25.5% compared with 22.8% for the second quarter of 2021, an increase of 270 basis points.

Working Capital and Balance Sheet

Cash flow from operations was $312 million in the second quarter of 2022 compared to $149 million in the second quarter of 2021. The increase in cash from operations in the second quarter of 2022 reflects a lower reported net loss and the benefit of a net $124 million cash interest rate swap settlement. The settlement provided a cash benefit in the second quarter of 2022 that will negatively impact operating cash flow over the next four years as this cash acceleration reverses.

As of June 30, 2022, Elanco’s net leverage ratio was 5.3x adjusted EBITDA, a decrease of 0.3x compared to March 31, 2022, driven by lower net debt and better adjusted EBITDA. Elanco expects to improve its net leverage over the rest of 2022, ending the year at approximately 5.0x adjusted EBITDA.

For further detail of non-GAAP measures, see the Reconciliation of GAAP Reported to Selected Non-GAAP Adjusted Information tables later in this press release.

Select Business Highlights Since the Last Earnings Call

• Signed a license agreement for a first-in-class product for feline diabetes care. The daily oral medication is under FDA regulatory review and is expected to be approved in the next 12 months.
• Received approval for Credelio in China, the first Elanco developed pet health product in the country, representing the 6th portfolio enhancing product approval in major markets this year, on track for at least 7 approvals in 2022.

Financial Guidance

Elanco is updating financial guidance for the full year 2022, summarized in the following table:

For the full year 2022, the company now anticipates revenue between $4,465 million and $4,550 million, including a headwind of approximately $205 million from the unfavorable impact of foreign exchange rates compared to 2021. Elanco is reducing its full year guidance range by $220 million at the midpoint compared to its May guidance. The reduction includes an incremental $65 million headwind from foreign exchange rates and $100 to $120 million from macro environmental factors including the pace of recovery from China's Covid lockdowns, disruptions in the global supply chain, and the impact from an expected economic slowdown around the world. Additionally, the reduction includes a $40 to $50 million headwind related to company-specific factors including pricing realization, slower innovation ramp, and U.S. parasiticides competition. Finally, the company has updated its guidance for reported net income, adjusted EBITDA, reported EPS and adjusted EPS to reflect the expected impact of the strengthening U.S. dollar, reduction in revenue, and the impact of increased inflation.

“While the change in revenue guidance today by $220 million is significant, the durability and diversity of Elanco’s portfolio remains highly valuable to our customers. Even with the myriad factors from the war in Ukraine and Covid lockdowns in China to droughts and excessive heat across U.S. cattle country, as well as competitive pressures in U.S. Pet Health, we are declining by approximately $50 million in constant currency sales in 2022, while we are increasing our profitability, paying down debt, and driving our Innovation forward,” said Todd Young, executive vice president and Chief Financial Officer.

Additionally, Elanco is providing financial guidance for the third quarter of 2022, summarized in the following table:

For the third quarter of 2022, the company anticipates revenue between $1,010 million and $1,060 million, with an expected headwind of approximately $60 million from the unfavorable impact of foreign exchange rates compared to the third quarter of 2021. The constant currency projected revenue decline of 3 percent at the mid-point is driven by expected declines in cattle, swine and contract manufacturing partially offset by expected growth in poultry and aqua. Pet health is expected to be generally flat. While the company is not guiding to the fourth quarter explicitly, growth at the mid-point of the implied range is approximately 2% in constant currency.

The financial guidance reflects foreign exchange rates as of the beginning of August.

Further details on guidance, including GAAP reported to non-GAAP adjusted reconciliations, are included in the financial tables of this press release and will be discussed on the company's conference call this morning.

Margin Target Timeline

Elanco remains committed to achieving 60% gross margin and 31% adjusted EBITDA margin, but is extending the timeline from 2023 and 2024, respectively, to achieve these targets as a result of the degradation in the global macro environment since the targets were established in December of 2020. These factors include significantly higher inflation, supply chain disruptions, the longer than expected recovery in China from Covid lockdowns, as well as the unfavorable impact of sales mix on gross margin. Elanco expects to expand both gross margin and adjusted EBITDA margin in 2022, with expansion continuing in 2023 and 2024 as well. The company plans to provide an updated timeline in 2023.

WEBCAST & CONFERENCE CALL DETAILS

Elanco will host a webcast and conference call at 8:00 a.m. Eastern time today, during which company executives will review second quarter financial and operational results, discuss third quarter and full year 2022 financial guidance, and respond to questions from analysts. Investors, analysts, members of the media and the public may access the live webcast and accompanying slides by visiting the Elanco website at https://investor.elanco.com and selecting Events and Presentations. A replay of the webcast will be archived and made available a few hours after the event on the company's website, at https://investor.elanco.com/investor/events-and-presentations.

ABOUT ELANCO

Elanco Animal Health Incorporated (NYSE: ELAN) is a global leader in animal health dedicated to innovating and delivering products and services to prevent and treat disease in farm animals and pets, creating value for farmers, pet owners, veterinarians, stakeholders, and society as a whole. With nearly 70 years of animal health heritage, we are committed to helping our customers improve the health of animals in their care, while also making a meaningful impact on our local and global communities. At Elanco, we are driven by our vision of Food and Companionship Enriching Life and our Elanco Healthy Purpose™ Sustainability/ESG framework – all to advance the health of animals, people and the planet. Learn more at www.elanco.com.

Cautionary Statement Regarding Forward-Looking Statements

This press release contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements concerning product launches and revenue from such products, our 2022 full year and third quarter guidance and long-term expectations, our expectations regarding debt levels, and expectations regarding 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 potential impact on our business and global economic conditions resulting from the conflict involving Russia and Ukraine;
• the success of our R&D and licensing efforts;
• misuse, off-label or counterfeiting use of our products;
• unanticipated safety, quality or efficacy concerns and the impact of identified concerns associated with our products;
• fluctuations in our business results due to seasonality and other factors;
• the impact of weather conditions and the availability of natural resources;
• risks related to the modification of foreign trade policy;
• risks related to currency rate fluctuations;
• our dependence on the success of our top products;
• the impact of customer exposure to rising costs and reduced customer income;
• the lack of availability or significant increases in the cost of raw materials;
• use of alternative distribution channels and the impact of increased or decreased sales to our channel distributors resulting in fluctuation in our revenues;
• risks related to the write down of goodwill or identifiable intangible assets;
• risks related to the evaluation of animals;
• manufacturing problems and capacity imbalances;
• the impact of litigation, regulatory investigations, and other legal matters and the risk that our insurance policies may be insufficient to protect us from the impact of such matters;
• actions by regulatory bodies, including as a result of their interpretation of studies on product safety;
• risks related to tax expense or exposure;
• risks related to environmental, health and safety laws and regulations;
• risks related to our presence in foreign markets;
• challenges to our intellectual property rights or our alleged violation of rights of others;
• our dependence on sophisticated information technology and infrastructure and impact of breaches of our information technology systems;
• the impact of increased regulation or decreased financial support related to farm animals;
• adverse effects of labor disputes, strikes, work stoppages, and the loss of key personnel or highly skilled employees;
• risks related to underfunded pension plan liabilities;
• our ability to complete acquisitions and successfully integrate the businesses we acquire, including KindredBio and the animal health business of Bayer (Bayer Animal Health);
• the effect of our substantial indebtedness on our business, including restrictions in our debt agreements that will limit our operating flexibility; and
• risks related to certain governance provisions in our constituent documents.

For additional information about the factors that could cause actual results to differ materially from forward-looking statements, please see the company’s latest Form 10-K and Form 10-Q filed with the Securities and Exchange Commission. 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 press release. 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 press release. 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 press release. Any forward-looking statement made by us in this press release speaks only as of the date thereof. 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. Comparisons of results for current and any prior periods are not intended to express any future trends or indications of future performance, unless specifically expressed as such, and should be viewed as historical data.

Use of Non-GAAP Financial Measures:

We use non-GAAP financial measures, such as revenue excluding the impact of foreign exchange rate effects, adjusted constant currency revenue growth, EBITDA, EBITDA margin, adjusted EBITDA, adjusted EBITDA margin, adjusted net income (loss), adjusted EPS, adjusted gross profit, adjusted gross margin and net debt leverage to assess and analyze our operational results and trends as explained in more detail in the reconciliation tables later in this release.

We believe these non-GAAP financial measures are useful to investors because they provide greater transparency regarding our operating performance. Reconciliation of non-GAAP financial measures and reported GAAP financial measures are included in the tables accompanying this press release and are posted on our website at www.elanco.com. The primary material limitations associated with the use of such non-GAAP measures as compared to U.S. GAAP results include the following: (i) they may not be comparable to similarly titled measures used by other companies, including those in our industry, (ii) they exclude financial information and events, such as the effects of an acquisition or amortization of intangible assets, that some may consider important in evaluating our performance, value or prospects for the future, (iii) they exclude items or types of items that may continue to occur from period to period in the future and (iv) they may not exclude all unusual or non-recurring items, which could increase or decrease these measures, which investors may consider to be unrelated to our long-term operations. These non-GAAP measures are not, and should not be viewed as, substitutes for U.S. GAAP reported measures. We encourage investors to review our unaudited condensed consolidated and combined financial statements in their entirety and caution investors to use U.S. GAAP measures as the primary means of evaluating our performance, value and prospects for the future, and non-GAAP measures as supplemental measures.

Availability of Certain Information

We use our website to disclose important company information to investors, customers, employees and others interested in Elanco. We encourage investors to consult our website regularly for important information about Elanco.

Elanco Animal Health Incorporated

Reconciliation of GAAP Reported to Selected Non-GAAP Adjusted Information

(Unaudited)

(Dollars and shares in millions, except per share data)

We define adjusted gross profit as total revenue less adjusted cost of sales and adjusted gross margin as adjusted gross profit divided by total revenue.

We define adjusted net income as net income (loss) excluding amortization of intangible assets, purchase accounting adjustments to inventory, integration costs of acquisitions, severance, asset impairment, gain on sale of assets, facility exit costs, tax valuation allowances and other specified significant items, such as unusual or non-recurring items that are unrelated to our long-term operations adjusted for income tax expense associated with the excluded financial items.

We define adjusted EBITDA as net income (loss) adjusted for interest expense (income), which includes debt extinguishment losses, income tax expense (benefit), and depreciation and amortization, further adjusted to exclude purchase accounting adjustments to inventory, integration costs of acquisitions, severance, asset impairment, gain on sale of assets, facility exit costs and other specified significant items, such as unusual or non-recurring items that are unrelated to our long-term operations.

We define adjusted EPS as adjusted net income divided by the number of weighted average shares outstanding for the periods ended June 30, 2022 and 2021.

We define net debt as gross debt less cash and cash equivalents on the balance sheet. We define gross debt as the sum of the current portion of long-term debt and long-term debt excluding unamortized debt issuance costs. We define the net leverage ratio as gross debt less cash and cash equivalents divided by adjusted EBITDA. This calculation does not include Term Loan B covenant-related adjustments that reduce this leverage ratio.

The following is a reconciliation of GAAP Reported for the three months ended June 30, 2022 and 2021 to Selected Non-GAAP Adjusted information:

For the periods presented, we have not made adjustments for all items that may be considered unrelated to our long-term operations. We believe adjusted EBITDA, when used in conjunction with our results presented in accordance with U.S. GAAP and its reconciliation to net income, enhances investors' understanding of our performance, valuation and prospects for the future. We also believe adjusted EBITDA is a measure used in the animal health industry by analysts as a valuable performance metric for investors. The following is a reconciliation of U.S. GAAP net income for the three and six months ended June 30, 2022 and 2021 to EBITDA, adjusted EBITDA, and adjusted EBITDA Margin, which is adjusted EBITDA divided by total revenue, for the respective periods:

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