Elanco Animal Health Inc

Revenue

Our products are sold in more than 90 countries, and as a result, a significant portion of our revenue is recorded in currencies other than the U.S. Dollar. Because of this, our revenue is influenced by changes in foreign currency exchange rates. During the nine months ended September 30, 2024 and 2023, approximately 53% of our revenue was denominated in foreign currencies.

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.

Our revenue by product category for the three and nine months ended September 30, 2024 and 2023, was as follows:

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Note: Numbers may not add due to rounding.

(1)Represents revenue from arrangements in which we manufacture products on behalf of a third party.

The effects of price, foreign currency exchange rates, volume and the impact of our divestiture of our aqua business on changes in revenue for the three and nine months ended September 30, 2024, compared to the three and nine months ended September 30, 2023, were as follows:

Three months ended September 30, 2024

Nine months ended September 30, 2024

Note: Numbers may not add due to rounding

Pet health revenue decreased $9 million, or 2%, for the three months ended September 30, 2024, compared to the same period in 2023, driven by lower volumes, partially offset by a 2% increase in pricing. Lower volumes were primarily attributable to continued competitive pressure on certain products in the U.S. veterinary channel, competitive pressure in Australia and supply volatility for vaccines in the U.S. These volume declines were partially offset by increased revenue from new products and improved demand for retail parasiticide products in the U.S. and Europe.

Pet health revenue increased $16 million, or 1%, for the nine months ended September 30, 2024, compared to the same period in 2023, driven by a 3% increase in pricing, partially offset by lower volumes. Volumes during the nine months ended September 30, 2024 were lower due to competitive pressure on certain products in the U.S. veterinary channel and purchasing patterns of certain over-the-counter (OTC) products by U.S. retailers. These decreases were partially offset by revenue from new products and improved demand for retail parasiticide products in certain European markets, including Spain.

Farm animal revenue decreased $31 million, or 6%, for the three months ended September 30, 2024, compared to the same period in 2023, driven by the divestiture of our aqua business on July 9, 2024, partially offset by a 3% increase in pricing. Excluding the impact from our aqua business divestiture, volumes for the three months ended September 30, 2024, were flat compared to the same period in 2023. Strength in U.S. cattle, led by Experiorand Rumensin, and increased revenue from poultry products in the U.S. and Europe were offset by lower demand for sheep products in Australia, volume declines associated with our previous strategic decisions to change how we operate in and sell into certain international markets, including Argentina, and the impact from the European recall of Kexxtone, which occurred during the second quarter of 2024.

Farm animal revenue increased $19 million, or 1%, for the nine months ended September 30, 2024, compared to the same period in 2023, driven by a 2% increase in pricing and higher volumes of non-aqua products, partially offset by the impact of the divestiture of our aqua business. Higher volumes of our non-aqua products were primarily driven by strength in U.S. cattle, led by Experiorand Rumensin, and strength in poultry sales globally, partially offset by weakness in global swine markets, volume declines associated with our previous strategic decisions to change how we operate in and sell into certain international markets, including Argentina, and the impact from the European recall of Kexxtone, which occurred during the second quarter of 2024.

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Cost of Sales

Cost of sales increased $5 million for the three months ended September 30, 2024, compared to the three months ended September 30, 2023, while cost of sales as a percentage of revenue increased to 48%, compared to 46% for the prior year period. Gross margin was unfavorably impacted during the three months ended September 30, 2024, compared to the prior year, by a combination of inflation, unfavorable manufacturing performance and product mix associated with the divestiture of our aqua business. These factors were partially offset by increased pricing.

Cost of sales increased $87 million for the nine months ended September 30, 2024, compared to the nine months ended September 30, 2023, and cost of sales as a percentage of revenue increased to 44%, compared to 42% for the prior year period. These increases were due to a combination of inflation, planned reduced throughput at certain manufacturing sites and product mix, partially offset by increased pricing.

Research and Development

Research and development expenses increased $1 million and $15 million for the three and nine months ended September 30, 2024, respectively, as compared to the same periods in the prior year, primarily driven by higher employee-related expenses and timing of project costs.

Marketing, Selling and Administrative

Marketing, selling and administrative expenses increased $10 million and $21 million for the three and nine months ended September 30, 2024, respectively, as compared to the same periods in the prior year. The increase for the three months ended September 30, 2024, was primarily driven by higher employee related expenses and investments supporting the U.S. pet health business. The increase for the nine months ended September 30, 2024, also included increases in marketing and promotional spend supporting our global pet health business, partially offset by cost savings associated with the completion of our ERP system integration in the second quarter of 2023.

Amortization of Intangible Assets

Amortization of intangible assets decreased $7 million and $13 million, for the three and nine months ended September 30, 2024, respectively, as compared to the same periods in the prior year. These decreases were partially driven by changes in foreign currency exchange rates, as well as the elimination of amortization related to our aqua business intangible assets, which met the criteria to be classified as held for sale on February 1, 2024, at which date amortization of these finite-lived intangible assets ceased. See Note 4. Acquisitions, Divestitures and Other Arrangements to the condensed consolidated financial statements for further information.

Asset Impairment, Restructuring and Other Special Charges

Amounts recorded to asset impairment, restructuring and other special charges during the three months ended September 30, 2024, primarily reflected $15 million of asset impairments tied to the financial difficulties of our contract manufacturing supply partner, TriRx, the largest of which was a $12 million impairment of a contract asset related to a favorable supply agreement. Asset impairment, restructuring and other special charges for the nine

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months ended September 30, 2024, also included a $53 million impairment charge related to the write-off of a pet health IPR&D asset, $45 million of costs associated with our restructuring plan announced in February 2024 and $17 million of transaction costs associated with the divestiture of our aqua business.

Amounts recorded during the three and nine months ended September 30, 2023, primarily represented costs associated with the implementation of new systems, programs and processes due to the integration of Bayer Animal Health. For additional information regarding our asset impairment, restructuring and other special charges, see Note 5. Asset Impairment, Restructuring and Other Special Charges to the condensed consolidated financial statements.

Gain on Divestiture

As discussed above, we recorded a pre-tax gain on the divestiture of our aqua business during the three months ended September 30, 2024, of $640 million. See Note 4. Acquisitions, Divestitures and Other Arrangements to the condensed consolidated financial statements for further information.

Goodwill Impairment

As previously disclosed, there was a sharp increase in long-term treasury rates during the third quarter of 2023, and as a result, we assessed our long-lived assets, including goodwill for impairment. Due principally to an increased discount rate assumption, which was driven by the sharp increase in long-term treasury rates, our quantitative goodwill impairment test resulted in a $1,042 million pre-tax impairment charge. See Note 11. Goodwill to the condensed consolidated financial statements for further information.

Interest Expense, Net of Capitalized Interest

Interest expense, net of capitalized interest decreased $14 million and $21 million, respectively, for the three and nine months ended September 30, 2024, as compared to the same periods in the prior year, primarily due to lower average outstanding debt balances given debt repayment activity in the current year (see Note 8. Debt to the condensed consolidated financial statements for further information). These decreases were partially offset by a $12 million non-cash charge during the three months ended September 30, 2024, related to the write-off of previously deferred financing costs given our early debt repayments.

Other expense, net

Other expense, net for the three and nine months ended September 30, 2024, primarily consisted of foreign currency exchange losses and mark-to-market adjustments. Other expense, net for the three months ended September 30, 2023 principally related to foreign currency exchange losses and an increase in the contingent consideration liability related to the NutriQuest acquisition. Other expense, net during the nine months ended September 30, 2023, also included a settlement provision of $15 million related to the Seresto class action lawsuits recorded during the second quarter of 2023 (see Note 13. Commitments and Contingencies to the condensed consolidated financial statements for further information).

Income tax expense (benefit)

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We recognized income tax expense of $195 million for the three months ended September 30, 2024, and an income tax benefit of $1 million for the three months ended September 30, 2023. Of the total income tax expense for the three months ended September 30, 2024, $171 million related to the income tax expense associated with the taxable gain on the divestiture of our aqua business. Our effective tax rate of 34.8% for the three months ended September 30, 2024, differed from the statutory income tax rate primarily due to the recognition of the gain on the divestiture of our aqua business, which exceeded the reported gain of $640 million primarily due to the derecognition of non-deductible goodwill. Our effective tax rate was also impacted by the jurisdictional earnings mix of projected income in higher tax jurisdictions and losses for which no tax benefit was recognized. Our effective tax rate of 0.2% for the three months ended September 30, 2023, differed from the statutory income tax rate primarily due to the recognition of the aforementioned $1,042 million goodwill impairment charge, which was non-deductible in most of the impacted jurisdictions.

We recognized income tax expense of $193 million and $22 million for the nine months ended September 30, 2024 and 2023, respectively. Our effective tax rate of 35.8% for the nine months ended September 30, 2024, differed from the statutory income tax rate primarily due to the income tax expense impact of the gain on divestiture, partially offset by the release of a valuation allowance attributable to the sale of our aqua business and the recognition of certain state tax credits. Our effective tax rate of (2.0)% for the nine months ended September 30, 2023, differed from the statutory income tax rates primarily due to the recognition of the $1,042 million goodwill impairment charge, which was non-deductible in most of the impacted jurisdictions.