Elanco, a veterinary pharmacology company, agreed to settle charges with the SEC over accusations that it made misleading statements about its revenue growth and user demand. The company will pay a $15m penalty without admitting or denying the charges.  

The SEC’s charges arise from deficiencies in Elanco’s Regulation S-K filings, which misleadingly attributed its increased revenue to customer demand rather than its use of distributor incentives.  

According to the SEC’s order, Elanco internally stressed the importance of maximizing growth as it tried to demonstrate to investors heightened demand from end-users.

The agency stated that this plan was designed to demonstrate that Elanco could survive independently of pharma giant Eli Lilly, from which the company separated in 2019. Before the spin-off, Elanco represented about 13% of Eli Lilly’s revenue.

Unsustainable revenue boosting

To achieve its post-IPO goals, Elanco nominally boosted its quarterly revenue by incentivizing distributors to make end-of-quarter purchases ahead of increased end-user demand, the SEC said. The plan was not entirely new: Elanco practiced a form of this strategy before its IPO, in which it would ultimately “flush” inventory build-ups at distributors by decreasing sales at a future date.

Without these incentivized sales to distributors, the company would have missed its growth targets, the SEC said. But despite internal concerns that this would lead to excess product build-up and inevitable revenue collapse, the company pressed on. “Inflating inventories and kicking the can down the road will end in a reset,” one employee wrote in an email.

According to the SEC, Elanco made materially misleading statements on its forms 10-Q, 8-K, and 10-K because it “failed to disclose that a significant portion of its quarterly revenue numbers were attributable to Incentivized Sales.” Elanco also failed to communicate to investors that continued growth would be difficult due to its distributors’ increased inventory, the agency said.

The bubble pops

Elanco’s ultimate discontinuation of the incentivized sales program in early 2020 caused a $160m decline in revenue for the first two quarters of 2020, causing its share price to decline by 13%, according to the order.

And while the company officially cited the uncertainty of the COVID-19 pandemic and a “strategic change” as reasons for the discontinuation of the sales incentives, the decision seems to have been a foregone conclusion. Elanco had already decided to unwind the end-quarter revenue boosting before the onset of the pandemic, the SEC stated.