On May 20, 2020, a plaintiff shareholder filed the latest securities class action lawsuit asserting claims based on COVID-19-related allegations. The lawsuit, filed against Elanco Animal Health, Inc., raises allegations concerning the company’s May 7, 2020 earning release, in which the company announced a significant revenue downturn that the company ascribed to the coronavirus outbreak. The complaint alleges that, in connection with the revenue downturn, the company announced that it had made changes in its distribution channels that had affected channel inventory levels and that in turn impacted the company’s financial results. A copy of the complaint can be found here.
Elanco is an animal health company that develops, manufactures and markets products for companion and food animals. Its shares trade on the NYSE.
In a January 8, 2020 press release (here), the company announced its 2020 financial guidance. On February 28, 2020, the company filed its 2020 10-K. Among other things, the 10-K contained a risk factor disclosure stating that “changes within existing distribution channels could negatively impact our market share, margins and distribution of our products.”
On March 24, 2020, the company issued a press release entitled “Elanco Provides Business Update Related to COVID-19,” the company withdrew its 2020 financial guidance. In the March 24 press release, the company said “as the situation around the COVID-19 pandemic is rapidly evolving, Elanco is withdrawing its previously announced 2020 revenue and earnings per share guidance.” In the March 24 press release, the company also said, among other things, that it is “closely monitoring distribution logistics,” stating further that “at this time, Elanco has not experienced any supply disruption and critical projects in the pipeline continue to advance.”
On May 7, 2020, the company released its financial results for the first quarter of 2020 (here). In the press release, the company announced that its revenue had “declined 9 percent due to a reduction of approximately $60 million in channel inventory driven by factors resulting from the COVID-19 pandemic.”
The results, the company said, reflect the impact the COVID-19 pandemic on the company’s business, particularly “actions the pandemic has prompted us to take with our commercial distribution partners.” The pandemic “created working capital pressures” and “dampened our assumptions about near-term demand from end users of our product.” These factors, “coupled with our recent evaluation of distributor performance has prompted us to tighten our approach across many facets of our distributor relationships.”
In a May 7, 2020 analyst call, Elanco CEO Jeffrey Simons allegedly made a number of statements about the impacts from the pandemic on its distribution network. Among other things, he allegedly said that “The COVID pandemic also impacted the inventory shift from our distributor consolidation. We expected the four remaining distributors would need to increase their inventory levels to handle the larger volume going through operations, offsetting the inventory drawdown in the eliminated distributors. With the liquidity and working capital pressures from COVID, the distributors are managing their inventory more tightly. Consequently, in Q1, we reduced the amount of product and distributor inventory by approximately $60 million.” The May 7 press release had stated that the company’s 9 percent revenue decline resulted from a reduction of approximately $60 million driven by factors resulting from the COVID 19-pandemic.
According to the complaint, the company’s share price declined over 13% on this news, on “unusually heavy trading volume.”
On May 20, 2020, a plaintiff shareholder filed a securities class action lawsuit in the Southern District of Indiana against the company and certain of its directors and officers. The complaint purports to be filed on behalf of a class of investors who purchased the company’s securities between January 7, 2020 and May 6, 2020.
The complaint alleges that the defendants failed to disclose to investors “(1) that, after consolidating its distributors from eight to four, the Company increased the amount of inventory, including companion animal products, held by each distributor; (2) that Elanco’s distributors were not experiencing sufficient demand to sell through the inventory; (3) that as a result, the Company’s revenue was reasonably likely to decline; (4) that as a result of the foregoing, Elanco would reduce its channel inventory with respect to companion animal product; and (5) that, as a result of the foregoing, Defendants’ positive statements about the Company’s business, operations, and prospects, were materially misleading and/or lacked a reasonable basis.”
The complaint alleges that the defendants’ statements violated Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder, and seeks to recover damages on behalf of the plaintiff class.
As part of my beat here at The D&O Diary, I read a lot of securities class action complaints. In fact, I read every single securities class action complaint filed. I am used to the idea that the complaints are all over the map in terms of quality. There are some that immediately strike you as stating very serious concerns. There are some that are less convincing. However it is rare that I have the reaction that I had to reading this complaint – that is, I have no idea what the plaintiff thinks the fraud is here.
After reading the complaint, I went back and read the company’s press releases. It looks to me pretty convincingly that what happened to the company is that as a result of the unanticipated drop in end-user demand for its products caused by the COVID-19 outbreak, the company’s distributors were unable to sell-through their inventory, which in turn caused the company to tighten its product supply to distributors. This sequence and outcome was contrary to what the company had expected going into the period; it had expected the reduction of the number of distributors to increase inventory needs among the remaining distributors. In other words, because of the coronavirus outbreak, things turned out differently than the company expected.
I don’t know how the plaintiff thinks she can make a fraud case out of this. The implication is something like – you should have told us that the outbreak of an unanticipated infectious disease pandemic would have a disruptive effect on end-user demand and consequently on your sale of inventory to your distributors. For the life of me, I don’t see how this amounts to anything, much less fraud.
Not only that, it is going to be difficult for the court to find in the complaint any allegations of scienter, much less the kind of allegations necessary to meet the requirements of the heightened standards for pleading scienter.
All of that said, this complaint does represent the latest example of an important post-pandemic trend, which is the filing of securities class action lawsuits based on allegations pertaining to the coronavirus outbreak. By my count, this lawsuit represents the seventh coronavirus-related securities class action lawsuit. The suits on this list include the lawsuits previously filed against Norwegian Cruise Lines (here), Inovio (here), Zoom (here), Phoenix Tree Holdings Ltd. (here), SCWorx (here), and iAnthus (here).
Although it arguably is not a convincing example of the type, this lawsuit may represent an example of a scenario that we may see play out in a host of forthcoming lawsuits – that is, a plaintiff shareholder will allege, after a company has announced a revenue downturn caused by the COVID-19 outbreak or announced that the COVID-19 outbreak has undermined a company’s business strategy, that the company misled investors about its anticipated revenues or business strategy.
Over the coming weeks and months, many organizations will be disclosing the negative impact that the coronavirus outbreak has had on revenues and results of operations. In some cases, investors will feel that they have been misled about the company’s prospects, business plan, or revenue sources. This complaint suggests that we are going to have to be prepared for the fact that some of the companies announced revenue downturns or disruption of business operations due to the pandemic are also going to get hit with securities lawsuits.