Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
The following discussion and analysis should be read in conjunction with the Consolidated Financial Statements and accompanying notes presented in Item 8 of this Annual Report on Form 10-K. Within the tables presented throughout this discussion, certain columns may not add due to the use of rounded numbers for disclosure purposes. Percentages and earnings per share amounts presented are calculated from the underlying amounts. Dollar amounts are in millions except per share amounts or as otherwise specified. References to years throughout this discussion relate to our fiscal years, which end on September 30.
Company Overview
Embecta is a leading global medical device company focused on providing solutions to improve the health and well-being of people living with diabetes. Over the close to 100 year history of our business, we believe that our products have become one of the most widely recognized and respected brands in diabetes management in the world. We estimate that our products are used by nearly 30 million people in over 100 countries for insulin administration and to aid with the daily management of diabetes. Our business traces its origins to 1924, when BD developed the first dedicated insulin syringe. Since then, we have built a world-class organization with a unique manufacturing supply chain and commercial footprint.
We have a broad portfolio of marketed products, including a variety of pen needles, syringes and safety injection devices, which are complemented by our proprietary digital application designed to assist people with managing their diabetes. Our pen needles are sterile, single-use, medical devices, designed to be used in conjunction with pen injectors that inject insulin or other diabetes medications. We also sell safety pen needles, which have shields on both ends of the cannula that automatically deploy after the injection to help prevent needlestick exposure and injury during injection and disposal. Our traditional and safety pen needles are compatible and frequently used with widely available pen injectors in the market today. In addition to pen needles, we sell sterile, single-use insulin syringes, which are used to inject insulin drawn from insulin vials. We also sell safety insulin syringes, which have a sliding safety arm that can be activated with one-hand after the injection to help prevent needlestick exposure and injury during injection and disposal.
We primarily sell our products to wholesalers and distributors that sell to retail and institutional channels who in turn sell to patients.
Separation from BD
Pursuant to the Separation and Distribution Agreement, the Separation from BD was completed on April 1, 2022 (the "Separation Date"). 57,012,925 issued and outstanding shares of Embecta common stock were distributed pro-rata to BD stockholders as of the close of business on March 22, 2022, the record date for the distribution, determined by applying a ratio of one share of Embecta common stock for every five shares of BD common stock. "Regular-way" trading of Embecta common stock began on April 1, 2022, under the ticker symbol "EMBC".
Periods Prior to Separation
Prior to the Separation, the Company was referred to as the Diabetes Care Business. For periods prior to April 1, 2022, the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K include certain assets and liabilities that were historically held at the BD corporate level, but are specifically identifiable or otherwise allocable to the Diabetes Care Business.
BD used a centralized approach to cash management and financing of its operations. While certain cash and cash equivalents were specifically identifiable to Embecta, the cash and cash equivalents held by BD at the corporate level were not specifically identifiable to the Diabetes Care Business and therefore were not allocated for any of the periods presented prior to Separation. These arrangements are not reflective of the manner in which Embecta would have financed its operations had it been a standalone company separate from BD during the prior periods presented. Cash pooling, related interest and intercompany arrangements were excluded from the asset and liability balances in the Consolidated Balance Sheets in Item 8 of this Annual Report on Form 10-K. These amounts were instead reported as Net Investment from Becton, Dickinson and Company as a component of equity.
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Additionally, BD provided certain services, such as legal, accounting, information technology, human resources and other infrastructure support to the Diabetes Care Business. The costs of these services were allocated to the Diabetes Care Business on the basis of the proportion of net sales, headcount, and other drivers. The Diabetes Care Business and BD considered these allocations to be a reasonable reflection of the benefits received by the Diabetes Care Business. Actual costs that may have been incurred if the Diabetes Care Business had been a standalone company would depend on a number of factors, including the chosen organizational structure, whether functions were outsourced or performed by Diabetes Care Business employees, and strategic decisions made in areas such as manufacturing, selling and marketing, research and development, information technology and infrastructure.
Periods Post Separation
For the period subsequent to April 1, 2022, as a standalone publicly traded company, Embecta presents its financial statements on a consolidated basis. The Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K have been prepared in accordance with accounting principles generally accepted in the United States of America.
Key Trends Affecting Our Results of Operations
Competition. The regions in which we conduct our business and the medical devices industry in general are highly competitive. We face significant competition from a wide range of companies in a highly regulated industry. These include large companies with multiple product lines, some of which may have greater financial and marketing resources than us, as well as smaller more specialized companies. Non-traditional entrants, such as technology companies, are also entering into the diabetes care industry and its adjacent markets, some of which may have greater financial and marketing resources than us.
Pricing Pressures. The increased scrutiny by regulators on healthcare spending, which has accelerated in light of the COVID-19 pandemic, along with a shift towards volume-based procurement and GPOs, which generally values lower cost over product features, benefits and quality, have placed significant pressure on Embecta to lower pricing. These trends may reduce our operating margins, which are only partially offset by our ability to differentiate our products and sell at higher prices.
Commoditization of Injection Devices. Given the growing demand for medical devices to assist in the treatment of diabetes and difficulties around access to diabetes care due to complex and costly insurance plans, patient care is increasingly focused on providing more affordable products, which has led to the commoditization of more traditional injection delivery devices, such as insulin syringes and pen needles. Existing and new local and regional low-cost providers, in combination with a shift from insulin vials to insulin pens, have made the pen needle category highly competitive. This has forced providers to provide clinical evidence to differentiate their products.
Changes in Clinical Practice. Increased penetration of oral anti-diabetic drugs (e.g., SGLT-2s & DDP-4s) and GLP-1s and GLP-1 combination products have delayed initiation of insulin therapy and contributed to less demand for our products.
COVID-19 Impacting Delivery and Allocation of Healthcare. The COVID-19 pandemic has accelerated the adoption of, and reimbursement by governments and private payers for, the delivery of healthcare using digital technologies, including telehealth technologies and other at-home self-care solutions and various media for virtual engagement with healthcare providers. Our ability to adapt the delivery of our products and sales and marketing efforts to these trends, including with the development of our diabetes care app, may materially affect our results of operations. The pandemic has also caused hospitals and other healthcare providers to reassess their prioritization and allocation of their healthcare resources. In many cases, providers were forced to balance between diverting resources toward COVID-19 needs and maintaining routine care, including for people living with long term conditions. If this trend persists, particularly in regions where COVID-19 continues to spread, it could have an adverse impact on the delivery of care for people with diabetes and our sales and marketing efforts.
Decentralization of Chronic Care. Many countries are facing an aging population and a rapidly growing number of people living with diabetes. While healthcare investments in certain regions continue to grow, there is an increased burden on physicians and longer wait times for patients. Healthcare delivery for non-emergency diabetes care is expected to continue shifting outside of hospitals to primary care providers, which could have a material impact on our results of operations.
Political and Economic Instability in Emerging Markets. We operate in a number of emerging markets, many of which are subject from time to time to significant political and economic disruptions. However, the number of countries we provide products to and our proactive channel management strategies help us manage this variability.
Recent Developments
COVID-19 Pandemic Impacts and Response and Global Economic Conditions
Various governmental measures to slow and control the spread of COVID-19 have led to a shift in healthcare priorities, supply chain constraints and the disruption of economic activities worldwide. As further discussed below, our future
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operating performance may be subject to further volatility due to the significant uncertainty with respect to the duration and overall impact of the COVID-19 pandemic. The impacts of the COVID-19 pandemic on our business, results of operations, financial condition and cash flows is dependent on certain factors including:
•the extent to which resurgences in COVID-19 infections or new strains of the virus, result in the imposition of new governmental lockdowns, quarantine requirements or other restrictions that may disrupt our operations;
•the continued momentum of the global economy’s recovery from the pandemic and the degree of pressure that a weakened macroeconomic environment would put on the global demand for our products; and
•the effectiveness of vaccines and vaccination efforts.
We continue to face increases in the cost and disrupted availability of raw materials, components, and other inputs necessary to manufacture and distribute our products due to constraints and inflation within the global supply chain, as well as increases in the cost and time to distribute our products. To date we have been able to successfully mitigate this disruption and provide uninterrupted supply to our customers by increasing our inventory levels and taking other measures.
The military conflict in Russia and Ukraine and the sanctions imposed by the United States government and other nations in response to this conflict have caused significant volatility and disruptions to the global markets. For all fiscal years presented, our net sales in Russia and Ukraine were not material to our consolidated net revenues. Although operations in both Russia and Ukraine do not constitute a material portion of our business, there is uncertainty around the military conflict and the impact it will have on the global economy, supply chains and fuel prices generally, and therefore our business. Refer to Part I, Item 1A. "Risk Factors" for further details.
In addition, our revenues and results of operations may be affected by various fluctuations in macroeconomic conditions and regulatory and policy changes, both on a global level and in particular markets, which include inflation and slowing economic growth and contractions, a rising interest rate environment, supply chain interruptions, tariff policy changes, volatility in capital markets and the availability of credit, tax rates and the rate of exchange between the U.S. dollar and foreign currencies. The nature and extent of the impact of these factors among others varies by region and remains uncertain and unpredictable and may affect our business.
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Results of Operations
For a discussion of Results of Operations of fiscal year 2021 compared to fiscal year 2020 see Exhibit 99.1 to the Company’s General Form For Registration of Securities on Amendment No. 1 to Form 10 dated February 2, 2022.
For the years ended September 30, 2022 and 2021, our Consolidated Statements of Income are as follows:
Operating expenses:
Selling and administrative expense 294.8 240.3
Research and development expense 66.9 63.3
Impairment expense 58.9 —
Other operating expenses 44.7 4.8
Interest expense, net (46.2) —
Other income (expense), net (6.8) 2.9
Net Income per common share:
Year Ended September 30, 2022 Summary (on a comparative basis)
Key GAAP financial results for the year ended September 30, 2022 were as follows:
•Revenue decreased by $35.8 million to $1,129.5 million from $1,165.3 million;
•Gross profit decreased by $25.5 million to $774.9 million, compared to $800.4 million. Gross profit as a percent of revenue was 68.6%, as compared to 68.7% in the prior year comparative period;
•Operating income decreased by $182.4 million to $309.6 million from $492.0 million; and
•Net income decreased by $191.2 million to $223.6 million from $414.8 million.
Key Non-GAAP financial results for the year ended September 30, 2022 were as follows:
•Constant Currency Revenues decreased by 0.5%;
•EBITDA decreased by $198.7 million to $334.5 million from $533.2 million; and
•Adjusted EBITDA decreased by $105.6 million to $459.9 million from $565.5 million.
Please see a description of our Non-GAAP Financial Measures below.
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Revenues
Our revenues decreased by $35.8 million, or 3.1%, to $1,129.5 million for the year ended September 30, 2022 as compared to revenues of $1,165.3 million for the year ended September 30, 2021. Changes in our revenues are driven by the volume of goods that we sell, the prices we negotiate with customers and changes in foreign exchange rates. Of this decrease, $30.1 million was attributable to unfavorable effects from foreign currency translation primarily attributed to the strengthening of the U.S. dollar, unfavorable impacts due to volume as a result of decisions to exit certain legacy customer relationships, and to a lesser extent, unfavorable changes to estimated sales deductions in the United States. This decrease was offset by contract manufacturing revenue recognized during 2022 that commenced subsequent to the Separation Date. Increases in price favorably impacted our revenues from customers in the United States, Canada, Mainland China, and countries within Central and Southeast Asia while decreases in price unfavorably impacted our revenues from customers in Eastern Europe, the Middle East, and Africa. Increases in volume favorably impacted our revenues from customers in countries within Central and Southeast Asia, Eastern Europe, the Middle East, and Africa and Canada while decreases in volume unfavorably impacted our revenues from customers in the United States, Latin America and Mainland China.
Cost of products sold
Cost of products sold decreased by $10.3 million, or 2.8%, to $354.6 million for the year ended September 30, 2022 as compared to $364.9 million for the year ended September 30, 2021. Cost of products sold as a percentage of revenues were 31.4% for the year ended September 30, 2022 as compared to 31.3% for the year ended September 30, 2021. The decrease in cost of products sold between periods was primarily driven by $13.8 million of impairment charges associated with the write-offs of certain construction in progress assets that were recorded in fiscal year 2021 and, to a lesser extent, a decrease in revenues in the current year period. This was offset by the current year impact of inflation on costs of certain raw materials (including freight), direct labor, and overhead. We intend to continue to work to improve productivity to help offset these increased costs.
Operating expenses
Operating expenses in 2022, 2021, and 2020 were as follows:
Increase
Selling and administrative expense $ 294.8 $ 240.3 $ 54.5
Research and development expense $ 66.9 $ 63.3 $ 3.6
% of revenues 5.9 % 5.4 %
Impairment expense $ 58.9 $ — nm
Other operating expense $ 44.7 $ 4.8 $ 39.9
nm = not meaningful
Selling and administrative expenses
Our selling and administrative expenses increased by $54.5 million, or 22.7%, to $294.8 million for the year ended September 30, 2022 as compared to $240.3 million for the year ended September 30, 2021. The increase period over period was primarily attributed to compensation and benefit costs resulting from increased headcount to support and enable Embecta to operate as a stand-alone publicly-traded company and, to a lesser extent, increases in marketing and advertising as a result of the Separation.
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Research and development expenses
Our research and development expenses increased by $3.6 million, or 5.7%, to $66.9 million for the year ended September 30, 2022 as compared to $63.3 million for the year ended September 30, 2021.
The increase was primarily attributed to increased investment in new products which includes our insulin patch pump.
Impairment expenses
We incurred impairment charges of $58.9 million during the year ended September 30, 2022 associated with the decision to abandon certain manufacturing production lines in the United States that were previously included as a component of Construction in progress within Property, Plant and Equipment, net in our Consolidated Balance Sheets in Item 8 of this Annual Report on Form 10-K.
Other operating expenses
We incurred other operating expenses of $44.7 million and $4.8 million for the years ended September 30, 2022 and 2021, respectively. The costs incurred primarily relate to accounting, auditing, and legal services, including costs to establish certain stand-alone corporate functions and other costs associated with the abandonment of certain manufacturing production lines discussed above. As we continue to stand-up various corporate functions as a stand-alone publicly-traded company, we expect to incur similar costs in fiscal 2023.
Interest expense, net
Interest expense, net increased to $46.2 million for the year ended September 30, 2022, primarily due to the issuance of long-term debt. If the United States Federal Reserve continues to raise the benchmark interest rate, then we would expect the interest expense on our variable rate debt to increase in fiscal 2023. See "Liquidity and Capital Resources" below and Note 11 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K for a further description of our long-term debt.
Other income (expense), net
Other income (expense), net decreased by $9.7 million to $(6.8) million for the year ended September 30, 2022 as compared to $2.9 million for the year ended September 30, 2021.
The decrease was mainly driven by amounts due to BD for tax liabilities incurred in deferred jurisdictions where BD is considered the primary obligor.
Other income (expense), net was not material for the year ended September 30, 2021.
Income tax provision
The decrease in the Company's effective income tax rate from 2022 as compared to 2021 was primarily due to the change in geographical mix of earnings and favorable unrecognized tax benefits recorded in 2022, partially offset by tax expense that has been provided on undistributed earnings of foreign subsidiaries.
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Non-GAAP financial measures
In evaluating our operating performance, we supplement the reporting of our financial information determined under GAAP with certain non-GAAP financial measures including (i) earnings before interest, taxes, depreciation, and amortization (“EBITDA”), (ii) Adjusted EBITDA, as further defined below, and (iii) Constant Currency revenue growth. These non-GAAP financial measures are indicators of our performance that are not required by, or presented in accordance with, GAAP. They are presented with the intent of providing greater transparency to financial information used by us in our financial analysis and operational decision-making. We believe that these non-GAAP measures provide meaningful information to assist investors, stockholders and other readers of our consolidated financial statements in making comparisons to our historical operating results and analyzing the underlying performance of our results of operations. Additionally, EBITDA and Adjusted EBITDA are important metrics for debt investors who utilize debt-to-EBITDA ratios. These non-GAAP financial measures are not intended to be, and should not be, considered separately from, or as an alternative to, the most directly comparable GAAP financial measures.
We believe EBITDA is an important valuation measurement for management and investors given the effect non-cash charges such as amortization related to acquired intangible assets and depreciation of capital equipment have on net income. Additionally, we regard EBITDA as a useful measure of operating performance and cash flow before the effect of interest, taxes, depreciation and amortization and as a complement to operating income, net income and other GAAP financial performance measures. We define Adjusted EBITDA as EBITDA excluding certain items that affect comparability of operating results and the trend of earnings. These adjustments are either non-cash or irregular in nature, may not be indicative of our past and future performance and are therefore excluded to allow investors to better understand underlying operating trends. The following are examples of the types of adjustments that are excluded: (i) stock-based compensation, (ii) non-cash long-lived fixed asset, goodwill and/or intangible asset impairment charges, (iii) restructuring-related costs, (iv) various costs that will enable the Company to operate as a stand-alone publicly traded company, and (v) other significant items management deems irregular or non-operating in nature. We use Adjusted EBITDA when evaluating operating performance because we believe the exclusion of such adjustments is necessary to help provide an accurate measure of on-going core operating results and to evaluate comparative results period over period.
For the years ended September 30, 2022 and 2021, the reconciliation of net income to EBITDA and Adjusted EBITDA was as follows:
Interest expense, net 46.2 —
Depreciation and amortization 31.7 38.3
Stock-based compensation expense 18.7 12.8
One-time stand up costs(1) 38.2 4.8
Other costs associated with impairment(2)(5) 5.5 —
European regulatory initiative-related costs ("EU MDR")(3) 1.9 0.9
Restructuring-related costs(4) 2.2 —
(1)One-time stand up costs incurred during the year ended September 30, 2022 primarily relate to costs to establish certain stand-alone corporate functions. Approximately $37.3 million of the one-time stand up costs are recorded in Other operating expenses and $0.9 million are recorded in Selling, general and administrative expenses. For the year ended September 30, 2021, $4.8 million of the one-time stand up costs are recorded in Other operating expenses. During 2022, the Company updated its definition for adjustments to include one-time stand up costs. This amount was not previously included as an adjustment for fiscal year 2021 as presented in Embecta’s Registration Statement on Form 10.
(2)Represents the expected costs of outstanding purchase commitments associated with the abandonment and impairment of certain manufacturing lines. Please see footnote (5) below. These costs are recorded in Other operating expenses.
(3)Represents costs required to develop processes and systems to comply with regulations such as the European Union Medical Device Regulation ("EU MDR") and General Data Protection Regulation ("GDPR") which represent a significant, unusual change to the existing regulatory framework. We consider these costs to be duplicative of previously incurred costs and/or one-off costs, which are limited to a specific period of time. These costs were recorded in Research and development expense. During 2022, the Company updated its definition for adjustments to include costs associated with complying with EU MDR. This amount was not previously included as an adjustment for fiscal year 2021 as presented in Embecta’s Registration Statement on Form 10.
(4)Represents restructuring-related costs recorded in Other operating expenses.
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(5)Relates to impairment charges associated incurred during fiscal years 2022 and 2021. During 2022, the Company updated its definition for adjustments to include fixed asset, goodwill and/or intangible asset impairment charges. For 2021, this amount was not previously included as an adjustment as presented in Embecta’s Registration Statement on Form 10. The impairment charges recorded in 2022 and 2021 were recorded in Impairment Expense and Cost of products sold, respectively.
Each reporting period, we face currency exposure that arises from translating the results of our worldwide operations to the United States dollar at exchange rates that fluctuate from the beginning of such period. A stronger United States dollar, compared to the prior-year period, resulted in an unfavorable foreign currency translation impact to our revenues as compared to the prior-year period. We evaluate our results of operations on both a reported and a Constant Currency basis, which excludes the impact of fluctuations in foreign currency exchange rates by comparing results between periods as if exchange rates had remained constant period-over-period. As exchange rates are an important factor in understanding period-to-period comparisons, we believe the presentation of results on a Constant Currency basis in addition to reported results helps improve investors’ ability to understand our operating results and evaluate our performance in comparison to prior periods. We calculate Constant Currency percentages by converting our current-period local currency financial results using the prior-period foreign currency exchange rates and comparing these adjusted amounts to our current-period results. These results should be considered in addition to, not as a substitute for, results reported in accordance with GAAP. Results on a Constant Currency basis, as we present them, may not be comparable to similarly titled measures used by other companies and are not measures of performance presented in accordance with GAAP.
For the years ended September 30, 2022 and 2021, the reconciliation of revenue growth to Constant Currency was as follows:
2022 2021 Total Change Estimated FX Impact Constant Currency Change
LIQUIDITY AND CAPITAL RESOURCES
For discussion on Liquidity and Capital Resources pertaining to the fiscal years 2021 and 2020 see Exhibit 99.1 to the Company’s General Form For Registration of Securities on Amendment No. 1 to Form 10 dated February 2, 2022, which is incorporated by reference herein.
Debt-Related Activities
Up to the date of Separation on April 1, 2022, Embecta was dependent upon BD for all of its working capital and financing requirements. Embecta has historically generated, and expects to continue to generate, positive cash flow from operations.
In February 2022, and in connection with the Separation, Embecta issued $500.0 million aggregate principal amount of 5.00% senior secured notes due February 15, 2030. Interest payments on the 5.00% Notes are due semi-annually in February and August until maturity.
In March 2022, Embecta entered into a credit agreement, providing for a Term Loan B Facility (the "Term Loan") in the amount of $950.0 million, with a seven-year term that matures in March 2029 and a Revolving Credit Facility in an aggregate principal amount of up to $500.0 million, with a five-year term that matures in 2027. The interest rate on the Term Loan is 300 basis points over the secured overnight financing rate (“SOFR”), with a 0.50% SOFR floor. The initial draw of the full amount of the Term Loan was for a 3-month period. Subsequently this borrowing has been continued for additional 3-month periods, most recently extended until December 31, 2022, at which point it can be repaid or further continued, at our option; we currently intend to continue to borrow under the Term Loan until maturity. Principal and interest payments on the Term Loan began on June 30, 2022. Such quarterly principal payments are calculated as 0.25% of the initial principal amount, with the remaining balance payable upon maturity. Principal amounts repaid under the Term Loan may not be reborrowed by us. Borrowings under the Revolving Credit Facility bear interest, at Embecta’s option, initially at an annual rate equal to (a) in the case of loans denominated in United States dollars (i) the SOFR or (ii) the alternate base rate or (b) in the case of loans denominated in Euros, the EURIBOR rate, in each case plus an applicable margin specified in the credit agreement. A commitment fee applies to the unused portion of the Revolving Credit Facility, equal to 0.25% per annum. As of September 30, 2022, no amount has been drawn on the Revolving Credit Facility.
Additionally in March 2022, Embecta issued $200.0 million of 6.75% senior secured notes to BD (the "Related Party Notes"). On April 1, 2022, BD transferred the Related Party Notes with a notional of $200.0 million issued by Embecta to Morgan Stanley pursuant to a tender offer. Morgan Stanley then sold the senior secured notes to qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act, as amended. As of April 1, 2022, the 6.75%
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Notes became third party debt of Embecta. The 6.75% Notes are due February 2030. Interest payments on the 6.75% Notes are due semi-annually in February and August until maturity.
The credit agreement and the indentures for the 5.00% and 6.75% Notes contain customary financial covenants, including a total net leverage ratio covenant, which measures the ratio of (i) consolidated total net debt to (ii) consolidated earnings before interest, taxes, depreciation and amortization, and subject to other adjustments, must meet certain defined limits which are tested on a quarterly basis in accordance with the terms of the credit agreement and indenture governing the 5.00% Notes. In addition, the credit agreement contains covenants that limit, among other things, our ability to prepay, redeem or repurchase our subordinated and junior lien debt, incur additional debt, make acquisitions, merge with other entities, pay dividends or distributions, redeem or repurchase equity interests, and create or become subject to liens. As of September 30, 2022, we were in compliance with all of such covenants. The credit agreement and the senior secured notes are secured by substantially all assets of Embecta and each subsidiary guarantor, subject to certain exceptions.
We utilized the aggregate proceeds received to make distribution payment of approximately $1,466.0 million to BD in connection with the Separation for assets transferred by BD to Embecta. Subsequent to the proceeds received and distribution payment made to BD, we retained approximately $165.0 million in cash and cash equivalents.
The following is a summary of Embecta's total debt outstanding as of September 30, 2022:
Total principal debt issued $ 1,645.3
Less: current debt obligations (9.5)
Less: debt issuance costs and discounts (37.7)
The schedule of principal payments required on long-term debt for the next five years and thereafter is as follows:
Certain measures relating to our total debt outstanding as of September 30, 2022 were as follows:
Short-term debt as a percentage of total debt 0.6 %
Weighted average cost of total debt 5.2 %
Leases
In conjunction with the Separation, we entered into a lease agreement with BD pursuant to which the Company would lease approximately 278,000 square feet of manufacturing space and equipment at BD's manufacturing facility in Holdrege, Nebraska for an initial term of 10 years. The lease is classified as a finance lease. Base rent payments commenced in the third quarter of 2022. The Company has an option to extend the lease term for an additional period of up to five years.
In addition, our lease portfolio consists of real estate and vehicles that are classified as operating leases.
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Maturities of our Holdrege finance lease and operating lease liabilities as of September 30, 2022 by fiscal year are as follows:
Finance Lease Operating Leases Total
On April 1, 2022, we entered into a real estate lease for a new Corporate Headquarters located in Parsippany, New Jersey, United States that has not yet commenced. The lease is expected to commence during the first half of fiscal year 2023 and is in existence for an initial term of 10 years. The Company has an option to extend the lease for additional periods of six years and four years, respectively.
Factoring Agreements
In conjunction with the Separation, we entered into Trade Receivables Factoring Agreements (the "Factoring Agreements") with BD, whereby Embecta owes BD a service fee calculated as 0.1% of annual revenues related to countries subject to the agreement, in exchange for the services provided by BD pursuant to the Trade Receivables Factoring Agreements.
Access to Capital and Credit Ratings
In January 2022, Moody’s Investor Services (“Moody’s”) and Standard & Poor’s Ratings Services (“S&P”) assigned credit ratings to Embecta of Ba3 and B+, respectively.
The following table summarizes our Consolidated Statements of Cash Flows for the years ended September 30, 2022 and 2021:
Twelve Months EndedSeptember 30,
Net cash provided by (used for)
Investing activities $ (24.0) $ (39.2)
Financing activities $ (48.0) $ (417.1)
Net Cash Flows from Operating Activities
Net cash provided by operating activities during the year ended September 30, 2022 was attributable to net income of $223.6 million and net adjustments of $188.6 million, which includes $96.2 million of non-cash adjustments related to asset impairment charges, depreciation and amortization, stock-based compensation, deferred income taxes, pension expense, and $92.4 million of net cash provided as a result of favorable changes in working capital. The favorable changes in working capital were driven by a decrease in trade receivables of $122.7 million and an increase of $73.3 million in accounts payable and accrued expenses. The decrease in trade receivables primarily relates to the Factoring Agreement, in which Embecta transfers certain trade receivable assets to BD in exchange for cash which is settled within a 30 to 45 day time frame. The increase in amounts for accounts payable and accrued expenses relates to increased compensation related costs associated with increased headcount. Offsetting the amounts above is an increase in amounts due from BD of $47.0 million, and increases of $23.4 million and $44.0 million in inventories and prepaid expenses and other, respectively. The increase in amounts due from BD primarily relates to factored receivables for which payment has not yet been collected from BD as of September 30, 2022. The increase in inventories is primarily driven by a concerted effort to build inventory through fiscal year end 2022 to meet expected demand. Prepaid expenses and other are primarily driven by increased prepaid service contracts related to information technology infrastructure as we transition to our own systems.
Net cash provided by operating activities during the year ended September 30, 2021 was attributable to net income of $414.8 million and net adjustments of $41.5 million, which includes $71.5 million of non-cash adjustments related to depreciation and amortization, impairment of property, plant and equipment, stock-based compensation, deferred income
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taxes, and pension expense, and $30.0 million of net cash used relating to changes in working capital. The net use of cash relating to working capital was driven by an increase in trade receivables of $31.8 million, increase in inventories of $18.0 million and an increase in prepaid expenses and other of $11.5 million, partially offset by a $30.8 million increase in accounts payable. The increase in trade receivables and inventory primarily related to higher sales in 2021 as compared to 2020 which led to higher outstanding trade receivables and inventories on hand to satisfy demand. The increase in prepaid expenses and other was driven by increases in prepaid taxes. The increase in accounts payable was driven by the timing of our rebate payments, which led to higher accounts payable as of period end, as well as increased accrued freight expenses due to higher sales in the period.
Net Cash Flows from Investing Activities
Net cash used for investing activities was primarily comprised of capital expenditures of $23.6 million and $36.8 million during the years ended September 30, 2022 and 2021 respectively, to support further expansion of our business and operations.
Net Cash Flows from Financing Activities
Net cash used for financing activities for the year ended September 30, 2022, was attributable to $1,266.0 million of net consideration paid to BD in connection with the Separation, $177.9 million related to net transfers to BD, $33.3 million of payments for long-term debt issuance costs, $8.6 million of dividend payments, $5.6 million of payments for debt fees associated with the Revolving Credit Facility, $4.8 million of required payments on long-term debt, and $1.8 million for finance lease payments. This was offset by proceeds from the issuance of long-term debt of $1,450.0 million.
Net cash used for financing activities for the year ended September 30, 2021 represents net transfers entirely to BD (see Note 4 to the Consolidated Financial Statements included in Item 8 of this Annual Report on Form 10-K).
Cash and cash equivalents
At September 30, 2022, total worldwide cash and equivalents were $330.9 million. These assets were largely held in jurisdictions outside of the United States. We regularly review the amount of cash and cash equivalents held outside of the United States and our historical foreign earnings are used to fund foreign investments or meet foreign working capital and property, plant and equipment expenditure needs. To fund cash needs in the United States, we rely on ongoing cash flow from United States operations, access to capital markets and remittances from foreign subsidiaries of earnings that are not considered to be permanently reinvested.
Contractual Obligations
Our contractual obligations as of September 30, 2022, which require material cash requirements in the future, consist of purchase obligations and lease obligations. Purchase obligations are enforceable and legally binding obligations for purchases of goods and services which include inventory purchase commitments. Over the next several years, we expect to incur significant costs associated with information technology infrastructure as we transition to our own systems. Lease obligations include lease agreements for which a contract has been signed even if the lease has not yet commenced.
As of September 30, 2022, total payments due for purchase obligations and lease obligations aggregate to approximately $174 million and $86 million, respectively, and will be expended over the next several years. Contractual obligations due within the next twelve months approximate $111 million related to purchase commitments and $6.0 million related to lease obligations.
Critical Accounting Policies
The following discussion supplements the descriptions of our accounting policies contained in Note 3 to the Consolidated Financial Statements contained in Item 8 of this Annual Report on Form 10-K. Financial Statements and Supplementary Data. The preparation of the Consolidated Financial Statements requires management to use estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, as well as the disclosure of contingent assets and liabilities at the date of the Consolidated Financial Statements. Some of those judgments can be subjective and complex and, consequently, actual results could differ from those estimates. Management bases its estimates and judgments on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. For any given estimate or assumption made by management, it is possible that other people applying reasonable judgment to the same facts and circumstances could develop different estimates. Actual results that differ from management’s estimates could have an unfavorable effect in our Consolidated Financial Statements. Management believes the following critical accounting policies reflect the more significant judgments and estimates used in the preparation of the Consolidated Financial Statements:
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Revenue Recognition
Our revenues are primarily recognized when the customer obtains control of the product sold, which is generally upon shipment or delivery, depending on the delivery terms specified in the distribution or sales agreement.
Our gross revenues are subject to a variety of deductions, which include rebates, sales discounts and sales returns. These deductions represent estimates of the related obligations, and judgment is required when determining the impact of these revenue deductions on gross revenues for a reporting period. Rebates are based upon prices determined under our agreements with the end-user customers. Additional factors considered in the estimate of our rebate liability include the quantification of inventory that is either in stock at or in transit to our distributors, as well as the estimated lag time between the sale of product and the payment of corresponding rebates.
Stock-Based Compensation
We expense all stock-based payment awards to employees, including grants of stock options, over the requisite service period based on the grant date fair value of the awards. The fair value of certain stock-based awards is determined using the Black-Scholes-Merton ("BSM") option-pricing model which uses both historical and current market data to estimate the fair value. This method incorporates various assumptions such as the risk-free interest rate, expected volatility, expected dividend yield and expected life of the options.
Income Taxes
Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates.
We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances are included in the tax provision in the period of change. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset.
From time to time, the Company engages in transactions in which tax consequences may be subject to uncertainty. The Company conducts business and files tax returns in numerous jurisdictions based on its interpretation of tax laws and regulations. In evaluating the Company’s tax provision, the Company establishes a reserve for uncertain tax positions unless such positions are determined to be more likely than not of being sustained upon examination based on the technical merits. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain tax positions as part of income tax expense.
Prior to the Separation, our operations were included in the tax returns of BD. Income taxes as presented in the Consolidated Financial Statements attribute current and deferred income tax assets and liabilities of BD to us in a manner that is systematic, rational, and consistent with the asset and liability method prescribed by the accounting guidance for income taxes. Our income tax provision prior to the Separation was prepared using the separate return method. The separate return method applies the accounting guidance for income taxes to the standalone financial statements as if we were a separate taxpayer and a standalone enterprise. We believe the assumptions supporting the allocation and presentation of income taxes on a separate return basis are reasonable
Additional disclosures regarding our accounting for income taxes are provided in Note 13 to the Consolidated Financial Statements included elsewhere in this Annual Report on Form 10-K.
Cautionary Statements Regarding Forward-Looking Statements
This Annual Report on Form 10-K contains statements that constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995 and other securities laws. Forward-looking statements include those containing such words as “anticipates,” “believes,” "can," “could,” “estimates,” “expects,” “forecasts,” “goal,” “guidance,” “intends,” “may,” “outlook,” “plans,” "possible," “projects,” “seeks,” “sees,” “should,” “targets,” “will,” “would,” or other words of similar meaning. All statements that reflect Embecta’s expectations, assumptions or projections about the future, other than statements of historical fact, are forward-looking statements, including, without limitation, forecasts relating to discussions of future operations and financial performance (including volume growth, pricing, sales and earnings per share growth and cash flows) and statements regarding Embecta’s strategy for growth, future product development, regulatory clearances and approvals, competitive position and expenditures. Forward-looking statements are based upon our present intent, beliefs or expectations, are not guarantees of future performance and are subject to numerous risks, uncertainties, and changes in circumstances that are difficult to predict. Although Embecta believes that the expectations reflected in any forward-looking statements it makes are based on reasonable assumptions, it can give no assurance that these expectations will be
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attained and it is possible that actual results may differ materially from those indicated by these forward-looking statements due to a variety of risks and uncertainties. Such risks and uncertainties include, but are not limited to:
•Competitive factors that could adversely affect Embecta’s operations, including new product introductions by Embecta’s competitors, the development of new technologies, lower cost producers that create pricing pressure and consolidation resulting in companies with greater scale and market presence than Embecta.
•Any events that adversely affect the sale or profitability of one of Embecta’s key products or the revenue delivered from sales to its key customers.
•Any failure by BD to perform its obligations under the various separation agreements entered into in connection with the Separation and Distribution, including the cannula supply agreement.
•Increases in operating costs, including fluctuations in the cost and availability of oil-based resins, other raw materials, and energy as well as certain components, used in its products, the ability to maintain favorable supplier arrangements and relationships, and the potential adverse effects of any disruption in the availability of such items.
•Changes in reimbursement practices of governments or private payers or other cost containment measures.
•The adverse financial impact resulting from unfavorable changes in foreign currency exchange rates, as well as regional, national and foreign economic factors, including inflation, deflation, and fluctuations in interest rates, and their potential effect on its operating performance.
•The impact of changes in United States, federal laws, and policy that could affect fiscal and tax policies, healthcare and international trade, including import and export regulation and international trade agreements. In particular, tariffs or other trade barriers imposed by the United States or other countries could adversely impact its supply chain costs or otherwise adversely impact its results of operations.
•Any continuing impact of the COVID-19 pandemic or geopolitical instability on Embecta’s business, including disruptions in its operations and supply chains.
•New or changing laws and regulations affecting Embecta’s domestic and foreign operations, or changes in enforcement practices, including laws relating to healthcare, environmental protection, trade, monetary and fiscal policies, taxation (including tax reforms that could adversely impact multinational corporations) and licensing and regulatory requirements for products.
•The expected benefits of the Separation from BD.
•Risks associated with indebtedness and our use of indebtedness available to us.
•The risk that dis-synergy costs, costs of restructuring transactions and other costs incurred in connection with the Separation will exceed Embecta's estimates.
•The impact of the Separation on Embecta's businesses and the risk that the Separation may be more difficult, time-consuming or costly than expected, including the impact on its resources, systems, including enterprise resource planning, procedures and controls, diversion of management’s attention and the impact on relationships with customers, suppliers, employees and other business counterparties.
•The Risk that we may not complete strategic collaborative partnerships and acquisition opportunities that enable us to accelerate our growth or strategic collaborative opportunities that give us access to innovative technologies, complementary product lines, and new markets.
There can be no assurance that the transactions or uncertainties described above will in fact be consummated or occur in the manner described or at all. As a result, you should not place undue reliance upon our forward-looking statements. The above list of factors is not exhaustive or necessarily in order of importance. For additional information on identifying factors that may cause actual results to vary materially from those stated in forward-looking statements, see the discussions under Item 1A,“Risk Factors,” or in our other filings with the SEC. Any forward-looking statement speaks only as of the date on which it is made, and Embecta expressly disclaims and assumes no obligation to update or revise such statement, whether as a result of new information, future events or otherwise, except as required by applicable law.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk.
In addition to the items noted below, the information required by this item is included in Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations, and in Notes 3, 11 and 14 to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K, and is incorporated herein by reference.
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Foreign Currency Exchange and Other Rate Risks
We operate on a global basis and are exposed to the risk that changes in foreign currency exchange rates could adversely affect our financial condition, results of operations and cash flows.
From time to time, we enter into foreign currency forward exchange contracts with major financial institutions to manage currency exposures for transactions denominated in a currency other than an entity’s functional currency. As a result, the impact of foreign currency gains/losses recognized in earnings are partially offset by gains/losses on the related foreign currency forward exchange contracts in the same reporting period. Refer to Note 14, Financial Instruments and Fair Value Measurements of the Notes to Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further information.
Consequently, foreign currency exchange contracts would not subject us to material risk due to exchange rate movements, because gains and losses on these contracts offset gains and losses on the assets, liabilities or transactions being hedged.
Interest Rate Risk
Debt - Our interest rate risk as of September 30, 2022 relates primarily to our Term Loan. The interest rate is set at 300 basis points over the SOFR, with a 0.50% SOFR floor. Based on our outstanding borrowings at September 30, 2022, a 100 basis points change in interest rates would have impacted interest expense on the Term Loan by $9.5 million on an annualized basis. To the extent we borrow on our revolving credit facility, we will also be subject to risks related to changes in SOFR. Refer to Note 11 to the Consolidated Financial Statements in Item 8 of this Annual Report on Form 10-K for further information.
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Item 8. Financial Statements and Supplementary Data.
Report of Independent Registered Public Accounting Firm
To the Shareholders and the Board of Directors of Embecta Corp.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Embecta Corp. (the Company) as of September 30, 2022 and 2021, the related consolidated statements of income, comprehensive income, equity, and cash flows for each of the three years in the period ended September 30, 2022, and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at September 30, 2022 and 2021, and the results of its operations and its cash flows for each of the three years in the period ended September 30, 2022, in conformity with U.S. generally accepted accounting principles.
Basis for Opinion
These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the Public Company Accounting Oversight Board (United States) (PCAOB) and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit of its internal control over financial reporting. As part of our audits we are required to obtain an understanding of internal control over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over financial reporting. Accordingly, we express no such opinion.
Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matter
The critical audit matter communicated below is a matter arising from the current period audit of the financial statements that was communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matter does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matter below, providing a separate opinion on the critical audit matter or on the accounts or disclosures to which it relates.
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/s/ ERNST & YOUNG LLP
We have served as the Company’s auditor since 2021.
New York, New York
December 22, 2022
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Consolidated Statements of Income
Embecta Corp.
Years Ended September 30
Operating expenses:
Research and development expense 66.9 63.3 61.4
Impairment expense 58.9 — —
Other operating expenses 44.7 4.8 —
Interest expense, net (46.2) — —
Other income (expense), net (6.8) 2.9 (0.7)
Net Income per common share:
(1)For periods prior to the Separation, this income statement line includes cost of products sold from related party inventory purchases. Refer to Note 4 for further detail.
See notes to the Consolidated Financial Statements.
Consolidated Statements of Comprehensive Income
Embecta Corp.
Years Ended September 30
Other Comprehensive Income (Loss), net of tax
Foreign currency translation adjustments (64.2) (8.9) 16.4
Other Comprehensive Income (Loss), net of tax $ (64.2) $ (8.9) $ 16.4
See notes to the Consolidated Financial Statements.
Consolidated Balance Sheets
Embecta Corp.
September 30
Assets
Current Assets
Cash and cash equivalents $ 330.9 $ —
Inventories:
Amounts due from Becton, Dickinson and Company 110.9 —
Prepaid expenses and other 77.9 23.2
Property, Plant and Equipment, Net 301.6 450.9
Goodwill and Other Intangible Assets 24.6 33.9
Deferred Income Taxes and Other Assets 95.5 11.4
Liabilities and Equity
Current Liabilities
Amounts due to Becton, Dickinson and Company 66.5 —
Salaries, wages and related items 48.5 28.2
Current debt obligations 9.5 —
Current finance lease liabilities 3.6 —
Income taxes 27.2 —
Total Current Liabilities $ 301.0 $ 164.0
Deferred Income Taxes and Other Liabilities 46.1 29.7
Non Current Finance Lease Liabilities 32.6 —
Commitments and Contingencies
Embecta Corp. Equity
Additional paid-in capital 10.0 —
Accumulated deficit (577.1) —
Net Investment from Becton, Dickinson and Company — 864.8
Accumulated other comprehensive loss (324.9) (270.5)
Total Liabilities and Equity $ 1,086.4 $ 788.0
See notes to the Consolidated Financial Statements.
Consolidated Statements of Equity
Embecta Corp.
Common Stock
Net income attributable to Diabetes Care Business — — — — 427.6 — 427.6
Other comprehensive loss, net of taxes — — — — — 16.4 16.4
Net transfers to Becton, Dickinson and Company — — — — (448.9) — (448.9)
Net income attributable to Diabetes Care Business — — — — 414.8 — 414.8
Other comprehensive loss, net of taxes — — — — — (8.9) (8.9)
Net transfers to Becton, Dickinson and Company — — — — (383.8) — (383.8)
Net income attributable to Embecta Corp. — — — 45.2 178.4 — 223.6
Other comprehensive loss, net of taxes — — — — — (64.2) (64.2)
Common dividends ($0.15 per share) — — — (8.6) — — (8.6)
Stock-based compensation plans — — 10.0 — — — 10.0
Issuance of shares related to stock-based compensation plans 42,402 — — — — — —
See notes to the Consolidated Financial Statements.
Consolidated Statements of Cash Flows
Embecta Corp.
Years Ended September 30
Operating Activities
Adjustments to net income to derive net cash provided by operating activities:
Amortization of debt issuance costs 3.2 — —
Impairment of property, plant and equipment 58.9 13.8 —
Net periodic pension benefit and other postretirement costs 10.2 9.4 9.4
Deferred income taxes (26.5) (2.8) (2.2)
Change in operating assets and liabilities:
Due from/due to Becton, Dickinson and Company (47.0) — —
Accounts payable, accrued expenses and other current liabilities 73.3 30.8 (3.8)
Income and other net taxes payable 10.3 — —
Other assets, net 0.5 0.5 —
Net Cash Provided by Operating Activities $ 412.2 $ 456.3 $ 498.5
Investing Activities
Acquisition of intangible assets (0.4) (2.4) —
Net Cash Used for Investing Activities $ (24.0) $ (39.2) $ (41.9)
Financing Activities
Proceeds from the issuance of long-term debt 1,450.0 — —
Payments on long-term debt (4.8) — —
Payment of long-term debt issuance costs (33.3) — —
Payment of revolving credit facility fees (5.6) — —
Payments on finance lease (1.8) — —
Dividend payments (8.6) — —
Net transfers to Becton, Dickinson and Company (177.9) (417.1) (456.6)
Net Cash Used for Financing Activities $ (48.0) $ (417.1) $ (456.6)
Effect of exchange rate changes on cash and cash equivalents (9.3) — —
Net Change in Cash and cash equivalents $ 330.9 $ — $ —
Opening Cash and cash equivalents — — —
Closing Cash and cash equivalents $ 330.9 $ — $ —
See notes to the Consolidated Financial Statements.
Notes to Consolidated Financial Statements
Embecta Corp.
Note 1—Background
Embecta Corp. ("Embecta" or the "Company") is a leading global medical device company focused on providing solutions to improve the health and well-being of people living with diabetes. The Company has a broad portfolio of marketed products, including a variety of pen needles, syringes and safety devices, which are complemented by a proprietary digital application designed to assist people with managing their diabetes. The Company primarily sells products to wholesalers and distributors that sell to retail and institutional channels who in turn sell to patients.
On April 1, 2022 (the "Separation Date"), Embecta and Becton, Dickinson and Company ("BD") entered into a Separation and Distribution Agreement (the "Separation and Distribution Agreement"). Pursuant to the Separation and Distribution Agreement, BD agreed to spin off its diabetes care business ("Diabetes Care Business") into Embecta, a new, publicly traded company (the "Separation").
The Separation occurred by means of a pro-rata distribution (the "Distribution") of all of Embecta’s issued and outstanding shares of common stock on the basis of one share of Embecta common stock, par value $0.01 per share, for every five shares of BD common stock, par value $1.00 per share, held as of the close of business on March 22, 2022, the record date for the distribution. Embecta is now a standalone publicly traded company and, on April 1, 2022, regular-way trading of Embecta common stock commenced on the Nasdaq Global Select Market under the ticker symbol "EMBC".
In connection with the Separation, BD and Embecta entered into various agreements to provide a framework for the relationship between BD and Embecta after the Separation, including, but not limited to, a separation and distribution agreement, a transition services agreement, a tax matters agreement, an employee matters agreement, a cannula supply agreement, contract manufacturing agreements, an intellectual property matters agreement, a logistics services agreement, distribution agreements, factoring and receivables agreements, local support and service agreements and other transaction documents.
Note 2 - Basis of Presentation
On April 1, 2022, the Company became a standalone publicly traded company, and its financial statements are now presented on a consolidated basis. Prior to the Separation on April 1, 2022, the Company’s historical combined financial statements were prepared on a standalone basis and were derived from BD's consolidated financial statements and accounting records. The financial statements for all periods presented, including the historical results of the Company prior to April 1, 2022, are now referred to as "Consolidated Financial Statements", and have been prepared pursuant to the rules and regulations for reporting on Form 10-K.
Periods Prior to Separation
Prior to the Separation, the Company was referred to as the Diabetes Care Business. The assets, liabilities, revenue and expenses of the Diabetes Care Business were reflected in the combined financial statements on a historical cost basis, as included in the consolidated financial statements of BD, using the historical accounting policies applied by BD. The Consolidated Financial Statements did not purport to reflect what the Company’s results of operations, comprehensive income, financial position, equity or cash flows would have been had the Company operated as a standalone public company during the periods presented.
The Diabetes Care Business had historically functioned together with the other businesses controlled by BD. Accordingly, the Diabetes Care Business relied on BD’s corporate and other support functions for its business. Therefore, for the period prior to the Separation, certain corporate and shared costs were allocated to the Diabetes Care Business based on a specific identification basis or, when specific identification was not practicable, a proportional cost allocation method, including:
i.expenses related to BD support functions, including expenses for facilities, executive oversight, treasury, finance, legal, human resources, shared services, compliance, procurement, information technology and other corporate functions.
ii.certain manufacturing and supply costs incurred by BD, including facility management, distribution, logistics, planning and global quality.
iii.certain costs incurred by BD’s Medication Delivery Solutions organizational unit in relation to selling and marketing activities, and related administrative support functions.
iv.certain costs incurred by BD for activities related to device research and development, as well as medical and regulatory affairs.
v.stock-based compensation expenses (see Note 9).
vi.certain compensation expenses maintained on a centralized basis such as certain employee benefit expenses.
Management believes these cost allocations were a reasonable reflection of the utilization of services provided to, or the benefit derived by, the Diabetes Care Business during the period prior to the Separation, though the allocations may not be indicative of the actual costs that would have been incurred had the Diabetes Care Business operated as a standalone public company. Actual costs that may have been incurred if the Diabetes Care Business had been a standalone company would depend on a number of factors, including the chosen organizational structure, whether functions were outsourced or performed by Diabetes Care Business employees, and strategic decisions made in areas such as manufacturing, selling and marketing, research and development, information technology and infrastructure.
BD utilized a centralized approach to cash management and the financing of its operations. Cash generated by the Diabetes Care Business was routinely transferred into accounts managed by BD’s centralized treasury function and cash disbursements related to operations prior to the Separation were funded as needed by BD. Balances held by the Diabetes Care Business with BD for cash transfers and loans were reflected as Due to related party prior to the Separation. All other cash and cash equivalents and related transfers between BD and the Diabetes Care Business were generally held centrally through accounts controlled and maintained by BD and were not specifically identifiable to the Diabetes Care Business. Accordingly, such balances were accounted for through Net Investment from Becton, Dickinson and Company. BD’s third-party debt and related interest expense were not attributed to the Diabetes Care Business because the business was not the legal obligor of the debt and the borrowings were not specifically identifiable to the business.
For the Diabetes Care Business, transactions with BD affiliates were included in the Consolidated Statements of Income and related balances were reflected as Due to related party, Due from related party or Related Party Loans Payable. Other balances between the Diabetes Care Business and BD were considered to be effectively settled in the Consolidated Financial Statements at the time the transactions were recorded.
As the separate legal entities that made up the Diabetes Care Business were not historically held by a single legal entity, Net Investment from Becton, Dickinson and Company was shown in lieu of stockholders’ equity in these Consolidated Financial Statements. Net Investment from Becton, Dickinson and Company represented BD’s interest in the recorded assets of the Diabetes Care Business and the cumulative investment by BD through the date of the Separation, inclusive of operating results.
Income tax expense and tax balances in the Consolidated Financial Statements were calculated on a separate tax return basis. The separate tax return method applies the accounting guidance for income taxes to the standalone financial statements as if we were a separate taxpayer and a standalone enterprise. Management believes the assumptions supporting the allocation and presentation of income taxes on a separate return basis are reasonable.
The provision for income taxes for the period prior to the Separation was calculated by applying an estimated effective income tax rate for the full year to ordinary income adjusted by the tax impact of discrete items.
As of the Separation Date
Certain assets and liabilities, including patents and unrecognized tax benefits that were included in the Consolidated Balance Sheet prior to the Separation, have been retained by BD post-Separation and therefore were transferred to BD through Net Investment from Becton, Dickinson and Company in the Company's Consolidated Financial Statements.
In connection with the Separation, additional pension assets, deferred tax assets, other compensation obligations, and certain other assets and liabilities were transferred to the Company through Net Investment from Becton, Dickinson and Company, and the Company recorded these in the Consolidated Balance Sheet.
As part of the Separation, Net Investment from Becton, Dickinson and Company was reclassified as Common Stock and Accumulated Deficit.
Periods Post Separation
Following the Separation, certain functions continue to be provided by BD under the Transition Services Agreements or are being performed using Embecta’s own resources or third-party service providers. Additionally, under manufacturing and supply agreements, the Company manufactures certain products for BD, or its applicable affiliate and BD manufactures certain products for the Company. The Company incurred certain costs in its establishment as a standalone public company and expects to incur ongoing additional costs associated with operating as an independent, publicly traded company.
All intercompany transactions and accounts within Embecta have been eliminated.
Certain reclassifications were made to conform the prior period Consolidated Financial Statements to the current period presentation.
Note 3 — Summary of Accounting Policies
Revenue Recognition
The Company recognizes revenue from product sales and considers performance obligations satisfied when the customer obtains control of the product, which is generally upon shipment or delivery, depending on the delivery terms specified in the sales agreement. When arrangements include multiple performance obligations, the total transaction price of the contract is allocated to each performance obligation based on the estimated relative standalone selling prices of the promised goods or services underlying each performance obligation. The point in time upon which shipment or delivery occurs is the most faithful depiction of when control of the goods transfers to the customer. Variable consideration such as rebates, sales discounts, and sales returns are estimated and treated as a reduction of revenue in the same period the related revenue is recognized. These estimates are based on contractual terms, historical practices and current trends, and are adjusted as new information becomes available. Revenues exclude any taxes that the Company collects from customers and remits to tax authorities.
Additional disclosures regarding the Company’s accounting for revenue recognition are provided in Note 7.
Cash Equivalents
Cash equivalents are comprised of certain highly liquid investments with original maturities of three months or less.
Trade Receivables
The Company grants credit to customers in the normal course of business and the resulting trade receivables are stated at their net realizable value. The allowance for doubtful accounts represents the Company’s estimate of probable credit losses relating to trade receivables and is determined based on historical experience, current conditions, reasonable and supportable forecasts and other specific account data. Amounts are written off against the allowances for doubtful accounts when the Company determines that a customer account is uncollectible.
Inventories
Inventories are stated at the lower of approximate cost or net realizable value determined on the first-in, first-out basis.
Property, Plant and Equipment
Property, plant and equipment are stated at cost, less accumulated depreciation. Depreciation is principally provided on the straight-line basis over estimated useful lives, which range from 20 to 45 years for buildings, 4 to 13 years for machinery and equipment and 1 to 20 years for leasehold improvements. Depreciation expense was $31.0 million in 2022, $37.2 million in 2021, and $36.5 million in 2020.
Property, plant and equipment are periodically reviewed when impairment indicators are present to assess recoverability or a decision has been made to abandon efforts associated with construction in progress assets. Recoverability is determined by comparing the carrying values of the assets or asset groups to the undiscounted cash flows to be generated from the use and eventual disposition of such assets or asset groups. If the asset’s or asset group’s carrying value exceeds such undiscounted cash flows, the assets or asset groups are not recoverable and an impairment loss is recognized based on the amount by which the carrying value of the asset or asset group exceeds its calculated fair value.
Capitalized Interest
The interest cost on capital projects is capitalized and included in the cost of the project. Capitalization commences with the first expenditure for the project and continues until the project is substantially complete and ready for its intended use. When no debt is incurred specifically for a project, interest is capitalized on project expenditures using the weighted average cost of the Company's outstanding borrowings. For the year ended September 30, 2022, the Company capitalized $5.2 million of interest expense into Property, Plant and Equipment, Net.
Advertising Costs
Advertising costs are expensed as incurred and included in Selling and administrative expense. The Company recorded advertising costs of $11.6 million, $9.3 million, and $8.2 million in 2022, 2021 and 2020, respectively.
Goodwill and Other Intangible Assets
Goodwill represents the excess of the consideration transferred over the fair value of net assets of businesses acquired. The Company has one reporting unit. Goodwill is evaluated for impairment as of July 1 each year, or more frequently if impairment indicators exist, by first assessing qualitative factors to determine whether it is more likely than not that fair value is less than carrying value. If the Company concludes it is more likely than not that fair value is less than carrying value, a quantitative fair value test is performed. If carrying value is greater than fair value, a goodwill impairment charge will be recorded for the difference (up to the carrying value of goodwill). We completed the annual goodwill impairment
test as of July 1, 2022 and concluded that no impairment to goodwill was necessary as the fair value of the Company's one reporting unit was significantly in excess of the carrying value.
No goodwill impairments were identified during the years ended September 30, 2021, or 2020, and no accumulated impairment losses are recorded.
Amortized intangible assets primarily consist of patents and customer relationships. Patents are generally amortized over 20 years using the straight-line method. Customer relationship assets are generally amortized over periods ranging from 10 to 15 years, using the straight-line method. Other intangibles with finite useful lives are amortized over periods principally ranging from 1 to 40 years, using the straight-line method. Finite-lived intangible assets are periodically reviewed when impairment indicators are present to assess recoverability from future operations using undiscounted cash flows. The carrying values of these finite-lived assets are compared to the undiscounted cash flows they are expected to generate and an impairment loss is recognized in operating results to the extent any finite-lived intangible asset’s carrying value exceeds its calculated fair value.
Foreign Currency Translation
Generally, foreign subsidiaries’ functional currency is the local currency of operations and the net assets of foreign operations are translated into United States dollars using current exchange rates. The United States dollar results that arise from such translation are included in Accumulated other comprehensive loss.
Shipping and Handling Costs
The Company considers its shipping and handling costs to be contract fulfillment costs and records them within selling and administrative expense. Shipping and handling costs were $27.4 million, $13.6 million, and $12.4 million in 2022, 2021, and 2020, respectively.
Contingencies
The Company establishes accruals for future losses which are both probable and can be reasonably estimated (and in the case of environmental matters, without considering possible third-party recoveries). Additional disclosures regarding the Company’s accounting for contingencies are provided in Note 6.
Stock-Based Compensation
Prior to the Separation, certain of the Company’s employees historically participated in BD’s stock-based compensation plans. Stock-based compensation expense was either allocated to the Company based on a proportionate cost allocation method or recorded based on specific identification. Effective April 1, 2022, the Company established the 2022 Employee and Director Equity Based Compensation Plan (the "Plan"). The Plan provides for the grant of various types of awards, including restricted stock unit awards, stock appreciation rights, stock options, performance-based awards and cash awards. Under the Plan, the exercise price of awards, if any, is set on the grant date and generally may not be less than the fair market value per share on that date. The Company measures stock-based compensation for equity awards at fair value on the date of grant and records stock-based compensation as a charge to earnings net of the estimated impact of forfeited awards. Accordingly, the Company recognizes stock-based compensation cost only for those stock-based awards that are estimated to ultimately vest over their requisite service period, based on the vesting provisions of the individual grants. The cumulative effect on current and prior periods of a change in the estimated forfeiture rate is recognized as compensation cost in earnings in the period of the change (see Note 9).
Benefit Plans
Prior to the Separation, the defined benefit plans in which the Company participated related primarily to plans sponsored by BD and for which other businesses of BD also participate (the "Shared Plans"). The Company accounted for the Shared Plans as multiemployer plans and therefore the related assets and liabilities were not reflected in the Consolidated Balance Sheets. For such periods prior to the Separation, the Consolidated Statements of Income reflect a proportional allocation of net periodic benefit cost for the Shared Plans associated with the Company. The Company's participation in the defined pension and postretirement benefit plans sponsored by BD concluded upon the completion of the Separation on April 1, 2022. At Separation, Embecta became the plan sponsor for certain non-United States defined benefit pension plans (see Note 17).
Research and Development
Research and development costs are expensed as incurred.
Income Taxes
Income taxes are accounted for using an asset and liability approach that requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial statement and tax basis of assets and liabilities at the applicable tax rates.
We maintain valuation allowances where it is more likely than not that all or a portion of a deferred tax asset will not be realized. Changes in valuation allowances are included in the tax provision in the period of change. In determining whether a valuation allowance is warranted, we evaluate factors such as prior earnings history, expected future earnings, carryback and carryforward periods, and tax strategies that could potentially enhance the likelihood of the realization of a deferred tax asset.
From time to time, the Company engages in transactions in which tax consequences may be subject to uncertainty. The Company conducts business and files tax returns in numerous jurisdictions based on its interpretation of tax laws and regulations. In evaluating the Company’s tax provision, the Company establishes a reserve for uncertain tax positions unless such positions are determined to be more likely than not of being sustained upon examination based on the technical merits. The Company’s policy is to recognize, when applicable, interest and penalties on uncertain tax positions as part of income tax expense.
While the Company believes it has identified all reasonable exposures and the reserve it has established is appropriate under the circumstances, it is possible that additional exposures exist and that exposures may be settled at amounts different than the amounts reserved. It is also possible that changes in facts and circumstances could cause the Company to either materially increase or reduce the carrying amount of its tax reserve.
The Tax Cuts and Jobs Act was enacted on December 22, 2017 and introduced an additional U.S. tax on certain non-US. Subsidiaries’ earnings which are referred to as Global Intangible Low Taxed Income (“GILTI”) . The Company has elected to treat GILTI as a period cost.
Prior to the Separation, our operations were included in the tax returns of BD. Income taxes as presented in the Consolidated Financial Statements attribute current and deferred income tax assets and liabilities of BD to us in a manner that is systematic, rational, and consistent with the asset and liability method prescribed by the accounting guidance for income taxes. Our income tax provision prior to the Separation was prepared using the separate return method. The separate return method applies the accounting guidance for income taxes to the standalone financial statements as if we were a separate taxpayer and a standalone enterprise. We believe the assumptions supporting the allocation and presentation of income taxes on a separate return basis are reasonable.
Additional disclosures regarding our accounting for income taxes are provided in Note 13.
Segment Data
The Company operates and reports its financial information as one segment. In making this determination, the Company (i) determines its Chief Operating Decision Maker (“CODM”), (ii) identifies and analyzes potential business components, (iii) identifies its operating segments and (iv) determines whether there are multiple operating segments requiring presentation as reportable segments. The Company’s decision to report as one segment is based upon the following: (1) its internal organizational structure; (2) the manner in which its operations are managed; and (3) the criteria used by the Company’s President, its CODM, to evaluate performance of the Company’s business and allocate resources and capital.
Fair Value Measurements
A fair value hierarchy is applied to prioritize inputs used in measuring fair value. The three levels of inputs used to measure fair value are detailed below. Additional disclosures regarding the Company’s fair value measurements are provided in Note 14.
Level 1—Inputs to the valuation methodology which represent unadjusted quoted prices in active markets for identical assets and liabilities.
Level 2—Inputs to the valuation methodology which include: quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; inputs other than quoted prices that are observable for the asset or liability.
Level 3—Inputs to the valuation methodology which are unobservable and significant to the fair value measurement.
Leases
We determine whether an arrangement contains a lease at inception. If a lease is identified in an arrangement, we recognize a right-of-use asset and liability in our Consolidated Balance Sheets and determine whether the lease should be classified as a finance or operating lease. We do not recognize assets or liabilities for leases with lease terms of less than 12 months.
A lease qualifies as a finance lease if any of the following criteria are met at the inception of the lease: (i) there is a transfer of ownership of the leased asset to Embecta by the end of the lease term, (ii) we hold an option to purchase the leased asset that we are reasonably certain to exercise, (iii) the lease term is for a major part of the remaining economic life of the leased asset, (iv) the present value of the sum of lease payments equals or exceeds substantially all of the fair value of the leased asset, or (v) the nature of the leased asset is specialized to the point that it is expected to provide the lessor no alternative use at the end of the lease term. All other leases are recorded as operating leases.
Finance and operating lease assets and liabilities are recognized at the lease commencement date based on the present value of the lease payments over the lease term using the discount rate implicit in the lease. If the implicit rate is not readily determinable, the Company utilizes its incremental borrowing rate at the lease commencement date. Operating lease assets are further adjusted for prepaid or accrued lease payments. Operating lease payments are expensed using the straight-line method as an operating expense over the lease term. Finance lease assets are amortized to depreciation expense using the straight-line method over the shorter of the useful life of the related asset or the lease term. Finance lease payments are bifurcated into (i) a portion that is recorded as imputed interest expense and (ii) a portion that reduces the finance liability associated with the lease.
For lease arrangements that are recognized on the Company’s Consolidated Balance Sheets, the right-of-use asset and lease liability is initially measured at the commencement date based upon the present value of the lease payments due under the lease. These payments represent the combination of the fixed lease and fixed non-lease components that are due under the arrangement. Variable lease payments are expensed as incurred. If a lease includes an option to extend or terminate the lease, we reflect the option in the lease term if it is reasonably certain we will exercise the option.
Finance leases are recorded in Property, Plant and Equipment, Net, Current finance lease liabilities, and Non Current Finance Lease Liabilities and operating leases are recorded in Deferred Income Taxes and Other Assets, Accrued expenses, and Deferred Income Taxes and Other Liabilities in our Consolidated Balance Sheets.
Use of Estimates
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions. These estimates or assumptions affect reported assets, liabilities, revenues and expenses, including determining the allocation of shared costs and expenses from BD, depreciable and amortizable lives, sales returns and allowances, rebate accruals, inventory reserves and taxes on income as reflected in the Consolidated Financial Statements. Actual results could differ from these estimates.
Net Investment from Becton, Dickinson and Company — Net investment from Becton, Dickinson and Company represented BD’s interest in the recorded assets of the Company and the cumulative investment by BD in the Company through the date of the Separation, inclusive of operating results and the net effect of the transactions with and allocations from BD. See Notes 2 and 4 for additional information.
Supplemental Disclosures Of Cash Flow Information
Cash paid for interest related to debt during the year ended September 30, 2022 was $38.9 million. The Company did not have any debt outstanding during the years ended September 30, 2021 and 2020. Cash paid for income taxes, net of refunds, for the year ended September 30, 2022 was $15.6 million. For the years ended September 30, 2021 and 2020, the Company's current tax liabilities computed under the separate return method are considered to be effectively settled at the time the transaction is recorded, with the offset recorded against Net investment from Becton, Dickinson and Company.
Recently Adopted Accounting Standards
In December 2019, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) 2019-12, Income Taxes - Simplifying the Accounting for Income Taxes (Topic 740). The updated guidance simplifies the accounting for income taxes by removing certain exceptions in Topic 740 and clarifying and amending existing guidance. The amendments are effective for fiscal years beginning after December 15, 2020, with early adoption permitted. The Company adopted the provisions of this new accounting standard at the beginning of fiscal 2022 and adoption did not have a material impact on its consolidated financial statements.
Recently Issued Accounting Standards Not Yet Adopted
In October 2021, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2021-08, "Business Combinations (Topic 805): Accounting for Contract Assets and Contract Liabilities from Contracts
with Customers" ("ASU No. 2021-08"). ASU No. 2021-08 will require companies to apply the definition of a performance obligation under Accounting Standards Codification ("ASC") Topic 606 to recognize and measure contract assets and contract liabilities (i.e., deferred revenue) relating to contracts with customers that are acquired in a business combination. Under current GAAP, an acquirer generally recognizes assets acquired and liabilities assumed in a business combination, including contract assets and contract liabilities arising from revenue contracts with customers, at fair value on the acquisition date. ASU No. 2021-08 will result in the acquirer recording acquired contract assets and liabilities on the same basis that would have been recorded by the acquiree before the acquisition under ASC Topic 606. ASU No. 2021-08 is effective for fiscal years beginning after December 15, 2022, with early adoption permitted. The Company intends to early adopt this ASU effective October 1, 2022.
Note 4 — Third Party Arrangements and Related Party Disclosures
Pursuant to the Separation, BD ceased to be a related party to Embecta and accordingly, no related party transactions or balances are reported subsequent to April 1, 2022.
In connection with the Separation, the Company entered into the Separation and Distribution Agreement, which contains provisions that, among other things, relate to (i) assets, liabilities and contracts to be transferred, assumed and assigned to each of Embecta and BD (including certain deferred assets and liabilities) as part of the Separation, (ii) cross-indemnities principally designed to place financial responsibility for the obligations and liabilities of Embecta's business with Embecta and financial responsibility for the obligations and liabilities of BD’s remaining businesses with BD, (iii) procedures with respect to claims subject to indemnification and related matters, (iv) the allocation among Embecta and BD of rights and obligations under existing insurance policies with respect to occurrences prior to completion of the Separation, as well as the right to proceeds and the obligation to incur certain deductibles under certain insurance policies, and (v) procedures governing Embecta’s and BD’s obligations and allocations of liabilities with respect to ongoing litigation matters that may implicate each of BD’s business and Embecta’s business.
Agreements that Embecta entered into with BD that govern aspects of Embecta's relationship with BD following the Separation include, but are not limited to:
•Transition Services Agreements ("TSA") - Pursuant to the TSA, Embecta and BD and their respective affiliates provide each other, on an interim, transitional basis, various services, including, but not limited to, information technology, human resources, procurement, quality and regulatory affairs, medical affairs, tax and treasury services. The agreed-upon charges for such services are generally intended to allow the servicing party to charge a price comprised of out-of-pocket costs and expenses and a predetermined profit in the form of a mark-up of such out-of-pocket costs and expenses. The services will terminate no later than 24 months following the Separation. The service recipient may terminate any services by giving prior written notice to the provider of such services and paying any applicable wind-down charges.
•Trade Receivables Factoring Agreements - Embecta and BD entered into trade receivables factoring agreements (the "Factoring Agreements"), under which Embecta transfers certain net trade receivable assets to BD, and pays a service fee calculated as 0.1% of annual revenues related to countries subject to the Factoring Agreements in exchange for the services provided by BD. Per the terms of the Factoring Agreements, the Company and its relevant subsidiaries sell receivables to the corresponding BD subsidiary in the same jurisdiction and such BD subsidiary collects the receivables from Company's customers. The BD subsidiary assumes the credit risk in respect of the receivables, and accordingly deducts a factoring fee from the purchase price of such receivables. Accordingly, Embecta accounts for the transfer as sales of trade receivables by recognizing an increase to Cash and cash equivalents and a decrease to Trade Receivables, net in the Consolidated Balance Sheets when proceeds from the transactions are received. The transfers are presented in the Consolidated Statements of Cash Flows as operating activities and the related service fee is presented as a component of Other income (expense), net in the Consolidated Statements of Income.
•Distribution Agreements - Embecta and BD entered into distribution agreements for certain territories, principally in the Asia Pacific Region and Latin America, whereby a subsidiary of BD is appointed as a distributor of Embecta or its relevant subsidiaries to support certain commercial operations of the diabetes care business on a transitional basis in these regions for a maximum of two years. The distribution agreements will each continue until either (1) certain governmental approvals needed to distribute products in the defined territory are obtained and order-to-cash processes and other services of the Company for such territory are migrated to an alternative commercial arrangement between the parties or (2) the applicable services are transitioned to a third-party distributor or independently performed by Embecta, but in any event no longer than the maximum term of two years. Embecta shall pay BD a return of 1.5% to 2.0% of net revenue for each territory.
•Cannula Supply Agreement - Embecta and BD entered into a cannula supply agreement whereby BD sells to Embecta cannulas for incorporation into Embecta's existing syringes and pen needles, safety syringes and safety pen needles, and insulin patch pump, pen needles and safety pen needle currently under development. BD retains
ownership of all cannula technology, cannula production activities and the intellectual property rights therein. Embecta is limited to a maximum number of cannulas that it can purchase under the cannula supply agreement, which will be an absolute upper limit of cannulas per year and yearly limits that vary with annual demand. The cannula supply agreement is terminable by Embecta without cause by providing at least 36 months’ written notice; however, such termination can be effective no earlier than five years from the Separation. The cannula supply agreement will be terminable by BD without cause by providing at least 36 months’ written notice; however, such termination can be effective no earlier than ten years from the Separation. However, in the event of a change of control of Embecta, BD has the right to terminate the cannula supply agreement in its sole discretion. The cannula supply agreement will also terminate automatically, subject to a 36-month wind-down period, if Embecta’s yearly forecast is below the required minimum purchase amount, and the parties have other customary termination rights for material breach or bankruptcy of the other party.
•Tax Matters Agreement - Pursuant to the tax matters agreement, Embecta agreed to certain covenants that contain restrictions intended to preserve the tax-free status of the distribution and certain related transactions. Embecta may take certain actions prohibited by these covenants only if Embecta obtains and provides to BD an opinion from a United States tax counsel or accountant of recognized national standing, in either case satisfactory to BD, to the effect that such action would not jeopardize the tax-free status of the distribution and certain related transactions, or if Embecta obtains prior written consent of BD. Embecta is barred from taking any action, or failing to take any action, where such action or failure to act adversely affects or could reasonably be expected to adversely affect the tax-free status of the distribution and certain related transactions or result in certain other taxes to BD, for all relevant time periods. In addition, during the period ending two years after the Separation, these covenants include specific restrictions on Embecta’s (i) discontinuing the active conduct of Embecta’s trade or business; (ii) issuance or sale of stock or other securities (including securities convertible into Embecta stock, but excluding certain compensatory arrangements); (iii) liquidating, merging, or consolidating with any other person; (iv) amending Embecta’s certificate of incorporation (or other organizational documents) or taking any other action, whether through a stockholder vote or otherwise, affecting the voting rights of Embecta common stock; (v) sales of assets outside the ordinary course of business; and (vi) entering into any other corporate transaction which would cause Embecta to undergo a 50% or greater change in its stock ownership.
•Logistics Services Agreement - Embecta and BD entered into a logistics services agreement whereby BD provides Embecta with certain order-to-cash and logistics services to support certain commercial operations for a maximum term of two years. Embecta will pay BD (i) reimbursable costs, including all shipping costs, selling costs, general administration costs, costs of goods, research and development services costs, and other income and expenses related solely to the diabetes care business, that are incurred by BD directly, as allocated costs or as costs payable to a third party and (ii) a monthly administrative fee of 1.0% of net revenue.
•Other agreements that Embecta entered into with BD include, but are not limited to, the employee matters agreement ("EMA"), an intellectual property matters agreement, local support services agreements, certain other manufacturing arrangements and a process services agreement and lease agreement for a manufacturing facility located in Holdrege, Nebraska. See Note - 16 for more information on the lease agreement for Holdrege.
The amount due from BD under the above agreements was $110.9 million at September 30, 2022 and is reflected in Amounts due from Becton, Dickinson and Company. The amount due to BD under these agreements was $66.5 million at September 30, 2022 and is included in Amounts due to Becton, Dickinson and Company.
Prior to the Separation, the Company did not operate as a standalone business and the Consolidated Financial Statements were derived from the consolidated financial statements and accounting records of BD. The following disclosure summarizes activity between the Company and BD up to the Separation, including the affiliates of BD that were not part of the Separation.
For the years ended September 30, 2022, 2021 and 2020, cost of products sold from related party inventory purchases were $28.0 million, $40.6 million and $43.4 million, respectively.
Corporate and Medical Segment Allocations from BD
BD provided significant corporate, finance, human resources, information technology, facilities, and legal services, among others (collectively, “General Corporate Expenses”) to the Company. Some of these services continue to be provided by BD to the Company on a temporary basis under the Transition Services Agreement. For purposes of these Consolidated
Financial Statements for the periods prior to the Separation, the General Corporate Expenses have been allocated to the Company.
The allocations of General Corporate Expenses are reflected in the Consolidated Statements of Income as follows:
Year ended September 30,
Cost of products sold $ 2.3 $ 13.0 $ 9.2
Selling and administrative expense 47.9 98.3 80.2
Research and development expense 3.5 5.2 5.4
Other (income) expense, net (0.6) (1.3) 0.5
Total General Corporate Expenses $ 53.1 $ 115.2 $ 95.3
These expenses were allocated to the Company on a pro rata basis of global and regional revenues, headcount, research and development spend and other drivers. Management believes the assumptions underlying the Consolidated Financial Statements, including the assumptions regarding allocating General Corporate Expenses from BD, are reasonable. Nevertheless, the Consolidated Financial Statements for periods prior to the Separation may not include all of the actual expenses that would have been incurred and may not reflect the Company’s Consolidated results of operations, financial position and cash flows had it been a standalone public company during the periods presented. Actual costs that would have been incurred if the Company had been a standalone public company would depend on multiple factors, including organizational structure and strategic decisions made in various areas, including information technology and infrastructure.
Related party transactions
The following transactions represent activity in the ordinary course of business between the Company and BD prior to the Separation for certain materials for use in production of certain medical products that were not at arm’s length. The following table summarizes related party purchases as follows:
Year ended September 30,
All significant intercompany transactions between the Company and BD prior to the Separation have been included in the Consolidated Financial Statements and are considered to be effectively settled for cash at the time the transaction is recorded. For the period prior to the Separation, the total net effect of the settlement of these intercompany transactions is reflected in the Consolidated Statements of Cash Flows as a financing activity and in the Consolidated Balance Sheets as Net Investment from Becton, Dickinson and Company.
Prior to the Separation, net transfers to BD were included within Net Investment from Becton, Dickinson and Company. in the Consolidated Statements of Equity and represent the net effect of transactions between the Company and BD.
The following table summarizes the components of the net transfers to BD as follows:
Year ended September 30,
Cash pooling and general financing activities(1) $ 255.9 $ 599.5 $ 591.8
Taxes deemed settled with BD (16.2) (72.5) (44.8)
Other Separation related adjustments, net (11.4) — —
Share-based compensation expense (8.5) (12.5) (12.7)
Pension expense (3.6) (9.4) (9.4)
Net Consideration paid to BD in connection with the Separation 1,266.0 — —
Related party senior secured notes 197.0 — —
Other transfers to (from) BD, net 84.1 (11.4) 14.4
(1)The nature of activities includes financing activities for capital transfers, cash sweeps and other treasury services. As part of this activity, cash balances were swept to BD on a daily basis under the BD Treasury function and the Company receives capital from BD for its cash needs.
Related Party Senior Secured Notes
On March 31, 2022, Embecta issued $200.0 million of senior secured notes to BD (the "Related Party Notes"). The Related Party Notes issued to BD were not issued for cash and instead were subject to a debt-for-debt exchange which occurred on April 1, 2022. As of April 1, 2022 the Related Party Notes were reclassified to Long-Term Debt in the Consolidated Balance Sheets as the Related Party Notes are third party debt for periods post Separation. Refer to Note 11 for further information.
Note 5 — Other Operating Expenses
In connection with the Separation further described in Note 1, the Company incurred separation and stand-up costs of approximately $44.7 million and $4.8 million during the years ended September 30, 2022 and 2021, respectively. There were no separation and stand-up costs incurred during the year ended September 30, 2020. The costs incurred primarily relate to accounting, auditing, and legal services, including costs to establish certain stand-alone corporate functions and other costs associated with the abandonment of certain manufacturing production lines.
Note 6 — Contingencies
The Company is subject to potential liabilities under government regulations and various claims and legal actions that are pending or may be asserted from time-to-time. These matters arise in the ordinary course and conduct of the Company’s business and include, for example, commercial, intellectual property, environmental, securities and employment matters. The Company intends to continue to defend itself vigorously in such matters and when warranted, take legal action against others. Furthermore, the Company regularly assesses contingencies to determine the degree of probability and range of possible loss for potential accrual in its financial statements.
An estimated loss contingency is accrued in the Company’s Financial Statements if it is probable that a liability has been incurred and the amount of the loss can be reasonably estimated. Based on the Company’s assessment, it has adequately accrued an amount for contingent liabilities currently in existence. The Company does not accrue amounts for liabilities that it does not believe are probable. Litigation is inherently unpredictable, and unfavorable resolutions could occur. As a result, assessing contingencies is highly subjective and requires judgment about future events. The amount of ultimate loss may exceed the Company’s current accruals, and it is possible that its cash flows or results of operations could be materially affected in any particular period by the unfavorable resolution of one or more of these contingencies.
The Company was not a party to any material legal proceedings at September 30, 2022 or September 30, 2021, nor is it a party to any material legal proceedings as of the date of issuance of these Consolidated Financial Statements.
Note 7 — Revenues
Measurement of Revenues
Payment terms extended to the Company’s customers are based upon commercially reasonable terms for the markets in which the Company’s products are sold. Because the Company generally expects to receive payment within one year or less from when control of a product is transferred to the customer, the Company does not generally adjust its revenues for the effects of a financing component. The Company’s allowance for doubtful accounts reflects the current estimate of credit losses expected to be incurred over the life of its trade receivables. Such estimated credit losses are determined based on historical loss experiences, customer specific credit risk, and reasonable and supportable forward-looking information, such as country or regional risks that are not captured in the historical loss information. Amounts are written off against the allowances for doubtful accounts when the Company determines that a customer account is uncollectible. The allowance for doubtful accounts for trade receivables is not material to the Company’s consolidated financial results.
The Company’s gross revenues are subject to a variety of deductions which are recorded in the same period that the underlying revenues are recognized. Such variable consideration includes rebates, sales discounts, and sales returns. Because these deductions represent estimates of the related obligations, judgment is required when determining the impact of these revenue deductions on gross revenues for a reporting period. Rebates provided by the Company are based upon prices determined under the Company’s agreements primarily with its end-user customers. Additional factors considered in the estimate of the Company’s rebate liability include the quantification of inventory that is either in stock at or in transit to the Company’s distributors, as well as the estimated lag time between the sale of product and the payment of corresponding rebates.
The Company’s liability attributed to variable consideration at September 30, 2022 and September 30, 2021 was $43.8 million and $71.7 million, respectively. The decrease is primarily attributed to the Factoring Agreements by which certain trade receivables are factored to BD net of variable consideration. Sales deductions recorded as a reduction of gross revenues for the years ended September 30, 2022, 2021 and 2020 were $336.4 million, $298.7 million, and $300.7 million respectively.
Disaggregation of Revenues
Disaggregation of revenue by geographic region is provided within Note 8.
Contract Assets and Liabilities
The Company does not have contract liabilities. Contract assets consist of the Company’s right to consideration that is conditional upon its future performance pursuant to private label agreements and are presented within Prepaid expenses and other in the Consolidated Balance Sheets.
The Company’s contract asset balance was $1.2 million and $1.4 million as of September 30, 2022 and 2021, respectively.
Note 8 — Segment and Geographical Data
Operating segments are identified as components of an enterprise in which discrete financial information is available for evaluation by the CODM in making decisions regarding assessing business performance and allocating resources and capital. Management has concluded that the Company operates in one segment based upon the information used by the CODM in evaluating the performance of the Company’s business and allocating resources and capital.
Disaggregation of Revenues
The Company has distribution agreements with regional or national distributors (including wholesalers and medical suppliers) to ensure broad availability of its products as well as a direct sales force in certain countries and regions around the world. In the United States and Canada, the Company utilizes large and small key account managers that call on payers, retailers, wholesalers and institutional customers, and field-based territory managers that call on health care providers and pharmacies. In certain markets within Europe, the Company has dedicated sales representatives and in certain regions of the Middle East and Africa, the Company has distribution agreements. In Greater Asia, the Company has distribution agreements and in China, the Company relies on its own commercial team to support sales execution. In Latin America, the Company maintains distribution agreements and direct sales representatives.
The Company disaggregates its revenue by geography as management believes this category best depicts how the nature, amount, and timing of revenues and cash flows are affected by economic factors.
Revenues by geographic region are as follows:
Year ended September 30,
(1)For the years ended September 30, 2022, 2021, and 2020 no individual country outside of the United States generated net revenues that represented more than 10.0% of total revenues.
Note 9 — Stock-Based Compensation
Periods Prior to Separation
Prior to the Separation, certain of the Company's employees participated in stock-based compensation plans sponsored by BD. Under these plans BD granted time-vested restricted stock units ("TVUs"), stock appreciation rights ("SARs"), and performance share units ("PSUs") to certain management level employees.
Prior to the Separation on April 1, 2022, share-based compensation expense in the Consolidated Statements of Income is representative of those employees who were dedicated to the Diabetes Care Business. Additionally, share-based compensation expense was allocated to the Diabetes Care Business for BD Corporate and Medical Segment employees who were not dedicated solely to the Diabetes Care Business. This stock-based compensation expense was allocated using a proportional cost allocation method and is included as a component of corporate allocations for periods prior to the
Separation. The amounts presented for the periods prior to the Separation are not necessarily indicative of future awards and do not necessarily reflect the costs that the Company would have incurred as an independent company.
As of Separation Date and Periods Post Separation
In connection with the Separation, and in accordance with the EMA, Embecta's employees with outstanding former BD share-based awards received replacement share-based awards under the Plan. The ratio used to convert the BD share-based awards was designed to preserve the aggregate intrinsic value of the award immediately after the Separation when compared to the aggregate intrinsic value of the award immediately prior to Separation. As a result of the award modification, Embecta will incur $6.1 million of incremental stock-based compensation expense. Of this amount, $2.3 million was recognized during the year ended September 30, 2022. $3.8 million will be recognized at a future date over the awards' remaining vesting period.
Effective April 1, 2022, Embecta established the Plan. A total of 7,000,000 shares of common stock are authorized under the Plan. The Plan provides for the grant of various types of awards including restricted stock unit ("RSU") awards, SARs, stock options, performance-based awards and other stock-based awards. Under the Plan, the exercise price of awards, if any, is set on the grant date and may not be less than the fair market value per share on that date. Generally SARs have a term of ten years and a three or four year vesting period, subject to limited exceptions.
The Company recognizes stock-based compensation cost only for those stock-based awards that are estimated to ultimately vest over their requisite service period, based on the vesting provisions of the individual grants. The cumulative effect on current and prior periods of a change in the estimated forfeiture rate is recognized as compensation cost in earnings in the period of the change.
On April 1, 2022, Embecta granted 48,192 potential shares to non-employee directors in the form of RSUs, which vest at the earlier of (i) the first anniversary of the grant date or (ii) the date of the first annual meeting of stockholders, subject to continued service of the recipients.
On April 4, 2022 and in connection with the Separation, Embecta granted 860,611 of potential shares to members of the Embecta leadership team as a one-time sign-on equity grant, subject to continued employment, comprised of the following:
•172,787 grants of time-vested RSUs which cliff vest on the third anniversary after grant date;
•528,167 grants of SARs which cliff vest on the third anniversary after grant date and;
•27,653 of TVUs and 132,004 of SARs granted to the Embecta's chief executive officer which vest evenly over three and four years, respectively.
Stock-Based Compensation Expense
Total direct and allocated stock-based compensation expense for the years ended September 30, 2022, 2021, and 2020 and the respective income tax benefits recognized by the Company in the Consolidated Statements of Income are as follows:
Cost of products sold $ 2.3 $ 2.7 $ 2.4
Selling and administrative expense 14.6 7.8 7.8
Research and development expense 1.8 2.3 2.2
Total Stock-Based Compensation Expense $ 18.7 $ 12.8 $ 12.4
Stock Appreciation Rights
SARs represent the right to receive, upon exercise, shares of common stock having a value equal to the difference between the market price of common stock on the date of exercise and the exercise price on the date of grant. SARs generally vest over a period of three to four years and have a term of ten years. The fair value of awards are estimated on the date of grant using a Black-Scholes-Merton (“BSM”) model. The BSM assumptions include expected dividend yield, risk-free interest rate, volatility, and term of the SARs.
In connection with the SARs granted during 2022, the Company used the BSM to determine the fair value of the SARs as of the grant date. In applying this model, the Company uses both historical data and current market data to estimate the fair value of its SARs. The expected dividend yield is based on forecasted patterns of dividend payments. The risk-free interest rate is based on the rate at grant date of zero-coupon United States Treasury Notes with a term equal to the expected term of the SAR. Expected volatility is estimated using historical volatility. Due to the lack of trading history of Embecta's stock at the time of valuation efforts, the historical component of expected volatility is based on historical monthly price changes of the peer group within the industry. BD's historical data for Embecta employees was used to estimate equity award exercise and employee termination behavior within the valuation model. The expected term represents the amount of time
that SARs granted are expected to be outstanding based on historical and forecasted exercise behavior. The weighted average fair value of SARs was determined using the following assumptions:
Risk-free interest rate 2.5 %
Expected volatility 37.8 %
Expected dividend yield 2.9 %
Expected life 6.5
Fair value per SAR $ 9.38
A summary of SARs outstanding as of September 30, 2022 and changes since the Separation Date are as follows:
Forfeited, canceled or expired (114.3) $ 28.64
SARs with an intrinsic value of $0.1 million and grant date fair value of $6.1 million were exercised since the Separation Date.
Time-Vested Restricted Stock Units
Time vested restricted stock unit awards vest on a graded basis over a period of three years. The related stock-based compensation expense is recorded over the requisite service period, which is the vesting period or is based on retirement eligibility. The fair value of all time vested restricted stock units is based on the market value of the Company’s stock on the date of grant.
A summary of time-vested restricted stock units outstanding as of September 30, 2022 and changes since the Separation Date are as follows:
Stock Units (in thousands) Weighted Average Grant Date Fair Value
Forfeited, canceled or expired (59.6) 28.03
The weighted average grant date fair value of time restricted stock units granted since the Separation Date is $31.23 and the total fair value of time vested stock units vested since the Separation Date is $1.6 million.
At September 30, 2022, the weighted average remaining vesting term of time vested restricted stock units is 1.7 years.
Unrecognized Compensation Expense and Other Stock Plans
The amount of unrecognized compensation expense for all non-vested stock-based awards as of September 30, 2022, is approximately $27.8 million, which is expected to be recognized over a weighted-average remaining life of approximately 2.2 years. At September 30, 2022, 4.1 million shares were authorized for future grants under the Plan.
Note 10 — Goodwill and Other Intangible Assets
Goodwill and Other Intangible Assets consisted of:
Amortized intangible assets
Less: accumulated amortization (3.9) (6.5)
Patents – net $ 5.5 $ 14.3
Customer Relationships and Other – gross 6.9 $ 5.2 $ 5.4
Less: accumulated amortization (1.8) (1.4)
Customer Relationships and Other – net $ 3.4 $ 4.0
Total amortized intangible assets $ 8.9 $ 18.3
Total Goodwill and Other Intangible Assets $ 24.6 $ 33.9
Intangible asset amortization expense was $0.7 million for the year ended September 30, 2022 and $0.3 million for the years ended September 30, 2021 and 2020, respectively. The estimated intangible asset amortization expense for each of the fiscal years ended September 30, 2023 through 2027 is expected to approximate $1.1 million per year and $3.4 million for years subsequent thereafter.
Note 11 — Long-Term Debt
5.00% Senior Secured Notes due 2030
On February 10, 2022 Embecta issued $500.0 million aggregate principal amount of 5.00% senior secured notes due February 15, 2030 (the “5.00% Notes”). Interest payments on the 5.00% Notes are due semi-annually in February and August until maturity.
6.75% Senior Secured Notes due 2030
On March 31, 2022, Embecta issued $200.0 million of 6.75% Related Party Notes at a discount of $3.0 million. The Related Party Notes issued to BD were not issued for cash and instead were subject to a debt-for-debt exchange which occurred on April 1, 2022. As such, the issuance of the Related Party Notes is a non-cash financing activity and is not presented in the Consolidated Statements of Cash Flows for the year ended September 30, 2022.
On April 1, 2022, BD transferred the Related Party Notes with a notional value of $200.0 million issued by Embecta to Morgan Stanley in exchange for certain notes of BD that were purchased by Morgan Stanley pursuant to a tender offer. Morgan Stanley then sold the senior secured notes to qualified institutional buyers in the United States pursuant to Rule 144A under the Securities Act of 1933, as amended. As of April 1, 2022, the 6.75%senior secured notes (the "6.75% Notes") became third party debt of Embecta. Interest payments on the 6.75% Notes are due semi-annually in February and August until maturity. The 6.75% Notes will mature on February 15, 2030.
Credit Agreement
On March 31, 2022, Embecta entered into a credit agreement (the “Credit Agreement”), providing for:
•a Term Loan B Facility (the "Term Loan") in the amount of $950.0 million, with a seven-yearterm that matures in March 2029. The interest rate is 300 basis points over the secured overnight financing rate (“SOFR”), with a 0.50% SOFR floor. The Term Loan was issued at a discount of 0.50%. Principal and interest payments on the Term Loan commenced on June 30, 2022. Such quarterly principal payments are calculated as 0.25% of the initial principal amount, with the remaining balance payable upon maturity; and
•a Revolving Credit Facility (the "Revolving Credit Facility") in an aggregate principal amount of up to $500.0 million, with a five-year term that matures in 2027. Borrowings under the Revolving Credit Facility bear interest, at Embecta’s option, at an annual rate equal to (a) in the case of loans denominated in United
States dollars (i) the SOFR or (ii) the alternate base rate or (b) in the case of loans denominated in Euros, the EURIBOR rate, in each case plus an applicable margin specified in the credit agreement. A commitment fee applies to the unused portion of the Revolving Credit Facility, equal to 0.25% per annum. As of September 30, 2022, no amount has been drawn on the Revolving Credit Facility.
The credit agreement and the senior secured notes are secured by substantially all assets of Embecta and each subsidiary guarantor, subject to certain exceptions.
The Credit Agreement and the indentures for the 5.00% and 6.75% Notes contain customary financial covenants, including a total net leverage ratio covenant, which measures the ratio of (i) consolidated total net debt to (ii) consolidated earnings before interest, taxes, depreciation and amortization, and subject to other adjustments, must meet certain defined limits which are tested on a quarterly basis in accordance with the terms of the Credit Agreement and the 5.00% and 6.75% Notes. In addition, the Credit Agreement contains covenants that will limit, among other things, Embecta’s ability to prepay, redeem or repurchase its subordinated and junior lien debt, incur additional debt, make acquisitions, merge with other entities, pay dividends or distributions, redeem or repurchase equity interests, and create or become subject to liens.
The following is a summary of Embecta's total debt outstanding as of September 30, 2022:
Total principal debt issued $ 1,645.3
Less: current debt obligations (9.5)
Less: debt issuance costs and discounts (37.7)
The debt issuance costs on the Term Loan, 5.00% Notes, 6.75% Notes and the discount on the Term Loan are reported in the Consolidated Balance Sheets as a reduction of debt and are amortized as a component of Interest expense, net over the term of the related debt using the effective interest method.
The schedule of principal payments required on long-term debt for the next five fiscal years and thereafter is as follows:
The estimated fair value of long-term debt (including current portion) at September 30, 2022 was $1,531.3 million compared with a carrying value (which includes a reduction for amortized debt issuance costs and discounts) of $1,607.6 million. Fair value was estimated using inputs other than quoted prices in active markets for identical assets and liabilities that are observable either directly or indirectly for substantially the full term of the asset or liability and would be considered Level 2 in the fair value hierarchy.
Note 12 — Earnings per Share
On April 1, 2022, the date of the Separation, 57,012,925 shares of Embecta's common stock, par value $0.01 per share, were distributed to BD shareholders of record as of March 22, 2022, the record date of the transaction. This share amount is utilized for the calculation of basic and diluted earnings per share for all periods presented prior to the Separation.
In connection with the Separation, and in accordance with the EMA, Embecta's employees with outstanding former BD share-based awards received replacement share-based awards under the Plan. The ratio used to convert the BD share-based awards was designed to preserve the aggregate intrinsic value of the award immediately after the Separation when compared to the aggregate intrinsic value of the award immediately prior to the Separation (see Note 9 for additional details).
The calculation of basic and diluted earnings per common share for the years ended September 30, 2022, 2021 and 2020 were as follows:
($ in millions and shares in thousands, except per share amounts) 2022 2021 2020
Stock awards and equity units (share equivalent) 437 — —
Earnings per common share - Basic $ 3.92 $ 7.28 $ 7.50
Earnings per common share - Diluted $ 3.89 $ 7.28 $ 7.50
For periods prior to the Separation, it is assumed that there were no dilutive equity instruments as there were no equity awards of Embecta outstanding prior to the Separation.
For periods subsequent to the Separation, diluted earnings per share is computed by giving effect to all potentially dilutive stock awards that are outstanding. For 2022, 1.8 million of dilutive share equivalents issuable under stock-based compensation plans were excluded from the diluted shares outstanding calculation because the result would have been antidilutive.
Note 13 — Income Taxes
Income (Loss) Before Income Taxes
The components of Income Before Income Taxes for the years ended September 30 consisted of:
Provision for Income Taxes
The provision (benefit) for income taxes for the years ended September 30 consisted of:
Current:
Deferred:
The Company's income tax provision for the first half of 2022 and the years ended September 30, 2021 and 2020 were prepared using a separate return method. The separate return method applies the accounting guidance for income taxes to the standalone financial statements as if the Company was a separate taxpayer and a standalone enterprise. The Company believes the assumptions supporting the allocation and presentation of income taxes on a separate return basis are reasonable.
For a portion of 2022 and all periods prior to the Separation, the Company’s domestic and foreign operations are included in BD’s domestic consolidated and foreign tax returns, and payments to all tax authorities are made by BD on the Company’s behalf. The Company files its own foreign tax return and makes its own foreign tax payments in Ireland. The Company’s current tax liabilities computed under the separate return method are considered to be effectively settled in the consolidated financial statements at the time the transaction is recorded, with the offset recorded against Net parent investment.
Tax Rate Reconciliation
A reconciliation of federal statutory tax rate to the Company's effective income tax rate was as follows:
Federal statutory tax rate 21.0 % 21.0 % 21.0 %
State and local income taxes, net of federal tax benefit (0.8) 0.7 0.6
Foreign income tax at rates other than 21% (7.0) (6.1) (6.7)
US tax on foreign earnings 0.2 0.5 0.5
Taxes on unremitted foreign earnings 3.2 — —
Nontaxable items (1.1) — —
Other, net (0.1) — —
Effective income tax rate 12.9 % 16.2 % 12.0 %
The decrease in the Company's effective income tax rate from 2022 as compared to 2021 was primarily due to the change in geographical mix of earnings and favorable unrecognized tax benefits recorded in 2022; partially offset by tax expense that have been provided on undistributed earnings of foreign subsidiaries.
The increase in the Company's effective income tax rate from 2021 as compared to 2020 was primarily impacted by favorable unrecognized tax benefits recorded in 2020.
Deferred Income Taxes
Deferred income taxes at September 30 consisted of:
Deferred tax assets:
Compensation and benefits $ 8.6 $ 2.1
Accruals and reserves 10.3 5.3
Intangibles 26.2 —
Property, plant and equipment 19.0 —
Capitalized research and development expenses 7.0 —
Leases 9.7 —
Tax loss and credit carryforwards 0.5 0.3
Gross deferred tax assets before valuation allowance $ 86.7 $ 9.3
Valuation allowance $ (10.4) $ (0.3)
Total deferred tax assets $ 76.3 $ 9.0
Deferred tax liabilities:
Property, plant and equipment $ — $ (8.3)
Taxes on unremitted foreign earnings (8.2) —