Embecta Corp. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Certain Factors Affecting Forward-Looking Statements The following discussion and analysis should be read in conjunction with the condensed combined financial statements and accompanying notes contained elsewhere in this Quarterly Report on Form 10-Q. This discussion contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and other factors described throughout this discussion and analysis, particularly in the section “Cautionary Statement Concerning Forward-Looking Statements.” References in this section to the “Diabetes Care Business” refer to the Diabetes Care Business as defined in the condensed combined financial statements included within this report. References in this section to “embecta” refer to embecta Corp. as defined in the condensed combined financial statements included within this report. Company Overview We are 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 Becton, Dickinson and Company (“BD” or “Parent”) developed the first dedicated insulin syringe. Since then, we have built a world-class organization with a unique manufacturing supply chain and commercial footprint, delivering over 7.6 billion units of diabetes injection devices globally in 2021. We generated revenues of $274.5 million and $284.2 million during the three months ended March 31, 2022 and 2021, respectively, and $563.8 million and $569.5 million during the six months ended March 31, 2022 and 2021, respectively. We have a broad portfolio of marketed products, including a variety of pen needles, syringes and safety devices, which are complemented by our proprietary digital applications designed to assist people with managing their diabetes. Our pen needles are sterile, single-use, medical devices, designed to be used in conjunction with insulin pens and are used to inject insulin or other diabetes medications. We also sell safety pen needles, which include resin injection-molded shields on both ends of the cannula that automatically deploy 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 incorporate a manually activated sliding sleeve to help prevent needlestick exposure and injury during injection and disposal. We primarily sell our products to wholesalers and distributors, which in turn sell such products to customers in primarily retail and institutional channels. Separation from BD In May 2021, BD announced its plan to separate its diabetes care business into an independent public company through a distribution of all of the outstanding shares of common stock of embecta Corp. to BD shareholders as of the close of business on March 22, 2022, the record date for the distribution (the "Spin Off Distribution"). On February 1, 2022, BD’s Board of Directors approved the Spin Off Distribution. On February 10, 2022, the SEC declared effective embecta’s Registration Statement on Form 10, as amended (the "Form 10"). "When-issued" trading of embecta common stock began on the record date of March 22, 2022, under the ticker symbol "EMBCV." The Spin Off Distribution was completed at 12:01 a.m., Eastern Time, on April 1, 2022. In connection with the spin off, 57,797,841 shares of embecta common stock were distributed to BD stockholders, 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, the distribution date, under the ticker symbol "EMBC." Basis of Presentation of Our Financial Information The accompanying historical unaudited condensed combined financial statements included in this report were derived from the unaudited interim condensed consolidated financial statements and accounting records of BD. These condensed combined financial statements reflect the historical results of operations, financial position and cash flows of BD’s Diabetes Care Business as they were historically managed in conformity with U.S. generally accepted accounting principles (“GAAP”). Therefore, the historical combined financial information may not be indicative of our future performance and does not necessarily reflect what our combined results of operations, financial condition and cash flows Dollar amounts are in millions except per share amounts or as otherwise specified. 15 Table of Contents would have been had the Diabetes Care Business operated as a separate, publicly traded company during the periods presented, particularly because of changes that we expect to experience in the future as a result of our separation from BD, including changes in the financing, cash management, operations, cost structure and personnel needs of our business. The results of operations for the interim periods are not necessarily indicative of the results of operations to be expected for the full year. The condensed combined financial statements include certain assets and liabilities that have historically been held at the BD corporate level but are specifically identifiable or otherwise allocable to the Diabetes Care Business. During the first half of 2022, in contemplation of the spin off, certain assets, liabilities, and operations attributable to the Diabetes Care Business were contributed to embecta. BD uses a centralized approach to cash management and financing of its operations. While certain cash and cash equivalents relate to and are specifically identifiable to embecta, the cash and cash equivalents held by BD at the corporate level are not specifically identifiable to the Diabetes Care Business and therefore were not allocated for any of the periods presented. These arrangements are not reflective of the manner in which the Diabetes Care Business would have financed its operations had it been a standalone company separate from BD during the periods presented. Cash pooling, related interest and intercompany arrangements are excluded from the asset and liability balances in the combined balance sheets. These amounts have instead been reported as Net parent investment as a component of Parent’s Equity. Additionally, BD provides certain services, such as legal, accounting, information technology, human resources and other infrastructure support to the Diabetes Care Business. The cost of these services has been 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 consider these allocations to be a reasonable reflection of the benefits received by the Diabetes Care Business. Actual costs that would have been incurred if the Diabetes Care Business had been a standalone company would depend on multiple factors, including organizational structure and strategic decisions made in various areas, such as information technology and infrastructure. Subsequent to the completion of the separation and distribution, we expect to incur expenditures consisting of employee-related costs, costs to start up certain standalone functions and information technology systems and other one-time transaction related costs. Recurring standalone costs include establishing the internal audit, treasury, investor relations, tax and corporate secretary functions as well as the annual expenses associated with running an independent publicly traded company, including listing fees, compensation of non-employee directors, related board of director fees and other fees and expenses related to insurance, legal and external audit. During the three and six months ended March 31, 2022, we incurred separation and stand-up costs of approximately $7.4 million and $15.8 million, respectively, reflected within Other operating expenses within the condensed combined statement of income, and as further discussed below. There were no spin off costs incurred during the three and six months ended March 31, 2021. Percentages presented are calculated from the underlying amounts. Relationship with BD We have entered into several agreements with BD to effect the spin off and provide a framework for the relationship between BD and embecta after the spin off, including the following: • Separation and Distribution Agreement; • Transition Services Agreement ("TSA"); • Tax Matters Agreement; • Employee Matters Agreement; • Intellectual Property Matters Agreement; • Contract Manufacturing Agreements; • Cannula Supply Agreement; • Lease Agreement for Holdrege, Nebraska; • Logistics Services Agreement; and • Distribution Agreements. Certain functions that BD provided to the Diabetes Care Business prior to the distribution will either continue to be provided to embecta by BD under the TSA or will be performed using embecta’s own resources or third-party service providers. Additionally, under the under the cannula supply agreement and certain contract manufacturing agreements, BD will supply certain raw materials and components to, and manufacture certain products for, embecta and its subsidiaries Dollar amounts are in millions except per share amounts or as otherwise specified. 16 Table of Contents and embecta will manufacture certain products for BD and its subsidiaries. BD and embecta also entered into a Trade Receivables Factoring Agreement, in which embecta remits 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 agreement. Due to these aforementioned contracts, we expect potential changes in costs and cash flows in the quarters immediately subsequent to the spin off. Specifically, we expect the TSA to result in higher expenses to operate as a standalone entity as compared to the costs we previously incurred in carrying out these functions as a component of BD. Following the spin off, we expect to incur certain one-time costs related to becoming a stand-alone entity; however, we also anticipate a decrease in certain separation costs related to the formation of new legal entities as well as expenses to complete the transfer of assets and liabilities from BD to embecta that we are currently incurring once the spin off is complete. Refer to the Other Operating Expenses fluctuation in the “Results of Operations” section for further details on these expenses. Furthermore, we expect the Trade Receivables Factoring Agreement to have an impact on the timing of our cash flows related to our outstanding trade receivables. In addition to the above, we also planned and executed a build up of inventory in the current period in preparation for the spin off. We anticipate this trend to continue as we operate as a stand-alone entity. COVID-19 Pandemic Impacts and Response 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 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, including the Delta and Omicron variants, 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. Russia and Ukraine Conflict 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. During both the three and six months ended March 31, 2022 net sales in Russia and Ukraine were not material to our consolidated net revenues in both periods. 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 II, Item 1A. "Risk Factors" for further details. Three Months Ended March 31, 2022 Summary (on a comparative basis) Key GAAP financial results for the three months ended March 31, 2022 were as follows: • Revenue decreased by $9.7 million to $274.5 million from $284.2 million; • Gross profit decreased by $5.1 million to $191.2 million from $196.3 million. Gross profit as a percent of revenue was 69.7%, as compared to 69.1% in the prior year comparative period; • Operating income decreased by $27.5 million to $98.9 million from $126.4 million; and • Net income decreased by $28.3 million to $79.6 million from $107.9 million. Key Non-GAAP financial results for the three months ended March 31, 2022 were as follows: • Constant Currency Revenues decreased by 1.3%; • EBITDA decreased by $33.2 million to $105.5 million from $138.7 million; and • Adjusted EBITDA decreased by $24.8 million to $116.8 million from $141.6 million. Dollar amounts are in millions except per share amounts or as otherwise specified. 17 Table of Contents Six Months Ended March 31, 2022 Summary (on a comparative basis) Key GAAP financial results for the six months ended March 31, 2022 were as follows: • Revenue decreased by $5.7 million to $563.8 million from $569.5 million; • Gross profit increased $7.5 million to $395.1 million, compared to $387.6 million. Gross profit as a percent of revenue was 70.1%, as compared to 68.1% in the prior year comparative period; • Operating income decreased by $35.0 million to $215.5 million from $250.5 million; and • Net income decreased by $34.8 million to $178.4 million from $213.2 million. Key Non-GAAP financial results for the six months ended March 31, 2022 were as follows: • Constant Currency Revenues increased by 0.2%; • EBITDA decreased by $42.6 million to $230.5 million from $273.1 million; and • Adjusted EBITDA decreased by $35.0 million to $254.8 million from $289.8 million. Please see a description of our Non-GAAP Financial Measures below. Results of Operations Our unaudited condensed combined statement of income is as follows: Three months ended March 31, Six months ended March 31, 2022 2021 % 2022 2021 % Revenues $ 274.5 $ 284.2 (3.4) % $ 563.8 $ 569.5 (1.0) % Cost of products sold 83.3 87.9 (5.2) 168.7 181.9 (7.3) Gross Profit 191.2 196.3 (2.6) 395.1 387.6 1.9 Operating expenses: Selling and administrative expense 66.9 55.8 19.9 129.1 109.0 18.4 Research and development expense 18.0 14.1 27.7 34.7 28.1 23.5 Other operating expenses 7.4 — nm 15.8 — nm Total Operating Expenses 92.3 69.9 32.0 179.6 137.1 31.0 Operating Income 98.9 126.4 (21.8) 215.5 250.5 (14.0) Interest expense (4.9) — nm (4.9) — nm Other income (expense), net (0.1) 2.1 (104.8) (0.1) 3.1 (103.2) Income Before Income Taxes 93.9 128.5 (26.9) 210.5 253.6 (17.0) Income tax provision 14.3 20.6 (30.6) 32.1 40.4 (20.5) Net Income $ 79.6 $ 107.9 (26.2) % $ 178.4 $ 213.2 (16.3) % Basic and Diluted Earnings per Share $ 1.38 $ 1.87 nm $ 3.09 $ 3.69 nm Weighted Average Common Shares Outstanding 57,797,841 57,797,841 nm 57,797,841 57,797,841 nm nm = not meaningful Revenues Our revenues decreased by $9.7 million, or 3.4%, to $274.5 million in the second quarter of 2022 as compared to revenues of $284.2 million in the second quarter of 2021. Changes in our revenue 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, $6.0 million was attributable to unfavorable effects from foreign currency translation primarily in countries with revenues denominated in Euros. Volume unfavorably impacted our revenues by approximately $3.7 million, for the three months ended March 31, 2022, as compared to the prior year period. The decrease in volume was primarily driven by lower revenue attributed to customers in the U.S. and in Europe. Dollar amounts are in millions except per share amounts or as otherwise specified. 18 Table of Contents Our revenues decreased by $5.7 million, or 1.0%, to $563.8 million for the six months ended March 31, 2022 as compared to revenues of $569.5 million for the six months ended March 31, 2021. Of this decrease, $6.9 million was attributable to unfavorable effects from foreign currency translation primarily in countries with revenues denominated in Euros and to a lesser extent unfavorable price and a decrease in volume in the US. This was offset by an increase in volume in certain emerging markets, which consist of countries within Eastern Europe, the Middle East, Africa, Latin America, Central and Southeast Asia as well as Mainland China. Revenues by geographic region are as follows: Three months ended March 31, Six months ended March 31, 2022 2021 As Reported Constant Currency 2022 2021 As Reported Constant Currency United States $ 139.8 $ 148.4 (5.8) % (5.8) % $ 290.7 $ 297.9 (2.4) % (2.4) % International 134.7 135.8 (0.8) 3.6 273.1 271.6 0.6 3.1 Total $ 274.5 $ 284.2 (3.4) % (1.3) % $ 563.8 $ 569.5 (1.0) % 0.2 % Cost of products sold Cost of products sold decreased by $4.6 million, or 5.2%, to $83.3 million in the second quarter of 2022 as compared to $87.9 million in the second quarter of 2021. Costs of products sold as a percentage of revenues were 30.3% for the three months ended March 31, 2022 as compared to 30.9% in the three months ended March 31, 2021. The decrease in cost of products sold between periods was primarily driven by a decrease in revenues in the current period. Costs of products sold as a percentage of revenues decreased by approximately 60 basis points as compared to the prior year period due to favorable product mix in the current year period. Cost of products sold decreased by $13.2 million, or 7.3%, to $168.7 million for the six months ended March 31, 2022 as compared to $181.9 million for the six months ended March 31, 2021. Costs of products sold as a percentages of revenues were 29.9% for the six months ended March 31, 2022 as compared to 31.9% in the six months ended March 31, 2021. The decrease in cost of products sold between periods was primarily driven by $10.0 million of impairment charges associated with the write-off of certain construction in progress assets that were recorded in the first quarter of fiscal year 2021, and to a lesser extent, a decrease in revenues in the current year period. This impairment charge negatively impacted our cost of products sold as a percentage of revenues in the prior year period by approximately 180 basis points. Excluding this impairment charge, our cost of product sold as a percentage of revenues would have been approximately 30.2% in the prior year period. Selling and administrative expenses Selling and administrative expenses increased by $11.1 million, or 19.9%, to $66.9 million in the second quarter of 2022 as compared to $55.8 million in the second quarter of 2021. Our selling and administrative expenses increased by $20.1 million, or 18.4%, to $129.1 million for the six months ended March 31, 2022 as compared to $109.0 million for the six months ended March 31, 2021. The increase for both the three and six month comparative periods were primarily driven by an increase in marketing and advertising spending and an increase in compensation and benefit costs due to increased headcount in anticipation of the spin off and becoming a stand-alone publicly-traded company. Research and development expenses Research and development expenses increased by $3.9 million, or 27.7%, to $18.0 million in the second quarter of 2022 as compared to $14.1 million in the second quarter of 2021. Our research and development expenses increased by $6.6 million, or 23.5%, to $34.7 million for the six months ended March 31, 2022 as compared to $28.1 million for the six months ended March 31, 2021. The increase for both the three and six month comparative periods were primarily driven by increased investment in the development of new products, specifically our insulin patch pump. Dollar amounts are in millions except per share amounts or as otherwise specified. 19 Table of Contents Other operating expenses We incurred other operating expenses of $7.4 million and $15.8 million for the three and six months ended March 31, 2022, respectively, driven by costs related to the spin off. The costs incurred primarily relate to accounting, auditing, and legal services, including costs to establish certain stand-alone corporate functions and other transaction costs as we transition to being a stand-alone publicly traded company. As mentioned within the “Relationship with BD” section, we anticipate certain separation costs to decline following the spin off. However, we do anticipate an increase in other costs related to the spin off, specifically one-time costs related to becoming a stand-alone publicly-traded company. Interest expense Interest expense increased to $4.9 million in the second quarter of 2022, mainly due to the issuance of the $950.0 million term loan and the issuance of the $500.0 million senior secured notes in March 2022. See Note 10 to the Condensed Combined Financial Statements included elsewhere in this report for a further description of our long-term debt. Other income (expense), net Other income (expense), net, was not material for both the three and six months ended March 31, 2022 and comparative prior year periods. Income tax provision The effective income tax rate for the three months ended March 31, 2022 was 15.2% compared to 16.0% for the three months ended March 31, 2021. The effective tax rate for the six months ended March 31, 2022 was 15.2% compared to 15.9% for the six months ended March 31, 2021. The decreases for both the three and six months comparative periods were primarily driven by the geographical mix of income attributable to various jurisdictions that have income tax rates that vary from the U.S. tax rate and costs related to the spin off. 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, shareholders 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) share-based compensation, (ii) impairment losses incurred, (iii) separation costs associated with our spin off from BD, and (iv) 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. Dollar amounts are in millions except per share amounts or as otherwise specified. 20 Table of Contents For the three and six month periods ended March 31, 2022, the reconciliation of net income to EBITDA and adjusted EBITDA was as follows: Three Months Ended March 31, Six Months Ended March 31, 2022 2021 2022 2021 Net income $ 79.6 $ 107.9 $ 178.4 $ 213.2 Interest expense 4.9 — 4.9 — Income taxes 14.3 20.6 32.1 40.4 Depreciation 6.4 9.7 14.8 19.0 Amortization of intangible assets 0.3 0.5 0.3 0.5 EBITDA 105.5 138.7 230.5 273.1 Share-based compensation expense 3.9 2.9 8.5 6.7 Separation costs (1) 7.4 — 15.8 — Impairment losses (2) — — — 10.0 Adjusted EBITDA $ 116.8 $ 141.6 $ 254.8 $ 289.8 (1) Relates to spin off costs incurred during the three and six months ended March 31, 2022. Refer to the Other operating expenses section above. (2) Relates to impairment charges incurred in the first quarter of fiscal year 2021. Refer to the Cost of products sold section above. Each reporting period, we face currency exposure that arises from translating the results of our worldwide operations to the U.S. dollar at exchange rates that fluctuate from the beginning of such period. A stronger U.S. dollar, compared to the prior-year period, resulted in an unfavorable foreign currency translation impact to our revenues as compared to the prior-year quarter. 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 three and six months ended March 31, 2022, the reconciliation of revenue growth to Constant Currency was as follows: Three months ended March 31, 2022 2021 Total Change Estimated FX Impact Constant Currency Change Total Revenues $ 274.5 $ 284.2 (3.4) % (2.1) % (1.3) % Six months ended March 31, 2022 2021 Total Change Estimated FX Impact Constant Currency Change Total Revenues $ 563.8 $ 569.5 (1.0) % (1.2) % 0.2 % LIQUIDITY AND CAPITAL RESOURCES Historical Liquidity Historically, we have generated positive cash flows from operations. As part of BD, the Diabetes Care Business was dependent upon BD for all of its working capital and financing requirements. BD uses a centralized approach to cash management and financing of its operations. The majority of the cash of the Diabetes Care Business was transferred to BD daily and BD funded the operating and investing activities of such Dollar amounts are in millions except per share amounts or as otherwise specified. 21 Table of Contents business as needed. This arrangement is not reflective of the manner in which the Diabetes Care Business would have been able to finance its operations had the Diabetes Care Business been a standalone business separate from BD during the periods presented. Cash transfers to and from BD’s cash management accounts are reflected within Net parent investment as a component of Parent’s Equity. Cash and cash equivalents held by BD at the corporate level are not specifically identifiable to the Diabetes Care Business and therefore were not allocated for any of the periods presented. Third-party debt and the related interest expense of BD have not been allocated to the Diabetes Care Business for any of the periods presented because BD’s borrowings were not directly attributable to this business. However, as of March 31, 2022, certain cash and cash equivalents, long-term debt and related interest expense that relate to and are specifically identifiable to embecta have been included in the balance sheet and statement of operations as further described in the "Financing Activities" section below. Specifically, as of March 31, 2022, we held $264.3 million in cash and cash equivalents, $1,450.0 million in long-term debt (excluding discounts and debt issuance costs), and $200.0 million in related party notes (excluding debt issuance costs). Future Liquidity On a recurring basis, our primary future cash needs will be directed toward operating and investing activities, which include working capital needs, capital expenditures, research and development funding, and mergers and acquisitions. We also intend to allocate cash to the interest payments and repayment of borrowings. Our ability to fund these needs will depend, in part, on our ability to generate or raise cash in the future, which is subject to general economic, financial, competitive, regulatory and other factors that are beyond our control. Following the separation and distribution, our capital structure and sources of liquidity have changed from our historical capital structure because we no longer participate in BD’s centralized cash management program. Our ability to fund our operating needs now depends on our ability to continue to generate positive cash flow from operations and raise capital in the capital markets. Based upon our history of generating strong cash flows, we believe that we will be able to meet our short-term liquidity needs. We believe that we will meet known and reasonably likely future cash requirements through the combination of cash flows from operating activities, available cash balances, investments in money market funds and available borrowings through and under our financing arrangements, as further discussed below. If these sources of liquidity need to be augmented, additional cash requirements would likely need to be financed through the issuance of debt or equity securities. Financing Activities On February 10, 2022, and in connection with the spin off, embecta issued $500.0 million aggregate principal amount of 5.00% senior secured notes due February 15, 2030 (the “Notes”). Interest payments on the Notes are due semi-annually in February and August until maturity, with the first interest payment due in August 2022 . On March 31, 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. The interest rate is 300 basis points over the secured overnight financing rate (“SOFR”), with a 0.50% SOFR floor. As of March 31, 2022, the initial draw of the Term Loan was for a 3-month period at an interest rate of 3.65%. The Term Loan was issued at a discount of 0.50%. Principal and interest payments on the Term Loan will begin 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, initially at an annual rate equal to (a) in the case of loans denominated in U.S. 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 March 31, 2022, no amount has been drawn on the Revolving Credit Facility. Additionally, on March 31, 2022, we issued $200.0 million of senior secured notes to BD at a discount of $3.0 million. The related party notes carry an interest rate of 6.75% and are due February 2030. Interest payments on the related party notes are due semi-annually in February and August until maturity, with the first interest payment due in August 2022. During the three and six months ended March 31, 2022, we incurred approximately $3.4 million of interest expense related to the $500.0 million of senior secured 5.00% notes and $1.0 million of interest expense related to the Term Loan that is recognized within Interest expense on the condensed combined statement of income. There was no interest expense recorded during the three and six months ended March 31, 2022 for the related party notes. Dollar amounts are in millions except per share amounts or as otherwise specified. 22 Table of Contents The credit agreement and the indenture for the 5.00% 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 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. As of March 31, 2022, we were in compliance with all of such covenants. We utilized the aggregate proceeds received to make distribution payment of approximately $1,466.0 million to BD in connection with the spin off for assets transferred by BD to embecta. The $1,466.0 million payment to BD consisted of $1,266.0 million of cash and $200.0 million of senior secured notes which were subject to a debt-for-debt exchange on April 1, 2022. Subsequent to the proceeds received and distribution payment made to BD, we retained approximately $165.0 million in cash and cash equivalents which is reflected within the condensed combined balance sheet. The schedule of principal payments required on long-term debt for the next five years and thereafter is as follows: 2022 $ 4.8 2023 $ 9.5 2024 $ 9.5 2025 $ 9.5 2026 $ 9.5 Thereafter $ 1,407.3 There was no material changes to the contractual obligations related to leases or purchase commitments as included in the Form 10 as of September 30, 2021. In addition, we entered into a Trade Receivables Factoring Agreement with BD effective at the time of the spin off. 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 Agreement. This factoring agreement will provide embecta with an additional source of liquidity. As of March 31, 2022, the Company transferred $105.2 million of trade receivables to BD in exchange for cash pursuant to the Factoring Agreement. 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 condensed combined statements of cash flows: Six Months Ended March 31, 2022 2021 Net cash provided by (used for) Operating activities $ 321.4 $ 241.1 Investing activities $ (10.1) $ (18.2) Financing activities $ (44.2) $ (222.9) Net Cash Flows from Operating Activities Net cash provided by operating activities during the six months ended March 31, 2022 was attributable to net income of $178.4 million and net adjustments of $143.0 million, which includes $27.3 million of non-cash adjustments related to depreciation and amortization, share-based compensation, and pension expense, and a $115.3 million net source of cash relating to changes in working capital. The source of cash relating to working capital was driven by a decrease in trade receivables of $133.3 million and an increase in other current liabilities of $5.8 million, partially offset by a decrease of $11.4 million in accounts payable and accrued expenses, and increases of $10.0 million and $2.4 million in inventories and prepaid expenses and other, respectively. Dollar amounts are in millions except per share amounts or as otherwise specified. 23 Table of Contents The decrease in trade receivables primarily relates to the Factoring Agreement entered into between embecta and BD, in which embecta transferred certain trade receivable assets to BD. The decrease in accounts payable and accrued expenses relates to higher amounts of payments being released during the six months ended March 31, 2022, as compared to prior period. The increase in inventories is primarily driven by a concerted effort to build inventory in preparation of the spin off. We expect to continue to build inventory for the remainder of fiscal 2022. Net cash provided by operating activities during the six months ended March 31, 2021 was attributable to net income of $213.2 million and net adjustments of $27.7 million, which includes $41.1 million of non-cash adjustments related to depreciation and amortization, impairment of property, plant and equipment, share-based compensation, and pension expense, and a $13.4 million net use of cash relating to changes in working capital. The net use of cash relating to working capital was driven by an increase in inventories of $9.1 million and an increase in prepaid expenses and other of $5.8 million. These changes were partially offset by an increase in other current liabilities of $1.1 million. The increase in inventories can primarily be attributed to the timing of capitalized variances as well as higher inventory on hand as of period end compared to prior year. The increase in prepaid expenses and other is mainly driven by an increase in value-added taxes and other miscellaneous prepaids. Net Cash Flows from Investing Activities Net cash used for investing activities was primarily comprised of capital expenditures of $9.7 million and $16.6 million during the six months ended March 31, 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 six months ended March 31, 2022, represents proceeds from the issuance of long-term debt of $1,450.0 million, offset by $33.3 million of payments for long-term debt issuance costs, $5.6 million of payments for debt fees associated with the revolving credit facility, and $1,266.0 million of net consideration paid to BD in connection with the spin off. See Note 10 to the Condensed Combined Financial Statements included elsewhere in this report as well as the Financing Activities section above for further details. Additionally, proceeds from the issuance of long-term debt was further offset by $189.3 million related to net transfers to BD (see Note 2 to the Combined Financial Statements included elsewhere in this report). Net cash used for financing activities for the six months ended March 31, 2021, represents net transfers entirely to BD (see Note 2 to the Condensed Combined Financial Statements included elsewhere in this report). Cautionary Statements Regarding Forward-Looking Statements All statements and assumptions contained in this Quarterly Report on Form 10-Q that relate to future events and expectations and, as such, 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,” “could,” “estimates,” “expects,” “forecasts,” “goal,” “guidance,” “intends,” “may,” “outlook,” “plans,” “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 not guarantees of future performance and are subject to 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 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. Dollar amounts are in millions except per share amounts or as otherwise specified. 24 Table of Contents • Increases in operating costs, including fluctuations in the cost and availability of oil-based resins and other raw materials, 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 U.S., 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 impact of the COVID-19 pandemic 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. • 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, procedures and controls, diversion of management’s attention and the impact on relationships with customers, suppliers, employees and other business counterparties. 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. 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 “Risk Factors,” included within Amendment No. 1 to the Form 10. Any forward-looking statement speaks only as of the date on which it is made, and embecta 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 3. Quantitative and Qualitative Disclosures About Market Risk. There have been no material changes in information reported since the filing the Form 10.