| | | | | | | | | | | | | | | | | |
Six Months Ended December 31, 2022 | Biologics | | Pharma and Consumer Health | | Total |
Manufacturing & commercial product supply | $ | 169 | | | $ | 632 | | | $ | 801 | |
Development services & clinical supply | 934 | | | 437 | | | 1,371 | |
Total | $ | 1,103 | | | $ | 1,069 | | | $ | 2,172 | |
Inter-segment revenue elimination | | (1) | |
Combined net revenue | | $ | 2,171 | |
| | | | | | | | | | | | | | | | | |
Six Months Ended December 31, 2021 | Biologics | | Pharma and Consumer Health | | Total |
Manufacturing & commercial product supply | $ | 303 | | | $ | 635 | | | $ | 938 | |
Development services & clinical supply | 886 | | | 419 | | | 1,305 | |
Total | $ | 1,189 | | | $ | 1,054 | | | $ | 2,243 | |
Inter-segment revenue elimination | (1) | |
Combined net revenue | | $ | 2,242 | |
The following table allocates revenue by the location where the goods were made or the service performed:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
| | Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | | |
United States | | $ | 734 | | | $ | 793 | | | $ | 1,432 | | | $ | 1,423 | |
Europe | | 356 | | 370 | | 630 | | | 722 | |
Other | | 88 | | 83 | | 169 | | | 155 | |
Elimination of revenue attributable to multiple locations | | (29) | | (29) | | (60) | | | (58) | |
Total | | $ | 1,149 | | | $ | 1,217 | | | $ | 2,171 | | | $ | 2,242 | |
Contract Liabilities
Contract liabilities relate to cash consideration that the Company receives in advance of satisfying the related performance obligations. The contract liabilities balances (current and non-current) as of December 31, 2022 and June 30, 2022 are as follows:
| | | | | | | | |
(Dollars in millions) | | |
| | |
Balance at June 30, 2022 | | $ | 194 | |
| | |
| | |
| | |
| | |
Balance at December 31, 2022 | | $ | 186 | |
Revenue recognized in the period from amounts included in contracts liability at the beginning of the period: | | $ | (113) | |
Contract liabilities that will be recognized within 12 months of December 31, 2022 are accounted for in Other accrued liabilities and those that will be recognized longer than 12 months after December 31, 2022 are accounted for within Other liabilities.
Contract Assets
Contract assets primarily relate to the Company's conditional right to receive consideration for services that have been performed for customers as of December 31, 2022 relating to the Company's development services but had not yet been invoiced as of December 31, 2022. Contract assets are transferred to trade receivables, net when the Company’s right to receive the consideration becomes unconditional. Contract assets totaled $513 million and $441 million as of December 31, 2022 and June 30, 2022, respectively. Contract assets expected to transfer to trade receivables within 12 months are accounted for within Prepaid expenses and other. Contract assets expected to transfer to trade receivables longer than 12 months are accounted for within Other long-term assets.
3. BUSINESS COMBINATIONS
Metrics Contract Services Acquisition
In October 2022, the Company acquired 100% of Metrics Contract Services (“Metrics”) from Mayne Pharma Group Limited for $474 million in cash, subject to customary adjustments. Metrics, based in Greenville, North Carolina, is an oral solids development and manufacturing business specializing in the manufacture of drugs containing highly potent active pharmaceutical ingredients. The operations and facility acquired have become part of the Company’s Pharma and Consumer Health segment.
The Company accounted for the Metrics transaction using the acquisition method in accordance with ASC 805, Business Combinations. The Company funded this acquisition with a portion of the proceeds of an October 2022 drawdown from its senior secured revolving credit facility. The Company estimated fair values at the date of acquisition for the preliminary allocation of consideration to the net tangible and intangible assets acquired and liabilities assumed. The Company has not completed its analysis regarding the assets acquired and liabilities assumed. Therefore, the allocation to property, plant, and equipment, intangible assets, goodwill, and income taxes are preliminary and subject to finalization. During the measurement period ending no later than one year after the acquisition date, the Company will continue to obtain information to assist in finalizing the fair values of the net assets acquired, which may differ materially from these preliminary estimates. If any measurement period adjustment is material, the Company will record such adjustment, including any related impact on net income, in the reporting period in which the adjustment is determined.
The preliminary purchase price allocation to assets acquired and liabilities assumed in the transaction, subject to finalization, is as follows:
| | | | | |
(Dollars in millions) | Preliminary Purchase Price Allocation |
| |
Trade receivables, net | $ | 15 | |
Inventories | 6 | |
| |
Property, plant, and equipment | 192 | |
Other intangibles, net | 53 | |
Other assets | 2 | |
Current liabilities | (9) | |
Goodwill | 215 | |
Total assets acquired and liabilities assumed | $ | 474 | |
The carrying value of trade receivables, inventory, and trade payables, as well as certain other current and non-current assets and liabilities generally represented the fair value at the date of acquisition.
Other intangibles, net consists of customer relationships of $53 million, which were valued using the multi-period, excess-earnings method, a method that values the intangible asset using the present value of the after-tax cash flows attributable to the intangible asset only. The significant assumptions used in developing the valuation included the estimated annual net cash flows (including application of an appropriate margin to forecasted revenue, selling and marketing costs, return on working capital, contributory asset charges, and other factors), the discount rate that appropriately reflects the risk inherent in each future cash flow stream, and an assessment of the asset’s life cycle, as well as other factors. The assumptions used in the financial forecasts were based on historical data, supplemented by current and anticipated growth rates, management plans, and market-comparable information. Fair-value determinations require considerable judgment and are sensitive to changes in underlying assumptions and factors. Preliminary assumptions may change and may result in significant changes to the final valuation. The customer relationship intangible asset has a weighted average useful life of 12 years.
Property, plant, and equipment was valued using the cost approach, which is based on current replacement and/or reproduction cost of the asset as new, less depreciation attributable to physical, functional, and economic factors. The Company then determined the remaining useful life based on the anticipated life of the asset and Company policy for similar assets.
Goodwill has been allocated to the Pharma and Consumer Health segment as shown in Note 4, Goodwill. Goodwill is mainly comprised of the growth from an expected increase in capacity utilization and potential new customers. The goodwill resulting from the Metrics acquisition is not deductible for tax purposes.
Results of the business acquired were not material to the Company's consolidated statement of operations, financial position, or cash flows for the three and six months ended December 31, 2022.
Bettera Holdings, LLC Acquisition
In October 2021, the Company acquired 100% of the equity interest in Bettera Holdings, LLC (“Bettera Wellness”) for approximately $1 billion. Bettera Wellness is a manufacturer of nutraceuticals and nutritional supplements in gummy, soft chew, and lozenge delivery formats.
4. GOODWILL
The following table summarizes the changes between June 30, 2022 and December 31, 2022 in the carrying amount of goodwill in total and by segment:
| | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Biologics | | Pharma and Consumer Health | | | | | | Total |
Balance at June 30, 2022 (1) | $ | 1,535 | | | $ | 1,471 | | | | | | | $ | 3,006 | |
Additions(2) | — | | | 215 | | | | | | | 215 | |
| | | | | | | | | |
Reallocation | 16 | | | (16) | | | | | | | — | |
| | | | | | | | | |
| | | | | | | | | |
Foreign currency translation adjustments | 1 | | | (7) | | | | | | | (6) | |
Balance at December 31, 2022 | $ | 1,552 | | | $ | 1,663 | | | | | | | $ | 3,215 | |
(1) As of result of the organizational realignments which were effective July 1, 2022, (described in Note 1, Basis of Presentation and Summary of Significant Accounting Policies), beginning balances have been reclassified to conform with the current period presentation.
(2) The addition to goodwill is a result of the Metrics acquisition. For further details, see Note 3, Business Combinations.
As part of the business reorganization discussed in Note 1, Basis of Presentation and Summary of Significant Accounting Policies, the goodwill from the previous Biologics, Softgel and Oral Technologies, Oral and Specialty Delivery, and Clinical Supply Services segments was reallocated between the current Biologics and Pharma and Consumer Health segments.
As a result of this realignment, the Company performed an interim quantitative goodwill impairment test for all of its reporting units as of July 1, 2022, which did not result in any goodwill impairment charges.
5. LONG-TERM OBLIGATIONS AND SHORT-TERM BORROWINGS
Long-term obligations and short-term borrowings consisted of the following at December 31, 2022 and June 30, 2022:
| | | | | | | | | | | | | | | | | |
(Dollars in millions) | Maturity | | December 31, 2022 | | June 30, 2022 |
Senior secured credit facilities | | | | | |
Term loan facility B-3 (6.375% as of December 31) | February 2028 | | $ | 1,426 | | | $ | 1,433 | |
Revolving credit facility (1) (6.032% as of December 31) | November 2027 | | 600 | | | — | |
5.000% senior notes due 2027 | July 2027 | | 500 | | | 500 | |
2.375% euro senior notes due 2028(2) | March 2028 | | 879 | | | 874 | |
3.125% senior notes due 2029 | February 2029 | | 550 | | | 550 | |
3.500% senior notes due 2030 | April 2030 | | 650 | | | 650 | |
Financing lease obligations | 2022 to 2038 | | 289 | | | 234 | |
Other obligations | 2022 to 2028 | | 2 | | | 2 | |
Unamortized discount and debt issuance costs | | | (43) | | | (41) | |
Total debt | | | $ | 4,853 | | | $ | 4,202 | |
Less: current portion of long-term obligations and other short-term borrowings (1) | | | 632 | | | 31 | |
Long-term obligations, less current portion | | | $ | 4,221 | | | $ | 4,171 | |
(1) During the six months ended December 31, 2022, the Company drew down $625 million on its revolving credit facility to fund the acquisition of Metrics and supplement operating cash flows, of which $25 million was repaid during three months ended December 31, 2022. The Company has elected to classify the borrowing on its revolving credit facility as current as it intends to repay a portion of the borrowing using cash flow from operations and/or refinance the borrowing through a senior notes offering within the next twelve months.
(2) The change in euro-denominated debt was due to fluctuations in foreign currency exchange rates.
Seventh Amendment to the Credit Agreement
In November 2022, Operating Company entered into Amendment No. 7 (the “Seventh Amendment”) to its Amended and Restated Credit Agreement, dated May 20, 2014 (as subsequently amended, the “Credit Agreement”). Pursuant to the Seventh Amendment, Operating Company (i) terminated its existing revolving credit commitments (and the related outstanding revolving borrowings), which is part of its senior secured credit facilities, and (ii) obtained $1.10 billion aggregate amount of new revolving credit commitments, borrowing thereunder an amount equal to the previously outstanding borrowings under the terminated commitments (as amended, the “Revolving Credit Facility”). The Revolving Credit Facility has an interest rate margin, at Operating Company’s option, based on a (1) prime rate, plus a margin ranging from 0.75% to 1.25% based on Operating Company’s consolidated leverage ratio or (2) Secured Overnight Financing Rate, plus 0.10%, plus a margin ranging from 1.75% to 2.25% based on Operating Company’s consolidated leverage ratio. The Revolving Credit Facility has a maturity date that is the earlier of (A) five years after November 22, 2027, and (B) the 91st day prior to the maturity of Operating Company’s $500 million 5.000% senior unsecured notes due 2027 (the “2027 Notes”) or any permitted refinancing thereof, if on such 91st day, any of the 2027 Notes remains outstanding. Otherwise, the Revolving Credit Facility under the Seventh Amendment has the same principal terms as the previously existing revolving credit commitments under the Credit Agreement.
The availability of capacity under the Revolving Credit Facility is reduced by the aggregate value of all outstanding letters of credit under the Credit Agreement. As of December 31, 2022, Operating Company had $496 million of unutilized capacity under the Revolving Credit Facility due to $4 million of outstanding letters of credit.
Measurement of the Estimated Fair Value of Debt
The estimated fair value of the Company’s senior secured credit facilities and other senior indebtedness is classified as a Level 2 determination (see Note 10, Fair Value Measurements, for a description of the method by which fair value classifications are determined) in the fair-value hierarchy and is calculated by using a discounted cash flow model with a market interest rate as a significant input. The carrying amounts and the estimated fair values of the Company’s principal categories of debt as of December 31, and June 30, 2022 are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
| | | December 31, 2022 | | June 30, 2022 |
(Dollars in millions) | Fair Value Measurement | | Carrying Value | | Estimated Fair Value | | Carrying Value | | Estimated Fair Value |
| | | | | | | | | |
| | | | | | | | | |
5.000% senior notes due 2027 | Level 2 | | $ | 500 | | | $ | 483 | | | $ | 500 | | | $ | 483 | |
2.375% Euro senior notes due 2028 | Level 2 | | 879 | | | 755 | | | 874 | | | 744 | |
3.125% senior notes due 2029 | Level 2 | | 550 | | | 469 | | | 550 | | | 476 | |
3.500% senior notes due 2030 | Level 2 | | 650 | | | 551 | | | 650 | | | 561 | |
Senior secured credit facilities & other | Level 2 | | 2,317 | | | 2,111 | | | 1,669 | | | 1,575 | |
Subtotal | | | $ | 4,896 | | | $ | 4,369 | | | $ | 4,243 | | | $ | 3,839 | |
Unamortized discount and debt issuance costs | | | (43) | | | — | | | (41) | | | — | |
Total debt | | | $ | 4,853 | | | $ | 4,369 | | | $ | 4,202 | | | $ | 3,839 | |
6. EARNINGS PER SHARE
Effective as of the first quarter of fiscal 2023, the Company computes earnings per share of the Company’s common stock, par value $0.01 (the “Common Stock”) using the treasury stock method. Prior to fiscal 2023, the Company computed earnings per share of the Common Stock using the two-class method required due to the participating nature of the previously outstanding Series A Preferred Stock (as defined and discussed in Note 13, Equity and Accumulated Other Comprehensive Loss).
Diluted net earnings per share is computed using the weighted average number of shares of Common Stock outstanding plus the weighted average number of shares of Common Stock that would be issued assuming exercise or conversion of all potentially dilutive instruments. Dilutive securities having an anti-dilutive effect on diluted net earnings per share are excluded from the calculation. The dilutive effect of the securities that are issuable under the Company’s equity incentive plans are reflected in diluted earnings per share by application of the treasury stock method. Prior to fiscal 2023, the Company applied the if-converted method to compute the potentially dilutive effect of the previously outstanding Series A Preferred Stock. The reconciliations between basic and diluted earnings per share attributable to Catalent common shareholders for the three and six months ended December 31, 2022 and 2021, respectively, are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(In millions except per share data) | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
| | | | | | | |
Net earnings | $ | 81 | | | $ | 97 | | | $ | 81 | | | $ | 190 | |
Less: Net earnings attributable to preferred shareholders | — | | | (4) | | | — | | | (13) | |
Net earnings attributable to common shareholders | $ | 81 | | | $ | 93 | | | $ | 81 | | | $ | 177 | |
| | | | | | | |
Weighted average shares outstanding - basic | 181 | | | 175 | | | 180 | | | 173 | |
Weighted average dilutive securities issuable - stock plans | — | | | 2 | | | 1 | | | 2 | |
Weighted average shares outstanding - diluted | 181 | | | 177 | | | 181 | | | 175 | |
| | | | | | | |
Earnings per share: | | | | | | | |
| | | | | | | |
| | | | | | | |
Basic | $ | 0.45 | | | $ | 0.53 | | | $ | 0.45 | | | $ | 1.02 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Diluted | $ | 0.44 | | | $ | 0.52 | | | $ | 0.45 | | | $ | 1.01 | |
The Company's Series A Preferred Stock was deemed a participating security, meaning that it had the right to participate in undistributed earnings with the Company's Common Stock. On November 23, 2020, the holders of Series A Preferred Stock converted 265,223 shares of Series A Preferred Stock and $2 million of unpaid accrued dividends into shares of Common Stock. On November 18, 2021, the holders of Series A Preferred Stock converted the remaining 384,777 shares of Series A Preferred Stock and $2 million of unpaid accrued dividends into shares of Common Stock.
Shares with an antidilutive effect on the weighted average shares outstanding for the three and six months ended December 31, 2022 and 2021 were not material.
7. OTHER (INCOME) EXPENSE, NET
The components of other expense, net for the three and six months ended December 31, 2022 and 2021 are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
| | | | | | | |
| | | | | | | |
Debt financing costs (1) | $ | — | | | $ | — | | | $ | — | | | $ | 4 | |
| | | | | | | |
| | | | | | | |
Foreign currency (gains) losses (2) | (25) | | | 15 | | | (1) | | | 24 | |
Other (3) | 2 | | | (1) | | | 3 | | | (5) | |
Total other (income) expense, net | $ | (23) | | | $ | 14 | | | $ | 2 | | | $ | 23 | |
(1) Debt financing costs for the six months ended December 31, 2021 includes $4 million of financing charges related to $450 million of U.S. dollar-denominated term loans borrowed in that period under the Company’s senior secured credit facilities.
(2) Foreign currency remeasurement gains/losses include both cash and non-cash transactions.
(3) Other, for the six months ended December 31, 2021, includes a gain of $2 million related to the fair value of the derivative liability associated with the formerly outstanding Series A Preferred Stock.
8. RESTRUCTURING COSTS
From time to time, the Company has implemented plans to restructure certain operations, both domestically and internationally. The restructuring plans focused on various aspects of operations, including closing and consolidating certain manufacturing operations, rationalizing headcount and aligning operations in a strategic and more cost-efficient structure. In addition, the Company may incur restructuring charges in the future in cases where a material change in the scope of operation with its business occurs. Employee-related costs consist primarily of severance costs and also include outplacement services provided to employees who have been involuntarily terminated and duplicate payroll costs during transition periods. Facility exit and other costs consist of equipment relocation costs and costs associated with planned facility expansions and closures to streamline Company operations.
During the three months ended December 31, 2022, the Company adopted plans to reduce costs, consolidate facilities, and optimize its infrastructure across the organization. In connection with these restructuring plans, the Company plans to reduce its headcount between 670 and 730 employees and incur cumulative employee-related charges between $14 million and $20 million, primarily associated with cash severance programs.
Restructuring costs for the three and six months ended December 31, 2022 and 2021 were recorded in Other Operating Expense in the Consolidated Statement of Operations.
The following table summarizes the charges recorded within restructuring costs:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
Restructuring costs: | | | | | | | |
Employee-related reorganization | $ | 12 | | | $ | 1 | | | $ | 14 | | | $ | 2 | |
Facility exit and other costs | 11 | | | — | | | 13 | | | — | |
Total restructuring costs | $ | 23 | | | $ | 1 | | | $ | 27 | | | $ | 2 | |
The following table summarizes the charges recorded within restructuring costs by segment. These amounts are excluded from Segment EBITDA as described in Note 15, Segment Information.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
Restructuring costs: | | | | | | | |
Biologics | $ | 18 | | | $ | — | | | $ | 18 | | | $ | — | |
Pharma and Consumer Health | 1 | | | 1 | | | 4 | | | 2 | |
Corporate | 4 | | | — | | | 5 | | | — | |
Total restructuring costs | $ | 23 | | | $ | 1 | | | $ | 27 | | | $ | 2 | |
9. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES
Risk Management Objective of Using Derivatives
The Company is exposed to fluctuations in the currency exchange rates applicable to its investments in operations outside the U.S. While the Company does not actively hedge against changes in foreign currency, the Company has mitigated exposure from its investments in its European operations by denominating a portion of its debt in euros. At December 31, 2022, the Company had euro-denominated debt outstanding of $879 million (U.S. dollar equivalent), which is designated and qualifies as a hedge against its net investment in its European operations. For non-derivatives designated and qualifying as net investment hedges, the effective portion of translation gains or losses are reported in accumulated other comprehensive loss as part of the cumulative translation adjustment. The unhedged portions of the euro-denominated debt translation gains or losses are reported in the consolidated statements of operations. The following table summarizes net investment hedge activity during the three and six months ended December 31, 2022 and 2021.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
Unrealized foreign exchange gain (loss) within other comprehensive income | $ | (85) | | | $ | 40 | | | $ | (4) | | | $ | 62 | |
Unrealized foreign exchange gain (loss) within statement of operations | $ | — | | | $ | (8) | | | $ | — | | | $ | (11) | |
The net accumulated gain on the instrument designated as a hedge as of December 31, 2022 within other comprehensive loss was approximately $123 million. Amounts are reclassified out of accumulated other comprehensive loss into earnings when the entity to which the gains and losses relate is either sold or substantially liquidated.
Interest-Rate Swap
In April 2020, pursuant to its interest rate and risk management strategy, the Company entered into an interest-rate swap agreement with Bank of America N.A. (the “2020 Rate Swap”) as a hedge against the economic effect of a portion of the variable interest obligation associated with its U.S. dollar-denominated term loans under its senior secured credit facilities.
In February 2021, in connection with an amendment to the Credit Agreement, the Company paid $2 million in cash to Bank of America N.A to settle the 2020 Rate Swap. This loss is deferred in stockholders’ equity, net of income taxes, as a component of accumulated other comprehensive loss, and amortized as an adjustment to interest expense, net over the original
term of the formerly outstanding term loans. The net amount of deferred losses on cash flow hedges that is expected to be reclassified from accumulated other comprehensive loss into interest expense, net within the next twelve months is not material.
In February 2021, the Company entered into a new interest-rate swap agreement with Bank of America N.A. (the “2021 Rate Swap”) as a hedge against the economic effect of a portion of the variable interest obligation associated with its Term B-3 Loans. The 2021 Rate Swap effectively fixed the rate of interest payable on that portion of the Term B-3 Loans, thereby reducing the impact of future interest rate changes on future interest expense. As a result of the 2021 Rate Swap, the variable portion of the applicable interest rate on $500 million of the Term B-3 Loans is now effectively fixed at 0.9985%.
The 2021 Rate Swap qualifies for and is designated as a cash-flow hedge. The Company evaluates hedge effectiveness at the inception of the hedge and on an ongoing basis. The cash flows associated with the 2021 Rate Swap is reported in cash provided by operating activities in the consolidated statements of cash flows. The unrealized gain recorded in stockholder's equity from marking the 2021 Rate Swap to market during the six months ended December 31, 2022 was $18 million.
A summary of the estimated fair value of the 2021 Rate Swap reported in the consolidated balance sheets is stated in the table below:
| | | | | | | | | | | | | | | | | | | | | | | |
| December 31, 2022 | | June 30, 2022 |
(Dollars in millions) | Balance Sheet Classification | | Estimated Fair Value | | Balance Sheet Classification | | Estimated Fair Value |
Interest-rate swap | Other long-term assets | | $ | 54 | | | Other long-term assets | | $ | 36 | |
10. FAIR VALUE MEASUREMENTS
ASC 820, Fair Value Measurement, defines fair value as the exit price that would be received to sell an asset or paid to transfer a liability. Fair value is a market-based measurement that should be determined using assumptions that market participants would use in pricing an asset or liability. Valuation techniques used to measure fair value should maximize the use of observable inputs and minimize the use of unobservable inputs. To measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, of which Level 1 and Level 2 are considered observable and Level 3 is considered unobservable:
Level 1 – Quoted prices in active markets for identical assets or liabilities.
Level 2 – Inputs other than Level 1 that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data by correlation or other means.
Level 3 – Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. Value is determined using pricing models, discounted cash flow methodologies, or similar techniques and also includes instruments for which the determination of fair value requires significant judgment or estimation.
Assets and Liabilities Measured at Fair Value on a Recurring Basis
The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable and accrued expenses of the Company approximate fair value based on the short maturities of these instruments.
The Company evaluates its financial assets and liabilities subject to fair value measurements on a recurring basis to determine the appropriate level of classification as of the end of each reporting period. The following table sets forth the Company’s financial assets and liabilities that were measured at fair value on a recurring basis and the fair value measurement for such assets and liabilities at December 31, and June 30, 2022:
| | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | | Basis of Fair Value Measurement |
December 31, 2022 | | Total | | Level 1 | | Level 2 | | Level 3 |
Assets: | | | | | | | | |
Marketable securities | | $ | 28 | | | $ | 28 | | | $ | — | | | $ | — | |
| | | | | | | | |
| | | | | | | | |
Interest-rate swap | | 54 | | | — | | | 54 | | | — | |
Trading securities | | 1 | | | 1 | | | — | | | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
June 30, 2022 | | | | | | | | |
Assets: | | | | | | | | |
| | | | | | | | |
Marketable securities | | $ | 89 | | | $ | 89 | | | $ | — | | | $ | — | |
Interest-rate swap | | 36 | | | — | | | 36 | | | — | |
Trading securities | | 2 | | | 2 | | | — | | | — | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
| | | | | | | | |
The fair value of the 2021 Rate Swap is determined at the end of each reporting period based on valuation models that use interest rate yield curves and discount rates as inputs. The discount rates are based on U.S. deposit or U.S. Treasury rates. The significant inputs used in the valuation models are readily available in public markets or can be derived from observable market transactions, and the valuation is therefore classified as Level 2 in the fair-value hierarchy.
Assets and Liabilities Measured at Fair Value on a Non-Recurring Basis
Long-lived assets, goodwill, and other intangible assets are subject to non-recurring fair value measurement for the evaluation of potential impairment. There was no non-recurring fair value measurement during the six months ended December 31, 2022.
11. INCOME TAXES
The Company accounts for income taxes in accordance with ASC 740, Income Taxes. Generally, fluctuations in the effective tax rate are due to changes in relative amounts of U.S. and non-U.S. pretax income, the tax impact of special items, and other discrete tax items. Discrete items include, but are not limited to, changes in non-U.S. statutory tax rates, amortization of certain assets, changes in the Company’s reserve for uncertain tax positions, and tax impact of certain equity compensation.
In the normal course of business, the Company is subject to examination by taxing authorities around the world. The Company is presently under audit in select jurisdictions in the United States and in Europe, but no material impact is expected to the financial results once these audits are completed.
ASC 740 provides guidance for the accounting of uncertain income tax positions recognized in the Company's tax filings. This guidance provides that a tax benefit from an uncertain tax position may be recognized when it is more likely than not that, based on technical merits, the position will be sustained upon examination, including resolution of any related appeal or litigation process. As of December 31, and June 30, 2022, the Company's reserve against uncertain income tax positions was $4 million and $5 million, respectively. The majority of the reduction is attributable to the expiration of the statute of limitations on certain of the reserves. Interest and penalties related to uncertain tax positions are recognized as a component of income tax expense.
The Company recorded a provision for income taxes for the three months ended December 31, 2022 of $33 million relative to earnings before income taxes of $114 million. The Company recorded a provision for income taxes for the three months ended December 31, 2021 of $18 million relative to earnings before income taxes of $115 million. The relatively higher income tax provision on lower earnings before income taxes is the result of decreased pretax income in tax jurisdictions with favorable tax rates, equity related compensation benefits in the prior-year quarter, and foreign tax credits claimed in the prior-year quarter resulting from amended returns. Generally, fluctuations in the effective tax rate are due to changes in the geographic distribution of the Company's pretax income resulting from its business mix, changes in the tax impact of permanent differences, restructuring, special items, certain equity related compensation, and other discrete tax items that may have unique tax implications depending on the nature of the item.
The Company recorded a provision for income taxes for the six months ended December 31, 2022 of $36 million relative to earnings before income taxes of $117 million. The Company recorded a provision for income taxes for the six months ended
December 31, 2021 of $28 million relative to earnings before income taxes of $218 million. The relatively higher income tax provision on lower earnings before income taxes is the result of decreased pretax income in tax jurisdictions with favorable tax rates and foreign tax credits claimed in the prior-year quarter resulting from amended returns. Generally, fluctuations in the effective tax rate are due to changes in the geographic distribution of the Company's pretax income resulting from its business mix, changes in the tax impact of permanent differences, restructuring, special items, certain equity related compensation, and other discrete tax items that may have unique tax implications depending on the nature of the item.
12. EMPLOYEE RETIREMENT BENEFIT PLANS
Components of the Company’s net periodic benefit costs are as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
Components of net periodic benefit cost: | | | | | | | |
Selling, general, and administrative expenses: | | | | | | | |
Service cost | $ | 1 | | | $ | 1 | | | $ | 2 | | | $ | 2 | |
Other expense, net: | | | | | | | |
Interest cost | 2 | | | 1 | | | 4 | | | 2 | |
Expected return on plan assets | (2) | | | (3) | | | (4) | | | (5) | |
Amortization (1) | — | | | 1 | | | — | | | 2 | |
Net amount recognized | $ | 1 | | | $ | — | | | $ | 2 | | | $ | 1 | |
(1) Amount represents the amortization of unrecognized actuarial losses.
As previously disclosed, the Company notified the trustees of a multi-employer pension plan of its withdrawal from participation in such plan in fiscal 2012. The actuarial review process administered by the plan trustees ended in fiscal 2015. The liability reported reflects the present value of the Company’s expected future long-term obligations. The estimated discounted value of the projected contributions related to such plans was $38 million as of December 31, 2022 and June 30, 2022, and is included within pension liability on the consolidated balance sheets. The annual cash impact associated with the Company’s obligations in such plan is approximately $2 million.
13. EQUITY AND ACCUMULATED OTHER COMPREHENSIVE LOSS
Description of Capital Stock
The Company is authorized to issue 1.00 billion shares of its Common Stock and 100 million shares of preferred stock, par value $0.01 per share. In accordance with the Company’s amended and restated certificate of incorporation, each share of Common Stock has one vote, and the Common Stock votes together as a single class. In 2019, the Company designated 1,000,000 shares of its preferred stock, par value $0.01, as its Series A Convertible Preferred Stock (the “Series A Preferred Stock”) and issued and sold 650,000 shares of the Series A Preferred Stock to affiliates of Leonard Green & Partners, L.P. In November 2021, the holders of the Series A Preferred Stock converted all then-outstanding shares of Series A Preferred Stock and $2 million of related unpaid accrued dividends into shares of Common Stock.
Accumulated Other Comprehensive Loss
The components of the changes in the cumulative translation adjustment, derivatives and hedges, minimum pension liability, and marketable securities for the three and six months ended December 31, 2022 and 2021 are presented below.
| | | | | | | | | | | | | | | | | | | | | | | |
| Three Months Ended December 31, | | Six Months Ended December 31, |
(Dollars in millions) | 2022 | | 2021 | | 2022 | | 2021 |
Foreign currency translation adjustments: | | | | | | | |
Net investment hedge | $ | (85) | | | $ | 40 | | | $ | (4) | | | $ | 62 | |
Long-term intercompany loans | 31 | | | (4) | | | (10) | | | (7) | |
Translation adjustments | 155 | | | (45) | | | (5) | | | (73) | |
Total foreign currency translation adjustment, pretax | 101 | | | (9) | | | (19) | | | (18) | |
Tax (benefit) expense | (17) | | | 9 | | | (2) | | | 14 | |
Total foreign currency translation adjustment, net of tax | $ | 118 | | | $ | (18) | | | $ | (17) | | | $ | (32) | |
| | | | | | | |
Net change in derivatives and hedges: | | | | | | | |
Net gain recognized during the period | $ | — | | | $ | 4 | | | $ | 18 | | | $ | 5 | |
Total derivatives and hedges, pretax | — | | | 4 | | | 18 | | | 5 | |
Tax expense | — | | | 1 | | | 4 | | | 1 | |
Net change in derivatives and hedges, net of tax | $ | — | | | $ | 3 | | | $ | 14 | | | $ | 4 | |
| | | | | | | |
Net change in minimum pension liability: | | | | | | | |
| | | | | | | |
Net gain recognized during the period | $ | — | | | $ | — | | | $ | — | | | $ | 1 | |
| | | | | | | |
Total pension liability, pretax | — | | | — | | | — | | | 1 | |
Tax benefit | — | | | — | | | — | | | — | |
Net change in minimum pension liability, net of tax | $ | — | | | $ | — | | | $ | — | | | $ | 1 | |
| | | | | | | |
Net change in marketable securities: | | | | | | | |
Net gain (loss) recognized during the period | $ | 1 | | | $ | (1) | | | $ | 1 | | | $ | (1) | |
Amounts reclassified from accumulated other comprehensive loss | 1 | | | — | | | 2 | | | — | |
Net change in marketable securities, pretax | 2 | | | (1) | | | 3 | | | (1) | |
Tax expense | 1 | | | $ | — | | | 1 | | | $ | — | |
Net change in marketable securities, net of tax | $ | 1 | | | $ | (1) | | | $ | 2 | | | $ | (1) | |
| | | | | | | |
For the three months ended December 31, 2022 and 2021, the changes in accumulated other comprehensive loss, net of tax by component are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Foreign Exchange Translation Adjustments | | Pension and Liability Adjustments | | Derivatives and Hedges | | | | | Marketable Securities | | Other | | Total |
Balance at September 30, 2022 | $ | (513) | | | $ | (38) | | | $ | 41 | | | | | | $ | (3) | | | $ | (1) | | | $ | (514) | |
Other comprehensive income before reclassifications | 118 | | | — | | | — | | | | | | — | | | — | | | 118 | |
Amounts reclassified from accumulated other comprehensive loss | — | | | — | | | — | | | | | | 1 | | | — | | | 1 | |
Net current period other comprehensive income | 118 | | | — | | | — | | | | | | 1 | | | — | | | 119 | |
Balance at December 31, 2022 | $ | (395) | | | $ | (38) | | | $ | 41 | | | | | | $ | (2) | | | $ | (1) | | | $ | (395) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Foreign Exchange Translation Adjustments | | Pension and Liability Adjustments | | Derivatives and Hedges | | | | | Marketable Securities | | Other | | Total |
Balance at September 30, 2021 | $ | (282) | | | $ | (46) | | | $ | 1 | | | | | | $ | (1) | | | $ | (1) | | | $ | (329) | |
Other comprehensive (loss) income before reclassifications | (18) | | | — | | | 3 | | | | | | (1) | | | — | | | (16) | |
Amounts reclassified from accumulated other comprehensive loss | — | | | — | | | — | | | | | | — | | | — | | | — | |
Net current period other comprehensive (loss) income | (18) | | | — | | | 3 | | | | | | (1) | | | — | | | (16) | |
Balance at December 31, 2021 | $ | (300) | | | $ | (46) | | | $ | 4 | | | | | | $ | (2) | | | $ | (1) | | | $ | (345) | |
For the six months ended December 31, 2022 and 2021, the changes in accumulated other comprehensive loss, net of tax by component are as follows:
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Foreign Exchange Translation Adjustments | | Pension and Liability Adjustments | | Derivatives and Hedges | | | | | Marketable Securities | | Other | | Total |
Balance at June 30, 2022 | $ | (378) | | | $ | (38) | | | $ | 27 | | | | | | $ | (4) | | | $ | (1) | | | $ | (394) | |
Other comprehensive (loss) income before reclassifications | (17) | | | — | | | 14 | | | | | | — | | | — | | | (3) | |
Amounts reclassified from accumulated other comprehensive loss | — | | | — | | | — | | | | | | 2 | | | — | | | 2 | |
Net current period other comprehensive (loss) income | (17) | | | — | | | 14 | | | | | | 2 | | | — | | | (1) | |
Balance at December 31, 2022 | $ | (395) | | | $ | (38) | | | $ | 41 | | | | | | $ | (2) | | | $ | (1) | | | $ | (395) | |
| | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Foreign Exchange Translation Adjustments | | Pension and Liability Adjustments | | Derivatives and Hedges | | | | | Marketable Securities | | Other | | Total |
Balance at June 30, 2021 | $ | (268) | | | $ | (47) | | | $ | — | | | | | | $ | (1) | | | $ | (1) | | | $ | (317) | |
Other comprehensive (loss) income before reclassifications | (32) | | | — | | | 4 | | | | | | (1) | | | — | | | (29) | |
Amounts reclassified from accumulated other comprehensive loss | — | | | 1 | | | — | | | | | | — | | | — | | | 1 | |
Net current period other comprehensive (loss) income | (32) | | | 1 | | | 4 | | | | | | (1) | | | — | | | (28) | |
Balance at December 31, 2021 | $ | (300) | | | $ | (46) | | | $ | 4 | | | | | | $ | (2) | | | $ | (1) | | | $ | (345) | |
14. COMMITMENTS AND CONTINGENCIES
From time to time, the Company may be involved in legal proceedings arising in the ordinary course of business, including, without limitation, inquiries and claims concerning environmental contamination as well as litigation and allegations in connection with acquisitions, product liability, manufacturing or packaging defects, and claims for reimbursement for the cost of lost or damaged active pharmaceutical ingredients, the cost of any of which could be significant. The Company intends to vigorously defend itself against any such litigation and does not currently believe that the outcome of any such litigation will have a material adverse effect on the Company’s consolidated financial statements. In addition, the healthcare industry is highly regulated and government agencies continue to scrutinize certain practices affecting government programs and otherwise.
From time to time, the Company receives subpoenas or requests for information relating to the business practices and activities of customers or suppliers from various governmental agencies or private parties, including from state attorneys general, the U.S. Department of Justice, and private parties engaged in patent infringement, antitrust, tort, and other litigation. The Company generally responds to such subpoenas and requests in a timely and thorough manner, which responses sometimes
require considerable time and effort and can result in considerable costs being incurred. The Company expects to incur costs in future periods in connection with future requests.
15. SEGMENT INFORMATION
The Company evaluates the performance of its segments based on segment earnings before other (expense) income, impairments, restructuring costs, interest expense, income tax expense, and depreciation and amortization (“Segment EBITDA”).
Segment EBITDA is subject to important limitations. These consolidated financial statements include information concerning Segment EBITDA (a) because Segment EBITDA is an operational measure used by management in the assessment of the operating segments, the allocation of resources to the segments, and the setting of strategic goals and annual goals for the segments, and (b) in order to provide supplemental information that the Company considers relevant for the readers of the consolidated financial statements. The Company’s presentation of Segment EBITDA may not be comparable to similarly titled measures used by other companies.
The following tables include Segment EBITDA for each of the Company's current reportable segments during the three and six months ended December 31, 2022 and 2021:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Three Months Ended December 31, | | Six Months Ended December 31, |
2022 | | 2021 | | 2022 | | 2021 |
Segment EBITDA reconciled to net earnings: | | | | | | | |
Biologics | $ | 181 | | | $ | 199 | | | $ | 294 | | | $ | 366 | |
Pharma and Consumer Health | 135 | | | 147 | | | 243 | | | 246 | |
| | | | | | | |
| | | | | | | |
Sub-Total | $ | 316 | | | $ | 346 | | | $ | 537 | | | $ | 612 | |
Reconciling items to net earnings | | | | | | | |
Unallocated costs (1) | (52) | | | (101) | | | (139) | | | (157) | |
Depreciation and amortization | (103) | | | (98) | | | (202) | | | (179) | |
Interest expense, net | (47) | | | (32) | | | (79) | | | (58) | |
Income tax expense | (33) | | | (18) | | | (36) | | | (28) | |
| | | | | | | |
Net earnings | $ | 81 | | | $ | 97 | | | $ | 81 | | | $ | 190 | |
(1) Unallocated costs include restructuring and special items, stock-based compensation, gain on sale of subsidiary, impairment charges, certain other corporate directed costs, and other costs that are not allocated to the segments as follows:
| | | | | | | | | | | | | | | | | | | | | | | |
(Dollars in millions) | Three Months Ended December 31, | | Six Months Ended December 31, |
2022 | | 2021 | | 2022 | | 2021 |
Impairment charges and gain/loss on sale of assets(a) | $ | (1) | | | $ | (16) | | | $ | 1 | | | $ | (19) | |
Stock-based compensation | (10) | | | (11) | | | (29) | | | (32) | |
Restructuring and other special items(b) | (33) | | | (23) | | | (42) | | | (31) | |
Gain on sale of subsidiary(c) | — | | | — | | | — | | | 1 | |
| | | | | | | |
| | | | | | | |
| | | | | | | |
Other income (expense), net(d) | 23 | | | (14) | | | (2) | | | (23) | |
Unallocated corporate costs, net | (31) | | | (37) | | | (67) | | | (53) | |
Total unallocated costs | $ | (52) | | | $ | (101) | | | $ | (139) | | | $ | (157) | |
(a) Impairment charges and gain/loss on sale of assets during the three and six months ended December 31, 2021 include fixed asset impairment charges associated with a product in the Pharma and Consumer Health segment.
(b) Restructuring and other special items during the three months ended December 31, 2022 include (i) restructuring charges associated with our plans to reduce costs, consolidate facilities, and optimize our infrastructure across the organization and (ii) transaction and integration costs associated with our Metrics acquisition. Restructuring and other special items for the six months ended December 31, 2022 also includes warehouse exit costs for a product the Company no longer manufactures in its Pharma and Consumer Health segment. For further details on restructuring charges, see Note 8, Restructuring Costs.
Restructuring and other special items during the three months ended December 31, 2021 include (a) transaction and integration costs primarily associated with the Bettera Wellness acquisition and (b) restructuring costs associated with the closure of the previously owned Bolton facility. Restructuring and other special items during the six months ended December 31, 2021 include (c) transaction and integration costs associated with the Delphi Genetics SA, Hepatic Cell Therapy Support SA, RheinCell Therapeutics GmbH, and Bettera Wellness acquisitions.
(c) Gain on sale of subsidiary for the six months ended December 31, 2021 was due to the sale of the Company's facility in Woodstock, Illinois and the associated business.
(d) Other income (expense), net during the three and six months ended December 31, 2022 and 2021 primarily includes foreign currency remeasurement losses/gains.
The following table includes total assets for each segment, as well as reconciling items necessary to total the amounts reported in the consolidated financial statements.
| | | | | | | | | | | |
(Dollars in millions) | December 31, 2022 | | June 30, 2022 |
Assets: | | | |
Biologics | $ | 5,902 | | | $ | 5,770 | |
Pharma and Consumer Health | 4,992 | | | 4,355 | |
| | | |
| | | |
Corporate and eliminations | 253 | | | 382 | |
Total assets | $ | 11,147 | | | $ | 10,507 | |
16. SUPPLEMENTAL BALANCE SHEET INFORMATION
Supplemental balance sheet information at December 31, 2022 and June 30, 2022 is detailed in the following tables.
Inventories
Work-in-process and inventories include raw materials, labor, and overhead. Total inventories consist of the following:
| | | | | | | | | | | |
(Dollars in millions) | December 31, 2022 | | June 30, 2022 |
Raw materials and supplies | $ | 803 | | | $ | 651 | |
Work-in-process | 144 | | | 109 | |
| | | |
Total inventories, gross | 947 | | | 760 | |
Inventory cost adjustment (1) | (129) | | | (58) | |
Total inventories | $ | 818 | | | $ | 702 | |
(1) Increase in inventory cost adjustment is primarily associated with the settlement of certain take-or-pay arrangements.
Prepaid expenses and other
Prepaid expenses and other consist of the following: | | | | | | | | | | | |
(Dollars in millions) | December 31, 2022 | | June 30, 2022 |
Prepaid expenses | $ | 67 | | | $ | 61 | |
| | | |
Short-term contract assets | 497 | | | 398 | |
| | | |
Spare parts supplies | 23 | | | 22 | |
Prepaid income tax | 31 | | | 26 | |
| | | |
Non-U.S. value-added tax | 37 | | | 48 | |
| | | |
| | | |
| | | |
Other current assets | 59 | | | 70 | |
Total prepaid expenses and other | $ | 714 | | | $ | 625 | |
Other accrued liabilities
Other accrued liabilities consist of the following: | | | | | | | | | | | |
(Dollars in millions) | December 31, 2022 | | June 30, 2022 |
Contract liabilities | $ | 175 | | | $ | 185 | |
Accrued employee-related expenses | 143 | | | 198 | |
Accrued expenses | 123 | | | 140 | |
Operating lease liabilities | 12 | | | 14 | |
Restructuring accrual | 7 | | | 1 | |
Accrued interest | 33 | | | 32 | |
Accrued income tax | 34 | | | 50 | |
Total other accrued liabilities | $ | 527 | | | $ | 620 | |