Please stand by. Welcome, ladies and gentlemen, to the Third Quarter Fiscal Year 2022 Earnings Conference Call for Embecta Corp. At this time all participants have been placed in listen-only mode. Please note that this conference call is being recorded, and that recorded will be available on the company's website for replay shortly.

I would now like to hand the conference over to your speaker today, Mr. Pravesh Khandelwal, Vice President of Investor Relations. Please go ahead..

Dev will make a few opening remarks on the overall performance of our business. Jake will provide you with a more in-depth review of financial results for the third quarter of fiscal 2022 as well as our updated financial guidance, as stated in the earnings press release issued earlier today.

Dev will then provide some closing thoughts on our strategic imperatives. We will then open the call for questions. I would now like to turn the call over to our CEO, Dev Kurdikar.

Dev?.

Good morning, everyone, and thank you for joining us today for Embecta's third quarter of fiscal year 2022 earnings call, which also marks our first full quarter as a standalone public company. Before we get into the content of today's call, let me also welcome Pravesh Khandelwal, whom you just heard.

Pravesh has joined us as our VP of Investor Relations. He was most recently in Investor Relations at a health care company and has prior experience in equity research. We are excited to have him join our team. Turning to Slide 5. Let me first start with who we are.

Quite simply, we are an organization with a truly unique opportunity to create the preeminent diabetes-focused company in the world. Our mission is to develop and provide solutions that make life better for people with diabetes. That is our entire focus. We are the global leaders in the business of injection devices.

We've been making and selling insulin injection devices for almost 100 years. Our global manufacturing infrastructure is unmatched, and supported by a geographically diverse sales and distribution network. We have built an incredible leadership team to advance our vision of empowering people to live a life unlimited by diabetes.

We have recently added to our leadership talent by recruiting experienced leaders for our regulatory affairs, R&D and quality functions, roles critical for our current business as well as for achieving our longer-term objectives.

Our global team of 2,000 employees have been hard at work standing up Embecta and driving our business for people with diabetes, for our customers and for our stakeholders. Switching to Slide 6. Here are our financial and operating highlights for the third quarter of fiscal 2022.

We are pleased with the company's strong performance in the quarter, our first as a standalone public company, amidst the current challenging operating environment, which includes having to navigate through raw material inflationary pressures, supply chain challenges, geopolitical concerns and varying COVID-19 restrictions.

This performance reflects the resilience of our business model, the defensive segment in which we operate and most importantly, the character and determination of our global team that works tirelessly to serve our customers and people with diabetes who use our products.

An important nuance of this business is that our products are primarily single-use disposable products and, hence, their use is not significantly financially burdensome in contrast with some other therapies. Moving to the financial results for this quarter, Embecta generated revenues of $291.1 million.

This represents a decline of 1.3% on an as reported basis and growth of 2% on a constant currency basis. The constant currency revenue growth was primarily driven by higher volumes and to a lesser extent, price in the United States and in Central and Southeast Asia. I'll comment on geographic revenue breakdown on the next slide in a moment.

GAAP gross profit end margin for the third quarter of 2022 totaled $202.9 million and 69.7%, respectively. Adjusted gross and EBITDA margins remained robust at 69.8% and 40.5%, respectively.

And based on our strong third quarter results and outlook for the remainder of the year, we're raising our financial guidance for constant currency revenue growth, adjusted gross margin and adjusted EBITDA margin for the second half of this fiscal year, while reiterating our as reported revenue growth guidance despite incremental FX headwinds.

Additionally, we continue to make progress building up our internal organization, systems and processes so that we can exit the transition service agreements that we have with Becton Dickinson within the planned time periods.

And lastly, we continue to advance the development of type 2 closed loop insulin delivery system, utilizing our proprietary patch pump technology. Now clicking through geographic revenues on Slide 7, third quarter U.S. revenues of $158 million increased by 4.1% on both an as reported and constant currency basis.

International revenues of $133.1 million decreased by 7.1% on an as-reported basis and 0.3% on a constant currency basis. Overall, constant currency growth of 2% was primarily due to an increase in base business volume in part due to the timing of certain orders within the U.S., the impact of contract manufacturing revenue to BD and improved pricing.

Somewhat offsetting this was the rebate reserve adjustment that occurred in the third quarter of 2021, which did not reoccur in the third quarter of 2022.

And while we benefited from the timing of certain orders this quarter, we continue to focus on the second half business performance as the timing and cadence of order patterns varies quarter-to-quarter. On a year-to-date basis, revenues were $854.9 million.

This represents a decrease of 1.1% on an as reported basis and an increase of 0.8% on a constant currency basis.

Overall, constant currency growth was driven by favorable price and volume, partially offset by the conscious decisions we made during the latter portion of 2021 to no longer participate in certain business and which we have discussed on our prior call.

With that, let me turn it over to Jake to discuss our Q3 results and our updated expectations for the second half of this year.

Jake?.

Our fourth quarter adjusted gross margin which is expected to be in the low 60s.

And a sequential increase in operating expenses, primarily due to additional R&D expense, as well as additional expenses incurred associated with standing up Embecta as an independent company In closing, Embecta continues to be very well positioned to exit fiscal year 2022 with a strong financial profile as we complete our first six months as an independent company.

That completes my prepared remarks, and at this time, I would like to turn the call over to Dev for some final remarks..

Thank you, Jake. Wrapping up our discussion on Slide 10, you will see that our capital allocation priorities are set with the intention to make strategic investments to accelerate our long-term growth profile. We expect to do this through commercial investments, the introduction of next-gen products, and M&A.

First, we can continue to expand and penetrate through our core business. This includes e-commerce investments as well as educating people with diabetes and other stakeholders on the benefits of using a new device for every injection.

Second, we intend to increase our investment in R&D – and we remain excited about our patch pump that is being developed for the Type 2 market. Finally, we continue to seek partnerships and acquisitions where we can use our manufacturing strengths and commercial capabilities to add value.

Before we open up the line for Q&A, I would like to extend my thanks to the global Embecta team for everything they have done and continue to do to serve people with diabetes while we stand up Embecta as an independent company. With that, operator, we will now open up the line for questions..

[Operator Instructions] Our first question comes from Travis Steed with Bank of America. Your line is open..

Hi, good morning everybody. Congrats on a good quarter. I guess I'd start with – maybe just talk about the performance in the quarter, the ability to kind of raise the guidance on the better performance in the quarter.

And it seems like on the margin side, most of the second half guide raise is all because of the Q3 outperformance and you're assuming some of the similar things for Q4.

And so just trying to think through how that could actually impact some of the longer term, is your view on the long-term margins are kind of in the same place, the low 60% by 2024 and 30% by on EBITDA margin?.

Thanks, Travis. This is Dev. Thanks for the question. Maybe I'll start off, and I'll ask Jake to jump in here. With respect to our thoughts on the longer term that we laid out in March, nothing has changed, really.

And with respect to this quarter's performance that we just disclosed today, those were all aligned with the guidance that we had provided earlier this year when we provided guidance for the second half of the year.

Maybe, Jake, you can comment on some specifics on the quarter?.

Yes. So Travis, again, thanks for the question. I think that really across different line items within the P&L, I think, for our first quarter as an independent entity, they did largely come in better than expected.

I think from a revenue perspective, some of that had to do with the fact that, as Dev mentioned in his prepared remarks, we had some orders that ended up just from a timing perspective falling into Q3 as compared to, say, what we previously would have expected it being in Q4.

Now that said, we provided guidance for the entirety of the second half of the year.

And as compared to that prior guidance, our business, our base business is doing slightly better than expected, so I think off to a good start and candidly had the contract manufacturing revenue to BD, which we've always said we viewed as sort of transient in nature, had that remained consistent at our prior guide of roughly $15 million instead of now us expecting $10 million in the second half of the year, that would have added another, let's call it, 80 basis points or so to our constant currency revenue performance.

So I think from an underlying base business standpoint, you should think of our kind of core injection franchise in doing something north of, let's call it, 1% to 1.5%, give or take, better than what we previously anticipated. So a positive start for the year.

Likewise, I would say from a gross margin and an EBITDA margin standpoint, still very, very robust at roughly 70% and a little over 40.5% for the third quarter. So I think out of the gate, continuing to manage cost well, continuing to stand up the company and continuing to drive leverage through the P&L. So very happy to see for our first quarter.

For the guidance for the second half of the year, we tried to be pretty prescriptive in the prepared remarks and talking about what that would imply for Q4.

And essentially, it still points people back to a thought that that the margin profile for Embecta, the gross margin line will be roughly in that kind of low 60s-ish area, and that the adjusted EBITDA margin will be in sort of that low 30s-ish area for the fourth quarter.

So nothing changed from our perspective regarding certainly the longer-term outlook. Inflation is probably a little bit more of a negative headwind right now than what we would have previously anticipated back when we provided sort of those 2024 goals and objectives back in March.

But I think I'm happy to say that that nothing has changed regarding our thoughts concerning the financial profiles of to Embecta either really near-term or longer term through 2024..

All right. That's helpful.

And if you think about all the different buckets that you gave, your content manufacturing agreement, the lease, the TSA, the whole list of things that you gave is kind of baked in, I don't know if there is a way to help quantify the different buckets or the totality of those things and to think about how much of that could roll off next year? And then additionally, with since you're a new company, I don't know if there is a way to think about FX and how like FX changes impact margins.

If there's any rule of thumb you'd love to give on that, would love to hear that..

Sure. So look, from an FX standpoint, maybe I'll start there first. But from an FX standpoint, I think that that impacted our gross margins, for instance, by roughly somewhere between 200 to 250 basis points negatively year-over-year in the third quarter.

And from a standup cost standpoint, I think we're not necessarily going to provide specific dollar amounts associated with each individual line item. Some of them, obviously, from a TSA standpoint, as we begin to kind of stand up the company, some of the TSAs could fall off.

But I would sort of point you back to sort of that move from kind of Q3, either gross or EBITDA margins to as sort of being the main drivers, right? And those were really, I would say, four main items.

So the sequential move from kind of Q3 adjusted gross margin to Q4 adjusted gross margin serves as sort of a good proxy as to kind of where we were sort of pre-spin to sort of post-spin and the longer-term outlook through 2024.

So in the third quarter to fourth quarter, we talked about gross margins going from sort of 70% into the low 60s and the fourth being driven by a combination of the supply agreement, probably most notably the cannula cost, different product and geographic mix shifts as well as just a variety of different incremental investments and standup costs and then lastly, obviously, the impact of inflation.

So each of those we would expect to probably impact Q3 to Q4 about equally..

All right, great. Thanks. Thanks for taking my question and congrats on a good quarter..

Thanks, Travis.

Thank you..

Our next question comes from Cecilia Furlong with Morgan Stanley. Your line is open..

Great. Good morning and thank you for taking the questions. I wanted to turn back to just your comments on the timing of some of the orders, the impact in Q3 and really how you're thinking about 4Q contribution to U.S.

versus OUS on a sequential basis, really what you saw in Q3 and how we should think about relative contributions in 4Q? And tied in with that too just how you're thinking about both China, some of the other geopolitical potential impacts on the business as well as the potential for pricing in 4Q as well?.

Hi, Cecilia. This is Dev. Again, I'll start off here, try to go through each one of the, I think, topics you had raised. So the first one, with respect to timing of orders, in our business, there is some order pattern variation that can occur quarter-to-quarter.

But frankly, it's in line with what we had thought would be could potentially happen when we gave second half guidance, and that's why we gave second half guidance versus quarter-to-quarter. I think, as you think about shifts from Q3 to Q4, and if you will, the geography mix between U.S.

and international, that is likely to shift a little bit more towards international in Q4 versus Q3. And it’s one of the factors that impacts the quarterly gross margin for Q4. If you look at it from a – certainly a normalized period of 12 months, I think you’re going to find that the U.S.

and international mix is well aligned with expectations that we’ve set previously. With respect to China and geopolitical concerns, again, when we gave guidance for the second half of the year, we knew that there were COVID-19 disruptions going on in China. You may remember at that time, lockdowns are still pretty fresh in everybody’s mind.

And the way things have played out in China again, have been within the range of outcomes that we are expected. Clearly, it’s a fluid situation. I think the geopolitical concerns in China may have heightened a little bit. We’ve all read about the drills that impact China, Taiwan. So it’s a situation we are watching closely.

But certainly even the updated guidance that we’ve given, we think, we’ve assumed sort of moderate level of continued impact on the China business as a result, both of COVID-19, as well as the geopolitical issues.

And then frankly – finally with respect to pricing, I did comment that we had some favorable price that we got in the most recent quarter in the U.S. and then some parts of Asia. And so, again in line with my previous commentary, where we get a chance to adjust and optimize price, certainly we do.

That happens on an ongoing basis, given just the diversity of the geographic revenue that we have and the diversity of customers that we have. Some of our contracts allow us to take price periodically. And so we exercised that when possible, and you saw the favorable impact of that in the quarter that we just supported.

Jake, anything you’d like to add to that?.

So the only thing I think I’d add is just maybe just a little bit more color regarding sort of the sequential move in kind of Q3, maybe revenue dollars to what we are essentially implying for Q4. And I think that’s really just due to a handful of items, the timing issue that Dev’s mentioned.

Second, we would expect there to be sequentially more of an incremental FX headwind from Q3 to Q4.

And then lastly, we would expect there to be more of a net headwind between the rebate reserve adjustments that we would’ve generated in the fourth quarter of last year versus sort of the – there’s going to be incremental rebate reserve adjustments that we are going to see, sort of negatively impacting us in in the fourth quarter.

So – but all that said, I think we’re very pleased that for the first quarter as a publicly traded company, that we have the opportunity to increase our second half of the year constant currency revenue expectations, and that’s really all due to slight improvements in that base business..

Great. And if I could follow-up as well and appreciate your commentary on R&D and just the timing there.

But can you speak to just your expectations?.

Expectations and that’s really all due to slight improvements in that base business..

Great. And if I could follow-up as well and appreciate your commentary on R&D and just the timing there. But can you speak to just your expectations, both for 4Q as well as 2023, fiscal 2023, as you ramp contributions to the patch pump program, 3Q was a bit lighter than we were expecting.

So just I’d love some more commentary on how you envision that ramping both the – through the balance of this year and into 2023?.

Yes. So let me talk about Q3 and Q4 in R&D. So first of all, our patch pump program is progressing as we would expect it to continue to be pleased with the progress that we are making in the development of that product.

With respect to R&D spend in Q3 and Q4, again, Cecilia, it’s a timing, it’s purely a timing thing in terms of total our expectations having changed with respect to what we expect to spend on R&D for this year. So I wouldn’t draw any big conclusions from the timing shift from Q3 to Q4 for R&D spend.

And respectfully – with respect to FY 2023, we’ll comment on that more specifically when we have our Q4 earnings call and we set guidance for 2023.

I would say though that our expectations that we laid out in March through sort of what we call long term, then FY 2024, none of that has changed with respect to either revenue or we had laid out expectations for R&D. So that hasn’t changed either. But – so respectfully, I’ll reserve our comments for FY 2023 when we speak in a little over 90 days..

Okay, understood, and congrats on the quarter and thank you for taking the questions..

Thank you, Cecilia..

[Operator Instructions] Our next question comes from Marie Thibault with BTIG. Your line is open..

Good morning, Dev. Good morning, Jake. And I’ll add my congrats here also on a strong quarter, nice to see. Wanted to ask maybe a very high level question. You’ve given us some commentary around timing shifts and some thoughts on standing up costs for the public company.

But just at a very high level, I’d love to hear a few months here into the transition what’s gone according to plan and what has surprised you either to the upside or downside about this whole process?.

Marie, this is Dev. Thanks for your comments and for the question. Look, at a high level, I must say I’m very, very pleased with how our team has performed in the first quarter as an independent company. This business has been part of BD for almost a 100 years.

So now you’re separate and you stand up a company and I’m very pleased with how the team has performed as I said. In terms of positive surprises, the morale and just the sort of leaning forward attitude of the team continues to drive our business forward.

I think on the – on negative side, candidly, it would’ve been nice to start off as an independent company without the raft of geopolitical issues, the inflationary pressure, the transportation disruptions that I know all companies are facing with.

But sort of having to wrestle through all of that in the first quarter as an independent company, let’s just say, I wouldn’t have been disappointed to avoid..

Of course, makes sense. And then maybe I can ask my follow-up here. Maybe on a timely issue, obviously, hearing news about a pricing cap on insulin here in the U.S., is that going to have any impact on your business at all? Does that present a tailwind at all? I’d just love to hear your thoughts. Thank you..

Yes. Look, in general, anything that expands access to insulin, so that people can – people with diabetes can manage their diabetes appropriately will help us, right.

Also my hypothesis, Marie, is that, pricing sort of caps and insulin are going to help more people get access to insulin than previously, which again, sort of the hypothesis would be, I mean, these are likely people that will be using injection devices to deliver their insulin and so could be a tailwind.

Now, all of this is still being wrestled through the legislative process. So it’s not something we are dialing in into any of our projections. But certainly I would expect it to be a net positive..

All right. Very good. I’ll jump back in queue. Thank you..

Thank you, Marie..

There are no further questions. I’d like to turn the call back over to Dev Kurdikar for any closing remarks..

Thank you all for attending our call and for your interest in our company. It’s something we deeply appreciate. I also want to end again by thanking our team for doing everything that they have done to continue to support people with diabetes, even as we stand up Embecta as its own independent separate company. Have a great day all.

And we look forward to speaking with you again next quarter..

This concludes the program. You may now disconnect..