Welcome ladies and gentlemen to the Fiscal First Quarter 2024 Embecta Earnings Conference Call. At this time, all participants have been placed in listen-only mode. Please note that this conference call is being recorded and the recording will be available on the company's website for replay following the completion of this call. I would now like to hand the call over to your host today, Mr. Pravesh Khandelwal, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone, and welcome to Embecta's fiscal first quarter 2024 earnings conference call. The press release and slides to accompany today's call and webcast replay details are available on the Investor Relations section of the company's website at www.embecta.com. With me today are Dev Kurdikar, Embecta's President and Chief Executive Officer, and Jake Elguicze, our Chief Financial Officer. Before we begin, I would like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events as outlined in our slides. We wish to caution you that such statements are, in fact, forward-looking in nature and are subject to risks and uncertainties, and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include, but are not limited to, factors referenced in our press release today as well as our filings with the SEC, which can be accessed on our website. In addition, we will discuss certain non-GAAP financial measures on this call, which should be considered a supplement to and not constitute for financial measures prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to the comparable GAAP measures is included in our press release and conference call presentation. Our agenda for today's call is as follows. Dev will begin by providing some remarks on the overall performance of our business during the fiscal first quarter of 2024 as well as an overview of our strategic priorities. Jake will then provide a more in-depth review of our Q1 financial results as well as our updated financial guidance for the year. We will then open the call for questions. With that said, I would now like to turn the call over to our CEO, Dev Kurdikar. Dev?

Good morning, and thank you for taking the time to join us. With the introduction of the first specialized insulin delivery device in 1924, this year marked the 100th year of our journey to deliver better diabetes care through innovation. Whether you are newly diagnosed, or transitioning to a new line of therapy, our mission is to make a person with diabetes every day experience as comfortable and convenient as possible while advancing towards a new generation of life-changing solutions. We have been one of the leaders in insulin delivery for nearly 100 years. And through our insulin delivery products, we touch an estimated 30 million people living with diabetes in over 100 countries, developing and providing solutions that make life better for people living with diabetes is at the core of everything we do and is what drives our global team. Turning to our strategic priorities for fiscal year 2024. We will continue to be focused on the same three core strategic priorities that we have had since we became an independent company. These priorities have served as the foundation for our actions and decision-making, driving our company forward, and they include, remaining focused on strengthening our base business while maintaining our global leader position in the category of insulin injection devices, separating ourselves from our former parent in a thoughtful manner to mitigate risk and position us for success as an independent company, and finally, investing in growth, most notably around our insulin patch pump program that is being developed for the Type 2 market as well as seeking M&A and additional partnership opportunities. We are advancing with determination and a sense of urgency in each of these objectives, and I'm very pleased with the progress that we've made in these areas. Turning to some first quarter highlights.…

Thank you, Dev, and good morning, everyone. Given the discussion that has already occurred regarding revenue, I will start my review of Embecta's financial performance for the first quarter at the gross profit line. GAAP gross profit and margin for the first quarter of fiscal 2024 totaled $185.9 million and 67%, respectively. This compared to $188.8 million and 68.5% in the prior year period. While on an adjusted basis, our Q1 2024 adjusted gross profit and margin totaled $186.3 million and 67.2%. This compared to $188.9 million and 68.5% in the prior year period. The year-over-year decrease in adjusted gross profit and margin was due to the negative impact of foreign currency translation, primarily due to the weakening of the US dollar. The impact of negative year-over-year manufacturing variances, including the temporary shutdown of our Suzhou, China facility as it relates to production for the domestic Chinese market as well as the impact of inflation on the cost of certain raw materials, direct labor and overhead. These headwinds were somewhat offset by a variety of cost improvement initiatives and our ability to generate positive year-over-year pricing. As compared to our prior outlook, our adjusted gross margin during the first quarter was better than we previously expected, and this was due to the higher-than-anticipated revenue that Dev referred to earlier as well as favorable geographic and product mix and FX. Turning to GAAP operating income and margin. During the first quarter, they were $45.5 million and 16.4%. This compared to $88.8 million and 32.2% in the prior year period. While on an adjusted basis, our Q1 2024 adjusted operating income and margin totaled $77.5 million and 27.9%. This compared to $101.6 million and 36.9% in the prior year period. The year-over-year decrease in adjusted operating income and margin is primarily due…

Thank you. [Operator Instructions] Our first question comes from Kallum Titchmarsh with Morgan Stanley. Your line is open.

Thank you very much for taking the question. I have a couple, if that's okay. Firstly, maybe if you could provide some color on your own plans of entering the GLP market with your pen needles, specifically, any thoughts on Lilly's KwikPen for Mounjaro approval in the UK a couple of weeks back, given, I think, Embecta's pen needles are the recommended choice on the label for this? How should we think about quantifying this opportunity and any additional ones down the line?

Good morning, Kallum, and thanks for the question. As I've commented before, every time a pen is used all over the world, whether it be for insulin or for GLP-1s, given our strong share positions in countries around the world, it certainly positions us well for our pen needle to be used. Most of the pens that are being used out there are compatible with our pen needles. The KwikPen you particularly difference on this call, that is the same pen that's used for insulin as well. And certainly, our pen needles have a strong position in the UK. I would expect that as GLP presentations maybe change in the ratio over time between vials, pens and auto-injectors, as more and more pens get introduced, and I think Lilly has commented publicly that they certainly are thinking about introducing GLP-1s in more countries with pens. We certainly expect to benefit from it. The other thing I would point out is some of the older GLP-1s will turn generic this year. They have in certain countries outside the US, and those presentations are also often in pens. And so that will benefit certainly our pen needle business as well.

Great. And then just one more, if that's okay. On the Q1 margins, specifically on the gross margin side, pretty strong there. You've come in beyond 67% for the quarter, yet you're keeping the full year guide between 63% and 64%. Why shouldn't those margins remain at these levels throughout the year?

Yeah. Thanks for the question, Kallum. So it really comes down to timing, right? I think in the first quarter, at a very high level, I think we're extremely pleased with the first quarter results. And I think it's particularly so when you think about all the separation oriented work that had to occur by all the associates. I think they did a tremendous job of keeping the business stable and continuing to advance obviously, all the ERP initiatives and separation work. So really good start, I would say, to the year from a financial standpoint. We talked about revenue in the first quarter, and revenue was better than we had previously expected it to be. And we largely attribute that to the timing of customer orders in advance of the ERP. To a far lesser extent, we did see some benefit in the quarter in terms of revenue from an improved FX environment in relation to the original guide. But really, the improvement as compared to our own internal expectations for Q1 for revenue really came down to the timing of the shipments. From a margin standpoint, that again, in relation to our expectations for Q1 gross margin, Q1 gross margins came in very strong at around 67.2% on an adjusted basis, again, largely because of the timing of the revenue that we saw in the quarter as well as the mix of the revenue, and the fact that because revenue was a little bit better, we needed to manufacture more product and had some positive variances in relation to our original expectations. So as we think about moving forward, as Dev mentioned, I think, in his prepared remarks, we think that, that timing benefit from a revenue standpoint will largely unwind itself in the second quarter of the year. And we still believe that the first half of the year from a revenue and margin standpoint is pretty much almost exactly in line with what we had communicated in our initial guide three months ago. So hopefully, that gives you a little bit more color in terms of the reason for the margin trajectory from Q1 to Q2. On a full year basis, again, we reaffirmed all our previously provided margin ranges, whether it's gross margin, operating margin or adjusted EBITDA margin.

That’s great. Thanks.

Thank you. Our next question comes from Travis Steed with Bank of America Securities. Your line is open.

Hi, good morning. This is [Caroline] (ph) on for Travis. Thanks for taking my questions. I wanted to ask about the patch pumps just following your 510(k) submission in January. Have you gotten any feedback from the FDA at this point? And then just your thoughts on timing of approval.

Yeah. Good morning, Caroline, and thanks for the question. Look, we're very pleased to have gotten the submission done almost a month ago now. As you can imagine, this is in the very early stages. Certainly, we know the review is well underway, and our team has been corresponding with the FDA. I wouldn't want to get ahead of the FDA with signaling timing, certainly so earlier -- so early in review process. But nothing atypical so far, Caroline. We look forward to working with the FDA and responding to all the questions that we'll have. And certainly, when there is something substantial to communicate, we will certainly do so. I should also take the opportunity to mention while that is under review, we continue to work on the closed-loop version of the pump as well. So that work is going on concurrently, and we are pleased with the progress on that version as well.

Thank you. And then can you talk about your constant currency growth expectations for the US versus internationally for the core injection business ex contract manufacturing for the year, and in particular, thinking about growth in China, actually in the quarter and then just your outlook for the fiscal 2024? Thank you.

Yeah. So I think the growth outside of the US is really expected to exceed the growth in the US, right? And that's been a trend, I think largely that we've seen over the past several years, essentially the US market being relatively flattish, and the international markets, particularly in the emerging markets for us, growing somewhere in that, let's call it, mid-single-digit, 4-ish plus percent type range. And that's sort of our thoughts right now for 2024, is that the US market were developed in nature still has sort of a flattish type constant currency revenue growth rate. And if we were to see more positive growth, that's going to come from sort of the international markets.

And if I can just add to that, just to connect the dots here, we commented that the Suzhou entity, the demerger process is complete. We plan to start production for the domestic China market in this quarter, that plant was already producing product for export markets, but primarily emerging markets. So from a manufacturing standpoint, we are really glad to get some of this separation work done [to us] (ph) and really strengthens our foundation to capitalize, if you will, on the growth that we expect over the continued long term in the emerging markets.

Thank you.

Thank you. Our next question comes from Marie Thibault with BTIG. Your line is open.

Good morning, Dev and Jake. Thanks for taking the questions and nice quarter. I wanted to ask here a follow-up on the patch pump. Are you planning to broadly launch or broadly commercialize the open-loop patch pump? And as a follow-up on that, now that you've got that submitted, should we expect R&D investments to step up, to stay flat? How are you thinking about the investment needed to get the closed loop pump to FDA submission?

Thanks, Marie. Good morning. Yes, we do plan at the right time to commercialize the open loop. Our view is that we will do a limited market release of the open loop pump. All the work that we've done so far indicates to us that there is a segment of the market that would benefit and be interested in an open-loop pump. But obviously, the timing of that is all dependent upon the review and eventual approval of the process. With respect to R&D expenses for the year, I mean I'll let Jake comment some more, but certainly, we've included our anticipated expenses for fiscal 2024 in the guidance, and it's a little too early to sort of comment long term beyond '24 at this point, but I'll let Jake add additional color.

Sure. Marie, I think R&D spending in the first quarter was probably actually a little bit lower than what we had sort of originally internally expected it to be just due to some timing issues. And we certainly expect that to pick up in terms of R&D spending as we move throughout the remaining quarters of the year. And I think continue to expect that R&D as a percentage of revenue is most likely going to exceed a 7%-ish type level for fiscal 2024.

Okay. That’s very helpful. Let me ask my follow-up on the ERP systems in that transition. I think I heard you say that the sales result this quarter benefited from the timing of customer orders related to that transition. Can you help clarify what that means? Were they ordering ahead of time to avoid disruption during the transition? And then as part of the ERP transition, what exactly remains to be done? And is there a risk around the IRS letter for extension, do you have any control? What's the plan if that doesn't come through? Thanks for taking the questions.

Sure, Marie. I'll take that. So with respect to ordering patterns during an ERP implementation, in this case, it's an ERP implementation, plus we are standing up our own shared services capabilities, and we are standing up our own distribution network. It's quite typical in transitions like this that you have a pause in taking new orders, as you're moving inventory from old distribution centers to new distribution centers. And so in circumstances like these, customers will often place orders in advance because certainly, we don't want and they don't want any stock-outs to occur. And so it's quite typical to get some lumpiness during an ERP transition. And so the timing effect that Jake referred to, because we were implementing in US and Canada, certainly, we had some timing benefit. And I think as I said in my prepared remarks, we are going to do a phased implementation around the world as we continue. There will be some atypical ordering patterns that might actually go from quarter to quarter as we complete these implementations. With regard to the private letter ruling that you're referring to, as you remember, BD agreed in principle to grant us a limited extension conditioned upon obtaining an acceptable supplemental private letter ruling from the IRS, and that would allow us to extend some of these TSAs until early fiscal 2025. And that, again, the reason for that is so that we can phase out these implementations and potentially reduce some of the implementation risk that is inherent in complex implementations like these. We've done significant work on preparing the filings. We've been closely cooperating with BD and providing them with all the necessary information. We anticipate that the filing will be made soon. And certainly, we work with them to make sure that our filing is well positioned. Obviously, I don't want to comment on the review or outcome. We don’t want to get in front of the IRS. But suffice to say that we have contingency plans, and we've incorporated or tried to be prudent in our guidance in contemplating the range of potential outcomes that can occur in ERP implementations of this sort.

That’s all really helpful. Thank you, Dev.

Thank you. [Operator Instructions] Our next question comes from Michael Polark with Wolfe Research. Your line is open.

Hey, good morning. Thank you. I have two, one boring one on the balance sheet and then a question on the patch pump. On the balance sheet, Jake, really appreciated the comments about the factoring agreement. We noticed the step-up in AR. Is $100 million a good level of AR for Embecta to carry or would you expect that this number to change one way or the other as you move through the transition?

Yeah, Michael. I mean, I think there could be a little bit of variability in the coming quarters just as we bring on for first, obviously, 60% of our revenue in the US and Canada and then the remaining 40% over the next several quarters. So we could see some variability from quarter-to-quarter. But I think right now, our expectation is that as we move throughout the year, we start to, in a more meaningful way, start to collect that cash that is now sort of sitting on the balance sheet in terms of AR during the remaining quarters of the year.

The follow-up on the patch pump program. The question is on the production side. Marie asked about R&D. I appreciate the comments there. But I imagine in parallel, you're thinking about how to create a production environment to make a lot of patch pumps and been looking at some of the incumbents here. It's a very exquisite process and takes a long time in dollars. Where are you in that? I know you're not -- you're reluctant to comment on timing of all this, but I have to imagine there's some kind of planning going on for commercial production of this product. And I'd love to get a flavor for how you're thinking about that and if you're putting CapEx dollars to work today on a project like that?

Mike, this is Dev. Good morning, thank you. And you're absolutely right. We have been working on commercial production of the product for a while now, actually even before the submission was made. I would say there are three specific things that we focused on. Number one is recognizing that there is expertise in production that may be not inherent in the company, we went through an RFP process and selected a contract manufacturer that could help us with production. That's sort of point number one. And we're working with that contract manufacturer now for over a year. The second thing I would point out is as we were designing the pump and going through the product development process, we were well aware that manufacturing of a very complex precision engineered medical device is going to be something that is going to be critical to the long-term commercial success of the product. And so we embedded design for manufacturability thinking in the product development process itself. And the third thing I would say is at our R&D side, we actually established a pilot production line and manufactured ourselves, I won't give you a specific number, but let me just say, a fair number of devices that we used in the testing that was used to generate the data as part of our FDA submission. With respect to capital, I'll let Jake comment on it. But obviously, there was some capital spent on the production lines that I mentioned -- at the pilot production lines that I mentioned at the R&D center, but nothing unusual. Jake, do you want to comment anything more?

Yeah, I would agree, Dev. And, Mike, I think from a CapEx standpoint, for our fiscal 2024, we would expect total CapEx, and this is sort of inclusive of the spending that occurs as it relates to ERP to be somewhere between, let's call it, $50 million to $60 million in 2024. And that's probably 60% or so focused on sort of the Software as a Service capital cash spend that actually shows up as a reduction of cash flow from operations in our cash flow statement. And then the remaining 40% of that is showing up and appearing on the CapEx line within our cash flow statement. So somewhere between $50 million to $60 million in total CapEx, I think, for 2024.

Thanks for the color.

Thank you. There are no further questions at this time. I'd like to turn the call back over to Dev for any closing remarks.

Thank you, Michelle. Before we conclude the call, I would like to express my gratitude to all my colleagues around the world. Our results truly are a testament to their continued relentless focus who are developing and providing solutions that make life better for people in with diabetes. Thank you all for attending our fiscal earnings call -- Q2 earnings call and for your interest in our business.

Thank you for your participation. This does conclude the program, and you may now disconnect. Everyone, have a great day.