Welcome, ladies and gentlemen, to the Fiscal Second Quarter 2024 Embecta Earnings Conference Call. [Operator Instructions] 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 conference 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 Second 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 a substitute 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 second quarter of 2024 as well as an overview of our strategic priorities. Jake will then provide a more in-depth review of our Q2 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. Let's start with our strategic priorities on Slide 5. We remain committed to the same trio of strategic priorities that have guided us since we established our service as an independent company. These priorities form the basis of our decisions and actions, and they are: remaining focused on strengthening our base business while maintaining our global leadership 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 long-term 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. During this past quarter, we made significant progress within each of these goals. Turning to some second quarter highlights. The second quarter was a strong quarter for Embecta, one in which we generated approximately $287 million in revenue, which represented an increase of 3.6% on an as-reported basis and 4.5% on a constant currency basis. When normalizing for the transient contract manufacturing revenue that we generate based on sales of non-diabetes products to our former parent, our constant currency revenue grew 4.9% as compared to the prior year period. This solid performance exceeded our expectations and occurred while simultaneously implementing our own ERP system, operationalizing our new distribution network including 7 new distribution centers, and standing up shared services capability in markets comprising 25% of our revenue in over 100 countries and serving approximately 5,000 customers. We also implemented these systems and processes in our third manufacturing plant. Thus, at the end of the second quarter, we have completed the implementation of our ERP system and operationalized our distribution…

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 second quarter at the gross profit line. GAAP gross profit and margin for the second quarter of fiscal 2024 totaled $185.4 million and 64.6%, respectively. This compared to $189.8 million and 68.5% in the prior year period. While on an adjusted basis, our Q2 2024 adjusted gross profit and margin totaled $185.8 million and 64.7%. This compared to $190.1 million and 68.6% in the prior year period. The year-over-year decrease in adjusted gross profit and margin was due to the impact of inflation on the cost of certain raw materials, direct labor, freight and overhead; the impact of negative year-over-year manufacturing variances, primarily attributable to the planned temporary shutdown of our Suzhou, China facility as it relates to production for the domestic Chinese market for part of the quarter; and the negative impact of foreign currency translation, primarily due to the strengthening of the U.S. dollar. As compared to our prior outlook, our adjusted gross margin during the second 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. Turning to GAAP operating income and margin. During the second quarter, they were $39.2 million and 13.6%. This compared to $55.6 million and 20.1% in the prior year period. While on an adjusted basis, our Q2 2024 adjusted operating income and margin totaled $74.9 million and 26.1%. This compared to $84.9 million and 30.6% in the prior year period. The year-over-year decrease in adjusted operating income and margin is primarily due to the adjusted gross profit changes I just discussed as well as an…

[Operator Instructions] Our first question comes from the line of Travis Steed with Bank of America Securities.

This is Caroline on for Travis. I wanted to start out first with the full year guidance. It looks like you beat [indiscernible] expectations by about $8.5 million and then raised the full year guide by $22 million. So I'm wondering if you can speak to any onetime impacts in the quarter? I believe you said previously that about $15 million was pulled forward and then contract manufacturing was a 40 bps headwind. So I just wanted to confirm that I got that right and see if there's anything else that we should be taking into consideration for the full year guidance here. And then I have one follow-up.

Yes. Thanks, Caroline. I think you might have had the numbers just transposed. We did very well in the quarter. I'm not necessarily going to refer to consensus expectations. But I think we did beat our own internal expectations by about $22 million in the quarter, and we did refer to about $16 million of that being attributed to timing. So simply in advance of the ERP implementations, we saw customers order some additional product in our international markets, probably by about $10 million in the quarter. And then in the U.S. in advance of our normal April 1 price increase, we saw some additional volumes in the U.S., and we estimate that to be a timing benefit of about $6 million in the quarter. So $16 million, we would affect to sort of reverse from Q2 into Q3. But then the underlying business did quite well, did about $6 million better than what we had previously internally expected, largely due to the U.S. In relation to the full year, we're raising our midpoint of the guidance range on the top line by about $8.5 million at midpoint, $6 million of which we think occurred in the U.S. in the second quarter. But obviously, we're affecting commissional favorability in the half of the year in relation to the prior guide. So a very strong quarter, I think for us, particularly when you think about all the work that had to occur related to the ERP implementations.

Yes, that trend so I appreciate that correction there. And then second question, can you provide an update on your plans for entering the GLP-1 market with pen needles. I know recently, it looks like Lilly got an approval for a Kwikpen. I'm not sure if there's anything more you can say there just again on your outlook for entering the GLP-1 market.

Yes, Caroline, this Dev. I'll take that. Yes, as you correctly pointed out, Lilly did get approval for the Kwikpen. Kwikpen, as you know, is the same pen that's used for insulin delivery. And pen used for insulin delivery, typically use our pen needles in most markets around the world. We do have leading share. Our expectation is as GLP presentation forms continue to evolve and more and more of them become available in pens, certainly, our pen needles can be used with it. We continue to have discussions with other potential entrants into the GLP-1 space, including [ generics ] now. Admittedly, they are years away. But our hypothesis is as more GLP-1 players enter the market, it's likely that many of them will present their version of the GLP-1 in a multidose pen form and our pen needles will be applicable for it. Now certainly, as these manufacturers work to expand capacity, in some cases, they're also using vials. And with the regulatory approval, our syringes can be used as well. So as more and more GLPs enter the market, more pens will become available and certainly, our pen needles can be used with those pens.

Our next question comes from the line of Marie Thibault with BTIG.

Congrats on a very nice quarter here. I'll leave the guidance questions to others. But I did want to ask a little bit more about accounts receivables. I know with Embecta now responsible for collecting some of those receivables, the plan was to work some of this down in fiscal '24. I know the ERP transition is still happening. Just wanted to try to understand why that receivables number ticked up a little bit, and how we can expect that to look for the rest of the fiscal year?

Yes. So Marie, the change in the receivable balance from, let's call it, fiscal year-end 9/30/2023 to where we are now entirely has to do with the fact that went live with our ERP implementations, and the factoring agreements that we had previously in place with BD where they would essentially factor those receivables on our behalf went away. And now we're responsible. All those receivables now appear on our balance sheet. And at this point, all of the factoring agreements have now ceased. So the receivables that you see on our balance sheet are 100% representative of what the AR balance is for Embecta look like. There's no additional receivables that we would need to put on to our balance sheet. From the last quarter, from Q1 or fiscal Q1 to where we are right now, we did see an increase in the AR, again, entirely due to now our EMEA and Asia receivables coming on to our balance sheet as a result of those ERP implementations. And I think the way that you should sort of think about this moving forward, maybe just from like a total cash standpoint, I think we said in our prepared remarks that we would expect our overall ending cash balance for fiscal 2024 to be very close to where it is right now from a Q2 standpoint, so somewhere around that kind of $300 million-ish mark. That's down about $20 million from where we were at year-end. And again, that entirely has to do with cash used for separation and stand-up activities. We estimate that we're going to use somewhere between $180 million and $190 million of cash this year related to separation. That comes on top of using about $145 million in the prior year. And I think that's really one of the things that is sort of distorting, if you will, the real free cash flow capabilities of the company. And I think as we move into fiscal 2025 and beyond, now that we're almost past all of the separation work, you're really going to see the true free cash flow potential of this organization.

Okay, Jake, that's helpful. And then I wanted to ask a question a little bit about some of the market dynamics, competitive dynamics. I think near the end of your fiscal second quarter, we saw a competitor sell off and transfer its pen needle and blood glucose meter business to another company. I wanted to hear if you've seen any disruption here now in the existing current quarter? And any thoughts on ability to maybe take some market share or make some efforts in those regions where that competitor was very active.

So we haven't seen any disruption really from our perspective with respect to the transaction you were referring to. And certainly, with respect to our sales force focus on ensuring that we present our products with as much vigor as possible and certainly continue to gain share, I mean that will continue. We find that -- we certainly think that our products that compete with these competitors' products are very well positioned. We have demonstrated continuity of supply, notably even through the ERP transitions that we referred to. And so we'll continue to make efforts in that area. But I'll leave it at that.

Our next question comes from the line of Kallum Titchmarsh with Morgan Stanley.

On the patch pump program, I know we're still in the early stages here. But now you've had some more time to consider the implications, I'm wondering when you expect the costs to begin ramping to support the commercial infrastructure behind the project? It seems, just eyeballing consensus, that there's about flattish OpEx across the next few years. So just curious on how we should be thinking about midterm changes there? And then I have one follow-up.

Yes, Kallum. So look, our focus right now is just undergoing -- completing the FDA review. We submitted our 510(k) in late calendar 2023, as you know. And so I certainly don't want to comment on either the outcome or the timing of when we would expect a decision from the FDA. And candidly, our focus right now is just completing that review and completing the remaining separation work and closing out FY 2024. So I'll refrain from talking about '25 expenses and beyond. But certainly, we are considering that as we get closer and we get more and more definitive decisions from the FDA, we are thinking about a potential Investor Day event or a call to better provide our thoughts on FY '25 and beyond, particularly as it respect -- as it relates to the patch pump.

That's fair enough. And then I know we've got to keep our eyes on leverage, but any change in your appetite for M&A?

I think leverage is front and center of our minds here. Jake referred to the fact that we certainly expect our free cash to improve in '25 and beyond. And we are going to be thinking pretty strongly about debt and debt pay down as well. So again, this is something that we will update the investment community on once we've closed out 2024 and finished up the rest of the separation projects. We certainly expect the AR to have normalized. And we'll just have a better sense of the free cash that will be available to the company and talk about our capital allocation priorities going forward from there.

And Kallum, I think on prior calls, we sort of referred to wanting to keep a larger cash balance on hand as we went through some of these ERP implementations in case something went wrong. Thankfully, everything has gone very, very well. I think the team has done a tremendous job as far as all of that is concerned. And I think that, as we go into the second half of the year and certainly into 2025, that's just going to provide us with a lot more flexibility in order to potentially pay down more material amounts of debt in addition to what we have been doing so far, which is really just paying off the 1% amortization each year for the term loan base.

[Operator Instructions] Our next question comes from the line of Ryan Schiller with Wolfe Research, LLC.

This is Ryan Schiller on for Mike Polark. I wanted to follow up on the patch pump. It seems to be a product that, if all goes according to plan, could really drive revenue growth. So what changes need to be made to the Tidepool pipeline algo to fit it to type 2? Can you give us your latest expectation on timing to get this to the FDA?

Yes. So look, from a technical aspect, that type of algorithm, Ryan, that you referred to, obviously, was approved for type 1. We are evaluating how it needs to be adapted for type 2. The way we are proceeding with this is our open-loop, as you know, is under review with the FDA. We are concurrently working with Tidepool on adapting that algorithm for type 2. And our anticipation is when we are ready, and again, this is something we can talk about after we get clearance, assuming we get clearance for FDA -- from FDA for open-loop, we'll certainly talk a little more about the clinical trial that will be required here and the timing of the clinical trial because from our perspective, that's a very critical element of having the Tidepool algorithm adapted for type 2 and really tested in patient use and taking all of the data and then submitting that to the FDA for the eventual clearance of a type 2 closed-loop pump. So more on timing post -- after we finish FY '24 and once we have clarity on FDA's decision on the open-loop.

That's helpful. And then one follow-up. A lot of the major insulin companies have been looking to get approval and to launch weekly basal insulin. How are you guys thinking about this? And what gives you the confidence that Embecta will be able to continue to grow and start to scale up in major geographies?

Yes, Ryan. So certainly, weekly insulin is something we are watching very closely as well. I think one form of weekly insulin -- certainly folks are expecting will get approved in Europe in the coming months. From what we understand right now, and clearly it's not widely available in most geographies, but it will be in a pen form. It won't be packaged with a pen needle, or at least that's what indications seem to be. And as I mentioned before, if it's a pen, quite possibly our pen needles can be used with it. Some of the factors that need to be considered when you think about the adoption of weekly insulin is obviously cost, right? Insulin, regular insulin costs have come down dramatically over the last few years. And so there's going to be needing to be a trade-off across cost and efficacy, if you will, is there increased efficacy with weekly insulin versus daily insulin. Promotional focus will matter where the pharma and biopharma companies decide to spend their selling dollars, will it be on GLP-1s or weekly insulin. A lot of the basal patients are seen by primary care physicians who may be reluctant to prescribe weekly insulin because obviously, dosing of insulin is tricky. And so they will be maybe, potentially concerned with potentially higher hypoglycemia. I believe in type 1, there is the greater potential for hypoglycemia in type 2, but sort of the fear might remain. People that are using multiple daily injections of insulin, they might just want to stay because they take multiple daily injections every day anyway. So our thinking is that to the extent that weekly insulin gets adopted, it might likely be with new basal patients rather than folks switching over. But look, I mean, these are all sort of hypothesis, right? I mean we don't have enough data of real use in patients to be able to accurately or perhaps more precisely determine the impact of weekly insulin on us. And so it's going to take time to figure all of it out. But some of the factors that I laid out here, Ryan, are those that we are considering certainly as things to watch as weekly insulin gets introduced into the world.

I'm currently showing no further questions at this time. I'd like to hand the call back over to Dev Kurdikar for closing remarks.

Thank you, Shannon. As we wrap up the call, I want to extend my heartfelt appreciation to all of my colleagues at Embecta across the globe. In the last 2 years since our spin-off, our team has worked nonstop on executing our strategic priorities, including major separation-related programs while never wavering from our mission of developing and providing solutions that make life better for people living with diabetes. Thank you all for attending the call and for your interest in our business.

This concludes today's conference call. Thank you for your participation. You may now disconnect.