Embecta Corp. (EMBC) Earnings Call Transcript & Summary

Good afternoon, and thank you for joining us for the second day of the Morgan Stanley Healthcare Conference. I'm Cecilia Furlong. I'm medical device analyst here at Morgan Stanley. It's my pleasure to have Embecta new spin-out first conference with us, invite the CEO, Dev Kurdikar; CFO, Jake Elguicze. Thank you both very much for being here.

Thank you, Cecilia, for having us, and thank you for those in the room that are here to listen to our story. And just sort of before we get started, you recognize that we might be making forward-looking statements and obviously risks and uncertainties associated with that. And in our filings and the SEC website, including our latest 10-Q, always refer to that if you have any questions. But with that, ready to jump in. Jake and I are here and wanting to answer your questions, Cecilia.

Okay. And on my end, on the disclosure side, please see morganstanley.com/researchdisclosures. Just to cover that one.

But I guess to start where a lot of conversations are starting these days on the macro. Just can you talk about the strengths that you saw in your business in your fiscal 3Q, I think, from our standpoint and your longer-term expectations for kind of a flat to down market exceeded that? But as you think about just the back half or the final quarter of your fiscal calendar, what you're incorporating in terms of just the timing of orders that you saw in fiscal 3Q as well as just some of the other macro pressures that we're dealing with, how much of that is incorporated in your backend guidance?

Yes. So Jake, why don't you talk about the Q3, Q4 second half and I'll talk about macro.

Yes. So look, I would say I think our business is a very profitable cash-generative business. If you step back, very profitable cash-generative business. But one, candidly, I think that has been a bit underinvested in, in terms of R&D and whatnot for a period of time leading up to spin. And as a result, I think our top line is sort of capable of flattish to very low single-digit constant currency revenue growth. In the March timeframe when -- pre-spin when we had an investor event that sort of the financial profile that we sort of outlined, flattish to constant currency revenue growth CAGR through 2024. We provided initial guidance in May for the second half of the year, which called for a constant currency revenue decline of about 3.5%. And it also called for gross margins and adjusted EBITDA margins in the low 60s and low 30s. First quarter out of the gate, very pleased with the results. We actually ended up having very low single-digit constant currency revenue growth in the third quarter. And our gross margins and EBITDA margins came in at roughly 70% and 40%, respectively. So because of that, and I would say because of the outlook for the fourth quarter, we're in a position, first quarter out of the gate, to be able to raise our previously provided financial guidance for the remainder of 2022. So pretty good start as a public company. And we try to take into consideration many of these different macro factors, including the inflationary environment that we're all operating in. But we didn't necessarily provide specific guidance previously for kind of Q3 versus Q4. But I think it's safe to say that Q3 came in a little bit better than we had initially expected. And certainly pleased to be able to raise our financial guidance out of the gate.

And with respect to the macro factors and look, I mean, we're not immune to the inflationary pressures that everybody is facing. But I think when we came out with second half guidance, I think we had sort of modeled it in appropriately multiple factors, right? The sort of plus, minuses along each individual limb, but broadly speaking, I think this is aligned with what we laid out in second half. As we look forward though and you just think about these macro factors that, I mean, one of the things that I think are stents that underpin this business, it's a chronic single-use, not an elective procedure kind of device, right? And so for people with diabetes, I think this is sort of the bread and butter ways of delivering insulin, which is necessary to just survive and make it through the day. And so we think that certainly from a demand perspective, our business is going to be resilient. If there are dramatic changes in the macro factors, we are seeing certainly that may impact us. But so far, what we have seen is that our demand has stayed fairly stable, if you will. The one thing I do want to point out, I think it's a competitive advantage for our companies. Over the last couple of years, there's been a lot of upheaval, right? COVID, the geopolitical situations, inflationary pressure, supply chain distribution and supply chain challenges. But what we've been able to do is maintain continuity of supply to our customers. And so patients who then want to walk into a pharmacy and ask their pharmacists for box of needles have been able to do so. And I think that's the real strength of our business as well.

I probably should have started here, but stepping back just with the spin, can you walk through how you're thinking about the value creation opportunity here? You'll have more focus on R&D. That's a big part of the story, and I want to get to the type 2 patch pump. But as you think about, you no longer have the scale of the leverage that BD did, how do you balance those factors and the long-term value creation opportunity?

So maybe one of the things to think about here is if you look at diabetes scale as part of BD pre-spin, the channels through which we served patients was dramatically different than the rest of BD. Our products go through generally the pharmacy channel, right? BD sells products mostly into hospitals and alternate care centers. And so the team that came with us was very commercial-facing and different from BD. The manufacturing plants that came with us are largely dedicated to diabetes products. So there was very little sort of synergy in the manufacturing plants. And then the product development was also dedicated to diabetes care. So if you think about sort of where the leverage was with part of BD was all in the back office area. And so as we've discussed before, some of our incremental spends sort of pre-spin compared to post-spin going forward is really going to be building up these back-office operations, finance, HR, new ERP system, new distribution system. And so really from a customer facing or from a sort of core value creation standpoint of creating products, manufacturing products and selling products, that was already pretty separate from the rest of BD. Our customer contracts are all very different as well. There was very little overlap between our customer contracts and the rest of BD contracts. Our supply chain, the sort of raw materials we use are also materially different than the rest of BD. So we don't see any pain points in those areas.

Okay. Turning back a bit to the macro. Just on the pricing side. Can you talk about, one, what you've seen in the market in the past few years from a pricing pressure standpoint, but then any opportunities you have going forward to look to, to take price helping offset some of the inflationary impact?

Yes. So Jake, why don't you talk about the pricing that we've seen historically?

Yes, sure. So I would say from 2019 through 2021, we've been able to grow our business about 2% on a constant currency basis. That's largely volume. I would say that during that time period, we saw modest headwinds in terms of price. And if you sort of peel that back, that really largely occurred almost entirely in 2020. 2019 continue to have modest positive pricing, likewise in 2021. And actually 2022 to date, we've continued to actually be able to drive modest positive price increases. As it sort of relates to kind of the macro, again, we're certainly using this inflationary times and these material cost increases that you're seeing in the market as a mechanism to go back to our customers and explain to them and have conversations with them about price increases. And while it's never an easy conversation to have, I would say that they've largely been pretty successful to date.

And the backdrop of 80% of our revenue is in developed markets. I mean, there isn't a developed market right now that's not ended inflation and inflation in the newspaper every day. And so that's helping. Also, we are hearing that we are not the only company working through a price increase. So all of that is helping as well. And as Jake said, I mean, we are optimizing and adjusting the price wherever we can. Some of this might take a little bit of time depending upon when customer contracts sort of roll off and new one starts. And so we have a diversity of geographies, a diversity of ways we go to market, some are tender markets, some are distributor markets. So it's not going to be a light switch, but we are certainly working towards taking price where we can. _

Okay. And do you think near term to, you've talked about your outlook for the U.S. market flat, maybe slightly down. Are there any drivers that you foresee organically that could support upside to that one? And then, 2, as you think about their M&A or partnerships, what is your preference for U.S., OUS. developed emerging markets as you think about assets you could add or partnerships that you can bring on?

In our -- I'll take the first part of your question, Cecilia, the U.S. core market, what can we do to drive growth? One of the things we've observed is in the U.S., even in the U.S. where there is stable reimbursement for our products with access to our product is widespread, that there is still reuse. Our products are supposed to be single use, but people use, reuse them on an average of 2 plus times. And so we are piloting initiative to try to address that in 2 ways. One is on the patient education side for making sure that patients understand that the product is indicated for single that are advantages to using a fresh needle per use. But then also on the prescribed dispensation side where we are piloting initiatives to work with our customers so that when a patient walks up to the pharmacy and wants to get a refill of their insulin, there is a prompt as to, do you have enough needles. If we are able to make a dent in that reuse rate, I think that changes the growth profile of our U.S. business. Those are the kinds of things that we are piloting in the U.S. side now. Remember that even in the U.S., where there is pump adoption, we know that there is a large number of people with diabetes that are taking insulin every day and that pool is increasing because the number of people coming into the fund is still increasing. So over time, what we've seen that our U.S. business has been stable, even though there has been pump adoption. But we think with these initiatives that we have, omnichannel initiatives, working with retailers to increase pen needle sort of reminder the point of dispensation, all of those factors could potentially improve our U.S. growth rate. With respect to M&A and partnerships, the way we think about it is the following, right? A patient walks into a pharmacy around the world, it's likely a person with diabetes because they're buying insulin. Many of these patients have comorbidities. So there are other things that they need as well. Those other things are different in developed markets and in emerging markets. What we have is a strong emerging market infrastructure, a commercial channel that can deliver products through pharmacies in 100 countries around the world that we think about 30 million patients access our product at least once a year. And we have great at high-volume manufacturing. And so as we think about M&A in partnership opportunities, we are trying to find products that we can add to the bag that can give patients products, market-appropriate products, but leveraging the strength that we have. So it's not so much that we think about should we focus on U.S. versus OUS. What we focus on is what are the right products to active back because we could have a partner in one market and a very different partner in the U.S. with a whole different kind of product because they are more market appropriate. And we believe we have the infrastructure strength to pull that off simultaneously.

And your willingness to look beyond just a focus on diabetes, you're looking at chronic applications and expanding your -- all of your scale, your marketing, your manufacturing specifically, but how do you think about just your openness there versus kind of continuing this core focus on diabetes?

Yes. Look, diabetes will continue to be a focus area for us that we've been -- our business has been in diabetes now for almost 100 years. But what I'm trying to convey is that the same patients that use our products also need other products. And so rather than thinking about it as we are diabetes company and want to stay focus on diabetes, at least at this early stage where we are month 5 into being independent, we are making sure we cast a net white to say, let's take an outside in view and let's see the people that are buying our products today, what else do they need as part of their management of the diabetes and the comorbidities that come with diabetes. And so we won't be restricted necessarily to insulin delivery or only to diabetes, but we will want to make sure that it is the same patient that's buying our product today. And we can leverage something that we have. so that we can find the right synergies.

Okay. As you think to just your outlook on R&D, and I think you said somewhere around 7%, kind of the percentage earmarked for the pump specifically, should we think about half of that going towards that? And then as you think about the software side for the closing system. Is that a partnership? Do you look to kind of target that internally or is that something you look for partnering?

So on the algorithm side, I'll take that question first. It is going to be likely a partner rather than sitting at a desk and writing sort of line one of code here for an algorithm. I think just from a timeliness perspective and knowing that there are algorithms out there that we might be able to partner with and bring into our product development program, I think is the likely course of action there. For us, with respect to spend, we haven't broken out how much of our spend is going to be on the patch pump versus other life cycle extension programs that we have. So what I would say is this, though, I would say, listen, the patch pump is an important growth accelerator for us. It sits top, a stable, profitable business. And I believe we have the flexibility to invest the resources and it will need to make it a success because I think it can fundamentally successful, it can fundamentally change the growth trajectory of the company. Is there anything else you want to comment on the spin?

No.

In terms of just timing when we could hear more from an update standpoint on the patch pump, how would you frame that? And then for that program specifically, is that an area you're still looking to augment as you sort of build out a team focus there? Or are you today sort of in place with the team to drive that product forward.

The bulk of our team is in place. I think the way -- maybe the way to address your question, Cecilia, would be to say, look, there are areas. It's a complex medical device. There are areas in which we will want outside help, but that outside health doesn't necessarily have to be talent that we have to bring in-house depending upon what it is, right? So for example, rapidly evolving areas like cybersecurity, will certainly want outside help in, even though we have our own internal experts as well. So there are areas where we'll augment the talent that we have with outside hope to get that product going. With respect to sort of markers of development, the way we think about their program is potentially having an open loop product then followed by a closed-loop product. So the key milestones there would be a 510(k) for the open loop product, an ID or a clinical trial for the closed loop, and then finally, a 510(k) for the closed loop. Those would be the 3 markers, but we've shied away from offering any timelines associated with those markers.

Okay. Is there anything to just BD spent a fair amount of time, investment in this area previously from their work that you're able to leverage? Or is this from your standpoint, largely kind of building this program from not scratch, but early stages?

Yes. Look, there are learnings. I would say there are certainly learnings that we've been able to leverage. There, as you mentioned, have been previous attempts and developing on the patch pump. And so through each one of those attempts, even the most recent one that BD had where they got feedback from the FDA, all of them have guided development. But notably, when the current version of the patch pump is being developed through the breakthrough device designation of the FDA. So what we've been able to do is even through the COVID period, have engagement with the FDA at the right point to discuss some key product development related items, and that has been very helpful as well.

As you think longer term too, you have high-volume manufacturing capacity capabilities, what does manufacturing for the pump look like? Is that something that you do internally? How are you thinking about this today?

Yes. So we recognize that manufacturing at scale of highly precision engineered electromechanical devices is going to be different. And it's going to require different skills and capabilities than manufacturing 8 billion units of pen needles. And so we are very open to getting in the right outside help to develop our manufacturing strategy here, including being open to contract manufacturing. But it's an area that certainly we recognize we need to augment our skill base.

How do you think too about you have an app today, you don't monetize it in 8 or 9 countries, I believe.

That's right.

But how do you think about leveraging that? What needs to shift in that kind of offering and ways you could look to monetize that, especially maybe in concert with the pump longer term?

Yes. So the app that we have today, as you pointed out, it's got 400,000-plus maybe now 450,000 plus downloads available in 8 or 9 countries. It's mostly a patient education tool around injection technique. The way we think about -- maybe let me step back and just think about -- explain sort of how we think about the digital ecosystem around devices. Certainly, the pump will require an app and that connected device with an app can form, if you will, the backbone of an ecosystem. The app that we have today has useful content in there that could be integrated into that app as well. But separately, there are countries, for example, notably Germany that are now looking at ways to think about this app as interventions, right? Medical interventions where with the right data, you can actually get reimbursed for the use of an app, and we are looking into that as well. But what I foresee over time is that patients that are using our advice, thirdly, we'll have access to an app that will provide the patient with obviously their information. If we build out our product portfolio to have another connected device, certainly from pulling data from those devices as well. But then linking into sort of the health care IT ecosystem so that providers can get access to that data as well. CPs can get access to that data as well. The app that we have now, as I said, is mostly a patient education tool, but it's got information and content that I think over time can become part of this digital ecosystem that I described.

Okay. And stepping back to, do you think about pumps on the market today and targeting type 2 patients. And obviously, there's a lot of focus on a type 2 pump or patch pumps that we've heard from different players in the market. As you think about just the timing when you enter the market, likely more competition, how do you see one that the market landscape when you're entering the market? And how do you look to differentiate? What are the biggest barriers as you think today? I know price is a big barrier for many to adopting pump technology. But how do you kind of play into that market?

Yes. So the type 2 insulin intensive market, we think is as big, maybe bigger than the type 1 market. Currently, the type 2 market pump adoption in the type 2 insulin-intensive market is likely in the single-digit range. It's in the 30%, 40% range for type 1, high 30s, maybe even low 40% range for type 1. And so the way we think about it is that the type 2 insulin intensive market currently is low penetration. The second factor to consider is most of the products pumps out there today have been designed for type 1. And there are some key differences between the user needs for a type 2 versus a type 1. Notably, in the case of patch pump, how much insulin can there is a wire old because type 2 patients need on average more insulin a day than type 1. And so as we think about how that market can evolve, keeping in mind that it's low penetration today, keeping in mind that we are actually designing the product for type 2. And then you add on factors like the cost is going to be an issue. The fact that we can go through a pharmacy and there isn't an upfront cost as 2 pumps have, I think that can be an advantageous position for us. We have a pharmacy channel. Our product goes through that. The people that will use a pump for type 2 don't start with the pump, right? They get diagnosed and it's a progressive disease. So they might be starting with an injection. These are the same patients that are maybe using our product today and actually procure a box of our needles from the pharmacy today. That provides us a unique opportunity to reach out to these patients and educate them on our pump when that's available. The fact that in the U.S., we have payer contracts that cover 90%, 95% of the covered lives. We have the beginnings of the sales force. We have the beginnings of a medical affairs and chemical affairs teams. So the way we think about it is, look, we have elements of the channel in place. It's a large market. It's low penetration. The players out there today, the pumps that are being used today have been designed for type 1. We are designing it for type 2. All of that -- and frankly, given that it's a brand new time for us, right? So all the revenue that we get -- any revenue that we get is all going to be accretive for us and actually expands our time pretty significantly and moves our weighted average market growth rate north of what it is today. So for all those reasons, we think that the type 2 patch pump is an attractive product for us. Certainly, in the U.S., you asked in the beginning about sort of what can you do in the U.S. But let's not forget the fact that 80% to 85% of the growth in the number of people with diabetes is going to be in emerging markets. That's as we've discussed, it's going to be a bread-and-butter injection devices BGM market, and we have significant strength in there, including a plant in China, one of our newer plant is in China, where we manufacture products for China and other markets in that region. So we think we can actually just -- again, given the strength of our infrastructure, commercial, and manufacturing infrastructure, we think we can address the needs of both these markets, developed markets with pump, type 2 for the reasons we have discussed. But also, let's not forget that our core product portfolio also has room in emerging markets.

On the core portfolio side and coming back to the -- closer to the near term, you talked about e-commerce investing also in DTC. How do we think about just the timing, the cadence, the investment from an R&D standpoint, SG&A, as you think about those initiatives for the next few years?

Yes. The investment on those initiatives will largely be in the SG&A. And besides the 2 initiatives I talked about, the omnichannel initiative around reminding patients about the benefits of using a new device for every injection, and then working with retailers around the dispensation of the products. The third piece we are working on, specifically the emerging markets is e-commerce. And what we are doing there is rather than continuing to leverage and maybe in addition to leveraging our sort of traditional strength of the pharmacy channel, we are exploring setting up an e-commerce channel because reducing or making it easier to access our products will improve our strength in those markets. And so we are now, honestly, Cecilia piloting a range of initiatives. And the approach we've taken here is rather than sort of just make one bet here or one bit there. We have decided to pilot a bunch of initiative to watch the results of those initiatives, analyze those results and then figure out which ones we want to double down on. So we are in the early stages of piloting those initiatives. I think there are early indications that e-commerce in emerging markets is going to be a growing area of importance for us.

And probably tying up everything emerging markets, it's an area you're growing, I think, kind of mid-single digits is how you framed it. But looking at your commercial feet on the street, if you will, over half of your force today outside the U.S. But as you think about augmenting that team, building that out further, what are the focus points and can this support both your core underlying business, but then maybe layer in some M&A, other assets? How do you think about the longer-term outlook for emerging markets?

I think on M&A and partnerships, it's going to come down to what product today and whether it just a direct fit into the channel we have in which case, it will have a minimal impact or whether it's going to need some sort of expansion of our sales force. The way I think maybe the right way to think about investments is going to be they are largely going to be investments in capabilities maybe more so than feet on the street. And then the investments are going to be directed towards emerging markets. So for example, setting up an e-commerce infrastructure in key markets outside the U.S., I think, obviously, it's going to take some investment as well, but that is the kind of investment that you should expect. And like you said, mostly in the SG&A line, less so in the R&D line.

Okay. With that, I think we're about out of time, Dev. Just I'll turn it back over to you for your last closing comments.

So thank you again, Cecilia, for having us, and thank you for all of you attending. Look, it's an exciting time to be at Embecta. We are a 100-year-old brand new company. Not many companies can say that, obviously. But the way at least I think about the business is we are a strong, stable core business, right? A must-have product, it's not discretionary. But on top of that business, we sit multiple options that we can drive growth and that's what me, Jake and the management team are focused on. Thank you again, Cecilia. _

Thank you.