Embecta Corp. (EMBC) Earnings Call Transcript & Summary

Welcome to the JPMorgan Healthcare Conference Day 3. My name is Caroline Borowski, and I'm an associate here at the JPMorgan Healthcare Group. It is my pleasure to introduce Dev Kurdikar, President and CEO of Embecta.

Thank you, Caroline. It's an absolute pleasure for us to be here. This is our first JPMorgan Healthcare Conference as our own independent company, and it's truly a thrill, especially because in our first year, we are back in person now after being virtual for a number of years. With me today, I have Jake Elguicze, our Chief Financial Officer; Pravesh Khandelwal, is sitting there. He is our Head of our Investor Relations. Our plan is to take about 20 minutes just to give you a strategy and business update. And then I'm sure we'll have time for questions. This is our forward-looking statement language. Let me first start, given that we are a new company, let me just first start by sort of emphasizing who we are. Our mission is to develop and provide solutions for people living with diabetes. That is our sole focus. That is all we do. We are global leaders in insulin injection devices. We've been making these devices now for almost 100 years. Our manufacturing strength, I would argue, is unmatched our global distribution capabilities and commercial capabilities allow us to get these products that we manufacture from our plants into the hands of an estimated 30 million people in over 100 countries. Since our spin, we've been hard at work. We carved out a business, as I mentioned, there was part of BD, Becton, Dickinson, for over 100 years. So we've been hard at work, bringing on talent, standing up our own systems and processes so that we can continue to progress towards our vision of a life unlimited by diabetes for people who suffer from diabetes. Turning to this page. Let me first just describe the landscape, right? The global diabetes landscape. It's a growing space where people with diabetes need chronic treatment. The prevalence of diabetes globally is steadily and consistently rising, maybe more so even in emerging markets where demographics, the improvements in economies are leading to different lifestyles, leading to different dietary habits and so the incidence of diabetes is rising. If you do get diagnosed with diabetes and say Type 2 diabetes, it's likely you'll start with conservative treatment, diet and lifestyle modifications, maybe some oral drugs, maybe some injectable drugs, but then eventually maybe on insulin. And once you're an insulin, you generally will remain on insulin for the rest of your life. There have been a lot of advances in diabetes treatment over the years. But insulin injections, we believe will remain the standard of care. And even with all the technological advancements that have occurred with adoption rates mostly in the U.S. and maybe some developed markets, there is still a lot of unmet need in this space. This map emphasizes the point I made about the prevalence and cost of diabetes growing consistently around the world. If you just take a look at the map, you'll see every region of the world. There's an increase in the number of people with diabetes. If you look at the total, which is on the top right-hand side of this page, more than 500 million people with diabetes rising to almost 800 million over the next 25 years, 10% prevalence rate. 3 out of 4 people with diabetes live in low- and middle-income countries. Cost is high, almost $1 trillion. That number has gone up by more than 300% over the last 15 years. So clearly, a big global issue. And as I mentioned, even with all the advances in diabetes treatments, there are still a lot of unmet need even with the most advanced treatments if you're using them. If you're insulin-dependent, you truly have to juggle your life every day. You have to serve as your own health care provider, right? So let me just sort of describe to you what a person with diabetes goes through. You have to self-monitor your blood glucose level several times a day. You have to consider the implications of the readings you get on your diet, on your medications. You have to take your medications. You have to adhere to them. Sometimes these medications are based on calculations you have to do based on what you ate and what your blood glucose reading was. You have to make daily decisions on what you're going to eat, whether you're going to exercise, when are you going to take your medications. And then finally, there is a chance you have to change your lifestyle, right? Including exercise and diet. So you can imagine you're a person trying to live your daily life, but you're constantly doing this juggle mental sort of gymnastics in your life everyday. And so it has a high burden on society, both in physical health, certainly, the financial cost that you have to pay for all these medications and treatments, and then certainly your emotional well-being. So in this large market with unmet needs, now here we are, an independent company with a leadership strength that's really based on a few core strengths. We have scale, we have a reputation for quality, and we have efficiency that create competitive advantages. So if you think about the fact that insulin was first used to treat diabetes in 1922, we made the first specialized insulin syringe in 1924, just 2 years after insulin was used. So we have a 100-year history now almost. And over that time, we built trust in our brand. We are, I said before, the #1 producer of pen needle, syringes and safety devices, touching almost 30 million people. And over that 100-year history, we now have established relationships with customers and key stakeholders. Manufacturing is a core strength of ours. We have 3 plants producing almost 8 billion units a year. They're highly automated plants. And again, because we've been producing these products for as long as we have, we have stable, strong supply base with long-standing relationships. Also, over the decades that we've been producing this devices, you can imagine, we've gone down the learning curve. And a lot of what we have learnt in terms of manufacturing, we protect as trade secrets, and it's sort of the [IP is embedded] on our manufacturing line and processes. The products that we produce are then distributed and we have vast commercial capabilities. They go into global distribution centers where more than 600 commercial employees around the world, slightly over half of them are in emerging markets, allow those products to be accessible to people with diabetes in over 100 countries. On the manufacturing side, we have 3 plants, 1 in Dun Laoghaire where we are the largest global producer of pen needles. In Holdrege, Nebraska where we are the largest manufacturer of specialized insulin syringes. And our newest plant is in Suzhou, China where we make pen needles, and we supply those products for markets in Asia, including China. As I mentioned, these are highly automated lines, 24/7 -- they're on 24/7. Our commercial capabilities are also quite strong. Almost half of our revenue comes from outside the United States. And what we've done is that we've tailored our go-to-market strategies depending upon the needs of the region so that we can manage reimbursement and take into account local market dynamic. So in North America, notably in the U.S., which is our single largest market, we have an ongoing collaboration with retail pharmacies, long-term care centers, integrated delivery networks. Our reimbursement landscape in the U.S. has been stable, and we have strong reimbursement, both from private payers as well as from Medicare. In EMEA, obviously, a conglomeration of almost 70 countries, we have direct teams. We also use distributors. The reimbursement landscape generally stable in most countries. And then in Asia and Latin America, we have some tender markets. We have some direct presence, and we use distributors as well. There, the reimbursement landscape is a mix of payer reimbursement, sometimes government reimbursement, but also self-pay. What we try to do, regardless of our go-to-market strategy in each of these countries that we are in, we try to differentiate our product based on quality, clinical outcomes, price and very importantly, our demonstrated ability to supply the market. This is a source of competitive advantage because if you think about a person with diabetes wanting to walk into their corner drugstore and pick up a box of needles and syringes that product needs to be available so that they can administer insulin to themselves. And so we've demonstrated that we can provide that product and keep those shelves stocked. Certainly, we've demonstrated that ably over the last couple of years, where there's just been so much turmoil in the manufacturing and sort of the operational landscape. So a big market. We have a strong leadership position, but now we are an independent company. And so we are beginning to think about where we're going to invest to change the long-term growth profile of this company. And those investments fall into 3 buckets: commercial investments; investing greater in R&D; and then thinking about M&A. So if you look at our core markets, we think that there is potential to continue to get some growth in the core. It's going to come in a couple of different ways, right? We have leadership share positions in most markets we are in. E-commerce is a growing channel, notably in Asia. So we are investing behind that. The other thing we've learned is that even in markets where there is strong reimbursement, people tend to reuse these needles. These needles are supposed to be single-use disposable products. And so we are looking at ways to collaborate with retailers, use digital marketing techniques to remind people that they should be using a fresh needle for every injection. Small changes in the reuse rate can have a notable impact on our business. The second thing we are doing is we are investing more in R&D, notably behind a patch pump for the Type 2 market that I'll speak to in a second here. And then finally, we want to seek partnerships and look for business development opportunities where we can add value through one of our strengths, right? And our strengths are this high-volume manufacturing expertise and distribution capabilities. We have a unique channel, especially for a med tech company, right? Our products are available through the retail channel. And finally, certainly, again, for a company of our size, we have strong emerging market infrastructure. That point is particularly important because if you think about where the growth is going to occur in the number of people with diabetes, that's disproportionately in emerging markets because of the reasons we spoke about earlier. I mentioned we are working on a patch pump. Our patch pump is focused on Type 2. And it's one where we've gleaned insights from discussions with people with diabetes as well as health care providers. We are proud that it's being developed under the Breakthrough Device designation of the FDA. What that has allowed us to do is to have interactive discussions with the FDA even through all the COVID EUA years while we are developing the product. So a few key things to keep in mind when we talk about a patch pump for Type 2, right? The user needs are quite different. Type 2 people with diabetes are looking for maybe less of an initial training burden, the ability to tailor alarms. Notably, people with type 2 generally need more insulin a day than people with Type 1. So we are designing our product with greater insulin holding capacity than the currently available patch pump. Obviously, advantages over tube pumps and then an algorithm that we are going to test and gather data through clinical trials for that's really focused on Type 2. And fundamentally, as I'm sure you appreciate, Type 2 is different from Type 1. We are very excited about the program. We are committed to resourcing it to the level necessary to give it its best chance of success. It can fundamentally transform our business because we have people with Type 2 that are currently using our products, but Type 2 is a progressive disease. So if it just progress to a point where somebody wants to adopt a pump, we want to have a solution available for them. It will also utilize some of the same channels that we have. It's a fully disposable product. So it can go through the retail channel, which we have. And thirdly, in the U.S., we have almost 95% of the covered lives in the U.S. through existing contracts. So it will leverage some of the stents we have. Since we became our own public company on April 1, we have been hard at work. On the left-hand side, you see we had a bell-ringing ceremony on November 1, where we were honored to be accompanied by a number of advocacy organizations that really support people living with diabetes. We were fortunate to have an experienced team and an experienced Board right at the outset on day 1. And then we demonstrated certainly strong execution. I'm sure we would all like to forget, but last year was a challenging year from an operational perspective. And we demonstrated a strong execution. We were able to maintain continuity of supply to all our customers from all our plants around the world. We've been making a lot of progress on doing the work necessary to be able to exit our TSAs, our transition services agreement. Most of these agreements we plan to exit by April of 2024. So 2 years from spin. And so we are standing up our own systems, we are standing up our own processes, we are bringing in talent. We've continued to advance the patch pump product I talked about. And then in December, we announced a deal with Intuity Medical. I think this is an example of the kinds of deals that we are looking for. So Intuity Medical has a novel blood glucose monitoring solution, an automatic blood glucose monitoring solution. Traditional BGMs use multiple steps to take 1 reading. This is a simple device with minimal steps all integrated into 1 device where the person with diabetes just puts their finger on the device and can get pricked and get a reading, including on their phone. And what we are trying to do here is understand that there is a market need that there is a product available in the market. And then we are using a channel that we have already in place to increase awareness of the product. We've done similar deals in smaller markets, one in France, one in China, all with the intention of what is the unmet need, is there a product available and how do we leverage our channel. We delivered on our second half expectations in 2022. Our revenue was approximately $566 million, down almost 5% on a reported basis and slightly over 1% on a constant currency basis. That was better than the guidance we had provided in August, which in itself was better than our initial guidance that we had laid out in May. Our adjusted gross and adjusted EBITDA margins were around 67% and 36%, both of which were also better than previously provided guidance. And our TSA expense came in right in line with what we projected at 35%. So we are proud of these results, that were the first 6 months of our company. And if you look at it from a full year perspective, we delivered about slightly over a $1.1 billion one in revenue. Our reported revenue growth was a decline of 3%. Our constant currency revenue growth was flattish negative 50 basis points. There were some puts and takes if you look at our full year results. We had some rebate reversals that occurred in '21 that were not reported in '22. We had already decided to exit some customer relationships in late '21's. There was an unfavorable impact of that on '22 versus '21, but we also benefited from some contract manufacturing that we did for BD in the second half of 2022 that we hadn't done in 2021. As we now roll into our fiscal year 2023, there are 3 key priorities that we have. Number one, we want to keep strengthening our base business, right? It's a strong, stable platform. It's a profitable business for us, and it will provide us a solid foundation to grow our business off of. We don't know fully what 2023 will bring. But I think we've demonstrated that we can navigate through operating challenges and we'll certainly strive to do so through all of 2023 and manage costs diligently as we have done. This is also a year where we have to do a lot of separation and stand-up work. We are 9 months in into now a 24-month TSA period, so we're 15 months to go here. We have to execute on an ERP implementation globally. We have to close our China entity, which was a deferred entity at close. But as we go through that process of transferring that entity from BD to us, we have to manage a temporary suspension of manufacturing operations at our Suzhou facility. And finally, there's a whole host of separation projects that we have to do setting up distribution network, all the back office functions. We have products that we need to reregister in virtually every country around the world, that's going to be a multiyear effort. So there's a lot of separation and stand-up work that we have to do. But while we are doing 1 and 2, we don't want to lose focus of the fact that what we -- our #1 goal at the end of this is to actually change the long-term growth profile of the company. So we'll continue to advance our patch pump development. We'll continue to seek M&A and partnership opportunities. So that concludes the presentation part. I'm going to turn it over to Caroline to sort of moderate the Q&A, but we are obviously happy to take any questions that you have, Caroline. And if you have time, the audience has.

Sure. So I guess, maybe just going a little bit off what you already mentioned in the presentation, can you provide a little bit more detail on the key objectives for the company in the short, medium and long term?

Yes, let me start with the long term, right? I mean, look, we've been a flattish business for a number of years. I think if you look at our investor presentation that we did even pre-spin, we -- on a revenue basis, we sort of said, look, our expectations are this is going to be flattish to 2024. What we want to do is change that growth profile, right? So we haven't lost sight that is our #1 long-term objective. But then if I flip quickly to the short term, right? I laid out some of the things that we have to do in 2023. I mean it is going to take some time for us to stand-up a business that had been part of a larger business for close to 100 years. So that is certainly a focus for us. And in the interim, it's a little bit of a mix of both, right? There is going to be some sort of tail stand-up work to be done. But we want to sort of lay the seeds for what is going to cause that long-term growth profile to go, right? So we are actually going to be increasing our investment in R&D. We have already, so that we can continue the patch pump development. And we are going to be seeking M&A and partnership opportunities. We are mindful of our balance sheet capacity, right? We want to keep an eye on our net leverage as well, right? We don't want to overextend ourselves, both sort of financially, as well as operationally. But we want to transition from where we sit today to get that revenue growing again.

And can you maybe provide a little bit more detail turning to the market from both a product and a geographical perspective?

Yes, sure. So let me start with the product. Maybe think about it in terms of the fact that insulin administration, right? Generally delivered by injection. The modality of these injections has changed, it's changing. It used to be primarily syringe, now more and more pen needles, right? So our product mix has been changing, more pen needles, less syringes. But there has always also been the adoption of pumps, most notably in Type 1, right? Where penetration rates now in the U.S. for Type 1 are estimated to be somewhere in the 35% to 40% range, much lower in Type 2. And so we are mindful of the fact that our core injection business in developed markets, there are going to be some challenges on volume as people adopt pumps, but at the same time, we want to develop that pump for Type 2. These are users that are using our product today, we want to provide them a solution for if they do migrate to wanting to use a pump that we have one for them. Geographically, the growth I talked about before, that's occurring in diabetes globally. The bulk of their growth is in emerging markets, emerging markets. The emerging markets as you well know, there are cost and affordability concerns, right? That is going to remain a bread-and-butter injection devices market. I mean, there you are people that are honestly simply trying to get diagnosed, and once they get diagnosed, you get access to insulin. And if you get access to insulin, obviously want some ways to administer insulin, right? So pump adoption is going to be limited there for at least a period of time. And so we want to utilize the strengths we have. I said we have more than 300 commercially-focused employees in emerging markets. We have a plant in China. We have a strong commercial team in China and in other parts of Asia-Pacific. And so we want to use that sort of growth in the number of people with diabetes, that's going to be a bread-and-butter injection market. And really, we make sure that the position we have, the strength that we have can capitalize on the growth opportunity over there. So from a product mix, just sort of high level, more pen needles, less syringes. Geographically, I would think about the emerging markets as being really over a long period of time being a core injection market where we are very well-positioned to provide the needs of that market.

And as we look at kind of the drug launches over the last several years, can you talk a little bit about what the impact of that has been on your business specifically?

Yes. And maybe one of the best ways to sort of think about that is to just look and see what's happened in the U.S., right? Because most of the impact of novel therapies has really been felt in the U.S., where there is good reimbursement for these drugs to get adopted. Once you go outside the U.S., by the way, even in developed markets and certainly in emerging markets, I mean, the effect is a lot more muted. So in the U.S., if you look at our U.S. business over the last several years, our U.S. business has been fairly stable. And that's in spite of these new drugs, that's in spite of pump adoption that we talked about before. And I think there are a couple of factors. One is certainly what we've seen so far is that when new drugs come into play, they don't make -- they don't necessarily make insulin unnecessary. There is an impact of a delay in the onset of insulin, but they haven't sort of eliminated the need for insulin, not so far. Secondly, cost and affordability do limit even in the U.S. Thirdly, if you just look at from a pump standpoint, the adoption numbers, right? You measure pump adoption in the tens of thousands of people in the U.S., but the top of the funnel is in millions, right? And so the vast majority of people still use injections. So for all those reasons, our U.S. business, certainly over the last several years, has remained stable in spite of new drugs, in spite of the pump adoption.

And maybe turning a little bit more to the financials, you beat your Q4 and H2 2022 expectations. But yet we still saw a pretty big jump in the stock. Do you mind kind of talking a little bit more about why you think that happened? And maybe what has changed in the last couple of months versus earnings?

Go ahead, Jake.

Yes, sure. So thanks, Caroline. So Embecta is a September 30 fiscal year-end. And as we mentioned, we spun out about 6 months into our fiscal year or April 1. Our first -- on our first earnings call in May of last year, we provided initial financial guidance for the second half of 2022. In the August time frame of last year on our third quarter earnings call, we had the opportunity to increase that second half of the year financial guidance. And ultimately, in December when we reported our actual results for 2022, we even exceeded those already increased expectations. So as it relates to the second half of 2022 performance post-spin, I think we remain very excited and very happy about that performance, particularly considering the operating environment and everything that we needed to do post-spin. As far as what's changed, I think the short answer is, structurally, from our perspective, nothing has changed as it relates to our thoughts as to what the financial profile of this company looks like in the near term or certainly through 2024. And if you step back just prior to spin in March of last year, we sort of outlined for the investment community what we thought the financial profile of Embecta looked like. And that included essentially a flattish constant currency revenue CAGR and adjusted EBITDA margin of approximately 30% by 2024. And we remain very committed and think that those are still the correct financial metrics through 2024 for Embecta. And quite frankly, we've probably absorbed anywhere from, let's call it, somewhere between 200 to 300 basis points of additional gross and EBITDA margin pressure since that March time frame through now, just as it relates to inflation and increased supply chain costs and foreign currency headwinds. And yet, we still think that, that flattish constant currency revenue CAGR and adjusted EBITDA margin of 30% through 2024 are the right numbers for us.

And your fiscal fourth quarter results were very strong again. You came in above targets and all the key metrics. But the fiscal 2023 guide seems to accelerate. The decline in margins to sort of what we thought the fiscal 2024 targets were going to be. So maybe can you talk a little bit more about what's driving some of that margin decline specifically?

Yes, go ahead.

So I think the right jump-off point to kind of compare against is the fourth quarter of 2022 margins. That's really the most representative to date for Embecta. And in the fourth quarter of 2022, we generated adjusted gross margin of about 64% and adjusted EBITDA margin of about 32%. Our guidance for 2023 -- for full year 2023 calls for adjusted gross margin of approximately 62% and EBITDA margin of 30%. And that decline, obviously, is going to be driven by the adjusted gross margins. And that's largely because of the need to continue to stand up and separate Embecta. So there's a few drivers. The main driver going from sort of that fourth quarter gross margin of 64% down to about 62%, largely has to do with our need to continue to separate and stand up Embecta. And as a result, we're going to incur additional regulatory, quality, supply chain manufacturing costs throughout our business. And then in addition, we do continue to expect to see some incremental headwinds from inflation and increased labor costs.