Embecta Corp. (EMBC) Earnings Call Transcript & Summary

Perfect. Thank you, everyone, for coming. Very pleased to have the team from Embecta. Here today, we've got Dev, CEO; Jake, CFO; and Pravesh from IR here as well. Just before I get started, I've got to read you some disclosures briefly. Any disclosures regarding this conference, please see www.morganstanley.com/researchdisclosures or please contact your Morgan Stanley sales representative.

So Dev, I [ wanted ] to start today just touching on the pretty solid fiscal year Q3 performance recently. And maybe you provide some high-level takes from that and the key drivers there?

Yes, happy to do that. First of all, thank you for having us, Kallum. Strong quarter. Really pleased with the performance of the team. It's been now 18 months we've been operating as an independent company. Most of you may know, this is a business that was part of a much larger company for almost 1 century. And so starting off with the new management team, and going through all the operating up and downs that have happened macroeconomically, I think we're very pleased with the performance of the business for the quarter. I'm going to ask Jake to comment on a few sort of highlights for the quarter, if you'd like.

Sure. So, I mean revenue -- really across the board, I think our financial metrics came in better than we had previously expected. And I think that's been sort of a trend that we've seen since we provided our initial guidance, right? This is now the -- we've had 5 quarters as a publicly traded company. I think we've been very fortunate to be able to be in a position to raise our financial expectations after each earnings conference call, including our fiscal third quarter call. And I think -- from a revenue standpoint, I think it really speaks to the resiliency of our base business. Despite everything that's going on regarding GLP-1s and advanced therapies over the past 5-plus years, I think our base business, whether it's in the U.S. or developed Europe has just remained incredibly resilient, and we saw that once again in Q3.

And just alluding to that, maybe if you can briefly touch on your guidance philosophy, a few quarters now with beats and raises there. How do you work through guidance internally?

Yes, sure. So, I think, again, we've been a publicly traded company for about 18 months or so now. I think from our approach, we're cognizant of the fact that we are a new publicly traded company with a new management team. I think we want to certainly make sure that we build a track record of consistency and credibility with the investment community. And we're always going to [ side ] on the approach of being balanced to slightly conservative. And I think that's what we've done so far. And I think that's certainly something that we're going to do moving forward. I think as it relates to fiscal 2023 guidance, if you step back and think about at the time that we had put our initial guidance out there, there was still a lot of uncertainty in China as it related to certain COVID lockdowns, and how that was going to play out. Inflation started to rapidly increase leading up to the time that we had put our initial guidance out there. And quite frankly, we also had a very -- a series of very complex separation activities in front of us. And I think that the way that, that has sort of played out, COVID -- obviously, our business in China has rebounded quite well. I think we've really -- inflation has certainly impacted us negatively, but not necessarily to the extent that we had initially thought. And I think we've really been able to manage pretty effectively the separation cost. So again, kind of coming back to the philosophy of trying to err on the side of balance is slightly conservative.

And maybe just talking about the base business in developed markets. Any recent contract wins worth calling out here?

Yes. So over the course of the year, by the way, one of our key strategic priorities has been to continue to strengthen the base business. We are already the market share leader in most geographies. And so certainly, in the U.S., winning the [ VF ] pen needle contract was a big win for us. We won tenders outside the U.S. as well. As part of strengthening the base business, we launched a new product with 34 gauge pen needle in Japan. It's a product really focused on Japan, because their reuse rate in Japan is lower than it is in most markets to make that product quite suitable for Japan. And we continue to invest in doing things or exploring initiatives that are in e-commerce, which is a growing channel that will help strengthen our base business. So a lot of activity on various fronts, and continuing to strengthen our base business. Coming back to the contract side, one of the things that we've been doing now over the last couple of years with our customers, we used to have annual contracts, and we've tried to get into more longer-term contracts to allow both us and frankly, our customers a sense of stability as we stand up our own company.

And I think we've mentioned in the past some competitive shortages. Where are we about for that at the moment?

Yes. Competitive product shortages, you can never really predict where we might get an opportunity. What we've tried hard to do is where they have occurred in certain regions of the world, make sure that patients in those parts of the world had access to our products, as well as then work with customers to make that supply, if you will, a little bit sticky so that, that business sort of stays with us, doesn't go away when the shortage is resolved. And we made good, solid progress on that in this year.

And on the pricing strategy, I know you have strong pricing power, and you've mentioned that a few times. Maybe talk us about your philosophy there?

Yes. What we try to do over there, obviously, we want to make sure that we capture the value that we think we are delivering into the healthcare system. And if you step back and think about the cost of treating a person with diabetes over the course of the year, we are a small part of that. But frankly, insulin delivery via injection tends to be the dominant way that insulin is administered. And is the dominant way where glucose is controlled around the world, right? So, we try to adjust our pricing, taking into account the value we bring into the healthcare system, but also thinking about our manufacturing capacity utilization as well as the unique competitive dynamics that may exist in the place. What we have been able to demonstrate so far -- obviously, I wouldn't want to talk about pricing in the future, but what we've been able to demonstrate out so far is our ability to take price in some region or [ other ] virtually every quarter we've been independent.

And now moving on to the big topic on everyone's minds, GLP-1s. Maybe let's just start with your high-level views on how that's impacting the company at the moment?

Yes. And it is absolutely a big topic on investors that follow med tech largely, but certainly diabetes companies, right? So look, one of the things that we did was to say Ozempic which was cleared in late 2017, weekly GLP launched in 2018. So it's been around now for more than 5 years. Let's just go back and see what has happened and see what we can learn from there. And certainly, weekly GLP prescriptions have grown dramatically over the past 5, 6 years, right? I mean, I think the CAGR is 40% plus. Insulin prescriptions have stayed reasonably flat, maybe a low single-digit decline, CAGR basis, but there hasn't been a dramatic falloff in insulin prescriptions. In that same time period, pump production, mostly in type 1, has grown as well. I think it's grown from penetration rate of low 30s to maybe high 30s now. Now that impacts the way insulin is administered, but certainly still requires insulin. So with these 2 things going on, weekly GLP-1s increasing, people moving to pumps from injection in type 1, if we look at our U.S. business, which is where all this action has really been concentrated, our U.S. business has stayed remarkably flat. Maybe small changes in volume negative, but more than offset by price to slight sort of CAGR on the revenue side. But it's generally flat. And so what that says is certainly with weekly GLP-1s, Ozempic being part of that pump adoption, our U.S. business has been flat, which is certainly in line with what we've expected. As we look into what the impact of GLP-1 has been historically, we think it has a delay potentially in the answer to [ insulinization ], but not the elimination of the need for insulin. The reason I say that is, even looking at prescription data, you see weekly GLP-1 insulin staying more or less flat or a slight decline. But you know there are new patients coming in. So had there not been a delay or some impact, it would have -- insulin prescriptions would have gone up. And so, we think that there is a delay. Now going further and saying, let's think about type 1 and type 2 individually. And recently, there was a letter in the New England Journal of Medicine about a small retrospective chart review of 10 patients, right, where the author showed that in a 12-month follow-up period, in some cases, most in other cases, all patients [ that ] gave [ vis-a-vis ] needed basal or basal and bolus insulin. Now that's a small study. It's 10 patients. It's a retrospective chart review. But fundamentally, you go ask yourself what causes type 1. It's autoimmune, right destruction of beta cells, therefore, not being able to generate insulin in the body. And is there any mechanism where GLP-1s could reverse that? And we are certainly not aware of any, right? It's also happened that these are adult early on for diagnosis patients, right? So most type 1 is often discovered in children -- diagnosed in children. So these were adults. And there is something called a honeymoon period that occurs in type 1, where there is still residual beta cell function. And so, the body can still make insulin. And GLP-1s, we believe they increase the body's ability to use that insulin more efficiently. So it's not altogether surprising. But -- and the author say [indiscernible] far deeper studies are needed to figure out whether GLP-1s have a role in type 1, and if so, what role would that be? Because like I go back physiologically or just looking at disease progression, it's not clear that you wouldn't need insulin if you were type 1. Type 2 a slightly different matter obviously. The disease progression is very different. It's a heterogeneous disease. Many different factors lead to type 2. At diagnosis, 50% of people with type 2 already have even [ C-levels ] above 7, 20% above 9. The higher the [ A1C ] to begin with, the more immediate the need for insulin. Secondly, there is already some loss of beta cell functionality even at diagnosis, maybe up to 40% to 50%. And then there is further degradation as the disease goes on. So it's hard to see how, again, there GLP-1s can actually reverse or cause beta cells to regenerate, because at some point, the disease will progress enough that you are going to need additional insulin. Another point to keep in mind is that while GLP-1s do have shown efficacy requiring less insulin, for us, we are in the insulin injection business, right? So one may require less total dosage in a day. But I think it's not clear whether that just means also less injections a day. And while we have said in the past that we believe that you can actually delay the initiation of insulin because the GLP-1s, nothing we have seen says we can eliminate the need for insulin. And for us, for an insulin injection company that has been living with a co-living with Ozempic for the last 5 years, the question for us is, is the delay in the future going to be greater than the delay that's already in the numbers. The switching data that we've seen, we've seen -- we haven't seen wholesale people stopping insulin that they get on GLPs. Rather, in most cases, we've seen people on GLP-1 and insulin together. So taking all of that totality of what I just said, and I know I went long, but I really wanted to explore this topic fully. Our view doesn't -- hasn't changed fundamentally from pre-spin -- and what we said was, listen, the U.S. is going to be a flattish business, maybe even a slight decline. Emerging markets still a growth story for us, will continue to be a growth story. The whole GLP-1 pump phenomenon tends to be focused in the U.S. And if you look at other developed markets besides the U.S., there's some [ delay ] in between the spectrum, depending upon sort of what's unique to that particular country, what the healthcare system is, what the reimbursement landscape looks like. But in some, maybe it's a little bit closer to the U.S. than it is to the emerging markets. And this is exactly the hypothesis we have laid out even pre-spin, and nothing we've seen so far in the data makes certainly me believe that, that hypothesis has changed to any material degree.

Very in depth. Is there any way perhaps like -- let's assume the demand for insulin reduces on the back of GLP-1. Is there a way that you could see this as an opportunity for your business as opposed to a direct risk?

Absolutely. And candidly, the way I think about it, it's not an either/or, right? I firmly believe our base business will continue to be stable, just along what I laid out for U.S., for the developed and emerging markets, and potentially be able to participate in the GLP-1, sort of secular GLP-1 growth over the next -- however many years. So GLP-1 injectable drug -- we are an injectable drug company. We just -- the drug happens to be insulin, right? But it's delivered via vials, pens or auto injectors. Ozempic, as you may know, is our pen, Mounjaro is auto-injectors. And I know there will be new GLP-1s. Other companies will come out with it, [ but ] the delivery forms may likely be a pen or an auto-injector, that will be a hypothesis. If it's a pen, you can use our pen needles. In some cases, the pharma companies package pen needle. In other cases, they may make it open. But certainly, if there's a pen involved in the delivery device, then certainly our pen needles can be used with it. For vials, certainly, our syringes can be used. Our syringes are marked for insulin. So, we have to go through and make sure from a regulatory process we're clear to be used, but can be used as well. Auto injectors, from a manufacturing standpoint, these are injection-molded parts with needles. We certainly have a core competency in injection-molded parts with needles. We make [ 8 billion ] units of them every year of high quality. But it would have to be mostly through business development or an M&A effort, because those devices are used in clinical trials with the drug. And so if you want to do it organically, it's got a long timeframe, because you've got to get in the very early stages on the drug development and sort of go through the clinical journey with the pharma company.

And just pivoting on to the patch pump program. Maybe give us a reminder of where you're at with that and some longer-term time lines there, if possible?

Yes. So the patch pump program, just as a reminder, is really focused on type 2. There's been a lot of press in the patch pump and just pump -- insulin pumps sort of market about new entrants and so on and so forth. So it is a patch pump. It is focused on type 2. It's being developed under the breakthrough device designation of the FDA, which is an indicator of the differentiated features and benefits of the pump. What we've said is, listen, we are focused on eventually getting to a type 2 closed loop pump. But the way we are going to get there is we're going to develop the pump first as an open loop, go through a 510(k) process for an open loop, get an algorithm. And just a few months ago, we signed an agreement with the type 2 on the algorithm, do a clinical trial with that algorithm and our pump, and then apply for 510(k) for a closed-loop system. We laid out that path again 18 to 24 months ago, and I'm very pleased that we've been able to stick with the time line -- our internal time line that we had in mind since then. Finding the agreement with Tidepool was a big step forward. It sort of gives us -- our investors an indication of where we are in the development. Recently, we started a small observational study with type 2 algorithm in type 2 patients. It's a small study. It is not a trial. It's not what's going to be used in closed loop submission for the 510(k), but it allows us to get an early read on how the algorithm will perform in type 2, and whether there are any tweaks that need to be made. So overall, Kallum, I'd say, very pleased with the progress. With respect to timing, I know that's the question on everybody's mind. We've been guarded on that for many reasons, but one amongst them is really focused on getting the work done before we talk a lot about where we are, and we are committed to sort of disclosing key milestones as we achieve them, as you've seen with the observational study in the algorithm. We've said that more revenue through 2024. The cost for the development of the patch pump are already in our numbers, and were included in the projections that we had laid out through 2024, even pre-spin.

And obviously, a lot of competitors now in this market. How are you going to make this product stand out from the others?

Yes. So the way I think about it is really ask myself 3 questions. And these are the same 3 questions that I asked 2 years ago, right? Is the market big enough? Does the product have enough differentiation to have room for itself in the market? And do we have a right to compete in this market? And the answers to all these 3 questions were [ yes ] 2 years ago and yesterday. So let's start with the market. This is a type 2 focused product, right, 2.5 million type 2 insulin intensive patients. That's greater than the number of type 1 patients in the U.S. if you look at the pump market in the U.S. And certainly, globally, you could say the type 2 insulin intensive is likely that much or more. We are sitting at [ 1 billion ] with 0 pump revenue. So even [ 10 million ] adds on point of growth. So certainly, a large enough market for us -- for it to be attractive to us, right? So the point one. Point 2 is talking about features and benefits. Type 2 for all the reasons I talked about in a time where GLP-1s is a progressive disease, people there -- people with type 2 typically need more insulin a day than people with type 1. So, we are building one with a larger reservoir. The demographics of type 2 people with diabetes is different. They are generally diagnosed as adults. They need a simpler pump. And so, we're designing it for ease of use, less complex sort of bolus calculations, simplified basal rates, simplified the tailored alarms. And so, there are features and benefits that are in type 2. And a lot of the competition in the space that's talking about you getting into type 2 is really taking the current type 1 pump and doing a clinical trial for type 2. That is not what we are doing. We're designing the pump from the get-go for type 2, which is why we have the breakthrough device designation. And the third one is, do we have a right to compete. In fact, it is unique because nobody gets diagnosed and starts up with a pump. Once you get diagnosed with type 2, typically, you will go through a whole regimen. That starts with diet and exercise, then oral, then injectable, then GLP-1s and then insulin and insulin basal. If you are on 1 daily shot of insulin, it's very likely you're taking in by injection. And if you're taking it by injection, you're very likely certainly in the U.S., taking it with our product sitting in your box or sitting in your home, right? So, we have a unique opportunity to [ reduce ] patients and educate them on the availability of the components available. That patient typically goes to a pharmacy to get that box, which is how we plan to get this pump into patients' hand through a pharmacy. So, we already have long-standing relationships with pharmacies in the U.S. And then finally, you need payer coverage. Well, we have 95% of the paid -- of the covered lives in the country already under contract with us. So, we have some of these key infrastructure elements, Kallum, that we need to compete. We're going to have to build others. We're going to have to expand our sales force. We are going to need clinical training. But I view those largely as a time and distance problems, because infrastructurally, we have some of the key things we need to be able to compete effectively.

And have you seen an obvious like impact and progress as a stand-alone in the patch pump development versus when you were part of the [ BD ]?

Absolutely. Look, we've made a lot of changes when we were a stand up -- when we became an independent company. I mean the first thing we did was, frankly, we took the 4 key functions that are involved in product development, which is R&D, quality, regulatory and medical and put them under one leader. That leader is new to the company, came for spin. So are the 4 individual function leaders. We've changed the talent significantly, both at the leadership level and below. We've built up our software capability. It was sort of nonexistent before. And from the funding perspective, certainly, if you compare to pre-spin, you're spending -- we're investing a lot more in the patch pump development. All of these changes have had pretty positive benefits, like -- nothing is done until we have the 510(k) clearance. But I think it's fair to say that I'm very pleased with the progress we've made and the time lines that we laid out 2 years ago and our ability to sort of [ due ] closely to those time lines.

I know the emerging market is an important part to your long-term growth story. Maybe an update there, any regions you're targeting in particular?

Yes. So emerging markets is an important part of our growth story. Within emerging markets, China in particular, has been in the news a lot, for a lot of reasons. It's an important market for us, and I'm very pleased with how our team is performing broadly in emerging markets just generally, but also in China. So, there was a question on guidance earlier, and I know Jake commented on this. When we were sitting here about 1 year ago, sometimes hard to forget, but China was still in the lockdown mode of COVID. And then it went through a major sort of reopening in the December time frame. And our China business was slowing down in the COVID mode. It's nice to see how it's come back and its approaching sort of its longer-term aspirations as we've gone on. Our plant in China, which had a bunch of COVID spikes 9 months ago, kept working through it, and built up enough inventory that allowed us to start the demerger process for our plant in China exactly as we had planned it. So generally speaking, Kallum, in emerging markets, our team over there has just performed extremely well in just driving our business and sort of capitalizing, if you will, on the growth in the number of people with diabetes over there.

Anything we need to be aware of on the demerger process? [ Whereabouts ] probably with that now?

So look, we'll give an update on the next earnings call. But we have said even in the Q3 earnings call that we had started the demerger process. A key step in the demerger process is just getting a business license, which we've obtained. So, no new news there, Kallum. But overall, if I just step back on the separation perspective, look, this is a complex separation. As I said, taking a business that's been part of a larger business for 100 years and just standing it up on its own. And so, there are a variety of separation projects going on across the company that are consuming a lot of cash right now. We are pursuing and executing on them very diligently, but at the same time, speeding enough to be able to get done, because I know it will free up cash and it will free up organizational capacity.

And Jake, maybe filling you in here for some margin questions, if that's okay. A lot of our incoming comes on those EBITDA margins. I think the Q4 guide is implying quite a heavy fall sequentially. Maybe just give us some high-level thoughts there, and whether we can expect some longer-term upside to that 30% target you have?

Yes. So, I think at the time that we set our original guidance for 2023, we probably had 6 months or so under our belt as a publicly traded company. A lot of uncertainty at that point regarding COVID lockdowns, regarding what inflation was going to do. And then obviously, all the separation work that was still in front of us and continues to be in front of us. But I think coming into the year, we called for adjusted EBITDA margins in 2023 to be about approximately 30%. Our latest guide now calls for adjusted EBITDA margins in 2023 to be about 33.5%. So very pleased, and it's really a credit to the team, and really just points to the stability of the base business, quite frankly, despite, again, the impacts from GLP-1s and shifts to the pumps. So very, very pleased with, I think, our margin progression during the course of 2023. I think as it relates to 2024, nothing has changed in our minds related to sort of what we think the financial profile of this business would look like even going back -- dating back to pre-spin. Pre-spin, we talked about this business being capable of a flattish constant currency revenue CAGR. If anything, those pre-spin numbers in terms of revenue assume much more of a contribution from contract manufacturing revenue. Now obviously, our former parent has really more aggressively in-sourced that. So that's actually more of an incremental headwind in comparison to what the pre-spin numbers would have thought. And it's really more -- further indicative of the fact that our base business has actually over-performed our pre-spin expectations from a revenue standpoint. I think from a margin perspective, we still feel very, very comfortable with that approximately 30% adjusted EBITDA margin in 2024. And when we had put that number out there in March of 2022, just prior to spin, inflation was nowhere near the impact that we're seeing right now. So, we've probably needed to absorb anywhere from between 400 to 500 basis points of incremental margin pressure and still feel very comfortable and think that an approximately 30% adjusted EBITDA margin in 2024 is very reasonable.

I think we've got one left. That's the last question. Is there anything that you believe investors typically ignore that is important for the Embecta story?

Yes, look, especially, in the current environment where GLP-1s are in the news, I would say this is an incredibly stable business. Insulin has been around for a 100 years. We've been participating in that business now as far as 98 years. It's an incredibly stable business. For a business of our size, slightly over $1 billion, great geographic diversity in revenue. Just -- almost 50% of our business comes from outside the U.S. We have a unique channel in that we can get to retail pharmacy and reach almost 30 million patients a year around the world. We have great presence in emerging markets, and we've honestly world-leading capability and high-volume manufacturing and distribution. So these are things that are part of our core, and they provide a solid foundation for us to continue to build this company up.

Right. Perfect. Well, Dev, Jake, thank you so much. Really appreciate your time.

Thank you.

Thank you, Kallum, and thank you all.