Please stand by. Welcome, ladies and gentlemen, to the second quarter of fiscal year 2022 earnings conference call for Embecta Corp. At this time, all participants have been placed in a listen-only mode. Please note that this conference call is being recorded and that the recording will be available on the company's website for replay shortly. During the call, the company will make forward-looking statements and it is possible actual results could differ from management's expectations. Risks, uncertainties and other factors that could cause such differences can be found in the company's earnings release and latest SEC filings, including the information statement dated February 11, 2022, filed as Exhibit 99.1 to the company's current report on Form 8-K and Form 10-Q. You're cautioned not to place undue reliance upon any forward-looking statements which speak only as of the date made. Although it may voluntarily do so from time to time, the company undertakes no commitment to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities laws. Management will also discuss -GAAP financial measures regarding our performance. Reconciliations to GAAP measures including the details of purchase accounting and other adjustments can be found in our earnings release and financial schedule and the appendix of the investor relations presentation. Unless otherwise specified, all comparisons will be on a year-over-year basis versus the relevant period. Revenue percent changes are on an FX neutral basis unless otherwise noted. When management refers to any given period, they are referring to the fiscal period unless specifically noted as a calendar period. The earnings press release, slides that accompany today's call, and webcast replay details are available in the Investor Relations section of the company's website www.embecta.com. I would now like to turn the call over to Mr. Dev Kurdikar, Embecta's President and Chief Executive Officer. Please go ahead, sir.

Thank you, Shannon. And welcome, everyone, to Embecta's second quarter of fiscal year 2022 earnings call, which also marks our first quarterly earnings call as a newly public company. My name is Dev Kurdikar. I'm the President and CEO of Embecta and I'm joined on the call today by Jake Elguicze, Embecta's Chief Financial Officer. As you know, we successfully executed the spinoff from Becton Dickinson on April 1, just about six weeks ago. Being able to ring the closing bell at the NASDAQ on day one was a motivating and uplifting day for our global team of 2,000 employees who are dedicated to our mission of developing and providing solutions for people with diabetes. I would like to thank all those who worked tirelessly for almost a year to ensure that the spin was executed smoothly, including all our former colleagues at Becton Dickinson. While we are now an independent company, we have a series of transition services agreements, or TSAs, with Becton Dickinson that we are now operating under. We have begun the work of recruiting people, implementing processes and setting up the systems that we will need to have in place before we exit the TSAs. In addition, our team continues to work tirelessly to overcome the multiple challenges that currently exists globally, including inflationary pressures, supply chain disruptions, COVID-19 restrictions, and geopolitical uncertainties. Throughout all these challenges, our focus remains on ensuring that people with diabetes that use our products continue to have access to them. Here's what we plan to cover during our prepared remarks this morning. As this is Embecta's first quarterly earnings call as a public company, we thought it would be helpful to spend a few minutes describing our company's history, our business and our competitive strengths as a diabetes injection devices…

Thank you, Dev. And good morning, everyone. It is my pleasure to have the opportunity to speak with you today about Embecta as, during the next several years, we believe that we have a truly unique opportunity to create the preeminent diabetes focused company in the world. Before I discuss the financial results for the second quarter of 2022, I would like to provide some background information and highlight a few items regarding the presentation of financial results for the second quarter and first half of fiscal years 2021 and 2022. First, Embecta has a September 30 year-end. So, the financial results for Embecta's fiscal second quarter and first half are for the three and six months ended March 31. Second, the Q2 and first half of fiscal years 2021 and 2022 results are based on carve-out accounting principles derived from the unaudited, interim condensed consolidated financial statements and accounting records of Becton Dickinson. These financial statements reflect the historical results of operations, financial position, and cash flows of BD's diabetes care business, as they were historically managed in conformity with US Generally Accepted Accounting Principles. In addition, these financial statements include general corporate expenses of BD, and shared segment expenses for certain support functions that are provided on a centralized basis within BD and which were not historically allocated to the BD diabetes care business. Nonetheless, these financial statements do not include all the actual expenses that would have been incurred had Embecta been a standalone public company during the periods presented. Third, we have introduced financial guidance for the second half of fiscal year 2022 in today's earnings press release, which I'll review in a few moments. These financial guidance items represent the company's expectations for financial performance as an independent company. This makes the evaluation of our…

Thank you, Jake. Slide 12, please. On slide 12, you will see some of the reasons why we think we have a strong business. First, as we showed earlier, we have a strong core, which translates into a compelling financial profile. Second, our core is broadly defensible. We have solid intellectual property, comprised of approximately 2,000 patents, knowhow and trade secrets. Our manufacturing knowhow has been gained over decades of experience, and it's carefully protected. And we have a long-term agreement with BD to continue to provide cannulas. These are the needles that are used in our products. Finally, we are able to build an organizational capability around the single-minded mission of developing and providing solutions for people with diabetes. This purpose motivates our workforce and continues to attract talent to Embecta. Slide 13 please. Let me now walk you through how our business today provides the financial foundation for growth. Both our business model and our healthy balance sheet provide a strong core. First, we have a stable, recurring, geographically diverse revenue base with almost half of our revenue coming from outside the United States. Our products are chronic use and the vast majority of people with diabetes will continue to use injection devices. Second, our margin profile is healthy. This is supported by our brand recognition, long history of reliable supply, scale and efficient manufacturing and distribution infrastructure. Third, we have a history of generating strong positive cash flow from our operations. Fourth, we have modest leverage and are considerably below the net leverage covenants in our credit agreement. Fifth, our starting cash balance will allow us to quickly capitalize on any suitable growth opportunities that we identify. Taken together, you can see that these elements allow us the financial flexibility to invest for growth. On slide 14,…

[Operator Instructions]. And our first question will come from Marie Thibault with BTIG.

Dev and Jake, congrats on your first quarter here as a public company. I wanted to start here – thank you for the extensive detail on the financial guidance. Just two quick questions on that. With the decision to discontinue some of the business, is that a process that you go through annually? Or is that part of a rolling review? I certainly understand the impact to this year's guidance on a year-over-year basis. But wondering if that's something we should expect in future years. And secondly, you gave some details on inflationary pressures, certainly on the cost input side. Curious if there's also inflationary pressure for the consumer and whether that changes their choice of whether to choose an Embecta brand or another perhaps less expensive brand.

Mary, this is Dev. With respect to the process of evaluating the choice of business that we do, let me just step back here. We have – you can imagine, over sort of our global scope hundreds of thousands of customers, and the way we do transact business with those customers depends certainly on the geography we are in. And those customers tend to be everything from retail, serving customers to patients, retail pharmacies, hospitals to pharmacies, distributors, vendors. The place where we pay particular attention to, as business comes up for renewal often is, is certainly on the tender side. And the dynamics of the tender business can differ year-over-year. I would say that the choice that we made almost 12 months ago, it's a process we go through every year certainly, but I would not certainly expect to see that level of change year-over-year. That's not something that I would expect to see, though it is a process that we go through certainly annually. We play pay close attention obviously to the business that we transact. With respect to the inflationary pressure, again, just given the diversity of our geographic revenue, the contracts that we have with our customers are different. We do have the ability to take price and adjust price as we renew our contracts, and we have done so. So we do have the opportunity to pass on some of these inflationary sort of cost pressures that we are feeling to the customer base. I would also like to point out that, if you are a person with diabetes that is incurring spend on obviously treating diabetes, the cost of our products tends to be a very small part of, if you will, the total spend on managing the disease. And so, that allows us a certain flexibility as well.

Maybe if I can just jump in just real quick just to add to what Dev said, again, we certainly do not think that these types of things moving forward would necessarily still have the same impact. Obviously, as the new management team came on board – and though for the past year, we were working on the spin and being prepared for the spin, we also wanted to make sure that from a longer term standpoint, that the health of the business was in a really good position as we sort of embarked as our own company. So, as we thought about which customers and which business we may want to no longer do business with, that was certainly taken into consideration. And we certainly feel that we are in a much better position from a health standpoint moving forward to grow Embecta more sustainably as a result of some of these decisions, even though they'll have temporary impacts in 2022. And just as it relates to sort of our longer term guidance or financial thoughts that we had put out there a few months ago in early March when we had an investor event, these types of things were taken into consideration when we talked about our nearer term through 2024 financial targets, which would have called for flattish constant currency revenue CAGR. So, we still feel very, very comfortable with those near-term numbers that we put out a few months ago.

A question here then on R&D and M&A thoughts. We're all very curious to hear more about the closed loop patch pump. Do you think that's something we'll hear more sort of on progress on that this year? Or is that more of a 2023 event where we might start to hear about some milestones? And secondly, as you consider M&A in the future, what's the ideal profile for something that you would look to? Is it all insulin delivery? Is it large? Is it small? Is it fast growing? Is it pre revenue? Any color you can give there would be helpful.

I'll take both the questions. Certainly, Jake can expand on them afterwards. With respect to the insulin patch pump, as I mentioned in my remarks, it's been developed into a breakthrough device designation of the FDA, and we continue to have this discussion with the FDA. It's progressing nicely. With respect to the milestones that you should expect to see, certainly, when we are ready to file our 510(k) on the hardware, the pump itself, certainly that's something that we'll be talking about. With respect to timing, I'm going to try to stay away from it. I think as you just heard, when we gave our near term guidance through the end of 2024, we hadn't included any revenue from the pump in that near term guidance. With respect to milestones, though, I would say certainly you'll hear more about that in fiscal 2023 from us as we achieve certain milestones. And let me leave it on that on the pump for now, Marie. With respect to your second question, maybe I'll ask Jake to start off and then I'll jump in.

Marie, could you just repeat the second part of the question, please?

It was essentially trying to understand M&A profile of what you see in a potential target? Would they be large, small? Is it totally focused on insulin delivery, pre-revenue, early stage or commercial stage? Any details?

From an M&A standpoint, I think this is truly where I think a company of our size has real advantages. We're at $1.1 billion or so in revenue. We have the scale, I think, to be relevant to our customers and to patients. And that's both in the US and internationally. But at only about $1 billion or so in revenue, I think we also have the unique opportunity to use M&A as a real growth accelerator for us. And the types of transactions I think that we would be sort of interested in really fall in three, I would say, different types of categories. First, pre-revenue, technology type deals that we would use in order to try and augment our own internal R&D product development efforts. And those tend to be smaller in nature and may have certain milestones and contingent payments tied to it. So, minimal cash up front and then maybe a series of milestones based on revenue achievement or certain regulatory approvals. Second, I think we're also interested in continuing to be more and more direct in certain international markets. So, we're largely direct today, but in some countries, we still go through distributors. So, to the extent that it might make financial sense and we would look to potentially become more direct in certain markets and recoup that pricing, that distributor pricing, and that would show up as improvements in revenue and improvements in margin for us. And then last, I would say kind of scale transactions, right? And a scale transaction for Embecta is going to be far, far different than maybe the types of things that some other companies would be looking at. So, we wouldn't necessarily envision ourselves competing with different targets for, say, some very, very large companies because, candidly, the types of things I think that we could look at that could move the needle in a more material fashion for us are not the types of things that would really move the needle on a more material way for a larger company. So, I think those are sort of the three large buckets of different types of M&A that we're interested in.

With respect to the therapeutic area question, Marie, about would it be diabetes focused, and the way we think about it, honestly, are does it leverage strengths and capabilities that we have, right? Is it going to leverage emerging market infrastructure? Can we leverage our manufacturing capabilities? Can we leverage our distribution strengths? Right? Is it a product that can be sold to the retail pharmacy where we have long history of working with retailers to provide our products to patients? So, we will certainly remain focused on diabetes, but I wouldn't preclude other products that we can sell to our existing channels where we can leverage our strengths as well.

Our next question comes from Cecilia Furlong with Morgan Stanley.

I wanted to turn back to your guidance for the back half of the year. If you could provide a bit more color, just what you're contemplating, specifically US versus international contributions, taking into account both what's going on in Russia-Ukraine, China, lockdowns and then also your decision to step away from certain businesses, just how all of that rolls into your 2H – your back half guidance and then anything you can provide also and how you're looking from [indiscernible] standpoint 2Q to 4Q would be helpful..

For the second half of the year, for revenue, we would expect to generate somewhere around $555 million. And again, that would equate to about $1.1 billion in full-year revenue, which is largely aligned with what BD had in their original guidance for diabetes care and what was recently taken out from their numbers when they're providing remainco guidance. So, the decline in constant currency revenue in the second half of the year of 3.5%, again, it's really in those three buckets that I mentioned in the prepared remarks. COVID being more of a year-over-year headwind because of the fact that we had some benefits last year in terms of purchasing, whereas now there are some disruptions and we're certainly, obviously, trying to navigate through them, but there are some temporary disruptions going on in some markets. Russia and the Ukraine, that's going to have a smaller impact to us in the second half of the year. We probably do somewhere to the tune of maybe like $6 million or so in annual revenue to Russia and Ukraine. So, right now, in the second half of the year, we're sort of factoring in that that might be somewhere to the tune of like a 3-million-dollarish headwind. We're not really contemplating really much, if any, revenue in the second half of the year there. And then, the larger impact that it's going to have in the second half of the year, for us, really comes back down to those decisions that we refer to sort of walk away and exit certain business. Again, that, in our mind, is more temporary in nature, and it's certainly not something that is indicative of Embecta's ability to grow in the future. So, while it's going to have somewhat – it had somewhat of a temporary impact in the first half of the year compared to 2021, it's going to have another temporary impact in the second half of the year as compared to 2021. But when we step back and we made those decisions last year, we really did it for the health and improvement of the business in the long term, and it's something we feel very comfortable with.

And if I could follow up also, just on R&D, really, what you're contemplating from an investment standpoint, both behind the patch pump this year, as well as going forward, but also the rest of your pipeline, just if you could talk a bit more about your expectations for R&D both, again, the back half of this year, but also into 2023.

From an R&D spend standpoint, we obviously are very committed to making sure that Embecta continues to accelerate the investment in R&D and other commercial initiatives as well to really try and drive an accelerated constant currency revenue growth rate in the future. There are a few different new product introductions that will be coming to the market over the next few years, probably, most notably, hopefully, the insulin patch pump. In the second half of the year, we would expect R&D expense to ratably tick up from sort of the first half of the year levels. And that will obviously be one of the areas that is going to be causing – we talked about EBITDA margin. And maybe I'll just mention EBITDA margin just very quickly just so that the investment community understands. I would caution people that the first half of the year does not – it's not indicative of all of the costs that Embecta will incur as we move forward. But in the second half of the year, going from the first half of the year, the EBITDA margin, one of the items that is going to be driving it is obviously a very deliberate decision on our part to continue to invest within R&D, but then there are other items, including increased raw material costs and inflation, as well as all the investments that we need to make in order to stand up Embecta. And as we step back and think about sort of the first half of the year to second half of the year adjusted EBITDA margin trends getting into the low 30s in the second half of the year, I would say well over 80% of that sequential movement from the first half of the year to the second half of the year has to do with increased costs to stand up Embecta as its own company, including the impact from the different contract manufacturing agreements.

Our next question comes Danielle Antalffy from SVB Securities.

I just have a question on – more of a high level question. And given your leverage to emerging markets, I would love to hear your views on how emerging market device innovation is evolving and how rapidly that could potentially accelerate and sort of how you're positioned against that? Kind of thinking, are emerging markets where the US was from a device perspective a decade ago, 20 years ago, and sort of how that's changing?

Emerging markets, as I mentioned before, is a source of strength for us. Right? And so, you sort of asked about it in the context of what United States was maybe a decade ago, but I think there are some differences as we look forward, right? So, as we think about the fact that we have 300 commercially focused employees in emerging markets, we have a plant in China, one of our newer plants, right, that's in one of the key emerging markets for us, that makes products for China as well as other emerging markets. As we look forward, the majority of the growth in the number of people with diabetes is expected to occur in emerging markets, right? So, if we start at the very top, that's where we're going to have growth in number of patients as we look forward. Secondly, as the GDP per capita sort of increases and as economies improve, those folks are getting better access to care and better access to insulin. And I think that's where I think you will see the strengths of our company really match with what the needs of that market are because, as those folks get access to care, they are going to focus on insulin, they are going to focus on injection devices. And we are well positioned there. Now, there will be a section of the market that will adopt newer drugs, the more advanced technology, but I think that is indeed decades away. I think we are just perfectly positioned to really match our strengths with the needs of the region. As we think about our M&A as well, by the way, we keep looking for, and we will keep looking for, and finding opportunities to really add to the bag for emerging markets. Part of our M&A strategy isn't that we need a product that's going to serve – the same product to serve our entire global market. So, we tend to use our sense over in emerging markets to continue to widen our product portfolio over there, so we can really meet the needs of those patients more holistically.

Our next question comes from Mathew Blackman with Stifel.

And just one for me with two parts. First is, just want to make sure I heard, Jake, what you said. You sort of touched on this. I think you said, like, 80% of the second half versus first half sequential step up in investments were standup costs. So, first, did I hear that correctly?

Yeah, Matt. You did. So, as we think about going from the first half of the year to the second half of the year, gross margin, obviously, is going from, again, 70%. But that is something that is not necessarily reflective of Embecta and all the costs that we would really incur moving forward, to the second half of the year, which we would expect it to be sort of in the low 60s. And from a gross margin standpoint, I would say that there's really three main drivers, the first of which I would sort of put in the bucket of kind of business related, that being incremental inflation, raw material and kind of some supply chain increased expenses that we would expect to incur in the second half of the year. And then, the other two are really I would say in the bucket of kind of spin related. And that's really related to an increase in expenses related to standing up Embecta. And then, second, just the impact of the different contract manufacturing agreements that we're going to have in place where we're selling product to BD at very low upper single digit gross margin. We would expect to sell about $15 million worth of product at upper single digit margin in the back half of the year to them. And then, on the flip side, there is product that we need to source from them and that's going to come at a markup, and none of that is necessarily included in the first half of the year. So, gross margin is obviously going to have an impact in terms of the flow through to adjusted EBITDA margin. And then, the other things that are impacting sort of the first half of the year to second half…

I guess the follow-up there is, if I think about those incremental investments, let's say, largely in R&D, that other portion of the incremental increase of second half versus first half, is there any way to tease out even in the roughest sense, those investments that you're making that you would expect to have – and I'm making these timeframes up, but sort of near-term payouts or payoffs or returns like the next 12 to 24 months, balanced versus, say, sort of longer term projects that may play out visibly, maybe on the top line three to four years. Is there any way to sort of balance or give us a sense of the balance between those investments?

I would say, most of our increased R&D spend is really around our insulin patch pump. And as you've commented before, certainly, we wouldn't sort of encourage anybody to think about revenue from that through the near-term guidance we've provided through 2024. So, it's an area of intense focus for us. We're committed to sort of investing as needed to make to make that project come to life and achieve commercial success. But revenue from the patch pump, we certainly haven't included in our near-term guidance through the end of 2024.

Thank you. That is all the time we have for today's call. Thank you for your participation.