Welcome, ladies and gentlemen, to the Fiscal Third Quarter 2023 Embecta Earnings Conference Call. [Operator Instructions] Please note that this conference call is being recorded and that the recording will be available on the company's website for replay following the completion of this call. I would now like to hand the conference over to your host today, Mr. Pravesh Khandelwal, Vice President of Investor Relations. Please go ahead.

Thank you, operator. Good morning, everyone and welcome to Embecta's fiscal third quarter 2023 earnings conference call. The press release and slides to accompany today's call and webcast replay details are available on the Investor Relations section of the company's website at www.embecta.com. With me today are Dev Kurdikar, Embecta's President and Chief Executive Officer; and Jake Elguicze, our Chief Financial Officer. Before we begin, I would like to remind you that some of the matters discussed in the conference call will contain forward-looking statements regarding future events as outlined in our slides. We wish to caution you that such statements are, in fact, forward-looking in nature and are subject to risks and uncertainties and actual events or results may differ materially. The factors that could cause actual results or events to differ materially include but are not limited to, factors referenced in our press release today, as well as our filings with the SEC which can be accessed on our website. In addition, we will discuss certain non-GAAP financial measures on this call which should be considered a supplement to and not a substitute for financial measures prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to the comparable GAAP measures is included in our press release and conference call presentation. Our agenda for today's call is as follows: Dev will begin by providing an update on the progress we've made on our strategic priorities for 2023 as well as some remarks on the overall performance of our business during the third quarter and year-to-date period. Jake will then provide a more in-depth review of our Q3 financial results as well as our updated financial guidance for the year and we will then open up the call for questions. With that said, I would now like to turn the call over to our CEO, Dev Kurdikar. Dev?

Thank you, Pravesh. Good day, everyone and thank you for taking the time to join us this morning. This time last year, we announced the results of our very first quarter as an independent public company and I'm pleased to say that we have made tremendous progress standing up our organization since then. I'm especially energized by the continued execution of our global team across all elements of our business and strategic priorities because we are not just here to build a new company but to also continue our mission of developing and providing solutions that make life better for people living with diabetes. At Embecta, we keep their needs front and center because we want everyone to be able to enjoy life unlimited by diabetes. As we turn to the next slide, you will see the strategic priorities that will help us advance towards this vision. First, we remain focused on strengthening our base business while maintaining our global leadership position in the category of insulin injection devices. Second, we continue to make progress in standup and separation activities to ensure success as an independent company. And finally, we remain focused on accelerating our constant currency revenues as we continue investing in growth, most notably around our insulin patch pump program that is being developed for the type 2 market as well as seeking M&A and additional partnership opportunities. We are moving with purpose and urgency in each of these 3 areas. During the third quarter, our team's disciplined execution was the key to delivering solid financial results that once again exceeded our expectations while also advancing these strategic priorities. In terms of strengthening our base business, we recently initiated a pilot launch of a finer gauge pen needle with our Nano Pro hub design in Japan. Today, with…

Thank you, Dev and good morning, everyone. Before I discuss the financial results, I would like to remind the investment community that Embecta was spun off from BD on April 1, 2022 and that the financial results during the pre-spin periods were based on carve-out accounting principles and do not reflect what Embecta's financial results would have been had Embecta operated as a stand-alone public company. Therefore, the financial results for the 9-month period ending June 30, 2023 and June 30, 2022, are not meaningfully comparable. Given the discussion that has already occurred regarding revenue, I will start my review of Embecta's financial performance for the third quarter at the gross profit line. GAAP gross profit and margin for the third quarter of fiscal 2023 totaled $189.5 million and 66.2%, respectively. This compared to $202.9 million and 69.7% in the prior year period. The year-over-year decline in GAAP gross profit and margin was expected and was due to a combination of factors which includes the impact of inflation on the cost of certain raw materials, direct labor and overhead, product and geographic mix, incremental standup and separation costs and FX. This was somewhat offset by manufacturing productivity improvement programs and increases in the average selling prices of our products. While on an adjusted basis, gross profit and margin for the third quarter of 2023 was $189.6 million and 66.3%. As compared to our prior outlook, our adjusted gross margin during the third quarter of 2023 was better than we previously expected and this was due to higher-than-anticipated revenue, favorable geographic and product mix and our ability to manage the costs incurred to stand up the organization. Turning to GAAP operating income and margin. During the third quarter, they were $51.3 million and 17.9%, respectively. This compared to operating income and…

[Operator Instructions] And our first question comes from Kallum Titchmarsh of Morgan Stanley.

Just across the [indiscernible] business. I know you touched on it briefly in your remarks but I'd appreciate some extra clarity if possible on pricing, specifically where you've been able to take price, capturing both products and geographies. And then how you expect this to trend as we head towards your fiscal year 2024.

Kallum, this is Dev. So with regard to pricing, ever since we spun off, now 5 quarters ago, we've been able to consistently take price across a variety of geographies. Most recently, in the most recent quarter, we were able to get some price in U.S. as well as in geographies outside the U.S. Pricing is something, Kallum, that happens to us on a rolling basis because we certainly have contracts that roll in and out across various geographies. Pricing overall globally can also get affected by customer mix. And whether it's a tender business and whether we've won a tender or not, versus normal, what I'll call sort of retail channel business. But I think consistently, we've been able to take price. I really don't want to project price going forward. But certainly, our efforts to optimize price in various markets around the world will continue. The pricing actually has also helped us in this recent inflationary environment by allowing us to offset the inflationary pressures that we've certainly experienced in spin. Jake, is there anything you would like to add?

Yes, sure. Maybe just a little bit more color regarding the impact. So I would say on a -- at a consolidated level, we saw pricing drive a little less than about 1% of positive year-over-year constant currency revenue growth for total Embecta. That was largely due to pricing tailwinds that we saw outside of the U.S. Pricing in the U.S. was flat. But I would say that in the U.S., we actually did see like-for-like pricing increases of about -- that would have driven about 1% of revenue growth in the U.S. year-over-year. But that was offset by about a 1% headwind coming from certain rebate reserve adjustments that were made in the third quarter of 2022 that did not reoccur and were a headwind then in terms of 2023. So we continue to be pretty pleased by our ability to drive price both in the U.S. on a like-for-like basis as well as through most countries internationally.

Our next question comes from Marie Thibault of BTIG.

I wanted to start here and talk a little bit more about the revenue guidance. It seems to me that certainly contract manufacturing revenue was strong this quarter and we aren't expecting any this quarter -- or next quarter. So I understand that dynamic but maybe you could walk us through your assumptions for base business growth. Any thoughts on sort of volume growth? I know you just talked about pricing but volume growth in the U.S., international and emerging market segments for the rest of the year.

Yes. So Marie, maybe I'll start and then Dev can certainly weigh in here. One of the reasons why we sort of break out the contributions from contract manufacturing revenue as compared to sort of the core injection business is because all along, we've known that it's going to be somewhat transient in nature as BD begins to just sort of in-source their ability to manufacture that product itself, right? So I think it's important for the investment community to understand that there's going to be some ebbs and flows in any given quarter as it relates to kind of the contract manufacturing revenue. And while we did generate about $3 million worth of contract manufacturing revenue in the third quarter of 2023, it was still a headwind year-over-year of about $2.3 million. And that equated to about just under 1% of a constant currency headwind in the quarter itself. Now as we sort of move forward here for the fourth quarter, contract manufacturing is going to be a much, much larger headwind for us as compared to the fourth quarter of 2022. So right now, given what we know, we're not factoring in any additional contract manufacturing revenue for the fourth quarter of 2023. And that compares to about $10 million worth of contract manufacturing revenue that we generated in the fourth quarter of 2022. So that alone equates to about a 3.6% constant currency headwind in Q4 versus the year ago period. So if you were to sort of normalize for that, our guidance for the core injection business, actually implies a step-up in Q4. And right now, we're anticipating that the core injection business on a constant currency basis grows somewhere between 1.3% and 3.3%. And that sort of acceleration in year-over-year constant currency revenue growth, it's largely coming from both our expectations for the U.S. as well as for China.

And maybe just a couple of points, Marie. You probably remember contract manufacturing is very low-margin business for us. And certainly, as it tails off, it allows us to think about what we want to do with that capacity in our plants, right? So it's not something that's unexpected and it's not something that impacts us on the bottom line in any sort of material way. And with respect to revenue, you asked about volume. I mean, clearly, with the growth rates we're talking about for Q4, admittedly with easy comparisons because U.S. had a timing benefit in Q3 of prior year quarter which obviously moderated itself in Q4 of prior year quarter, so that helps from a growth comparison. And China, you remember, was still in the throes of COVID and was coming -- was sort of dealing with that and so allows us somewhat of an easy comparison in China for fourth quarter as well. Having said all of that, that growth is going to come primarily from volume and that's what we anticipate. Look, overall, from a guidance perspective, what we've done, Marie, is we've taken our performance in Q3 and sort of just added that to our expectations for full year. Our expectations for Q4, frankly haven't changed materially from what we said. We are pleased that our business across the board is operating at the higher end of our range. And so we've taken the low end of our guidance up, as you can see, maintained our expectations, maybe bolstered them a little bit, higher confidence in Q4 and that's what we've done.

Okay. That's very helpful detail. Maybe I can ask my follow-up on China. Good to hear that you've initiated the demerger process for the China facility. As we get closer now, what are your best expectations for when that facility will be shut down, how long that might take and when we should start modeling an improvement in gross margins again.

Sure, Marie. So China, you remember, was a deferred entity long planned. In fact, we've been planning for it more than 1.5 years now. Several steps involved. The first step of which is getting a business license and we've actually done so already. And so with the receipt of that business license as required by local regs and again, as long planned, we've suspended manufacturing operations. We wanted to take advantage of the fact that since the operations are suspended, we wanted to do our first deployment of an ERP solution and that's going on right now. Obviously, when you implement ERP at a plant, you want to be able to test that and run through different manufacturing work orders and whatnot to make sure it's all operating. So all of that process is going on right now. Marie, with respect with timing, we've refrained from actually talking about timing. Clearly, we don't want to get ahead of the regulatory authorities. We want them to follow their process. And secondly, obviously, it would be competitively sensitive information. China and emerging markets tend to be fairly competitive markets. Having said all of that, we certainly built up enough inventory to cover and maintain continuity of product supply to our customers during the anticipated time. Everything so far is going per plan. And certainly, our thoughts are all incorporated in the guidance that we gave for this year.

And Marie, maybe I'll just jump in here. As it relates to the potential margin pressure, obviously, as Dev said, we're anticipating a sequential step down in part due to the fact that we're going to see some negative manufacturing variances as a result of this temporary suspension. Again, I think it's still too early at this point in time and we certainly don't want to jump in front of any regulators regarding timing. But we will see some continued year-over-year margin pressure as a result of that in the near term. And then I think it's probably still a little bit too early to talk specifically about calendarization for 2024. But obviously, this is something that we've known about for quite a long period of time dating back to the pre-spin periods. And we still feel very comfortable and think that an adjusted EBITDA margin of approximately 30% for 2024 is still very reasonable.

[Operator Instructions] And our next question comes from Travis Steed of Bank of America Securities.

I guess the first one, I'll ask on the patch pump. Just curious, have you already started a trial with the patch pump? I know you've said timing, not in 2024. But is there a chance that we could see something in 2025 there? Just any additional color you can provide on that pipeline program.

Yes, Travis. When you ask about the trial, I assume you are talking about a trial for the closed-loop pump, that, obviously the data of which will be submitted to the FDA with our 510(k) for the closed loop. We have not started that trial. Our focus right now is on the open loop system. As we have said, we want to do the open loop 510(k) into the FDA first. What we have done, is we've started a small observational study with Tidepool and actually, we've started the development work on engineering -- the engineering work required to integrate the Tidepool algorithm with our system. And so certainly, you can see that we are working in parallel on our closed-loop system but our initial focus is still getting on the -- getting the FDA 510(k) in for the open loop system. With respect to timing, look, you know -- I know we've said in '24 no revenue. But I recognize that as we go through 2024, we certainly will want to provide a multiyear outlook. And as part of that, certainly, we'll be talking about our patch pump as we go through 2024 as well. But to answer your question directly, the trial that we have is an observational study, certainly will provide us data that will help with the development of the closed-loop system but it's not the data that will get submitted to the FDA for the closed loop 510(k) clearance.

Great. And the follow-up, there's been a lot of conversation on kind of the competitive threats from the pharma side of things, one, once weekly insulin and two, GLP-1s. So the way I'd ask the question, first is -- are you spending money today like on R&D and manufacturing to develop products that could actually benefit from GLP-1s? And then the other way I'd ask the question on once weekly insulin, just trying to think about like your overall mix of your business, will -- does it match the overall market where roughly half of those patients are on basal-only insulin? And how do you -- would you think about the impact if patients go from 7 in basal injections per week to 1 per week.

Yes, Travis. Look, with respect to GLP-1s, I mean, that's a market we watch closely. I think it's, frankly too early to say what impact it will have over the long run. We watch those -- we get all the market data, we see what's going on with the prescriptions. Right now, the data is a little bit confounding because there are a lot of prescriptions also for obesity as we've all been reading in the press. And also, the progression from -- all the way from diet and exercise for type 2 to the oral drugs to injectable drugs and then finally to insulin, I mean that's a multiyear process, right? So it's going to take some time for us to fully understand. You also know that this is mostly a developed market, primarily a U.S. phenomenon, right? All our growth really is coming from emerging markets. What we've seen and GLP-1s, by the way, have been around for a number of years, right? What we've seen is our U.S. business has stayed fairly stable over that time. We don't want to project sort of going out in the future, what we do to our business but it is something that we are watching carefully. With respect to the program of -- with respect to your question on what are we doing, if you will, broadly speaking, to maybe take advantage of the tailwinds in the new drug space. I mean, again, I don't want to talk specifically about R&D programs but it is an area we're watching closely. Certainly, some of the ways these drugs are delivered matches well with our manufacturing competencies, right, injection molding plastic parts, attaching needles to them to create delivery devices for these drugs. So it's an area of interest for us, Travis. But honestly, I don't want to go beyond that with respect to where we are spending money on specific programs. With respect to once weekly insulin, I would largely put it in the same category of new drugs. I mean once you take insulin on a weekly basis, right, there is always the danger of have you taken too much. So I think we got to wait and watch to see what happens with once weekly insulin. With respect to sort of the proportion of our product that goes into basal insulin versus multiple daily injections, look, the market data on that is not very clear. At the point of dispensation, we don't get data that tells us whether patients are using our products for daily injections or weekly injections. And so rather than sort of give vague estimates, I'm just going to say that, again, that's going to be a U.S. phenomenon. Our growth is in emerging markets. We don't expect any of these new drugs, frankly, whether it be once weekly insulin or these new GLP drugs to make their way into emerging markets in any material way for a period of time.

I would now like to turn the conference back to Dev Kurdikar for closing remarks.

Thank you. Before we conclude the call, I would like to express my gratitude to all my colleagues around the world for just the incredibly immense amount of work that they've been doing over the past 1.5 years to stand up Embecta as an independent company. That they have been doing so without impacting our customers through what has been a fairly challenging operating environment and in the midst of a spin, is a testament to their commitment to fulfilling our mission of developing and providing solutions that make life better for people with diabetes. Thank you all for attending the call. We look forward to speaking with you again in a few months and thank you for your interest in our business.

This concludes today's conference call. Thank you for participating and you may now disconnect.