Embecta Corp. (NASDAQ:EMBC) Q1 2024 Earnings Call Transcript February 9, 2024
Embecta Corp. misses on earnings expectations. Reported EPS is $0.3497 EPS, expectations were $0.45. EMBC isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).
Operator: Welcome ladies and gentlemen to the Fiscal First Quarter 2024 Embecta Earnings Conference Call. At this time, all participants have been placed in listen-only mode. Please note that this conference call is being recorded and 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 call over to your host today, Mr. Pravesh Khandelwal, Vice President of Investor Relations. Please go ahead.
Pravesh Khandelwal: Thank you, operator. Good morning, everyone, and welcome to Embecta’s fiscal first quarter 2024 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 constitute 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 some remarks on the overall performance of our business during the fiscal first quarter of 2024 as well as an overview of our strategic priorities.
Jake will then provide a more in-depth review of our Q1 financial results as well as our updated financial guidance for the year. We will then open the call for questions. With that said, I would now like to turn the call over to our CEO, Dev Kurdikar. Dev?
Dev Kurdikar: Good morning, and thank you for taking the time to join us. With the introduction of the first specialized insulin delivery device in 1924, this year marked the 100th year of our journey to deliver better diabetes care through innovation. Whether you are newly diagnosed, or transitioning to a new line of therapy, our mission is to make a person with diabetes every day experience as comfortable and convenient as possible while advancing towards a new generation of life-changing solutions. We have been one of the leaders in insulin delivery for nearly 100 years. And through our insulin delivery products, we touch an estimated 30 million people living with diabetes in over 100 countries, developing and providing solutions that make life better for people living with diabetes is at the core of everything we do and is what drives our global team.
Turning to our strategic priorities for fiscal year 2024. We will continue to be focused on the same three core strategic priorities that we have had since we became an independent company. These priorities have served as the foundation for our actions and decision-making, driving our company forward, and they include, remaining focused on strengthening our base business while maintaining our global leader position in the category of insulin injection devices, separating ourselves from our former parent in a thoughtful manner to mitigate risk and position us for success as an independent company, and finally, 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 advancing with determination and a sense of urgency in each of these objectives, and I’m very pleased with the progress that we’ve made in these areas. Turning to some first quarter highlights. First, we published our 2024 environmental, social and governance report. This report provides a summary of the progress we made in 2023 to develop our ESG strategy, including establishing policies and systems that underscore our commitment to delivering our products and solutions responsibly and with a view towards how our business impacts the broader communities in which we operate. Next, the team’s hard work gained recognition, leading to the acceptance of six Embecta abstracts as posters for presentation at the upcoming Advanced Technologies and Treatments for Diabetes or ATTD Conference in March.
We believe that poster presentations like these continue to validate our value proposition that a larger insulin reservoir would benefit a person with Type 2 diabetes and potentially facilitate more adults using a single pump for a full three days, resulting in a greater health economic benefit to patients and payers. Additionally, Embecta is set to host an industry-sponsored symposium at ATTD focused on unlocking the potential of insulin pumps for personalized Type 2 diabetes care. These educational objectives align with our commitment to innovation and improvements in diabetes care. By supporting this symposium, we are excited about the potential for helping advance informed decision-making around insulin pump therapy for patients with Type 2 diabetes.
During Q1, we also notably advanced our separation programs by completing the implementation of our ERP system for approximately 60% of our revenue base and our manufacturing facility within the US, while also operationalizing new shared services capabilities and the distribution network serving the US and Canadian markets. Furthermore, we made significant progress in terms of the development of our insulin patch pumps that are being developed specifically for the Type 2 market, including the filing of a 510(k) premarket application for the open loop version of our insulin patch pump with the FDA. I’ll share more about these latter accomplishments in the following slides. Finally, during the first quarter, solid execution led to financial results that exceeded our internal expectations.
And based on these results, coupled with our outlook for the remainder of the year, we are raising our financial guidance ranges for revenue and adjusted earnings per share. Next, I would like to get into a bit more detail regarding the advancements we made in terms of our separation efforts. As I just mentioned, during Q1, our team made significant progress in the global implementation of our ERP system, shared services capabilities and distribution network. These are complex programs, and we’ve adopted a phased implementation approach to mitigate the separation risks. As of today, we have implemented our ERP system and operationalized shared services capabilities and a new logistics and distribution network to support the US and Canadian markets.
In addition, we implemented our own ERP in Suzhou, China and Holdrege, Nebraska, which are two of our three manufacturing plants. During our fiscal second quarter, we plan to implement our systems, capabilities and processes in additional markets as well as at our remaining manufacturing plant in Ireland. As such, by the end of our fiscal second quarter, we anticipate having slightly more than 85% of our revenue base and all three of our manufacturing locations on our own ERP platform. We anticipate implementation of our ERP system and the relevant shared service capabilities in all markets, excluding those in deferred closing jurisdictions within a few quarters. To facilitate the phased implementation of our ERP solution, distribution network and shared services capabilities, we had requested an extension for certain TSAs and related agreements from BD.
BD agreed to provide a limited extension, contingent upon securing additional private letter ruling from the IRS. This ruling would enable us to extend specific TSAs for a limited set of markets until early fiscal year 2025. Throughout the company, we have been and will continue to exert substantial efforts to mitigate the risks associated with potential disruptions as we transition away from TSAs with BD and implement and integrate our own systems and processes. While we have been generally successful at avoiding major disruptions, there is a possibility of temporary sales disruptions in specific countries as we navigate the complexities of securing all necessary product registrations, licenses and other requirements while concurrently standing up our own systems and capabilities.
Lastly, and as we’ve mentioned on prior earnings calls, we had completed several important steps in the demerger process for our Suzhou, China manufacturing entity in order to ultimately transfer that legal entity from BD to Embecta. I am pleased to report that we have completed the China legal entity transfer, and we anticipate resuming domestic production for the Chinese market in our fiscal second quarter, which is in line with our previous expectations. We had previously commented that this plant was already manufacturing products for export to other markets. This is a significant accomplishment by our team and culminates a process that has spanned years in planning and execution. Turning to our insulin patch pump program. A month ago, we announced the submission of our 510(k) application for the open loop version of our insulin patch pump to the FDA.
This marks a critical milestone in the program. We are pleased to have this filing complete, and we look forward to working with the FDA through the review process. We are also continuing our development of a closed-loop insulin patch pump that is targeted for use by individuals who have Type 2 diabetes. The pump hardware is expected to be substantially the same across both the open loop and closed loop versions. This should allow us to streamline development across our patch pump platform while also addressing a potential market need for an open-loop pump tailored for Type 2 users. One noteworthy feature of our pumps is the insulin reservoir size, accommodating up to 300 units. We believe this enhancement is crucial considering that Type 2 users typically require up to 100 units of insulin daily.
Our goal is to have a three-day wear indication for our pumps, that would provide an appropriate supply of insulin that better aligns the needs of users and payers with the pump replacement cycle. While our open loop submission is under FDA review, we are also actively advancing our closed-loop pump development in collaboration with Tidepool. As a reminder, Tidepool already has a standalone Type 1 algorithm cleared by the FDA and we are working with them to adapt their algorithm into a Type 2 closed-loop system. We are pleased with the progress made so far and proud of the team that has managed to execute this program while also maintaining their focus on multiple separation activities. Now let’s review our first quarter revenue performance in a bit more detail.
During Q1, we generated revenue of $277.3 million, which represented an increase of 0.6% on an as-reported basis and a decline of 0.3% on a constant currency basis. When normalizing for the impact of year-over-year changes of the non-diabetes products that we contract manufacture and sell to BD, our underlying core injection business grew 0.5% on a constant currency basis. Our Q1 revenue exceeded our previously communicated expectations, primarily due to the timing of customer orders in advance of our aforementioned ERP implementation as well as FX tailwinds in relation to our original outlook. As a reminder, when we provided our initial financial guidance for fiscal year 2024, we indicated that we generated approximately 49% of our fiscal year 2023 as reported revenue dollars during the first half of that year.
And that we anticipated generating a slightly lower percentage of the midpoint of our annual as-reported revenue dollar range during the first half of 2024. We continue to believe that this will be the case as the positive impact from the timing of customer orders that occurred during Q1 is expected to unwind during fiscal Q2. And while these remain our assumptions, as I mentioned earlier, we do plan on implementing our ERP system and other previously noted associated capabilities for additional markets within our fiscal second quarter. And as such, we may see some atypical ordering patterns within the next few quarters. Turning back to our Q1 results. From a geographic perspective, revenue came in better than we previously expected in many regions including the US, Canada and Asia.
Regarding the US, during the quarter, revenue totaled $148.6 million, which represented a year-over-year decline of approximately 0.5%. However, when normalizing for contract manufacturing revenue headwinds, our US core injection business grew by 0.9%. While during Q1 our international revenue totaled $128.7 million, which equated to flat year-over-year constant currency growth. That completes my prepared remarks. And with that, let me turn the call over to Jake to take you through the first quarter financial results as well as our updated full year financial guidance in more detail. Jake?
Jake Elguicze: Thank you, Dev, and good morning, everyone. Given the discussion that has already occurred regarding revenue, I will start my review of Embecta’s financial performance for the first quarter at the gross profit line. GAAP gross profit and margin for the first quarter of fiscal 2024 totaled $185.9 million and 67%, respectively. This compared to $188.8 million and 68.5% in the prior year period. While on an adjusted basis, our Q1 2024 adjusted gross profit and margin totaled $186.3 million and 67.2%. This compared to $188.9 million and 68.5% in the prior year period. The year-over-year decrease in adjusted gross profit and margin was due to the negative impact of foreign currency translation, primarily due to the weakening of the US dollar.
The impact of negative year-over-year manufacturing variances, including the temporary shutdown of our Suzhou, China facility as it relates to production for the domestic Chinese market as well as the impact of inflation on the cost of certain raw materials, direct labor and overhead. These headwinds were somewhat offset by a variety of cost improvement initiatives and our ability to generate positive year-over-year pricing. As compared to our prior outlook, our adjusted gross margin during the first quarter was better than we previously expected, and this was due to the higher-than-anticipated revenue that Dev referred to earlier as well as favorable geographic and product mix and FX. Turning to GAAP operating income and margin. During the first quarter, they were $45.5 million and 16.4%.
This compared to $88.8 million and 32.2% in the prior year period. While on an adjusted basis, our Q1 2024 adjusted operating income and margin totaled $77.5 million and 27.9%. This compared to $101.6 million and 36.9% in the prior year period. The year-over-year decrease in adjusted operating income and margin is primarily due to the adjusted gross profit changes I just discussed, an increase in SG&A costs associated with standing up the organization as well as higher R&D expenses associated with our insulin patch pump program. The adjusted operating income and margin performance during Q1 was better than we previously expected, primarily due to the overachievement at the gross margin line, coupled with the timing of R&D spending within the quarter.
Turning to the bottom line. GAAP net income and earnings per diluted share was $20.1 million and $0.35 during the first quarter of fiscal 2024, which compared to $35.2 million and $0.61 in the prior year period. While on an adjusted basis, net income and earnings per share were $35.3 million and $0.61 during the first quarter of fiscal 2024. This compared to $55.4 million and $0.96 in the prior year period. The decrease in year-over-year adjusted net income and diluted earnings per share is primarily due to the adjusted operating profit drivers I just discussed. An increase in year-over-year interest expense associated with the rise in SOFR and the impact that had on our variable interest rate debt as well as an increase in our adjusted tax rate from approximately 25% to approximately 26%.
I would like to point out that due to certain discrete tax items, our adjusted tax rate in Q1 was higher than our full year guidance, which calls for an adjusted tax rate of approximately 22%. As we move forward throughout the remainder of the year, we would expect our adjusted tax rate to be below 22%. Lastly, from a P&L perspective, for the first quarter of 2024, our adjusted EBITDA and margin totaled approximately $90.4 million and 32.6%. This compared to $110.2 million and 40% in the prior year period. Turning to the balance sheet and cash flow. As of December 31, our cash balance totaled $298.7 million, which was down from our fiscal year-end 2023 balance of $326.5 million. The decline in cash during the first quarter was primarily due to an increase in accounts receivable.
As a reminder, at the time of spin, Embecta entered into factoring agreements with BD in which BD would collect receivables on Embecta’s behalf in exchange for fees. The increase in accounts receivable is a direct result of our implementation of certain business continuity processes in North America, including our ERP system that went live in November of 2023, and expiration and termination of a portion of the factoring agreement between Embecta and BD for services in the United States. As such, Embecta is now responsible for the collection of any outstanding trade receivables in the US and the increase in accounts receivable is a direct result of this impact. And we expect to convert these outstanding receivables into cash during fiscal 2024.
That completes my comments on our fiscal Q1 results. Next, I’ll provide an update on our full year 2024 financial guidance. Beginning with revenue. On a constant currency basis, we are reaffirming our previously provided guidance range which calls for revenue to be flat to down 2% as compared to 2023. The low end of the guidance range continues to assume that about half of the decline will result from reduced contract manufacturing revenue in 2024 as compared to the prior year, while the remaining 1% headwind continues to factor in competitive shifts negatively impacting volume. Finally, the low end of our constant currency revenue guidance range continues to assume that pricing will be flattish as compared to the prior year. While the high end of our constant currency revenue range includes all the same factors impacting the low end, except for a slightly smaller year-over-year headwind associated with contract manufacturing revenue as well as the ability for us to modestly raise prices.
Turning to FX. Foreign currency rates have moved in a slightly positive manner in comparison to our initial guidance. And as a result, we currently expect FX to be a headwind of about 0.4% versus the prior year. This compares to our prior guidance, which called for FX to be a headwind of approximately 1%. These FX assumptions are based on foreign exchange rates that were in existence in the late January time frame, including a euro to US dollar exchange rate of approximately $1.09. On a combined basis, our updated as-reported revenue guidance range calls for a decline of between 0.4% and 2.4%, resulting in an updated revenue guide of between $1.094 billion and $1.116 billion. Turning to margins. We are reaffirming our guidance ranges for our adjusted gross margin of between 63% and 64%, adjusted operating margin of between 23.75% and 24.75% and adjusted EBITDA margin of between 29.5% and 30.5%.
Finally, due to improvements in FX, we are increasing our adjusted earnings per share guidance from a range of between $1.90 and $2.10 to a new range of between $1.95 and $2.15. Our updated guidance range continues to assume that our annual net interest expense will be approximately $116 million, that our annual adjusted tax rate will be approximately 22% and that our weighted average diluted shares outstanding will be approximately 58.1 million. This concludes my prepared remarks. And at this time, I’d like to turn the call over to the operator for questions.
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Q&A Session
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Operator: Thank you. [Operator Instructions] Our first question comes from Kallum Titchmarsh with Morgan Stanley. Your line is open.
Kallum Titchmarsh: Thank you very much for taking the question. I have a couple, if that’s okay. Firstly, maybe if you could provide some color on your own plans of entering the GLP market with your pen needles, specifically, any thoughts on Lilly’s KwikPen for Mounjaro approval in the UK a couple of weeks back, given, I think, Embecta’s pen needles are the recommended choice on the label for this? How should we think about quantifying this opportunity and any additional ones down the line?
Dev Kurdikar: Good morning, Kallum, and thanks for the question. As I’ve commented before, every time a pen is used all over the world, whether it be for insulin or for GLP-1s, given our strong share positions in countries around the world, it certainly positions us well for our pen needle to be used. Most of the pens that are being used out there are compatible with our pen needles. The KwikPen you particularly difference on this call, that is the same pen that’s used for insulin as well. And certainly, our pen needles have a strong position in the UK. I would expect that as GLP presentations maybe change in the ratio over time between vials, pens and auto-injectors, as more and more pens get introduced, and I think Lilly has commented publicly that they certainly are thinking about introducing GLP-1s in more countries with pens.
We certainly expect to benefit from it. The other thing I would point out is some of the older GLP-1s will turn generic this year. They have in certain countries outside the US, and those presentations are also often in pens. And so that will benefit certainly our pen needle business as well.
Kallum Titchmarsh: Great. And then just one more, if that’s okay. On the Q1 margins, specifically on the gross margin side, pretty strong there. You’ve come in beyond 67% for the quarter, yet you’re keeping the full year guide between 63% and 64%. Why shouldn’t those margins remain at these levels throughout the year?
Jake Elguicze: Yeah. Thanks for the question, Kallum. So it really comes down to timing, right? I think in the first quarter, at a very high level, I think we’re extremely pleased with the first quarter results. And I think it’s particularly so when you think about all the separation oriented work that had to occur by all the associates. I think they did a tremendous job of keeping the business stable and continuing to advance obviously, all the ERP initiatives and separation work. So really good start, I would say, to the year from a financial standpoint. We talked about revenue in the first quarter, and revenue was better than we had previously expected it to be. And we largely attribute that to the timing of customer orders in advance of the ERP.
To a far lesser extent, we did see some benefit in the quarter in terms of revenue from an improved FX environment in relation to the original guide. But really, the improvement as compared to our own internal expectations for Q1 for revenue really came down to the timing of the shipments. From a margin standpoint, that again, in relation to our expectations for Q1 gross margin, Q1 gross margins came in very strong at around 67.2% on an adjusted basis, again, largely because of the timing of the revenue that we saw in the quarter as well as the mix of the revenue, and the fact that because revenue was a little bit better, we needed to manufacture more product and had some positive variances in relation to our original expectations. So as we think about moving forward, as Dev mentioned, I think, in his prepared remarks, we think that, that timing benefit from a revenue standpoint will largely unwind itself in the second quarter of the year.
And we still believe that the first half of the year from a revenue and margin standpoint is pretty much almost exactly in line with what we had communicated in our initial guide three months ago. So hopefully, that gives you a little bit more color in terms of the reason for the margin trajectory from Q1 to Q2. On a full year basis, again, we reaffirmed all our previously provided margin ranges, whether it’s gross margin, operating margin or adjusted EBITDA margin.
Kallum Titchmarsh: That’s great. Thanks.
Operator: Thank you. Our next question comes from Travis Steed with Bank of America Securities. Your line is open.
Unidentified Analyst: Hi, good morning. This is [Caroline] (ph) on for Travis. Thanks for taking my questions. I wanted to ask about the patch pumps just following your 510(k) submission in January. Have you gotten any feedback from the FDA at this point? And then just your thoughts on timing of approval.
Dev Kurdikar: Yeah. Good morning, Caroline, and thanks for the question. Look, we’re very pleased to have gotten the submission done almost a month ago now. As you can imagine, this is in the very early stages. Certainly, we know the review is well underway, and our team has been corresponding with the FDA. I wouldn’t want to get ahead of the FDA with signaling timing, certainly so earlier — so early in review process. But nothing atypical so far, Caroline. We look forward to working with the FDA and responding to all the questions that we’ll have. And certainly, when there is something substantial to communicate, we will certainly do so. I should also take the opportunity to mention while that is under review, we continue to work on the closed-loop version of the pump as well. So that work is going on concurrently, and we are pleased with the progress on that version as well.
