Great. Okay, the time has started, so let's begin. Kallum Titchmarsh from the U.S. MedTech team here at Morgan Stanley. Really pleased today to be joined with the Embecta team. We have Dev, Jake, CEO, CFO respectively, and Pravesh in the audience as well from IR. Thank you all as well for coming. Before I get started, I need to read some disclaimers. For important disclosures, please see the Morgan Stanley Research Disclosure website, morganstanley.com/researchdisclosures. Okay. Thank you, gents, for coming.
Thank you.
Thank you.
So let's track back in early August. Let's start with the fiscal year Q3 results. Wasn't particularly surprised to see a beat and raise, but maybe you could give us an overview of what you saw play out through the quarter. I think the biggest beat was below the top line, but it seems there were some one-timers there as well. So maybe level set us what you saw. Anything surprise you in particular?
Yeah, so maybe I can get started here, and then Jake can fill in some more information here. But overall, look, largely aligned with what we expected. This year in particular, as you know, we've been doing a series of ERP implementations. Along with that, moving distribution network from our former parent, BD, to our own, and simultaneously standing up shared services, right? So in advance of all of these implementations, which obviously have consumed a lot of time, we've also made sure that we don't have a discontinuity in product supply. And what that has meant is, you know, some inventory stocking with distributors so that they do have enough inventory to continue to supply patients if we were to have an issue. And so that has led to certain lumpiness in distributor ordering through the year.
This quarter, in particular, from a revenue standpoint, was, you know, a little bit low from what would have been a normal quarter, but it was something that we had signaled at the Q2 call because we had some pull forward of product ordering in Q2, then at the gross margin line, there was certainly some one-timers that impacted us favorably in Q3, and maybe Jake can talk about those.
Yeah, so we saw because of the large buildup in terms of inventory in advance of the ERP go lives, we had an amount of profit in inventory that was sort of capitalized on the balance sheet, and then once we ended up selling that product into the end markets, we ended up releasing that profit. Now, normally, we recognize, you know, PII, smaller amounts, you know, in any given quarter. There was a larger bolus that ended up positively impacting us, you know, this quarter. You should think of that sort of, that would've ratably happened normally under more normal circumstances, you know, throughout the year. It just so happened to impact us, you know, favorably in the quarter.
But coming back to, I think, something that Dev had said, I think if you look at our business, we thought all along pre-spin that this was going to be a very, very stable business.
Mm-hmm.
Now, there was a lot of separation work that had to occur over the last two and a half years in order for us to sort of maintain that stability, but that's largely how things played out. On a year-to-date basis, our business, if you put aside the sort of small contract manufacturing revenue of the non-diabetes products that we sell to BD, our core injection business has grown about 0.4% on a constant currency basis. And if you peel that back even a little further, what we're seeing there is that our syringe business has been declining, let's call it double digits, 13%, year- over- year for the first nine months of the year. That's a trend that we have seen happen for the last several years occur.
Now, more offsetting that is the fact that our pen needle business, which makes up $850 million, give or take, of our $1.1 billion in revenue, has actually been growing 4% on a constant currency basis. In addition, our, our safety products, whether it's pen needles or syringes, has been growing around 2%. So of the, let's call it $950 million of our $1.1 billion in revenue, it's actually been growing around 2.3%-2.5% constant currency year to date. It's really this phenomenon with syringe, and largely in the U.S. business in syringe, that has been causing these declines.
As we move forward here, you know, the amount of U.S. revenue associated with syringe is going to become less and less, so it's gonna become less and less of a headwind as we move forward in future years, but the core business, despite having to go through a tremendous amount of separation work, has remained incredibly stable. The higher margin products that we have within our portfolio have actually been growing, let's call it two-ish%, and at some point in the future, those syringe declines are just gonna become de minimis in the U.S.
That makes sense, and let's just zoom out a bit on market trends in the core business. Less of a debate from the incoming than I get right now, but let us know what you're seeing on the insulin demand side. I think last year there was a little noise around that, the GLP-1-
Yeah
Patch pumps as well. So just let us know what you're seeing.
So the insulin demand in the aggregate level, certainly in the U.S., remains stable. But I think what's interesting is if you parse that insulin demand and say: What's going on with insulin delivered in pens versus insulin delivered in vials? You see a bifurcation. And what I mean by that is insulin delivered in pens is actually stable to maybe even slightly growing.... insulin delivered via vials is declining and has been. And that matches well with what we see internally with what's going on with syringes. That the vial, therefore the syringe usage continues to go down. Pens is flat to maybe even slightly growing. And in aggregate, therefore, insulin remains sort of stable. That's something that we've observed for a period of time and continue to observe now.
If you go outside the U.S., certainly in emerging markets, our growth rates in emerging markets are well aligned with our expectation. I've often said that, you know, we expect sort of low to mid-single-digit growth over there. Again, this year has been a little lumpy as we've been through the ERP implementations, but on a year-to-date basis, I think it's fair to say it's well aligned with our expectations. And then, if you look at the other developed markets, this all falls somewhere sort of in between.
Got it. And in the U.S. specifically, I think you've been clear historically that price has helped to some degree. From some of our channel checks, there may be some resistance, it seems, to continued price hikes looking forward. Is that fair, do you think? And how are you thinking about your pricing power looking ahead?
Yeah. So, obviously, I wouldn't comment specifically on our forward sort of pricing strategy here, but pricing has been an important factor for us over the last several years in many markets around the world, not just in the U.S., and we'll continue to look for ways to optimize price going forward. Is it possible that there might be increasing resistance to pricing? Entirely possible, right. And certainly, you know, when we gave guidance for the rest of this year in August, we took all our latest information into account. When it comes to twenty-five and beyond, we'll certainly talk about that more on Analyst Day. But your broader point being, you know, could you see increasing resistance to price in certain markets? Absolutely, that's possible.
But again, we'll try to find ways to optimize that around the world. And then, you know, the impact on margins, certainly we're gonna try to optimize our cost base as well, right? Because obviously, pricing has been an important factor in us being able, over the last two and a half years, to deliver on the margins that we've delivered so far.
Great. Maybe we could spend some time talking about international. It's obviously a big part of the business. You mentioned, you know, you're seeing trends shifting away from syringes over to pen needles. Maybe touch on some regions in particular that you've seen an acceleration of that trend, which, you know, are driving the growth in that part of the business for you guys.
Yeah. That trend is most prominent in the United States.
Yeah.
And it's not a new trend. I mean, this has been going on for a long period of time. And I think syringe usage is declining as some people convert over from syringes to pen, even though pens have been available now in the U.S. for decades. But as payer coverage changes, as certain insulin forms become available in pens versus vials, you do get that patient shift from vials to pens. In terms of new patients that are being exposed to insulin therapy, more likely than not, it's pens. But I don't think we can also ignore the fact that during the COVID epidemic, it impacted seniors disproportionately. Seniors have 3X the prevalence rate on diabetes as the general population, and because of the advanced age, also more likely to use insulin, and that impacted syringe demand as well.
So for those factors, I do think we have seen and will continue to see syringe decline, but we are heartened by the fact that both insulin and pens, right, which is a key driver of the demand for our products, remain stable to into growing. Certainly, our pen needle business has continued to grow over time as well.
Opportunities ahead. I think the most eye-catching thing for me from the Q3 print was on the GLP-1 pen needle opportunity in Germany. Maybe refresh us on what that offering is, how you went about getting it in place, and which countries are next to target?
Hmm. Yeah. So, you know, I'm gonna take this opportunity, Kallum, also to talk... Answer your questions, but maybe expand a little bit on-
Sure
You know, how I think GLP-1s could potentially be a sustainable tailwind for, for us over a number of years, right? Even five to ten years. But to answer your question specifically, it's a, it's a small pack. It's fourteen counts. Why fourteen count pen needle? Because, you know, typically with a three-month subscription, prescription, you would need twelve pen needles, but obviously you want to have extras. Lilly's launching Mounjaro in a pen in Germany. Pen is the same pen that they've used before for insulin. It's compatible with our pen needles. And so our team saw an opportunity there that obviously, if a patient is going to go pick up a three-month prescription of GLP-1s from their pharmacy, you don't want to give them a hundred-count box of pen needles, right?
Getting the right three-month supply of pen needles at the point of dispensation with a three-month supply of GLP-1 made instinctive sense. Now, what that allows us to do is obviously optimize pricing for GLP-1 delivery using a pen needle, and so certainly, you know, we've taken advantage of that opportunity available to us. And as GLP-1 delivery via pens increases around the world, certainly we are watching that closely, and we'll introduce the right small count pack for that country over time as well. Now, to speak about GLP-1s a little bit more broadly, right? GLP-1s, initially, when they were launched, they still are available in the form of autoinjectors. Novo sells Ozempic in the form of pen. It comes co-packaged with pen needles, right? And we'll see over time whether they continue to co-package pen needles in countries where they're allowed to.
But in a couple places like China and Japan, you can't co-package pen needles with pens. Lilly has spoken openly about, you know, launching GLP-1s with KwikPens, and that was the opportunity in Germany. There will be opportunities. They have. I believe they have KwikPen approval for Mounjaro delivery in Europe as in other countries in Europe as well, and we are watching that closely. As the delivery forms, you know, changes or the mix changes between autoinjectors to pens, certainly we can capitalize on that because our pen needles are compatible. But, we fully expect that over time, biosimilars will enter the fray as well, and we are in discussions with multiple potential biosimilar entrants about co-packaging our pen needles with their drug as well.
The pen needle that we have currently, we believe is well qualified to be part of that, including we have some data for cold storage, which is important for co-packaging, and so we are involved in those discussions as well. And so over time, we think that the use of our pen needles for GLP-1 delivery can be a tailwind. It's one that we have the capacity in place to fulfill, so we don't need incremental capital. And given the highly automated nature of our plants, you know, any revenue contribution from incremental pen needle volume for GLP-1 delivery has a pretty significant drop through our P&L. And so we remain excited about this opportunity broadly, and we think, you know, it certainly has the potential to be a multi-year tailwind for us.
When does that become more evident in the P&L?
So I think, look, this is evolving. I think it's going to be driven by the availability of pens for GLP-1s. But certainly, look, we'll monitor our performance in Germany over time here, over the next year, and then I think we'll be in a better position to sort of use at least that data point to have a more refined estimate of when you'll actually see the impact of that in our P&L.
We received some questions, I think, last week or the week before, around Lilly and Zepbound vials, which maybe that's something you could potentially benefit from?
It is. Look, any delivery form of GLP-1 that uses our existing products, whether it be pen needles or syringes, obviously is a net benefit, a net benefit for us, right? On syringes, obviously, I want to caution that our syringes are marked for insulin delivery. They're not marked for, you know, the actual markings in the barrel, not for GLP-1 delivery, so they're not indicated for GLP-1 delivery, and also, I think it remains to be seen whether vials actually become a sustainable form, if you will, of GLP-1 delivery over time, or whether it is something that as GLP-1 manufacturers are trying to get beyond the shortages that exist, is sort of, if you will, a temporary fix or not, right? It remains to be seen.
But, you know, more broadly, anything that expands the use of our currently made products is gonna be a net benefit for us.
Great. And then the patch pump, open loop system received approval last Friday. How would you describe the company's motivation behind the patch pump program right now?
Yeah. So, first of all, thrilled to receive that clearance. Our team has been hard at work since spin, and it was one of the three priorities that we had laid out pre-spin, right? Stabilize this core business, separate and stand up, and then, you know, the investments we're putting into putting behind Zodiac. So absolutely pleased to see that pay off with a 510(k) clearance on the open loop. But I also want to remind everybody that it was part of a broader strategy, which was, listen, what we are after is a closed loop pump.
Mm-hmm.
But rather than doing all the pump hardware, software development and then doing a clinical trial and then getting the whole thing approved at one time, this was a way to de-risk by getting the hardware, software development get done as an open loop, getting the clearance. Because now what we have is, we have a pump that's got 510(k). We signed up with Tidepool, that has 510(k) clearance for Type 1, and obviously we would integrate with the CGM, which are obviously commercial, right? So sort of that de-risks the closed loop now down to, you know, human factors studies and a clinical trial.
I think what I want to say about the patch pump is we are very sensitive to the fact that our net leverage stands at approximately 3.7 at the end of the last quarter. Over the last couple calls, we've started talking about our desire to have more material pay downs of debt, beyond the mandatory required for our Term Loan B. So the way we think about pump investments broadly, whether it be commercial or R&D, is we want to do them in a measured way, because paying down that debt and managing net leverage is a key priority.
I think the way we'll approach this, we won't give numbers for 2025 and beyond yet, but the way we will approach this is really to start thinking about what's the right level of pump investment that we should make, keeping in mind our other priorities, and then making some trade-offs between where that money gets spent, right? Does it get spent on, for example, enhancements we can make on open loop? You know, we have six-month shelf life now, right? Because we wanted to get the pump done, and obviously, getting more data just requires more time. We could go get. We are getting more data to extend that shelf life. You know, the pump that got approved with an open loop comes with a lockdown wireless controller, but we know patients want a BYOD approach. Certainly, that's another area we could pursue.
Extended wear is a third area we could pursue, especially taking advantage of our 300-unit capacity for a reservoir, and then, you know, obviously, there's the clinical trial for a closed loop, and so we'll monitor pump spend carefully, be very choosy about where we spend. I think one thing I would like to sort of make sure everybody understands is that we don't, at this point, intend to do a full commercial launch of our open loop because we recognize now, as we recognized two years ago, that in this marketplace, what you really need is a closed loop pump.
How limited of a commercial launch will it be for the open loop?
How unlimited?
How limited?
How limited? Quite limited.
Okay.
Listen, we'll talk more specifically, you know, when we talk in December, right? Again, let me just expand on that because I'm not trying to... Given the product enhancements we wanna make, we do think there's an opportunity to put the pump in the hands of, you know, a very, very small number of patients, so we can actually get real-time feedback in terms of how the pump performs, even as we are making these choices between where we want our pump investment to go. You know, what we are not inclined to do at present is, you know, right now in the early stages, add, you know, a number of heads to go start selling this pump into PCPs or endocrinologists at this point.
That's not something that we are contemplating at this point. We are more focused on, you know, like I said, what's gonna be the right investment level and, you know, within that investment level, where should we spend our money between product enhancements, closed loop, and commercial?
Timelines on the closed loop, anything you can give us roughly just to put us in the right zip code?
Yeah, look, you know, we've said closed loop in the past. I mean, let's think about what needs to be done, right? I mean, I think there is integration work that needs to be done between the pump sensor and the algorithm, the human factors studies that need to be done, and then obviously there's the clinical trial, right? The clinical trial is gonna involve a number of patients, right? Hundreds, you know, typically 13 weeks plus some follow-up time. So you could imagine a clinical trial, you know, between start to finish, easily taking a year or more. And then you add in all the integration work and some human factors work, you could be looking at a couple years timeframe, roughly, right? And so I think that's the right way to think about it.
Now, listen, we just got open loop, right? We got to lay out our plans more specifically for closed loop. So, so I hope you don't mind that I reserve the right to sort of revise the timeline as we do some more work. But, but what I do want to say is, you know, it's not five years away now that we have open loop approval.
Very fair. And on the 300-unit reservoir, why don't you think that's worked in the market before?
Look, I can't comment on why it hasn't worked in the market for other places before, but maybe what I can comment on why certainly we think it's the right product, specifically on Type 2. Like, the most obvious one is the 300-unit reservoir, right? I mean, Type 2 is required on average, about 100 units a day, a 3-day wear. It makes sense, right? I think it makes also sense from a payer perspective, because the cost per day could potentially be lower. But there are other factors, I think, in the design of the product that sort of give us some incremental confidence about why this product starts. For example, you know, we have far fewer basal rate settings than the predicate device here, which sort of argues for less complexity.
We've tried to design the user interface in such a way that it's easier to use. You know, it's a fully disposable pump, unlike some other pumps that have reusable components. Therefore, it can flow easily through the pharmacy supply chain, and obviously, we have a lot of experience in selling products to the pharmacy. We have established relationships with all the key retailers. You know, 95% of the covered lives in the country have some sort of payer relationship with us, so we have good payer network coverage as well, so I think for all those reasons and finally, obviously, while the product is indicated for both Type 1 and Type 2, given that we've designed it with some Type 2 considerations in mind, you know, we would sort of be, from a marketing standpoint, more targeting Type 2.
Type 2, as you know, is a progressive disease, right? I mean, most of these people are starting with exercise and ending up with insulin, but when they start with insulin, they're starting with a basal injection, more likely than not using our products. So we have a unique opportunity to sort of reach these people with diabetes and inform them on the availability of our products. So I do think that we have some things that give us some incremental confidence around why this product, you know, could get adopted.
Is it fair to say at the planned Investor Day, I think in December, maybe, we're gonna get more color on the costs associated with the patch pump, and then maybe some more product differentiation color? Is that fair?
Yeah, I think that Analyst Day, you know, broadly speaking, what we want to do is just lay out certainly what FY twenty-five looks like, but, you know, we're considering sort of laying out here's a three-year roadmap, from a business standpoint, and a financial standpoint.
So you've established significant manufacturing facilities that can produce these med supplies at quite a scale. Are there any additional opportunities aside from those that we've touched on, that you're looking at to leverage those facilities that you have?
Yeah, and that's a great point, Kallum, right? I mean, if you strip down to what are the core strengths of the company, I mean, we are world-class at high-volume medical devices, you know, built using a quality system that today produces 7.5 billion devices that enter the human body. And there are not that many companies that can claim that kind of expertise, right? And it's not just the engineering expertise, but our whole ops team. If you look at 2.5 years, or even more, going through the COVID years, what they have demonstrated over time is the ability to keep product supply in pharmacies so that people didn't get interruption in their care. That is something that we want to leverage.
In a couple of the plants, we even have space available, you know, if we wanted to get into producing other products. And the other strength we have is we can get products into the hands of consumers/patients in more than a hundred countries in the world. So we will be, now that separation is, call it done, but getting close to done, you know, we will be looking at opportunities of how to leverage the strengths. And so broadly speaking, you know, we have several choices here, right? Our cash uses and separation will go down in 2025 versus 2024. We do want to manage our net leverage and start making some debt repayments.
We talked about potential investments in the pump, and we've talked about wanting to take advantage of GLP-1 tailwinds, which is, you know, fits right into the core of our business. And then also look at opportunities, how we can widen the product portfolio here, so that we can really leverage our sales channel.
Are there any agreements in place with BD that prevent you from pushing into other areas within, like, the, I guess, med supplies, drug delivery space?
So there are agreements that were part of our separation agreements that limit what we can do with the technology that came to us with spin.
Mm-hmm.
But I'm not aware of anything that would prohibit us from independently getting into new areas, right? So, you know, we get our cannula from them, right?
Yeah.
We have a cannula supply agreement. We can't use those for anything besides the products we make today.
Got it.
But that doesn't mean we couldn't acquire something else and get into a different space.
Sure, sure. And Jake, on the separation activities, seems we are essentially done now. We're nearly all the way there, I think just some rebranding next year. So any color you could provide us on the next steps here, and any potential financial impact, I think, from that?
Yeah, so separation activities, I mean, as you can imagine, we had 11 major separation, you know, programs. And, you know, life to date, over the last two and a half years, we've probably spent around $400 million worth of our cash on separation activities, including, you know, we estimate to spend around $180 million this year, a mixture between mostly OpEx and some CapEx associated with the ERP systems. That's probably two X what was originally included in the pre-spin, you know, model. And I think it's something that, you know, candidly, really has masked the free cash flow generation capabilities of this company.
The amount of cash that we've had to use to be able to separate as effectively as we have and avoid any type of, you know, ERP disruptions or distribution network disruptions and set up our own shared service functions and whatnot. You know, in addition, you know, pre-spin SOFR rates were close to zero. We probably had to absorb another $35 million per year in annual interest expense over and above what the pre-spin deal model would have indicated. You know, we started the spin at around, let's call it, $270 million in cash on hand.
At the end of last quarter, we had about $280 million of cash on hand, and that's despite using a significant amount of cash, you know, obviously, for separation, for interest, and then we also continued to pay around a $35 million dividend. I think as we move forward here, we certainly expect to see the costs associated with those one-time separation activities to materially decrease. On our last earnings call, I think we talked about it going from around $180 million in 2024, down to somewhere in that kind of $50 million-ish range, you know, next year. The overwhelming majority of that is gonna be spend associated with brand transition.
and that BD transition activity is going to last, you know, into twenty twenty-six. So we're going to see a material step down and improvement, if you will, in free cash flow generation next year as the separation costs go down. There's still going to be some lingering amount of separation activities associated with BD that's going to linger into twenty twenty-six, but then beyond that, it really goes away. And I think it's really going to free up, beginning next year, it's really going to free up our, you know, the options that we have as to what to do with that cash. And, and, you know, Dev mentioned several times, you know, there's an intention here to make significant amounts of more material debt repayment beginning in twenty twenty-five.
On that debt repayment, you said leverage is about three point seven times. Is there any, you know, target maybe you're pushing for next year that you can maybe give us some color around right now?
Yeah. So, the three point seven times, again, net leverage, right? So it takes into consideration the cash that we have on our balance sheet. That being said, we do want to actively de-lever and help reduce interest expense moving forward. Over the longer term, I think to the extent that we could target a capital structure with a net leverage ratio in or around the three times mark, I think we would feel comfortable with that. So, you know, from time to time, that might continue to dip below three times.
If we found something attractive in terms of an acquisition, that would take that up, as long as there's a path back down over the next, let's call it, twelve to eighteen-month time period, to, to bring that back down closer to a three times net levered mark, I think we would feel comfortable with that.
Understood, and then on the longer-term margin outlook for Embecta, I think the Street's kind of hovering around 30% EBITDA out to, like, 2027. What are the drivers, in your opinion, that are crucial to margin expansion, if you think there's room for some, looking ahead?
Yeah, so I think I'm going to refrain from giving specific, you know, commentary regarding twenty twenty-five through twenty twenty-seven. You know, we'll certainly do that, as Dev mentioned, at the Analyst Day in December. But, you know, maybe... Look, in relation to sort of pre-spin margins that we would've laid out, you know, we talked in March of twenty twenty-two about a flattish, you know, top line and a gross margin profile that was sort of in the low sixties, and EBITDA margin profile that was around 30%. You know, I'm pleased to say that as we've gone through an enormous amount of separation activities, we've done a little bit better than that in terms of the financial performance.
You know, the top line CAGR is gonna be somewhere in that kind of one-ish % range, so modestly better than flat. You know, the EBITDA profile is gonna end up being somewhere close to 125-150 basis points better than what we had laid out, you know, sort of pre-spin, and that's largely coming from the gross margin line, and that comes despite having to absorb probably close to 400-500 basis points of inflation that was never previously contemplated in those pre-spin margins. How have we been able to do that?
We've really been able to do that through a, you know, an excellent supply chain team continuing to take costs out of the system, as well as our ability to drive price and favorable mix. You know, more higher margin pen needle and safety products, and less of a focus, if you will, in terms of syringe volumes. Now, this business has remained incredibly stable, despite a lot of noise going on regarding GLP-1s and whatnot, since spin. And I think as we move forward, I think there's going to be additional opportunities to rightsize the cost structure associated with this organization. I mean, very deliberately, we have not done that to date.
But there is going to be an opportunity as we move forward to rightsize and do some cost optimization to kind of our core business. I think that this business could benefit, as we've said, from GLP-1 tailwinds moving forward, and that's going to sort of, you know, then help counterbalance additional investments that we're going to choose to make, on the pump, and any potential pricing pressure that we may see, you know, moving forward over the next few years. But this business, I think, has been incredibly, incredibly stable, despite going through a lot of separation work. And I think, you know, our thoughts are that over the next several years, this business is gonna continue to be pretty stable.
Pretty helpful. I think that takes us to time. Dev, Jake, thank you so much.
Thank you.
Thank you.
Thank you for having us.