Embecta Corp. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. Certain Factors Affecting Forward-Looking Statements The following discussion and analysis should be read in conjunction with the Condensed Consolidated Financial Statements and accompanying notes contained elsewhere in this Quarterly Report on Form 10-Q. This discussion contains a number of forward-looking statements, all of which are based on our current expectations and could be affected by the uncertainties and other factors described throughout this discussion and analysis, particularly in the section “Cautionary Statement Concerning Forward-Looking Statements.” Company Overview We are a leading global medical device company focused on providing solutions to improve the health and well-being of people living with diabetes. In our 100-year history of our business, we believe that our products have become some of the most widely recognized and respected brands in diabetes management in the world. We estimate that our products are used by nearly 30 million people in over 100 countries for insulin administration and to aid with the daily management of diabetes. Our business traces its origins to 1924, when BD developed the first dedicated insulin syringe. Since then, we have built a world-class organization with a unique manufacturing, supply chain and commercial footprint. We have a broad portfolio of marketed products, including a variety of pen needles, syringes and safety injection devices, which are complemented by our proprietary digital application designed to assist people with managing their diabetes. Our pen needles are sterile, single-use, medical devices, designed to be used in conjunction with pen injectors that inject insulin or other diabetes medications. We also sell safety pen needles, which have shields on both ends of the cannula that automatically deploy after the injection to help prevent needlestick exposure and injury during injection and disposal. Our traditional and safety pen needles are compatible and frequently used with widely available pen injectors in the market today. In addition to pen needles, we sell sterile, single-use insulin syringes, which are used to inject insulin drawn from insulin vials. We also sell safety insulin syringes, which have a sliding safety shield that can be activated with one-hand after the injection to help prevent needlestick exposure and injury during injection and disposal. We primarily sell our products to wholesalers and distributors that sell to retail and institutional channels who in turn sell to patients or use the products to deliver insulin injections to patients. Key Trends Affecting Our Results of Operations Competition. The regions in which we conduct our business and the medical devices industry in general are highly competitive. We face significant competition from a wide range of companies in a highly regulated industry. These include large companies with multiple product lines, some of which may have greater financial and marketing resources than us, as well as smaller more specialized companies. Non-traditional entrants, such as technology companies, are also entering into the diabetes care industry and its adjacent markets, some of which may have greater financial and marketing resources than us. Pricing Pressures. We face significant pricing pressures from competitors in the pen needle and insulin syringe categories who not only can provide competitive products at lower costs, but also provide payors and customers with more choices for formulary partners in these categories. In addition, t he increased scrutiny by regulators on healthcare spending, which accelerated in light of the COVID-19 pandemic, along with a shift towards volume-based procurement and group purchasing organizations, which generally values lower cost over product features, benefits and quality, have placed significant pressure on Embecta to lower price in both developed and emerging markets. These trends may reduce our operating margins, which are only partially offset by our ability to differentiate our products and sell at higher prices . Commoditization of Injection Devices. Given the growing demand for medical devices to assist in the treatment of diabetes and difficulties around access to diabetes care due to complex and costly insurance plans, patient care is increasingly focused on providing more affordable products, which has led to the commoditization of more traditional injection delivery devices, such as insulin syringes and pen needles. Existing and new local and regional low-cost providers, in combination with a shift from insulin vials to insulin pens, have made the pen needle category highly competitive. This has forced providers to provide clinical evidence to differentiate their products. Changes in Clinical Practice. Introduction of new drugs and increased penetration of oral anti-diabetic drugs (e.g., SGLT-2s), GLP-1s and GLP-1 combination products have delayed initiation of insulin therapy and contributed to less demand for our products. New drug therapies in development are targeted to challenge the current diabetes treatment paradigm, including the frequency of insulin use. Insulin therapy in developed markets continues to transition to infusion pumps. Decentralization of Chronic Care. Many countries are facing an aging population and a rapidly growing number of people living with diabetes. While healthcare investments in certain regions continue to grow, there is an increased burden on Dollar amounts are in millions except per share amounts or as otherwise specified. 16 Table of Contents physicians and longer wait times for patients. Healthcare delivery for non-emergency diabetes care is expected to continue shifting outside of hospitals to primary care providers, which could have a material impact on our results of operations. Political and Economic Instability in Emerging Markets. We operate in a number of emerging markets, many of which are subject from time to time to significant political and economic disruptions. However, the number of countries we provide products to and our proactive channel management strategies help us manage this variability. Recent Developments We continue to face increases in the cost and disrupted availability of raw materials, components, and other inputs necessary to manufacture and distribute our products due to constraints and inflation within the global supply chain, as well as increases in the cost and time to distribute our products. To date we have been able to successfully mitigate this disruption and provide uninterrupted supply to our customers by increasing our inventory levels and taking other measures. We are continuing to work with BD on the process to obtain a supplemental private letter ruling to the private letter ruling BD received in connection with the Separation and the distribution in order to finalize the conditional limited extension granted by BD to the Company until November 1, 2024 of certain services under the TSA, the Logistic Services Agreement (“LSA”) and other transaction documents in a limited set of markets to support various services provided by BD to the Company, including, but not limited to, information technology, procurement, quality and regulatory affairs, medical affairs, tax and treasury services, distribution logistics, and shared services infrastructure support for order-to-cash, source-to-pay, and record-to-report (“Interim Business Continuity Processes”). We continue to monitor and respond to the conflict in Ukraine and the associated sanctions and other restrictions. We also are monitoring the Israel-Hamas war and Houthi attacks on commercial shipping vessels and other naval vessels. As of February 9, 2024, there is no material impact to our business operations and financial performance as a result of the aforementioned conflicts. However, the full impact of the conflicts on our business operations and financial performance remains uncertain and will depend on future developments, including the severity and duration of the conflicts and their impact on regional and global economic conditions. We will continue to monitor these conflicts and assess the related restrictions and other effects on our business. In addition, our revenues and results of operations have been affected by various fluctuations in macroeconomic conditions and regulatory and policy changes, both on a global level and in particular markets, which include inflation and slowing economic growth and contractions, a rising interest rate environment, supply chain interruptions, tariff policy changes, volatility in capital markets and the availability of credit, tax rates and the rate of exchange between the United States dollar and foreign currencies. The nature and extent of the impact of these factors among others varies by region and remains uncertain and unpredictable and may affect our business. Dollar amounts are in millions except per share amounts or as otherwise specified. 17 Table of Contents Results of Operations Our unaudited Condensed Consolidated Statements of Income are as follows: Three months ended December 31, 2023 2022 % Revenues $ 277.3 $ 275.7 0.6 Cost of products sold 91.4 86.9 5.2 Gross Profit 185.9 188.8 (1.5) Operating expenses: Selling and administrative expense 90.3 72.8 24.0 Research and development expense 20.2 16.9 19.5 Other operating expenses 29.9 10.3 190.3 Total Operating Expenses 140.4 100.0 40.4 Operating Income 45.5 88.8 (48.8) Interest expense, net (27.7) (25.6) 8.2 Other income (expense), net (3.5) (7.1) (50.7) Income Before Income Taxes 14.3 56.1 (74.5) Income tax provision (benefit) (5.8) 20.9 (127.8) Net Income $ 20.1 $ 35.2 (42.9) Net Income per common share: Basic $ 0.35 $ 0.62 (43.5) % Diluted $ 0.35 $ 0.61 (42.6) % Three Months Ended December 31, 2023 Summary (on a comparative basis) Key financial results for the three months ended December 31, 2023 were as follows: • Revenue increased by $1.6 million to $277.3 million from $275.7 million; • Gross profit decreased by $2.9 million to $185.9 million from $188.8 million. Gross profit as a percent of revenue was 67.0%, as compared to 68.5% in the prior year comparative period; • Operating income decreased by $43.3 million to $45.5 million from $88.8 million; and • Net income decreased by $15.1 million to $20.1 million from $35.2 million. Revenues Our revenues increased by $1.6 million, or 0.6%, to $277.3 million for the three months ended December 31, 2023 as compared to revenues of $275.7 million for the three months ended December 31, 2022. Changes in our revenues are driven by the volume of goods that we sell, the prices we negotiate with customers and changes in foreign exchange rates. The increase in revenues was driven by $2.3 million associated with the positive impact of foreign currency translation primarily due to the weakening of the U.S. dollar and $3.4 million of favorable changes in price. This was partially offset by a $2.1 million decrease in contract manufacturing related to sales of non-diabetes products to BD and $2.0 million of unfavorable changes in volume. Revenues by geographic region are as follows: Three months ended December 31, 2023 2022 United States $ 148.6 $ 149.3 International 128.7 126.4 Total $ 277.3 $ 275.7 Dollar amounts are in millions except per share amounts or as otherwise specified. 18 Table of Contents Cost of products sold Cost of products sold increased by $4.5 million, or 5.2%, to $91.4 million for the three months ended December 31, 2023 as compared to $86.9 million for the three months ended December 31, 2022. Cost of products sold as a percentage of revenues was 33.0% for the three months ended December 31, 2023 as compared to 31.5% for the three months ended December 31, 2022. The increase in cost of products sold for the three month comparative period was primarily driven by the negative impact of foreign currency translation primarily due to the weakening of the U.S. dollar, the impact of inflation on the costs of certain raw materials (including freight), direct labor, and overhead, and the impact of negative year-over-year manufacturing variances primarily attributable to the planned temporary shutdown of our Suzhou, China facility as it relates to production for the domestic Chinese market. We intend to continue to work to improve productivity to help partially offset these increased costs. Selling and administrative expenses Selling and administrative expenses increased by $17.5 million, or 24.0%, to $90.3 million for the three months ended December 31, 2023 as compared to $72.8 million for the three months ended December 31, 2022. The increase for the three month comparative period was primarily driven by an increase in compensation and benefit costs due to increased headcount. Research and development expenses Research and development expenses increased by $3.3 million, or 19.5%, to $20.2 million for the three months ended December 31, 2023 as compared to $16.9 million for the three months ended December 31, 2022. The increase for the three month comparative period was primarily driven by increased spending on our insulin patch pump platform. In December 2023, we submitted our first 510(k) premarket filing to the U.S. Food and Drug Administration ("FDA") for our proprietary disposable insulin delivery system. Other operating expenses We incurred other operating expenses of $29.9 million and $10.3 million for the three months ended December 31, 2023 and 2022, respectively, driven by costs related to the Separation. The costs incurred primarily relate to accounting, auditing, legal services, supply chain, employee retention, increased costs associated with the implementation of our new ERP system and other Business Continuity Processes, and certain other costs to establish certain stand-alone functions to assist with the transition to being a stand-alone entity. As we continue to stand-up various corporate functions as a stand-alone publicly-traded company, we expect to incur similar costs associated with the same type of activities in the current year. During the three months ended December 31, 2023, the Company recorded approximately $1.9 million of severance costs related to the optimization of certain business functions. These costs were primarily recorded in the U.S. Severance costs related to the optimization of certain business functions were not material in the comparable prior year period. Liabilities for costs associated with these activities were not material to any period presented. Interest expense, net Interest expense, net increased by $2.1 million to $27.7 million for the three months ended December 31, 2023 as compared to $25.6 million for the three months ended December 31, 2022. The increase for the three month comparative period is primarily a result of higher interest rates on our variable rate debt, primarily as a result of increases in SOFR that impacted our Term Loan, which was partially offset by an increase in interest income from amounts held in interest bearing accounts and money market funds. If the United States Federal Reserve resumes raising the benchmark interest rate, then we would expect the interest expense on our variable rate debt to increase during the remainder of fiscal 2024. Other income (expense), net Other income (expense), net, was $(3.5) million and $(7.1) million for the three months ended December 31, 2023 and 2022, respectively. The costs incurred primarily relate to amounts due to BD for income taxes payable incurred in deferred jurisdictions where BD is considered the primary obligor. Dollar amounts are in millions except per share amounts or as otherwise specified. 19 Table of Contents Income tax provision (benefit) The effective tax rates were (40.6)% and 37.3% for the three months ended December 31, 2023 and 2022, respectively. The decrease in the Company’s effective tax rate from the prior comparative period is primarily due to a tax benefit of approximately $17.1 million for the establishment of a deferred tax asset related to tax law changes in Switzerland. The tax law changes instituted a higher cantonal tax rate and additional tax basis that is amortizable for income tax purposes over a period of seven years. LIQUIDITY AND CAPITAL RESOURCES We believe that our cash and our cash equivalents and cash from operations, together with our borrowing capacity under our revolving credit facility, will provide sufficient financial flexibility to fund seasonal and other working capital requirements, capital expenditures, debt service requirements and other obligations, cash dividends on common shares, share repurchases and additional growth opportunities for the foreseeable future. However, should it become necessary, we believe that our credit profile should provide us with access to additional financing in order to fund normal business operations, make interest payments, fund growth opportunities and satisfy upcoming debt maturities. The following is a summary of Embecta's total debt outstanding as of December 31, 2023: Term Loan $ 933.4 5.00% Notes 500.0 6.75% Notes 200.0 Total principal debt issued $ 1,633.4 Less: current debt obligations (9.5) Less: debt issuance costs and discounts (31.0) Long-term debt $ 1,592.9 The schedule of principal payments required on long-term debt for the next five years and thereafter is as follows: 2024 $ 9.5 2025 9.5 2026 9.5 2027 9.5 2028 9.5 Thereafter 1,585.9 Certain measures relating to our total debt outstanding as of December 31, 2023 were as follows: Total debt $ 1,602.4 Short-term debt as a percentage of total debt 0.6 % Weighted average cost of total debt 7.2 % The credit agreement and the indentures for the 5.00% Notes and the 6.75% Notes contain customary financial covenants, including a total net leverage ratio covenant, which measures the ratio of (i) consolidated total net debt to (ii) consolidated earnings before interest, taxes, depreciation and amortization, and subject to other adjustments, must meet certain defined limits which are tested on a quarterly basis in accordance with the terms of the credit agreement and indentures governing the 5.00% Notes and the 6.75% Notes. In addition, the credit agreement contains covenants that limit, among other things, our ability to prepay, redeem or repurchase our subordinated and junior lien debt, incur additional debt, make acquisitions, merge with other entities, pay dividends or distributions, redeem or repurchase equity interests, and create or become subject to liens. As of December 31, 2023, we were in compliance with all of such covenants. The credit agreement and the senior secured are secured by substantially all assets of Embecta and each subsidiary guarantor, subject to certain exceptions. For additional information related to the Company's debt related activities, refer to Note 11 within the Notes to Condensed Consolidated Financial Statements within this Form 10-Q. Dollar amounts are in millions except per share amounts or as otherwise specified. 20 Table of Contents Leases Maturities of our finance lease and operating lease liabilities as of December 31, 2023 by fiscal year are as follows: Finance Lease Operating Leases Total 2024 $ 2.7 $ 4.8 $ 7.5 2025 3.7 3.9 7.6 2026 3.7 2.9 6.6 2027 3.8 2.2 6.0 2028 3.9 2.2 6.1 Thereafter 36.2 11.3 47.5 Total lease payments $ 54.0 $ 27.3 $ 81.3 For additional information related to our leases, refer to Note 16 within the Notes to Condensed Consolidated Financial Statements of this Form 10-Q. Factoring Agreements In conjunction with the Separation, we entered into the Factoring Agreements with BD. Embecta owes BD a service fee calculated as 0.1% of annual revenues related to countries subject to the agreement, in exchange for the services provided by BD pursuant to the Factoring Agreements. In November 2023, the portion of the Factoring Agreement between Embecta and BD for services to the U.S. for the Company’s U.S. subsidiary expired and terminated as a result of our implementation and onboarding of certain Business Continuity Processes in North America. Access to Capital and Credit Ratings In November 2023 and June 2023, Moody’s Investor Services and Standard & Poor’s Ratings Services published updates to our credit ratings of Ba3 and B+, respectively. These ratings remain unchanged from the initial published ratings from January 2022. Cash and cash equivalents were $298.7 million as of December 31, 2023 as compared to $326.5 million as of September 30, 2023. The primary sources and uses of cash that contributed to the $27.8 million decrease were: September 30, 2023 Cash and cash equivalents balance $ 326.5 Cash used for operating activities (13.1) Cash used for investing activities (2.7) Cash used for financing activities (13.5) Effect of exchange rate changes on cash and cash equivalents 1.5 December 31, 2023 Cash and cash equivalents balance $ 298.7 Net cash used for operating activities was primarily attributable to: Net income $ 20.1 Non-cash adjustments related to depreciation and amortization, stock-based compensation, and deferred income taxes 1.1 Change in accounts payable and accrued expenses (15.7) Change in trade receivables (78.6) Change in inventories 4.1 Change in amounts due from/due to Becton, Dickinson and Company 17.1 Change in prepaid expenses and other 43.7 Change in income and other net taxes payable 4.4 Change in other assets and liabilities, net (9.3) Net cash used for operating activities $ (13.1) Dollar amounts are in millions except per share amounts or as otherwise specified. 21 Table of Contents The change in accounts payable and accrued expenses is primarily due to timing attributable to payments to vendors in the first quarter of fiscal 2024. As a result of our implementation of certain Business Continuity Processes in North America, including our ERP system, that went live in November 2023, and the expiration and termination of a portion of the Factoring Agreement between Embecta and BD for services to the U.S. subsidiary, we are now responsible for the collection of any outstanding trade receivables in the U.S. The increase in trade receivables is a direct result of this impact, and we expect to convert these outstanding receivables due from customers into cash during fiscal 2024 in line with contractual payment terms. The change in inventories is driven by product sales of certain inventory levels that had been built up at the end of fiscal 2023 in anticipation of our North America ERP system and other Business Continuity Processes that went live in November 2023 . The change in amounts due from/due to Becton, Dickinson and Company primarily relates to the termination of the portion of the Factoring Agreement between Embecta and BD for services to the U.S. subsidiary as we are now responsible for the collection of any outstanding trade receivables in the U.S. The change in prepaid expenses and other are primarily driven by a reduction in payments during the first quarter of fiscal 2024 to BD for future payments made to third parties on our behalf as a result of our implementation of certain Business Continuity Processes in North America, including our ERP system, that went live in November 2023. The change in income and other net taxes payable was primarily due to the timing of required tax payments. The change in other assets and liabilities, net is primarily due to costs capitalized associated with the implementation of our ERP system. All other movements related to working capital were due to timing of payments and receipts of cash in the ordinary course of business. Net cash used for investing activities was primarily comprised of capital expenditures of $2.7 million and $4.7 million during the three months ended December 31, 2023 and 2022, respectively, to support further expansion of our business and operations. Net cash used for financing activities was primarily attributable to: Dividend payments $ (8.6) Payments on long-term debt (2.4) Payments related to tax withholding for stock-based compensation (2.2) Payments on finance lease (0.3) Net cash provided by financing activities $ (13.5) Contractual Obligations Our contractual obligations as of December 31, 2023, which require material cash requirements in the future, consist of purchase obligations and lease obligations. Purchase obligations are enforceable and legally binding obligations for purchases of goods and services which include inventory purchase commitments. Over the next several years, we expect to incur significant costs associated with information technology infrastructure as we transition to our own systems. Lease obligations include lease agreements for which a contract has been signed even if the lease has not yet commenced. Refer to "Management's Discussion and Analysis of Financial Condition and Results of Operations" in our 2023 Form 10-K for further details. As of December 31, 2023, there have been no material changes to our contractual obligations outside the ordinary course of business. Critical Accounting Policies Our significant accounting policies, which include management’s best estimates and judgments, are included in Note 3 to the Consolidated Financial Statements included in our 2023 Form 10-K. A discussion of accounting estimates considered critical because of the potential for a significant impact on the financial statements due to the inherent uncertainty in such estimates are disclosed in the Critical Accounting Policies section of Management’s Discussion and Analysis of Financial Condition and Results of Operations included in Embecta's 2023 Form 10-K. There have been no changes to our critical accounting policies as of December 31, 2023. Dollar amounts are in millions except per share amounts or as otherwise specified. 22 Table of Contents Cautionary Statements Regarding Forward-Looking Statements This Quarterly Report on Form 10-Q contains statements that constitute forward-looking statements under the Private Securities Litigation Reform Act of 1995 and other securities laws. Forward-looking statements include those containing such words as “anticipates,” “believes,” "can," “could,” “estimates,” “expects,” “forecasts,” “goal,” “guidance,” “intends,” “may,” “outlook,” “plans,” "possible," “projects,” “seeks,” “sees,” “should,” “targets,” “will,” “would,” or other words of similar meaning. All statements that reflect Embecta’s expectations, assumptions or projections about the future, other than statements of historical fact, are forward-looking statements, including, without limitation, forecasts relating to discussions of future operations and financial performance (including volume growth, pricing, sales and earnings per share growth and cash flows) and statements regarding Embecta’s strategy for growth, future product development, anticipated product and regulatory clearances, approvals, and launches, competitive position and expenditures. Forward-looking statements are based upon our present intent, beliefs or expectations, are not guarantees of future performance and are subject to numerous risks, uncertainties, and changes in circumstances that are difficult to predict. Although Embecta believes that the expectations reflected in any forward-looking statements it makes are based on reasonable assumptions, it can give no assurance that these expectations will be attained and it is possible that actual results may differ materially from those indicated by these forward-looking statements due to a variety of risks and uncertainties. Such risks and uncertainties include, but are not limited to: • Competitive factors that could adversely affect Embecta’s operations, including adoption of new drug therapies for treatment of diabetes, new product introductions by Embecta’s competitors, the development of new technologies, lower cost producers that create pricing pressure, and consolidation resulting in companies with greater scale and market presence than Embecta. • The risk that Embecta is unable to extend the TSA, the LSA, and other transaction agreements or replace the services, including the Interim Business Continuity Processes, that BD currently provides to it on substantially similar terms as the terms on which BD is providing these services or that BD terminates such services. • Any failure by BD to perform its obligations under the various separation agreements entered into in connection with the Separation and distribution, including the cannula supply agreement. • Any events that adversely affect the sale or profitability of one of Embecta’s key products or the revenue delivered from sales to its key customers. • Increases in operating costs, including fluctuations in the cost and availability of oil-based resins, other raw materials, and energy as well as certain components, used in its products, the ability to maintain favorable supplier arrangements and relationships, and the potential adverse effects of any disruption in the availability of such items. • Embecta’s ability to obtain clearance from the FDA of any product, to market and sell such products successfully, to anticipate the needs of people with diabetes, and future business decisions by Embecta and its competitors. • Changes in reimbursement practices of governments or private payers or other cost containment measures. • The adverse financial impact resulting from unfavorable changes in foreign currency exchange rates, as well as regional, national and foreign economic factors, including inflation, deflation, and fluctuations in interest rates, and their potential effect on its operating performance. • The impact of changes in United States, federal laws and policy that could affect fiscal and tax policies, healthcare and international trade, including import and export regulation and international trade agreements. In particular, tariffs or other trade barriers imposed by the United States or other countries could adversely impact its supply chain costs or otherwise adversely impact its results of operations. • Any continuing impact of the COVID-19 pandemic or geopolitical instability on Embecta’s business, including disruptions in its operations and supply chains. • New or changing laws and regulations affecting Embecta’s domestic and foreign operations, or changes in enforcement practices, including laws relating to healthcare, environmental protection, trade, monetary and fiscal policies, taxation (including tax reforms that could adversely impact multinational corporations) and licensing and regulatory requirements for products. • The expected benefits of the Separation from BD. • Risks associated with indebtedness and our use of indebtedness available to us. • The risk that dis-synergy costs, costs of restructuring transactions and other costs incurred in connection with the Separation will exceed Embecta's estimates. Dollar amounts are in millions except per share amounts or as otherwise specified. 23 Table of Contents • The impact of the Separation on Embecta's businesses and the risk that the Separation may be more difficult, time-consuming or costly than expected, including the impact on its resources, systems, including ERP, procedures and controls, diversion of management’s attention and the impact on relationships with customers, suppliers, employees and other business counterparties. • The risk that we may not complete strategic collaborative partnerships and acquisition opportunities that enable us to accelerate our growth or strategic collaborative opportunities that give us access to innovative technologies, complementary product lines, and new markets. There can be no assurance that the transactions or uncertainties described above will in fact be consummated or occur in the manner described or at all. As a result, you should not place undue reliance upon our forward-looking statements. The above list of factors is not exhaustive or necessarily in order of importance. For additional information on identifying factors that may cause actual results to vary materially from those stated in forward-looking statements, see the discussions under “Risk Factors,” included within the 2023 Form 10-K. Any forward-looking statement speaks only as of the date on which it is made, and Embecta expressly disclaims and assumes no obligation to update or revise such statement, whether as a result of new information, future events or otherwise, except as required by applicable law.