Embecta Corp. (EMBC) Q2 2023 Earnings Call Transcript
Welcome, ladies and gentlemen to the Fiscal Second Quarter 2023 Embecta Earnings Conference Call. At this time, all participants have been placed in a 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 conference call 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 second 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 Chief Executive Officer; and Jake Elguicze, our Chief Financial Officer.
Before we begin, I’d 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 overview of Embecta, our strategic priorities for 2023, and some remarks on the overall performance of our business during the second quarter. Jake will then provide a more in-depth review of Q2 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?
Good morning, everyone, and thank you for joining us today. The end of the last quarter marked one year since we officially launched Embecta and kicked off a bold new chapter for a company that has been integral to the evolution of diabetes care over the past century.
It has been a remarkable year from ringing the bell at NASDAQ twice to transitioning our global employees from BD’s HR systems to our own Embecta systems moving into approximately 30 offices around the world, attending more than 30 conferences and symposiums and serving an estimated 30 million people in 100 plus countries.
For all those milestones, it’s that last number, the 30 million people with diabetes who use our products that motivates our global Embecta team. As you know, our mission is to develop and provide solutions that make life better for people living with diabetes and we are proud to have a role in helping them live their lives with fewer limitations. We remain driven by a sense of urgency to accelerate the journey to better diabetes care, something we’ve been doing for nearly 100 years now.
Our accomplishments in the first year since our spin-off from BD have made me even more excited for what the future holds for us and for people living with diabetes. Our strategic priorities for fiscal year 2023 are shown on slide five. First, we are focused on strengthening our base business while maintaining our global leadership position in the category of insulin injection devices.
Second, we want to finish the work to operationally stand up and separate Embecta as an independent company. And finally, we intend to continue investing in R&D, most notably around our patch pump that is being developed for the Type 2 market as well as seek M&A and additional partnership opportunities.
Moving to slide six. During the first six months of our fiscal year, we have made progress in each one of those strategic priorities yielding results that have exceeded our internal expectations.
In terms of solidifying our base business, we have continued to deepen our partnerships with key customers resulting in winning preferred brand status, implementing growth initiatives, and signing multi-year agreements with major retailers and payers. These trends and partnerships are in addition to us being awarded exclusive preferred status on the Express Scripts National Preferred Formulary as well as pen needle and insulin syringe contract wins from the US Department of Veterans Affairs as noted last quarter.
Additionally, we are helping patients shift behavior to clinically recommended best practices through a dedicated media campaign, educational materials, and retail pharmacy programs, thereby helping raise awareness of the importance of using a new needle with each insulin injection and maintaining an adequate supply of needles. And recently, we held our first industry-sponsored educational symposium at the Advanced Technologies and Treatments for Diabetes Conference.
Second, we continued to make progress in our separation efforts as demonstrated by the exit of several transition service agreements as we continue to build up our internal organization, systems, and processes. We also published our inaugural ESG Strategy report providing a summary of how we are managing environmental, social, and governance issues. This initial report sets the stage for how we operate our business, engage with our stakeholders, and drive results that we believe will support the sustainability and strength of Embecta well into the future.
And we signed a co-promotion collaboration agreement with PolyPhotonix under which our commercial teams in the UK and Ireland will promote PolyPhotonix’s sleep masks used for the management of two common sight-threatening complications associated with diabetes as well as entered into an agreement with Tidepool to help develop automated insulin delivery solutions for people with Type 2 diabetes using our proprietary patch pump.
Our global team has continued to execute our key commercial programs which is allowing us once again to raise our guidance for key financial metrics. Before I discuss our revenue performance, I’d like to share some additional details regarding our recently announced partnership with Tidepool.
Our collaboration agreement with Tidepool is focused on the development of an automated insulin delivery system for people living with Type 2 diabetes, a population that we believe could be better served by an AID system tailored to meet their unique needs.
Under the terms of the agreement, Embecta will leverage Tidepool’s expertise in diabetes management software to develop an AID algorithm for our closed-loop patch pump system that is being designed with the specific needs of people living with Type 2 diabetes. The recent FDA clearance of the Tidepool loop for Type 1 diabetes, an algorithm technology that started as a patient-led initiative affirms the Tidepool’s approach to AID system development combines patient’s insights with a robust diabetes management solution.
We are excited to be able to work with the team at Tidepool and to collaborate on the development of a patient-centric Type 2 automated insulin delivery system. Next, let’s review our second quarter and first half of the year revenue performance in a bit more detail. During Q2, we generated revenues of $277.1 million, which represented an increase of 0.9% on an as-reported basis and 4% on a constant currency basis.
These results exceeded our internal expectations and included US revenues, which totaled $146.4 million and grew 3.6% as well as international revenues, which totaled $130.7 million and grew 4.4% on a constant currency basis. The year-over-year growth in the US was primarily driven by the contract manufacturing and sale of certain non-diabetes products to BD, which did not occur in the prior year period and accounted for approximately 2.5% of the year-over-year growth, an adjustment to our rebate reserves which contributed approximately 1% of the year-over-year growth and favorable pricing dynamics.
This was partially offset by the unwinding of the previously communicated timing benefit of certain distributor orders in Q1. Turning to our performance outside of the US. During Q2, the year-over-year growth within our International business was primarily due to an increase in product volumes, which were aided by a competitive products supply shortage in certain regions and a timing benefit of certain orders, which we expect to unwind during the remainder of the year.As we have communicated before, it is not uncommon for us to get timing benefits from distributor orders in any particular quarter that get unwound in succeeding quarters.
Turning to our revenue performance for the first six months of the year, we generated revenues of $552.8 million, which represented a decrease of 2.0% on an as-reported basis, but an increase of 2.3% on a constant currency basis. The year-over-year constant currency growth was due to a combination of contract manufacturing revenue which contributed approximately 1.3% and our base business performance, which contributed approximately 1.0%.
That completes my prepared remarks. And with that let me turn the call over to Jake to discuss our Q2 financial results in a bit more detail as well as provide our updated fiscal 2023 financial guidance and underlying assumptions. Jake?
Thank you, Dev, and good morning everyone. Before I discuss the financial results for the three-month period ending March 31st, I would like to remind the investment community that Embecta was spun-off from BD on April 1st of 2022 and that the financial results during the pre-spin periods were based on carved-out accounting principles and do not reflect what Embecta’s financial results would have been, had Embecta operated as a standalone public company.
Therefore, the financial results for the three and six-month period ending March 31st, 2023 and March 31st, 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 second quarter at the gross profit line.
GAAP gross profit and margin for the second quarter of fiscal 2023 totaled $189.8 million and 68.5% respectively. This compares to $191.2 million and 69.7% in the prior year period. The year-over-year decline in GAAP gross profit and margin was driven by the negative impact of inflation, the impact of low-margin contract manufacturing revenue that was not in the prior year period, and incremental standup and separation costs including the mark-up on the purchase of cannula from BD.
While on an adjusted basis, gross profit and margin for the second quarter of 2023 was $190.1 million and 68.6% respectively. The adjusted gross margin performance during the second quarter was better than we previously expected due to a greater-than-anticipated benefit from pricing as well as favorable product mix. Additionally, adjusted gross margin during the quarter was also aided by two items that are not expected to reoccur during the second half of the year.
These two items relate to the adjustment to our rebate reserves which Dev mentioned and a year-to-date true-up of certain charges from our former parent that when taken together positively impacted adjusted gross margin by approximately 200 basis points as compared to our previous expectations.
Turning to GAAP operating income and margin. During the second quarter they were $55.6 million and 20.1% respectively. This compares to the operating income and margin of $98.9 million and 36% respectively in the prior year period.
The decline in year-over-year GAAP operating income and margin is primarily due to an increase in selling and administrative expenses associated with separating and standing up Embecta to operate as a standalone publicly traded company as well as an increase in research and development expenses including amounts paid in connection with the collaboration agreement signed with Tidepool to develop and commercialize in interoperable automated glycemic controller to complement our insulin patch pump currently in development.
While on an adjusted basis, during the second quarter of 2023, operating income and margin totaled $84.9 million and 30.6% respectively. The adjusted operating income and margin performance was better than we previously expected due to the overachievement at the gross profit and margin line that I referenced earlier.
Turning to the bottom line, GAAP net income and earnings per diluted share was $14 million and $0.24 during the second quarter of fiscal 2023. This compares to $79.6 million and $1.38 in the prior year period. As I mentioned at the outset, because the financials for pre-spin periods were prepared on a carve-out accounting basis, the comparisons of pre-spin to post-spin periods are not meaningfully comparable.
One example of this would be additional operating expenses necessary for us to operate as a standalone entity while another is interest expense which burdened our P&L in the current year by $26.8 million, but it was only $4.9 million in the prior year period.
While on an adjusted basis, net income and earnings per share were $43.3 million and $0.75 during the second quarter of fiscal 2023. Lastly from a P&L perspective for the second quarter of 2023, our adjusted EBITDA and margin totaled approximately $96.7 million and 34.9%. Like our adjusted operating profit due to the revenue and gross profit overachievement in the quarter, our adjusted EBITDA during the second quarter also exceeded our previous expectations.
Finally, with respect to our balance sheet and financial condition at quarter-end. As of march 31st, 2023, we held approximately $346 million in cash and cash equivalents and approximately $1.64 billion in debt, which taken together with our last 12 months adjusted EBITDA resulted in a net leverage ratio of approximately 3.1 times.
That completes my prepared remarks, as it relates to Embecta’s financial results for the second quarter of fiscal 2023.
Next, I’d like to discuss Embecta’s updated 2023 financial guidance and certain underlying assumptions. Beginning with revenue, given our performance during the first half of the year, we are once again increasing our constant currency revenue guidance range.
As we are now calling for full-year 2023 constant currency revenue growth of between zero and 1%. This is an increase as compared to our previous guidance range which had called for a decline of 1.5% on the low end to 0.5% of growth on the upper end. This new range translates into a second half of the year constant currency revenue range of between flat to down approximately 2%.
The low end of our new constant currency revenue range assumes no additional contract manufacturing revenue during quarters three and four, which would result in a headwind of approximately 3% during the second half of fiscal 2023.
As you may recall, we generated approximately $15 million of contract manufacturing revenue during the second half of fiscal 2022. The headwind from the lack of additional contract manufacturing revenue is expected to be somewhat offset by our base business growing at approximately 1% or consistent with the performance achieved during the first half of the year.
While the high end of our new constant currency revenue range assumes a modestly smaller headwind associated with contract manufacturing revenue and a slight improvement during the second half of the year in terms of our base business performance as compared to the first half of the year, largely attributed to our anticipated performance in both the US and China.
And while we continued to make progress in this area, our updated constant currency revenue guidance range continues to assume an immaterial amount of revenue associated with any recently announced partnership agreements.
Turning to our thoughts on FX. They remain unchanged from our previous expectations and as such, our updated guidance continues to call for a foreign currency headwind of approximately 2.5% during 2023. Our updated FX assumptions were based on foreign exchange rates that were in existence in the early May timeframe.
On a combined basis, we are raising our full year as reported revenue guidance from a range which called for a decline of between 2% and 4% to a new range which calls for a decline of between 1.5% and 2.5%. In dollar terms, this equates to a revenue range of between $1,101 million and $1,113 million.
Lastly, concerning revenue, we currently anticipate a sequential decline from Q2 to Q3 in terms of our as-reported revenue dollars due to the timing benefits and rebate reserve adjustments that positively impacted Q2 that are not expected to reoccur during the third quarter coupled with lower contract manufacturing revenue.
Moving to margins. Based on the performance that was achieved during the first half of the year, we are raising our expectations for adjusted gross, adjusted operating, and adjusted EBITDA margins. As we now anticipate that our adjusted gross margin will be approximately 64.5% up from our prior guidance of approximately 63.5%.
Our adjusted operating margin is expected to be approximately 28% up from our prior guidance of approximately 26.5%. While our adjusted EBITDA margin is now projected to be approximately 32.5% for the full year 2023, up from our previous guidance of approximately 31.5%.
Consistent with the comments we made on our first quarter earnings conference call, this implies a step down in our margin profile from the first half of the year to the second half of the year. And it’s due to a combination of factors, including the revaluation of our inventory that occurred at the beginning of our current fiscal year which we will sell at a higher standard costs during the second half of the year, positive absorption that was achieved during the first half of the year as we manufactured additional product in advance of our planned temporary suspension of our manufacturing operations in our facility in Suzhou, China later this year that are associated with the corresponding regulatory approvals and transitions there as well as total operating expenses as a percentage of revenue that during the second half of the year are expected to be similar to that which occurred during the second quarter.
Continuing down the P&L, we currently expect that our net interest expense will be approximately $113 million was slightly favorable as compared to our previous expectation which called for interest expense of approximately $115 million during 2023.
Our assumptions regarding our non-GAAP tax rate and weighted average shares remain unchanged at approximately 25% and 57.7 million shares, respectively. At the bottom line, this translates into our new full year 2023 adjusted earnings per diluted share range of between $2.50 and $2.60, which is an increase from our previous range of between $2.20 and $2.35 or a raise of approximately $0.27 at the midpoint.
In closing, during the first half of the year, Embecta made good progress in each of our three major strategic priorities, including strengthening our base business, separating and standing ourselves up as an independent entity and investing in growth. We generated solid financial performance during the first half of the year, and we are pleased to be able to raise several of our financial metrics yet again.
That said, we are mindful that we’re only halfway through our first full fiscal year as an independent entity. And as we look ahead, we still have some important separation activities in front of us, including the implementation of our ERP system, managing through the anticipated temporary suspension of manufacturing operations at our facility in Suzhou, China, and setting up our own distribution network.
That completes my prepared remarks. And at this time, I would like to turn the call over to the operator for questions. Operator?
Thank you. [Operator Instructions] Our first question comes from Cecilia Furlong with Morgan Stanley. Your line is open.
Good morning and thank you for taking the questions and congrats on the quarter. I wanted to ask specifically, as we think about just 2Q, some of the benefits you called out, whether it was OUS competitor dynamics or competitor issues as well as some of the stocking dynamics that you called out. How we should think about the impact 2Q to 3Q and into the back half of the year? And then coupled with that too just any update to how you’re thinking about timing associated with the China manufacturing shut down and impact both top line as well as gross margin?
Yes. Thanks, Cecilia. So while our second quarter results were certainly aided by some things, which we don’t expect to reoccur in the second half of the year, we were really pleased with the performance by the team in the second quarter.
About a third of our constant currency revenue growth in Q2 was due to the combined impact of the rebate reserve adjustment and the timing of orders from distributors internationally. So in the quarter, we booked a rebate reserve adjustment of about $5 million in the second quarter of last year of 2022. We booked a rebate reserve adjustment of about $4 million. So the net impact was only about $1 million year-over-year. But the total amount, which we didn’t expect coming into this quarter was about $5 million during the quarter.
In terms of the distributor impact, the orders internationally, that was around $3 million benefiting us in the quarter. And that, again, we would also expect to unwind in the third quarter of the year. The other third, I would say, of our constant currency revenue growth in Q2 was due to the contract manufacturing revenue. And that’s really just a function of the fact that we generated about $3.5 million of contract manufacturing revenue in the second quarter of this year and we didn’t have any of that in the second quarter of last year.
And then the remaining one-third of our constant currency revenue growth was due to our base business, which is performing better than we had previously expected. And I’ll turn the call to Dev and maybe he can answer the question that you had on Suzhou.
Hi, Cecilia. So as you remember, China was a different entity for us at close. And as we go through the process of transferring the Suzhou entity from BD to us, there is a variety of steps we have to go through to get a variety of manufacturing and business licenses, quality audits and so on.
And so during that process, the plant has to seize operations for a period of time. It can come back up to produce product — the manufacturer of that plan that is used for markets outside of China, but it does have to shut down for a period of time. And what we are planning to do is implement our ERP solutions at the same time, taking advantage of the fact that the plant is going to be shutting down.
And so obviously, there is a connection between Suzhou transition and ERP implementation. And our plan right now is to implement that ERP, not just when we are technically ready, but certainly, when customers are ready as well. And so that’s some of the things that we are working through.
What we have done, though, is we’ve built up inventory that we need to accommodate the transfer of the plant and the shutdown of the plant and all of that has been incorporated into guidance. With respect to specifics on timing, you can imagine, it’s a bit of a sensitive topic, both from a competitive reason, but also we don’t want to get ahead of the regulatory authorities here.
So we’ll provide an update on that at an appropriate time, Cecilia. Suffice to say that our team has been working pretty hard, both locally in China as well as from an Ops perspective to do what we can to have a pretty smooth transition.
Great. Thank you for that. And if I could follow up, too, on your pump program as well, just the announcement in partnership with Tidepool. How we should think about next steps what you’ll disclose from a timing standpoint? And also just from a pipeline standpoint, is it still the open lead system first followed by closed loop? Just any color broadly would be helpful and thank you for taking the question.
Sure, Cecilia. So yes, we are still thinking about an open loop system first and a closed loop. We are pretty excited about our partnership with Tidepool. Tidepool, as you may know, recently got 510(k) clearance for their algorithm, albeit it was for Type 1. And as we looked at of our options and as we looked at the fact that certainly, we wanted to develop a closed loop system as well after an open loop system, it seemed like the right time to combine, if you will, forces with Tidepool. They bring a patient centricity as well as expertise in diabetes management software so that, together, we can work on an algorithm that was really specific for the needs of Type 2 people. And in fact, our teams are already collaborating with each other.
With respect to timelines, Cecilia, respectively, I’m going to stick with what we’ve said and what we’ve demonstrated today. We’ll make announcements when we hit critical milestones like we did with Tidepool. But for now, all I’d say is we’ll still stick to our previous commentary about not having any revenue included in the projections that we had laid out pre-spin all the way through fiscal 2024.
Thank you for taking the questions.
Thank you. And one moment for our next question. Our question comes from Marie Thibault with BTIG. Your line is open.
Hi, there. Good morning, Dev, Jake, Pravesh. This is Sam Eiber on for Marie. Thanks for taking the questions this morning. Maybe I can start, Jake, on gross margins, very high this quarter even after take into account the 200 bps of nonrecurring items there. I guess how should we think about that for the rest of the year? And more specifically, the three dynamics between the China shutdown, any inflationary pressures and then also the revalued higher cost inventory?
Yes, sure. Thanks, Sam. So you’re right. I mean gross margins came in, again, very strong for the second quarter in a row, sort of in the upper 60s. If you recall, on our first quarter earnings call, we had told the investment community that we expected our adjusted gross margins to sort of trend into the mid-60s during the second quarter of the year and then into the low 60s in the second half of the year.
And really, the only change from our standpoint is what occurred in the second quarter. And that really has to do with the onetime benefits that we saw from the rebate reserve reversals as well as some of the cost true-ups that we had in the quarter from our former parent. So absent that, adjusted gross margin would have been around 200 basis points lower, probably still slightly favorable as compared to what we had previously thought largely due to the fact that we continue to execute well on pricing initiatives, which seem to be sticking, as well as the fact that we benefited from some favorable product mix.
But absent that, I think it would largely have been maybe just slightly favorable to what we had previously expected. Kind of consistent with our prior thoughts, the second half of the year guidance range really sort of indicates and implies low 60s around 61-ish percent or so adjusted gross margin in the second half of the year, which is all very consistent with our previous thoughts.
And if you think about what the sequential drivers are of that margin shift from the first quarter, the first half of 2023 to the second half of 2023, it really does come down to those previously mentioned items. The inventory revaluation being the largest component of it.
I would say the rebate reserves that — and cost true-ups that positively impacted our adjusted gross margin in the second quarter is probably the next largest item. And then, lastly, it’s the favorable absorption from manufacturing the product in advance of the temporary shutdown in Suzhou. So I would rank them really in those — in that order.
Got it. Yes, that all makes sense. And I appreciate the added detail there. Maybe I can ask my follow-up here on the TSAs. It sounds like you guys are making some progress here in this quarter. I guess is $60 million still about the right assumption in terms of TSA expense for this year? And does 2024, March ’24, still feel like the right time line to work through most of these TSAs?
Yes. So I would say the $60 million number for TSAs is still something that we think is a reasonable number for the entirety of this year. In the second quarter, the way I think that you should sort of think about the trend of the TSA expense, we generated probably around $17 million or so in the first quarter of the year. That stepped down into the second quarter of the year to probably around $16 million.
And then in the second half of the year, obviously, we continue to expect the TSA expenses to continue to trend lower than the first half of the year. Now that’s going to get offset by some additional standup cost of our own. That’s going to impact our P&L. But still feel like a $60 million-ish number for the entirety of 2023 is the right TSA amount.
Great. Thanks for taking the questions.
Thank you. [Operator Instructions] Our next question comes from Travis Steed with Bank of America Securities. Your line is open.
Good morning, everybody. Maybe, Jake, I’ll start with a high-level question. Investors still learning your guidance philosophy as a new company. And early, I don’t know if it’s a reflection, you’ve had two good quarters in a row, more of a reflection of early on, things are just harder to predict like the contract manufacturing revenue or things that are just going off better than you expected or is this more of you making sure to set a kind of conservative guidance at this point? Just kind of high level how you think about the guidance and the upside the last couple of quarters? And then longer term, the margins beyond ’23, I’d love to kind of high-level thoughts on how you’re thinking about some kind of regular cadence of operating margin expansion or more of a reinvestment phase, if you will?
Yes. So maybe I’ll start with the last question first, Travis. I think nothing has changed right now in terms of our thoughts as to what the longer-term kind of fiscal 2024 for financial objectives are for the company as compared to what it is that we would have put out there sort of pre-spin.
So we remain very committed to the achievement of those targets, including an adjusted EBITDA number of 30%. So that remains consistent with even the pre-spin period. I’m not going to refrain from talking about how we did, if you will, in comparison to sort of consensus estimates.
But rather, I’d sort of answer your question by saying that I think we are a new management team who wants to develop a track record of consistency with the street in terms of meeting the previously provided financial objectives that we would have put out there. So I think that’s very important to us and certainly not lost on us.
And in relation to our updated guidance, I’d say that from a revenue standpoint, we certainly increased the midpoint of our full year constant currency revenue range by about 1% or $11 million. Again, about half of that was due to the — sort of the onetime rebate reserve adjustment, the other half was just due to the fact that I think our team is really doing an excellent job just strengthening that base business, which is really one of our key kind of strategic objectives for 2023.
And that’s both in terms of the US and international. And then from a margin standpoint, I’m really pleased with the performance that we’ve been able to exhibit for the first six months of the year. So we’ve been able to raise our — from our original guidance ranges, we’ve been able to raise our adjusted gross margin and adjusted EBITDA margin by about 250 basis points each, and our operating margins by about 300 basis points.
So I think we’re doing a nice job in the first year, first full year, I should say, post-spin of trying to manage that cost base.
That’s helpful. Go ahead.
If I may just add a little bit of color, right, with respect to where we are versus where we thought we would be when we first gave our guidance for the year, besides the fact that it was a new management team, certainly, when we first gave guidance for the year, you remember, China, which is an important part of our emerging markets growth story, had just lifted COVID restrictions, and we weren’t quite sure how that was going to play out, weren’t quite sure how inflation was going to moderate, which obviously has an important impact on our results. And then, finally, we are, have been and will be for a while in the midst of a lot of separation work. So we try to take all those factors into account.
Having said all of that, obviously, very pleased with where we are. And what we’ve done in this new updated guidance just thematically is to take all the overperformance in Q2 and just sort of roll it forward in the guidance. And the second thing I would say we’ve done thematically is tightened our range of expectations towards the mid to upper end of our expectations. And so that’s what we’ve tried to do. Obviously, pleased that we’ve been able to do that.
That’s super helpful response. Thank you. And on the Tidepool, maybe a little bit of additional color on kind of what’s required to do the Type 2 algo? If you’re converting the loop algo or you’re starting fresh? And the FDA path that pathway can go a little faster than the loop pathway did? And if it’s fair to think that if you’re working on algo integration, if the hardware pump design is mostly complete at this point?
So, Travis, we literally just signed the agreement. So I don’t want to get too far ahead of the team in terms of what the regulatory pathway would look like. But I think, suffice to say, what we do expect is to be able to use the expertise they had in developing the loop Type 1 algo towards an algorithm that is going to be designed specifically for Type 2.
And our teams have just started collaborating. So as that work progresses, we’ll certainly provide more updates on that. And then I appreciate the question on the status of the pump design, but respectfully, I’m going to refrain, Travis, from answering that. I have said and I said on this call, too, it is still our intent to do the open loop before the closed loop. And I must say I’m very — continue to be very pleased with the progress that we are making.
Right. That’s fair. And then one quick kind of modeling clarification question. And so the onetime restructuring standup cost in the quarter, just a little bit of color on that, and how that’s going to play out going forward? And then the CapEx requirements for the new ERP system. I think before we were thinking about $90 million to $100 million. Kind of curious what the CapEx requirements are going to be on that?
Yes. So as far as the onetime costs are concerned, I would say that largely, they’re coming in, in or around what it is that we would have previously expected. So no real change in terms of the onetime cost in a material way from what we had previously thought.
And then in terms of the CapEx associated with the ERP implementation and really any of the kind of standup activities, I would say, during the course of 2023, we may spend and use anywhere from $125 million to $150 million or so of cash associated with these kind of onetime activities.
I would tell you that probably about half of that during the course of 2023 is going to be sort of onetime OpEx that we would then kind of add back for non-GAAP purposes. And then the other half is the CapEx associated with a lot of the standup activities, probably most notably the ERP system.
So I think that’s one thing that I think the investment community should be aware of is that when looking at our net leverage levels and certainly the free cash flow that we generate, I mean, this is a very, very strong free cash flow generating business that I think this year, in 2023, is going to be somewhat masked by the fact that we do need to spend a fair amount of cash on the separation activities and that moving forward, that free cash flow generation will then largely just fall to the balance sheet, which we can then use for our own capital deployment. So I’ll pause there.
That’s perfect. Thanks, everybody, and I’ll drop.
Thank you. One moment for our next question. We have a question from Anthony Petrone with Mizuho Securities. Your line is open.
Hi. Thanks and good morning. Thanks for setting us in here and congrats on the execution out of the gate. One question on utilization. This pen needle and safety needle utilization. Dev, you mentioned in your comments. And maybe just, overall, where that sits per user today? What are some of the initiatives to get utilization per needle down? And what should we be thinking about just in terms of timing of some of those initiatives taking hold in the P&L? And I’ll have one follow-up. Thanks.
Thanks, Anthony. So you are referring to the reuse rate which we’ve mentioned previously and the fact that even though pen needles are single-use devices, they are often reused. What we are doing there is a couple of things, Anthony. One is, working on a, if you will, a direct-to-patient, direct-to-consumer media campaign, to remind folks of the need to use one needle per injection that is absolutely the appropriate thing to do.
But the second thing we are doing is working with certain retailers, especially in the US so that when a patient goes to the pharmacy and gets a supply, a month’s supply of insulin, they leave with an adequate supply of pen needles as well. Now we provide almost 8 billion devices around the world. Half of our sales are outside the US, almost half of them are outside the US.
So in terms of when we can actually see these initiatives play out into the P&L, Anthony, I’ll tell you, I mean, it’s going to take some time. We are talking about changing human behavior. But in some of the pilot work that we’ve done in the US, the results have been fairly encouraging. And so our approach is to try a few things. We are — like the changing human behaviour. So try a few things, pile it, then gradually expand that. And so that’s where we are in the process.
Very helpful. And the follow-up here would be on the M&A comments. We’ve seen some activity from Embecta. The debt ratio sits a little bit north of 3. Maybe just a refresh on the M&A strategy, the types of assets potentially that would be good adjacencies to the core insulin delivery business. And then maybe just scale of deals. It sounds like certainly it will be — tuck-ins are on the table, but would a scale transaction actually be also something that Embecta contemplates? Thanks again.
Yes, absolutely, Anthony. So with respect to our M&A/business development strategy, we are looking for assets that allow us to use some of the strength that we have, right? So high-volume manufacturing. We have a world-class operations team that produces high-quality 8 billion units a day in three plants around the world.
Second thing is we have a well-established retail channel in multiple countries around the world. And third is, certainly for a country — a company of our size, we have great emerging market infrastructure. And the needs in emerging markets for people with diabetes are somewhat different in the products they use because of cost and affordability concerns.
So we want to be able to leverage one of these three things. And the partnerships that we’ve done so far, we’ve been leveraging our sales channels. The PolyPhotonix one that we announced today is really a good example. It’s very specific to the UK just because of the way NHS and general practices work in the UK. But these are the kinds of things that we are doing to leverage one of the three strengths that we have.
With respect to M&A specifically, obviously, we want to be careful of the capital constraints of the balance sheet that we have. And so tuck-ins are likely, but you never say never. This is a fast evolving space.
We are in a great position with the infrastructure we have with almost 650 now commercial people all around the world. But we also want to be mindful of the work we have to do in front of us, right? We have a lot of separation work to do, implementing a new ERP, implementing a new distributions network.
So while we are vigorously looking for M&A, we are going to be thoughtful with respect to the work we have in front of us with respect to our capital constraints as well as making sure that we leverage the spend that we have.
And I’m showing no other questions in the queue. I’d like to turn the call back to Dev Kurdikar for closing remarks.
Thank you, Catherine. Before we conclude the call, I would like to express my gratitude to all my Embecta colleagues for the immense amount of work they have been doing over the past year to stand up Embecta as an independent company, even as they fulfill our mission of developing and providing solutions for people with diabetes. Thank you all for attending the call and your interest in our business and Happy Mother’s Day this coming weekend to all of you and the mothers in your lives. Thank you.
This concludes today’s conference call. Thank you for participating. You may now disconnect.