Vericel Corporation (NASDAQ:VCEL) Q3 2018 Earnings Conference Call November 6, 2018 8:30 AM ET
Gerard Michel – Chief Financial Officer
Nick Colangelo – President and Chief Executive Officer
Dan Orlando – Chief Operating Officer
Danielle Antalffy – Leerink Partners
Ryan Zimmerman – BTIG
Chad Messer – Needham
Good day, ladies and gentlemen, and welcome to the Vericel Corporation Third Quarter 2018 Earnings Call. At this time, all participants are in a listen-only mode. Following managements prepared remarks, we will have a question-and-answer session and instructions will be given at that time. [Operator Instructions] As a reminder, today’s conference is being recorded for replay purposes.
It is now my pleasure to turn the conference over to your host, Gerard Michel, Chief Financial Officer. Please go ahead.
Thank you, operator, and good morning, everyone. Welcome to Vericel’s third quarter 2018 conference call to discuss our financial results.
Before we begin, let me remind you that on today’s call we will be making forward-looking statements covered under the Private Securities Litigation Reform Act of 1995, and all of our projections and forward-looking statements represent our judgments as of today. These statements may involve risks and uncertainties that could cause actual results to differ from expectations and that are described more fully in our filings with the SEC which are also available on our website. In addition, any forward-looking statements represent our views only as of today and should not be relied upon as representing our views as of any subsequent date.
With us on today’s call are Nick Colangelo, Vericel’s President and Chief Executive Officer; and Dan Orlando, our Chief Operating Officer.
I will now turn the call over to Nick.
Thank you, Gerard, and good morning, everyone. I’m very pleased to report that we continued our strong performance in 2018 with another record quarter for the company. Our third quarter revenues of $22.5 million, representing 58% growth compared to the third quarter of 2017, marks the sixth consecutive quarter of record revenues for the reported quarter following the launch of MACI.
Our third quarter results also continue to demonstrate the leverage in our business model, as this strong revenue growth generated significant improvements in gross margins, profitability and cash flow. Gross margins expanded to 64% of net revenues compared to 50% gross margins in the third quarter of 2017, and we achieved positive adjusted EBITDA and positive operating cash flow for the quarter.
Based on the strength of our performance, year-to-date, as well as our updated forecast for the fourth quarter, we’ve raised our full year revenue guidance for 2018 to $87 million to $90 million, up from our previous guidance of $80 million to $83 million. Our updated forecast is based on strong MACI growth trends as reflected by orders to date in the second quarter of the year – or second half of the year and continued strength in biopsy growth following the expansion of our MACI sales force and case management team earlier this year.
Given the accelerating growth of MACI as well as the results of our recently completed third-party market assessment demonstrating a significantly expanded addressable market for MACI, we’ve decided to further expand the MACI sales force in 2019. Our sales team is one of the most accomplished sales forces in the industry, and our third quarter results demonstrate our ability to rapidly recruit, train and effectively deploy new representatives. For more details on our performance in the third quarter as well as our sales force expansion and forecast drivers moving forward, I’ll now turn the call over to Dan.
Thank you, Nick. I’d like to start with the exciting news about the MACI sales force expansion. We will be increasing the MACI sales force by 20%, adding a sixth sales region and increasing from 40 to 48 representatives. As with the previous two sales force expansions in 2017 and 2018, we expect that the new representatives will be hired by early Q1 2019, and the fully trained new hires will move into the new territory alignment effective April 1.
The expansion is principally focused on selling geographic white spaces to increase our overall reach and frequency, so we expect this will be a very smooth implementation with minimal impact to existing territories. As Nick mentioned, our commercial team has successfully executed this expansion process the last two years, and we fully expect the 2019 expansion to be just as successful. The decision to expand the sales force was not based solely on geographic considerations, but on the continued increase in new MACI surgeons, expanding utilization from early adopters and our sales representatives’ ability to drive demand in underpenetrated markets.
Their efforts are reflected in the strong sales performance to date and by the fact that over 800 surgeons have trained on the MACI procedure since launch. We remain on track to meet our goal of training a total of approximately 900 surgeons by the end of 2018, up from 500 trained surgeons at the end of 2017. The growing surgeon customer base and demand for MACI is driven by the simpler MACI surgical procedure, the improved speed of patient rehabilitation following surgery, best-in-class case management support and continually improving patient access as demonstrated by the recent expansion of the Cigna MACI medical policy to include patella defects.
Fortunately, we are prepared to meet this increased demand as a result of our recently completed MACI clean room expansion, which came online during the third quarter. Given the rapidly expanding physician customer base and positive experience with MACI, as evidenced by accelerating volume growth, we recently completed a third-party assessment of the target addressable market, or TAM, for MACI.
As part of this project, which was initiated approximately one year after launch, we commissioned a qualitative and quantitative primary market research study with over 200 surgeons to gain a deeper understanding of the surgeons’ assessment of the overall cartilage repair market and our expected future use of MACI. This allowed us to better segment the patient population that undergoes cartilage repair procedures by size, defect, location, age and the ability to undertake the rehabilitation required of all cartilage repair procedures.
Based on the output of this research and the best available published epidemiology and procedure data, the MACI TAM was determined to be approximately 60,000 patients annually, which represents a significant expansion of the MACI addressable market. We believe that this TAM aligns with MACI’s current penetration rate and growth trajectory and better reflects the long-term potential for MACI in this large and underpenetrated market.
Quickly now turning to Epicel. We had another solid quarter of growth and continue to make strategic investments in this franchise. Of significance in the second quarter, we shared that we partnered with our largest Epicel customer to facilitate training sessions with all of the burn centers in their network, many of which had not previously ordered or used Epicel. We’re so pleased that since that training, orders from these network affiliates have helped fuel Epicel growth over the past two quarters. Overall, as a commercial organization, we are very pleased with our results through the third quarter of 2018, as we continue to execute on our strategic imperatives.
I’ll now turn the call over to Gerard to review our third quarter 2018 financial results and the updated financial guidance.
Thanks, Dan. As Nick mentioned earlier, we reported total net revenues of $22.5 million in the third quarter of 2018, an increase of 58% over net revenues of $14.3 million in the third quarter of 2017. Total net revenues for the quarter included $16.4 million of MACI and $6 million of Epicel net revenue compared to $9.9 million of MACI and $4.4 million of Epicel net revenue, respectively, in the third quarter of 2017. This represents revenue growth of 66% and 36% for MACI and Epicel, respectively.
Gross profit for the third quarter of 2018 was $14.3 million or 64% of net revenues compared to $7.1 million or $0.50 of net revenues for the third quarter of 2017.
Total operating expenses for the third quarter were $15.7 million compared to $11.1 million for the same period in 2017. The increase in operating expenses was primarily due to $1.2 million in service fees paid to MACI pharmacy distributors; a $1 million increase in MACI sales force expenses as a result of the MACI sales force expansion earlier this year; a $1 million increase in reimbursement support services as a result of increased MACI demand; and a $1 million increase in stock-based compensation expenses.
Loss from the – from operations for the third quarter was $1.3 million compared to a loss of $4 million for the third quarter of 2017. Material noncash items impacting the operating loss for the quarter included $1.9 million of stock-based compensation expense and approximately $300,000 in depreciation expense.
Other income for the quarter was approximately $300,000 compared to an expense of $1.4 million for the third quarter of 2017. The increase in other income is primarily due to income recognized upon the exploration of unexercised warrants in the current quarter compared to an expense for the change in the fair value of warrants in third quarter of 2017.
Non- GAAP adjusted EBITDA was over $900,000 for the quarter compared to a loss of $2.9 million for the third quarter of 2017. Vericel’s net loss for the quarter ended September 30, 2018, was $1.1 million or approximately $0.02 per share compared to a net loss of $5.4 million or $16 per share for the third quarter of 2017.
As of September 30, 2018, the company had $97.8 million in cash and short-term investments compared to $26 million – $26.9 million in cash at December 31, 2017. It is important to note that for the third quarter, we had approximately $2 million of positive operating cash flow. The third quarter demonstrated our ability to consistently translate revenue growth into significant improvements in gross margins, profitability and cash flow.
While our revenue grew 58%, gross profit grew more than 100% compared to the third quarter of 2017. And the incremental $8.2 million in revenue generated an additional $3.8 million in adjusted EBITDA relative to the third quarter of 2017.
As Nick mentioned in his opening, we have raised our revenue guidance from a range of $80 million to $83 million to a range of $87 million to $90 million. This implies that we expect fourth quarter revenue to be between $27.5 million and $30.5 million. We expect fourth quarter growth over the fourth quarter of 2017 to be entirely driven by MACI. We do not expect significant growth for Epicel in the fourth quarter compared to last year given that Q4 2017 was the highest single quarter on record for Epicel.
We expect gross margins to continue to increase with 15% to 20% marginal cost of goods for MACI and Epicel. Year-to-date, our marginal costs, when measured against 2017, had been a bit lower than this range, but that is mainly due to the manufacturing expense in the first half of 2017 being a high comparator while we were manufacturing both Carticel and MACI as well as the initial MACI manufacturing learning curve.
We expect R&D expenses in the fourth quarter to be closer to what we reported in the first and second quarters this year, as the third quarter benefits from the phasing of some expenses, while SG&A will be up slightly from the third quarter.
That completes my financial review. Now I’ll turn the call over to Nick.
Thanks, Gerard. We continue to deliver strong revenue growth, and our third quarter results demonstrate how that revenue growth translates into significant improvements in gross margins, profitability and cash flow. Leading performance indicators and an expanded addressable market point to that growth continuing, which supports our decision to raise full year 2018 revenue guidance and further expand the MACI sales force. Our business continues to perform very well, and the company is in a strong position to execute on both our operating and strategic business plans.
That concludes our prepared remarks. Now I’d like the operator to open the call to your questions.
[Operator Instructions] And our first question comes from Danielle Antalffy of Leerink Partners. Your line is now open.
Hi, good morning guys, thanks for taking the questions. Congrats on a very strong quarter. This is great to see. So also very excited about the new TAM that you’re highlighting. And so I just had a few questions about the inputs there. Wondering if you could give a little bit more color and how to think about 60,000 patients is obviously much larger than I think you were saying 11,000 patients before. Or is it safe for us to assume the same ASP or because the market is potentially significantly larger? Do you think there could be some downward pressure, whether that’s from payer pushback given the size of the market or potential competition long term coming in? How do we think about that?
Yes. So first, let me answer about the ASP question. This is Gerard. The – it’s assuming the same ASP we currently have. And in terms of the inputs into the new TAM, let me take a step back and just explain to you how the old TAM was created. That was really looking at published epidemiology and procedure data. And what we did was take the epidemiology data and understand from that the size of the lesions that were being seen on diagnostic arthroscopies, the types of lesions. And from that, we overlaid it on the procedure data and then took demographic cuts in terms of BMI, age, et cetera. What it turns out is the cartilage procedures that are – that occur actually are not representative of what’s seen on diagnoses nor is it representative of the overall U.S. demographic.
So there is many more, a much higher percentage of cartilage repair procedures fit on our label than you would think if you just look at the diagnostic epidemiology data. The second thing is we tried to talk to doctors, that’s the large survey, to better understand where they thought MACI would fit. So we layered at that on top of the epidemiology data, the survey data in terms of what type of lesions are treated because, otherwise, actually, it would have had a much, much larger TAM. So that’s on a qualitative basis how the framework we used to use and we’re using now to come up with the TAM.
Okay. That’s very helpful. And then last question for me just as we think about now this much larger TAM for MACI. How does that – you guys have been pretty transparent about – you only did a raise in early June and potentially utilizing that cash to execute on small M&A. Does the fact that this TAM is now so much larger change that strategy? Or are you still planning to or intend to pursue M&A versus invest – reinvest in the business? Thanks so much.
Good morning, Danielle, this is Nick. And this larger addressable market does not at all change our strategic plan going forward. We’ve been pretty consistent saying investing in the business and bringing on potential new products that have a strong strategic fit are not mutually exclusive, and that hasn’t changed. As we’ve demonstrated, we’re planning to continue to expand the MACI sales force. We think that’s a great investment with a very rapid payback. And so we’ll continue to invest in the business, but also look at other product opportunities that can maximize long-term value of the company.
Okay. Thanks for that.
Our next question comes from Ryan Zimmerman of BTIG. Your line is now open.
Good morning, Ryan.
So congrats on a very strong quarter. Let me echo the sentiments that Danielle shared. I want to talk about rep expansion for a moment. Just – you created a sixth territory. And so does that imply that you can go to maybe a little bit deeper in your existing territories with penetration today? It sounds like you’re not going to have any disruption in the addition of those reps. But how do you think about the existing territories where you have reps today? And then I have a follow-up.
Ryan, this is Dan. So the – when we say white space geography, so the concept is that we’re not going to disrupt every territory across the country. We will disrupt a handful or half a dozen or so that have rather large geographies. And what we found through these successive expansions is that it’s built our confidence along with evidence from this new TAM that our confidence in going into relatively untapped markets and being able to create a market for MACI. So think of this – the majority of this expansion, it’s not the entirety of it, but the majority of it going into space that because of geography, distance, travel for a representative, we’re not getting the utility of MACI as we would hope.
What it means for existing territories is that we’re not breaking that very important rep-physician relationship that’s been built either from our legacy representatives or from new hires in the previous past two years in the heart of their geographies. And we think that, that’s a very important factor to help drive business. So I’m very excited about this expansion. And it’s proved positive of both the work that was done in the TAM. It’s demonstrative of what our new reps have been able to do in the previous two years. And we have every confidence that these new geographies will turn profitable in relatively short order, like the other expansions have proven.
Okay, helpful. And then you commented on this a little bit, Gerard. At the midpoint, the implied fourth quarter guidance is certainly above where the Street is currently sitting. Just talk to us about what you’re seeing in the fourth quarter that supports the confidence to raise again?
Yes, and it’s the same things we’ve discussed in the past, so it’s an important question. First of all, the biopsies that come in are very strong and leading indicator, so that can give us a pretty good handle on the percentage of the business we can be confident we’re going to get. We also have a pipeline report, which shows us how many cases are moving through the medical authorization process, so that gives us a good window. And then just the overall momentum. We don’t expect, all of a sudden, growth to just flatten, so we’ve factored that. And we have a number of models we use. But again, it’s all the – again, important question, but all the variables and inputs that we talked about in the past.
Okay, helpful. And then last one for me, and I’ll hop back in queue. You’ve talked about expanding MACI manufacturing capacity. Just kind of tell us where you’re at from a capacity standpoint and what the expansion does for you in terms of manufacturing.
Yes. I think, Ryan, we’ve talked about the fact that the facility where we manufacture MACI actually had a MACI clean room and a Carticel clean room, which was much larger. And so when Carticel was no longer on the market, we’ve been able to just simply convert existing Carticel clean room space to MACI manufacturing capacity. So for us, it’s great in terms that the real estate is already there, the footprint is in place. It really just involves adding new hoods and incubators. So for us, it’s a couple hundred thousand dollars to expand our capacity. In this case, adding another clean room increased capacity by about 40%.
Great. Thank you.
[Operator Instructions] Our next question comes from Chad Messer of Needham. Your line is now open.
Great. Good morning and let me add my congratulations on another strong quarter. Great. So your view of the addressable market is up about five times , and we’re doing a 20% sales force expansion. I know, in the past, you’ve said that the size of the sales force wouldn’t be measurably larger, orders of magnitude larger than where it is now. But I think this is your third incremental expansion. Just wondering – I’m wondering how big of a sales force you might think you need in the future given that this market is much larger than you’d previously been thinking.
Thanks, Chad. This is Nick. I think in terms of sort of our target surgeons that we’ve talked about in the past, about 3,000 self-identified sports medicine surgeons, we probably will continue to add incrementally as the business expands. There’s a service component. There’s a call frequency and reach component. And as the business expands, you need more reps to be able to service even that group. And we’ve said, again, it wouldn’t be orders of magnitude, but it would grow over time as the business continues to expand.
I think one of the interesting things out of the market assessment research is that there are other surgeons, orthopedic surgeons, that are not self-identified sports medicine surgeons that actually do some repair procedures, and that will be another area of analysis for us going forward to really understand the breadth of the surgeon universe that are not sports medicine surgeons and how we could most effectively capture that business that’s out there. So that will be a project we’ll be looking at moving forward.
Great. Thanks. And it looks like, this year, we’ve kind of broken the past seasonality of 3Q being weakest for MACI. Wondering if you actually are seeing a change in seasonality. Or is essentially this just a growth that’s so strong that we pushed past it?
So I think it’s primarily growth that’s pushed past it. The best guess – I don’t want to say guess, but it really is a hypothesis on how the growth has pushed it. Yes, I think we’ve seen a bit more volatility in the growth itself, so it’s – I don’t – I wouldn’t take the growth we have this quarter and say automatically that’s what you’re going to see next quarter because that’s the conclusion we’ve reached if I say that’s purely due to growth. But I think growth is the primary reason you’re not seeing that seasonality at the moment.
All right. Great. Thanks and congrats again.
Ladies and gentlemen, this concludes today’s question-and-answer session. I would like to turn the call back over to Nick Colangelo for any closing remarks.
Okay. Well, thank you very much. And again, we appreciate everyone’s questions and continued interest in Vericel. Obviously, we’re very excited about the opportunities that lie ahead. And we look forward to reporting on our progress on our next call. Have a great day.
Ladies and gentlemen, thank you for participating in today’s conference. This does conclude the program, and you may now disconnect. Everyone, have a great day.