Vericel Corporation (VCEL) Q3 2017 Earnings Report, Transcript and Summary

Good day, ladies and gentlemen, and welcome to the Vericel Corporation Third Quarter 2017 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions] As a reminder, today’s conference is being recorded. I would now like to introduce your host for today's conference, Mr. Gerard Michel. Sir, you may begin.

Thank you, operator, and good morning, everyone. Welcome to Vericel's third quarter 2017 conference call to discuss our third quarter 2017 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 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; Dan Orlando, our Chief Operating Officer. I will now turn the call over to Nick.

Thank you, Gerard, and good morning, everyone. Before I turn the call over to Dan and Gerard to review our third quarter commercial and financial performance, I'd like to comment on a several business highlights for the quarter. First, we reported record third quarter revenues and our second straight quarter of 30% or greater revenue growth versus the same quarter in the prior year. The strong revenue growth was driven by the momentum of MACI's uptake in the second full quarter following launch as we all as significant growth for Epicel in the quarter. Total net revenues for the third quarter were $14.3 million, an increase of 30% compared to the third quarter of 2016. Total revenues for MACI were $9.9 million, an increase of 19% over Carticel revenues in the same period in 2016 and total revenues for Epicel were $4.4 million, an increase of 67% compared to the third quarter of 2016. We also reported a significant improvement in gross margins, which increased 50% of net revenues compared to 37% of net revenues in the third quarter of 2016. The improved gross margins demonstrate the leverage of unit volume increases in our business model. I'm pleased to report that all of our MACI key launch performance indicators, including the number of surgeons trained, the increase in biopsies, uptake by surgeons that were former or non-Carticel users, and total orders for the quarter point to a continued acceleration in MACI uptake. Third quarter growth in MACI biopsies and implants was driven by both previous and new user segments. We expect this momentum to continue particularly in light of the fact that we currently have less than 10% penetration into the patient population that we believe could benefit from MACI annually. Dan will provide further details on both our promotional activities and key launch performance indicators. While we believe MACI uptake is driven primarily by its favorable product profile is also supported by our transition to a new case management model. In this new model, we've directly contracted with a case management service provider to manage reimbursement and patient support services for MACI. By directly managing the customer facing portion of our medical authorization and benefit review, we can ensure a high-quality experience for both surgeon offices and patients. Equally importantly, our payor access strategy has been executed in accordance with our planned timelines. Our goal was to ensure that the majority of payor medical benefit policies were updated and the access for MACI was available for our top plans within nine months following the launch. As we recently announced with UnitedHealthcare and multiple other commercial plans updating their policies after less than three quarters on the market, the number of covered lives for commercial plans providing access to MACI is approximately equivalent to the number of covered lives for commercial plans that previously covered Carticel. This is a significant achievement reflects the tremendous work of our market access team over the past year. Based on this expanded medical policy coverage which has opened up important markets that were not available to Carticel as well as the continued momentum of MACI in the third quarter, we decided to expand the MACI sales force again. Our sales team is one of the most accomplished sales forces in the industry. However, there are many more cartilage repair surgeons can be reached at our current size and the level of surgeon interest continues to grow. This decision therefore reflects our confidence in MACI’s future prospects and the value of our sales representatives can create as they work to deliver therapies to improve the lives of patients. I will now ask Dan to provide further detail on our commercial results.

Thank you, Nick. The third quarter represents the second full quarter following the launch of MACI with our expanded sales force of 28 representatives in the first quarter with Carticel not in the market. As mentioned earlier in the call, MACI revenue for the third quarter increased 19% over Carticel revenue in the third quarter of 2016 representing the second consecutive quarter of strong MACI growth following launch. Biopsies are by far the most important leading indicator for near-term MACI growth, and biopsies increased 44% in the third quarter and 27% year-to-date in 2017 respectively compared to the same period in 2016. Overall, surgeon interest and demand for MACI continues to expand particularly in the segment of surgeons who had never used Carticel and the former Carticel user segment of surgeons who had not used Carticel in the last two years. In our first two full quarters since launch, we have seen a higher growth rate in both MACI biopsies and MACI implants from these newly engaged surgeon segment. The significant increase in MACI biopsies and rapid expansion of our MACI surgeon customer base is very encouraging for MACI’s long-term growth prospects especially since the rate at which biopsies convert to implants has been very consistent over the last five years and we have not seen a material change from previous conversion rates since the launch of MACI. While we cannot be certain that conversion rates will remain constant in the feature given this growth in biopsies, we are confident that implant volume growth will continue to accelerate into 2018. To help drive this growth and ensure appropriate utilization, we have been very active with both marketing activities and medical education; to date we have trained over 440 surgeons on the MACI’s surgical procedure with approximately 50% of the trained surgeons coming from the former Carticel user and non-Carticel user segments. Peer to peer education programs continue to be a priority. We have conducted over 20 national, regional, local programs since launching MACI. And in the fourth quarter, we will be conducting two additional national training programs both wide and web-based and we have also had strong presence at industry meetings since launching MACI and we will be attending three additional national meetings that will include MACI’s surgical demonstrations, MACI’s symposium or MACI case study presentations here in Q4. Turning to patient access, our aggressive MACI payor access continues to play out on schedule. Our strategy was designed to have the majority of payor medical policies updated with the nine months following the launch and I’m very pleased to report that 28 of the top 30 plans now have medical policies which allow access to MACI. We estimate that this represents over 85% of commercialized and is equivalent to the coverage we had with Carticel. There will always be a small plan here or there which do not have specific MACI policies, but for these we generally are able to gain approvals on a case-by-case basis. We are well positioned in the increased MACI demand with our current manufacturing facility without significant capital investment and we are on track to convert a portion of a Carticel clean room to expand MACI capacity to handle in anticipated volume growth for the foreseeable future. Given the MACI launch momentum particularly the expanded patient access and expand surgeon interest, we are pleased to announce the sales force expansion from 28 representatives in four region to 40 representatives in five regions. In some geographies, the expansion is a direct result of improved payor access versus previous Carticel medical policy and in other areas it’s a direct response to the need to increase support for the newly engaged surgeon segments. We expect our new sales representatives to be trained and in place by the start of Q2 2018. In summary, the MACI launch is progressing according to plan and momentum continues to build for this exciting new product. I’ll now turn to Epicel. Revenue in the third quarter was $4.4 million, up 67% over the third quarter of 2016, as we saw significant increase in the number of orders and institutions ordering Epicel compared to the same period in 2016. While Epicel volumes are inherently volatile, the number of Burn centers taking biopsies and treating patients is steadily increasing and on average we expect that Epicel volume should continue to grow. As we have previously discussed, the first phase in Epicel growth, which reengaging surgeons who had previously used Epicel and were trained on the optimal use of the product. We believe that the recent growth is the result of our investment in related Epicel’s peer to peer training intended to establish a standard of care and to help surgeons identify Epicel patient. We are focusing our messaging on graft take rates and patient survival to reinforce the powerful potential lifesaving benefits of Epicel. Along with our increased promotional efforts, we have improved our presence at Burn Association meetings, including speaker programs targeted to major regional and national Burn conferences and we will have presented – held Educational Symposia and exhibited at more than half a dozen important conferences and programs over just the second half of this year alone. Finally, we also have created a reimbursement hotline, staffed with billing experts to aid hospitals with coding and reimbursement for Epicel. Epicel can be an important lifesaving therapy for severe burn patients. We are pleased with our investments to-date and expanded its utilization, and we are confident that through our continued support, we will reach more patients in need. I'll turn the call back to Nick now.

Thanks, Dan. The commercial team has done an outstanding job in driving MACI uptake, expanding access to MACI and optimizing the patient and physician experience with our new case management services. I'm optimistic that these efforts will continue to drive growth for MACI and that our commercial and medical initiatives for Epicel will continue to increase its penetration in the severe burn market. I'll now turn the call over to Gerard to review our third quarter financial results.

Thanks Nick. Total net revenues for the quarter ended September 30, 2017 were $14.3 million, which included $9.9 million of MACI net revenues and $4.4 million of Epicel net revenues, compared to $8.3 million of Carticel net revenues and $2.6 million of Epicel net revenues respectively in the third quarter of 2016. Total net revenues increased 30% compared to the third quarter of 2016 with MACI revenues increasing 19% of Carticel revenues and Epicel revenues increasing 67%, compared to the same period in 2016. Gross profit for the quarter ended September 30, 2017 were $7.1 million or 50% of net revenues compared to $4.1 million or 37% of net product revenues for the third quarter of 2016. The significant increase in gross profit margin is due to the fact that the marginal costs to produce MACI and Epicel are approximately 15% to 20%, so that every $1 million in incremental revenue increases gross profit by about $800,000 to $850,000. Research and development expenses for the quarter ended September 30, 2017 were $2.9 million compared to $3.4 million in the third quarter of 2016. The reduction in third-quarter R&D expenses is primarily due to a reduction in ixCELL-DCM clinical trial expenses. Selling, general and administrative expenses for the quarter were $8.2 million compared to $7 million for the same period in 2016. The increase in selling, general and administration expenses is primarily due to an increase in expenses for marketing initiatives related to the launch of MACI, and an increase in personnel costs primarily related to an increase in the MACI sales force. Loss from operations for the quarter ended were $4 million compared to $6.4 million for the third quarter of 2016. Material non-cash items impacting the operating loss for the quarter included $800,000 of stock-based compensation expense and approximately $400,000 in depreciation expense. Other income for the quarter was $1.4 million compared to approximately $300,000 million for the same period in 2016. The change in other expense for the quarter is primarily due to the change in the fair value of warrants in the third quarter compared to the same period in 2016 and interest expense on our outstanding revolving credit agreement and term loans. Vericel's net loss for the quarter was $5.4 million or $0.16 per share compared to a net loss of $6.7 million or $0.38 per share for the same period in 2016. As of September 30, 2017, the Company had $15.5 million in cash compared to $23 million in cash at December 31, 2016. We’ve had a higher than expected account receivable balance over the past four quarters due to the change in our pharmacy model in 2016 and 2017 and the previously disclosed contractual dispute involving a pharmacy provider and a third-party payor. At the end of the third quarter we had approximately $7 million of accounts receivable that we would not otherwise have carried. Since the close of the third quarter we have collected approximately $4 million of that $7 million and anticipate collecting the balance of the next three quarters. Augmenting this additional cash flow will be the expected $5.5 million payment related to the licensing agreement with ICT. The funding transfer is subject to approval by the State Administration of Foreign Exchange of the People's Republic of China and we hope to conclude this in the fourth quarter of 2017. Finally, we have used only $2.5 million of our $10 million revolver with Silicon Valley Bank and we have an ATM in place. As a result we believe that we have adequate access to capital to fund the Company's operations to profitability. Regarding future MACI performance almost all of the implants occurring in any quarter are the results of biopsies taken one to four quarters earlier. Although, there is no guarantee to conversion rates for [whole consent], we believe that biopsy growth represents a strong leading indicator from MACI implants. Over the last four quarters, we've seen high-teens biopsy growth versus the prior four quarters. Based on this we expect MACI revenue in the coming quarters to grow at least with that rate. Epicel is more difficult to project given the relatively small number of patients, but when measured over the prior four quarters we do expect meaningful revenue growth going forward. Gross margin should continue to increase consistent with 15% to 20% marginal cost from MACI and Epicel. Our operating expenses will increase given the MACI sales force expansion, the increased investment in case management services based on higher MACI volumes and the start of a post-approval commitment in the clinical trials studying MACI and pediatric patients. This increase in operating costs which will be at a lower rate than revenue growth will rise over the next few quarters and reach approximately $2 million per quarter more than the third quarter 2017 operating expense. That completes my financial review. Now, I'll turn the call over to Nick.

Thanks, Gerard. We had a very strong third quarter driven by the accelerating uptake of MACI as well as significant growth for Epicel. Our robust revenue growth and margin expansion reflect the success of our commercial teams, sales and marketing initiatives coupled with strong physician enthusiasm for MACI and Epicel. We believe that these results position the Company for strong short-term and long-term growth moving forward. That concludes our prepared remarks. Now, I'd like the Operator to open the call to your questions.

[Operator Instructions] Our first question comes from Chad Messer with Needham.

Great. Thanks for taking my question and congrats on another good quarter. Appreciate the added color that you gave on expenses both margins and where SG&A and R&D can go. Is it possible maybe to expand on that a little bit more? Is there some rule of thumb for a sales force expansion, I know you expanded it in the past. Is that a good sort of rule of thumb to look at how cost went up before as you expanded the sales force as you're doing it again?

Hey Chad, it’s Gerard. I think for the sales force itself, yes that's a good rule of thumb. However, we are putting additional investment in hub services to really smooth the process of a patient from the doctor deciding that they want some MACI implant to getting insurance approval, so it will be a bit higher than when you saw in the past and that's why we gave a fairly specific numbers saying, hey, I think what we did this quarter and over a couple quarters ramp it up until we get about $2 million higher a quarter. That would pay perform within the sales force and the bulk of that is from the hub services.

Okay. I appreciate that. And then you had basically no net cash used or at least the cash balance didn't go down during the quarter even though you've got this – accounts receivable was there debt drawdown or share issuances, what accounts for you guys…

We did have a judicious use of the ATM. We issued approximately 1.9 million shares for approximately $6.9 million net cash. We think we're in pretty good shape with the current tools in hand to get the profitability and that’s part of the reason we went through all that detail about the AR, DSO and ICT et cetera.

All right. Great. Just watching your cash, I'm sure you guys are too. Thanks for the update.

Our next question comes from Kevin DeGeeter with Ladenburg.

Hey. Good morning, guys. Thanks for taking my question. With regard to trends you're seeing in the markets for MACI, one of your peers did complete enrollment in clinical trial back over the summer. Have you seen any impact in certain centers with regard to patients who might have otherwise gone and clinical trial being now candidates for commercial sale of MACI?

Well Kevin, I don't think we've seen a meaningful increase due to that if you think about it our competitors made it be enrolling single-digit numbers of patients a month, so it really doesn't have a huge impact for us. We are just pleased, obviously generally that we're seeing increased utilization across the board whether they were investigators and other studies or not.

And with regard to your comments in the prepared portion of the call with regard to gross margin, can you just help us think how mix may impact expansion of gross margin going forward specifically that kind of call $0.80, $0.85 per $100 of kind of for us profit. How does that sort of fall depending over there that's Epicel versus MACI revenue following through?

Yes. That’s a great question. I think the percentages I gave really are based on our anticipated mix. I think on the margin if Epicel is growing by leaps and bounds and continue to grow by leaps and bounds and superseded took over MACI. I think maybe it might be a tad bit lower, but I think it's within the margin of error. The material cost for these per patient are roughly similar.

Okay. And then lastly for me and then I'll get back in the queue. With regard to sales force expansion is 40 sort of the right number now that you have essentially full access in payor coverage and how should we think about the trend in potential sales force growth going forward to the extent the demand continues to pull through?

Yes. Thanks Kevin, it's Nick. For the time being, we do think it's the right number. As Dan mentioned, there were a couple drivers, one is that with increased expanded medical policies, it opened up some geographies where we didn't have good Carticel coverage in the past, so that was sort of an easy one. And then as you think about a sales force expansion, obviously there's a larger universe of orthopedic surgeons that we would like to reach with the appropriate frequency and making sure we can do that in light of increasing workloads being driven by increased by biopsies implants et cetera. So it's a combination of all of those factors, increased medical policy better region frequency on our target universe, and making sure that we can do count the work activity for our sales reps.

Maybe just one more quick follow-up question with regard to your comments on extended coverage for orthopedic surgeon. When you think about some of them are kind of call them mid-tier orthopedic surgeons by volume, sort of what’s the lower bound or how many cases given orthopedic surgeon needs to be seeing a month for to makes sense to allocate a MACI rep to be calling of them?

Yes, I don't know that we can answer the exact number of like cartilage repair that they do on a monthly basis. It's more about seeing the right mix of patients, our typical patient is 35 years old or typical physician is more sports injury associated and so I would say that the typical threshold for a physician if somebody can treat at least two of these patients annually, and from that they'll get biopsies, say from twice that number, two to three times that number of potential patients. So that is like – it's a continuous pool of patients that physician creates or thinking of the appropriate patient and applying MACI where [they tried] and typically that would be the lower threshold.

Yes, Kevin I think as we've talked about before, the data that's available in this marketplace is not like we're used to from large pharma days, where you have INS data and deciles for each of the physicians and you make decisions on how deep you want to go into those deciles. So a lot of it is we've been in this market for two decades. We know the high potential physicians, and so we have a certain target universe and a certain sort of hierarchy of surgeons we want to get to.

But I just chime in from an economics perspective, if it's like four or five calls to convert a box, I mean one year plan to every other year would yield the positive impact probably I mean I expected probably get more than that if we converted somebody, but it doesn't take much business from a dock. I think after probably three or four calls or cell therapy specialist will know whether or not it's worth continuing a call and try to convert the dock. So I think on the margin after a call or two build all of it or move on or whether to convert the dock…

Great, that’s right. That’s right, helpful. Thank you, guys.

The next question comes from Ted Tenthoff of Piper Jaffray.

Great, thank you very much. Can you hear me okay?

Yes.

Good, so very nice quarter and again the MACI launchings to be doing particularly well. Just looking kind of down the road maybe a couple years, ultimately how big do you think this product can get and is just something where you would have to expand manufacturing at some point?

Yes, Ted, I’ll start as we talk about often in our corporate presentation and as I mentioned on my prepared remarks, we think we are probably penetrating maybe 10% of the patients that we believe could benefit from MACI annually. So we think there's just a kind of upside for this product as we continue to build the brand over the foreseeable future. In terms of manufacturing capacity as Dan alluded to, we had a much larger footprint from a clean room perspective for Carticel and we had a separate MACI suite and once we removed Carticel from the market in the middle of this year, Dan and his team have embarked on converting part of the Carticel clean room over to MACI cell. We don't have any real estate constraints that we need to expand beyond that again. We're certain to be able to do that. So for us it's more about getting the certain volume levels. We may have to add some headcount at some point down the line, but there's no real estate constraint for us in terms of projected volumes into the future.

Okay. Excellent. Thanks. End of Q&A

And I am showing any further questions at this time. I’d like to turn the call back over to our host.

Okay. Well, thank you very much for your questions and continued interest in Vericel. We're excited about the opportunities ahead and look forward to reporting on our progress on our next call. Have a great day.

Ladies and gentlemen, this does conclude today’s presentation. You may now disconnect and have a wonderful day.