Vericel Corporation (VCEL) Earnings Call Transcript & Summary

It's Peter Harrison from Morgan Stanley's med tech investment banking practice. I want to welcome Vericel to the conference. Before getting started, I got to get the formality of the disclaimer out of the way. So here we go. Please note that this webcast is for Morgan Stanley's clients and appropriate Morgan Stanley employees only. This webcast is not for members of the press. If you are a member of the press, please disconnect and reach out separately. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representatives. With that behind us, let's get started. I want to welcome Vericel. With us today is Nick Colangelo, CEO; and Gerard Michel, CFO. Why don't we get started with kind of, Nick, why don't you provide an overview of the company, where you're focused, how you think about the business, then we'll move into questions from there on.

Yes. Thanks, Peter. It's really a pleasure to join you today, and we appreciate the invitation. And before I begin, I'll do my disclaimer, which is our discussion will contain forward-looking statements. And so we encourage everyone to refer to our documents on file with the SEC for further information. So for those of you who are not familiar with Vericel, we're a leader in advanced therapies in the sports medicine and severe burn care market. We have a portfolio of highly innovative cell therapies and specialty biologics that have a uniquely significant barrier to entry in the industry. So we currently market 2 products in the U.S., MACI and Epicel, which are products that we acquired from Sanofi, when we bought their Cell Therapy and Regenerative Medicine business back in 2014. Both MACI and Epicel are regulated by the FDA as combination device biologics, with the biologic component being the use of the patient's own cells to restore tissue and restore function. So our lead product is a product called MACI. We launched MACI in 2017 for the treatment of cartilage defects in the knees. It's the leading cartilage repair product in the market and the only FDA proved product in its class. Likewise, Epicel is the only FDA-approved permanent skin replacement for adult and pediatric patients with large body surface area burns. We also added an exciting new product to our portfolio called NexoBrid, which we licensed from MediWound last year, and that's an orphan biologic product that's an enzymatic debridement agent for patients with severe burns. And so as I mentioned earlier, the unique part of our portfolio is that there are very strong competitive barriers to entry. So for MACI and Epicel as combination device and biologic products, there is no established generic biosimilar or 510(k) pathway. So anybody who wants to come in and compete with us in the marketplace has to go through the normal clinical trial development process. And there's really nothing -- no like products on the near-term horizon for either MACI or Epicel. So strong competitive position for us there. Likewise, upon approval, NexoBrid would enjoy biologic and orphan exclusivity. So these are long-lived assets that we believe will allow us to have sustainable top-tier revenue growth for many years to come. So since we launched MACI, our compound annual revenue growth rate has been above 30%. And again, we think that will continue for many years, especially because we're in large and underpenetrated markets. We also have a very attractive business model and a really robust profitability profile. So for MACI and Epicel, the marginal cost of goods are about 20%. So about 80% of every incremental revenue dollar falls to the gross margin line. So we expect in the coming years that our margins will grow from the 68% we achieved in 2019 into the mid-70% gross margins. And then because we have premium-priced products and relatively concentrated call points, we have very high sales productivity as measured by revenue per rep. And about over the long term, 50% of every incremental revenue dollar falls to the adjusted EBITDA of our operating margin line. So a very unique profitability profile as well. And finally, we have a strong balance sheet. We ended the second quarter with about $81 million in cash, no debt, and a really strong shareholder base with about 90% of our outstanding shares from our institution investor. So we think we're positioned for success going forward, and we're really excited about what's going on with the company.

That was very helpful. And we already have a few questions online. People, please put them in the portal. But let me start. Usually, I start with the sports medicine franchise, but given the exciting news on NexoBrid BLA yesterday, why don't we start there? I'm talking about what the timeline is, what the market potential is, how does it fit with Epicel? And how do you think about that mix? And then we also have a question from online on NexoBrid. What is the expected first year revenue, so similar to the market opportunity I was talking about for the company.

Right. So we did announce great news yesterday. We filed or submitted the BLA back at the end of June. And yesterday, we announced that the FDA had it -- had accepted for filing the BLA with a target PDUFA date of June 29, 2021. So that's the timelines that we're working on now. It's a very important milestone that we achieved and announced yesterday. So NexoBrid, I'll just give you just a quick background on the burn treatment algorithm. So when you're treating severe burn patients, and we are focused on severe hospitalized burn patients, there's 2 things you need to do for patients with large partial-thickness or full-thickness burns. First, you need to remove the burned tissue or scar. And then you need to figure out how you're going to cover the wound. So we have had, obviously, in our portfolio, Epicel, which falls into the latter category of covering a burn. We did not have a product in the debridement space. So NexoBrid is an enzymatic debridement agent. You need to get the scar or dead tissue off because it causes infections, it causes further burn progression because of inflammatory responses and so on. And right now, the standard of care is surgical removal. So you basically take a knife and you slice away at the skin until you get to healthy tissue. How do you know that because you start to see the bleeding and so on so there's a lot of healthy tissue loss, blood loss, et cetera. So there's a great need for a selective and effective debridement agent, which is what NexoBrid is. This is a product that's approved in Europe and other international countries. It's an orphan biologic in the U.S. Pivotal Phase III study results were announced last year. The study met its primary and all secondary endpoints. And it's a program that's been supported by BARDA, principally throughout its development period. And the reason for that is when the standard of care for removing and treating these burn patients is surgical, if you have a mass casualty event, so a dirty bomb or another event where you have hundreds or thousands of burn patients. You don't have enough OR teams or enough OR capacity to treat those patients. So that's what has driven BARDA's interest in the program. So with NexoBrid, it's a bedside treatment where you simply put the gel on the burn area over a course of 4 hours. It's a mixture of proteolytic enzymes that recognize denatured proteins from thermal burns, and it basically dissolves the bad tissue and leaves the healthy tissue. So it's a remarkable product. And we're really excited to bring the product to the U.S. market because we think it will change the standard of care. In terms of the addressable market, there's about 0.5 million burn patients in the U.S. each year, about 40,000 are hospitalized. For Epicel, we're really sort of in that really narrow part -- bottom part of the funnel, where there's probably 600 to 800 patients a year that fall within Epicel's label of having 30% or 40% plus burns. 30% by label, but 40% plus is typically the patient that receives Epicel. So that's only about 600 to 800 patients a year, so less than 2% of the hospitalized burn patients make up the addressable Epicel market. Now with NexoBrid, you basically play at the top of the funnel because virtually all of those 40,000 patients are going to have to have some sort of debridement. So we think it's about a $200 million market opportunity for us in addition to the $100 million market opportunity for Epicel. So it's a great strategic fit for us. We're in these burn centers already, nearly triples our addressable market. Again, we think we'll change the standard of care for these burn patients.

And in that first view after approval, how do you think about, I'm just quoting the question online, the mix between BARDA sales and non-BARDA sales? Do you have a sense of that yet? Are you providing guidance on that?

Well, yes, in terms of the BARDA sales, the initial procurement from BARDA for stockpiling for response preparedness, it's about $16.5 million. We have a profit split with MediWound. So after cost of goods, we're splitting the profit. So we said about $6 million for us spread over the next 6 quarters. So it started in the third quarter of this year. So just call it $1 million a quarter through the end of 2021. That will vary depending on the delivery schedule, but that's a pretty good place to start for modeling purposes. In terms of commercial revenues, again, the PDUFA date is the end of the second quarter next year. It's typically -- it will take a little time to get the labeling finalized to get approval through the back or P&T Committee. So we expect start recognizing revenue in the fourth quarter next year. And then certainly, 2022 will be sort of the year of first meaningful commercial sales. And we haven't forecasted or just given any guidance on that yet, it's a little premature.

Perfect. Very helpful. Now why don't we pivot back to the sports medicine franchise, and you guys have been transparent on the TAM for MACI being about $2 billion. Would love to understand how you think about that, how you think about the penetration needed to continue to drive your differentiated growth profile in medtech probably defined.

Yes. So I'll start, and Gerard can add additional commentary. But the TAM for us is about -- there's about 0.75 million cartilage repair surgical procedures that are done each year. We did a very large quantitative market assessment project a couple of years ago with a survey of over 200 orthopedic surgeons. And long and short of it is, the addressable market for us is about 60,000 patients a year. So it's less than 10% of the procedures that are done each year, but at a $40,000 price point per implant, it's a big market opportunity, as you mentioned, over $2 billion. And the way -- right now, we've disclosed publicly that we're probably at about a 10% penetration rate in terms of the biopsies received, probably more like 5% or so or less based on the implants. And there's really 3 drivers to how we'll continue to grow. Keeping in mind there's no like competition on the horizon, right? So we've got multiple years where we're the leading player in the marketplace. And the first lever is adding additional surgeons. So 1 metric that we gave sort of before this COVID disruption is that we look at new biopsying surgeons. And we had about 1,400 surgeons in 2019, that was up about 25% over 2018. And we said that's a good proxy for what we see as sort of baseline growth. And we expanded our sales force from 49 to 76 reps this year and expanded our target surgeons of other high-volume cartilage repair orthopedic surgeons from 3,000 to 5,000. So we have a long way to go in terms of adding new surgeons, but that's the first lever. The second is getting more biopsies per surgeon, right, as they identify more patients who are appropriate patients for MACI within their practices. So deeper penetration into the practices. And then, of course, increasing the conversion rate. So getting that biopsy to implant conversion rate up from around 37% where it's been for the last year or so or few years and moving that up over time through a number of initiatives.

Perfect. And one last question from the audience on MACI and some of the points you were making, do the top 10% of surgeons do 80% of the MACI cases. So what's kind of the concentration of surgeons, if you guys disclose that?

We haven't really disclosed it other than to say, we certainly have -- I think that's a bit of a steep Pareto chart. But certainly, we have some very high-volume users. This 10% doesn't account for 80% of our business. As I mentioned, we've gotten a much -- because of the simplicity. And you can think of MACI, there's a number of examples in the industry where you kind of go from invasive to minimally invasive or less invasive surgeries, and that's what MACI did. So in the last year, Carticel was on market. We had about 350 surgeons do a Carticel procedure. I gave you the numbers on MACI biopsying surgeons, not all of them do an implant every year, but you can see the breadth of surgeons that are adopting this product into their practice. And so we do have some very high-volume users. We definitely have a long tail, but it's not, again, quite as concentrated as that.

Very helpful. I guess I need to ask the COVID question because everyone else gets asked it. So how has COVID impacted your business? How do you think about the recovery? I know there were some debates with other clients yesterday about -- is fourth quarter when we see the V-shape, if it's a V-shape, or is it now pushed into first quarter. So I'd love to think about how has your business been impacted? And how is the recovery going?

Yes. So just kind of dialing back to the second quarter briefly. So we had said, we believe that about -- there was about 10% of surgical -- elective surgical capacity that was online in April and then 60% May, 80% in June. And then back to more or less normal moving forward through the third quarter. And you can see that in MACI's performance where we outperformed surgical capacity every month. But we were down about 80% in April, 30% in May, but then up 20-plus-percent in June. So we had a very steep recovery. And we said -- both in implants and biopsies, and we said, biopsies that continued into July. So by the time we did our earnings call in August, we were starting to see some of those sort of sporadic outbreaks again in California, Texas and Florida. And there was a lot of commentary around, are we going to see a second wave or not. And we said that we don't believe MACI will be impacted by that for a couple of reasons. Number one, there's a lot of underlying demand for MACI. Our patients are younger, active, healthier patients who have symptomatic cartilage injuries and they're not likely to defer, in our opinion, these procedures. 95-plus percent of our procedures for MACI are done in outpatient surgery center, whether it's a hospital, outpatient surgery center or an ambulatory surgical center. So when states are worried about sort of maintaining in hospital beds, that's sort of outside of where MACI procedures are done anyway. So for a number -- and MACI's well reimbursed, so it kind of fits in with practices that are trying to regain lost revenue. So we had said that we felt that even if there were some outbreaks regionally in the latter part of the year, we didn't think it would have a big impact on us. And we maintain that position, I think, while there may be some in the MedTech space that say the recovery might move into next year, I think what you see in our space is some commentary this week saying all those disruptions that people were worried about in August haven't really materialized. For large-cap MedTech saying, we think we're seeing a V-shaped recovery. And I think that's probably more applicable to our space and our situation.

Great. That's helpful. Maybe we could drill down a little bit on the margins. Obviously, it's a lot of upside as you drive the margin from high-60%. I'd love to like kind of get -- I don't know if it's Gerard or you, Nick, your views on where they can go and what drives kind of a material ramp in the next couple of years on margins?

Sure. I'll pick that up. The -- I mean the business has tremendous leverage on the gross profit side. We have plenty of incremental capacity here in Cambridge. And we maintain a workforce that is always ready to deal with a lot of spikes in demand. So the marginal cost is probably somewhat under 20% combined for Epicel and MACI. What we've actually done from the launch of MACI from '17 through about '19 is have 80% of every marginal revenue dollar hit the gross profit line and about 50% of every marginal revenue dollar hit the EBITDA line. In '19, that meant we had 68% gross margin, and we had positive operating cash flow and positive adjusted net income. Looking forward, the years ahead, we don't -- we're not going to have any downward price pressure, either from competition or just generally the more of a dynamic in MedTech, where you have downward pricing pressure. We're not going to see that with our types of products. So we think we'll be looking at something over 70% on the gross profit line, and something in the 20% range on the operating profit line in the not-too-distant future.

Great. Super helpful. And how do you think, as that -- those incremental dollars fall down to the bottom line. How do you think about capital allocation, your priorities, where you're going to spend that capital, return to shareholders, invest in the business? How do you think about that?

We're always looking for opportunities. The products this business is based on was [ long ] with Nick bringing these products to $6 million. NexoBrid was another, I think, very good transaction, great fit, great economics for us. So we are looking for other things to bolster both the sports medicine franchise as well as the burn care franchise. In addition, if something came along that made sense, appropriately derisked in cell therapy that leveraged our know-how and capability in that area, we could look at that if it was a focused vertical. We will, at some point, put some capital work to increase capacity simply because things are growing so quickly. It's a high-class issue that in the next couple of years, we'll probably add some capacity. So that would be capital allocation, but primarily deals and then at some point in the not-too-distant future, probably thinking about additional capacity.

And would you -- do have a -- where are you in capacity now in your facility in Cambridge? Just a ballpark?

Yes, we could probably grow at -- excuse me, the light keeps turning off in this silly room, but we could probably put at least -- grow another 40% or so easily with what we have here and probably more than that with some modest changes.

So a lot of running room then?