Vericel Corporation (VCEL) Earnings Call Transcript & Summary

Good afternoon. This is Peter Harrison from Morgan Stanley's Investment Banking division. I'd like to welcome you to the Vericel fireside chat with CEO, Nick Colangelo. Before I get started, I'm required to read the following to you all. 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 representative. And with that out of the way, let's get started with our chat with Nick. Nick, before we get into specifics, why don't we give a high-level overview of Vericel for those who may be new to the story and hearing of this the first time today.

Yes, happy to do it. And let me start by saying, Peter, thanks for the invitation. We're delighted to be here at the Morgan Stanley conference today. And likewise, I will just say that this discussion will contain forward-looking statements. So I'd invite all the listeners to refer to our documents on file with the SEC for further information. So for those who are not as familiar with Vericel, we are a leader in advanced therapies for the sports medicine and severe burn care markets. We -- one of the defining features of our company is that we have a highly innovative portfolio with significant barriers to entry. So we're currently marketing 2 commercial products in the U.S., MACI and Epicel, that we acquired from Sanofi back in 2014. These are products that are made and regulated by the FDA as combination device biologic products. They use a patient's own cells to repair tissue and restore function. Our leading product is a product called MACI, which we launched in 2017 for the repair of cartilage defects of the knee, and it's the leading restorative cartilage where -- repair product in the market and the only FDA-approved product in its class. Our second product is called Epicel. It's a severe burn care product that is indicated for treating patients with large total body surface area burns greater than 30%. And then finally, when you think about severe burn care patients that are hospitalized, which are the patients that we focused on, the first thing you do for those patients is remove the burn tissue or eschar and then you figure out how you're going to cover or close that wound. So Epicel is used to help close full thickness burns. And then we've licensed it in a product called NexoBrid, which is an enzymatic debridement agent to remove that eschar before you treat the patient. So a very a strong strategic fit with our franchise. And as I mentioned, our portfolio is very unique in that there are significant barriers to entry. So because MACI and Epicel are regulated as combination device biologics, there's really no generic pathway that's been established, either on the device side or on the biologics. So no biosimilar pathway, no 510(k) pathway for these kinds of products. So a very long runway that we think will provide for sustainable revenue. And the same will be the case for NexoBrid when it's approved in the U.S. in that it's an orphan biologic product that will have not only IP protection into the 2030s, but biologics and orphan exclusivities as well. So great barriers to entry that, again, we think will allow us to continue to sustain our high revenue growth. And since we've launched MACI in 2017, our compounded annual growth rate has been about 25%. We've had strong revenue growth from both products, and we expect that to continue as our guidance for this year implies north of 30% growth. So the other defining characteristic besides an innovative portfolio, high revenue growth is really the profitability profile of the company. So we make both MACI and Epicel here at our facility in Cambridge, Massachusetts. Marginal cost of goods is about 20%. So about 80% of incremental revenue falls to the gross profit line. So our margins have gotten much stronger over the years. We've guided to about 70% to 71% gross margins this year. And when NexoBrid launches, it will be in line with that gross margin profile. But the really unique part and the leverage we get is on the operating margin or adjusted EBITDA line. So these are premium priced products and concentrated call points. So we have about 76 reps for MACI; about, call it, 15 commercial people in the field for Epicel. And so we've been consistently generating at least 50% adjusted EBITDA on a marginal basis. And so even last year during the COVID year, we had record revenues, we had operating cash flows of about $18.5 million adjusted EBITDA of the same. And when you look at our revenue guidance for this year and the fact that our operating margin guidance -- or adjusted EBITDA guidance is about 23% to 25%, you'll see that the adjusted EBITDA would be around $40 million, so essentially a doubling of our profitability, and that's a good proxy for operating cash flow as well. So we ended the second quarter with about $116 million in cash, about $15 million in operating cash flow for the first half of the year. So we think we've gotten the company into a very strong position.

That's super helpful, great overview. One thing that's critical for most investors these days is the TAM or total addressable market. Obviously, you play in 2 very big TAMs. Maybe talk a little bit about the sports medicine TAM, how you think about that? And then on the burn side, without the sale of NexoBrid to come, how does the TAM -- what is it today? And how does it change over time as you get a new product to address different kinds of burns?

Yes, that's great. So I'll start with MACI in the cartilage repair market. And there are a large number of cartilage repair procedures that are done each year. So about 750,000 procedures. And the MACI label is very broad. So MACI's indicated to treat focal cartilage, symptomatic cartilage defects anywhere in the knee. So broad label from that perspective. There's no limit on the size, number of defects, location of defects, whether there's bone involvement or not. So a large -- probably half of those patients fall within the MACI label. But we know surgeons have certain profiles of patients in mind. And when we did our addressable market exercise, we asked them, what percentage of the patients you see would be deemed clinically appropriate for MACI? And based on age and location, size of the defect, et cetera, about 1/3 of those patients would be deemed appropriate for MACI. And then when you kind of overlay payer sort of requirements around the size of the defect, you get down to about 60,000 patients a year. So it's about 1/10 of the number of procedures that are done or less than 10%. But at our price point of about $45,000 per implant, it makes for a $2 billion-plus addressable market. And it certainly supports the growth that we've seen over the years with MACI. On the burn care side, as I mentioned earlier, we focus on hospitalized burn patients. And there's about 0.5 million burns in the U.S. each year, about 40,000 of those patients are hospitalized. And when you think first about Epicel, these are the catastrophic burn patients, so the most severe burn patients. Those, as I mentioned, by label, with 30% or greater body surface area burns, that's about 1,500 patients a year. But Epicel is routinely used in 40% and above burns. And by the way, we treat patients with 70%, 80%, 90% of their body surface area burned, which is why Epicel is such an important product. But there's about 600 of those patients a year. And when you look at the number of grafts that are used on average per patient and the price of the graft, which is about $3,000 per graft, you get to an addressable market of a couple of hundred million dollars. And we'll talk a little bit more about the TAM having grown based on the larger number of grafts per patient that have been used. But it's a good $200 million-plus market opportunity for Epicel. When you think about NexoBrid, which is a product, again, that removes that dead tissue or eschar when the patient is first being treated. There, you play at more at the top of the funnel. So the majority of those patients that are hospitalized are going to need to have some sort of debridement. Right now, the standard of care is surgical debridement, so you take a knife and you basically excise the burned tissue. Very traumatic for patients. Obviously, burns our variable depth. It's a 3-dimensional burn and you're taking a 2-dimensional [ life ] and cutting away the burn tissue. So there's a lot of healthy issue that's lost, a lot of blood that's lost. So clearly, a need for a product that selectively and effectively removes that eschar, and that's what NexoBrid does. It's an enzymatic debridement agent that just removes the dead tissue and leaves the healthy tissue. So our initial TAM estimate, and this will be revised as we get closer to launch as we kind of finalize pricing and so on, was another $200 million plus in terms of the addressable market for NexoBrid. So the combination of those products is upwards of $0.5 billion addressable market for our burn care franchise.

And on that franchise, you mentioned how efficient the reps were for Epicel today. Different kind of burn patient for NexoBrid. Do you think you'll need to change your sales force, grow it when that gets to market? Or how do you think the sales force will look when you bring that attractive and promising product to market?

Yes. So there's about 140 burn centers in the U.S., and probably the top 70 or 80 is where our Epicel reps have consistently spent time because that's where Epicel-appropriate patients are treated. And we had about 7 reps and 4 clinical support specialists. Now we have 6. So we're at about 15. And ahead of the NexoBrid launch, our plan is to go to 11 or 12 territories, 7 or 8 clinical support specialists and then the management structure. So that's one of the beauties of bringing NexoBrid in. We'll expand from the 80-ish centers we currently focus on to 140, but that won't require a big commercial investment. So highly synergistic with our current sales force.

That's great. Maybe talk a little bit about the growth you're seeing and how visible your growth is because unlike most of my clients, you talk about biopsies and grafts and all that as leading indicator for the healthiness of your business and the surgeon usage. Maybe talk a little bit how you get conviction that Vericel will continue on this pathway out, differentiated growth combined with your profitability?

Yes, that's a great question. And we kind of think, just so people understand, the way our products are made is we take a small biopsy of the relevant tissue. So in the case of a cartilage injury, we take a small biopsy of the cartilage, expand those cells, seed the cells on a collagen membrane, which is surgically implanted. And those cells replicate and basically regrow the cartilage that's naturally present in the knee. Same thing in the case of Epicel. We take a small biopsy of the healthy skins, isolate the keratinocytes, culture them and form the skin grafts. And so the starting point for us is always a patient's own tissue or biopsies. And yes, that gives us a lot of visibility into how the business is performing. So when we think about MACI, I'll start there. The 3 growth drivers that we typically talk about is the number of surgeons that are taking biopsies, which is kind of a measure of the breadth of penetration into your target surgeon audience. The number of biopsies they're sending in because absent COVID disruptions, they typically haven't seen full patient schedules. And if you're getting more biopsies per surgeon, it means you're penetrating more deeply into their practice. And then the third is the conversion of those biopsies into implants. And so those are the 3 growth drivers. Now we expanded our sales force last year from about 49 to 76 territories for MACI. At the same time, we expanded our target surgeon universe from 3,000, which was our initial launch targets, to 5,000. We had done a big sort of sales force sizing exercise after having acquired data on 12,000 surgeons. And so we could see who -- which surgeons do large volumes of cartilage repair, do open procedures, and there were another couple thousand high-value targets that we were pursuing. So that's where the target universe is. And right now, a primary growth driver is the number of surgeons and the growth of surgeons sending in biopsies. So through 2019, which is really our third year into launch, we were still growing biopsying surgeons at about 25%. We had gotten to 1,400 that year out of 3,000. Cumulatively, it was even higher than that. So probably 1,700 or 1,800 had sent in a biopsy. So pretty good penetration on the initial 3,000 surgeons. Even last year, during COVID, we were able to grow it to 1,500 biopsying surgeons. And we said for this year, we expect surgeon -- biopsying surgeons to grow by 20% or more. So right back to that sort of 20-plus percent growth in surgeons. And we've always said that's a good proxy for long-term growth for the brand. And we mentioned on our second quarter earnings call that we had the highest number of biopsying surgeons ever since we launched MACI in the second quarter, and we had record biopsies. So those underlying growth drivers are very strong and give us conviction that we'll be able to continue to penetrate the market. Likewise, you see, as surgeons become experienced with the product, that you tend to see the biopsies per surgeon grow. We saw that through 2019. It was disrupted of course, in 2020. But we said we expect -- we're already back to those 2019 levels and expect growth for this year as well. So those are the 2 of the 3 primary drivers. There's a temporal aspect of this as we saturate our target universe. And who knows, maybe in a few years, we'll have the same sort of percentage penetration as we did initially and you'll be getting biopsies from 2,700, 3,000, whatever number of surgeons, then it will be sort of the number of biopsies per surgeon and how those biopsies convert that will grow the brand in the out years. So we think there's multiple levers for growth that we'll see deliver that strong sustained growth over time. So that's the case for MACI. On Epicel, we mentioned on our second quarter earnings call that we had the highest number of biopsies ever in a quarter for Epicel, and the highest number of grafting centers for Epicel in the second quarter as well. So we've seen a pretty substantial uptick in the baseline performance of revenues and the underlying factors for Epicel, where we used to be doing $5 million or $6 million a quarter. Our last 3 quarters were close to $10 million, and this second quarter of this year was $12.2 million, so the highest revenue ever. So we've seen those, as we've expanded the sales force and sort of restructured into sales reps and clinical support specialists and bifurcated those roles, we've seen sort of an expansion in the number of burn centers as well as sort of the increase in the number of grafts per patient that led to the larger addressable market that we talked about earlier.

Great. A lot of that is great to see. I guess that's a good segue into what have you seen in COVID and with Delta? Obviously, there's been a few companies today who came out with some 8-Ks talking about weakness in their business. How are you seeing Epicel, MACI going through COVID and then now with the Delta variant flaring up?

Yes. And we -- and I think it even started back sort of with Medtronic a few weeks ago talking about Q3 dynamics. So yes, I think -- and I've been saying, I think it's going to become a theme during this quarter. And I'll just start with kind of what we said during -- for the -- in terms of guidance for MACI for the second half of the year. Epicel, not really relevant in terms of how COVID or the variants impact the business. Certainly, in the first wave where everything came to a screeching halt, we saw impact for Epicel. After that, even when you saw these resurgences in the fourth quarter, et cetera, you still saw record revenues for Epicel and underlying metrics. So it's really not -- other than access sometimes to the burn centers, when you don't have a case, it doesn't really impact. It's not an elective procedure, so it doesn't really impact the Epicel business. For MACI, what we said in the second -- on our second quarter earnings calls is that for the year, we expect the same sort of revenue cadence that we typically see, where you see 40% of the revenue in the first half of the year, 60% in the second half of the year. And again, that's consistent with what we've seen over the years. In terms of the cadence in those quarters, we said we expected to see the typical cadence in Q3 compared to Q2 and that the factors in place for the strong uptick that we always see in Q4 were in place. And obviously, our guidance assumes that the biopsy conversion rates and the timing of those conversions were in line with historical precedent and that COVID-19 dynamics didn't change materially. So that's kind of what we said on our second quarter earnings call. Leaving aside outliers, like last year in Q3, we saw this very steep V-shaped recovery. But leaving aside those kind of outliers, typically, what we see in the third quarter is a single to sort of low double-digit step down in the summer, as people are taking vacations and so on. And then a strong ramp in the fourth quarter where you can have upwards of 40% of our revenues for the year for MACI in the fourth quarter. And so I think there's 2 dimensions to the whole COVID thing that are likely to reinforce these seasonality patterns, right? Number one is early in the quarter, there was kind of that reopening phenomenon where folks were able to take vacations for the first time in a long time. And so I think that -- a lot of commentary around that. Obviously, the back half of the quarter, middle to back, has been around the Delta variant and the resurgence there. And so those kinds of things can have an impact, right, on elective procedures. So while we have very strong underlying growth drivers for both products that I mentioned earlier, certainly, these dynamics that you see with COVID, either the reopening or the resurgence, makes timing of procedures more difficult to predict, obviously. And then it does create some uncertainty for the back half of the year on all of that unfolds, right? So I think that's sort of how we're thinking about it at this point.

Great. And maybe pivoting back to your pipeline product, NexoBrid. Remember last year, even in this conference, you had some exciting news for the product. And then since that time, you all being Vericel have assumed primary responsibility BLA and its kind of pathway through the FDA. So maybe talk a little bit about the time lines there? How you're thinking about when you've taken over the path forward for NexoBrid?

Yes. So as we mentioned on our last earnings call, so the PDUFA date where our partner, MediWound, got a response letter was at the end of June. And we had said we expect to have a Type A meeting with the FDA, and that, you have to request a meeting within 3 months. So that kind of gives you the outer bounds of when you would be requesting that meeting. The meeting is typically scheduled within 30 days. And then you have final meeting minutes 30 days after that. So that's sort of the outer bounds of sort of the front end of the resubmission process. And so we've moved along that path, and we'll end up giving a more firm time line guidance once we get to our next earnings call. But that's the front-end time line. Once you resubmit the FDA has a 6-month review period, so that's the back end. And so the real question is, how long does it take you to file a resubmission following sort of that Type A meeting with the FDA, and then you have that 6-month review. So what I think we've -- most investors and analysts are thinking about is it's kind of a second half of next year potential approval for the product. But again, when we get to our earnings call in early November, we'll have been through that meeting, presumably, and we'll be able to give and have received the minutes and be able to give more guidance around time lines.

Great. What we haven't touched on is reimbursement in pricing. How -- what trends have you seen? Have the ASPs of your 2 products held up? Any trends there that investors should be aware of?

Yes. So we're very fortunate in that regard. With respect to Epicel, obviously, it depends on whether the patient is commercially insured as a Medicare patient. Sometimes they're uninsured. But typically, those patients are -- the hospitals are reimbursed under a DRG. And so we directly sell to the hospitals. They are reimbursed by the payers. And so there's really no sort of -- that dynamic hasn't changed. And at this point in time, we typically take low single-digit price increases for Epicel every year, and that's just sort of the dynamic there. With respect to MACI, it's a little different kind of reimbursement and one of the unique aspects of our positioning in the medtech universe where we don't really have those downward pressures, either from -- because of competition or otherwise on ASP. So MACI has a separate J-CODE. So about 80% of the time, the institution or a practice is outside of the whole billing and reimbursement for MACI. So we have a case management team that will get the prior approval working with the payer, the physician and the patient. We'll distribute -- the product is dispensed -- distributed through specialty pharmacy. And so the institution never really even touches the product. About 20% of the time, a hospital will buy and bill and submit for reimbursement themselves because they have a contract with a payer. So that dynamic is kind of intact. And 90% of the time, MACI's covered by commercial insurance. The other 10% is military and workers' comp. We really don't have any Medicare, Medicaid business. So there's really not that dynamic out there around pricing for MACI, which is great. The plans cover the product under a medical benefit. So they know the clinical data, they know the price of the product, and they know that only the appropriate patients will receive the product, which is how they manage it, because they'll approve it before it's utilized. So we really don't have any pushback from that perspective. And likewise, the surgeons are reimbursed under a separate CPT code. And again, that really -- there's no pushback on that CPT code. Again, there's no [indiscernible] involved. So we're very fortunate in that regard.

Great. Look, I think M&A is another thing we haven't talked on about, it's always on investors' mind. And look, as I sit back and look at you all, you have a differentiated growth profile, you had the luxury of a strong balance sheet. And I was noticing, I think it was last week now, you did hire a new Head of Business Development. So as we throw all that stuff on the mix, how should we think about Vericel with M&A opportunities versus your organic opportunities and capital allocation priorities for you all?

Yes, that's a great question. So we've been pretty consistent in sort of our business development approach, really kind of 3 prongs to it. Number one is looking for additional products that fit within our sports medicine franchise that our customers use. So we're routinely looking at those kinds of opportunities. Now I wouldn't say there's hundreds of them, right? There's a handful of them that we would be interested in because we really focus on -- as I mentioned, we have a very innovative portfolio. We have a certain financial profile. And any time we look at business development opportunities, it needs to check those boxes, right? Because that's just -- we've passed on any number of things that didn't fit the innovation profile or would not allow us to maintain kind of our current financial profile, either at a gross margin level or an adjusted EBITDA level. So that's kind of an overriding philosophy that we have. But we do look at things, again, that would be synergistic with our sports medicine franchise. Same thing on the burn care franchise. Exactly what we did with NexoBrid, when you think of that treatment pathway, you say you have to remove the burn tissue or eschar, that's what NexoBrid will do. If the underlying burn is full thickness, which means it goes all the way down to the muscle, fat or bone through the dermal layers, that's where Epicel plays. And we would like to look at partial thickness burn opportunity. So there's still areas within burn that we'll look at. And then strategic adjacencies to either one of those kinds of -- either one of those franchises. And then finally, because we are sort of one of the only companies with at least 2 advanced cell therapies approved in the U.S., we have a unique set of capabilities around developing, manufacturing and importantly, how do you commercialize these kinds of products. So we'll look at those opportunities, again, assuming they're de-risked and meet the profile that I mentioned. So those are probably -- we spent the majority of our time on opportunities around our commercial franchise, but we do look at those kinds of opportunities as well. So that's our business development focus. The capital allocation is a little broader than that. What would you use the capital you're generating. And as you've noted, and I noted, based on our guidance, we'd be at close to $40 million in operating cash flow, and that only gets better as the years progress, right? And so we expect to be a pretty powerful profit and operating cash flow generating company. And so the allocation is: one, the business development opportunities; two, as we continue to grow at this rate, we think about capacity planning and expansion, and that's on the horizon for us. And that's really where we focus on. And we're fortunate, as you said, to have a strong balance sheet, generating cash. It gives us a lot of strategic flexibility as we move forward.

Great. We have about 2 minutes left. And I guess with that, I think you have a unique franchise with some strong barriers to entry, a lot of growth ahead of you. What keeps you up at night? What do you worry about that could derail all the success you've had at Vericel?

Well, I guess I think about it from different dimensions. One, on a commercialization front, it's really been a commercial execution story and will continue to be so because there's really not any like competition coming down the pipe, right? And I have a great deal of faith in our track record of performance and our team that's generated that performance. So while we are very cognizant on an hourly basis of how we're doing, that's probably not what keeps me up at night. The -- I think about things, we have a single manufacturing site. So what do we do around risk mitigation around that. We spent a lot of time as a management team and a Board trying to mitigate risks around that, whether it's through mundane things like insurance or redundancies or appropriate stockpiling of key sole source materials and things like that. So we spend a lot of time on those kinds of issues. It doesn't derail anything.

Right. Perfect. Well, look, with that, I think we're out of time. I want to thank you for attending the conference. And best of luck on all fronts.

Thank you as well, and thank you.

Bye.