Organogenesis (ORGO) Q4 2022 Earnings Call Transcript

Organogenesis (ORGO)
Q4 2022 Earnings Call
Mar 01, 2023, 5:00 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Welcome, ladies and gentlemen, to the fourth quarter and fiscal year 2022 earnings conference call for Organogenesis Holdings Inc. At this time, all participants have been placed in listen-only mode. Please note that this conference call is being recorded and that the recording will be available on the company's website for replay shortly. Before we begin, I would like to remind everyone that our remarks today may contain forward-looking statements that are based on the current expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated, including the risks and uncertainties described in the company's filings with the Securities and Exchange Commission, including Item 1A Risk Factors of the company's most recent annual report and its subsequently filed quarterly reports.

You are cautioned not to place undue reliance upon any forward-looking statements, which speak only as of the date made. Although it may voluntarily do so from time to time, the company undertakes no commitment to update or revise the forward-looking statements, whether as a result of new information, future events or otherwise, except as required by applicable securities laws. This call will also include references to certain financial measures that are not calculated in accordance with the generally accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures.

Reconciliations of these non-GAAP financial measures to be the most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release on the investor relations portion of our website. I would now like to turn the call over to Mr. Gary S. Gillheeney Sr., Organogenesis Holdings' president and chief executive officer.

Please go ahead, sir.

Gary Gillheeney -- President and Chief Executive Officer

Thank you, operator, and welcome, everyone, to Organogenesis Holdings fourth quarter and fiscal year 2022 earnings conference call. I'm joined on the call today by Dave Francisco, our chief financial officer. Let me start with a brief agenda of what we'll cover during our prepared remarks. I will begin with an overview of our fourth quarter revenue results and the update on some of our key operating developments in the recent months.

Dave will then provide you with an in-depth review of our fourth quarter financial results, our balance sheet and financial condition at year-end, and our 2023 financial guidance, which we introduced today with our press release. I'll then share a few thoughts on our outlook for 2023 before opening the call up for questions. So, beginning with a review of our revenue for Q4, we reported net revenue of $115.5 million for the fourth quarter, a decrease of 10% year over year, which was driven by a 10% decrease in our sale of advanced wound care products and a 6% decrease in sale of our surgical and sports medicine products. Fourth quarter sales results came in above the low end of the guidance range we provided on our third quarter earnings call.

And moreover, sales of both our advanced wound care and surgical sports medicine products exceeded the low end of the range for their respective guidance. That said, the composition of our Q4 revenue by product was different than what we guided. Specifically, the low end of our guidance range assumed a 12% decline in total net sales driven by mid-single-digit growth in sales of PuraPly products and nearly a 30% decline in sales of non-PuraPly products. As we outlined on our Q3 call, we expected our sales in the physician office setting to be impacted by overall market disruption driven by reimbursement uncertainty related to CMS publishing ASPs for skin substitute products this year in competitive pressure from smaller amniotic players.

And as expected, we did, in fact, see a continuation of the challenging operating environment in the physician office in Q4, which was the primary contributor to the 10% decline year over year in sales of non-PuraPly products. However, we were pleased that these sales results were above the high end of our guidance range. We are proud of the team's execution in Q4 and believe our ability to deliver results in line with our guidance represents another clear illustration that we have the right strategy to maximize our competitive position as a leader in the advanced wound care market. We navigated a challenging operating environment with strong execution by our commercial team who leveraged the powerful combination of our comprehensive portfolio, our expanding breadth of customers across multiple physician specialties in sites of care, and well-established brand loyalty.

While our net sales declined year over year, there were a number of bright spots in our Q4 results, which will help support growth in 2023. Excluding ReNu, NuCel and Dermagraft, our team delivered low double-digit growth in the number of accounts that we serve in both the hospital outpatient setting and the physician office setting compared to the prior period. We delivered double-digit growth in sales of advanced wound care products in the hospital outpatient setting, which partially offset the impact of the headwinds that we saw in the office setting. And we're pleased by the encouraging market response to our new product introductions.

Turning to an update on our operational progress in recent months. First, we were pleased to announce in a separate press release this afternoon, the achievement of an important milestone and notable progress in our ongoing phase 3 clinical trial of ReNu for the treatment of knee osteoarthritis. Specifically, we completed the interim analysis of 50% of the patients enrolled who had reached the FDA-approved six-month primary efficacy endpoint. This interim analysis of patient safety and effectiveness was reviewed by the independent study data monitoring committee, or the DMC, who assessed study performance relative to the primary objectives and statistical power of the study.

By way of reminder, the primary efficacy endpoint is a reduction in pain at six months from the start of the study comparing the ReNu and control groups, a significant clinical reduction in pain while maintaining or improving patient function is necessary for FDA approval. Based on DMC's review, we were instructed to continue the study as planned. This is very positive news, and we're encouraged by the results of the DMC's review of the data from the first 50% of the 474 required patients enrolled in the trial, which supports our belief that the results of the original study protocol are on track. This morning's press release also announced that our clinical team delivered on our stated milestone of completing patient enrollment by the end of 2022.

And in fact, as a result of the strong momentum in patient enrollment toward the end of the year, we enrolled more than 500 patients in this phase 3 clinical study. The team's hard work in activating additional sites and implementing additional recruiting strategies helped accelerate the pace of enrollment over the second half of '22 to get us to this very important clinical milestone. In recent months, we've also made progress with respect to our efforts related to our second phase 3 study for ReNu. We submitted an IND amendment to the FDA in Q4 of last year and responded to a request for additional information in late February, and we expect to hear from the FDA in coming weeks and remain on track with our plan to launch a second phase 3 study by the end of the second quarter of this year with the first patient enrolled expected to be at the end of the third quarter of this year.

As a reminder, our plan is based on the belief that moving forward, as soon as we hear from the FDA, will enable us to leverage the major operational advantages of continuing with the current active investigator sites. This plan essentially gives us more options in our regulatory strategy. And as we've discussed previously, we expect to present our strategy in a meeting with the FDA and to propose that the completed 200-patient RCT and the first phase 3 study with more than 500 patients together represent valid scientific evidence of ReNu safety and effectiveness for the treatment of knee osteoarthritis. In addition to a notable clinical progress in recent months, we've also continued to evaluate potential alternatives after the decision to pause construction of our Canton, Massachusetts manufacturing facility last fall.

Recall that this project was put on hold in response to material increases in the expected investment for this facility due to inflation in materials and construction costs in recent years. Specifically, the last estimated project investment represented a 40% increase from the original budget two years ago. While this decision is not expected to impact our ability to meet the market's demand for our existing commercialized products or our ability to achieve our target of greater than 80% gross margins in the future, the building was intended to be used to manufacture multiple products, including Dermagraft and TransCyte, and we remain focused on bringing these products back to the market as soon as possible and expect to have a definitive plan in place by the end of the third quarter of this year. Lastly, I'd like to share a few thoughts on the virtual CMS skin substitute town hall conducted on January 18, which I previewed on our Q3 earnings call.

The event was organized as an opportunity for interested parties to present and respond to four specific questions related to changes in payment in terminology of skin substitute products under the physician fee schedule. Organogenesis participated and value the opportunity to share our feedback and responses to CMS' questions during the five minutes allotted to each presenter. And while we applaud CMS for engaging with key constituents during the town hall, we believe a longer discussion of this wide-ranging, complicated, important initiative is warranted. And it's our current understanding that CMS will not be formally engaging with key constituents or providing updates in advance of their annual proposed update to the physician fee schedule in July.

However, we plan to continue our vigorous efforts to engage with key constituents, including CMS, on this topic in the coming months. With that, let me turn the call over to Dave.

Dave Francisco -- Chief Financial Officer

Thank you, Gary. I'll begin with a review of our fourth quarter financial results, and unless otherwise specified, all growth rates referenced during my prepared remarks are on a year-over-year basis. Net revenue for the fourth quarter of 2022 was $115.5 million, down 10%. Our advanced wound care net revenue for the fourth quarter of 2022 was $108.8 million, down 10%.

And lastly, net revenue from surgical and sports medicine products for the fourth quarter of 2022 was $6.7 million, down 6%, with net revenue from PuraPly products for the fourth quarter of 2022 was $56.8 million, down 9%. Gross profit for the fourth quarter of 2022 was $88.4 million or approximately 76.5% of net revenue compared to 74.5% last year. The change in gross margin was driven primarily by changes in product mix and normalized fixed cost absorption as compared to the prior-year period, which was impacted by our La Joya restructuring activities. Operating expenses for the fourth quarter of 2022 were $79.7 million compared to $75.5 million last year, an increase of 4.2% or 6%.

The increase in operating expenses in the fourth quarter of 2022 was driven by a $3.1 million or 38% increase in research and development costs and a $1 million or 2% increase in selling, general and administrative expenses compared to the prior-year period. Fourth quarter 2022 GAAP operating expenses including certain nonoperating items totaling $0.8 million, consisting of employee retention and benefits, as well as other exit costs associated with the company's restructuring activities. This compares to $1.8 million of restructuring-related charges in the prior year. Excluding these nonoperating items and noncash intangible amortization of $1.2 million in both periods, non-GAAP operating expenses for the fourth quarter of 2022 increased 7% year over year, driven by higher clinical study-related spending in support of our ReNu studies and mid-single-digit growth in SG&A expense.

Note, we have a detailed reconciliation of these nonoperating and noncash items in today's earnings press release. Our non-GAAP operating expenses growth in 2022 reflects our strategy to prioritize investments in areas that enhance our foundation for future growth. Specifically, of the roughly $37 million increase in non-GAAP opex in 2022, roughly 70% was invested in sales and marketing, R&D, and clinical initiatives, including expanding our commercial team, supporting new product development, and funding clinical studies. The balance of the increase in non-GAAP operating expenses this year was largely focused on continuing to enhance infrastructure to support our growth objectives going forward.

Operating income for the fourth quarter of 2022 was $8.7 million compared to operating income of $19.8 million last year, a decrease of $11 million. Total other expense for the fourth quarter of 2022 was zero in the fourth quarter of 2022 compared to $0.9 million last year, a decrease of $0.9 million. The change in total other expense was primarily related to a $0.5 million gain on capitalized interest related to our decision to pause the Canton manufacturing project. The remaining year-over-year decline in total other expense for the fourth quarter of 2022 is attributable to lower interest expense on outstanding borrowings.

Net income for the fourth quarter of 2022 was $7.5 million, compared to $51 million last year, a decrease of $43.5 million. As a reminder, net income for the fourth quarter of 2021 included a benefit of $32 million in income taxes recognized, resulting from the release of the valuation allowance, previously recorded against the full amount of our net U.S. deferred tax assets. Adjusted EBITDA for the fourth quarter of 2022 was $14.1 million or 12% of net revenue compared to $26.3 million or 21% of net revenue last year.

We provided a full reconciliation of our adjusted EBITDA results in our earnings press release. Turning now to the balance sheet. As of December 31, 2022, the company had $103.3 million in cash and cash equivalents and restricted cash, and $70.8 million in debt obligations. This is compared to $114.5 million in cash, cash equivalents, and restricted cash, and $73.6 million in debt obligations, of which $0.2 million were financed lease obligations as of December 31, 2021.

We also have up to $125 million of available borrowings on our revolving credit facility as of December 31, 2022. Turning now to a review of our 2023 financial guidance, which we introduced in our press release this afternoon. For the 12 months ending December 31, 2023, the company expects net revenue between $450 million and $462 million, representing a year-over-year change in the range of flat to an increase of approximately 2% as compared to net revenue of $450.9 million for the year ended December 31, 2022. The 2023 net revenue guidance range assumes net revenue from advanced wound care products of between $420 million and $428 million, representing a year-over change of down 1% to up 1% as compared to net revenue of $422.2 million for the year ended December 31, 2022.

Net revenue from surgical and sports medicine products between $30 million and $34 million, representing an increase of 5% to 19% year over year, as compared to net revenue of $28.7 million for the year ended December 31, 2022. And net revenue from the sale of our PuraPly products of between $180 million and $200 million, representing a decrease of approximately 26% to 18% year over year, as compared to net revenue of $242.7 million for the year ended December 31, 2022. In terms of our profitability guidance for 2022, the company expects to generate GAAP net income between $7.2 million and $13.9 million, adjusted net income between $12.3 million and $19 million, EBITDA between $27 million and $36.1 million, and adjusted EBITDA between $36.5 million and $46 million. In addition to our formal financial guidance for '23, excuse me, we are providing some considerations for modeling purposes.

For the fiscal year 2023, we expect sales of our non-PuraPly products, which include our amniotic PMA and other products, will increase at the midpoint of the range of approximately 28% year over year in 2023. Gross margins of approximately 75.7% to 76.5%. Total GAAP operating expenses will increase 1% to 2% year over year. And total non-GAAP operating expenses will increase approximately 2% and 3%, respectively, year over year.

Our 2023 non-GAAP operating expenses include noncash intangible amortization of approximately $4.9 million and estimated restructuring charges of $2.1 million. Total interest and other expenses of approximately $5.2 million compared to $2 million last year, and non-GAAP tax rates of approximately 29% and 27%, respectively. Noncash depreciation of $6.4 million and noncash stock comp expense of approximately $7.8 million, and weighted average diluted shares of approximately $133 million. We also expect full year 2023 capex to be approximately $25 million to $30 million.

And finally, I'd like to remind investors that our business experiences significant quarterly seasonality each year, with Q1 and Q4 representing our smallest and largest revenue quarters, respectively. Over the last five years, our first quarter revenues have ranged between approximately 18% to 22% of annual revenue. For 2023, we expect the first quarter revenue in the range of approximately $95 million to $100 million or 21% to 22% of our full year 2023 net revenue. With that, I'll turn the call back over to Gary for some closing remarks.

Gary Gillheeney -- President and Chief Executive Officer

Thanks, David. 2022 was a challenging year, but we are proud of the team's commitment to our long-term growth strategies, and we expect that to continue this year. Although it may not be readily apparent based on the net revenue growth reflected in our 2023 guidance, our guidance reflects our expectations for measured growth in sales of advanced wound care products in 2023, driven primarily by the impact of key products in the physician office setting working through nationwide launches with recently published ASPs. We also expect to navigate the continued challenges in the office setting in 2023 due to the competitive noise from smaller skin substitute players operating outside the published ASP framework and customer uncertainty surrounding CMS' potential changes for Medicare payments under the physician fee schedule for its advanced wound care treatments.

We applaud CMS for pushing forward with their initiatives to publish ASPs for skin substitutes this year. We now have the opportunity to introduce our differentiated and clinically proven solutions to patients nationwide. This represents a significant long-term growth opportunity for Organogenesis. And while sales of our advanced wound care products in the office setting will be impacted in 2023, we expect to deliver stable growth in sales of our advanced wound care products in the wound care centers and hospital outpatient centers.

We expect growth in the number of new and active customers. We expect growth in the number of units sold and stronger adoption of our new products entering full commercialization. And importantly, executing on our strategy this year is expected to result in growing our share of patients treated with advanced modality, again, in 2023. We also expect to deliver continued progress in strengthening our competitive position in the surgical and sports medicine markets in 2023.

So we are in year 2 of our strategic repositioning of this business following the FDA enforcement deadline in May of 2021. We continue to identify opportunities to expand our commercial focus beyond spine fusion and foot and ankle with an emphasis on increasing awareness of our product solutions for surgical wound in soft tissue procedures and will continue to optimize our independent agency relationships and continue to look further for further progress in our ongoing pilot programs, which we're testing potential commercial strategies, including using small direct teams of specialists in certain procedure areas. We also look forward to strong market adoption of our new product, PuraPly MZ, as it enters full commercialization this year. And as Dave mentioned earlier, we are focused on prudent investment in our highest priority operating expense areas, which we expect will help drive strong adjusted EBITDA generation in 2023 despite a more measured net revenue growth profile this year.

We are confident that we have the right strategy to continue to build on our leadership position in the office setting, as well as in wound care centers across the United States and to strengthen our competitive position in the surgical sports medicine market in 2023. Importantly, we continue to believe that the long-term growth opportunity for Organogenesis is very compelling, and we remain confident in our long-term target of sustainable low double-digit growth on a normalized basis. Our business fundamentals are strong. We will continue to be a leader in advanced wound care while improving our competitive position in surgical sports medicine and burn markets by launching highly innovative, highly efficacious products as we deliver on our mission to provide integrated healing solutions that substantially improve patient outcomes and reduce the overall cost of care.

Operator, I'll turn it back to you.

Questions & Answers:

Operator

Thank you, sir. [Operator instructions] And our first question will come from Ryan Zimmerman from BTIG. 

Ryan Zimmerman -- BTIG -- Analyst

All right. Thanks for taking the questions. Gary and Dave, I appreciate all the color. I'm going to ask a number of questions if that's OK.

I think there might be some capacity here on the call. And if there's others in queue, certainly, I'll hop back. But I want to start with guidance for a bit here. And just talk about your assumptions underpinning the guidance from a macro perspective.

I can appreciate the competitive noise, but I'm curious if you assume market growth for 2023. And if so, what is that market growth specifically? And then I want to ask also about if you can elaborate on why PuraPly has seen such drastic declines in usage for '23 because the pricing into '23 was held fairly flat, I think, as of the last update from CMS. And then I'll ask some other questions if I could. 

Gary Gillheeney -- President and Chief Executive Officer

So, I mean I'll start. Dave, you can jump in. So, there's clearly market growth in our 2023 guidance. As Dave mentioned, our non-PuraPly products are expected to grow at the midpoint at 28%, and that's a reflection of all of the new accounts that we talked about during the year and that I mentioned that we're expecting again in 2023.

We have more active accounts. We have more units being sold both in the outpatient setting and in the physician office. So, significant opportunities for growth in the non-PuraPly products. Now, as it relates to PuraPly, PuraPly was published and will be published in 2023 for the entire year, and that typically causes a pause.

We've actually seen that pause at the end of Q4. Once the physician fee schedule dropped in mid-December, we've seen a pause in the acquisition of PuraPly XT. So, now with that product published, we have that pause that we will overcome with the growth of the rest of our portfolio. And once we get by this year, the comps going forward will be more relative.

Dave Francisco -- Chief Financial Officer

Yeah, absolutely, Gary. I think the only other thing on the growth perspective from '23 on the non-PuraPly side of the house, we obviously brought in incremental sales reps throughout 2022. These guys came in around July and August time frame and are really up to speed and ready to contribute in '23. 

Ryan Zimmerman -- BTIG -- Analyst

OK. And just I want to ask one thing on PuraPly while we're still on the topic. I did see a disclosure in the 10-K as I was looking through it ahead of this call. As it relates to these rebates that may take effect from CMS to implement a rebate, it calls out the fact that there may need to be refund amounts calculated for 2023.

And I'm just wondering if you can elaborate on what that means, what you expect to potentially owe to CMS if that does follow through. 

Gary Gillheeney -- President and Chief Executive Officer

So, I'll transfer it to Dave, but we don't know what that amount would be, if any. So, that's not something that's calculable at this point in time. 

Dave Francisco -- Chief Financial Officer

Yeah, it's unclear at this point, Ryan, how that's going to play out. So -- 

Ryan Zimmerman -- BTIG -- Analyst

Just citing the risk factor in the 10-K. 

Dave Francisco -- Chief Financial Officer

Yeah, that's correct. 

Ryan Zimmerman -- BTIG -- Analyst

OK. And then as far as -- first off, on a more positive light, I think the clinical trial, the interim analysis looks fantastic. To be able to not have to up your power for that trial is really great. Just you elaborated a little bit, Gary, on kind of what the plan is going forward with CMS.

You're on track. You're seeking IND. But help us understand some of the outcomes here. So, if you can't submit that 200-patient RCT in conjunction with the phase 3 trial, what does the second trial potentially look like? Help us understand kind of timelines for when a new indication could potentially be on market. 

Gary Gillheeney -- President and Chief Executive Officer

Sure. So, if, in fact, our first phase 3 trial with the 200-patient study was accepted, we would expect BLA approval in the first half of 2025. To answer your question, if the second study is required, which we are initiating, our next submission -- or discussion rather with the FDA would be to use the first phase 3 trial and the interim analysis of the second phase 3 trial. And if accepted, that would be a BLA approval in Q1 of 2026.

If the second trial has to go all the way through the end for 100% efficacy data, we are looking at the second half of 2026 for BLA approval. 

Ryan Zimmerman -- BTIG -- Analyst

Very helpful on that. And then if I could squeeze a couple more in. Competitive pressures, I think, were supposed to abate after the fourth quarter. CMS published a number of new products into the first quarter, yet they are persisting into 2023.

And just help us understand kind of the line of sight and your current thinking around what happens now in terms of competitive pressure. Do you think this gets better over one more quarter, the entirety of the year? Just curious to get your perspective there. 

Gary Gillheeney -- President and Chief Executive Officer

Sure. So, CMS did publish 41 additional products on the list. I believe they've removed several, which has created some confusion. And I think just the whole process has created confusion, which is why we still expect to see some impact in the market clearly in the first quarter.

Now if CMS publishes the rest of those products, we would expect to see that competitive impact start to get much better for us once that information is absorbed in the market. But one of the other trends that we're seeing is even with the competitive noise, we're starting to see some of the customers actually, even with those rebating programs out there, reverting back to some of our technology because perhaps they're not getting the results. So, we're starting to see some improvement in just recruiting those customers back. And as we launch on a national basis with Affinity and now XT, there's -- you have that competitive noise in accounts that we haven't been in with those products.

We're starting to see some inroads a little earlier. So, that tells me that clinicians are seeing the benefits of our products and perhaps not so much in some of the other products they're using on the dehydrated side. So, we think it gets better, Ryan. We think it gets better because efficacy is going to win.

We think it gets better because eventually, some of these others will get published. So, to answer your question, we think it improves. But right now, it's -- the noise is the same and the confusion is the same. Though our trends in 2023, so far, are encouraging. 

Ryan Zimmerman -- BTIG -- Analyst

Right. That's helpful. And I apologize, I'm bouncing around a little bit here. But the last question for me, and I'll hop back in queue, given the guidance on the top line, implied expenses are up modestly, but there's -- I mean they're essentially in line with kind of where your sales are, and I know some of these are noncash.

But that said, how are you thinking about kind of your spend into '23? And what are your levers to control that and get a little bit more adjusted EBITDA, net income? Because it is going to be down year over year based on the guidance. 

Dave Francisco -- Chief Financial Officer

Yeah, Ryan. I mean the one thing I would say is that, obviously, this is an environment where, from our standpoint, we are looking at flattish top line, absolutely. And you can see there based on the prepared remarks, we also see a decline in gross margin, which is primarily related to the mix shift out of PuraPly. As you might imagine, that's a fairly profitable business there, franchised.

So, what we're trying to do is be prudent about the operating expenses that we're investing back in. It's relatively minor. I think the levers we've got are we're digging in pretty deep to ensure that we're optimizing all the tools that we have and redeploying resources where they'll add the most value. So, we're looking at all those different things.

And we think that the investment profile that we've got going forward, again, to your point, is consistent with where we are around on the top line.

Ryan Zimmerman -- BTIG -- Analyst

OK. I'm going to stop there and hop back in queue. But appreciate you answering all my questions tonight.

Gary Gillheeney -- President and Chief Executive Officer

Thank you.

Dave Francisco -- Chief Financial Officer

Thanks, Ryan.

Operator

Thank you. We are currently showing no remaining questions in the queue at this time. That does conclude our conference for today. Thank you for your participation.

Gary Gillheeney -- President and Chief Executive Officer

Thank you.

Duration: 0 minutes

Call participants:

Gary Gillheeney -- President and Chief Executive Officer

Dave Francisco -- Chief Financial Officer

Ryan Zimmerman -- BTIG -- Analyst

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