Ladies and gentlemen, thank you for standing by. At this time, I would like to welcome everyone to the Organon Third Quarter 2023 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] As a reminder, this call is being recorded. Thank you. I would now like to turn the call over to Jennifer Halchak, Vice President, Investor Relations. Please begin your conference.

Thank you, operator. Good morning, everyone. Thank you for joining Organon's third quarter 2023 earnings call. With me today are Kevin Ali, Organon's Chief Executive Officer, who will cover strategy and operational highlights; and Matt Walsh, our Chief Financial Officer, who will review performance and guidance. Dr. Sandra Milligan, Organon's Head of R&D, will also be joining us for the Q&A portion of this call. Today, we will be referencing a presentation that will be visible during this call for those of you on our webcast. The presentation will also be available following this call on the Events & Presentations section of our Organon Investor Relations website at www.organon.com. Before we begin, I would like to remind listeners that certain information discussed by management during this conference call will include forward-looking statements. Actual results could differ materially from those stated or implied by forward-looking statements, due to risks and uncertainties associated with the company's business, which are discussed in the company's filings with the Securities and Exchange Commission, including our 10-K and subsequent periodic filings. In addition, we will discuss certain non-GAAP financial measures on this call, which should be considered a supplement to and not a substitute for financial measures prepared in accordance with GAAP. A reconciliation of these non-GAAP measures to the comparable GAAP measures is included in the press release and conference call presentation. I would now turn the call over to our CEO, Kevin Ali.

Good morning, everyone, and thank you, Jen. Welcome to today's call, where we will talk about our third quarter 2023 results. In the third quarter, we navigated some external factors impacting the business. The strength of the U.S. dollar persists. We are navigating a challenging economic and policy environment in China. And as we said from the very beginning that we expected the biosimilars market for Humira to be a slow formation, it has been slower than we thought. Still, in the third, we delivered product sales that grew 1% at constant-currency. That represents our eighth consecutive quarter of product growth. Total revenue, which includes lower margin product sales to Merck, was down 1% at constant-currency, compared with the prior year. In the third quarter, ex-FX, our Women's Health was down 7%, our Biosimilars franchise grew 10%, and the Established Brands franchise, which represents nearly 2/3 of our business, grew 3%, again, demonstrating its continued stability. Adjusted EBITDA was $447 million, representing a 29.4% margin and adjusted diluted EPS was $0.87. With these results in mind, we are lowering our revenue guidance by $150 million at the midpoint to a range of $6.15 billion to $6.25 billion, about $100 million of this is from FX rates that have worsened since we last guided in August. The remaining impact primarily reflects the operational factors I just described, plus changes we are making to our go-to-market model for Nexplanon. We are also revising our range on our adjusted EBITDA margin to 30.5% to 31.5% to reflect the lower gross margin stemming from the impacts of foreign exchange on revenue, unfavorable product mix, and the timing of manufacturing costs. Now let's start by reviewing revenue beginning with Women's Health. The Women's Health franchise was down 7% on a constant-currency basis in the third…

Thanks, Kevin. Beginning on Slide 10, let's walk through the drivers of our 1% decline in revenue at constant-currency for the third quarter. Starting with the impact of loss of exclusivity, LOE was about $10 million in the third quarter, and the small amount that we have realized year-to-date has been related to generic competition for NuvaRing in the U.S. In the third quarter, we had about a $30 million volume impact from VBP in China, consistent with the first two quarters of the year, as the impact continues to be related to last year's implementation of Round 7 that included our cardiovascular product Ezetrol, which is sold as Zetia in some markets outside of China, as well as the July implementation of Round 8 that included REMERON and HYZAAR. We experienced a $25 million price erosion in the quarter. In prior quarters, Established Brands was the franchise contributing most significantly to this area. But as Kevin just referenced, we've been able to stem price erosion in Established Brands to the low end of our expectations. What we saw in Q3 was price pressure being driven within other franchises. Given the nature of biosimilar competition, we're seeing pricing pressure broadly across that franchise. Additionally, two issues within Women's Health in the US. First, customer mix in Nexplanon has been skewing towards the 340B channel. And second, within fertility, we're seeing price pressure as we competitively position ourselves to grow volume in the attractive market for reimbursed fertility services. We had about $70 million of volume growth in the third quarter, primarily from Established Brands, particularly in our LAMERA region and non-VBP products in China. Setting aside the slow market formation for Humira biosimilars in the U.S., which Kevin covered in detail, our Biosimilars volume was up nicely in the U.S.,…

[Operator Instructions] Our first question comes from a line of Navann Ty with BNP Paribas.

I have three questions please. Can you hear me okay?

Yes, we can.

Could you clarify Nexplanon's change in the go-to-market model and what drove the change and will it smooth the quarterly cadence of Nexplanon revenues? And then on fertility, have you seen biosimilar competition pressure intensifying? And also curious about what level of discount did Organon provide when onboarding accounts in Q3? And then just one overall, if you do still expect a long-term, high single-digit, low double-digit growth with the current Women's Health portfolio?

I'll try to address the three questions you had. First question on Nexplanon. So, it was historical that many years pre-spin that the increase in price for Nexplanon always happens sometime in the fourth quarter. So you'd see this very lumpy buy-in in the third and fourth quarter, taking advantage of the eventual price increase, price protection. And so, you'd end up having this very difficult seesawing type of thing in the first quarter of every year. In addition to that, physicians and systems usually just kind of get online in terms of updating their reimbursement schedules in the first quarter of every given new year. And so there was a point in time there where physicians actually were challenged -- let's call it, stressed in terms of the difference in price versus the reimbursement schedules. So by changing into being able to take price in the first quarter, we do two things. We align with the rest of the LARC industry in terms of when they take price, we align with when the schedules of reimbursement actually hit with physicians at the state level. And finally, we end up taking away some of this lumpiness and get more of a smoother, more predictable forecasting trends for you all and for us as well to be able to point to. So, I think we wanted to take away some of this unpredictability and the volatility of the buy-in and buy-out phenomenon that we talked to. We want to be able to speak more in terms of the opportunities that exist, just to look at any given year. That's essentially why we took the change in the go-to-market model for Nexplanon. And we believe it will have an impact at the very least of which it'll smoothen things out for us.…

Thank you. Our next question comes from the line of Umer Raffat with Evercore. Please go ahead.

This is [Jiachen] on for Umer. Just want to ask about your China business. Previously, it was estimated that 70% to 80% of business will have gone through the VBP by end of this year. So with some of the new dynamics you just described, how should we think about the China business going into 2024, especially in the first half of the year? And also, how much impacts have you seen from the government review campaign happened in the healthcare sector this year in China?

Thanks for the question. So China is obviously our second largest market in Organon, a very important market. We've had a long history in China. It continues to be a very important market for us to focus on. The first question in regards to the VBP impact. By the end of this year, probably three-quarters, 75% of our business will have gone through -- the Established Brands business will have gone through the volume-based procurement process, which basically means now, our focus and our strategy to move the business over to the retail sector in all the various forms of the retail sector, whether it's e-commerce, whether it's actually folks going into the pharmacies into the retail sector is really starting to take hold. And we continue to see an opportunity to grow our business in many different sectors in the retail sector, whether it's e-commerce, whether it's pharmacy dispensing. And we're working with all the top pharmacy chains in China, and we've got good ongoing programs going with that as well. In regards to the policy framework that you talked about in your second question, yes, I believe if you are a company that has what I would consider concentration risk, too much business in the public sector and the volume-based procurement process that is exposed, you will have more problems. But we actually -- no single product of ours represents more than 16% of our overall business, and we've shifted essentially most of that business to the retail sector, so out of the control of that. So it has been disruptive. There's no doubt for the summer period of time. We're coming out of that as we speak right now. We feel we're in a very good position. We're seeing growth in the fourth quarter. We've increased access in the retail sector. And we feel that next year will be a healthy year for us in China, definitely overcoming some of the issues that we saw this year, and I feel very strongly about that.

Our next question comes from the line of David Amsellem with Piper Sandler.

Just two for me. Broadly speaking, just given the headwinds you cited, are there any initiatives that you're considering to try to boost EBITDA margins as you think about '24 and longer term? That's number one. Number two is thinking broadly about Biosimilars, what's the role of that segment in the organization? And is that something you might look to monetize in some way, either as a way to pivot to acquisition of brand assets or to address the debt balance? How do you think about that?

Thanks for the question, David. On the first part, I'll take that one. So we are and have been managing the business pretty tightly. From a cost perspective, most of the increases that you've seen in our reported results, whether it's in the SG&A line or the R&D line, have been for revenue-producing activities in the future so that we can sustain our long-term revenue growth rate. That said, as regards what you might refer to as infrastructure costs, administrative costs, et cetera. We're going after those, hard to manage those as tightly as we can. And so just we're rest assured that we're really examining the cost structure hard to make sure that we're differentiating from revenue-producing costs that represent investments in the future, and any costs related to running the business from an administrative perspective, we are clamping down on those.

And David, in regards to your second question regarding Biosimilars, I've always maintained that biosimilars is really an opportunistic -- an opportunity for us in the short to medium term. I look through, I guess, the end of the decade, when you have, say, for example, I/O is coming off a patent. There's going to be still a very robust market there. Hadlima, our Humira biosimilar is definitely slower than we had anticipated. But when you start to think about kind of our share of total prescriptions, we're 3x greater than our nearest competitor that launched in the July timeframe. So to me, it is a question -- more a question of when, not if this market will start to open up. You're talking about the fact that 1/3 of the patients currently today are spending about $1,000 out of their pocket every month for co-pay cost for Humira, still to this day, even after LOE. And when you consider the fact that 2/3 of -- it's estimated that 2/3 of Americans today are moving check-to-check. I truly believe that over time that, that market will start to open up on its own, and it will be something where we are talking about more of a linearity to our Hadlima business going forward as opposed to that kind of quick peak and then on the other side coming straight down. So it is something that we believe in the biosimilar franchise. That's very opportunistic for us, and we'll continue to treat it is as so. Because remember, the return on invested capital is very good. We don't spend a lot of money in regards to our biosimilar franchise in regards to boots on the ground or any other type of resources. So it's a very healthy return on that. So we feel good about it for the time being.

Our next question comes from the line of Jason Gerberry with Bank of America.

This is Bhavin Patel on for Jason Gerberry. Two questions from us. The first is on free cash flow. It seems like the lower $700 million to $800 million free cash flow target from $1 billion previously is mainly due to net working capital use as well as lower EBITDA outlook. So how likely is this net working capital use impact to carry over into next year? Do you think that we should start thinking about $700 million to $800 million of free cash flow as an annual benchmark? Or do you see it possibly getting back to $1 billion annually next year? And then the second is on capital allocation. Notice these plans for further debt paydown in 2024. So can you frame any sort of leverage ratio target or at least how you may balance the debt paydown with business development and paying dividend?

Okay. So we'll take the free cash flow question first. We started the year with an anticipation of in round numbers, about $1 billion of free cash flow. We have had to take that back given developments this year, as we noted, related to lower EBITDA as well as the investment in net working capital. Now the latter is temporary, okay? That will come back out of the business. We will be fully through the implementation of our global ERP system in the second quarter of next year. So working capital should work its way back into our bank accounts as cash, sort of more or less ratably over that timeframe. And so we do see that the business should return to a higher level of free cash flow generation next year. And when you combine that with the fact that we expect to see lower onetime costs from the separation next year, we're actually quite optimistic about what next year's free cash flow number will look like and when we guide to that in February. In terms of capital allocation, we've been, since the spin-off, trying to achieve a balance of capital allocation between investments and growth for the future, and balancing that against the near term and certain benefits of leverage reduction. That equation has been tilted a little bit more, given where interest rates have gone, the near-term benefits of debt reduction look more attractive. So as we've said in the past a few times, it raises the bar on the type of business development and M&A transactions that we would execute. And that's one of the reasons why you've seen, relatively speaking, a lower level of activity in BD in 2023 than you saw in 2022. We continue to believe that the business -- the cash flow profile that the business exhibits supports a dividend, certainly at the level that we have. There's no plans to change that in the near term.

Our next question comes from the line of Chris Shibutani with Goldman Sachs.

This is Roger on for Chris. Just one quick question from our end. So just given the updated statements from the FDA recommending that all labeling for biosimilars include one statement, the biosimilarity statement, can you comment on how you view this change and whether this act as a tailwind or headwind for the uptake of Hadlima?

Yes. Look, listen, that's a draft statement right now. It's in draft form. It's not necessarily going out in terms of what people need to do right now, but I think it's eventually going to take hold. What I do believe is we've already made the investment in interchangeability. We -- the data has already come on very strong with our partners at Samsung Bioepis we believe that we'll be able to launch our interchangeability indication, probably sometime in the second quarter -- end of the second quarter, beginning of the third quarter of next year. It will definitely, I think, help us in terms of being a tailwind. What we're seeing playing out in the market today is the fact that interchangeability, especially at the pharmacy level, will be able to have an easier switch for patients when they get to the pharmacy, they'll understand that do they want to, for example, pay $1,000 a month or -- as a co-pay or do they want to pay $100 or whatever it is, it's going to be in that particular plan. And so having that ability to have the interchangeability designation, I think, will help to guide pharmacists to be able to more actively switch from Humira to the biosimilar specifically. And if they switch, obviously, we have a commanding market share right now in terms of total prescriptions, we'll be able to get a lot of share of that. So it is a tailwind, I believe, for us for whoever has the interchangeability designation. And I think there's only about maybe a handful, 3 or 4 actually that will have the interchangeability designation as opposed to others that haven't initiated the studies. So that's -- I think that's where it is because it's in draft form right now, and I think people are going to want to see it, and see that you actually have it, and we'll have it end of Q2, beginning of Q3 next year.

Our next question comes from the line of Balaji Prasad with Barclays.

This is Mikaela on for Balaji. Just two from us. I guess, can you talk a bit more about the Hadlima ramp into 2024? And I guess, elaborate on just some of the key factors impacting it. And on Women's Health, will you be able to reverse the weakness seen? And I guess, any further comments on what will be needed here?

Yes. For Hadlima, the ramp-up of 2024 will be -- I mean, what we see right now is the fact that what AbbVie has been able to do is essentially use their bundling power to essentially exclude -- especially in the PBM world. But remember, about 40% of the lives covered right now or what we would call WAC sensitive or what we call low net cost sensitive, it's just going to be some time until we're able to get those plants to start opening up. There's a time lag between kind of the discounts you lose on the AbbVie business as well as kind of compared to the benefit you gain from the discounts that you get going with a biosimilar. We'll definitely see better business next year, but at the same time -- at the same token, we do see that this is another market formation year in 2024. And then the breakthrough, I believe, will come in 2025, when kind of the floodgates will start to open up slowly and give us an opportunity. That's why see Hadlima more as kind of a longer-tail business and continued growth, double-digit year-over-year, which will help us in the outer years. There's no doubt about it. In regards to women -- to Women's Health question, yes, we found some issues this particular quarter, but it doesn't change the overall trajectory of our Women's Health business. Let's remember that in Q3 of 2022, there was 18% growth in the U.S. for Nexplanon. That was because the previous year, there were some COVID issues. So 2023 in this quarter is really a function of a few things. Lapping a very, very strong quarter of last year. And second, the fact that the go-to-market model has changed in terms of taking price. Right now, people would start to kind of build their inventories in order to take advantage of what the upcoming price change. Now that's not happening. So that's what you're lapping. And then ultimately, you'll see that kind of come to fruition in the first quarter of next year, where people will start to take inventory at that point of time.

There are no further questions at this time. I would now like to turn the call over to Kevin Ali for closing remarks.

Thank you. It's been an opportunity for us to kind of show what we've been able to accomplish a lot in a very short period of time as a stand-alone company. We're just a little bit over 2.5 years old. And we've got a very talented team dedicated to continuing the growth of Organon's business. We look forward to the future. There's been some headwinds in this quarter, but we see them as more transient. China is starting to grow again in Q4, so that overhang is starting to lift, and we see China's growth opportunities as solid for next year. We've taken some changes in regards to our go-to-market model on Nexplanon, and that will continue to show progress for next year as well. And we see opportunities for Hadlima. And it's not a question of if, it's a question of when it starts to open up and ultimately drive more incremental growth for us as a company. So we feel we're in a good position to continue our work and continue our focus, and we take the opportunity to look forward to speaking to you on the next earnings call. Thank you very much.

I would like to thank our speakers for today's presentation, and thank you all for joining us. This now concludes today's call. You may now disconnect.