Organon & Co.

After the speaker's remarks, there will be a question and answer session. During that time, you can simply press star 1 on your telephone keypad to ask a question and star 1 on your telephone keypad to withdraw from the queue. As a reminder, this call is being recorded. Thank you. I would now like to turn the call over to Jennifer Holchak, Vice President, Investor Relations.

Please begin your conference. Thank you, operator, and 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 your webcast. The presentation will also be available following this call on the events and presentation 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 like to turn the call over to our CEO, Kevin Ali.

Good morning, everyone, and thank you, Jen. Welcome to today's call, where we'll talk about our third quarter 2023 results. In the third quarter, we navigated some external factors impacting the business. The strength of the US dollar persists. We are navigating a challenging economic and policy environment in China. And we have 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 quarter, 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, XFX, our women's health, was down 7%. Our biosimilars franchise grew 10%. And the established branch franchise, which represents nearly two-thirds 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're 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 quarter. primarily driven by NuvaRing, which went LOE in 2018 and now has five generics in the market. The fertility business is flat year-to-date, but we anticipate a very strong fourth quarter, driven by identifiable market tailwinds in China, as well as the onboarding of a large new customer win in the U.S. Strong finish in the fourth quarter underpins our expectation that the fertility business will deliver high single-digit revenue growth for the full year on a constant currency basis. In China, we are seeing IVF cycles pick up after a slower third quarter stemming from the Chinese government's ongoing review of healthcare practices, which commanded significant physician attention. This is a transient issue impacting the entire industry. The fourth quarter of 2023 will also benefit from an easier year-over-year compare as the fourth quarter of 2022 was impacted by COVID. Year-to-date, the fertility business in China has been a growth engine, up 15% FX. We are doing very well in that important market and we have been gaining market share in China. In the U.S., the fertility market is growing and demand is very strong. Strategically, we are working on an evolution of our go-to-market strategy into the reimbursed market segment, which is rapidly growing. Over the past three years, the percentage of employers providing fertility benefits has increased from 30 to 40 percent. To compete in the reimbursed market, we have traded price for volume. We are having success. And we're excited about some of the significant accounts we have recently secured that will start to benefit the business in the near term. In fact, a recent win in the reimbursed book of business represents our largest customer win since becoming an independent company. Inventory bills from this customer will help to drive what we expect to be a strong fourth quarter for fertility in the U.S. Particularly encouraging is that as we head into 2024, we expect Organos Fertility Products will be the preferred brand in a significant percentage of covered lives in the US. Let's now turn to Nexplanon, which declined 3% XFX in the quarter and is up 2% year-to-date on a constant currency basis. We expect a robust fourth quarter in Nexplanon, resulting in full-year performance in line with that low single-digit growth year-to-date. We've made some key strategic decisions to better position Nexplanon in the U.S. and to accelerate growth globally. The initiatives undertaken will position Nexplanon for strong growth in 2024, and we expect to reach a billion-dollar run rate in 2025. We have made some changes to our U.S. go-to-market model. We will not take effective price in Nexplan in the U.S. in 2023. Our future U.S. pricing increases will now be aligned with when health plans update their pricing and reimbursement schedules. This timing update will make a meaningful difference to the value physicians see from carrying and implanting Nexplanon. Additionally, we see a healthy uptick in customer purchases ahead of when a new price increase goes into effect. So by postponing our price increase until next year, we anticipate about $20 million of customer buying will shift into 2024. Also, as we have signaled in the last couple of quarters, our next one on mix in the U.S. has been skewing more heavily towards higher discounted channels. We are adapting to this industry-wide dynamic by removing voluntary discounts in these federal programs, which we believe will benefit the fourth quarter and going forward. Secondly, We limited our participation in the annual Mexico tender on the basis of price. That represents about $20 million of negative impact to Nexplanon revenue in 2023. Lapping this impact will be a tailwind to Nexplanon's results next year. And thirdly, overall demand outside the U.S. has been strong, Asia and in Africa. In fact, so strong that we've invested in expanding our Nexplanon supply capacity to satisfy these fast-growing international markets. We have visibility to approximately $20 million of throughput related to that demand that we expect to be realized in 2024. So I've talked about three factors that will drive Nexplanon growth next year, which together represents $60 million, or about seven points of growth that we have high visibility into for next year. Turning to other women's health products, let's talk about Jada, our device for postpartum hemorrhage. This is the first time we're publicly breaking out revenue for Jada. And so you'll see that year-to-date, Jada has generated $31 million, more than double the revenue for the same period last year. Jada is now available in over 85% of the largest birthing hospitals in the U.S., and more than 36,000 mothers have been treated with Jada since launch. Given our progress in making JADA available in the majority of the hospitals in the U.S., our focus will now shift to supporting hospitals and users in the incorporation of JADA into their standard PPH readiness and response protocols. We believe JADA can achieve a peak of up to $150 million in the U.S. and more than $250 million peak when layering in the potential sales outside the U.S. Globally, there are over 100 million births annually, and less than 4 million of those are in the U.S. JADA is a great fit for our global footprint. And finally, in October, we made our first U.S. shipment of Zosciato, an FDA-approved medication for the treatment of bacterial vaginosis in patients 12 years of age and older, developed by our collaborator, Darre Bioscience. Our go-to-market strategy leverages the knowledge and experience of the Nexplanon commercial teams. Our skilled market access team continues to meet with customers to review Zosciato and obtain competitive managed care formulary status in the bacterial vaginosis marketplace. Let's move now to our biosimilars business, which grew 10% XFX in the third quarter and 15% year-to-date. Understandably, we get the most investor questions on the recent launch of Hadlima in the U.S., so let's focus the discussion there. At an 85% discount, we priced HeadLima to enable expanded access and to bring the economic benefits of biosimilars directly to the patient. We've emphasized that's where we believe we can offer the highest value to patients. We have focused our commercial efforts on payers who want to bring lower net costs to patients. We estimate that together, those plans represent about 40% of the covered lives in the U.S., While not as rapidly as we may have hoped for, we're having success. Among the July cohorts of entrants, we're out prescribing our next closest competitor by a factor of over three times. We're winning in both the commercial and managed Medicaid space across the competitive set, and we're rapidly closing in on the gap on Amgen's Amgen Vita, despite their six-month lead in the market. Consistent with comments we've made around HeadLima's launch, There is a market need for a simple, single-price strategy, and we believe that product attributes will be a key to uptake. We're well-positioned with a product that has high-concentration citrate-free formulation, as well as the low-concentration formulation, a user-friendly pen backed by the Arthritis Foundation, a wealth of real-world evidence from over 20 studies, and interchangeability expected by mid-2024. We view the slower market formation for virus similars as a clear missed opportunity to pass on savings to patients. Right now, about a third of patients on Humira pay at least $1,000 a month. That is more than they would pay for Adlima out of pocket without insurance coverage. We believe it is not a matter of if, but when this market starts to meaningfully form. Our very intentional focus on the low cost segment of the market together with our product profile could very well help the market convert much faster. Rounding out the top line discussion, let's move to established brands. Year to date, the established brands franchise has grown 1% XFX. Over the past quarters, we've highlighted some fundamentals of our established brand strategy, which explains why the franchise has been performing ahead of external expectations In the first quarter, we talked about manufacturing optimization for Nasonex and AttaZ to meet increasing demand, resulting from heightened promotional activity. Last quarter, we talked about adapting our commercial model to compensate for payer pressure and to mitigate pricing declines in select markets through our policy work. What bears repeating this quarter is the product and geographic diversity of the portfolio and the way we have been managing these assets has led to very stable results. During any given quarter, we are navigating and capitalizing on geographic and competitive complexities that can vary widely across our five geographic regions and 49 products. The stable results in established brands we have delivered since then have been a testament to the diversity of the portfolio as well as the solid execution by the team. Now let's turn to slide nine, where we can take a look at revenue by geography. Let's focus on China, because that is the region that's currently moving most dynamically this quarter. As you probably understand, the Chinese economy has had a slower than expected recovery post-COVID. The general economic slowdown is impacting Chinese consumers. which for our business had read through to the retail business. We've had a long operating history in China and our experience in navigating this dynamic market. We've implemented initiatives that help us reach the consumer more directly, for example, through e-commerce. In addition, in recent weeks, our traditional retail business that is through pharmacies has also started to improve. The other macro issue at play in China is that for the first time in recent history, the healthcare budget in China is in a deficit. The authorities are seeking options to offset this decline, which includes stricter enforcement of the volume-based procurement rules and investigations into prescribing patterns at the hospital level. Our portfolio has seen a very muted impact from these particular initiatives. We have strong diversity in our China business. No product represents more than 16% of revenue in China. Also, most of our portfolio has already been through VBP and has weathered those impacts. And because we have a long operating history in China, our team is experienced and has reallocated resources to other areas less impacted by this campaign. Overall, we believe that we will see a return to a more normal level of engagement in the hospital and retail channels by the beginning of next year. In fact, we're already seeing growth in China in the fourth quarter. Since then, We have given new life to established brands and have expanded our pipeline in both biosimilars and women's health. As we move into 2024, we will be working to reduce leverage and maximize the power of our existing portfolio. We will also look to bring in assets and enhance our growth profile. We are currently creating our own opportunities. We are overturning every stone to unlock value. The transient headwinds we saw in 2023 will serve as tailwinds for us next year. We believe we are well positioned to build from here and deliver mid single digit revenue growth over the medium term. Now let's turn the call over to Matt, who will go into our financial results in more detail. 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 VPP 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 Heisar. 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 U.S. First, customer mix in Nexplanon has been skewing towards the 340B channel. And second, with infertility, 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 Lomero 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., Canada, and Brazil due to volumes from new customers as well as greater depth of purchasing from existing customers. The bar for supply other primarily represents sales to Merck, off $15 million for the quarter compared to prior year. As we've discussed in the past, this revenue stream is essentially a series of lower margin contract manufacturing arrangements that have been declining since the spinoff and will continue to decline going forward. And finally, you can see the financial reporting headwind we had in foreign exchange translation, about 65 basis points for the third quarter. In August, when we last updated guidance, we raised our revenue guidance based on where spot rates were at that time. With the benefit of hindsight, late July, early August happened to be the most favorable point in the year in terms of FX spot rates versus the U.S. dollar. Since then, the dollar has strengthened as much as 6% across some of our most significant currencies, which has caused us to give up the second-half favorability we were anticipating based on August spot rates and then some. I'll remind everyone our sensitivity to foreign exchange and financial reporting is a function of more than 75% of our revenue being generated outside the United States. Now let's turn to performance by franchise. As has been our convention, I will target my comments over the next three slides to those areas most relevant to your modeling as we think about where we will end the year. Let's start with women's health on slide 11. As Kevin covered in some detail at the outset, Nexplanon is experiencing headwinds in 2023 that we don't expect will recur next year. The math on those headwinds, especially those in the second half, indicate that it's hard to envision a scenario where Nexplanon doesn't return to strong growth in the high single digits next year. Demand for fertility is solid, and that therapy area continues to have strong structural tailwinds, even if we have to continue to give up some price, as we did in the third quarter, in order to gain greater market share. In the area of new products, the Jada device for postpartum hemorrhage is now hitting a steeper part of its revenue curve post-launch, and Sashiato is now in the channel as of last month, and we're looking forward to what that launch will yield in 2024. Turning to biosimilars on slide 12, biosimilars grew 10% XFX in the quarter and has grown 15% XFX year-to-date. RENFLEXIS grew 15% in the quarter, and it's on track for its sixth consecutive year of annual revenue growth in the U.S. EntreZone continues to operate in a competitive environment in both the U.S. and Europe. However, volume remains strong in the Limeira region, mainly in Brazil, and this is offsetting competitive pricing dynamics. With regard to HEDLIMA, our original expectation for global HEDLIMA sales in 2023 was that it would represent just under 1.5% of full-year 2023 revenue. Given the slower market formation in the U.S. for Humira biosimilars that Kevin discussed, global Humira revenue mix will be significantly less than that in 2023. And in fact, this is one of the key factors driving our 2023 revenue guidance revision. Turning to slide 13. Established brands grew 3% XFX in the third quarter, and it's still in positive territory for the year at 1% growth year to date. We've talked about the durability of established brands. This year is a case in point. That 3% growth XFX was delivered despite three pretty significant headwinds. First, VBP in China, which is currently capturing our largest product, Ezetrol, in round seven, and now we have round eight underway. Second, the economic slowdown and challenging policy environment in China. And third, we grew despite the market action that occurred at the very beginning of the year for injectable steroid products. Given year-to-date performance in the outlook for the fourth quarter, we expect established brands to deliver at least level performance year-on-year at constant currency. Now let's turn to slide 14 where we show key non-GAAP P&L line items metrics for the third quarter, and year-to-date performance. For reference, GAAP financials and reconciliations to the non-GAAP financial measures are included in our press release and in the appendix slides of this presentation. For gross profit, we are excluding from cost of goods sold, purchase accounting amortization, and one-time items related to the spinoff, which can be seen in our appendix slides. Non-GAAP adjusted gross margin was 62.6%, compared with 67.1% in the prior year period. The year-over-year decline in gross margin is primarily due to foreign exchange translation and inflationary manufacturing and distribution costs. Product mix and pricing erosion were also factors, but to a lesser extent in this quarter. With respect to the foreign exchange impact on cost of sales, third quarter adjusted gross profit margin reflects the timing of FX recognition related to inventory purchases which has impacted us unfavorably versus the prior year, and this will continue into the fourth quarter. Moving down the P&L. In October, we were able to reach agreement in principle on the key terms of a settlement with Microspherics to resolve patent infringement claims for Nexplanon that predated the spinoff. We reserved an amount of $80 million to cover the settlement. The settlement will be paid out over three fiscal years. $35 million in 2023, $25 million in 2024, and $20 million in 2025. That total of $80 million in legal reserves was the main driver in GAAP SG&A increase year over year. On a non-GAAP basis, as you can see, SG&A increased 4%, mainly due to higher employee-related costs. Total non-GAAP R&D excluding IPR&D expense increased 7% in the quarter. The increase is primarily due to continued investments into our pipeline and higher costs associated with the development of these assets. Including IPR&D, R&D expense was actually down 2% year on year. We had $10 million of IPR&D expense in the third quarter of 2022 against no such expenses in this quarter. These factors culminate in an adjusted EBITDA margin of 29.4% in the third quarter of 2023 compared to 35.5% in the third quarter of last year. Non-GAAP adjusted net income was $223 million or 87 cents per diluted share compared with $337 million or $1.32 per diluted share in 2022. The year-over-year decrease in net income was a result of lower adjusted EBITDA, as well as higher interest expense. Turning to our net leverage ratio on slide 15, as we've previously discussed, we expected upward pressure on our net leverage ratio this year, with the peak expected to be in the third quarter, and this has played out. Next quarter, we will be lapping a low adjusted EBITDA quarter last year due to last year's market action on injectable steroids. and that should drive a decline in the net leverage ratio in Q4, all else equal. Turning to slide 16, we provide a closer look at our cash flow. For full year 2023, we expect to generate between $700 million to $800 million in free cash flow before one-time charges. At the midpoint of the range, this is about $250 million below what we expected earlier in the year, and the difference is attributable to lower expected EBITDA as well as working capital use. On the latter, we're now deep in the implementation of our new global ERP system that has temporarily tied up cash and current accounts to mitigate potential disruptions to normal operations. As a reminder, in 2022, we generated just over 75% of our annual cash flow in the second half, and we expect this year to follow a similar pattern. One-time cash costs related to the spinoff transaction are trending in line with our expectation of about $350 million for the full year 2023. The single biggest component of separation costs relates to the implementation of the global ERP system that I just referenced, and we're on track to complete that in the second quarter of 2024. As a result, these one-time costs associated with the spend, especially those that are related to transition services agreements, as opposed to the longer tail manufacturing services agreements, should decline meaningfully next year. For CapEx, PP&E of 3% to 4% of revenue remains a good range for forecasting purposes as we continue to deploy that capital into our internal manufacturing and packaging capabilities, as well as our technology infrastructure to help drive cost efficiency and productivity. Turning to revenue guidance on slide 17, we bridge our expected revenue change year on year. We have revised the number of these ranges based on how we expect to finish the year. LOE impact has been minimal so far in 2023. We expect the year to finish similarly. The small amount realized was related to the impact of generics for NuvaRing. We lowered our range to $10 to $20 million, down from $50 to $75 million, as we do not anticipate a generic entrant for Dulara in the U.S. this year. And in addition, the impact of generic competition for Adozet in Japan on that LOE event has been lower than anticipated this year. Turning to VBP, we now expect the annual impact to be slightly lower than what we guided to in the second quarter as we're tracking better with both Ezetrol, which was in the implementation of Round 7 in November of last year, as well as the recent Round 8 implementation in July of this year, which included our Remeron and Hyzar products. We're lowering our estimate of potential price erosion to $90 million to $100 million, down from $100 to $150 million, an improvement from the bridge that we showed you last quarter. Here we're seeing the momentum of our established brands portfolio being able to manage price erosion better than expected across several markets. We've lowered our outlook for volume growth for the year, and that underpins our revision to the revenue guidance. We lowered our range to $370 to $400 million, or about 6% year-on-year growth at the midpoint down from the 9% we were forecasting last quarter as a result of changes we've made to our go-to-market model for Nexplanon, a slower than expected uptake of Hadlima, and macroeconomic and policy headwinds in China. When we reported our second quarter results in August, the U.S. dollar had been steadily weakening over the first seven months of 2023, and we saw favorability in our forecast if rates simply held at where spot rates were in early August. Since then, FX has retraced, and we gave back all of those gains and then some. We're now raising our FX exposure to $120 to $130 million, representing about a 200 basis point headwind for the full year of 2023, compared with the zero to 80 basis points of headwind we expected for the full year back in August. Together, these factors result in revising top-line guidance to $6.15 billion to $6.25 billion, which represents growth of 1.6% to 3.3% growth on a constant currency basis. Moving to the other components of guidance on slide 18, we're revising our range on expected gross margin to the low 60% range, which reflects impacts from foreign exchange on revenue, unfavorable product mix, and timing of manufacturing costs. We're in the midst of our budget planning process for 2024, so while we aren't providing 2024 gross margin guidance today, we can say directionally that the factors that have impacted gross margin in 2023, especially in the back half, will be factors for us in 2024 as well. For example, inflationary pressures will likely persist at the COGS line. The Fed dialogue around higher for longer as regards its influence over short-term interest rates in the U.S. suggests that the strong dollar is likely to continue to be a headwind given our significant ex-U.S. revenue exposure. For operating expenses, our ranges for SG&A and R&D as a percentage of sales are consistent with what we laid out last quarter for our expectations for the year and reflect the investments we're making in the business to position it for future growth. In closing, bright spots in the third quarter performance included the continued steady performance of established brands, our largest revenue segment, and within women's health, the strong performance of Jada and the launch of Zasciato. The 2023 guidance revision was necessary in light of the macro issues around economic and policy conditions in China and FX translation, as well as the slow market formation for Humira biosimilars. Even with this, We believe Organon will post constant currency revenue growth in the low single digits. And on a reported basis, we're likely to post revenue growth for 2023 that exceeds the revenue growth rate of last year.

With that, we can now turn the call over to Q&A.

And at this time, I'd like to remind everyone, in order to ask a question, press star then the number one on your telephone keypad. We ask that you limit yourself to one question and one follow-up question, please. We'll pause for just a moment to compile any questions. Again, if you'd like to ask a question, please press star 1 on your telephone keypad now. Our first question comes from a line of Navan Thai with BNP Paribas. Please go ahead.

Hi, good morning. I have three questions. Can you hear me okay?

Yes, we can.

Okay, great. Could you clarify next-plan-on change in the go-to-market model and what drove the change and will it smooth the quarterly cadence of next-plan-on revenues? And then on fertility, have you seen biosimilar competition pressure intensifying? And also curious about what level of discount did Organum 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. Thank you.

Thanks, Navon. Good to hear your voice. And I'll try to address the three questions you had. First question on Nexplanon. You know, so we've, it was historical that many years pre-spend that the increase in price for Nexplanon always happened 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. 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, you know, challenged, let's call it stressed, in terms of the difference in price versus the reimbursement schedule. 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, you know, 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 will smoothen things out for us. In terms of your second question around the biosimilar penetration in the U.S., we really haven't seen any additional biosimilar penetration. As a matter of fact, what we do see is clearly more of a movement of patients moving over to the reimbursed segment just because of essentially company-sponsored benefits that are uptake in terms of the fertility sector. And so with that, you're really kind of trading off price for volume. And we can't announce it right now, but ultimately what we've been able to do is secure a very large win in that reimbursement sector. We'll probably be talking more about it, obviously, in our next earnings call. And so you'll see some buy-in in the fourth quarter for inventory purposes. But that is essentially what's happening is essentially we're getting more and more opportunities to really be on some of these plans in regards to kind of the PBM-driven process with the reimbursed market segment. And finally, yes, our long-term goal really is to see continued growth in our women's health portfolio. We see fertility. It'll be high single-digit growth this year. It'll likely be kind of following the same trends of next year. And we assume that next month we'll have a very, very good year next year in terms of the ability to kind of course correct with regards to the go-to-market model and to be able to take price in next year, in the beginning of next year for next month. And finally, the issue of regarding the ex-U.S. business, we've got supply kind of opening up so that we can meet more demand outside of the U.S., especially in Latin America, in Asia Pacific, and in the African regions, because the supply, actually the demand has been very robust And so that gives us a lot of confidence in the future growth opportunities for our women's health business. And not to mention, Jada, now we're reporting it out. It's doing extremely well. And we'll be launching Zosciato as we speak right now. So that will continue to be a contributor in the future.

Thank you.

Our next question comes from the line of Uma Rafa with Evercore. Please go ahead.

Hi, this is Chen Xiang for URMER. Thanks for taking our questions. Just want to ask about your China business. Previously, it was estimated that 70 to 80% of business will have gone through the VPP 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 impact have you seen from the government review campaign happened in the healthcare sector this year in China? Thank you.

Thanks for the question. So China is obviously our second largest market in Oregon, 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 factor in all the various forms of the retail factor 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 talk 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 represent more than 16% of our overall business, and we've shifted significantly. 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, you know, 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.

Thank you.

Our next question comes from the line of David Amselem with Piper Sandler. Please go ahead.

Thanks. 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 2024 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? Thank you.

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 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, you know, 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, IOs coming off a patent and There's going to be still a very robust market there. Had Lima, 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 three times 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 know, you're talking about the fact that a third of the patients currently today are spending about $1,000 out of their pocket every month for copay costs for Humira, still to this day, even after LOE. And when you consider the fact that two-thirds of, it's estimated that two-thirds of Americans today are living check to check, I truly believe that over time, 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 head Lima 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. It's very opportunistic for us. And we'll continue to treat it 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.

Thank you.

Our next question comes from a line of Jason Gerbery with Bank of America. Please go ahead.

Hey guys, this is Bhavan Patel for Jason Gerberry. Two questions from us. The first is on free cash flow. It seems like the lower $700 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 to $800 million free cash flow as an annual benchmark, or do you see it possibly getting back to a billion annually next year? And then the second is on capital allocation. Notice these plans for further debt pay down in 2024. So can you frame any sort of leverage ratio target, or at least how you may balance the debt pay down with business development and paying dividend? Thank you.

Okay, so we'll take the free cash flow question first. We started the year with an anticipation of, in round numbers, about a billion dollars of free cash flow. We have had to take that back given developments this year, as we noted, related to a lower EBITDA as well as the investment in networking capital. Now, the latter is temporary. 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, you know, 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 one-time 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 spinoff, 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 a relatively speaking 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. Thank you.

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

Hi, 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 acts as a tailwind or headwind for the uptake of headlema? Thanks.

Yeah, so 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. The data has already come out 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 play 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 or a month as a copay 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, three or four, actually, that will have the interchangeability designation as opposed to others that haven't initiated the studies. So 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.

Great. Thank you.

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

Hi, everyone. This is Michaela on for Balaji. Thanks for taking our questions. Just two from us. I guess, can you talk a bit more about the Hadley-Moor 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 theme? And I guess any further comments on what will be needed here? Thank you.

Yeah. For Hedlima, 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 TBM world. But remember, about 40% of the lives covered right now are what we would call whack-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 the kind of the floodgates will start to open up slowly and give us an opportunity. That's why I see HAD Lima more of as a 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 the women's health question, yeah, 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 was some COVID issues. So 2023 in this quarter is really a function of a few things. We're 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 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 in time.

Thank you. Certainly.

There are no further questions at this time. I would now like to turn the call over to Kevin Alley 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 standalone company. We're just a little bit over two and a half 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 Hadlema, and it is 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.