Matthew Walsh
Chief Financial Officer at Organon & Co.
Thanks a lot, Kevin. As Ive done in previous quarters, Ill remind you that our results prior to spin-off are presented on the carve-out basis of accounting. Thats a GAAP convention. Its not intended to present results as if Organon were a stand-alone company. So I want to be clear as we discuss results that because our spin date was June two of last year, it wont be until next quarter, the third quarter of 2022, that we can draw a true apples-to-apples comparisons to prior year results where all P&L line items represent post-spin stand-alone financials for Organon. Until then, as Ive said over the past few quarters, the revenue line is where well have the best comparability to prior year periods and thats where well start the financial discussion. Now turning to slide six. Revenue for the third quarter was approximately $1.6 billion, down 1% as reported, but up 5% at constant currency when compared to the second quarter of last year. In this graphic, we break out the change in revenue according to key drivers, and Ill highlight some of the more significant impacts. The impact of loss of exclusivity or LOE during the second quarter compared to the second quarter of last year is approximately $10 million is primarily related to NuvaRings LOE in the United States. We didnt have any LOE impact in Established Brands this quarter.
The most significant LOEs facing the portfolio washed out prior to the spin-off, and we expect only modest new LOE exposure going forward. Since the spin-off in 2021, we have been expecting a generic entrant in the U.S. for Dulera that did not happen in 2021 and has not happened thus far in 2022. Continuing to read across the waterfall chart, the impact from volume-based procurement in China was negligible in the second quarter, which is also the case year-to-date as the implementation of the next rounds of BBP have been delayed. Moving across, we saw an approximate $60 million impact coming from price in the second quarter, which is consistent with our expectation that we will see low single-digit price erosion on a company-wide basis. This is mostly coming from Established Brands where products are subject to mandatory price reductions in some markets. We had good volume growth in the quarter. You may recall, we had some onetime favorability in Established Brands last quarter. We continue to see some benefit in Japan where certain competitors are out of the market because they didnt receive good manufacturing practice or GMP certification. But the impact of that in this quarter is about half of what it was in Q1. In addition to volume growth in Established Brands, we also saw volume growth from our key growth drivers, including the China retail sector, biosimilars and NEXPLANON.
The other bucket primarily represents supply sales to Merck and other third parties, which consists of lower margin sales of pharmaceutical products under contract manufacturing arrangements. For the quarter, supply sales were down about $25 million year-on-year, and thats consistent with our view that we expect volumes under these arrangements to decline. And finally, foreign exchange translation continues to be a headwind for us. And FX represented about 500 basis points of headwind for the quarter, which is not really surprising given the fluctuations in the global currency markets and the composition of our business with approximately 80% of our revenues derived outside the United States during the second quarter. Briefly on slide seven. This depicts the geographic mix of our revenues. As Kevin mentioned, all of our geographic regions grew versus prior year at constant currency EUCAN benefited from volume growth in the Established Brands franchise most notably from respiratory and cardiovascular products. Strong performance from RENFLEXIS and ONTRUZANT drove growth in the U.S., along with increased NEXPLANON sales in the quarter. Asia Pacific, Japan, as we mentioned earlier, had some help from a near-term competitor supply issue, however, to a much lesser degree than last quarter.
In China, growth in retail as well as the recently repatriated brands, Marvelon and Mercilon offset the decline in fertility that was due to strict protracted covid lockdowns. Finally, the LAMERA region showed strong results on a constant currency basis, primarily from growth in NEXPLANON as well as benefiting from the timing of an order of ONTRUZANT in Brazil. So now lets take a look at performance by franchise, and well start with Womens Health on slide eight. Our Womens Health business was down 2% as reported, but up 1% at constant currency in the second quarter. NEXPLANON grew 8% ex FX during the quarter, and that strong performance was partially offset by NuvaRing, where we continue to see pressure from generic competition. Fertility was down low single digits this quarter, and that was due to the impact of COVID lockdowns in China. In the United States, FOLLISTIM had some unfavorable channel mix this quarter, but that was partially offset by other products in the fertility portfolio. Year-to-date, fertility is up mid-single digits on a constant currency basis. We expect the fertility business to deliver double-digit growth in 2022, driven by recovery in China and strong demand across our markets. Turning to biosimilars now on slide nine. Biosimilars grew 39% as reported and 42%, ex FX. RENFLEXIS grew 39% ex FX in the quarter driven by strong performance in the U.S.
The infliximab market continues to grow and biosimilar adoption for infliximab also continues to grow with biosimilars now representing close to 40% of the infliximab market share in the U.S. ONTRUZANT was up 61%, driven by continued uptake in the United States since its launch in July 2020 as well as the timing of a government contract in Brazil that hit the second quarter this year compared with the third quarter of last year. And most factors were partially offset by competitive pressures in Europe. Turning to Established Brands on slide 10. Revenue for Established Brands was down 2% as reported, but up 4%, ex FX, during the quarter. As Kevin mentioned, this franchise is performing very well. Its a sizable and stable source of revenue for us. In addition, the sequential revenue trend on this franchise is fairly steady, as you can see on slide 18 in the appendix. In the second half of the year, we expect that well see impact from next rounds of VBP in China, but still with minimal LOE risk expected until we see a generic entrant for DULERA, together with the strong performance year-to-date, we now expect that revenue for Established Brands will be flattish for full year 2022 at constant currency. Now turning to our income statement on slide 11. Our GAAP income statement for the second quarter is available in our earnings release. I encourage investors to look at that important information. Here on slide 11, well be looking at our non-GAAP income statement for the second quarter.
For gross profit, were excluding from cost of goods sold, purchase accounting amortization and onetime items related to the spin-off. Making these straightforward adjustments, the second quarter of 2022 non-GAAP adjusted gross profit was $1.047 billion on revenues of $1.585 billion, representing a gross margin of 66.1%, up from 65.6% in the second quarter of last year. Year-to-date 2022 gross margin is tracking a bit ahead of the prior year period on both an adjusted and as-reported basis. And underlying that is really product mix. We have less and lower margin supply sales in 2022 as we expected would be the case. There were also allocated costs related to the spin in the 2021 financials that are not in 2022 and impact apples-to-apples comparability as I mentioned at the outset. Adjusted EBITDA margins were 32.3% in the second quarter. Ill draw your attention to the R&D line in this P&L. That $203 million of R&D expense in the second quarter includes IP R&D and milestones of $97 million related to the Biosimilars transaction with Shanghai Henlius Biotech. So as Kevin mentioned, that would be $97 million that in prior quarters, we would be adding back to our adjusted EBITDA calculation, driving adjusted EBITDA to $609 million or 38.4% margin on a like-for-like basis with prior quarters.
SG&A costs were modestly higher in the second quarter of 2022 compared with prior year, primarily due to standing up Organon as an independent company as well as commercial expenses associated with business development transactions completed in the last year. R&D expenses increased in support of a growing pipeline, for example, OG-6219 and ebopiprant. Spending of this kind to develop new products, support new product launches and to build capabilities, theyre going to be drivers of our adjusted EBITDA margin in the intermediate term. On that topic, its important to take another look at the business development slide that Kevin showed. As Kevin mentioned, were looking for balance in our BD program. That includes adding immediately accretive or imminently accretive deals to the portfolio. Together, those commercialized deals that weve done to date, shown in the first column of this slide, theyre expected to contribute about a point of revenue growth in 2022. Our pipeline assets in the second column are longer cycle and require years of investment in order to realize their significantly larger commercial potential relative to the immediately or imminently accretive deals that weve completed so far.
Our goal is to construct a suitably sized portfolio of these longer-term pipeline projects to enable Organon to sustain attractive revenue growth well beyond the five-year planning horizon, when we need to be launching new products that can more than offset any revenue declines we might see related to NEXPLANONs LOE. All of our business development projects, whether near-term accretive or pipeline compete for capital. We analyzed all of these opportunities on a risk-adjusted basis set against the baseline, the next best use of capital, which, in our case, is reducing outstanding leverage. And that happens to be a good lead into the next slide. As we look at debt capitalization and leverage on slide 13, as of June 30, 2022, we have bank debt of $8.9 billion netted against cash and cash equivalents of $545 million. Our bank covenants allow us to add back acquired and process R&D and milestones to our LTM EBITDA calculation, which is consistent with how weve been showing you leverage on prior earnings calls. And on that basis, net leverage was about 3.5 times as of June 30. Recall that at the spin-off in 2021, we had a pro forma leverage ratio of about 4 times. And we said that we were targeting a leverage ratio of less than 3.5 times on a sustained basis.
Weve made solid progress on debt reduction, and that was aided by another voluntary $100 million repayment of the U.S. Term Loan B during the quarter. This is the second voluntary repayment of debt that weve completed since the spin-off, $200 million in total. Our capital allocation priorities remain consistent with past communications. Our first priority, of course, is servicing the dividend which were targeting at a low 20s percentage of free cash flow, which we believe strikes an appropriate balance between reinvesting for growth and delivering near-term value for shareholders. Our second priority is organic growth which would include life cycle management opportunities for existing products within our portfolio, supported by capital deployed in our manufacturing plans. On the latter, we expect to see annual capex in the range of 3% to 4% of revenue on an ongoing basis, excluding separation costs. So because these first two priorities are not big absorbers of capital, that leaves significant self-generated cash flow for our third capital allocation priority, which is really a tie, between execution of external growth plans to develop a portfolio of new product opportunities balanced against discretionary debt reduction, just like we did this quarter.
Were committed to maintaining our BB BA2 Parent rating, balancing debt reduction with capital deployed for externally sourced growth initiatives. Turning to revenue guidance on slide 14 now. Here, we bridge our expected revenue change year-on-year. Compared with our last guidance update, the biggest difference on this slide is the FX translation impact, which has gone from an approximate $200 million to $300 million impact or a headwind of 300 to 475 basis points to an approximate $350 million to $400 million impact or now 550 to 650 basis point headwind based on where FX spot rates are today. Accordingly, were adjusting our guidance range for full year 2022 revenue from $6.1 billion to $6.4 billion to $6.1 billion to $6.3 billion, consistent with the movements weve seen in foreign exchange. We feel comfortable maintaining the low end of the previously guided revenue range because the view on a few of our key drivers has improved modestly, for example, LOE. But given the volatility in currency markets, Ill employ language here, as I did last quarter and signaled that if exchange rates dont improve from here, we would likely be at the lower end of our revised guidance range. For LOE, at this stage of the year, the Generic of Delaire is looking unlikely. So we expect LOE impact for 2022 will be less than the approximate $100 million full year impact we had communicated last quarter, and that remaining exposure is mainly tied to NuvaRing.
For VBP in China, the implementation of around seven and eight have been delayed. So again, weve not had any year-to-date impact from BBP this year. but we think that remains likely to occur in the second half, which could result in approximately $50 million of impact in 2022. We continue to expect about $200 million of price erosion in 2022 in-line with the historical pricing trends for global markets that weve been selling into for many years. And for volume, were tracking to $600 million to $700 million of volume growth for the full year. The majority of that volume increase has been coming from our multiple growth pillars, NEXPLANON, Biosimilars, Fertility, China Retail, followed by favorable onetime items like that competitive issue in Japan, and, to a lesser extent, recently completed business development transactions. We do expect net volume growth across our product portfolio and Established Brands as well, which is well supported by our first half actual performance. Turning to other guidance metrics on slide 15. As I mentioned, we are recasting our revenue range to incorporate the continued strength in the U.S. dollar. The other range that were modifying this quarter is for adjusted EBITDA margin.
Operationally, there are no changes in our outlook. In fact, on an absolute dollar basis, EBITDA is less impacted by foreign exchange relative to revenue. So if not for these adjustments, we and our industry peers are making to incorporate in-process R&D and milestones, we would be keeping our full year margin range identical to prior guidance. But given effect to the now approximate $110 million of IP R&D, we now have a view for 2022 that impacts margins by just under two percentage points. So were adjusting the range accordingly from 34% to 36% to 32% to 34%. And by the way, that approximate $110 million nudges our R&D expense as a percentage of revenue into the upper single-digit range from mid- to upper single-digit range. And to remind you, our criteria for inclusion of an IP R&D estimate attached to a business development transaction will be to have a signed contract. Business development is a strategic priority for us and future M&A activity that involves upfront and door milestone payments could impact our guidance ranges.
And while we will work to provide details on those relevant payments when we announce the transaction, we do not plan to update our guidance between quarters based solely on those associated payments alone. Wrapping up the financial discussion. On a constant currency basis, the business is doing very well. Operationally, the business is performing as we expected, and we believe Biosimilars and Womens Health should deliver solid growth in 2022, paired with a revenue trajectory within Established Brands thats meaningfully better than we expected prior to the start of the year.
At this point, Ill turn the call back to the operator for questions.
