Matthew Walsh
Chief Financial Officer at Organon & Co.
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 seven 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 eight 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 and establish 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, 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., 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 spin-off 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 happens 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 Xaciato 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% ex FX in the quarter and has grown 15% ex FX 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. Ontruzant continues to operate in a competitive environment in both the U.S. and Europe. However, volume remains strong in the LAMERA region, mainly in Brazil, and this is offsetting competitive pricing dynamics. With regard to Hadlima, our original expectation for global Hadlima 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% ex FX 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 ex FX 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 and 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 onetime items related to the spin-off 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 MICROSPHERIX to resolve patent infringement claims for Nexplanon that predated the spin-off. 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 IP R&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 IP R&D, R&D expense was actually down 2% year-on-year. We had $10 million of IP R&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 $0.87 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 onetime 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.
Onetime cash costs related to the spin-off 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 onetime costs associated with the spin, 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 million to $20 million, down from $50 million to $75 million as we do not anticipate a generic entrant for DULERA in the U.S. this year. And in addition, the impact of generic competition for Atozet 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 seven in November of last year, as well as the recent Round eight implementation in July of this year, which included our REMERON and HYZAAR products.
We're lowering our estimate of potential price erosion to $90 million to $100 million down from $100 million 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 million 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 that 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 million to $130 million, representing about a 200 basis point headwind for the full year 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. Also, the Fed dialogue around higher for longer as regards its influence over short-term interest rates in the U.S., suggest 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 Xaciato. 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.
