Vapotherm, Inc.
Q1 2022 Earnings Call Transcript

Published: 8 May 2022

[Operator:]

Good afternoon, ladies and gentlemen, and welcome to the Vapotherm First Quarter 2022 Financial Results Conference Call. As a reminder, this call is being webcast live and recorded. It's now my pleasure to introduce your host, Mr. Mark Klausner of Westwicke. Sir, please go ahead.

[Mark Klausner:]

Good afternoon, and thank you for joining us for the Vapotherm First Quarter 2022 Financial Results Conference Call. Joining us on today's call are Vapotherm's President and Chief Executive Officer, Joe Army; and its Senior Vice President and Chief Financial Officer, John Landry. As a reminder, this call is being webcast live and recorded, and we will be referencing a slide presentation in conjunction with our remarks. Because there is a short delay between the live telephone audio and the presentation being shown on the webcast, for the best experience, please either use the webcast for both the audio and video content or if you dialed in by phone, download the slides from our website and advance them yourselves. To access this webcast, please visit the Events section in the IR section of our website in vapotherm.com. and a replay of the event will be available following the call. Before we begin, I would like to remind everyone that our remarks today contain forward-looking statements. All statements made on this call, including during the question-and-answer session, other than statements of historical fact are forward-looking statements. In some cases, you can identify forward-looking statements by terms such as may, will, should, expect, plan, anticipate, assume, could, intend, target, transform, return, drive, project, contemplate, believe, estimate, predict, potential, strategy, continue or the negative of these terms or other similar expressions, although not all forward-looking statements contain these words or the use of future dates. Forward-looking statements on this call include, but are not limited to, statements concerning financial guidance, return to historical disposable turn rates, gross margin improvements, future revenue growth, reduction of cash operating expenses to pre-COVID levels, progress towards profitability, release of new products and the ability of such products to command premium pricing, the timing and success of the planned relocation of manufacturing operations, penetration of new care areas, receipt of regulatory approvals for new indications for our products and the future behavior of COVID-19, flu, RSV and other respiratory illnesses. These statements are based on the current plans and expectations of management and involve inherent risks and uncertainties that could cause actual results to differ materially from those indicated, including those identified in the Risk Factors section of our annual report filed on Form 10-K for the year ended December 31, 2021 which was filed with the Securities and Exchange Commission, or SEC, on February 24, 2022, our quarterly report filed on Form 10-Q for the quarter ended March 31, 2022, which will be filed today and in any subsequent filings with the SEC. Such risk factors may be updated from time to time in our filings with the SEC, which are publicly available on our website. We undertake no obligation to publicly update or revise our forward-looking statements as a result of new information, future events or otherwise, unless required by law. With that, it's my pleasure to turn the call over to Vapotherm's President and Chief Executive Officer, Joe Army.

[Joseph Army:]

Thanks, Mark. Good afternoon, and thank you for joining us today. The COVID pandemic had a profound impact on our business, both good and bad. As we're moving to the endemic phase of this virus, we wanted to take this opportunity to provide a deep dive into the performance of our business during the pandemic and in the years leading up to it and share our vision of Vapotherm's future, which we remain very bullish about. In light of this, we'll not be providing the traditional review of our first quarter performance. There is a lot of detail around our financial and operating performance for the quarter in our press release issued earlier today as well as in the 10-K, which will be filed shortly. So we encourage you to review those documents for specifics. We have a unique business capable of doing things no one else in our industry can do. Over the coming slides, we'll walk you through a brief history of our business and how it's been transformed by COVID since March 2020. And update you on our plans for the coming years. My goal is that coming out of today's call, you'd be clear on the 4 fundamental aspects of our plan. Number one, transform this business into a consistent, predictable 20% revenue grower. Number two, drive gross margins above 60% and set ourselves up for expansion to 70%. Number three, return our cash operating expenses to pre-COVID levels. And number four, drive this business to profitability. As I said before, quality has a profound impact on our business, both good and bad. On the positive side, in accelerating the growth of our installed base to levels we did not expect to see until 2025. Elevated global awareness of our brand and its remarkable efficacy and we believe enabled us to take significant share in the respiratory space. On the negative side, it order to meet every customer need during this global pandemic, it required us to take actions and incur costs that hurt our gross margins, temporarily increased our cost structure, made the business more volatile and difficult to predict and created revenue comps which cloud our fundamental growth profile. 2022 will be a transitional year as we come out of the pandemic and shift our focus to a more stable and sustainable operating model. In 2023, you'll see us firing on all cylinders, delivering growth, driving towards profitability. So let's start with a review of where we were at the end of 2019. In the years leading up to the onset of COVID, we were making good progress building our position in the respiratory care landscape. From 2016 to 2019, we increased the number of disposables sold by over 80% from $145,000 per year to over $260,000 per year. During these 3 years, our market share in the respiratory care space nearly doubled, accounting for approximately 6% of the U.S. market. We were pleased with the progress we've made and even more excited about the roughly 94% of the market still in front of us. So what drove this performance over the period. As you know, we run a razor-razorblade business made up of capital units single-use disposables. So a critical element of our success is the growth of our capital unit, installed base, which in turn drives recurring disposables revenue. What you see in this chart is the annual growth of our U.S. installed base from 2015 to today. Prior to 2020, we drove a steady increase in that installed base from 2015 when we first launched our direct sales force in the U.S. To the end of 2019, we saw our installed base grow at a 17% comp annual growth rate. And then COVID hit. Beginning in the second quarter of 2020, the world experienced an explosion in demand for respiratory care equipment, and we were there to support our customers. COVID radically changed the trajectory of our U.S. installed base growth, which nearly doubled from the end of 2019 to the end of 2021 for a 40% compound annual growth rate over this period. Beyond growth in the number of units, we also saw a big shift in the composition of our customer base, particularly in the U.S. The pandemic shined a spotlight on Vapotherm and our technology allowing us to rapidly expand our share of the biggest hospitals in the U.S., hospitals we generally referred to as gold accounts, the top 1,000 U.S. hospitals measured by respiratory discharges. As we dramatically grew our U.S. installed base during COVID, we also won a large number of these gold accounts because of our superior technology, our outstanding field team and our ability to deliver product that others couldn't. As you can see in this chart, the turn rate or the number of disposables used per month by each unit of capital equipment was very predictable on a quarterly basis and followed a clear seasonal pattern with Q1 typically having the highest turn rates because of flu and RSV, lower turn rates in the second and third quarters when the weather got warmer and the kids got out of school, and increase in turn rates as we moved into the fourth quarter when flu and RSV came back. From 2015 to the end of 2019, you could see that we could sell our watch by these turn rates with the average turn rate being approximately 1.9 per month. As we moved into 2021, historical patterns around respiratory distress changed dramatically. Seasonal trends reversing the volatility and turn rates increasing. In the first quarter of 2020, U.S. disposable ordering patterns became highly correlated with COVID hospitalizations, making the volumes of disposables sold significantly more volatile and unpredictable big increases in demand was no warning. During Omicron surge in late 2021 and early 2022, hospitalizations associated with each of the prior surges followed a bell-shaped distribution normalizing at pre-surge levels following a spike. However, Omicron was different. Following a spike in January, hospitalizations began to decline in February and then fell off a cliff in March. And Omicron patients were less sick than previous surges. When we gave guidance in February, we were expecting to see a tail of hospitalizations similar to what we had seen with the initial spikes in 2020. With the holiday wave in the winter '21 and most recently with Delta, the expected tail did not materialize, and that combined with a much lighter-than-expected flu and RSV season due to Omicron masking in late December, caused the respiratory sensors from hospitals to decrease a lot. Now as we move into what appears to be an endemic phase of COVID, where it becomes a more normalized part of the respiratory landscape, we expect to see a return to less volatile turn rates in a traditional seasonal pattern of flu, RSV and respiratory illness in general, provided masking is no longer live spread. As noted before, one of the benefits of COVID was the big ramp of our installed base and the increase in new accounts, including significant growth in gold accounts, the top 1,000 U.S. hospitals as measured by respiratory discharge. However, one of the uncertainties coming out of COVID is whether hospitals that adopted our technology during the pandemic to address huge spikes in hospitalizations would continue to use our systems post-pandemic. Based on what we've seen over the last 2 years and through the end of the first quarter, we believe the customers we won during COVID and especially the gold accounts have performed on par with comparable pre-COVID customers. That is important because if all gold accounts before the same during COVID gives us confidence they will continue to perform similarly as COVID subsides and respiratory census patterns begin to normalize. Those of you who follow Vapotherm are aware of our One Hospital One Day or 1H1D strategy, which is meant to educate our customers on the full capabilities of our technology to help patients through all 4 care areas of their hospital that we serve today, regardless of whether the patients are hypoxic, like COVID patients or hypercapnic, like COPD patients. When we're in 1H1D new conversations with hospitals, we're focused on educating them on a couple of key factors. First, the benefits of our technology on both hypoxic patients and hypercapnic patients. Second, how our technology could be used in the 4 key care areas that we serve today. The emergency department or ED, the adult intensive care unit, or AICU, the neonatal intensive care unit, or NICU, and the pediatric intensive care unit, or PICU. We believe this play works well. Historically, around 2/3 of our capital equipment sales came from existing customers as they expand their use into new care areas and treat new patient symptoms like hypercapnia and COPD patients. Looking at the chart in the center of the slide, you can see the more care areas we treat, the better the accounts revenue. This data is exciting. It shows us there is a large opportunity within our U.S. gold customers to go deeper and wider to drive revenue growth without needing to add more customers. Within our gold accounts, 71% are only using our technology in 1 or 2 care areas. We need huge room to expand and get all units turning at or above historical levels. It's also important to note the more care areas they use us in the higher the turn rates are. Beyond the 4 care areas highlighted here, we will be expanding into additional care areas within the hospital where ideally, patient census would be less correlated to the typical seasonal respiratory census. Expansion in one of these care areas will drive recurring revenue growth while potentially reducing the seasonality in that core respiratory business. I hope you could see in the detailed data we just reviewed why I'm confident in our ability to return to historical turn rates. Just doing the simple math, assuming our plan works, the 35,000 units in the global installed base yield 800,000 disposables per year or $90 million in recurring revenue. It's important to note how sensitive our disposables revenue is to even small changes in turn rates. For example, for each 0.1 increase in the monthly turn rate we generate $5 million in incremental disposables revenue. Now I want to share with you why I believe it's possible for us to possibly exceed our historical turn rates. What you're looking at on this slide is a historically U.S. quarterly disposables turn rate for different groups of customers. First, hospitals that use our technology in emergency department, which is the blue line on the graph, have higher turn rates than the hospitals that do not, which is the gray line. We've seen this consistently over a number of years, and it will continue to be a focus as part of our 1H1D strategy and our new account strategy. Winning and expanding into ED accounts is an important part of our plan as over 50% of all hospital admissions come through the ED. Second, during the summer of 2020, we noted a small group of accounts that had significantly higher turn rates in 2019 pre-COVID than all the other accounts. We engaged in artificial intelligence consulting firm to analyze these accounts to understand the customer journey that led to such high turn rates. There was significant and multiple signal in the data sets that identify the specific customer journey. From this, 1H1D was refined and optimized to help customers along the same path. For obvious competitive reasons, we're not going to lay out the entire journey but use on hypercapnia and on general care floors were 2 very important elements, which is exactly what 1H1D and our HVT 2.0 launch are all impacted. One area of our history that I don't think is fully appreciated is our proven ability to drive higher ASPs through product innovation. On both capital and disposables in both the U.S. and internationally, we've seen substantial increases in ASPs over the past 6 years as we have shown the value we bring to customers and patients alike. Like best-in-class med tech companies, we have consistently increased average selling prices by delivering more clinical and economic value in our new products. As we look ahead, we expect to drive higher capital and disposable ASPs as we introduced new higher-value products and services like the upcoming HVT 2.0 launch. Our product development road map is designed to create a digitally enabled care ecosystem to deliver breakthrough patient outcomes at a lower total cost throughout the care continuum. The next-generation HVT 2.0 launch will be critical and exciting for us later this year. With its internal blower, HVT 2.0 enables us to access the 50% of all U.S. hospital beds on general care floors that don't have medical air in the room. As we observed in our high turner project using our high-velocity therapy technology in the general care floor areas, it was associated with higher turn rates. With our large installed base, strong field teams around the world, well understood clinical efficacy, pipeline of new products and demonstrated ability to deliver to our customers and patients, no matter what, we've created a strong foundation, and seeing tremendous growth over the past 2 years. But growth is just one piece of the puzzle. We need to fuel that growth of capital we have, while driving the profitability as quickly as possible. That is exactly what we plan to do. Before I turn the call over to John and have him walk you through how we intend to do this, I want to address the revenue covenant in our new debt facility. The covenants based on hitting a trailing 6-month revenue milestone beginning in July and reported at the end of August. In light of lower-than-expected revenue in March, we could face a challenge hitting the first revenue milestone. However, we can still achieve our revenue milestone if respiratory distressed hospitalizations return to normal levels. We're in full compliance today and are routinely communicating progress with our lender. We've also worked successfully with this lender in my last company during the 2008 financial crisis, and I'm confident we'll do so again. With that, I'd like to turn the call over to John.

[John Landry:]

Thanks, Joe. As Joe mentioned, our plan is to take this business from where we are today and drive it to adjusted EBITDA profitability. Part of that formula includes driving predictable 20% revenue growth. The other part of that focuses on how we manage our cost structure in a post-COVID world. Starting with cost of goods sold. As you may recall, the business had negative gross margins when Joe and I joined in 2012. We put a 3-point plan in place to improve gross margins every year. One, increase ASPs through the introduction of new products that offer higher clinical and economic value; two, reduce direct material and labor costs; and three, drive increased volumes through our fixed overhead base. Through disciplined execution of this play, we drove gross margin to 50% in 2020. Just as we saw volatility on the top line during COVID, we experienced similar impacts on our gross margins. With COVID causing huge spikes in demand for capital and disposables as hospitals fought to navigate through a pandemic and care for record numbers of patients, we made the strategic decision to do whatever it took to deliver for our customers for 2 reasons. One, it was the right thing to do; and two, we knew this was going to be a once-in-a-lifetime opportunity to win the large numbers of big new customers who would end up being super valuable for years to come. In order to meet all customer needs we took a number of nontraditional actions that worked but resulted in roughly 10 percentage points of temporary gross margin erosion, primarily caused by 2 factors

[Joseph Army:]

Thanks, John. In closing, let me recap our plan for the remainder of 2022 and 2023. First, we'll drive 20% revenue growth by getting disposable turn rates back to historical levels by expanding usage in the 4 care areas in our gold accounts using 1H1D. Educating all accounts on use with hypercapnic patients, developing new care areas and launching important new products like HVT 2.0, especially to the general care force. Second, we will improve gross margins to 60% by late 2023, early 2024 by spinning up a world-class factory in stable, low-cost Mexico executing on our 3-point plan and burning off the expense of inventory caused by massive onetime costs incurred during COVID meet every customer need. Third, we will normalize our cost structure to pre-COVID levels while investing aggressively in future growth drivers, especially HVT Home and the digital opportunities. This 3-point plan executed by the very best team in the medical technology space will drive us to profitability. This is truly a unique business, made up of best-in-class people that has done amazing things together, especially in meeting every customer need during the pandemic. I want to thank each and every one of them for their dedication and commitment to our customers, patients and each others. Now on the profitability. I'd like to open it up for questions now.

[Operator:]

[Operator Instructions]. Our first question is from the line of Margaret Kaczor of William Blair.

[Brandon Vazquez:]

This is Brandon on for Margaret. Thanks for the extensive overview of the slide deck. This is extremely helpful as you guys are kind of evolving and hopefully stabilizing a little bit post-COVID now. First question, I just wanted to focus on, there's a lot of really encouraging information here on the gold account. I'm just kind of curious, how do you keep going deeper into these accounts? Joe, you had highlighted that there's a lot of accounts that you're only being used in 1 or 2 care areas. What's the strategy here to kind of get them into the third and fourth care area to kind of get into that higher ring of disposable terms?

[Joseph Army:]

Brandon, thanks very much for the question. So 1H1D is the play that we use for driving into the new care areas that we operate in. So literally, we use a combination of speakers bureaus, a lot of different education opportunities, but it's really having our field team in those accounts, executing on 1H1D and educating in new core areas that, in fact, expands this course. That's, quite frankly, what we're really measuring where we're really focused. I'm really a lot less interested right now in opening net new gold accounts and are very focused on continuing to run 1H1D to expand those goals because I think as you could see, the amount of money to be made by simply expanding from 1 care area to 2 or from 2 carriers to 3 is quite substantial.

[Brandon Vazquez:]

Got it.

[Joseph Army:]

Brandon, if I could interrupt for just 1 second. One other thing I think would be important to note in there is the turn rates. When you go from 1 care area, your turn rate is about what is it, 1.8%. You go to 2 care areas and it goes up. You go to 3 care areas, it goes up even more. So the more care areas you go into the higher the overall turn rate is on that account. We think that's a very interesting and promising phenomenon.

[Brandon Vazquez:]

Yes, absolutely. And as you kind of get through covered now, hopefully, you can get a little more on the offensive there. That makes sense. And then just -- obviously, there's been a lot of volatility as we've seen in the slides and obviously, through the operating metrics in terms of capital and disposables. Any color you can kind of give us on your long-term guidance, assuming and certainly, you guys have some different kinds of models to get to 20% growth over the next couple of years. How should we be thinking about capital? Does it kind of normalize to some kind of a pre-COVID level? Are you assuming more disposable turn rates in that long-term guidance in line with pre-COVID or elevated? So anything around those would be helpful as well.

[John Landry:]

Brandon, it's John. Thanks for the question today. So when we take a look at our revenue long-term -- long-term revenue guidance, one of the things we're looking at in terms of capital is we expect our capital contribution to be more in that 20% of total revenue range and return our recurring revenue to the 70%, 75% level and service comprising the rest. So as we think about the near term, the goal would be to get our turn rates back up to the historical turn rates over the 4 to 6 quarters to go execute on our 1H1D plan, in particular, in those gold accounts where we have the higher turn rates and especially the 4 core area accounts. And then as well, longer term, as our new product pipeline begins to come to fruition, we expect that to be a contributor to top line revenue growth as well.

[Operator:]

Next question is from the line of Marie Thibault from BTIG.

[Sam Eiber:]

Joe and John, this is Sam Eiber on for Marie. John, you just mentioned -- I was going to ask on timing of turn rates may be normalizing. You just mentioned the 4 to 6 quarters after COVID ends. Is that what is still the right way to think about it? And are we at that stage at this point or maybe that clock starting? It seems like 2023 is really where these things start to meaningfully improve.

[John Landry:]

Yes, Sam, this is John. Yes, that's right. I think that's the right way to think about it. I think now with Omicron largely behind us. It gives our field team uninterrupted opportunity to go in and run our 1H1D program. In particular, in those larger gold accounts and to go drive deeper into those accounts and expand them from one care area to the next. So that's going to be, I think, from a clock perspective, I think that's right. As we continue to grow and expand that 4 to 6 quarters puts us to your point in the mid-2023 time frame. So that's about the right timing. And at that same time, we also have the opportunity to have our HVT 2.0 come out here in a more full market release. So that will be coming out later this year, which will -- the sales team will be able to use that along with the 1H1D program to continue to drive top line growth.

[Sam Eiber:]

Great. Really appreciate the color there, John. And then maybe on the HVT 2.0, I guess, how material revenue contribution could that be maybe starting in 2023?

[Joseph Army:]

This is Joe. That's an interesting question. I'll tell you that our previous experience with our Precision Flow Plus launch, which was the last time we came out with a new capital platform. There was significantly less technology upgrade in the Precision Flow Plus and these are a pretty significant increase in the ASP, and we also saw a pretty significant uptake in net new accounts and expansions, but something that we really hadn't expected was we also saw fleet upgrades. So we sort of look at this one as being interesting in that regard. And at that time, I was not crazy about fleet upgrades. I wanted people to go open up new accounts and let's expand the installed base. But installed base is 35,000 units. And let's remember, half of those were pre-COVID. So I think there's probably some opportunity around that, too.

[Operator:]

Next question is from the line of Bill Plovanic of Canaccord.

[William Plovanic:]

I'm not sure if we covered this in opening remarks but I think the elephant in the room is just the debt outstanding and the covenants and the potential briefs and the covenants. And I think you've laid out kind of your past forward here, what do you think is the [indiscernible] that you'll have to breach and/or renegotiate those covenants over the next 6 to 12 months?

[Joseph Army:]

Well, I don't think I want to put a probability to it only because the level of uncertainty around are we going to return to somewhat normal rates in the -- normal census rates here in the next 3 months. But I will tell you that if there is a bump in the road, it's not going to be a big bump, but it's not going to be a long bump. And we're not jumping up and down about it, we're taking it seriously. We'll communicate effectively. And also this is not -- this is not something that we view as a catastrophic situation.

[William Plovanic:]

Okay. Great. That's helpful. And then just I think you laid this I just want to be kind of clear on this. You're saying that it's cash flow positive or earnings positive as we get into 2023. And kind of when in 2023? Sorry, if I missed that.

[John Landry:]

Yes, Bill, this is John. So from a profitability perspective, we're looking at adjusted EBITDA profitability, and that would be late in 2023 that will allow us to grow into our top line as well as have all the pieces in place with regard to our gross margin expansion and to have a higher normalized cost structure in place. So that will take us to the tail end of 2023.

[Operator:]

That concludes our question-and-answer session for today. I'd now like to turn the call back over to Joe Army for any closing remarks.

[Joseph Army:]

Thanks very much. Well, thank you all very much for joining us today. We really appreciate you trusting us with your capital. It means an awful lot to us, and we look forward to updating you on our next call. Have a good day.

[Operator:]

This concludes today's conference call. Thank you all for joining. You may now disconnect.