Vapotherm, Inc.

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 Westwick. Sir, please go ahead.

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 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 event section in the IR section of our website, 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 factor 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 VapoTherms President and Chief Executive Officer, Joe 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 Vacotherm'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 will be clear on the four 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, COVID has a profound impact on our business, both good and bad. On the positive side, it accelerated the growth of our install 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, in 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, 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 three 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 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-blade business made up of capital units and single-use disposables, so a critical element of our success is the growth of our capital unit install base, which in turn drives recurring disposables revenue. What you see in this chart is the annual growth of our U.S. install base from 2015 to today. Prior to 2020, we drove a steady increase in that install base from 2015 when we first launched our direct sales force in the U.S., To the end of 2019, we saw our install base grow at a 17% compound 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. install 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 Vaporform and our technology, allowing us to rapidly expand our share of the biggest hospitals in the U.S., hospitals we generally refer to as gold accounts, the top 1,000 U.S. hospitals measured by respiratory discharges. As we dramatically grew our U.S. install base during COVID-19, 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 when 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 increasing 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 and the volatility in 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, with big increases in demand with no warnings. Until the 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 the 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 of 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 census in 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 and a traditional seasonal pattern of flu, RSV, and respiratory illness in general, provided masking is no longer widespread. 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 two 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 golden cows perform the same during COVID, it 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 one H, one D strategy, which is meant to educate our customers on the full capabilities of our technology to help patients through all four 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 1H1B conversations with hospitals, we're focused on educating them on a couple of key factors. First, the benefits of our technology are both hypoxic patients and hypercapnic patients. Second, how our technology can be used in the four 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 two-thirds 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 in COPD patients. Looking at the chart in the center of the slide, you can see the more care areas we treat, the bigger 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 one or two care areas, leaving 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 four 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 into one of these care areas will drive recurring revenue growth while potentially reducing the seasonality in that core respiratory business. I hope you can see from the detailed data we just reviewed why I'm confident in our ability to return to historical turn rates. Just doing a simple math, assuming our plan works, the 35,000 units in the global install 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 revenues. 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 the historical U.S. quarterly disposables turn rate for different groups of customers. First, hospitals that use our technology in the emergency department, which is the blue line on the graph, have higher turn rates than 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 an 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 identified 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 two very important elements, which is exactly what 1H1D and our HVT 2.0 launch are all aimed at. 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 six 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 critical and economic value in our new products. As we look ahead, we expect to drive higher capital in disposable ASPs as we introduce new, higher-value products and services like the upcoming HVT 2.0 launch. Our product development roadmap 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 HPT 2.0 launch will be critical and exciting for us later this year. With its internal blower, HPT 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 was associated with higher turn rates. With our large install 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 that's seen tremendous growth over the past two years. But growth is just one piece of the puzzle. We need to fuel that growth with capital we have while driving to 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 covenant is based on hitting a trailing six-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 could still achieve our revenue milestone if respiratory distress 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.