Pulmonx Corporation (LUNG) Earnings Call Transcript & Summary

Good afternoon, and thank you for joining us for the third day of the 2021 Morgan Stanley Healthcare Conference. I'm Cecilia Furlong, medical device analyst and a member of the health care research team here at Morgan Stanley. It's my pleasure to have Pulmonx with us today, Glen French, President and CEO; and Derrick Sung, CFO. And before we begin, I'll run through our disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website at www.morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. And with that, Glen, Derrick, thank you both for joining us today.

Thank you.

And I wanted to start off COVID, the topic du jour, it seems like, at this conference. But you're arguably one of the more or most COVID-exposed names in our universe coverage. 2Q came in ahead of expectations, both in the U.S. and OUS, and you raised your guidance by about $1 million at the midpoint. At the time of your 2Q planning, I'm just curious, related to rising COVID case rates specifically in the U.S., what were you seeing? And how did that translate into acute impact on ICU capacity versus what you've seen in prior way of COVID?

Sure. First, just for the benefit of anybody who's not super familiar with our story, we have a treatment for severe emphysema in these patients. We perform a procedure which solves a problem that they have with trapped gas in their lungs. Essentially, the highly damaged tissue basically holds on to air. So it's very much like having a 1- or 2-liter bottle -- empty bottle in your chest cavity. And our procedure where we place these little valves and allow air to exit the target area allows that trapped gas to be pulled out of the lung and the healthier tissue to expand in its space. The people who perform our procedure are pulmonary and critical care specialists. These are the exact same people who are responsible for leading the charge in the ICU. So when COVID is hot in an area, our physicians are very much tied up with managing 20 hours a day in the ICU. In addition to that, our procedure is -- falls under the sort of definition of an elective procedure. And so we get a little bit of a double whammy with that as it relates to COVID waves, and that's what Cecilia was referring to when she indicated that we may be one of the more significantly impacted groups. Now having said that, we are a global business. We're commercial in about 25 different countries. And what that means is we have on the order of 200 accounts in the United States and a similar number outside the United States. And what we see when things get impacted, when I say outside the United States, I mean, about 45% -- 50% is in the U.S., 45% in Europe and roughly 5% in Asia Pacific. And when COVID hits, it tends to hit different regions in different -- in some cases, just exclusively, some countries in Europe might get hit, while others don't or at different stages. And similarly, in the United States, we've all read about Texas or Florida or -- now moving up into the upper Midwest and so forth. And what we have seen is that when COVID does swamp an area, it does, in fact, swamp the ICU. So specific, Cecilia, to your question about places like Florida or Texarkana was the first place to communicate that they were basically going behind the moon for a little bit. It happens. Hospitals today in relation to prior waves are way better at managing this than they were before. That's not to say that the doctors aren't distracted and that the procedures aren't postponed in those areas, our procedures. But what it does say is that the first time the COVID hit, our revenues went to virtually 0. That's -- it's nothing like that anymore because hospitals have found a way to close off a few doors and isolate those patients. And unless the ICUs get totally swamped, we're going ahead and charging forward. But there is an impact on our business in those areas and at those times when COVID's really high.

I wanted to -- you talked about the global nature of your business. And looking at the balance of the year, we're currently modeling around 55% of sales stemming from U.S. markets. In light of what you've seen recently either around COVID or holiday impact or any other factors you call out, does that outlook still look reasonable from your standpoint?

We think about roughly 50% of the business in the U.S. and 50% outside the United States. With regard to COVID impact, we see the bulk -- as I said before, think about -- and these are just using round numbers. But 50% of the business in the U.S., 45% -- a little bit less than 45% in Europe and the balance in Asia Pacific. So let's just talk about the 2 big areas. As far as vacation impact, in August, we saw that in Europe. We anticipated it was going to happen, and it happened in the way that we thought it was going to happen. It really doesn't happen in this -- to the same degree, at least in our business in the United States. So that really wasn't our -- it wasn't the issue. COVID was. We saw it coming. We did anticipate some amount of it. I think the mountain has been a bit taller than we thought it was going to be. But nonetheless, we did see that coming, and we did factor that in. So again, 50-50 split roughly is more the way that we're thinking about it as we look forward. And I think another way to think about it in the back part of the year is that really, Europe, at this point when it came back from its summer vacations basically at the end of August, just started moving, and they're moving in that direction. There's no meaningful COVID headwinds in Europe right now. We're still pulling out of a number of different regions within the United States as it relates to COVID. So that's another way to think about how that distribution might end up in the 50-50 kind of range.

And to add, Cecilia, that over the longer term, we do expect the U.S. to grow faster than outside the U.S. So over the long term, we do expect a shift towards the U.S., whether that's 60% or 70% U.S. Like the comments that Glen made certainly pertain to the remainder of this year.

Okay. And thinking to just sticking with the U.S., recovery in the U.S. exiting the second quarter, about 80% of your U.S. accounts were active versus, I think, closer to 60% back in March. What has happened from a COVID or center standpoint from your view to get back towards that 90% kind of pre-COVID active rate?

Well, so the second quarter, we -- was essentially -- for all intents and purposes, it was essentially like a non-COVID quarter for us in the U.S. I mean it was really -- I mean, we did have some COVID impact. But it was -- if you look across from the first quarter of last year through the second quarter of this year, it was clearly the best environment for us in the United States. And so rebounding up into the 80% range, which -- when we reported on the pre-COVID 90% range, our denominator was fundamentally different. And obviously, in any new -- I mean, we're not taking anything out of the denominator. So if, I don't know, when a doctor moves from 1 hospital to another and that hospital happens to be down, they're still in the denominator. So I think the 80% to 90% range is sort of the normal window that what you would expect to see. So I kind of view -- so we've talked a lot about this idea of accounts being activated or active versus the productivity of the accounts. I think in terms of account activation, we were back into what I would consider the neighborhood of where we should be. And we talked a little bit about how we were beginning to then move productivity up from kind of the low 4s to the high 4s in terms of procedures per quarter, and we see that continuing to improve over time, absent the impact of COVID, of course.

On the account procedure side or productivity side specifically, I think pre-COVID, it was closer to 7%, but you also are very concentrated, very targeted, small account base at the time. You've grown that, continue to grow that throughout COVID. So I'm just curious, kind of as you think about a post-COVID world, where can account productivity, if you look across your base, really trend? And if you look at kind of what your high-volume centers could potentially be doing on a monthly basis, what's a reasonable outlook for some of your top kind of performing highest-volume centers?

Yes. Whether pre-COVID or in the midst of COVID, our top centers were running at about $1 million on an annualized basis, so in that sort of annualized run rate range. Now that's really not all that spectacular in my view. That's doing 2 procedures once a week. So that's more or less a couple of hours of a doctor's time each week. And in these centers of excellence, we would expect that our top sites would be doing more than that. So that is -- you can do the math. It's -- that's far more than 7 per quarter. It's more on the order of 25 per quarter, which is where sort of our top-end accounts were. And so as we look at sort of the same-store sales number, if you will, we don't see that constrained by doctors' time. We don't see that constrained by the availability of procedure rooms or anesthesia. We're -- but what we are trying to do is to ensure that we take a very thoughtful and deliberate approach in setting up these accounts, establishing them in a way where they have the processes in place to move patients through from the front door through the screening process and to treatment and then turning on the referring physicians and then ultimately going direct to patient to drive patients in off the edges. But anyway, we're -- the productivity of the accounts right now is on -- was on the rise throughout this -- coming out of the second quarter, which is the last time we reported. I anticipate, I haven't looked at the most recent numbers, but we're going to have some impact with COVID. We always do. So we'll see how things come out. But the idea is, over time, we drive to the numbers that we'll realize through increasing same-store sales, so to speak.

Okay. And just in terms of center expansion, too, we saw you accelerate that in 2Q, bringing 20 centers online. As we think forward just in terms of kind of your target quarterly rate of new account openings, is closer to 10 or we saw 12, I believe, in the first quarter, but closer to that range or the 20 we saw in 2Q kind of a more realistic cadence for you?

Yes, it's a good question. And gosh, I hate -- I guess, we're on this theme, though. I'm going to tell you, during this phase where hospitals are significantly impacted by COVID, it's really hard to move around those hospitals. We walk in to a hospital, try to get them off the ground, we're not Medtronic. We haven't sold them multiple products for the last several decades. We have to negotiate terms and conditions that will allow us to do business. We have to interface with radiology with a whole array of different parts of the hospital. And those areas of the hospital outside the procedure room, so we have complete access to the procedure. We have not -- there's not been a single procedure that's been done that we've been blocked from being in the room on, if we chose to do so. But moving around the rest of the hospital is a challenge. And as a consequence, during significantly impacted COVID quarters, we were doing about 10 new -- we were adding about 10 new centers. And during -- in the pre-COVID phase, we were adding about 15. Now you mentioned in the second quarter, a quarter during which I said was essentially a non-COVID quarter, we did add 20. But that's a one-off. I mean we've never done that -- we had never done that before. Will we do that again in an unimpacted quarter? I certainly hope so. But right now, as you said, we're looking at the data that we have across multiple quarters and saying 10 is a reasonable number during a COVID-impacted quarter, which, in the U.S., it looks like -- it looks pretty clear that quarter 1 and quarter 3 are going to be COVID impacted, at least in our business; quarter 2 and quarter 4, we expect to be largely non-impacted by COVID. And so we would be anticipating the higher numbers in the unimpacted quarters.

Okay. And kind of last question on commercial type of dynamics, but territory expansion, you're targeting about 55 reps exiting 2021. You're at 53, talked about exiting the second quarter. If you think about an optimal sales force size, how do you think about further investment in your team? And that this 55-rep target exiting the year, are there any major geographies still covered or for future adds at this point really about optimizing your geographic presence?

The latter. It's really about -- I mean, right now, we're at 53, as you mentioned. 55 is not a magic number. We're in the right neighborhood here. We're covering all the -- what we refer to as the NFL cities and beyond. It's all the big metro areas, and we've dropped in some territories in between those areas where the geography just dictates that it's just too far to expect people to move. So we feel like we're in the right range. And I think that as we look forward, a significant influence is going to be just opportunity. We're going to look at -- these reps pay for themselves if they're doing 4 procedures per month. So it's not a very high bar, and we're dropping -- unlike what we did when we were first starting these territories, as we've gotten larger with this group, it's impossible at this point that anybody we dropped into a territory wouldn't have 1 or more existing accounts in it. So it's a lot easier to bring people up to speed when they have existing accounts. It's a lot easier to rationalize the spend on a new rep. So in no way are we trying to save money, but we're trying to optimize this process of opening up the very best hospitals that we can, get the docs trained, get the nurses trained and then activate the folks on the edges. And we're evaluating a number of different ways that we may optimize that. And as I said, opportunistically, if I had to guess, I think we're going to land on a number. Certainly, it would seem to me probably not above 100, but certainly above 50. But we're going to -- we're doing a number of assessments in the near term to look at the ways that we want to continue to invest in that field footprint.

As you compare your commercial model or your sales force approach versus other med tech markets, just from an efficiency or impact-to-margin standpoint, what would you call out any nuances in the interventional pulmonology space specifically versus kind of markets that are more mature in that tech?

Well, the majority -- if you're talking about intervention pulmonology, we're not swimming against any kind of current here. Most of the interventional pulmonology procedures are being done in the types of hospitals that we're calling on by the people that are doing our procedure. So this concept of having physicians that are doing procedures, getting patients -- about 80% of our patients come through referring physicians, either general pulmonologists and the probability that a patient is seeing a pulmonologist goes up with disease severity or internal medicine physicians, our patients are coming. About 80% of them are coming through 1 of those 2 categories into these treating sites. And we just feel like it's -- though it's a simple procedure, we believe that it's better to be done at centers that are doing some number of them as opposed to 2 a quarter or 1 a quarter or something like that. So that's the approach we've elected to take. And I don't know that it -- I'm sure there's some comps to that, but we do have a pretty efficient model when you talk about 50 to 100 reps driving the kinds of revenues that we expect to drive. Our average revenue per patient is -- in the United States is north of $10,000. And at the gross margins we're generating, we're not super sensitive to investing in additional reps where it makes sense. So that's the opportunistic side.

Okay. And just curious, too, as you think about really how you're targeting your sales force today. Is it account expansion? Or is it really driving deeper penetration? Can you just talk about how you balance those with your sales force as you look out and maybe kind of a post-COVID world is a better landscape to think about? But just curious kind of how you've incentivized your reps on those 2 metrics to drive growth.

Yes. Well, they're incented to drive growth, and we are not incenting them to on any -- in any case, for adding hospitals. So there's not -- what we are requiring of our reps is that they take the time and make the effort over the near term and the long term to ensure that we can treat a number of patients at these individual centers. So that's really -- so the incentive is around setting up accounts the right way, so that we can drive a high degree of same-store sales over time. At the current rate, whether it's 15 in a quarter or 20 in a quarter, I'd probably be concerned if it was 50 in a quarter. We feel pretty comfortable at the rate at which we're expanding. We feel good about the activity and the commitment and the engagement with the physicians. So anyway, that's where we are with that.

Okay. Turning outside of the U.S., your international business and really focusing on Asia Pac. China is a small business for you today. And with COVID headwinds hopefully clearing and access increasing, how are you thinking about further investment in the region near term and the ramping contributions over the next several years? And really, as you think about the biggest barriers to driving further penetration in the region today, what would you highlight?

Well, in the Asia Pacific area, we -- that is Asia for us and Australia, and we are presently in China and Australia. And China is one of these -- all of Asia Pacific is fairly binary as it relates to COVID. A handful of cases shut down a major metro area. You probably need 1,000 times as many cases to shut down a major metro area in Europe or the United States. But there's a much lower trigger amount. And so it's been fairly bumpy. We've been at a good pace in markets when the switch is on and basically no pace when the switch is off. With -- once things clear, we were on a very nice trajectory. And as you mentioned, off of a small base in China, we see continued investment in China. We've got 4 full-time reps there plus a manager. We just opened a position for a marketing person in China. We see there as being a nice opportunity as we look ahead. In Australia, we've actually demonstrated the ability to impact our business in a very constructive way as of late. We continue to see further investment there. But the biggest opportunity in the region is Japan. We've been in interactions the last major market to come online. As I mentioned before, we're in about 25 different countries. Most -- all of the major European countries, the U.S. and so forth, but Japan is the 1 out-buyer right now. Our interactions with the Japanese regulatory authorities have been super constructive. We've actually had some interactions with the reimbursement body as well and are anticipating that this is going to lead to our submission later this year and approval and reimbursement in place in the latter part of 2023. So we're looking forward to that coming online. And ultimately, over time, Japan becoming our #2 market.

And just in Japan, too, at this point, are you anticipating you won't need to conduct specific clinical trials in the region that kind of underlying your outlook today?

Yes, that's a great question. And as you're implying, it's quite common that companies have to execute clinical trials to get into some number of markets, Japan being one that has a reputation for that. We have -- although we don't have regulatory approval yet, it would be extraordinary for -- at this point, we've had a number of super-constructive interactions both with PMDA as well as the Japanese experts, and we've had no conversations about the need to execute a Japanese-specific trial. As you know, we've executed 4 randomized controlled trials. The data are very consistent. So we're headed down the path of not having to do clinical research in Japan.

Okay. Turning to market development, it's a fairly nascent market for you coming in. You have a small competitor, but you really are the one driving the growth. And as you think about just limiting factors outside of COVID, limiting factors to faster market growth, tougher adoption, just curious, how have you seen awareness over the past 12 to 18 months either from initiatives you've driven online, your websites, patient targeting? Just curious how you've seen awareness of Zephyr as an option for these patients to increase and your ability as you think through 2022 or a post-COVID world to leverage that to really drive acceleration in the business. Just curious kind of how you've seen that shift over time and the outlook you have today.

Well, globe -- so you're just talking -- you're not talking about a specific market; you're just talking in general?

Globally.

Got it. So we have seen -- certainly, through the second quarter, we saw a real nice step-up in virtually all of our metrics. I think literally all of our metrics that indicate what the future holds in terms of scheduled cases, in terms of number of StratX scans, calls into our treating centers, inquiring about Zephyr, calls into our reimbursement services group. There's a whole array of indicators. We've got now over 100 followers at the various different social media kind of channels, if you will, that we have on a global basis. Most of those -- virtually all of those are patients. Most of those are patients-seeking treatment. Some of them are patients that have had treatment who are just wonderful. They're kind of coaching up the folks who haven't yet gotten treatment on what to expect, and I think there's a great deal of credibility that comes from that. But we have seen these indicators sort of be moving in a positive direction over time. So that's -- that gives us some optimism. We also believe that as we -- awareness is kind of expands the opportunity unto itself. The more -- it's a lot of word of mouth. So the more individuals you can bring up the learning curve, the less resistance there is to the flow of patients. So we feel like the investments we're making today are going to kind of pay off down the road. And then, finally, if you consider the tools that we have in place, all emphysema patients today are diagnosed either by CT scan or autopsy. And we're not really particularly interested in autopsy as a mechanism. So the CT scan data are part of the diagnosis, specifically a patient with emphysema has a bunch of tissue destruction, shortness and breadth as a result. And so they'll do a chest scan, and they'll go look at the density of someone's lung tissue against normative values, determine whether the density is far less. And if it is, then the patient almost certainly, particularly if they're a former smoker, has emphysema. And so we are able to use our StratX system to take that same CT scan data, download it in and identify whether the patients are going to be a good candidate for our treatment or not. And if they are, then they go down the path toward our treatment, which involves another diagnostic, which again stacks the deck in our favor in terms of a high responder rate and consistent data. But StratX also throws off the patients that aren't immediately good candidates for valves. And those are the patients that we're really targeting with AeriSeal. So we're trying to find a way where all the patients that come seeking treatment will be able to find something under our umbrella that will be helpful to them to the extent that they have severe emphysema. We think that that's that idea. Now I imagine if -- just to use simple numbers, if 5 out of 10 patients can go down the treatment path today and 5 out of 10 patients can't and they get looped back to their physicians, once we have something for both sides of that equation, we think we will also realize a step-up in the flow rate just because of the positive feedback loop of not having 5 people coming back disappointed saying they didn't have anything for them. So we're working very diligently on pushing AeriSeal forward, both as -- which is an injectable polymer, which we are using, and we've undertaken a clinical trial in Europe, multicenter, multinational trial, to see whether we can use that to seal off the fisher, complete the fisher and allow what used to be a CV-positive, collateral ventilation-positive, patient to become a candidate for valves, so increasing the addressable market with valves; or in those patients where that can't be accomplished using AeriSeal as a stand-alone treatment, sort of a bronchoscopic surgical procedure, if you will, by removing that region of the lung from communication and reducing the space it occupies.

Okay. And Glen, I wanted to ask to reimbursement side, it's great to see Anthem positive coverage announcement. As you look forward, what additional efforts do you have left with some of the smaller payers after securing the last of the big 5? I realized reimbursement is not really been an issue. But just kind of can you walk through the outlook you have today and just the economics to a hospital performing this procedure?

Well, I'm going to hand off to Derrick on the economics question. But let me just say that I'm super happy about the fact that we are in a great shape from a reimbursement perspective. We've -- we get reimbursed a fair amount of money that almost always more than covers the cost associated with the procedure. 75% of our patients are covered by the government. Medicare, if you have a technology that's medically necessary, doesn't require preauthorization. 25% of our business is commercial. All of the big 5s with the exception of Blue Cross Blue Shield Association are positive or neutral, and neutral is the same as positive in terms of time to gaining approval in our world and our prior authorization, I should say. And what's happened with Blue Cross Blue Shield has been spectacular. We've taken -- Blue Cross Blue Shield Association is a tough nut to crack. So we've been -- we view it kind of like a tree that we're cutting down limb by limb. And we had about 1/3 of all of the covered lives that had flipped positive under a multitude of other plans like HCSC or Blue Cross Blue Shield in North Carolina. We just flipped Anthem, which is another 1/3. So we're 2/3 covered. And I think the largest Blue Cross Blue Shield plan that remains is Blue Cross Blue Shield of Michigan. And I'm happy to report that earlier today, they flipped effective September 1 to a positive position. Heard it first here on the Morgan Stanley call. But in any case -- so we're just -- we're chopping this tree down limb by limb, and it will be soon becoming irrelevant what Blue Cross Blue Shield Association says if all of its members of -- we put forward these cases, and they end up ultimately getting approved on appeal 100% of the time or nearly 100% of the time. So I think they throw their hands up in the air and say, hey, the association doesn't have to pay for the appeals. We do. We're going to flip over because we're losing them all. Derrick, maybe you could talk about the other part of that question, please?

Sure. I think you're asking about the economics of the hospital Cecilia. And our understanding is that most hospitals here are making money on the procedure itself. We don't hear pushback as in regards to the economics in terms of hospitals losing money per se. In fact, some of these patients have come in to get the procedure done, our Zephyr valve procedure. They may bring with them other comorbidities that may also increase revenue to the hospitals. I think the most important takeaway here is that we don't see -- we would have heard if reimbursement was an issue for the hospital to treat these patients. So it's not an area that we see at this point. And we continue to see our CMS rates that we get for reimbursement have been moving up modestly every year. And so we feel like we're in a good position there.

Cecilia, one of the greatest indicators, I think, is that these hospitals come to us and say, let's collaborate on how we can drive more patients. And clearly, if they weren't making money, they wouldn't be asking us to drive more patients, so.

On that note, I think we are out of time, but I think it speaks to the value of the technology. But again, Glen, Derrick, I wanted to thank you both for the time this afternoon. It's great getting to chat with you again. Thank you.

Thank you very much, Cecilia.

Thanks.