Good afternoon, ladies and gentlemen and welcome to the Vapotherm third quarter 2019 financial results conference call. As a reminder, this call is being webcast live and recorded. It is now my pleasure to introduce your host, Mr. Mark Klausner of Westwicke. Please go ahead, sir.

Good afternoon and thank you for joining us for the Vapotherm third quarter 2019 financial results conference call. Joining us on today's call are Vapotherm's President and Chief Executive Officer, Joe Army and its Vice President and Chief Financial Officer, John Landry. I would like to remind you that this call is being webcast live and recorded. A replay of the event will be available following the call on our website. To access the webcast, please visit the Events link in the IR section of our website, vapotherm.com. Before we begin, I would like to remind everyone that our remarks and responses to your questions today may contain forward-looking statements covered under the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on the current 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, 2018, which was filed with the Securities and Exchange Commission on March 22, 2019 and in any subsequent filings with the Securities and Exchange Commission. 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. This call will also include references to certain financial measures that are not calculated in accordance with Generally Acceptable Accounting Principles or GAAP. We refer to these as non-GAAP financial measures. Reconciliations of these non-GAAP financial measures to the most comparable measures calculated and presented in accordance with GAAP are available in the earnings press release on the Investor Relations portion of our website. With that, it's my pleasure to turn the call over to Vapotherm's President and Chief Executive Officer, Joe Army.

Good afternoon and thank you for joining us today. I will begin by discussing the progress we made in 3Q, then I will hand the call over to John Landry, our CFO, to provide additional financial details of our 3Q 2019 results and our revised guidance, after which I will update you on our key areas of focus with regards to 2019 before taking questions. I am generally feeling pretty good about how we are doing in building the company despite the shortfall in U.S. capital revenue in the quarter. Big picture, total revenue grew by 15%, led by 24% growth in disposables. Gross margins were nearly 45% and our cash burn improvement program is making progress. Operationally, our expanded field sales force is coming along nicely. Our installed base is tracking to plan. Our ED guarantee program is gaining traction. Disposable turn rates are strong year-to-date and our product development efforts are all progressing according to plan. I mentioned last quarter that some of our legacy U.S. sales professionals had not been performing to their capital sales program. I am pleased to report that this quarter, nearly two-thirds of these legacy tenured sales professionals grew their installed base, according to our plan. In addition, last year's expansion class of sales professionals continued to develop in line with our expectations as they progress towards their one-year anniversary. We like how sales pipelines are building as it takes multiple quarters to build and are the key to increasing our installed base. Despite all of these positive signs, we came in below our U.S. capital revenue expectation for the quarter. The primary reason for this shortfall was the mix of sold versus placed capital units. During 3Q, we saw a higher percentage of placed units compared to sold or leased units than…

Thank you Joe. Revenue in the third quarter of 2019 was $10.8 million, representing a 15.1% increase over revenue of $9.4 million in the third quarter of 2018. Total U.S. revenue was $8 million, representing an increase of 6.6% over the third quarter of 2018 primarily due to 16.2% increase in disposable revenue as a result of a larger installed base of precision flow units and higher average selling prices. This increase in disposable revenue was partially offset by a decrease in revenue generated from the sales of precision flow units on a year-over-year basis. Total international revenue was $2.8 million, representing an increase of 49.8% over the third quarter of 2018 primarily due to an increase in disposable revenue as a result of a larger installed base of precision flow units and higher average selling prices and to a lesser extent, increases in service and other revenue. Capital revenue, including revenue from both product sales and lease revenue, was $2.5 million in the third quarter of 2019, representing a 7% decrease over the prior year. U.S. capital revenue was $1.9 million, as compared to $2.1 million in the third quarter of 2018 primarily due to fewer sales of precision flow units and to a lesser extent, slightly lower average selling prices. International capital revenue was $647,000 in the third quarter of 2019, an increase of $77,000 over the third quarter of 2018. Disposable revenue was $7.8 million in the third quarter of 2019, representing a 24.3% increase over the third quarter of 2018 and was primarily driven by an increase in our worldwide installed base of precision flow units and higher average selling prices. During the third quarter of 2019, we sold roughly 79,000 disposables worldwide. Disposable revenue was $6 million in the U.S. compared to $5.1 million in…

Thanks John. Before opening the line for questions, I would like to review how we intend to focus our efforts over the balance of the year. First, we are expanding our U.S. sales channel by 10% from the 52 territories at the end of 3Q to 57 territories by year-end. This has gone smoothly to-date and we like the quality of sales professional candidates we are seeing. Secondly, we are focused on preparing for the full launch of our new disposable products. We are wrapping up a limited market release of our new ProSoft line of next-generation Hi-VNI technology patient interfaces. These cannulas are comfortable, lightweight material that ensure minimal gentle contact with the skin. We are also in the midst of a limited market release of our integrated aerosol drug delivery Hi-VNI disposable. This product can help clinicians deliver continuous nebulization of drug with our Hi-VNI technology which could be especially helpful to them during the upcoming RSV season. I have already spoken a bit about our oxygen assist module for the precision flow. We expect to receive the CE mark by the end of the year and we will be focused on beginning a limited market release in a handful of European countries, including our newly direct U.K. market as soon as this clearance is received. During the limited market release, we will test several business models including sales, rentals and placements of the oxygen assist module. Early indications from our prelaunch work suggest this technology may help us open net new accounts. The only caveat to this timeline relates to the transition of the European regulatory model from the previous Medical Device Directive to the new Medical Device Regulation. This change could potentially lead to the approval process spilling over into 1Q of 2020. As mentioned earlier,…

[Operator Instructions]. Our first question comes from Robert Hopkins with Bank of America Merrill Lynch. Please go ahead. Your line is open.

Hello. Great. Thanks for taking the question. This is Kyle Pezzi, on for Bob. I just had a quick question about the capital environment in the United States. Obviously it came in a little bit weaker than we had expected this quarter and it sounds like ASP was a little bit lower. I just wanted to make sure that I understand, is there anything thematic going on there that's worth calling out? And then I just have a quick follow-up after that.

No. Kyle, before John gets into the details, I just want to remind you that our primary focus is on the long-term growth of that installed base. And that's tracking in line with our expectations. Installed base is a metric that I focus on the most as this is the key driver of our high-margin recurring disposable revenues. Worldwide, that installed base grew 18.5% or just over 2,400 precision flow units. And it now is over 72% of our overall revenue comes from disposables.

Yes. So Kyle, I can add a little more color here in terms of the third quarter. Approximately $450,000 of the shortfall between the midpoint of the range and where we came in at was attributable to a shift in the number of units that we placed at customers versus selling directly to the customers. So when you take that number times our average selling price, that's roughly the delta between the midpoint of guidance and where we came in at.

That's helpful. And then I guess, in terms of kind of growth rates as we think about next year and look at historical trends, what will it take to get to that mid-teens to high-teens rate that we have seen historically? Do you expect growth rates to kind of be on the slower end for the next few quarters and then accelerate from there? Just any kind of broad comments are helpful.

Well, I would say, broadly speaking, the thing that I pay attention to again is that installed base. The disposables grew 24%. It's now 72% of our total revenue base, Kyle. And what I am going to just stay laser focused on is just keep expanding that installed base, whether it be through placements, sales, leases. Those three elements are really how we drive it as well as through the expansion of that sales force which we expect to have that fully completed by the end of this quarter, by the end of December. And then lastly,, accelerating the revenue growth through the use of the next set of new products that we are coming out with, both the ProSoft as well as the aerosol specialty disposable we are pretty excited about. Those are the types of things that we are looking at continuing to drive our growth.

Thank you for taking my question.

Thanks. I appreciate it.

Thanks Kyle.

Our next question comes from Anna Nussbaum with William Blair. Please go ahead. Your line is open.

Hi guys. This Anna, on for Margaret. I just wanted to follow-up on the 18.5% growth in the installed base despite the lower-than-expected total system sales. Was your disposable utilization probably pretty predictable on those placement? Can you speak to the ROI and implied growth out of those placements? And then what you expect for the installed base growth going forward as well?

Sure. Hi Anna, it's John. So in terms of the installed base growth, it was 18.5% and what we find is generally that the installed base growth is a fairly good indicator of our disposable growth going forward. So when we look at the installed base growth year-over-year, last year it was roughly 18%, 19%. And our disposable year-over-year growth this year is going to be roughly 21%. So we find that to be a pretty good indicator of the future events of that disposable stream. In terms of the placement and the economics on that capital, in terms of return on investment of that invested capital, generally based upon the average selling prices and our cost structure we can receive a cash-on-cash return on that invested capital in roughly one year.

Okay. Got it. Thank you. And then you talked a little bit about the ED or your strategy on the ED. How did that play out in the quarter relative to expectations? And I guess just in terms of growing that program, how has it benefited overall?

Well, this is Joe. I will take that one. So that ED guarantee program, we substantially exceeded our internal expectations around that. It's really has helped us to start conversations with ED clinicians. When we offer a money back guarantee to hospitals, if a BiPAP intolerant patient goes on our technology and then fails, we believe that it breaks down an initial barrier for us in that sales cycle. And remember, we are working to displace a two generational technology that everybody's been trained on in the emergency department as the go-to for every respiratory distress patients. The ability to put our money where our mouth is, is a pretty powerful message and to-date, we have sold almost 3,700 disposables under that program and we have only had a handful of disposables returned to us. So this is a very interesting differentiator. I can tell you that our sales professionals really like this. They understand how to use it and they are getting better and better at it and engaging fully with those ED physicians.

Got it. Thanks for taking the questions.

Thank you.

Thanks Anna.

Our next question comes from Jason Mills with Canaccord Genuity. Please go ahead. Your line is open.

Hi. This is actually Cecilia, on for Jason. I just wanted to ask about gross margins. It's continued to come in ahead of our expectations, partially driven by the strong recurring revenue. But I was just wondering if you have any updated thoughts just on your ability to continue to expand margins going forward? If you are still targeting the 200 to 300 basis points expansion you talked about previously? And then just also the impact that oxygen assist module could have on gross margins going forward?

Sure. Hi Cecilia, it's John. I will take this one here. So in terms of the gross margin improvement, we did have 600 bips of improvement on a year-over-year basis. We are happy to report that all three elements of our three-pronged play are working. Of that improvement, roughly 20% to 25% of that year-over-year improvement was tied to a change in mix as we pointed out to higher recurring disposable stream. But the remaining 75% to 80% were tied to the three key elements of our three-pronged approach which is the cost reductions in our disposable, taking direct material labor out, reductions in our overhead rates per unit as a continue to scale and then the last piece is our ASP increases. So we like what we see you. We haven't set or haven't offered guidance yet for 2020. But we have communicated the 200 to 300 bips of improvement on a year-over-year basis and we like what we see there right now. In terms of the oxygen assist module, I think it's a little bit premature to comment on what that could potentially do to our gross margins going forward, but it is an important part of increasing on the average selling prices of our technology as we drive more clinically valuable technologies into the hand of our customers. And we are also looking with that, to have a more streamlined disposable as well as capital unit which would again go hand-in-hand with reducing the overhead rates per unit as we build more and then the direct material and direct labor cost reduction initiatives. So it plays a very important part in that going forward and we will provide more commentary on the 2020 guidance in the year-end 2019 results call.

Great. Thank you for the color. And then I just wanted to ask as well on the sales force, the turnaround you have seen that you highlighted in Q3. Just if you could provide any more qualitative comments around what you are seeing? But then also your updated thoughts around peak productivity levels going forward with this new rep profile versus your prior expectations with the older rep profile?

Well, I have been very lucky to be able to be in the field with a number of our sales professionals in the last quarter. And in fact I was out with one of our more recent additions to our team last week in Colorado. And I can tell you what I am noticing is that the noise in our field organization has settled down. Our leaders have done a really good job at helping them understand where we are going to grow this business and working through all of the structural changes that we made to that organization a year ago. It's important to remember that 75% of our field organization has less than one year experience under their belt with us. The vast majority of these folks now are tenured seasoned medical device sales professionals. But the B2B sales professionals that we have with us that have come up through the ranks have done an outstanding job as well. So I will tell you, I am really, really proud of the entire team. I really like what I am seeing. They are settling right down. I like what I am seeing out of our field leaders. And our clinical team in particular has done an outstanding job of serving customer. So I guess that's about all I am going to say on that topic. And in terms of what peak productivity is going to look like, I don't think that I am prepared to discuss that at the moment. We might have more thoughts on that in 2020 as we are going to have these guys go out there and run a little bit and see how the do. But I am liking what I am seeing.

Our next question comes from Sean Lavin with BTIG. Please go ahead. Your line is open.

Thanks so much for taking the questions. This is Marie Thibault, on for Sean today. Just a couple of quick questions. I don't think we have had the chance to see Vapotherm's purchasing patterns and revenue cadence around a really strong flu season. So I wondered what your thoughts are? We are hearing from some that this could be a pretty strong flu season. So I wonder what you are hearing in the field on that? And in terms of how we should think about capital and disposable cadence around that?

Well, how about if I take the first part around the flu season and then Johnny can talk to you a little bit about the overall cadence of the break between disposables and capital. We have heard the same thing out of Australia. Our Asia-Pac leaders have been sharing with us that this was a, what they would characterize as a moderate to severe flu season in the Southern hemisphere. They have characterized that the type of flu that they have seen is consistent with what we saw in 2017 in the U.S. Sometimes the Southern hemisphere is a really good predictor for the U.S. flu season and sometimes it's not. One of the things that was characterized by the Southern hemisphere flu season this year was that it began a bit earlier than historically. I can tell you in looking at the CDC flu report which they publish weekly on a one-week lag, we are beginning to pick up signs of the flu in the U.S. but it's still very, very early in the season and it would be much too soon to make any kind of prognosis around the type of flu that we are going to see. Because like I said, sometimes the Southern hemisphere thing translates and sometimes it doesn't. That said, we are coming into our busy season. Now fourth quarter and first quarter from a census point of view in the acute care facilities in the Northern hemisphere are the busiest. It's when our turn rates are the most robust. Also it is also when the respiratory department tends to be heard the loudest when they are looking for more capital equipment investments. John, anything you want to add to that?

I think that covers it, Joe, in terms of the turn rate summary. The third quarter is, as Joe said, our seasonally slowest period of time from a turn rate perspective. 1.67 was our rate for the third quarter. As we look to the fourth quarter, we are more aligned around the two turns per month from a disposable utilization perspective. And as you recall, obviously the first quarter of the year is the most robust from a turns perspective, about 2.2 turns. We use the lower of the prior year or the historical average to determine our turn rates and we will continue to do so to eliminate some of that volatility that we see in the variety of flu season as they occur.

Great. Thank you for all that color. My other question was around Palladium and the 510(k) clearance during the quarter, I believe, for the Gen1 device there. Can you tell us a little bit more about the roadmap for that or what you are willing to say publicly about that?

I could tell you why we did it. We hadn't had a full-blown 510(k) in front of the agency in quite some time and it was a way to mitigate risk with the commercial version of our next-generation Hi-VNI system. We were very pleased with the process that we went through with FDA. It was a very robust one. And now we feel very good about what's going to come next when we submit the 510(k) for that next-gen commercial version. As John mentioned on the call earlier, we will be bringing that into a limited market release in 2020, although it will be late in the year and we are pretty excited about that. We think that could be a very important tool for hospitals to use throughout their care continuum.

Perfect. Thank you so much.

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

Thanks very much. I want to thank you all for your interest in Vapotherm. We really appreciate it and we look forward to updating you on our progress again next quarter.