Good afternoon, ladies and gentlemen, and welcome to the Vapotherm Second 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 Second 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 everybody that 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 risks 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 generally 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'll begin the call by discussing our second quarter 2019 results, then I'll hand the call over to John Landry, our CFO, and he's going to provide additional financial details on our second quarter results, after which I'll update you on our key areas of focus with regards to 2019 and then we'll open it up for questions. At the midpoint of 2019, I'm feeling pretty good with how we're executing on most fronts. Big picture, the new reps are coming up to speed. We opened up 36 gold and silver Emergency Department accounts this quarter. The U.S. disposable turn rates ticked up again. We grew our disposables 29%. Gross margins were above 45%, and our cash burn decreased by over $1 million. On the other hand, our legacy tenured rep performance in the U.S. produced lower-than-expected U.S. capital equipment sales. As we discussed on the last call, we went through an awful lot of change at the U.S. field team last fall. Just to remind you, expansion, realignment of the clinical team, a new sales leader model and a new sales rep profile. For the most part, these changes are working as or were better than we expected. Today, roughly 60% of our 52 U.S. sales territories are staffed with reps that have a new profile. Of the remaining 40% legacy tenured reps, half of them have been developing and maturing nicely and getting the job done. We're proud of them for the way they work through the transition and the success they are experiencing. However, some of the legacy tenured reps have had trouble adjusting to the changes we made, and they didn't build the pipeline as we expected. This quarter, we saw a decent chunk of our legacy…

Thank you very much, Joe. Revenue for the second quarter of 2019 was $12 million, representing an increase of 13.5% over revenue of $10.6 million in the second quarter of 2018. Total U.S. revenue was $8.7 million, representing an increase of 11% over the second quarter of 2018, while total international revenue was $3.3 million, which represented an increase of 21% over the second quarter of 2018. Capital revenue, including revenue from both product sales and lease revenue, was $2.9 million for the second quarter of 2019, representing a 20.5% decrease over the prior year. U.S. and international capital revenue were $1.9 million and $1 million, respectively, for the second quarter of 2019. Disposable revenue was $8.5 million in the second quarter of 2019, representing a 28.9% increase over the second quarter of 2018 and was primarily driven by an increase in our worldwide installed base of Precision Flow units and higher utilization rates. During the second quarter of 2019, we sold roughly 88,000 disposables worldwide. Disposable revenue was $6.5 million and $2 million in the U.S. and international markets, respectively, in the second quarter of 2019. Worldwide service revenue was $527,000 in the second quarter of 2019, and of this amount, $281,000 was generated in the U.S. and $246,000 in our international markets. Gross profit for the second quarter of 2019 was $5.5 million, an increase of $1.4 million over gross profit of $4.1 million in the second quarter of 2018. Gross margin was 45.5% in the second quarter of 2019 compared to 38.8% in the second quarter of 2018. The increase in gross margin was driven by a favorable sales mix of disposables as well as a decrease in disposable component costs in comparison to the second quarter of 2018. Additionally, we improved operating efficiency by holding operating…

Thanks, Johnny. Before opening up the line for questions, I'd like to review how we intend to focus our efforts over the balance of the year. First, with regard to the U.S. sales force, we're focused on getting our underperforming reps back on track and are preparing to expand our sales channel again in the fourth quarter. While we are proud of the way our sales force has worked throughout the changes, our focus for the second half of the year is to get underperforming legacy tenured reps back into the habit of delivering plan while backfilling the seasoned medical device reps by the end of the year. Some of that work has already begun. In the fourth quarter, we expect to expand the number of sales territories, and we anticipate starting 2020 with 57 territories, up from the current 52. Second, we will focus on the launch of new products. We have begun preparing for a limited market release of our new ProSoft line of next-generation Hi-VNI Technology patient interfaces. These cannulas are designed to improve patient comfort and user friendliness to increase material softness, color coding and new packaging. We decided to push back the limited market release of our integrated aerosol drug delivery Hi-VNI disposable to late third quarter to coincide with the kids' return to school, which typically marks the beginning of our busy season where this product would be more used. I've also spoken a bit about our Precision Flow oxygen management module for the PF units. Third quarter will be focused on refining the offering for both our international distributors and newly direct U.K. markets as we expect to have secured international regulatory clearance by the end of the year. The only caveat to this time line relates to the transition of the European…

[Operator Instructions]. And your first question comes from the line of Margaret Kaczor from William Blair.

So first question for me is just a little bit of a follow-up on the sales force commentary that you guys had. So maybe you can remind the folks on the call of the changes that were made last fall that -- I'm talking just about the expansion component of it. And did it really take a few quarters to see the impact from the change in structure because of the length of sales cycle or some other reason? And then I'll have a follow-up in terms of kind of the pipeline of new placements going forward.

You bet. So just to remind you, last year, we changed the rep profile. Historically, we had used B2B sales reps that have -- we're looking to break into medical technology. And in the fourth quarter, we were then now in a position -- because of the improving economics of the Precision Flow system, we were now in a position to actually hire seasoned, senior, experienced medical device professionals, sales professionals. So the intention was to expand the sales force by 25% and really do it with those folks. In addition, we restructured our clinical manager team. And we moved those resources around a bit and deployed some of those positions back into sales positions. We also changed -- and so, of course, when you grow a sales force by 25%, you also touch the geography a fair amount. See, everybody's territory lines were changing. And then we went from -- to a single region leader model. Historically, the clinical people had reported to one manager, and the salespeople reported to another. And what we found was a single leader model seemed to make the most sense. I would tell you that I'm tickled pink with the way that the new reps are coming up the curve. What I'm not happy about is that while we're only supposed to have 25% of them, 60% of our field organization today is that new profile largely because we incurred a lot of unplanned turnover of tenured reps that just could not wrap their heads around shrinking sales territories. We all learned a long time ago from John Brown at Stryker that there is three truths, right? Every year, you're going to get a smaller territory. Every year, your quota is going to go up. And every year, you're going to go make…

Got it. That's helpful. And so you've still got the lower-performing reps. You're maybe focused on retraining them, push comes to shove. You'll figure out a new model that clearly is working. But maybe talk a little bit about the pipeline for new placements and how that's looking at this point because part of it for us is you've got the existing accounts that you sell into, you've got the new accounts that you're selling into. With some of the higher disposable utilization rates, it seems like that pipeline should remain strong for continuing placements. But maybe walk us through that.

Well, let me start by answering the last part first. That installed base, which is what we look at, we look at total revenue, installed base and gross margin, right? Those are the three things that are driving us crazy, we're focused right on them. That installed base is right where it needs to be in the U.S. and international. So we are set up very well for the second half of the year. We really like the turn rates increasing, but we're going to just sit tight for the time being, Margaret, because we still want to work through any remaining uncertainty with that U.S. sales force. We want to create a buffer in there, right? The pipelines continue to improve. They keep growing, and we like the way they're doing it, particularly when you start to think about 60% of that sales force started in the fourth quarter. Their pipelines are maturing very nicely. And a good bunch of our tenured people, their pipelines are healthy and strong. So I like what I'm seeing there. I'm just going to remain a little bit more cautious on the capital equipment in the U.S. side than in the disposables. That's working the way we want it to.

Okay. Good. And then if I can sneak one more in. In terms of kind of the disposable utilization rates being better, can you walk us through those higher turn rates? You referenced an ED focus and a guarantee program, but are you seeing continued interest across the board? Or is it really focused on kind of some of the new dynamics you've got?

No. It's the same -- Margaret, it's the same thing we've been doing. It's driving into gold and silver EDs, the largest EDs in the country, there's roughly 2,000 of them, and driving the message of Mask-Free NIV for the spontaneously breathing patient. And we now know and every one of these EDs we go, we found the magic bullet, right? We know that every single one of them have mask-intolerant patients, and our sales force is getting more and more experienced to teaching them this. It's interesting. I was in the field early this quarter visiting a bunch of EDs throughout a couple different parts of the country. And what I found interesting was even though those turn rates are up in it, look, it's not up crazy, right? It's 1.72 to 1.9. So -- but for us, that model is pretty sensitive as you know the turn rates. So we're very cautious about that. I'm still finding even when hospitals in the early stages of their adoption, they're still only using it for hypoxic patients and not yet hypercapnic patients. When I go into hospitals that have been using it for nine, twelve months, that's when I really see them using it on a full gamut, getting the full value out of it. So this ED play is working. I like this. I think this is a good thing, and we're going to just pound this thing like you can't believe.

And your next question comes from the line of Jason Mills from Canaccord Genuity.

This is actually Cecilia on for Jason. And I just wanted to ask about your Q3 guidance and kind of what this implies for sequential ramp in Q4 and just your thoughts around the sales force disruption, maybe that ameliorating a little bit in Q4 and what you see from capital versus the disposable sales mix in those two quarters.

Sure. It's John. I'll take this one here. So in terms of our guidance for the third quarter, given the sales force disruption we spoke about and some of the legacy reps turnover that we had earlier in the year, coupled with the fact that the third quarter is our seasonally slowest quarter, we feel that the range of $11 million to $11.4 million is our best estimate right now for the third quarter revenue. If you recall, for the first half of the year, we were tracking about $400,000 ahead of guidance, which gives us confidence we'll be able to deliver on the full year number. With regard to the fourth quarter, we'd expect the revenue as modeled in to increase in the fourth quarter of the year. Recall that the fourth quarter is our largest capital quarter of the year. Typically, it's tied to the hospital budget cycle, which culminates in the December time frame. With that, we also have a number of the sales reps who've been hired recently in the -- well, recently, fourth quarter of 2018, coming fully up to speed and tenured by the fourth quarter of '19 as well as the fact that we see that the pipelines that they're building as well as the tenured rep pipelines, we feel comfortable that we'll be able to deliver on that guidance of $49 million to $51 million for the full year.

Okay. Great. And then I guess just turning back to focus on the ED. I was just curious, in those new accounts that you're opening, what type of organic growth into other departments are you seeing so far? And kind of what have those trends been?

So it's really hard to tell you the answer to that question because we don't know where the boxes are kept outside of the ED. So the -- really what we know is they're actually storing Precision Flow units in the ED and using them there. The rest Precision Flow units, they will literally go into an equipment corral and they'll set up on like the second floor or something until somebody needs them. So we don't know where in the hospital they move to, whether it's in the pack queue, general care floor bed, ICU or whatnot. What we look at is the overall disposable dollars, the disposable units, number of patients being treated, we look at those turn rates, and then we see the hospitals buy additional Precision Flow units. And generally, we're seeing that one to two quarters after they've adopted in the ED. That pattern has continued. The second pattern that has continued is that roughly 2/3 of our capital equipment in any given quarter is coming from existing customers that are expanding their fleet. That pattern has continued. So I don't have any more clarity than that, and we know that when we go in and open up the ED, it spreads throughout the hospital.

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

Well, I just wanted to say thank you again. We appreciate all your time and support, and we're very excited about what the second half of the year will bring and look forward to talking to you in October.

This concludes today's conference call. You may now disconnect.