Vapotherm, Inc.

Good afternoon, ladies and gentlemen, and welcome to the Vapotherm Third Quarter 2020 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 Westwick. Please go ahead, sir.

Good afternoon, and thank you for joining us for the Vapotherm Third Quarter 2020 Financial Results Conference Call. Joining us on today's call are Vapotherm's President and Chief Executive Officer, Joe Armie, and its Senior 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. 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 factor section of our annual report filed on Form 10-K for the year-ended December 31, 2019, which was filed with the Securities and Exchange Commission, or the SEC, on March 4, 2020. and our quarterly reports on Form 10-Q for the first, second, and third quarters of 2020 as filed with the SEC on May 5, 2020, August 4, 2020, and November 4, 2020, respectively, 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. 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.

Joe Army Thank you, Mark. Good afternoon and thank you for joining us today. I will begin by discussing our third quarter 2020 results. Then I'll hand the call over to John Landry, our CFO, to provide the financial details of our 3Q results, after which I'll update you on our key areas of focus for the remainder of the year before taking questions. 3Q was another good quarter for Vapotherm as we generated $30.6 million in revenue, a 183% increase over 3Q 2019. increased our worldwide install base by more than 2,700 units to approximately 25,000 units, and opened 43 net new gold and silver accounts in the U.S. In addition, we printed a 50.8% gross margin for the quarter despite continued significant headwinds. On our 2Q call, I stated my belief that our business had been significantly transformed as a result of two factors. One, the increased awareness and usage of our high-velocity therapy, and two, our continued progress in developing the Oxygen Assist Module, or OM for short, and our next-generation system. With another quarter under our belt, I'm increasingly confident in our ability to sustain this transformative momentum post-COVID-19. Today, I'll update you on what I'm seeing in our business that's driving my thinking on this. as well as provide an update on the work we've been doing on our product pipeline during 3Q. 2Q was incredibly hectic as we devoted a substantial amount of our energy to rapidly ramp our capacity in an effort to meet all customer needs in the midst of a significant surge in COVID-19 hospitalizations. 3Q was primarily about working to settle down and prepare the organization for sustainable long-term growth. We focused on three things this quarter. First, we ramped production capacity in an effort to meet all future customer demand. Second, we expanded our clinical education efforts to teach new customers how to use our equipment on both type 1 hypoxic and type 2 hypercapnic patients. Third, we continued work on our future growth drivers, the oxygen assist module and the next generation system. We expanded our maximum theoretical production capacity by adding new lines which are fully qualified and ready to go. We developed the capability to run three shifts per day in the event we experience a significant surge in demand for our capital units. This reduced our need for overtime and settled our production team down for the long haul. We now believe we are in a position to meet all potential future customer demand without burning out our teams. We also expanded our warehouse capacity by 40% and it implemented all applicable safety measures in an effort to keep our people safe. Importantly, we made all these changes while not adding material to our fixed cost base. On the clinical education front, our field team is focused on implementing and educating both our new and existing customers on how to use our high velocity therapy on patients suffering from both type one respiratory distress, such as those with COVID-19, and type two respiratory distress, such as those with COPD. We believe this continued focus on education will help drive the broader adoption of our technology, especially when customers experience firsthand how our high velocity therapy is different from traditional high flow therapy and how it can be used to help patients beyond COVID-19. To give you a sense of the success we are having, I'd like to share with you a story from a gold ED hospital in the New York metro area. This hospital became a customer during the initial COVID-19 surge. We believe our team did a great job getting them up to speed quickly on high-velocity therapy so they could treat the respiratory distress experienced by the surge of COVID-19 patients, most of whom were hypoxic. As the surge subsided, our team was able to educate this customer on the full clinical utility of high-velocity therapy, including type 2 patients in respiratory distress. This customer now uses us in adult ICUs, the general care floor, pediatric ICUs, and the ED, and recently converted to our new ProSoft nasal cannula, and aerosolized disposable patient circuit, which is intended to deliver aerosol medication without disrupting therapy. In addition, the customer will be trained in the NICU soon and is just placed in order to expand their fleet of precision flow units and vapotherm transfer units further. Post-surge, disposable turn rates in this hospital have ramped as we'd expect for a net new account. I am really encouraged by the trends I'm seeing in this and other customers, which gives me confidence that we can use the increased access and awareness driven by COVID-19 to support long-term growth. Our third focus was our continuing work on our future growth drivers, primarily the Oxygen Assist Module, or OM, and our next generation systems. We recently updated the Ohm software to operate with both the Medtronic Nelcor and Massimo SpO2 sensors to improve the user experience, and the early clinician feedback from the limited market release continues to be positive on both neonate and adult populations in the United Kingdom, Europe, and the Middle East. Recall that the OM device is designed to help caregivers maintain patients within a physician-prescribed oxygen saturation range while requiring significantly fewer manual adjustments to the equipment. Our pre-pandemic strategy was to focus on the neonatal patient population as our clinical data is strong. However, based on the clinical experience in the UK, Europe, and the Middle East, we now believe there is a significant unmet clinical need in both neonate and adult patient populations. We expect to move into full market release with this product in the UK, Europe, and the Middle East in 1Q 2021 and are continuing to work with FDA on the appropriate regulatory pathway in the U.S. We believe we've made good progress on our next generation system, especially given the fact that our team was restarting from a hard stop in late first quarter. While the initial version of this device will be optimized for the hospital setting, we expect to learn a great deal about clinical utilization and patient needs that will inform our strategy when we're ready to launch a home-specific product. I also want to throw up in a plug for our new Felix one portable negative pressure mask. This idea came from a respiratory therapy leader in New York city and can be used with a variety of respiratory support devices, including our high velocity therapy and may mitigate the risk of transmission of potentially infectious particles to caregivers treating COVID-19 patients. We are proud to be donating all of the profits from this product. to nonprofit funds set up by the American College of Emergency Physicians, American Association of Respiratory Care, and Emergency Nursing Association. Lastly, I want to thank all our teammates and partners around the world for their extraordinary efforts to serve our customers and their patients on the front lines during this crisis. This has been remarkable to see what they've accomplished in a very uncertain and stressful period. We believe they have repeatedly and successfully navigated the day-to-day challenges of scaling our capacity significantly while adapting to significant change at work and at home made necessary by the COVID-19 pandemic, and I've never been prouder of our team. Now I'll turn it over to John Landry, our CFO, to provide a financial review. Johnny?

Thank you, Joe. As mentioned, revenue in the third quarter of 2020 was $30.6 million, representing a 183% increase over revenue of $10.8 million in the third quarter of 2019 or the prior year. U.S. revenue was $25.5 million, an increase of $17.5 million or 218% over the prior year, while international revenue was $5 million, an increase of $2.3 million or 81% over the prior year. Our worldwide install base has now grown by approximately 8,200 PF units year-to-date, including third quarter's growth of approximately 2,700 PF units. As of the end of the third quarter, our worldwide install base consists of approximately 24,800 PF units, which reflects growth of 50% since the beginning of the year. Our U.S. disposable utilization rate in the third quarter of 2020 was 1.92 as compared to 1.66 in the prior year. This is the third quarter in a row where our U.S. disposable utilization rate exceeded our historical experience by approximately 0.25 turns. We believe this increase in U.S. disposable utilization rates in the quarter was largely due to the increased usage of our technology for the treatment of respiratory distress experienced by many COVID-19 patients. Given the significant increase in the installed base, we continue to believe that turn rates are likely to return to more normalized level once COVID-19 cases begin to moderate and may even be slightly lower than historical averages as the newly installed PF units become productive. U.S. disposable average selling prices increased in the third quarter due to the continued uptake of the ProSoft nasal cannula and air-slide disposable patient circuit, both of which were launched in the first quarter this year. The international disposable utilization rate in the third quarter of 2020 was 1.63 as compared to 1.80 in the prior year. Recall that we use a distributor network internationally, which results in slightly lumpier disposable utilization rates, especially in the third quarter of each year due to seasonality. Gross profit in the third quarter of 2020 was 15.5 million, an increase of 10.7 million over gross profit of 4.8 million in the prior year. Gross margin was 50.8% in the third quarter of 2020 compared to 44.5% in the prior year. We improved gross margin faster than anticipated due to improved overhead absorption. Recall, we significantly scaled production beginning late in the first quarter of this year in order to meet increased customer demand for our products, especially capital equipment. This provided us with a significant tailwind through the third quarter, which we expect to normalize given our current inventory position. These tailwinds continue to be partially offset by headwinds in the form of higher labor costs, increased supplier freight, and expediting fees incurred to meet the rapid increase in production capacity and a much higher mix of capital equipment revenue than we recorded in the third quarter of 2019. Operating expenses were $26.7 million in the third quarter of 2020, an increase of $10.2 million over $16.5 million in the prior year. The increase in operating expenses was primarily due to commissions earned on increased revenue and increased headcount in the worldwide sales and marketing organization, general and administrative expenses, and new product development costs associated with our next-generation system, partially offset by reduced worldwide T&E due to COVID-19. Net loss in the third quarter of 2020 was $12.4 million, or 49 cents per share, compared to $12.8 million, or 65 cents per share, in the prior year. Adjusted EBITDA for the third quarter of 2020 was negative $8.2 million compared to a negative $10.6 million in the prior year. Adjusted EBITDA adjusts for foreign currency gains or losses, net interest expense, depreciation and amortization expense, and stock-based compensation. The $2.4 million decrease in adjusted EBITDA loss in the third quarter of 2020 as compared to the prior year was primarily due to higher revenue and gross profit partially offset by higher operating expenses. As of September 30, 2020, cash and cash equivalents were $139 million compared to $148.3 million as of June 30, 2020, and $71.7 million as of December 31, 2019. In the third quarter of 2020, our cash burn was $9.3 million. In October, we refinanced our debt facilities and entered into a $52 million facility with CIBC Innovation Banking, consisting of a term loan of $40 million and a $12 million revolving line of credit. At closing, we paid off in full the outstanding balances on our previous term loan and revolving line of credit. This new term debt facility reduces our interest rate by over 500 basis points and our interest expense by approximately $2 million per year. Before we provide our guidance for the fourth quarter and full year 2020, I would like to discuss our perspective on the current operating environment and trends we are seeing in the business. A couple of weeks ago, our expectation for Q4 disposable utilization was based on a light flu and RSV season and modest COVID impact on our business. Our hypothesis was that better hygiene practices, social distancing, and increased rates of flu vaccination would likely lead to a light flu season this year in the U.S. and Europe. similar to what was experienced in the southern hemisphere. In addition, we were expecting the RSV season to be soft, given that kids are not spending as much time in person at school in the US. We still believe our hypotheses regarding flu and RSV are correct. However, we have recently seen an increase in COVID-related hospitalizations across the US and Europe. As a result, we now believe the impact of COVID hospitalizations during the quarter will offset reduced flu and RSV activity and the net result in disposable utilization will be similar to what we have seen in a normal flu season. Should COVID hospitalizations rise sharply, the net result may be similar to what we have seen in a severe flu season. On the capital equipment front, sales have been dynamic on a month-to-month basis and difficult to predict going back to March. Generally, we have seen significant increases in capital equipment sales in geographic areas where COVID has seen its first wave of outbreaks. we have not typically seen meaningful increases in capital equipment sales in geographic areas when COVID outbreaks have occurred a second time. As it's difficult to predict what geographic areas will be impacted by COVID outbreaks, it remains difficult to predict our capital equipment sales. In addition, we believe some of our capital equipment sales that typically would have occurred in the fourth quarter this year were moved into the third quarter as hospitals prepared for the fall and winter. As a result, while capital equipment sales in Q4 will grow over Q4 2019, we have not factored in a significant impact on COVID. In the event that we see a stronger than anticipated flu or RSV season, where new geographic areas are impacted by COVID for the first time in Q4, capital equipment sales will likely be above our current expectations. Overall, we expect revenue in the range of 18 million to 20 million in the fourth quarter of 2020, an anticipated year-over-year increase of 38 to 54% over the prior year. For the full year 2020, we expect revenue of between 102.8 million to 104.8 million, an increase of 114 to 118% over 2019. With that, I'd like to turn the call back to Joe to discuss our key areas of focus for the remainder of the year.

Thanks, John. Before opening the line for questions, I'd like to review how we intend to focus our efforts for the remainder of 2020. The play is very simple and it's more of the same from the third quarter. First, we plan to continue educating our net new gold hospitals on how to use our high velocity therapy on patients experiencing type two respiratory distress. Given what we've seen to date, we believe these efforts are paying off. We'll set the stage for long run future growth across our business. Secondly, we plan to focus on new product development. In 4Q, we plan to expand the NICU and adult OM limited market release in the UK, Europe, and the Middle East. With respect to the US, we hope to have finalized our own neonate IDE study design and regulatory pathway with the FDA by the end of the year. We also plan to submit the next generation system for regulatory clearance for both the hospital and home settings, and spend more time thinking about the elements we will need in place to serve respiratory distress patients in the home. Lastly, we plan to continue to run our three-pronged gross margin improvement plan, leverage our operating expenses, and drive working capital efficiencies over time. To provide a little more insight into how impactful our high velocity therapy is at treating the respiratory distress experienced by many COVID-19 patients, I want to share one of the many patient stories with you from last quarter that comes from a VA hospital, as relayed to me by one of our sales professionals. This week, we visited a VA hospital for military week. Hearing the success stories from the RTs and the doctors on how they have successfully used high velocity therapy to treat respiratory distress from all comers, including COVID patients, was incredible. One of the head pulmonary doctors told me a story about a COPD exacerbation patient whose respiratory distress he had successfully treated using Vapotherm. He stated this was a very sick patient who not only had a Vapotherm in the room, but also had a vent and BiPAP. At first, he told me they intubated the patient and peak pressures were very high, no matter the mode of ventilation. He told me they then extubated a patient of BiPAP because his CO2 level of 112 made him uncomfortable. But the patient continued to decline, and his CO2 continued to rise. The doctor told me that he then put the patient on Vapotherm device, and within 45 minutes, his CO2 was in the 80s. Continuing the therapy on 40 liters, he told me that after six hours, the patient had completely turned around. This was a true aha moment for the doctor and a few others in the building. It also gave us an opportunity to educate on different leader flows and how Vapotherm is different from common high-flow nasal cannula. In conclusion, I'm feeling good about how we performed in 3Q and how we're set up for the remainder of 2020 and beyond. Our installed base continued to grow materially faster than anticipated, and we're beginning to see these net new gold accounts use our high-velocity therapy on type 2 patients and expand usage throughout the hospital. We believe there is significantly more awareness of the benefit of our technology than there was at the beginning of the year. Revenue has significantly exceeded our expectations for this point in the year, and our gross margin improvement plan is ahead of schedule despite strong headwinds. Our key product development initiatives, including OM and the Next Generation System, are progressing nicely. Lastly, I want to reiterate how very proud of our team for working to meet the needs of our customers I am. Thank you for trusting us with your capital. It means a lot to us. Now I'd like to open it up for questions.

Ladies and gentlemen, in order to ask a question, you do need to press star and then 1 on your telephone keypad. Please stand by while we compile the Q&A roster. Our first question comes from the line of Margaret Cazor with William Blair. Your line is open.

Hey, good afternoon, guys. Thanks for taking the questions. First off for me is just a follow-up on the quarter. You know, you guys saw strong capital sales this quarter, but you also referenced that geographies with second waves aren't driving significant capital demand. So I know this is really hard to parse out, but how much of that Q3 demand was COVID-related versus expanding within accounts? And ultimately, when do we get to a good quarterly run rate range as we think about kind of the post-COVID day program?

Hey, Margaret, it's Joe. I'll take a shot at that. We'll let John follow up what he's got. So within the third quarter, an awful lot of that capital equipment sales did, in fact, come from COVID in the southern tier, in Texas, Florida, Arizona, and so forth in the Sun Belt. So, you know, in that July spike, we were busier than all hell getting product out the door. The disposables themselves, I mean, we're feeling pretty good about our ability to predict, at least within a relevant range, how those disposables are performing. But, you know, capital equipment sales, that one was, if we hadn't had the inventory on the shelf that we put on at the end of the second quarter, we'd have been in a world of hurt. We wouldn't have been able to take care of the customers because our ability to predict this is very, very limited. You just don't know where it's going to show up. And then I think the other piece of what you said is we did see what we believe to be a fair amount of capital equipment that we booked in the third quarter actually typically would have been in the fourth quarter. But what we're hearing from the accounts is they were all getting nervous and getting ready to see if they were going to get whacked here in the fall.

Hi, Margaret. John, I would agree with that. I think what we saw was obviously a lot of COVID demand. And in regards to second waves and where we've seen it, typically we see the capital equipment sales in areas of the world or the U.S. where COVID strikes for the first time. We haven't seen it to as great an extent where we've seen second waves in different geographic regions of the world. Not to say that it won't take place, waves at this point in time.

Okay. And so that gets me to the last part of that question, which was, you know, at what point do we get to kind of a good quarterly run rate post-COVID? And is Q4 then that number where you guys aren't assuming that much from a capital perspective related to COVID?

Yeah, that's right, Margaret. So as we took a look at the capital and thought about our guidance for the fourth quarter, in particular, as Joe mentioned, we feel pretty good about where we're thinking disposables in that business will be, given our experience and hypotheses around flu, RSV season, and COVID hospitalizations. On the capital side, it is a bit more of a wild card to predict it. We did, in developing our guidance, It was more of a thought process around a modest impact from COVID-19 in the fourth quarter. We expect to see growth over the fourth quarter of 19, but obviously a sequential decline from what we saw here in the third quarter, which we expected or suspect most of that was front-loaded here for the back half of the year into Q3.

Okay. And then if I can, as we look forward, you guys did give that example of that New York hospital. Can you give us more color? That sounds like maybe a non-customer pre-COVID, and then you were able to convert them, really cross the hospital within months, or at least a fairly rapid time period. So is this a typical experience amongst the accounts? What convinced them to be able to do so other than kind of that quote-unquote aha moment there? And, you know, are these things more next-gen updates or kind of what gets you to there or is it clinical and economic data and so on?

Thanks, guys. So just to kind of to make sure I'm getting that right, Margaret, the question would be that New York Hospital, what I shared with you, is that a kind of a one-off or are we starting to see more and more of that? Is that really your question? Correct. Yeah, so I wouldn't have told you the story if it was a one-off. I wouldn't call it a we see these every day, but we're seeing more and more of this. You know, that field team has done an absolutely phenomenal job this summer out in the field teaching all of these net new customers how to use this technology, particularly on type 2 hypercapnic patients. That's really the play that we've been running over and over and over again because we've This was a tremendous opportunity for us to expand that installed base, but we were really, really focused on making sure that they're using it on both types of patients, and, you know, that's what we're beginning to see. We were pretty – we like what we're seeing with respect to that particular account and others like it.

Okay, great. Thanks very much, guys.

The next question is from Bill Polvinik with Canaccord. Your line is open.

Great. Thanks. Good evening, and thanks for taking my call. Hey, good. A couple questions here. And, you know, I think most of these questions run around champagne problems, right? When you have a lot of systems in the field and you... You've got to drive utilization and how much longer will the extra capital sales continue. But to hone in on some of the questions, one, capital sales, what was the mix of new, like totally new accounts versus units going into existing? And then how many gold accounts did you sign up in the quarter? And then I have a couple follow-up questions.

Great. Sure, Bill. This is John. Good to speak with you. In terms of the mix of new accounts versus existing accounts, it follows roughly the same model that our business has historically seen. Roughly two-thirds of those capital equipment sales went into existing customers as we continue to go deeper and wider into the book. And then I guess in regard to the number of the ED gold and silvers, we had another 43 this quarter, bringing us to almost 150 for the first three quarters of the year.

Excellent. And so two-thirds went into existing accounts and one-third went into new accounts. Correct. For the capital. Okay, I just wanted to be clear. That's a pretty big number. And then, you know, the R&D went up sequentially, and is that programs to support the VAPO 2.0, or is that queuing up for the OAM trials, or what specifically? Because, you know, it's a pretty good jump sequentially. Okay.

Sure, Bill. In regard to that level of investment in R&D and the sequential increase, that's tied to our HVT 2.0, our next generation system. which we're targeting to, which has the ability to break away from the need to be connected to wall gas. We'll have an internal blower capability, which will allow us to access areas of the hospital that don't have piped in air, will also allow us to potentially tackle patients in respiratory distress outside the hospital, whether they may be in a home setting or in transport to a hospital facility.

And then lastly, it's just... Regulatory-wise, what do you think the pathway on the OAM is going to be in the U.S.? I know you're in discussions. Is this going to be a big trial or is it a small trial? And, you know, what type of follow-up do you think it could be at this point? And then really the same question on the 2.0, because my understanding the 2.0 will also integrate the OAM. So I don't know if it's, you know, it'll be one trial where it'll be the 2.0 with OAM, but any color would be helpful. Thank you.

All right. Well, let's unpack that, first of all, and talk about the clinical trial that we did at Oxford and St. Peter. So that was roughly 30 patients, right? And, you know, they were each on the technology test. either on our technology or on the control for 24 hours bill. So in terms of any kind of follow-up, there was really not a lot of follow-up in that study. That study was very, very conclusive around the clinical efficacy of the technology, even at that size. So, you know, as you know, the FDA has designated this breakthrough technology. We continue to dialogue extensively with them. We are liking the direction that those conversations are taking. Our focus here in the fourth quarter is, is on finalizing the NICU IDE study and getting it cleared from FDA. And that will inform us a lot more in terms of the overall regulatory pathway. But, you know, we like where we're at with these guys so far. Outside the United States, you know, you make a good point about the own technology being integrated into the next generation. And, you know, it's our intention here and later this quarter during the fourth quarter to be able to file that for regulatory clearance in Europe and, you know, outside the U.S. So that entire own platform will already be integrated into the next gen outside the U.S.

Great. Thank you. And again, ladies and gentlemen, thank you for a question. It is star and then one on your telephone keypad. Our next question is from Marie Fadl with PTIG. Your line is open.

Hi, Joe. Hi, John. Thank you for taking the questions this evening. I wanted to spend my first question on the training and education angle, really encouraging anecdote you told us about, Joe, and certainly something that's key to my thesis on DAPL theorem. So I'd love if you could give sort of a progress update on how, you know, many of the new accounts your field team has been able to touch at this point in terms of training and education. And How long do you think that process might take as we ease out of the COVID wave? Thank you.

Well, we've touched them all, Marina. So first of all, it's good talking to you. Thank you for asking the question. Same here. We've touched them all in terms of spinning them up and teaching them how to use it on type 1 patients. You know, our people were all over those accounts when the initial surges took place. Our people were in there, you know, building gear, teaching them, training them, getting them set up. And for the ones where we couldn't physically get in the hospital, you know, we used our Vapotherm Academy, that distance learning tool. We've traded over 17,000 clinicians with that thing since the beginning of the year. So, you know, we're touching them in multiple ways. Really, the play here since the last time we all spoke was, you know, the expansion of that field clinical organization, and then full court press, driving them into all of those net new accounts, teaching them about how to use our technology on type two. And, you know, we're feeling very good about that right now. We like the progress that we're making. You know, there's always going to be some accounts that's going to take us longer to get to than others, either because they're in the midst of another surge or because, you know, it's just they're entrenched in their old, the previous technology. But As far, we're pretty happy with the way that it's going and are confident. We're just going to keep running that play over and over and over again. We like this a lot.

All right. That's really helpful, Joe. Thank you. Wanted to use my follow up on disposables. John, you gave us some good commentary on how you think about Q4 disposable turn rates being similar to a flu season, given some of the offsets with COVID this quarter. But could you walk us through kind of the Q3 cadence? And as I think of it, you know, sequentially between Q3 and Q4, do you envision higher hospitalizations from what you've seen so far into Q4? Thank you.

sure henry it's nice to speak with you again in terms of the you know seasonality to point out uh Typically, Q3 is our seasonally lowest quarter of the year from both a capital and disposable perspective here in the Northern Hemisphere. This year is obviously different for us. We had quite strong demand here in the third quarter. And as we look at our disposables, as we think about the fourth quarter, we see them kind of roughly in line with where we saw them in the third quarter, as we think about in terms of volumes going into the fourth core as compared to third core sequentially. That factors in those items we spoke about on the call regarding our expectations around like flu RSV season being offset by the COVID hospitalizations that we're seeing now. Should COVID hospitalizations spike or dramatically increase we got it to. Our baseline assumption assumed COVID hospitalizations ongoing at sort of the rate that we're seeing now.

That's very helpful. That's it for me. Thank you.

Thanks, Marie. Our next question is from Bob Hopkins with Bank of America Merrill Lynch. Your line is open.

Hi there. You actually have Brad Bowers on for Bob today. Just a quick question. I was just wondering if you could give any color on some of the trends you've seen so far into Q4. And also, if you could explain a little bit more why you think that second wave wouldn't see as many capital units being sold, that you could give a little bit of color on why you think that might be and why it would continue into Q4 when we're seeing COVID spiking up again. Thank you.

Sure. This is Joe. I'll take a stab at that. And we want to have Johnny answer some of that. So, you know, if you'd asked us for our guidance, you know, three weeks ago, four weeks ago, you know, there was not a whole lot of talk about COVID. It just wasn't. And we really weren't seeing a lot of it in the business. This business is really, if you think about our business, really two different things, right? The disposable component to this is, is increasingly, I mean, it's always been very predictable, but even in the midst of COVID, we've done a pretty good job of being able to predict this. It's not really hard to stay ahead of it, whether it be from a production inventory point of view or whatnot. And we know that as COVID hospitalizations increase, we're treating those patients. We've been doing a heck of a job treating them and taking good care of them. The real wild card here, the thing that's really, really unpredictable is the capital equipment sales, right? Because it can come on very, very quickly, and you just don't see it. It just comes on very, very quickly, and there's no way for us to forecast where the COVID census is going to hit. You think about it, the first wave, it really hit in New York City. It hit parts of Pennsylvania, New Jersey, New Orleans, that kind of thing. Second wave was really the Sun Belt, right, during that July time frame. We just have no idea where it's going to hit next. That said, in the last week or so, we've seen an increase in activity in our international business, particularly in the European and Middle Eastern sectors. And we're going to begin, we can feel it coming in the U.S., where there's going to be more COVID patients in that hospital. The question really is, which geographies? If they go into New York City, given how much gear we put into New York City, those hospitals are ready. Man, they are ready. I'll see our disposables go up a lot, right? But we're not going to see more capital if they've already got what they need. Goes into a different part of the country that hasn't experienced a wave yet. Well, you know, I said that on the last call. If you see hospitalizations rise in a new part of the country, you haven't seen it before, you can pretty much bet that our capital revenue is going to be impacted by that. But, you know, I hate to say this. I don't mean to be cavalier, but your guess is as good as mine where the hell COVID is going to show up because I have no idea. The way we've approached this problem, though, is, I mean, you're trying to deal with the unknowable. So we said, okay, then we only have really three things we could do, right, optionality, flexibility, and speed. So if we can't forecast it, then we're going to build up some inventory. We're going to add production lines so that if we get slammed, we're going to be able to go in there and meet every customer need. We've learned how to run third shifts. We've learned how to do weekend work. All of that has created that optionality to make sure that we take care of those customers and get them whatever they need whenever they need it and do it in a really short time frame. So that's the best I can do on that one.

gotcha so i mean i guess you kind of alluded to this earlier and often your response i also appreciate all that color there it's super helpful but um would it would i be misclarifying it to say that if we did see continued to increase covet i guess nationally that it would make your q4 guidance look a little bit conservative thank you and i understand why no yeah not listen nationally if at all if it shows up in new york city they've got all the boxes they're going to need to take care of them these people are in good shape right

Showing up in Texas. Texas has got a lot of gear now. They're ready to go. Those hospitals are ready. If it shows up in a different part of the country, you say nationally, right? But we don't look at it that way. We have to look at, like, what city is that gear going in and how many of our systems do they have in that city? That's the key variable in forecasting that capital revenue, and that's what I'm telling you is so unpredictable. Gotcha. Appreciate all that. Thank you very much.

The next question is from Bill Provenic with Camacord. Your line is open.

Yeah, great. Thanks for taking my follow-up. I'm just trying to kind of triangulate something on the capital sales. You know, the commentary of two-thirds of the sales are to existing accounts. Is that because COVID is rolling into those accounts and they already have some systems, so they expand significantly? or you're getting deeper into those accounts and then all the new ones are essentially the COVID. And I'm trying to, because if you did 2100 systems in the U.S., that'd be 1400 to existing, which would be a bigger forward number. And I'm just trying to understand that. And then my second question is, I think you called it the Felix one negative pressure mask. Where does that kind of hit into the revenue segment, reporting segments, just so we make sure we tease it out. And any qualification of the size of that, I think, would be helpful so that we make sure that we don't put that on an ongoing basis past the COVID issue.

Bill, let's deal with the second one. Let's deal with the second one first because that's the easiest one by far. Don't bother modeling it. It's going to be a very, very low-priced product. It's designed to help them deal with a problem right now. I would be surprised if we sold this beer after we're done with COVID, there's really not going to be a need for this. And it's, it's, it's not going to, you're not going to even notice it in my revenue lines. So I wouldn't worry about it. Right. The second one.

I just wanted to make sure, I just wanted to make sure it wasn't a million or 2 million bucks, you know, like all of a sudden, you know, next year. Okay. That's, that was a, that was the reason for the question on that.

Yep. Understood. Understood. Good question. The other one is, so our split between existing customers and net new customers, sounds like we put an awful lot of gear into existing customers and then really getting into the why. So I want to back up and remind you of our strategy here is to go into the largest emergency departments in the country, right? So that's what our installed base is. And when we think about where these COVID patients show up, Bill, they show up in the biggest EDs in the cities, right? So it only makes sense. And historically, by the way, just as a matter of historical fact, two-thirds of our capital revenue in any given quarter goes to existing customers expanding their fleet. So this is actually in line with what we've always seen. It's just much, much bigger numbers. And, you know, candidly, we're pretty excited about it. We love that current customers are buying this gear because it's just accelerating the path of them sending it throughout their hospitals. So... Bottom line is we're in the right place at the right time. We're calling on the right customers. Our focus on these large gold emergency departments, we were very fortunate that we were already there before this COVID thing struck, which is why they would be buying so many.

That's very helpful.

Thank you. Ladies and gentlemen, this concludes the Q&A period. Dr. McCall, back over to you, Mr. Joe Army, for any closing remarks.

Well, 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. Have a great night.

This concludes today's conference call. Thank you for your participation in Engineering Now! Disconnects.