Vapotherm, Inc.

Good afternoon and welcome to Vapotherm's third quarter 2023 financial results conference call. All participants are in listen-only mode and this call is being recorded. After the speaker's remarks, there will be a question and answer session. It is now my pleasure to turn today's conference over to Dorota McKay, Vapotherm's Vice President and Chief Accounting Officer. Dorota, you may begin.

Good afternoon. And thank you for joining us for the Vapotherm Third Quarter 2023 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. 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 at 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 factors section of our annual report filed on Form 10-K for the year ended December 31st, 2022, and Form 10-Q, which will be filed today, and then 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 accepted accounting principles or GAAP. We generally refer to these as non-GAAP financial measures. Reconciliations of the historical 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 Armey.

Thank you all for joining us. On today's call, I will review the progress we made during the third quarter, and John will review our financial results. I will then provide my thoughts on the fourth quarter before we open the call for Q&A. Revenue, excluding revenue from the Vapotherm Access Call Center business, which we commercially exited in the fourth quarter of 22, grew 18% in the third quarter as compared to the third quarter of 22. Now that the underlying market has returned to more normal year-over-year comparability, the progress we're making on the top line is clear to see with growth in the high teens this quarter. We continue to execute well against our path to profitability initiatives and saw another sequential quarter, our sixth quarter in a row, of reduced non-GAAP cash opening expenses, lower inventory balances, and reduced cash burdens. The significant progress we've made in these key metrics when combined with the additional actions we took in the third quarter of this year to further reduce our non-GAAP cash operating expenses gives us confidence that we will become adjusted EBITDA positive in the fourth quarter of 2023. This, along with further expected reductions in our inventory levels, should allow us to then turn cash flow positive in mid-2024. which means that we should have enough cash in our balance sheet to execute our business plans without raising additional capital. Revenue in the third quarter was $15.2 million. Worldwide capital equipment revenue growth of 25% versus the third quarter of 2022 was driven by HVT 2.0 sales in the U.S. and precision flow sales in Brazil in support of a tender that was awarded to our distributors. In the U.S., customers continue to upgrade their install base of precision flow units to HVT 2.0 units, given its easy use in building air source, which allows it to be used throughout the hospital. We're also excited to announce that we recently received regulatory clearance of HVT 2.0 in Brazil, which will allow us to bring the HVT 2.0 to our second largest market. Worldwide disposables revenue increased by 18% compared to the third quarter of 2022. We expect to increase worldwide disposables revenue by growing our HVT 2.0 install base and our ongoing efforts to increase awareness of the effectiveness of our technology in treating acute hypercapnic respiratory failure in COPD patients, as well as other non-seasonal conditions requiring respiratory support. The HyperX study, which I will discuss in a moment, was specifically designed to show the effectiveness of our technology in hypercapnic patients. Turning to our gross margin improvement initiatives, our gross margin was 40% as compared to gross margin of 14% in the third quarter of 2022, which included inventory write-offs and reserves as we transitioned from the precision flow to HVT 2.0. First margin in the third quarter decreased by 300 basis points from the second quarter of 2023 as we scaled our Mexico operation to run 24-7 for the first time in advance of the upcoming RSV increases. Doing so, we incurred higher scrap rates and lower first pass yields as we worked through the new higher learning curve of the additional shifts and incurred higher freight costs. Overall, the transition to our Mexico operation has been incredibly smooth, as evidenced by our consistent sequential improvement in gross margin for several quarters. We had a setback this quarter, but we believe that these one-time costs are behind us, the performance is back on track, and we expect to see significant gross margin improvement return in the fourth quarter of this year. Early in the quarter, we took steps to further reduce operating cash expenses which reduced cash operating expenses in the third quarter to $12.3 million from $14.2 million in the second quarter of this year and from $19.5 million in the third quarter of 2022. We expect that our annual cash office run rate going into 2024 will be $48 million to $50 million. At that level of spend, we expect to be cash flow positive sometime in the middle of 2024. We believe that our current cash balance is sufficient to get us to that point. We continue to reduce our inventory levels and converted another $1.5 million of excess inventory into cash in a quarter. We remain on track to normalize our inventory levels by the end of 2024 by selling off excess inventory we purposely built or purchased during the pandemic to ensure we could fulfill every customer need during COVID surges. Last but not least, we ended the quarter with $14.4 million of unrestricted cash. Our cash burn was $3.6 million this quarter. We have consistently reduced our cash burn every quarter for the past six quarters to a combination of revenue growth, gross margin improvement, and reduced cash operating expenses. We are not cash flow positive yet, but we've made incredible progress in getting to adjusted EBITDA, is the first step, which we expect to see this upcoming quarter. Through continued execution, we then expect to become cash flow positive in mid-2024. On the clinical front, I'd like to update you on three important clinical trials. First, the HYPERACT clinical trial has been accepted for initial presentation at the Society for Clinical Care Medicine's Congress in January of 2024. The HYPER-F trial was designed to compare the ability of our high-DNI technology to treat acute hypercapnic respiratory failure in the emergency department compared to bi-level positive airway pressure, or BiPAP. BiPAP is a form of non-invasive ventilation delivered by a form-fitting face mask, which is the current standard of care for hypercapnic patients. Seed hypercapnia is a life-threatening condition in which a patient is unable to effectively remove excess carbon dioxide out of their body. While bi-level pressure systems are the current standard of care, many patients cannot tolerate the discomfort and complications associated with the mask required for those systems. IV and I are delivered via a mask-free interface, providing greater patient comfort protecting the patient's ability to speak remotely. The primary endpoint of the trial was not inferiority of HB&I with traditional measurements associated with laboratory values, ease of use, and patient comfort. There were no adverse events, and we're excited to share the results of this important study with the medical community. Second, we have stopped our moderation neococcal trial, which was designed to support the safety of the oxygen assist module on the precision flow platform in RELAC. Our ultimate goal is approval of the oxygen assist module on the HVT 2.0 platform. Based on our work to date, we believe the quickest path to this goal is to stop the current trial and start a trial with the oxygen assist module on the HVT 2.0 platform once our development work is complete. We are pleased to note there were no adverse events. and we've published the results to date as a pilot study. Our international business continues to successfully sell the oxygen assist module for precision flow, and we expect it to be a major contributor of growth in our international business. Lastly, the results of a UK-based investigator-initiated clinical trial were recently presented at the European Respiratory Society International Congress. This study showed that use of our technology is more effective than standard oxygen therapy for the treatment of acute asthma in children. Fifty children were enrolled in this study. Twenty-two were treated with standard oxygen therapy, and 28 were treated with our technology. Eighty-six percent of the children treated with standard oxygen therapy required escalation of therapy, while only 61 percent of the children treated with our technology needed further escalation. In addition, children treated with our technology met hospital discharge criteria in a median time of 29 hours compared to a median time of 37 hours for those treated with standard oxygen. In conclusion, I'm pleased with the progress we've made on our profitability initiatives. At the midpoint of our 2023 revenue guidance range, we expect to deliver resident growth, excluding revenue, in the April 10 access cost of the business. of 20% in the last three quarters of this year versus the same three quarters of 2022, despite an almost 50% reduction in cash operating expenses from 2021 to 2023. Our differentiated technology, large installed base, and recently launched HVT 2.0 product give us the opportunity to drive significant revenue growth. The last three quarters of this year will be the first three quarters without the impact of COVID skewing the results and demonstrate the strong growth potential in our underlying business without incremental investments. Also, the combination of expected revenue growth, continued gross margin improvement, and decreased cash outbacks positions us to become a destiny that got positive in the fourth quarter of 23 and then cash flow positive in mid-2024. I will now turn the call over to John, who will review the financial news after the quarter.

Thanks, Joe. Worldwide revenue in the third quarter of 2023 was $15.2 million. U.S. revenue was $11.2 million, and international revenue was $4 million. Worldwide capital and worldwide disposables revenue grew 25% and 18%, respectively, as compared to the third quarter of 2022. HVT 2.0 capital sales represented 73% of our U.S. unit sales in the third quarter of 2023. Gross margin was 39.6% in the third quarter, which is down from 42.8% in the second quarter of 2023 due to inefficiencies in our Mexico facility as we significantly ramped production in anticipation of RSV and flu season in the Northern Hemisphere. Gross margin in the third quarter of 39.6% increased from 13.8% in the third quarter of 2022. This increase is largely due to the absence of inventory reserves and write-offs we made in connection with the transition from precision flow to HVT 2.0 in the third quarter of 2022, year-over-year revenue growth, and a lower cost of operations in Mexico. GAAP operating expenses were $16.3 million in the third quarter down from $24.8 million in the third quarter of 2022. Non-GAAP cash operating expenses were $12.3 million in the third quarter, down from $14.2 million in the second quarter of 2023. Non-GAAP cash operating expenses decreased from $19.5 million in the third quarter of 2022, a year-over-year reduction of $7.2 million, or 37%. We recorded an adjusted EBITDA loss of 6.1 million in the third quarter of 2023, which is $300,000 less than our adjusted EBITDA loss of 6.4 million in the second quarter of 2023, and significant improvement over our adjusted EBITDA loss of 17.7 million in the third quarter of 2022. We continue to make progress in reducing inventory from the peak of 38.4 million in the second quarter of 2022. We ended the quarter with $23.1 million of inventory, a reduction of almost $15 million over the last five quarters. We remain on track to further reduce our inventory levels by another $10 million over the next five quarters, resulting in inventory of roughly $13 million by the end of 2024. We ended the quarter with $14.4 million of unrestricted cash, a decrease of $3.6 million in the quarter versus a decrease in cash of $7.7 million in the second quarter of 2023. Lastly, I'm pleased to report that we met our 2023 one-time minimum net revenue covenant requirement of $25 million, but the six-month period ended September 30, 2023. We recorded net revenue of $31.2 million for this measurement period, Our next minimum net revenue covenant test will begin in 2024 with the minimum net revenue level set at a discount to the company's 2024 annual operating plan. We also remain in compliance with our minimum unrestricted cash and cash equivalents covenant of $5 million. I'll now turn to guidance. We now expect annual revenue of $69 million, $71 million, which represents an annual growth rate of 8% to 11% excluding revenue from the Vapotherm Access call center business, which we exited commercially in the fourth quarter of 2022. Excluding Vapotherm Access, revenue growth in the fourth quarter will be 13% at the midpoint of our updated revenue expectations. This is a deceleration from the third quarter, primarily due to a tough comp in the fourth quarter of last year due to an unusually early flu season. Our revenue guidance at the midpoint of the range and excluding vapor therm access reflects net revenue growth of 20% over the last three quarters of last year, which we believe accurately reflects the underlying trajectory of the business. For full year 2023, we continue to expect that 65% to 75% of our revenue will come from disposables revenue and that the remainder will come from capital and service revenue. We now expect gross margin for the full year 2023 to be in the range of 41% to 43%. We now expect that GAAP operating expenses will be between $68 million to $70 million, a decrease of $2 million from previous guidance. We now expect that non-GAAP cash operating expenses will be between $54 million to $56 million, a decrease of $1 million from previous guidance. We expect to exit the year with an annual non-GAAP cash operating expense run rate of $48 million to $50 million. We believe that the additional reduction in non-GAAP cash operating expenses taken in the third quarter and our continued focus on reducing our inventory balance will offset the reduction in our revenue and gross margin expectations for 2023. Therefore, we continue to expect to end 2023 with unrestricted cash of between $10 million and $15 million. With that, I'll now turn it back over to you, Joe.

Thanks, John. As we look to close out the year strong, our focus will continue to be on adding towards profitability through revenue growth, gross margin improvement, and driving cash operating expenses below pre-IPO levels, while investing prudently in future growth drivers such as the home market and clinical studies. By delivering fourth quarter results, including positive adjusted EBITDA, we should be well positioned to execute on our 2024 plans and achieve financial self-sustainability. We made a lot of structural changes over the past six quarters. I'm very proud of our execution on our path to profitability initiatives. I'd like to thank our team for their ongoing efforts, as we are now on the cusp of adjusted EBITDA profitability while still driving top-line growth. As always, we appreciate your support of Aprilfell and look forward to updating you on our next quarterly call. I will now open up the call for questions.

Thank you, ladies and gentlemen.

We will now begin the question and answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request, and your questions will be pulled in the order they are received. Should you wish to decline from the polling process, please press star followed by the two. If you are using a speakerphone, please lift the handset before pressing any keys. Your first question comes from Margaret Carvor with William Blair. Please go ahead.

Hey, everyone. This is Macaulay on for Margaret tonight. Thanks for taking our questions. Just to start on cash, obviously good to see cash burn continue to improve this quarter. So I guess should we expect a similar level the next few quarters as you work towards that cash flow positive next year? And I know you mentioned the cash OpEx run rate in 2024, but are there any additional levers you could pull to maybe even improve upon that further?

Hi, McCauley. This is John. Thanks for your question tonight. Yes, we're pleased with the reduction in our cash burn this past quarter. I think as we look forward here to the fourth quarter, it's kind of a two-step process, McCauley. First step is really to get to adjust the EBIT positive, which we're targeting here in the fourth quarter. And then the next step is cash flow break-even mid-year 2024. And really a couple steps, that two-step process is in place. I think the major driver that we have As you pointed out, is cash OpEx reductions. We've taken all the actions we believe we need to take to allow us to get to that point. And the second real main lever that we have, Macaulay, is around our inventory reduction. As you probably can tell, we have about $23 million of inventory at the end of the fourth quarter. Basically, we want to drive that back to four turns per year in terms of inventory levels. which will free up about $10 million of incremental cash by the end of 2024. So over the next five quarters, we plan to unlock about $10 million of cash from a balance sheet and return it back to our cash books by the end of the year. So that's our plan from a cash perspective.

Great, thanks. Very helpful. And then kind of just to tie two HVT loans into one here as a follow-up, I think you mentioned last quarter HVT He 2.0 accounted for roughly 70% of the US capital sales. So was it similar this quarter? And then I guess, how should we think about the timing of entering the market in Brazil after the regulatory approval you mentioned?

Yes, Macaulay, I'll take this one as well. From an HVT 2.0 perspective, we did see a little bit of a bump up in terms of the concentration of HVT 2.0 capital sales as a percentage of the total unit sales from low 70s to about 73% this past quarter. We expect to see HVT 2.0 continue to be a larger percentage of the overall capital unit sales longer term. In terms of our international HPT 2.0 approval from Brazil perspective, we're looking to close that as quickly as possible. Brazil is a very important market to us, second largest in the world for us. So getting that product into Brazil and being in a position to help treat those patients is really what we're looking to do here as quickly as possible.

Great. Thanks again for taking my questions.

You're welcome. Your next question comes from Mary with BTIG.

Hi, Joe. Hi, John. Thanks for taking the questions this evening. I wanted to ask a two-parter on capital and disposables. You know, HVT 2.0 sounds like there continues to be strong demand for it, and it's certainly a big growth driver year over year, but I noticed it did step down a decent amount sequentially. Is this just seasonality? Has there been any change in sort of demand or capital, you know, CapEx environment, that sort of thing. And then on disposables, looks like you've had a nice recovery up to about 60% of pre-COVID turn rates. Very nice to see. Wanted to understand if that sort of meaningfully changes your outlook on the disposable turn rate going forward.

Hi, Maria. I can take those questions. So I'll start first with capital. So from a CapEx perspective, we saw hospital CapEx spending tighten up a bit here in the third quarter. In fact, we saw a lot of deals that we had with the U.S. government push into the fourth quarter, which is unusual since September 30th is a typical fiscal year end for the government. So unusual pattern there. We're not losing deals, we're just taking longer to get done. The receptivity to our HVT 2.0 continues to be strong from a customer perspective. And we're now just starting to see some inbound requests for quotations for the HVT 2.0, given that the AC611 high flow nasal cannula solution for the V60 will be coming off the market soon. So So that's from a capital perspective. On the disposables perspective, we did see a recovery in the return rate against the prior COVID three-year average. So we did bump up to approaching 60% here in the third quarter. As we look forward to the fourth quarter, our focus is going to be really on driving the usage in the hypercapnia and NIPPP patients in the existing accounts. Our goal is to get back to our historical DPC turn rates over time. And if we do that, you know, over the next three years, we can grow our business, you know, 15% plus per year just by getting back to those turn rates in our gold account. So as we look at the mix of disposables, we expect that there'll be, you know, 65 to 70% this year, just given the HVT 2.0 capital strength this year. But, you know, longer term, we expect them to be about 75% contribution of our total revenue.

Perfect. Very helpful. Very encouraging, John. And then maybe my follow-up, you know, heard mention of the impact to gross margins from, you know, building inventory ahead of the RSV flu season. What are your expectations for the winter season this year and those illnesses? Just curious to kind of level set post-COVID now that it does feel like we're truly in a post-COVID era. Thanks for taking the questions.

Yep. Sure. Thanks, Marie. So, you know, we're just... we're just starting to see the impact of the RSV and the flu season here in the U S which is prior to COVID typically happened around this time in the fourth quarter. So our guidance is really based on the expectation that we'll see a mild to moderate flu season in the fourth quarter with about 25% of the overall 2023, 2024 flu season taking place in the fourth quarter this year and the balance taking place in the first quarter of 2024. That's what we, prior to the pandemic, and we expect to return back to that type of traditional pattern here going forward. So that's what we're looking at from a modeling perspective and how we developed our guidance here for the balance of the year.

Understood. Thank you.

Thank you.

Ladies and gentlemen, as a reminder, should you have a question, please press star followed by the one.

There are no further questions at this time. Please proceed.

Thank you for joining us on today's call. We look forward to updating you again next quarter. Have a nice evening.

Ladies and gentlemen, this concludes your conference call for today. We thank you for participating and ask that you please disconnect your lines.