Outset Medical, Inc. (OM) Earnings Call Transcript & Summary

Thank you, everyone, for tuning into the final session of today. I'm very excited to have members of Outset Medical's senior leadership team with us here today, including Leslie Trigg, President and CEO; and Nabeel Ahmed, CFO. Before we jump into the fireside chat, I just have to read everybody's favorite disclaimer. For important disclosures, please see or visit morganstanley.com/researchdisclosures. If you have any questions, please reach out to your Morgan Stanley sales representative. So with that, Leslie and Nabeel, welcome, and thank you so much for your time here today and have been really looking forward to the discussion.

Thanks. Thanks for including us. We're happy to be here.

Thanks, Drew.

Thanks. And just maybe to start on what's really been on everyone's front of mind. It's just the COVID Delta impact. So you commented last month that you don't expect a direct impact from Delta, just given the stable end markets and Tablo's cost-saving value prop. I mean does that view still hold on today just several weeks more into the quarter? And is there any reason to expect that, that has changed?

Yes. We don't have any new information since we shared that. And believe me, I mean, we're obviously trying to keep really close tabs on it. I just talked to a couple of our sales reps just really late last week to see if anything has changed. I think I like the position we're in. We are in a bit of a safe harbor as medical device companies go, I think, for a couple of reasons. One is dialysis is not elective. It's life sustaining. You don't have the option not to go and get your dialysis. So that's kind of one. And I think that maybe the second reason it's -- outside it's a bit of a safe harbor. We haven't really seen any challenge in getting access to pushing our sales process forward, to pushing our pipeline forward. And it's probably because while the physician is the prescriber when Tablo is purchased, the physician is not the decision maker. Our reps, they don't have to get into an OR, they don't have to get into a cath lab, they don't have to get into an EP lab to make sure our product gets used. Our purchase decision maker is actually the health system executive. And so we -- those deals can get done via Zoom just really, frankly, as easily as they can in person. And so we have not seen any slowdown or any real impact -- negative impact on our pipeline or really our installs or implementations. I know we sound like maybe a bit of an outlier compared to maybe other medical device CEOs that you've talked to today and last week, but we continue to grow right through this pandemic.

Great. And just something maybe taking the other side of the argument here is just several companies have pointed out that there's -- and we've seen this in media, just hospital staff shortages. We've been hearing that from procedure-related companies. I mean within that context, could you be seeing a positive near-term impact, just given Tablo's ease of use, lower training barriers, could this accelerate a bit of near term adoption or drive an accelerated pace of fleet expansion in the acute setting?

Yes, it's definitely a benefit. I don't know that I would say it would drive acceleration as much as it just adds one more reason why, why a hospital or health system is deciding to purchase Tablo. I mean cost reduction is still like the #1 driver. But I will say that the staff shortages have enabled us to highlight why the simplicity of Tablo really is important. So I'll give you an example. We're sharing some clinical data here for the first time at this conference. It was a retrospective data analysis of over 100,000 acute treatments that were performed on Tablo between 2 and 24 hours, and this is going to be formally presented at an upcoming scientific conference. But one of the interesting data points out of the retrospective was that the average number of alarms during a Tablo treatment even up to 24 hours was just over 2. So when you have an alarm that's only alarming, I mean, we have a machine that's only alarming like twice over a 12-, 16-, 20-, 24-hour treatment that obviously saves a lot of nurse time. That's one of the bigger complaints with incumbent dialysis machines is that there's a lot of nuisance alarms. And we specifically worked really hard actually through software and sensors to try to eliminate nuisance alarms. And I think that that's evidence that the engineering team here did a pretty good job. And so I think a machine that doesn't alarm a lot in combination with another feature that we introduced pretty recently last year, remote monitoring does allow a hospital to rethink its staffing ratios. It's patient-to-nurse ratio then can expand where a single nurse can be monitoring 3 to 4 patients on dialysis remotely from like the central nurse's station without having to go constantly in and out of the room, getting in and out of PPE because the machine is kind of running quietly independently without a lot of alarms. So yes, I think it's absolutely being recognized as a benefit of Tablo.

Great. And maybe just to go on to the acute care setting more deeply here. I think investors may have been overly focused on the home opportunity and not paying as much attention kind of as the acute market deserves. And can you just talk broadly to your overall acute strategy, focusing on the nation's largest IDNs and health networks? And just maybe help level set us for the acute story and the opportunity?

Yes, sure. Well, so taking a big step back, it is a large TAM. We size it at over $2 billion, $2.2 billion to be precise. And the reason why it's uniquely large and specific to Tablo is that in the past, the manufacturers who have participated in the acute dialysis space, they've only been able to serve a small portion of the treatments that are done in patients. They really have only been able to serve the ICU-based dialysis. We specifically designed Tablo as we say kind of like as an enterprise solution where we can -- that same device platform can be used for dialysis on the floor or in the ICU. About 85% of the treatments performed in the acute setting are actually kind of run-of-the-mill regular dialysis, 3- or 4-hour treatments done bedside at the floor, we can do those. The 15% are much sicker patients, much more complicated patients in the ICU, running longer, slower dialysis up to 24 hours, Tablo also can serve those patients. And so we have the ability to capture 100% of all the treatment volume that any given hospital across the country is doing on an annual basis. And so that's what leads to such a big opportunity specific to Outset and our technology. The problem that we saw is cost. And probably the most important thing to understand about this cost environment is that there is no single individual DRG for dialysis in the inpatient setting. So if a patient is getting a cardiovascular procedure winds up needing dialysis, the hospital only gets to bill the procedure code for that cardiovascular procedure. The cost of the dialysis, which is typically $5,000 to $15,000 per patient, they eat the cost of that 100%. So really, in that sense, the conversation we end up having with health system executives is "Hey, we can reduce the cost of your dialysis services in patient by 50% to 75%". And in doing so, actually expand your margin across about 600 different DRGs, procedures that wind up involving dialysis that you're losing money on. So that's really the essential value proposition. It's actually margin expansion through cost reduction. And it's helpful because it's near term. It's first and foremost, through supplies cost reduction. Using Tablo is simply a lot less expensive than using the incumbent machines in the ICU. The supplies for the incumbent machines are typically in the $300 to $500 range per treatment, whereas it's about $50 per treatment on Tablo. So you've got a big delta there. And then also on labor cost reduction. A lot of hospitals in the past have outsourced dialysis to a service provider, frankly, because the machines were too complicated. They never felt like they could train their own staff. That's changed now with the simplicity of Tablo. And so we've given hospitals an opportunity to terminate their service agreements and sort of re-insource it using their own team to deliver dialysis, which adds incrementally several hundred additional dollars per treatment in savings. And also, importantly, gives the hospital total control over compliance, clinical quality and so on and so forth. So that's kind of the underpinnings of why Tablo has really taken off quite quickly in the acute space.

And with the in-sourcing for a moment, I mean it's tough to put like a penetration or anything there maybe. But can you even do that? It's like what progress have you been seeing to date? And like how much further do you have to go in terms of just in-sourcing as just a single driver for the acute setting?

Well, overall, when I think about our progress, and we did -- we lifted guidance again in Q2 and forecasting at the top end of that potentially a 100% growth rate for this year. So we're penetrating, I think, at an impressive rate. But again, the opportunity here is massive. And so I would say we're still certainly in the single low -- probably low single-digit penetration rates. At the regional level for regional health systems and even at the national level, I mean, there's just -- there's so much more opportunity to go after, both in terms of new customer acquisition and then also expansion within our current customer base. So if all we did was continue to penetrate this acute market, we would have many, many, many years of very high growth on revenue ahead of us. And then in terms of like the in-sourcing itself, I would say we've got customers that are -- they already own dialysis on their own, and they're buying Tablo just to get the supplies cost reduction. Probably a greater majority of our hospital customers are also using it to in-source. But generally speaking, we don't see any end in near term site. I think we've got a lot of runway here.

Maybe just with respect to the installed base, I think our model is forecasting about 11,000 to 12,000 total consoles in the hospital plus the acute -- or subacute setting. I mean, are these numbers achievable or kind of in line with your estimates or forecast going out to 2025?

Nabeel, maybe do you want to comment on that?

Yes, yes. So, Drew, first of all, 2025 is a long way away. Now having said that, we're happy with our progress so far. We exited 2020 with approximately 1,100 consoles in our installed base. We're expecting that number to grow and we'll print the new number here when we exit 2021. But having said that, given the size of the TAM that we have ahead of us, I don't think -- I mean, I don't think there's any reason why your numbers aren't achievable, right? Having said that, a long way to go, to go get there.

Got it. Probably thought I'd try. Normally, it's a 2022 question, but went a little further this time. Just maybe to take a step back for a moment on the competitive front, Leslie, I think you've talked about the market opportunity being overall between home and acute somewhere around the $11 billion range. I think that you may have expected new entrants, but kind of what's your sense of how Tablo or your views of how Tablo is stacking up maybe as a superior technology to competitors as you're further penetrating the acute setting and more so into the home?

Yes. Well, on the -- maybe I'll start with acute first. I think on the acute side, we're always going to sleep with one eye open on the competitive front. I don't think I can't envision Outset ever as a complacent organization that's overconfident and under urgent. That's the very status quo that we've got our eye on disrupting. But that being said, I think when I look sort of objectively and subjectively perhaps a little bit at our offering on the technology front, I think we have a pretty long runway of protected proprietary sort of features and benefits, for example. Tablo is the only device on the market or coming that can treat from 0 to 24 hours. So you absolutely need that to be an enterprise solution in the hospital. You absolutely need to go down to very, very low flow rates around 50 mL. And we are the only system on the market to go from 50 to 300. You absolutely need 2-way wireless transmission, and we're still the only device that has FDA clearance for 2-way transmission for over-the-air wireless software updates, prescription, changes in management, et cetera, remote monitoring. And I think you need some pretty heavy-duty ICU-grade features. We're the only system in the market to do ultrafiltration only, which means you're not delivering dialysis, you're just removing fluid. And we've got some really unique features that allow the user to kind of toggle back and forth between dialysis and UF and also fluid management and clotting prevention. We've got some features and also some software and sensors that allow us to really minimize clotting, and we are sharing today the first data set on that. We will be presenting it at ASN a retrospective analysis of 50 treatments at 24 hours, the meantime was 23.5 hours. One of the most common complaints with the existing devices in the ICU is that they tend to clot off when you get up about 12 hours or more. In this treatment look that we did, Tablo had just a 4% clotting rate, 96% no clot at 23.5 hours, which going back to nursing shortages is a big deal, right? It's a better treatment for the patient. If they don't have to be taken off therapy, if they continue on -- and it's certainly less expensive for the hospital if they're not buying a whole new disposable set and they're not expending additional labor to stop and restart the treatment. So those are some of the ways. And I think a mounting evidence base behind Tablo in the acute setting that's all coming together in a way that we feel really confident about from a competitive standpoint.

Got it. And maybe just on some of that data that you just mentioned, can you tie that into maybe some of the per console utilization trends that you've been seeing? And kind of how is the data going to fit in with your clinical sales and support strategy for really driving utilization of Tablo higher once a console is in place in the acute setting?

Yes. I think you could have a couple of implications. One thing we look at is what's the XT attach rate for console sale. And because this XT feature, we do sell as an upgrade to customers at a higher ASP. And so we believe that as this evidence base grows and this very low clotting percentage, I think, could have a positive effect at the number of customers choosing this upgraded XT feature, which comes at a higher ASP in the future and then perhaps more of utilization of the longer treatments. I don't think, though, having said all that, in terms of utilization, I don't think we necessarily forecast any big changes or really any changes in our average utilization nationwide just because our installed base is growing larger and larger in lots and lots of treatments. The utilization rate factors in other variables, new customers that are coming on board, more tenured customers that are using the machines a lot more. So I think we still probably stand by our utilization average of about 5 treatments a week. But I do think it could certainly benefit the XT attach rate.

Got it. And sorry if I'm misremembering this, but have you provided or disclosed kind of what your XT rate is at this point? Or could we see that at the fourth quarter call?

We haven't, Drew. What we have commented on is so XT attach drives are ASP, and we have commented qualitatively on ASP lift as a driver of revenue growth, which is what happened in Q2.

Got it. Okay. And Leslie, maybe we talked about acute, I want to make sure we talk about the home setting for a moment. But I mean is the biggest risk to Outset home market potential, is it competition or pending competition? Or is it really kind of the treatment status quo and the need to really broaden adoption towards the home from in-center dialysis?

Yes. I think the -- and I'm going to answer that 1 second. I think my big picture on home is I don't think there's a risk to home. I don't -- in terms of it happens or doesn't happen. To me, it's not binary. I think it's a question of not if, but how rapidly. That's just broadly how I think about it. And we don't model or foresee some big inflection point. And I think that's a good thing. It's not like either something exogenous that has to happen or not happen for this market to really grow nicely over time. And that's what we forecast is kind of an up into the right, but probably with a consistent slope, not like a jagged upturn. And so -- no, I don't see -- I see competition is helpful. When you have a big player like CVS using its voice and its platform just talking about home, that's a big deal. Their voice is a bit louder well for now than Outset's. But so we really view that as helpful, and I think they've done a lot of great work. I mean we're so early against a $9 billion TAM that it's definitely a rising tides, lifts all boats story. The factors of how quickly home starts to grow, I think really will come down to how quickly the providers are responding to the ETC, the financial incentives that are tied to getting more patients home, how quickly are payers reacting to all of these dialysis patients going into Medicare Advantage, which is going to elongate the period of time that payers are paying for dialysis. We're starting to see a lot of really good movement and actuation of payers trying to really kind of push and actively advocate for home dialysis. And I do think here in home, COVID will have an effect. I know any number of our patients on home with Tablo were motivated by not wanting to dialyze in a clinic anymore. So I think that will continue to have a positive effect. So net-net, to me, the question isn't home yes or no. I think it's the slope of the curve more than anything. But we continue to take a pretty conservative view of how rapidly that's going to grow because for us, like that's the second wave of growth. This first wave of growth being acute really gives us a lot of luxury of time for that home market to really develop and mature while we maintain our very high growth rate status as a med-tech company.

Got it. Okay. And sticking with home, in June, you signed a multiyear agreement with Satellite Healthcare. And I think you highlighted a reason -- a key reason why Satellite was targeted was because they had ambitious goals kind of around the percentage of patients that they wanted to get or sent home by a certain year. So I mean, how many opportunities are there or partnerships out there like this? And do you really see that -- you mentioned that it's not really going to be an inflection point in terms of adoption. But how helpful could these partnerships be in quickening the slope of adoption?

Yes. Well, I'll try to -- we're under NDA with a number of different partners on home. So I'll probably try to keep it high level. I think what constitutes sort of ambitious goals. I would say now, today, in a good way, this has gotten higher. I think 5 years ago, ambitious would have been like 10% at home. All the providers that we're talking to are talking about 30% to 40% of these patients at home, let's say, over, again, the next kind of ensuing 5 years. But that if it happened would be a pretty dramatic increase. And that's the way that most of these providers, health systems and the dialysis care organizations are thinking about it, which I think is great. And we see a direct connection to again the changes in Medicare Advantage and the ETC model, which starts to pay out much more significantly towards the latter years, sort of '23, '24, '25. Everybody is trying to kind of glide path up to very high rates of home by those outer years of the ETC. How many players do I think really have those types of goals? We see it expanding. I mean the provider universe is expanding again by health systems getting into the mix and starting up home programs. There are some subacute providers that are taking a really close look at starting home programs. And then we've got this emerging group of sort of services start-ups that are very well funded privately and doing both CKD program management for health systems and payers and also now trying to get into kind of a home-first model of care. So we, in a great way, I think, compared to maybe the incumbent device 15 years ago, so many things are different in the environment for us. We say sort of we're lucky in being if they're kind of at the right place at the right time with the right technology and a much richer partner set and channels for patients to get home.

Got it. One concern that we've heard from investors is at this notion that Tablo might be disadvantaged from a reimbursement standpoint on like a 3x treatment per week for some other machines that are typically used 5 treatments per week. I mean, is this really a disadvantage? Or kind of what's your view to that kind of argument?

Yes, sure. So maybe there's just some reeducation that would be helpful here. So Tablo is not disadvantaged or advantaged, frankly, from a reimbursement perspective. It does offer for the first time home patients, the opportunity to do 3 times a week their in-center schedule. But Tablo also offers them the opportunity to dialyze 4 times a week, 5 times a week, 6 times a week. What we were going after is delivering the benefit of flexibility in frequency as opposed to a requirement. CMS only pays for 3 times a week dialysis, like that's it. And so in that sense, I think Tablo really potentially saves providers from losing money because a lot of providers when the patient had to dialyze 5 or 6 times a week, they were eating the cost on the supplies because they weren't being reimbursed by CMS for anything more than 3. So now with Tablo, they can really comport the patient's prescription to the, let's say, the -- what the patient needs clinically, but also what the MAC in that area pays for. Some MACs do pay for more than 3 times a week if the patient needs more than 3 times a week, Tablo absolutely could be used as many times a week as is required. But for areas, the vast majority where 3 times a week is covered, Tablo now for the first time allows providers to align what they're getting paid for with what they're prescribing for.

Got it. Understood. We don't have much time left, but I wanted to kind of sneak in a very forward-looking question. So we've talked about the opportunity in the acute setting. We talked about the opportunity in the home setting. I think on the first quarter call, you mentioned additional growth opportunities in developments like international data analytic initiatives and maybe some other R&D programs. So can you maybe talk a little bit about that today? Or maybe ask differently, when could we see potential items being discussed more frequently on the international side or data analytics?

Sure. As a blanket statement, we're an ambitious bunch, and I don't think we'll ever be done sort of inventing or expanding into new areas. We're not there yet. I think on the OUS side, we're very fortunate to have a very high octane Chief Commercial Officer, he's run very, very big businesses, $1 billion plus in the past that had a very large global footprint. So I think we now have the capacity and the horsepower to kind of lift our head up and really think about the possibilities outside of the United States. Kind of over the 5-year, is it very possible/probable that we'll be a global organization? Yes, probably. When in the 5-year and what is '22, '23, 24 look like? Not prepared to answer that I think for all the right reasons because we're trying to be thoughtful about it, not only in terms of the revenue, but we have made promises to investors on gross margin that we intend to keep. And so we want to make sure that when we make moves outside the United States, they're not only growth friendly, but they're also margin friendly. And so like we've taken with acute and home, the international rollout will be definitely a measure twice cut once type of cadence. And then I think in terms of internal R&D, yes, not there yet. But generally speaking, I think we continue to be very excited about invention in sensors, software, data, consumer, the breadth of consumer information in the home, ways that we could leverage content on Tablo so on and so forth. So multiple vectors and hired a new leader in June from AWS Health to guide our efforts there.

Got it. We only have a minute left, but just going to open the floor if you had any closing remarks or takeaways that you're hoping to discuss that we may have missed?

No, I'm going to give the floor to Nabeel since I have been optimized this conversation. Nabeel, any closing remarks from your side in terms of the financial health of the company?

Yes. Just I would go back to sort of some of the comments we made in Q2 where we -- as I think about the first half of this year, so we've sort of delivered positive gross margins, exited with 4.4% gross margins in Q2. On track to do double-digit gross margins in Q4, which if you go back to where we were kind of a year ago, it's pretty remarkable progress that I am super proud of the team for being able to deliver. And then Leslie touched on sort of our high octane commercial officer, Chief Commercial Officer. And again, on the commercial side, on the top line side, we've been able to raise guidance here to $97 million to $100 million, which at the top end represents doubling on a year-on-year basis. So again, super proud of our team for being able to do that and really excited to talk to you guys and update you when we print our Q3 results there.

I mean, it's all really exciting. I wish we had another 30 minutes to talk about all the other questions and topics today. But Leslie and Nabeel, really appreciate your time, and thanks so much for having the session with us.

Thanks again, Drew. It's great to be here.

Thanks, Drew.