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

Good afternoon now, Travis Steed, Bank of America analyst for Medical Devices, and welcome to have Outset Medical here, Leslie Trigg, CEO; and Nabeel Ahmed, CFO.

Thanks, Travis.

Thanks.

So Leslie, I just wanted to start out with Q1 since you reported that last week. And it sounds like there really wasn't any pressures incrementally from staffing or labor shortages or CapEx cycle. And I just wanted to make sure we understood it looks like you guided mid- to high single digits for Q1, and you did basically 8.5%. So in line with your guidance, but it doesn't feel like there was anything there, but it's a little bit less than consensus of expectations for Q1 -- or sorry, you still beat consensus of expectations, but the beat wasn't as big as it had been in the last couple of quarters. And so there's some questions around that. But it suppose like maybe the Street was this maybe a little higher than it had been historically. So I just want to make sure we get the clear message on Q1.

Sure. Well, maybe I'll kick off and interpret over you. Thanks for spending your lunch time with us, by the way. So look, we were thrilled with Q1, delivered really strong top line revenue growth, 33% year-over-year, 8.5% sequential growth and coming off of a really big Q4 as well. Gross margin is always a big catalyst for us and something that another commitment we take very, very seriously and delivered a beat, if you will, on the gross margin expansion. And both acute and home performed really, really well. So we thought it was a great quarter. .

That's great. So no staffing like there was no impact from staffing or hospital staffing on the quarter and nothing assumed in the full year guidance on that?

No, I've heard other medical device companies talking about staffing, but for us, that was not a big needle mover. We have not really seen any new trends around capital equipment purchasing behavior at the hospital level. And I think it's because, again, Tablo is not a multimillion-dollar robotic system. So even for a hospital that's going to buy 10 Tablo's, you're still talking about something that's $0.5 million with a payback period that from a CFO's perspective is really attractive. We're talking about a payback of 7 to 12 months.

And Travis, just the back half of your question, again, remember that when we gave you the Q1 guidance of mid- to high single-digit growth, we're sort of in the middle of the first quarter at that point, right? And so our business is one of high visibility, high predictability, given the backlog and the pipeline that we have coming into any period really. And so again, Q1's performance really just validated that for us. And we continue to now have the conviction around or our year guide and the ramp for the full year.

Right. And I was looking at where the Street shook out for Q2, it was up 11.5% sequentially. Last year, it was up 10% sequentially. It seems to be the right ballpark, but just like do you feel like that's a good place for the Street to be at this point for Q2?

Yes, Travis. So we guided to sequential expansions and growth as you move through the rest of the year. And so that's right in line with that guidance, and so happy with that. And more importantly, happy with the visibility that we've got as we move into Q2 and through the rest of the year.

Right. And then looking at the visibility for the last year, you basically started the year with a backlog of 1,251 systems. And you're not going to update that quarterly. But it seems like you have a lot of predictability with that backlog, right, for the full year?

We do, Travis, at any quarter, we look at the backlog. We've got entering the quarter and then the pipeline. And so again, we're happy with the way Q1 played, and we're happy with the backlog and the pipeline the way it sits here looking at Q2 and then the rest of the year. So yes, happy with all that.

Is there a backlog for home, too? Or is it just acute?

It's for both. So a backlog, just as a reminder, is a signed order agreements. The customer has a contractual commitment to buy Tablo. We talked in our Q4 call about home consoles being a significant part of the backlog and that continues to be the case as we sit here today.

And if there was upside for the year, do you think it's more like a going to come in acute or home?

If I rewind the tape and I look at last year, the sort of upsides for us have come from, by and large, a few sources. One, we could place more consoles that comes in acute and home or could come in acute a home. We've seen ASP overperform for us. Typically, that will come in the acute because we'll have a higher uptake of our XT upgrade that's acute-only. And then three, we've seen upside from consumables. You might remember our Q3 call where we talked about a large consumable order as an example. So lots of drivers of potential upside. But where we are today, we are most focused on executing for the next 3 quarters to get to the guidance range that we've laid out.

Okay. That's fair. And Leslie, I guess, just to spend a little more time on the home. Maybe just level set us on where you are in the home process. Like this is going to be the year of inflection. How have things gone so far? Like it sounds like things are going ahead of schedule. Just kind of want to get a sense for how things are shaping up there?

Yes, sure. So to rewind the tape for maybe a few of you guys that were not as close to us in 2021. We started sending patients home on Tablo in 2021, having gotten FDA clearance in 2020. And really took 2021 to sort of test, learn and refine, hoping that by the end of '21, we'd really be ready to kind of step on the gas and grow home much, much more meaningfully and that is exactly the way it played out. And so that's why we were very confident in the mid-February call of sort of characterizing 2022 is much more of an inflection point in home. And with represented, let's say, by revenue growth or home revenue as a percentage of total revenue, that would be meaningfully meaningfully higher in '22 compared to '21. What we commented on just last week was so far so good, so far so good in the quarter. We were a bit above the number of patients at home at the end of the quarter compared to our internal objectives. The number of home programs. And to be clear, our home program is really just a new location, a new ZIP code where patients can find Tablo for home. We were ahead of where we were hoping to be for Q1 and still feel very confident about this inflection point for the rest of the year.

And you focused a lot on the retention. How do you measure that? Like what are your metrics? And like how are you -- like are you out in the field? Do you have sales reps like calling the patients? Just kind of on the ground like how are you controlling the retention aspect?

Well, so we have very, very good data on retention because we send about 0.5 million data points back on every treatment back to our cloud and then also to the providers EMR. We also ship supplies to the patient's home. And so it's very easy for us to track who's coming off -- or excuse me, who's coming on, who's coming off and what's that patient. So I think our granularity is we have a fine point on it. And so far, the retention has been materially longer than with the incumbent system. You're always going to have -- I think the right way to think about retention is kind of the uncontrolled and the controllable part of retention. Unfortunately, we will have desk, and fortunately, we will also have transplants and enable that bridge to transplant. Typically, in the literature, that's around 15%. That's what we've been seeing in our real world population. But beyond that, very, very, very, very small numbers of patients who are actually opting off. So I've been really happy. This is the one metric I have always cared about more than anything because if we can grow the base and keep the base, it makes it that much easier to grow at 30%, 50%, et cetera, percent when you're not trying to refill the back end because you've lost them.

And it sounds like you've got roughly 300 patients on home at the beginning of the year and planning to get somewhere around 700 to 800 was the math that we were doing to get to the guidance. So roughly 500 patients a year moving to the home. Is that the kind of the pace that you expect this launch to go over time? Or do you think you're going to accelerate that?

Well, I don't think we've given guidance about the out years, but I would say that our ambitions are much greater than that over the long term. We plan to and believe that we will have thousands and thousands of patients on home. That said, I still think of us in the build -- very much in the building phase and the learning phase. And so harkening back to your question about retention, what I really don't want to do is pursue sort of growth at any cost because I think the cost is very, very high. When we study the history of the incumbent machine, which ended up having 40% to 50% drop out of a year that -- it's sort of a pure victory to just grow at any pace and then have 50% of your patients leave you inside of a year is going to set up a really tough comp for the out years of growth. And so I would call it ramping growth with a really fine point on retention at the same time.

And you think about limiting factors in that growth. It seems like it's more you, as a company, limiting the growth. Is that fair?

Well, again, I think we are going to grow at a pace that also allows us to maintain an industry-related retention rate. At the same time, I still think there's some work -- there's, of course, work to do in any new medical device market. And so for us, we're putting more investment towards physician education would be an example of that. Educating nephrologists about why home, how home, et cetera. Now the good news for us, I mean, we sort of have the right device at the right time, at the right place because there are a lot of macro tailwinds, reimbursement and otherwise that are already pushing patients towards the home. And I think we've already seen a lot of really encouraging physician movement toward putting more patients in the home.

And you just talked about any program destination home. Like how is -- just like thinking about bottoms up, like how is that going to help like day-to-day patients, like how incremental is that on the business?

So taking 1 step back. So we have 2 segments of customers within home. Segment 1 are health systems that are already using Tablo in the acute setting, and we are working with them to set up a new service line for the health system to manage a home dialysis program. And then customer segment #2 is what we call sort of the progressive existing dialysis providers. Those are entities that sit in size right below DaVita and Fresenius, maybe managing 10,000 to 30,000 patients each. The destination home program is something that we developed for the health system customer. And that's because while I would say almost universally, all health system executives are very, very interested in keeping that patient and standing up a home program for themselves. The question then becomes, how? We've never done it before, how do we get through accreditation, licensing, certification? What's the road map? We don't have anybody who's ever done that before. So the insight for us, and it's actually very similar to what we did on the acute side. When we started 3 or 4 years ago talking to health systems about in-sourcing dialysis, they have never done that before either. And so we sort of developed kind of in-sourcing in a box in a sense and what we've done, and it worked really well. And so we've transferred that same concept, call it sort of home in a box where we can help the health system with the how to and in the process of doing so, really accelerate the glide path to starting up a new home program.

Maybe just a good reminder, just to go back and like think about like where do you get involved with the patient to go on the home? Like in the dialysis clinic, there's a patient's like, "oh, I want to switch to home". Just kind of walk through each step of the way of how you start interacting with the patient, you get the patient on the system and then you manage that patient?

Sure. So Outset and our team, our support team gets involved in a couple of ways, but not every step of the way. We have our field service team go out and do a home assessment. We work with patient. Where is the Tablo going to be installed because they do need access to tap water. So what is your access to tap water? Is it your kitchen faucet, is it going to be in the bathroom? And then you do have to have a drain line, the used dialysate is called does have to run somewhere into a faucet or a backup or other. So we'll handle the site assessment for them. We'll handle any modifications that they may need to do in the home. And then the clinic really from that point forward, the location takes it from there. We're effectively in a train the trainer model where we'll train the sites home dialysis, training nurses, they will train the patients and then we really support on the back end. We obviously have a 24/7 customer experience support line. And so if the patient has any technical questions about Tablo along the way, our team is there to help.

Is PD patients an opportunity for you like as they burn off the therapy?

I do. I do think so. PD is a great therapy, and it serves many patients very, very well. There are physiological limitations to PD that typically mean 70-plus percent are off PD within 2 to 3 years. The opportunity we see as an educational one, going further upstream and making sure that PD patients are educated enough about how to stay at home on an HHD technology and not very much of that is being done today. So we do see an opportunity. We don't need to do it right now. I think the 2 flow streams and the tributaries into the Tablo flow stream today are just patients who are new to dialysis, starting on home and existing patients in the clinic. But I absolutely view the opportunity with kind of the PD inflow to be a big one for us in the future.

And there's been some reimbursement changes, legislation changes that really are pushing into the home. Is that having an impact on the business today? Like when is that actually going to show up in the like basically the number of patients that are hitting your revenue stream, just like when is the inflection point from those things? Or is it more just like a slow tailwind that's going to help over time?

Well, I think when we made the comment, which was a big one for us because we're not prone to verbally, generally, when we made the comment in mid-February that we expected an inflection point for home in 2022, it was considerate of the fact that those tailwinds are already helping us. And so just as a quick reminder, we did receive a new technology add-on payment, which is specific only to Tablo, patients using Tablo on the home, that provider gets about a 10% increase in the base rate. So I think that already is helping and changing some provider minds about how quickly they want to contract with outset for Tablo. So I think that's already underway.

Okay. Maybe a couple of minutes on acute. Like as you sit here, you've kind of reflected the last couple of years, your launched acute, what do you think you've learned from that, like and think about where you're going in acute like, what's still the opportunity over the next couple of years? We kind of see the same pace of growth that we've seen in the last couple of years in acute?

I think we're just getting started in the acute. Again, it's a $2.5 billion TAM that's acute alone home we sized at $9 billion, but just on the $2.5 billion, we're barely getting started. And we've said publicly, we're at high single digits, low double digits penetration. And we're proud of the fact that we've contracted with 8 of the 8 largest national health systems. But those health systems just that pocket are at varying levels of penetration. Most of them, again, just getting going with the Tablo program. So a lot of runway in the existing customer base. And then there's 3,600-odd hospitals that offer dialysis. So we've certainly got plenty to eat on the buffet, if you will, for new customer acquisition too.

When you sit down to the table with customers or potential customers as the awareness of Tablo increase, does that change on how the conversations are going?

For sure. I think a couple of years ago, like any new medical device company or any new therapy, you're not going to have a whole lot of organic awareness. But I think the -- I would say, generally, the sales cycle, the sales process continues to shrink as there are just many more reference accounts, there's more cases, more knowledge, physician awareness, executive awareness of the cost reduction benefits and the clinical benefits of Tablo.

And on the cost reduction benefits, obviously, hospitals are facing a lot of margin pressures from many different angles at this point. Like is that resonating with hospitals? Are you seeing more of an uptick from that?

I think cost reduction is as an evergreen popularity to it. So I wouldn't say that it's a moment in time that's unique for the last couple of years. I mean, recapping dialysis is not reimbursed in the inpatient setting, which is really important to understand. It is a pure-play cost center. So when we come in and say, "Hey, look, we have a way to expand your margin across like 600 different DRGs and bring the cost of your dialysis down by 50% to 75% per treatment, that tends to resonate whatever it is".

And then are you going to start focusing more on the smaller hospitals now kind of moving forward?

No. It's we just -- that was an observation we shared that originally we had sized the market without them. But what we realized is these very large regional health systems and the national health systems also have small hospitals, too. And so that's actually a hand in glove fit as we're pursuing larger regional national deals, those also happen to evolve a lot of small hospitals. But look, even for a lower volume small hospital, they're still spending a couple of million dollars a year on dialysis. It's meaningful for them.

And then just a quick question on the competitive front. Anything you're seeing there, anything that you think that at some point, when do you expect competition in the whole market? Or do you there's a couple like CVS and Quantum, a few of those companies, so I was kind of curious what you're seeing on the competitive front?

Well, I think we're at a stage where all comers are welcome. And I'm sure every medical device CEO stands up here and says that, but I actually mean it. Because I think one of the limitations of the home hmeo market, if you rewind the tape 10 or 15 years ago was that we had only 1 company really talking about home. And that's tough, that's tough. Now we've got CVS. We have Fresenius, really promoting home and it truly is kind of a rising tide to all those.

And then Nabeel to bring you into the conversation. Like...

Yes. Do you want to say something?

No.

We'll talk a little bit of margins and supply chain, exactly. So on inflation, I don't know, is there any way to break down like if you think about the cost to make a Tablo today versus a year ago or 6 months ago? Like is the cost going up 5%, 10%, 20%? Like how much is the cost and the components actually gone up on the system?

It's interesting, if you go back when we went public, we have, for the last 7 quarters, actually improved our gross margin. And the bulk of that, Travis, is from bringing the cost of Tablo down. So we have had an aggressive cost-down program on Tablo, which is where we're looking at components to make sure that we can reengineer them, find new suppliers, sign better deals, a bunch of strategies. So Tablo is cheaper to make today than it was certainly when we went public and when we launched Tablo. And we expect Tablo to continue its cost down trajectory over time. It's one of the drivers of our gross margin expansion getting to high teens for 2022.

So even -- a lot of that is probably from scale, though, where you're saying actually component cost a bunch.

It is -- there's absolutely a scale component, but more of it is component cost down. We -- one of the reasons, and we've gotten this question from a lot of investors and prospective investors, why our supply chain not been as big a deal to you? We've been doing this now since we launched Tablo, meaning looking at components and driving the cost down. So yes, individual components in the simplest terms do cost more, but we've got a strategy -- have strategies to work through that and have been doing that for 2, 2.5 years now.

So both of you feels like you feel pretty good about the supply chain environment over the rest of the year?

We feel good about our ability to mitigate what we can see. In the supply chain, I mean, it's trench warfare. Our team is certainly working hard but we feel good about our ability to mitigate what we've seen and still get to high teens for this year. And then to get to our 50% -- roughly 50% gross margin commitment for 2025.

When you look at the margins for this year, I think you're expecting quarter-over-quarter improvement Q1, 2, 3, 4. Like how much of that is -- like what are the driving forces for this year, revenue, volume versus the cost down?

The big drivers for this year: number one, we'll continue to be cost down on the console; number two, we've talked about our cartridge transition to Mexico. So we used to build the cartridge, I guess, we still build a cartridge in Southeast Asia. We're ramping up a Mexico-based manufacturer. By Q3, the Mexico-based manufacturer will be the bulk of our volume and there's a big savings there primarily in freight. So that's going to -- those are the 2 big drivers for this year. And then if we propel over the longer term, you'll see leverage from our services team and then revenue mix as the installed base grows, we're selling more consumables and the consumables will bring higher margin.

And the path to 50%, like how should we think about 2023, 2024? How many points of margin should we expect a year?

It will be linear. It will be linear between sort of the high teens, sort of roughly 50% in 2025.

I think the reason I feel so good about this is it does not require any magical thinking. And there's no big chunk of this that we haven't figured out. There's no air pocket. We're like, okay, we'll figure that it later. I mean these are very well-understood strategies to gross margin expansion that have been sort of tried and true. And particularly, if you look at the capital equipment market, the journey that we're on is not unlike many of the biggest capital equipment companies today, that today enjoy higher margins, but perhaps did not start that way.

How should we think about margins of home versus acute? Like is one more profitable than the other?

So on the acute side, number one, the utilization, the cartridge pull-through will be higher, just our more tenured customers. If you're now using Tablo on the floor, you will -- we will sell more treatments to them. That's number one. Number two, on the acute side, the ASP can be higher. We've talked about our XT feature. XT is what allows Tablo to run 24 hours. We upcharge for it. It's obviously useful only in the acute and so we see higher ASP in the acute. Having said all of that, baked into our guidance comments for this year, meaning high teens and baked into our 2025 expectation of roughly 50% is the notion that home will continue to grow as well acute.

And there's a lot of focus on profitability and cash. And when you look at your cash burn and the cash in your balance sheet, how do you feel like in terms of how much cash you need to burn this year and next year and the need to potentially raise more money at some point?

Yes. So Travis, our commitment is to break even on a cash flow basis exiting 2024. And we believe we've got enough cash to go and do that as we sit here today. And so again, we'll burn cash this year. Obviously, the burn rates will decrease as we move forward, both as a function of revenue expansion as well leverage from an OpEx perspective.

Okay. And then kind of last question here. Any data releases or data that we should be looking at to help drive the market? And if there's anything on the horizon Leslie that we should be paying attention to? Or it's just going to be continued build out of the home and acute?

Yes. I think we'll continue to -- as we look out through the rest of '22, yes, there are a number of abstracts that are being submitted for our big in our space, the ASN, the Society of Nephrology coming up in the fall. I think in number -- if they are accepted, there will be a number of abstracts on home, but also on acute, both the clinical versatility, the economic cost savings. We hope to continue to share data on our faster training times, longer retention rates, et cetera. So I think there's not some big study or there's no proof point that we're kind of hanging around the hoop waiting for. It's go time right now, and the team is executing well.

Okay. All right. Great. That's all I had unless you had anything else that you wanted to make sure that you got the point across.

Well, look, I would say a couple of things. I'd say we had a really strong Q1. I say we've got a lot of momentum coming out of the first quarter. Leslie talked about momentum in home, especially. We also have some in the acute. We had another quarter of gross margin expansion, and we have a lot of confidence around our ability to hit our top line and our gross margins.

Great. Thanks a lot to join the conversation.

Thanks. Thank you to you guys.

Thank you, everyone.