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

Thanks, everyone, for joining us today. Welcome to another session. I'm Drew Ranieri, one of the medical device analysts here at Morgan Stanley. It's my pleasure to have Outset Medical here with us today, Leslie Trigg, the CEO; and Nabeel Ahmed, the CFO. Before we kind of get into it, I just have to go through our disclaimer. For important disclosures, please see the Morgan Stanley research disclosure website. And if you have any questions, please reach out to your Morgan Stanley sales rep. So with that out of the way.

I will do that.

So it's been an interesting year at Outset. And just maybe over the past 6 weeks now since the ship hold resolution has come in, there's still a lot of focus on rebuilding the home market or the home patient funnel and kind of the factors that are driving the acute care setting too in your guidance. And these are definitely topics I want to get into. As we're maybe looking a little bit near term kind of on the macro side, just wanted to talk about and this is maybe related to the acute side is just any update that you're seeing in terms of capital spending from hospitals? And you've mentioned there's an elongated capital cycle or the conversations are at least taking a bit more time. So just are you still seeing that? Are there any signs that's improving? Just curious how you're thinking about that or seeing?

Yes. Well, first of all, thank you for having us, and thank you for coming out to hear the update. It's great to see all of you. And we've been kind of just run into people after so long and always. And we have had an exciting year, so thank you for acknowledging that. Classic high-growth earlier-stage company, there's always a lot going on. But getting to the macro, we talked about and started really feeling 2 effects really in June. The capital spending was more on the perimeter for us. It was something that we were starting to just hear our health system executives talking more about. We -- as we kind of got through and into Q3, we still haven't seen any hospitals pulling out of deals or discontinuing the dialogue with us because of capital spending. But I would still say we're kind of idling and neutral. I haven't seen it get any worse, but I haven't necessarily noticed any new positive behavior. What we see in our conversations is just more interest in, "Hey, are there leasing options, what are the various leasing options, who are the leasing partners? Let's go talk to said leasing partners take that back to the hospitals, figure out, do we want to buy? Do we want to lease?" Which is all the same to us, by the way. And so I would say that it probably still has the potential to elongate our sales cycles, but the bigger issue for us is still remains staffing.

It's interesting that you're bringing up the leasing dynamic. I mean, we're hearing from other capital companies that they're starting to kind of skew a little bit more towards that for earlier stage high-growth technology. But I guess we kind of always thought about it more as the capital sale, at least that's kind of what we have in our model. But I mean, do you expect a significant change in how the placement mix will be between capital or at least as you're looking ahead?

Not really, and it doesn't have any impact on us from a revenue standpoint.

We will never lease or, I mean, at least we're not leasing now in any significant volumes. It's really we have financial services partners with whom our customers can contract the lease. So as it will still look like a capital sale into the foreseeable future, it's just how our customers consume, if you will.

Okay. Okay. And maybe just on another piece of the macro for a moment, but still on the staffing shortage side, there's been maybe a little change in how I think maybe it's impacted Outset. Earlier in the pandemic, it was staffing shortages or driving the need for training for placing these systems. And now it sounds like it might be a little bit of a bottleneck in some regard. But how is the environment kind of shaping up into the quarter? I mean is it in line with kind of your expectations as you think about the 2022 guides?

Yes. I would say, again, in line, we're probably idling and neutral. The good news is I don't perceive that the staffing challenges have gotten any worse but nor have I seen a material improvement. It is a little different for Outset and maybe a medical device company operating in the cath lab or the OR where it's just affecting procedure volume. And here's just as a level set for everybody. Here's how a little different for us. The value proposition around Tablo has never been more resident. There is very, very, very significant cost reduction when -- for a health system that adopts Tablo on the order of 50% to 75% cost reduction for the cost of their dialysis program on a per treatment basis. So that is extremely compelling. The easiest part of our sales cycle is the first part, where you're telling the economic cost reduction story, walking through the financial models and showing the health system executives the before picture and the after picture. It's extremely compelling. So that's always very quick. What's not as quick is the how to implementation stage because in order to terminate their service agreement with an outsourced dialysis provider and take it back in-house, which is what generates the quantum of cost reduction, in order to do that, they do need to hire some incremental nurses and specifically dialysis nurses. And so what we're seeing is no decrement on interest level, no decrement on intent to in-source with Tablo, just reticence and just uncertainty around, well, how long is it going to take us to hire 5, 8, 10 dialysis nurses and others. I think we've continued to get better, smarter and become more valuable partners to the hospitals by -- now that we've seen a bunch of different flavors of how this can be solved, and it can be solved. We're able to better partner with hospitals to say, "Hey, here's Solution A that's worked with this other -- for this other hospital. Here's Solution B, that's worked with another hospital. Here's Solution C set that's worked with another hospital you've seen". So we're getting better at it and helping hospitals get over it. But it does -- and we would expect it through the remainder of the year to continue to affect our sales cycle. Again, not our pipeline thus far. We feel great -- I feel great about the pipeline and the interest level and the core value proposition of Tablo, but the sales cycle is -- and I think will continue to be a bit longer as those conversations play out.

Okay. Maybe to go back to some of the earlier comments about kind of the Outset and post ship hold resolution world. But I mean, again, it's been a few weeks since you had successful resolution here, and I was completely wrong on the timing. I'll be the first to admit that, but…

Thank you for doing that. I was going to bring it up and dispute it. But we still love you to...

Beat you to the punch. But can you give us an overview or an update on how customers are reacting to the ship hold? And it doesn't sound like you're losing demand or any issues on pipeline. And kind of as we were doing our diligence on the wrong call, it was actually surprising like there was no negative commentary on the technology. It was great. But what are hospitals on the -- what's kind of the feedback been on the acute side. And really, we'll talk about home, I'm sure, but anything there?

I think that we talked about on the acute side, the impact of kind of the maybe the negative halo effect in June. There was some of that on the acute side. Again, nobody dropped out of the pipeline or said, "Hey, we're not interested anymore". But of course, it generated questions and maybe there was a bit of competitive -- competitor opportunism about trying to kind of confuse the marketplace about what exactly was the ship hold, was it acute, was it home? I think our team did a really, really fantastic job of managing those conversations. I would say any residual hangover from that is past us. We're behind it. So I don't think we'll be talking about that moving forward. I think the team has done really good job of managing that.

So maybe to go to guidance for a moment for Leslie or Nabeel, but with bringing down guidance to about $105 million to $110 million for the year. As you're kind of thinking about the ship hold resolution, I mean it sounds like it actually might be going at least the potential pressures that you were thinking about might be better. How do you kind of think about that in terms of your guidance? Could there be upside as a result?

There's really two things that we baked into our guidance through. So number 1, on the home side, so coming off the ship hold, we really have to rebuild our home patient pipeline. And so having never been on ship hold and came out of that before, we're assuming that that takes us a couple of quarters to get through, right? So we are actively working with our provider partners and it's up to them to sort of identify patients upfront in the funnel and move them through the funnel to ultimately get home with Tablo. So one is this re-ramping of our home business. And then on the acute side, we talked on our Q2 call about some nascent headwinds around staffing shortage. And again, what's baked into our guidance is our assumption that these headwinds continue certainly through the back half of this year, and that's what's sort of baked into our guidance. Now what moves us up into guidance range, Drew, is if home goes a little quicker than we expected or if our acute customers are able to better navigate some of these staffing shortages than sort of we've expected as we sit here today. Having said that, it's still relatively early into 2H. And so there's a lot more that we need to see before we sort of comment beyond that.

Got it. So $25 million for third quarter is still good, right?

So our guidance commentary for 3Q was that we expect 3Q to be flattish to 2Q. So arithmetically, you are correct, but I won't comment beyond that.

Okay. Okay. Maybe we'll focus on acute and then go on to the home but just a couple of questions here. I mean the VA news, the announcement came out after your recent report. So I mean it's a clear positive win, a long-tailed opportunity. But maybe just kind of give us your updated thoughts there on how we should kind of think about the rollout on the VA? And is this really acute? Is this home? Is it all of the above? Just anything that more that you can provide there?

Sure. I myself had really underestimated or I just didn't know how many veterans were managing CKD. The figure from a couple of years ago, the best estimate is that the department is managing 600,000 veterans with chronic kidney disease. Not all of them will eventually go into need dialysis, but then let's just call many if not most will. And from a couple of years ago, about 40,000 veterans that are on dialysis right now. So I had really underappreciated just how big that market could be for home. We had gotten an insight into how big the opportunity could be on the acute side because during COVID, the VA did place an order for Tablo consoles for a number of their hospitals, specifically for COVID business is one contract we called out is very COVID-related. So we had gotten a sense of how big that opportunity is. There are roughly 100 -- I think, precisely 106 VA hospitals. So we have in the acute setting, both greenfield opportunities VA hospitals that probably don't know anything about Tablo, and we get to go in now and educate them with an opportunity to win the business and also expansion within our existing VA footprint. The total contract amount is -- and the total opportunity is $50 million within a period of 5 years. That's not divvied per year. It's just $50 million with over the next 5 years, and that would be specifically an opportunity for Tablo. So that could be meaningful. I am, as I might have alluded to, I'm even more excited about this on the home side because fewer than 5% of veterans have access to or using home, whereas that figure is closer to 15% at home for the general population. So I think we have a really interesting opportunity to partner with the VA to help them stand up their own home programs just like we're doing with the health systems. And so I think this could be kind of a rising tide lifts all boats story for us in the homes that I'm excited about, and there would be upside to plans that we've talked about in the past.

And that disparity between the VA and just non-VA, the 15%. I mean, is it really just more handholding with the VA? Or is there any other bottlenecks to maybe helping the VA kind of achieve at least that 15%?

Well, I think that it's probably been an access issue. Here too, for most veterans actually have -- I learned have been sent by the VA to commercial service providers for dialysis and center and their incentives haven't always been aligned to driving home. The VA has publicly announced home dialysis as a major strategic initiative. So it seems like their intent -- the VA's intent is to actually set up their own home program. And we hope to be a partner in helping them do that because that will provide, I would say, aligned incentives and provide a lot more access to home for veterans.

Got it. So let's maybe go into home market -- home opportunity for a moment. And you kind of touched on rebuilding the funnel earlier, but just maybe help us better understand kind of the process and like in the past 6, 8 weeks, I mean are you incrementally more confident now than you were when the ship hold first got resolved that the patient funnel is building and that the provider network is building as well?

The answer would be, yes. I mean, I'm certainly more incrementally confident than I was today after and more confident as everyday has passed. There's a couple of reasons for that. One, our retention rate remains very, very high and the is the one key leading indicator that I hope you all ask me in every single meeting is what's your retention rate. Because I really think that that is the key to long term sustainable growth is keeping people on the therapy because now we're growing on top of a really solid base instead of growing just to fill in focus who have left the therapy. So we're really effectively, maniacally focused on retention and that's remained in the single digit range for patients to topping off because they don't like it. So we, I think our team continues to do a really exceptional job at creating the experience for the consumer in the home. The second thing I think they give me a lot of confidence in the home forward. We didn't lose any of our contract or our orders out of our backlog for home and providers would have had sort of an easy excuse to walk away and none of them did so. And 3, we know -- we have a number of locations where they do offer both the incumbent device in Tablo. And we know that the patient preference for Tablo remains overwhelmingly favorable when patients are given a choice. So I don't think any of that has changed. It was certainly a curve ball and one that was highly unexpected. But it, to me, does not change the enormity of this market, the clear technological advantages of Tablo. And I think the increasingly clear and overwhelming patient preference for our device over the original choice.

So still on track to reaching about 100 home programs in home, too.

We are on track. And we haven't lost -- yes, we haven't lost sight of that goal, yes. And that's an availability metric just for those of you that haven't heard this, but in how many different locations or ZIP code is Tablo offered. And so we've set a goal for ourselves to have Tablo available in about 100 locations by the end of the year, and we're still tracking to that goal.

Is there any way to kind of frame what that could mean and maybe patient volume or patient demographics, like what is the opportunity to have a console?

Yes, not yet, but I promise I will be able to answer that question someday. What I can say, though, is that we have not found a ceiling, and I think that's really interesting. We have centers that are more mature. They've just been offering Tablo and home for a longer duration of time and they continue to add patients. So I think just studying this space as a student of it with the incumbent device in the past. I know there wasn't a lot of talk about just kind of reaching ceilings or thresholds that you couldn't really have a maximum of more than X patients per center 3, 4 or 5 we've kind of often talked about. That has not been our experience so far. Having said that, I don't want to be overly bullish on a very small base. So more to be revealed, but we haven't yet found something that we consider to be a max.

Got it. And we were kind of talking the hallway about the nephrologist and increasingly getting them prescribing Tablo. So how are you building kind of those relationships and kind of what's the pathway to take away any type of bottleneck from like just a nephrologist, maybe not knowing about Tablo. Is it just all about training? Or is word essentially out now about the technology?

Yes. It's, of course, multifactorial. We're not going to rely on a single silver bullet or even a gold bullet, for that matter. It's incumbent upon Outset and our sales team in the field to educate physicians. We do a lot of that actually in the hallways of the hospital because those are in a way that really helps us from an efficiency standpoint, those nephrologists that are rounding in the hospital are the same nephrologists that also have patients in the clinic also have the capacity to send patients home. So we're able to do a lot of kind of kill 2 birds with 1 stone work in the hospitals when our reps are there for other reasons. That's kind of the first element. The second element are our provider customers themselves. So I'm thinking about a couple of customers and they have their whole huge network of nephrologists. We partner with these 2 providers, I'm thinking about for regional dinners where they'll help us promote the dinners and get their nephrologists to the educational set. They don't have to be dinner, and it's totally as a med friendly. But some sort of educational opportunity there talking about Tablo in their -- in e-mail blasts in newsletters and updates that go from their CMO to their network of physicians. So it's a bit of a push, but I'm also liking what I'm seeing so far in terms of the poll. So the providers are doing some of that lifting for us as well.

And how does the American Heart Association like publication kind of factor into home adoption? I mean, dialysis patients obviously have some comorbidities, too. But is this just a modest tailwind, major tailwind in terms of driving even more home adoption?

Yes, I'm glad you picked up on that because I think that might -- maybe had been underappreciated by investors. I think that was pretty significant. I have never seen the AHA pick another therapy outside of the cardiology space to promote like that. So I think that the tangible answer to, hey, what does that mean? What's next? What's to come? I don't know yet. But I think it's very, very significant and speaks also to the kind of day-to-day partnership that cardiology does have with nephrology both in the acute setting and even in the chronic outpatients that cardiologists are managing that they, too, want to see those patients at home. I mean, look, the data for many, many, many years, frankly, thank you to our incumbent device competitor. The data on home hemodialysis is unequivocally favorable in terms of mortality reduction in hospitalization, reduction in ER visits, reduction in med use. We think we have an easier, better solution to get to those outcomes, but the outcomes themselves are very, very clear. And I think it's meaningful that the cardiology community is recognizing that.

Got it. So another tailwind. Maybe as we think about next year for 2023 and Nabeel's smiling, you know where I'm going. But just from a quantitative or a qualitative perspective, can you just help us maybe frame what 2023 might look like? I mean after the ship hold there, numbers kind of came down, but just any moving pieces that you can kind of help us kind of think about next year?

Sure. So let me first talk about sort of the long term beyond 2023, right? The most important thing is that demand for Tablo in both of our acute and home end markets remains very strong. Tablo's value proposition resonates in the acute, where we are working to help hospitals reduce the cost of dialysis. And then in the home, Tablo's value proposition enables midsized dialysis organizations to send patients home and harvest better economics and allows hospitals to stand up home programs, have better patient outcomes and harness patient economics, right? So that's in the long run, nothing changes. With respect to sort of where we are today, looking at the back half of this year, we are really focused on executing into the guidance range for 2H. And that means getting our home business back on track, right, re-ramping that home business. And number 2, helping our acute customers sort of get beyond the staffing situation that's in the market today, right? Now 2023, we think sort of the staffing will have some impact on '23 because our sales cycles are elongated, right? So we will see some sort of effect of these staffing shortages into '23, certainly into the first half of '23. And then very honestly, Drew, we don't have the visibility into the full year '23 to be able to comment on sort of what that year will look like, right? We will be -- we do expect, again, going back to where I opened -- we do expect to grow at a differentiatedly high rate. We are a high-growth med device company, will continue to be so. What will happen to '23 really depends on sort of what happens in the back half of this year and which is why our focus is on the back half of this year, getting those 100 home programs, getting the home business back and getting the acute business back on track.

I'm going to ask maybe a hard question, but it's something that I have found from investors kind of really over the past few months is just as you're kind of thinking about being a differentiated growth company from your IPO until the March kind of time frame, the upside surprises were kind of decreasing over time. So has there been any type of philosophical change in the way you're communicating or you're thinking about forecasting your revenue numbers, your pipeline, at least that you're going to communicate with us?

Yes. The short answer is no. I mean through the time of our IPO, our business has been, obviously, this Q2 exogenous situation notwithstanding, our business has been one of high visibility, right? We've always given guidance based on our backlog at any point in time and based on the pipeline and how we see that playing out, right? That remains unchanged. Our commitment is always to give you guidance, which is based on what we know at a point in time and to give you the best guidance we can. And I'm proud of sort of how we've performed relative to that guidance in the 2 years-ish that we've been public.

Maybe to go back Leslie, to -- you're talking about the incumbent having some like positive data at least helping in that regard for the home. But I mean they recently hosted kind of an Investor Day or investor meeting, but they -- we're talking about their advantages versus your technology. But just how would you kind of counter those arguments? And kind of broadly, what are you thinking about from a competitive standpoint with even some of the newer emerging potential dialysis?

Yes. Maybe I'll make one comment, if you don't mind, before the technology, which is that I am immensely appreciative to Fresenius' promotion of home. I really am. Their platform and their voice is obviously, at this point in time, at least a little bit bigger than ours. And so for those of you that missed it, they're really actively and aggressively talking about 25% plus of their whole patient population at home by 2025. That's an enormous number. And what I doubly appreciate is that they think they're going to get there through home hemo. And they also have a PD platform, but they really believe in home hemo as the growth engine is going to get them to 25%, and they've talked about pockets of a country where they're at 35%, 38%, touching 40% at home. So that tells me -- and by the way, we've sized our TAM, which is $9 billion just in the U.S. with an assumption that only 30% of the analysis population ever gets home. So I suspect -- I say this as a private citizen, not as the Outset CEO, but I suspect that our TAM may end up looking potentially conservative as time rolls on here on the home side when I see numbers like that. But going specifically to the technology, I still think that at its simplest form, this is kind of a right place, right time, right technology story. I've always thought that. And I don't feel differently about that when I look at both who's in the market today and what might be coming in the future. The most kind of valuable attributes of Tablo that really inform the patient experience, really are simplicity, which is showing up in a very simple promise that we make, which is, hey, provider more of your patients are going to choose Tablo because it looks easier and it is easier. Your training will be cut by 75%, you're going to train more people faster and more -- and people will get home faster. And then 3, your patients are going to be happier at home for a much longer period of time. So far, so good, we have delivered on all 3 of those promises. And I think the way we've done that is, again, through kind of the water and dialysate on demand, the simplicity, obviously, of fewer steps, nothing to memorize, no mental math and giving people frequency, flexibility, letting them kind of choose their own adventure in terms of how many times a week they dialyze. We still have a very proprietary position on all 3 of those dimensions that nobody else in the market fulfills. On the horizon, there are a small handful. I'd be surprised if there weren't at this point with all of the noise around home and just macro hospital to home. Everybody is talking about home. I mean it's -- this is the moment for home care, broadly speaking. And certainly, I feel it's a feeling statement, but I feel kind of all these points of light now really just simmering under the surface of a major implosion for -- or explosion of home dialysis across the board. So it would shock me if more people weren't coming to the same conclusion.

And just as you're thinking about the competitive landscape, I mean, what does that mean from an innovation perspective at Outset, one is Gen, Gen 2 maybe or coming from a hardware perspective? Or are we thinking more software updates? Just anything that we can think about in terms of the cadence for products.

I understand the question. It pains me because it took us 8 years and like $450 million to get to the current generation. So we're pretty proud of it. But basically, it's like calling the baby ugly, but -- and it's not and it's perfect. But I think you will see us do more on the software side and on the data side than the hardware side. We will continue to make hardware improvements. Those are more likely to be in the areas of keeping our margin promises to shareholders, cost reduction, component end of life, manufacturability, serviceability, device performance will never be done working on those items. And some of those will result in hardware changes, but many, many more of them will be accomplished through software. I continue to be very interested in the home environment. And are there -- is there sort of an integrated suite of other biometric measurement devices that may be paired to Tablo over time. On the acute side, we had a lot of success with this XT feature, which was layered on top of our ASP, and then we sold for an incremental $10,000. We are taking -- and we'll continue to take a close look at other XT like features, which are premature to talk about, but have already been identified as potential opportunities in the acute setting.

We're getting up to our time but maybe one last question. I mean, there's a major nephrology conference coming up in the fall, but any data that we should be kind of thinking about that will be presented there?

Yes, both acute and home, and we will talk about that on our next earnings call, but we had the highest number of submissions and acceptances ever in our history for Tablo. What was gratifying to us is that many of those were submitted by customers, which is always great to see a validation of their own experiences, both economic and clinical on the device across multiple settings. So yes, we're excited about it.

All right. Great. We'll have to close it there. But Leslie, Nabeel, thanks for joining us today.

Thanks, again, for having us.

Thank you.

Thanks to you all.