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

My name is Rohin Patel. I cover medical devices and supplies here at JPMorgan. I'd just like to introduce Leslie Trigg, CEO of Outset.

That's quite an introduction, thank you. [ Barry ] I love it. It's sufficient. It only consumed 15 seconds. So thanks for the time back. I don't really have much more to add about my own introduction, but I am happy to be here. I am the Chair and CEO of Outset, and thanks to JPMorgan for including us this year. Really excited to share the story with you guys. As a reminder, you've heard it a billion times during the conference, I will be making -- I might be making some forward-looking statements. Encourage you to look at our public filings with the SEC for more information on the risks and uncertainties around those. More important, Outset is a high-growth MedTech company focused on transforming dialysis from the hospital to the home through a technology we call Tablo. There's a lot to transform in this space. I will tell you that. There's a lot of work to do in reducing the cost and reducing the complexity and certainly in improving the quality of the patient experience. Now providing solutions to those challenges, which is what we do, gives Outset access to a very, very, very large total addressable market, almost $11.5 billion just here in the U.S. alone. We already have an established footprint in a $2.5 billion acute market here in the U.S. and a rapidly growing base of patients using Tablo in the home, almost a $9 billion market here in the U.S. We did preannounce expected 2022 revenue on Monday of approximately $115 million. Over the last 5 years, we've been able to drive a compound annual growth rate of 175%. Now as we look forward, we see multiple tailwinds propelling the adoption of Tablo forward really across the care continuum, again, all the way from the hospital to the home, and I'll be talking about that -- those tailwinds throughout the presentation. But before we look forward, I'm going to take a step back. And for those of you all that are maybe less familiar with this sector, let me describe it a bit to you. So dialysis is one of the largest, most expensive and unfortunately, least-changed sectors of healthcare. You may or may not know, we spend, as a country, $73 billion on the care of end-stage renal disease, ESRD, patients in this country every single year. And in fact, this data is a few years old. Of that figure, Medicare picks up the tab for approximately $41 billion, which in of itself is roughly 7% of the Medicare budget on less than 1% of the Medicare population. Now this problem also, unfortunately, is not getting smaller, it's getting bigger. Today we have about 600,000 people on dialysis, again, here in the United States. We deliver over 90 million treatments in the United States, 90 million. I mean 90 million episodes of care. That's about 245,000 dialysis treatments today as we sit here at JPMorgan. The population is expected to grow over 30% just over the next 8 years. So lots of work to do. And despite the costs and the challenges and perhaps the suggestions that things aren't quite working well, the delivery care model for dialysis has remained virtually unchanged over decades. About 135,000 people start dialysis every year. The majority of them, what we call crash into dialysis through the hospital, meaning they actually don't know that they have failing kidneys. They don't have access to or aren't able to access nephrology care in advance. They then go into acute renal failure in through the ER, in through the hospital where they're stabilized on dialysis for the first time, and it's welcome to the rest of your life, they're discharged into a dialysis clinic. The other 40% are sort of managed into 1 of about 7,000 dialysis clinics all over the country. The vast majority of dialysis patients do experience the therapy through the clinic. Very, very few are dialyzing today at home. We intend to change that. But just giving you a picture of the current state here, almost 90% still dialyze 3 times a week in the clinic. And the clinic environment, I will tell you, has changed very little since the '80s. If you walk into a clinic today in '23, it will barely look noticeably different from a clinic in the 1980s. So we'll talk a lot more about improvements in quality and cost a little bit later. So this is sort of our current state. It's an expensive care delivery model. And so in the inpatient environment, probably the most important thing for you to know is that when dialysis is delivered inpatient, it is not separately reimbursed. So if a patient comes in, let's say, for a mitral valve replacement and they wind up needing dialysis or they're just a chronic dialysis patients to begin with, any dialysis that occurs during that inpatient stay, the hospital eats the cost of that. They cannot bill separately for it. So that leads to data like the following: A loss of between $5,000 and $25,000 per admission if that admission involves dialysis. That's a lot of money. It turns out dialysis is typically involved in about 600 different DRGs. So we take a big step back, dialysis for a hospital is a margin eroder. Now in the chronic setting, we're spending about $30 billion just on the cost of dialysis treatments in the in-center setting. And it's a bit of a, unfortunately, not virtuous, but vicious cycle because there's a 34% readmission rate from the chronic environment back into the hospitals where hospitals are not being reimbursed for the dialysis that's continued to be performed. So a lot of problems to be solved and a great, almost desperate need for more solutions because of the cost and of course both in the past and more recently really acute staffing challenges that more and more are leading to suboptimal care, all of it exacerbated by pretty antiquated equipment. Most of the equipment that's used in a hospital or a clinic setting was first developed in the 1980s or the 1990s. So I do have a piece of good news after all of that, sort of depressing state affairs. There is a way forward. And I'm sure that you'll be shocked to learn that a medical device company thinks it's a technology way forward. But we do see a technology way forward and the technology way forward is something called Tablo. It is a first-of-its-kind device, and I'll talk a little bit about why and how, specifically aimed at reducing the cost, reducing the complexity and most importantly, dramatically elevating and changing the patient care experience. It is the first single hardware platform, same device, whether you're using it in the ICU or whether you're using it in the home, that's never been done before. It is connected, intelligent and actually gets smarter over time, never been done before. We transmit over 0.5 million data points from every console, every treatment, everyday up to the cloud. That gives us a tremendous sort of almost an embarrassment of riches when it comes to data that we are then able to kind of feed into software updates, predictive algorithms that again make Tablo more and more advanced over time through 2-way wireless data connectivity. We -- the original idea for Tablo was sort of born out of observations that we had. We were a team not from dialysis. And I think that there was tremendous advantage in that. We were able to sort of come into this space fresh and take a look at what hospitals and healthcare providers were being asked, what were they being asked to do. And this is what they were being asked to do, buy and manage all of this stuff. You have to buy a bunch of different machines that all do usually 1 thing, they do it really well, but kind of only 1 thing. And then you're going to need to build and maintain a huge water treatment room, often the size of this room, and minimally half the size of this room, which effectively is an industrial water processing facility. There's 1 attached to every clinic in the world. Yes, these water treatment rooms are used with industrial equipment, like you see in the middle circle there, to purify incoming water, make dialysate in these like huge vats and then send the purified dialysate through plumbing in the walls and deposit it into the back of these antiquated dialysis machines, and that's what you're being asked to do. And so our technology ambition, which I admit, was ambitious, was to integrate all of the features and functions of all the machines and 1,000 square foot water treatment room at a 35-inch box, what could be easier. So after 8 years and a lot of blood sweat and tears, mostly tears, the engineers' tears, I was happy the whole time. But they did make it. We did cross the finish line and deliver this all-in-one solution. That really enables the healthcare provider to, again, down select operational efficiency, down select to 1 device that their nurses and their clinicians can use in the ICU, that folks can use in the subacute space and that consumers can use in the home. So I'll talk a little bit about, so where is magical, wonderful Tablo being used and what problems is it solving? It is an opportunity for 1 device across multiple markets. As I mentioned, it's almost an $11.5 billion opportunity for us just in the U.S. with $2.5 billion of that in the acute and almost $9 billion in the home. So I'll talk about the acute, which for reference also includes the subacute space, rehab, LTAC, where we have a nicely growing business there with a very similar value proposition. So simply put, we reduced cost and complexity in the hospital. I mentioned to you that hospitals cannot separately bill for the most part for dialysis, and it's a pure-play cost center, and it's a pain point for hospitals. We reduced cost using Tablo in 2-ways: Supplies cost reduction, labor cost reduction. On the supplies cost front, before Tablo, BT, existing ICU machines, for example, the incumbent machines require hospitals to, again, buy, maintain and store in pharmacy in a lot of variable prescriptions, bags and bags, thousands of bags of premixed sterile dialysate. Tablo makes dialysate on-demand in real time, purifies the water on demand and makes that dialysate to the patient's prescription while the patient is dialyzing. So it gets rid of all the cost and complexity of the bags. Labor. Because of the complexity of the equipment, most hospitals over time ended up actually outsourcing dialysis. They would hire DaVita, Fresenius, a third-party dialysis service provider, write a big check and throw it over the wall. Hey, you guys bring your nurses in here and deliver dialysis treatment when we have a patient who needs dialysis, which is frequently. 2 problems with that model, even before we got to the staffing challenges, length of stay because there might only be a handful of nurses in any given community. Said nurse might be at some other hospital, hospital A, B, C, but not hospital D. patients are waiting. In the ICU, patients are waiting on the floor to receive treatment, not -- obviously not ideal clinically and very, very costly. Even a small hospital, medium hospital would be paying millions of dollars a year in these contracts. So what Tablo enables, because of another benefit, simplicity, it started enabling hospitals to terminate their service agreements and in-source dialysis using their own team. Tablo was originally designed to be easy enough for a consumer to use. So it certainly is easy enough for a clinician in the hospital, be it a dialysis nurse or a non-dialysis nurse, to pick up and learn very quickly. And so the model here and labor cost reduction is to terminate the service agreement and use your own team to deliver dialysis in the inpatient setting. Typically what we see as a result of supplies plus labor cost reduction is a cost-down trajectory of between 50% and 75% per treatment. I'll show you a case study in a second. With a potential payback -- I would say a typical payback period of under 1 year, depending on the hospital's volume, so a very -- typically a very CFO friendly capital sale. This is the case study I mentioned. It happens to be from St. Mark's, an HCA hospital in Salt Lake City. They adopted Tablo. They terminated a service agreement, took it all in-house. They estimate their savings at almost $0.5 million a year. This is -- a hospital on the smaller side, but meaningfully $500 per treatment, which is a lot. It was a 70% cost reduction per treatment for them and a 50% cost reduction in labor between the outsourced model and their in-sourced model. And there are many, many, many examples of this across the country. So transitioning to the home and actually these 2 segments are cross-linked for us in a commercial strategy that I'll get to in a few minutes. But transitioning for the home, I think a lot of us, maybe most of us in this room have heard about home dialysis for a really long time. It's -- I think it's been a great idea for a really long time. I don't always think it's been a great idea at the right time. Some of the historical barriers that probably contributed to what I consider to be kind of right idea at the wrong time, one, reimbursement. In the past, there's been a real disconnect between what CMS pays for dialysis in the clinic or the home, which is 3 times a week and the number of treatments that a patient had to do in the home on the incumbent device, which was 5 or 6 times a week. So automatically you've got a conflict there with providers losing money on the fourth, fifth and sixth treatment. That was a barrier, understandable. Incentives were missing. There were no financial incentives. In fact, there were more financial incentives to keep people in the clinic. That was a problem. And lastly, I think there was a technology problem. The incumbent technology just proved over time to be out of reach for the interest and capabilities of the majority of the patient population. So good news, things have changed. Things have changed actually so much that my view now is that home is now the right idea at the right time. We believe, of course, we have the right technology to leverage it, but right idea, right time. And the reason why I say that, it has only taken like 15 years. So things move quickly. But the reason why I say it's the right idea at the right time; one, we do actually have new financial incentives. CMS put a program in place that's running through 2027 that pays clinic operators or any healthcare provider more or less depending on their growth in the home population. So there are distinct advantages and incentives now to move more patients to the home. 2, for the first time, starting a year ago, dialysis patients could sign up for Medicare Advantage. That was never the case. And so this has really brought the payers to the table because prior to that, if the dialysis patient had commercial insurance, the commercial insurer would pay for that for 30 months and after month 30, it's like welcome to Medicare. And the commercial insurer didn't really need to worry about the cost of dialysis anymore, but now they do. Approximately 40% of the dialysis population has already selected a Medicare Advantage plan. And so those folks will be members with the cost of dialysis for an enduring period of time, which is giving payers much greater incentive to ensure that more and more of their members move home, which has been demonstrated over many, many years to be a higher quality, lower cost environment. That is no longer a debate. 3, we've had some clinic staffing shortages that you might have read about in the news that we believe will continue to persist over at least the next couple of years. Home is a solution for a clinic staffing shortage. You don't need labor in the home. Just to be clear, these are patients who are independent or with a family member, dialyzing completely on their own safely and effectively in the home. So it's actually a really great solution for clinic staffing shortages. So this may be an incremental tailwind moving forward. And last, maybe touching on COVID a bit. We believe patient preferences have changed quite a bit. I think we all were impacted in different ways by COVID to say the least. And I think for many patients, the realization that's sitting in a room with 30 or 40 other immuno-compromised individuals 2 feet away from you may not be desirable. So I think also the general rise of the hospital, the home movement, the general rise of telehealth and just patient comfort and sort of this normalization around care, higher and higher acuity care in the home is all serving as supplemental tailwinds to home dialysis. So those are the reasons why I think we feel very strongly that home dialysis is the right idea, these reasons why this is the right time and our belief that this is the right technology and here's our thesis about the right technology. One, we were able to design Tablo from the beginning. This is a huge second mover advantage. We were able to design Tablo from the get-go to specifically target and remove the key barriers that we know from all of our patient market research and physician market research had prevented more people from adopting it in the past. 3, key things, I mean, I could go on and on, but this is like baby pictures. So I will only regale you with 3 advantages. One is the treatments per week. I talked about that reimbursement mismatch with treatments per week. With Tablo, we designed it such that a person can maintain a 3 times a week schedule in the home, just like they're doing in the clinic without being asked to do it 5 or 6 times a week. And trust me, you will never ever, ever meet someone who wants to do more dialysis regardless of the setting. So a huge advantage. 2, training time. The incumbent device does require and they've published on this in the past, about 4 to 6 weeks of training. That's over 100 hours. That's like imagine 5 days a week, 5 hours a day for 4 to 6 weeks. And oh, by the way, you need to have a care partner with you the whole time. That's really obviously quite burdensome. And so we were really focused on getting the training time down. We did this through sensors and automation. Most of the setup of Tablo is automated. There's a few manual steps, but we have no memorization. We have no mental math. There's just a lot less to learn. So we know now in our real-world experience that we've cut that by over 75%. Most people -- our mean training time is between 8 and 10 days. And lastly, prep time. With the incumbent device, patients are asked to fill up the tub on the bottom and prepare the dialysate in advance, that process takes 8 to 9 hours, and you're going to repeat that a couple of times a week. With Tablo, the second the patient walks up and presses, gets started on the touch screen. Tablo automatically starts purifying the water and making that dialysate in real-time, sort of streaming dialysate on demand, no pun intended with Netflix. But anyway, what I think what that all really means is that we've just kind of changed the benefit burden ratio, benefit going up and burden going down. And this has shown up in some of the data even as early as our clinical trial, which we completed in order to achieve actually the second ever clearance for home from the FDA in 2020. In that trial, we had a 0% dropout rate during the in-home arm. And you might say, well, no big deal, why would anybody drop out? The incumbent trial -- incumbent devices trial with the exact same protocol had a much, much, much higher dropout rate. So that was our first clue like, okay, this could be really cool. Like maybe people will finally be able to stay on home for much, much longer. I'll kind of take you to the right that so far has played out in the real world. We really fixate, it's beyond focus. It's an obsession. We really, really obsessed over the controllable attrition rate, which were really not death and transplant, but somebody kind of raising their hand and saying, like, I don't love it. I'm going to go back in-center. I don't like Tablo. And for us, even as our patient numbers have grown, and admittedly, let's be clear, on a much smaller base than the incumbent device. But even as we've continued to grow rapidly, this controllable attrition rate has hovered at 10% or less. So we're really proud of that and intend to keep that patient experience, one that's very, very sticky. And then our adherence rate to prescribe treatment is obviously very, very high. And that was -- that has been a big problem in the past. 5 and 6 treatments being prescribed, but maybe 3 only being done, obviously, is clinically suboptimal. And perhaps the feedback that I'm the most excited about are these patient-reported outcomes. I remember, I was there the first time somebody was ever treated with Tablo. And the person automatically said like, "I feel different." And we ended up kind of a moniker around the office is the feeling better effect. Because it was over and over and over and almost every single person would say things like, "I don't feel like I'm on dialysis or I don't feel like I just was on dialysis." I remember the first person who told me, he had actually been able to go back to work. Most dialysis patients in the clinic, they will sleep the rest of the day and a lot of the next day. And then they're back in the clinic and they repeat that over and over and over again. I think all of us can scarcely even imagine that lifestyle. But with Tablo, people are going back to work, and they are reporting in big numbers, less cramping, fewer headaches, less fatigue. So we're really, really proud of people just feeling well and being able to obviously enjoy the things that they really want to do and value in life. Which brings us to, so how are we going to get it out into the world and how do patients access Tablo. Really, it's a 2-pronged commercial strategy. The first prong is through actually the clinics. We -- our current partners, our current customer base or we would describe as kind of progressive midsized dialysis clinic operators who are nimble, who are moving fast, who are very responsive to some of these new financial incentives and have very clear goals in mind about how many new patients they want to send home every single year. So those are the kind of partners obviously that we want and that we can help with. The benefits and the feedback we've gotten from customers so far, they're using Tablo preferentially to actually drive higher adoption rates. We do have enough evidence now with kind of 2 commercial years under our belt. We know that patients choose Tablo almost every time when offered a choice and that more patients agree to go home with Tablo. Why? Because it doesn't even -- it doesn't look intimidating at first flash. It isn't intimidating. It is very fast for people to train on, and it's easier to manage, easy to manage in the home. So I think providers have seen benefits in faster throughput because the training doesn't require as much time and then longer retention rates, again, this differentiated kind of 90% retention rate. The second prong for us though is to expand the provider universe. This is what I'm the most excited about. We need to expand the channels through which a patient is going to be able to access and go home. There is no structural reason why a patient has to pass through a clinic to get to the home. That's just kind of the way it's been, but there's no reason it needs to be that way. And so this is where we -- I talked about cross-link between acute and home. This is where the strategy comes together. We are using our very kind of thick and growing foundation of acute customers, hospitals and health systems to stand up their own home programs. I talked about the majority of new patients every year actually coming in through the hospital. The hospitals control the referral stream, not the downstream clinics. And so more and more hospitals are eyeing moves into home dialysis for the following reasons. One, it is a new chronic predictable revenue stream that's very complementary to perhaps what we now know through COVID, was a more volatile elective procedure volume. 2, it comes with a very attractive contribution margin for them. And 3 more recently, it's a solution for discharge management because of some of these clinic staffing shortages, a lot of these clinics may be going down from 3 shifts to 2 shifts or 2 to 1. And so hospitals have increasingly been talking to us about difficulty in discharging their dialysis patients into a clinic. If a hospital or a health system stands up their own home program, which, by the way, was the way it was done in the '70s, sort of before the rise of kind of the industrial complex around dialysis. So this is not a new idea, but hospitals can control discharge and also really control cost. They're going to do a better job in a value-based care environment and ensuring that patients don't return to the hospital and stay home. So this is sort of current state, moving to future state. I'm realizing the slide design probably should have been more left to right, but we're going right to left with the intent around a much, much bigger home market for all. As these -- as we penetrate into these markets and grow markets like home, we also will and already do leverage a very efficient business model. I hate the analogy razor, razor blade, but I'm going to use it instead of a better one. Yes, it is a razor, razor blade model with the purchase of the Tablo consoles, then generating a very long tail recurring revenue stream through the sale of disposables. There's a disposable component to every treatment and service. And so all of that adds up to roughly about $20,000 per year recurring revenue in the acute setting per console and about $15,000 per year per console in the home setting. We -- moving to kind of 2022 and 2023, and I want to make sure we save enough room for questions here. But we did exit 2022 in a very strong financial position. As mentioned, preannounced revenue of about $115 million for 2022, exited the year with an installed base of 4,000 consoles. This compares to about 2,600 consoles as we exited the prior year. So we saw some really nice growth there. Roughly 3,200 of those in the acute setting. We more than doubled the installed base in the home, the chronic, to 800. The company continues to make very good consistent progress against gross margin. We expanded gross margin approximately 800 basis points in '22 and left with a very strong balance sheet, $261 million as of September 30. And as some of you may have read, we also announced a debt arrangement in November, which gives the company access to an additional up to $300 million in capital over time as needed. We are entering 2023 with a lot of conviction and confidence in this plan. We did on Monday, announced revenue guidance of between $140 million and $150 million, which would represent somewhere between 22% and 30% growth. We of course continue to march upward on gross margin, our next mile marker on margin that we talk about is a 50% gross margin, not as a terminal value, but as our next goal and intend to exit 2023 in the mid-20%, again, on that trajectory up to 50%. And then we continue to or intend to continue very disciplined, determined execution to the same commercial strategy that has worked so well for us over the last 2 years. On the acute side, what we call land and expand, big contracts with the national IDNs, large regional players that put Tablo in an in-sourcing program into a couple of their hospitals and then expand and proliferate those programs through the rest of their network over time. And then what we call sort of high growth, high retention, again, premium on retention in the home, high-growth, high retention strategy for our home segment. I want to leave you with perhaps the most important goal and aspiration and prediction that we have for 2023. I think '23 will be another year of deep impact for patients, for people and their families. Dialysis patients have been, in my view, served up good enough for a really, really long time. And they do deserve great. They deserve the experience that we would all want to have. I was reading something actually this week. It was a quote -- a quotation from Emerson, and it read something like a good indignation reveals one's powers. And I will tell you like we're a pretty indignant group. And we absolutely will not rest and we will not be done until a new human experience is the new norm. And we will continue to relentlessly execute toward profound and permanent change in the where and the how and the who can perform dialysis on behalf of patients and all of their families. So with that, I want to thank you for your interest in the story, and we can transition to Q&A. I'd also like to invite Jim Mazzola, our Vice President of Investor Relations, up here with me. No clapping? Is the clapping after? Anybody have questions?

Oh great. Okay, you can take the first question from -- just if you want to wait for the mic, sorry.

Wanted to understand the value prop for your acute care customers. So if I'm thinking about this right, you had $450,000 savings from the HCA hospital. And I think you said that each customer, acute care customer is about $20,000. So does that mean that hospitals pay about $470,000 a year for clinic referrals or the clinic process? Am I thinking about that right? And what are the components in that?

Yes, sure. So maybe we'll talk about it on a per treatment basis, and then you can sort of multiply that by volume, right, of the hospital's volume. So a hospital that's outsourcing dialysis, and this number has continued to escalate, is probably paying actually somewhere between like $1,000 and $1,500 per treatment. Let's say, for a treatment in the ICU compared to an in-source, let's say, even with their own labor rates escalating maybe for a treatment $300 for their own team to perform the dialysis. And then all of the disposables that would be related to Tablo and dialyzer and other things that are outside of Tablo, you might be all in sort of 75 to 100. So you're really looking at a delta potentially of like 1,500 down to a couple of hundred.

I'm not clear, do you have distributors or -- because I see like for sleep apnea and oxygen, which has significantly simpler products, they have very successful distribution with all of those companies that does that?

No, we don't have distributors. It's not a DME model, I'm really glad you asked that, in the home. And so let's say that we have a partner that's a dialysis clinic operator, right? They might have, I don't know, a 100 clinic locations. They have home programs. And so our customer actually is the clinic provider, and they have home training nurses. So we go in and train the home training nurses, it's the train the trainer model and then their patients are trained by their own clinical team.

Why not utilize the network of people who do oxygen and other things at the home?

Yes, it's an interesting idea. We're pretty margin sensitive. We take our commitments to shareholders pretty seriously about our gross margin goals and cash goals. And I think that would ultimately prove out to be a more expensive model for us in the way that we're currently doing it.

Could you talk at all about the TPNIES add-on payments and what impact that's had and what might happen when that rolls off?

Sure, yes. So maybe just some brief background. CMS set up a new program, it's effectively a new technology add-on payment called TPNIES, TPNIES, choose your favorite pronunciation, but anyway T-P-N-I-E-S. And there were a set of criteria that new technologies, specifically in the renal space needed to meet. We applied, a number of other companies and technologies have applied for it, and Outset was fortunate enough to be the only technology and company to receive it. It equates to about $25 per treatment, and it's a 2-year duration, which is the genesis of the question. So we're now in year 2. I would say that it's by and large, #1, it's been a new program for CMS. And so I think it took a little bit of time, as you can imagine, for them to figure our case, here's how we're administering it and here's how you apply for it, et cetera. But I would say it has generally been very helpful, but in a different way. It really added a pretty significant halo effect to Tablo. It was -- it's really tough criteria to me. You have to prove that your device is a substantial clinical improvement over what's already in the marketplace. So I think that perhaps its greatest benefit was one that I didn't predict and probably a qualitative one where it really sort of sent shockwaves through the industry that Tablo got it. It really was a pretty significant stamp of approval from a government agency.

Can you expand on the opportunity in assisted living and congregate living types of facilities where, otherwise, I think so many people have to be transported by BLS ambulance to great expense to the system?

Yes.