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

Good morning, everyone. I'm Stephanie Piazzola. I cover medical devices at Bank of America. Next up, we have Outset Medical. We have CEO, Leslie Trigg and CFO, Nabeel Ahmed. Thank you both for joining us.

Of course.

Thanks, Stephanie.

So since you just reported Q1 last week, maybe that's a good place to start with an overview of the quarter. You had some headwinds to revenue, but it sounds like those are behind you now and some other positive updates as well. So maybe talk through those and what you thought the key takeaways of the quarter were?

Sure. Happy to. Well, I think the -- I don't think I know the 2 big headlines of the quarter were getting FDA clearance for TabloCart, which has definitely been a headwind, a persistent headwind for Outset over the last 3 quarters, as we saw that affect the timing of orders kind of pushing out from quarter-to-quarter. Getting that back on track and online was really, really a big deal. And two, probably the second big, big headline was our own restructuring and a very significant amount of cost reduction that we announced we had taken out, not only of 2024, but also '25, '26 and '27 that will allow us to reach cash flow breakeven a couple of quarters earlier than we had previously announced with some potential upside incremental to that. We had already taken out about $20 million to $25 million in October on an annualized basis, and this is on top of that. And so I think we felt really good about our ability to kind of right size our expense profile with the rest of the business. And from that standpoint, I think, to me, it's kind of cleared for takeoff. We've cleared out TabloCart. We did have a little trouble in the quarter due to the Change Healthcare cyberattack, oddly. As we saw a couple of our customers deferring purchases both treatment and consult until their own cash flow normalized, but we saw a really, really strong start to the quarter in April. So we also feel like that very temporal factor is behind us. So just looking forward to executing and growing into our guidance range for the remainder of the year.

Yes. And then maybe just touching on guidance a little bit more. You guided to Q2 low $30 million, which is maybe a little bit below expectations but reiterated the full year guide of $145 million to $153 million. So maybe just talk through some of the first half or second half dynamics that give you confidence in the full year guidance?

Yes. So Stephanie, we'd always talked about this year as being kind of the tale of 2 halves, right, where 1H, we expect it to look like the back half of last year, given again the absence of Cart. Now we did get that approval a little bit earlier than we had anticipated, but what's baked into 2Q is our expectation that we're going to ramp back a little bit, if you will. We still have to get customers to sign purchase orders to sort of -- we have to redo order agreements activities that we had -- we had to stop when we went on hold. So we really think of 1Q as being kind of ramping back up, if you will, setting us up well for a strong second half. And then when we think about the second half and kind of our conviction in the guidance, there's -- again, there's 2 components. So one, we will have stronger recurring revenues, consumables and service off our larger installed base. And with those larger recurring revenues, the implied console guide for 2H is roughly the same as the console revenue we actually produced in 1H of '23, which is when we had TabloCart card available, right? So you can sort of think about 1H '23 gets 2H '24 into the guidance range. And obviously, we have a bunch of performance levers. We can sell more consoles. We can again go sell more Cart into our installed base, folks who've been waiting. ASP is ways a lever for us. Tablo pro plus attach is always a lever. So that's kind of how we think about the second half.

Okay. Great. And you kind of just touched on this, but maybe following up on the TabloCart approval now that you have that. Maybe talk about the process of getting that back out into the market is like? Is everything ready to go from a manufacturing perspective and just the process of reengaging with customers that previously deferred their Tablo orders because of TabloCart?

Yes. Well, so we're just about a week into this. So with that as a caveat, I would say the customer reaction receptivity has been really positive and really high. We're already generating quotes right now. Manufacturing is -- it will not be an issue. We had inventory, and we had continued to produce during FDA clearance, knowing that the clearance was not an if, but a when. So no issues in terms of supply. The variables here are how many hospitals will have to run this through their capital budgeting, their own internal processes again. Some of them had budgeted the capital. This TabloCart is about $10,000 and most hospitals are buying many or multiple of them. And so it does tend to trigger the capital purchasing approval cycle. How long does that take and how many hospitals do have to go through that again are unknown variables at this time. Some of them had budgeted for that back in Q3 or Q4 or even Q1 and choosing to wait. And so that will be a factor. And then also, we do have deals that are in our pipeline without TabloCart and sometimes that works to your disadvantage, right, to try to interrupt a staged sales cycle and interject or add a PO for something new can inadvertently push the timing of orders outside of Q2 and that we don't want to do either. And so acknowledging that there are some unknowns that are out of our control, there is a lot that's in our control. So we have been very aggressive in educating new customers, our existing customer base, making sure even our new sales team members who actually haven't sold TabloCart before because they've maybe joined the team since we pushed the pause button on it, all of that within a week is relatively done. And now we're going through, as I said, kind of the MSSA process, codes, POs and working with hospitals to get through their internal approval cycle. So all of this is to say, in our view, the major catalyst for the back half, the second half of the year is TabloCart and all the work is designed to really make sure that we are right on the launch pad ready to go for Q3, Q4.

Okay. And then maybe just last 1 on TabloCart. Is there a way to think about kind of this backlog that formed when customers were delaying their Tablo orders in the last few quarters and how we should think about that coming back in the second half? Is it like all of the orders coming back, some of the orders or what is the best way to think of that?

Yes. So number one, we've sort of baked that into our guidance range, and I'd go back, Stephanie, to what I said, we're kind of to get into our guidance range is this notion of repeating 1H of '23, and then we will have some of these, call them backlog orders or what have you, that will move us up through the guidance range. But in addition to we're not just depending on those. It's also our ability to sell more consoles. It's also pro plus attach, other factors as well. But that's kind of how we thought about the guidance range.

Okay. And then maybe to follow up on the restructuring. You mentioned earlier, a few part question why you decided to take that action now? How you thought about the shift and what you're choosing to prioritize investing in and then the expected cadence of savings through 2027?

Okay. Well, I can kick that off and...

Yes, I can do the cadence. Yes.

So on the why now -- okay, so to take a quick step back. So we -- as I just mentioned, we did undertake a cost reduction effort in October, and that enabled us to get cash flow breakeven into 2027 and gave us the time and the space to get there. So that was a really important first step forward, and that was, again, $20 million, $25 million on an annualized basis rolling forward. But as we thought about it more in Q1, we really just decided to challenge ourselves to figure out if we could get there sooner. We are very well aware that our shareholders, both existing and potential future shareholders would like to see outside, in all companies, get to cash flow breakeven as quickly as possible and burn less cash. And so it really became a challenge, a thought exercise, could we figure it out? Could we make it happen? And so took most of the quarter to determine how to do that in a way that did not jeopardize revenue growth, the guidance that we've given for the coming years. And how can we do that without also jeopardizing any of our gross margin expansion initiatives because those have been really, really successful for us. And that was a big bright spot in Q1. We overperformed again on gross margin, and have a lot of conviction on the rest of the march up. So we didn't want to do anything to jeopardize that. And we did get there. So how? We are holding kind of gross margin as a protective nonnegotiable and revenue growth as a protected nonnegotiable. We took a really hard look at R&D, long story short, our R&D and operations. And we are a very ambitious imaginative bunch of people. And so we have been investing quite heavily, I would say, in ideas and projects on the R&D side, that I would describe as future-proofing far into the future, where the spend was high, but the return profile was not short term. And so that's a big area that was probably at least half of where we were able to reduce our spend. And I'll say before turning to Nabeel, also take advantage of the very, very extensive lead that we already have over the incumbents in the space. And this is another point that had been brought up by many shareholders. And it's a good point. You guys are already so far ahead, Tablo is light years ahead. Why do you need to continue to spend so much on R&D. And this is not to say that we are going to stop being innovative, far from it, but we're going to look to be innovative in ways where the return profile matches the spend profile in the same period.

And just on your last part of the question, Stephanie, on cadence. So it's roughly $20 million coming out of this year out of 2024 and then that annualizes to about $30 million in 2025 and a little bit more than $30 million in '26 and '27. So in aggregate, we've identified a little over $100 million in savings. And then as Leslie pointed out, to the extent that we can accelerate gross margin a little bit better than what we've sort of anticipated, that will deliver even more savings and get us to breakeven potentially quicker than we've guided.

Got it. And then to follow up on gross margins. You saw -- you've seen nice sequential improvement each quarter. You just reported 31% in Q1. And expect to exit the year in the mid-30% range, which is nice progress toward the goal 50%, maybe just give an overview of your 3 main drivers of gross margin improvement and curious if any of them change or become more or less impactful over the next few years?

Yes. It's interesting. We went public, and this is now a few years ago with negative 36% gross margins in that zone. So we have already expanded gross margins by kind of 60 percentage points. And the path from here to 50 is -- the slope is narrower or less steep than it has been, right? So we've kind of I think, Just credit to our team has done a tremendous job here expanding gross margins, and we continue to have conviction on that path. The levers are the same 3. So one, it's console cost down. Since we've had consoles, we've taken out cost of components, either supply chain or R&D programs. Those programs continue. They continue to be funded within kind of the framework we talked about. Number 2 is just a natural pull-through of consumables and service leverage as the installed base grows, right? If the installed base grows and we pull through consumables, which have a much higher gross margin than console, we get lift. Service on the edges every incremental service contract is all margin. You don't have to add field service engineers at the same rate. So there's this element of just buoyancy based on the installed base growth. And then the final thing I'll say is we have made and we'll continue to make investments in remote diagnostics -- remote repair capabilities to even further enhance service leverage. So it's console cost down, it's consumable pull-through and service leverage. We've been doing it through today, and we'll continue to do it going forward.

Got it. And then maybe just touching on 1 of your other recent announcements was the multiyear agreement with U.S. Renal Care, so maybe just give us an overview of that agreement, what these patients and their home programs are doing today and now how you expect it to help drive home hemo adoption with Tablo?

Yes. And I will say we've seen really good growth so far this year in home. And I continue to be very bullish about it. So our go-to-market strategy is 2 tiered. So the first of which U.S. Renal Care belongs is partnering with what are known as midsized dialysis organizations, MDOs. And U.S. Renal Care is the largest of those. I think that they are probably around 36,000, 40,000 patients that they manage now. So they're operating at very, very significant scale. The second tier strategy is upstream of that, and that's all about expanding the provider universe, expanding channel access, giving patients more options to access home. And we've seen very significant movement in that -- executing against that strategy. Two of our fastest-growing home programs were entities that actually were not even in the home business a year or 18 months ago. These are new businesses that are formed to be home-only programs. The only reason they are in dialysis is to serve patients at home. And those are all to a program all Tablo only. They are specifically choosing Tablo for 2 reasons, and this is the same for U.S. Renal Care. One, it is immensely faster to train the average person, almost regardless of the demographics on Tablo compared to the incumbent system. The incumbent system, this is widely reported over their 20-year history, typically takes 4 to 6 weeks to train 1 person. And that's 5 days a week, 5 hours a day. Our main training time and we have closely studied this regardless of demographics is 8 to 10 sessions and they're ready to go home. So that has been a real enabler in getting patients to adopt home, lowering the barriers to adoption there and really opening up the envelope as to who can be successful in getting through training in home. And that's really measured by our 90-day retention rate, which is 90%. Now you might think, well, 90 days, that's not that long. That was my first reaction, kind of so what who cares. And then we looked at the government's data on this, the USRDS, and with the incumbent device, the retention rate at 90 days, their retention rate is 65%. So we are driving a very early difference in 90 days, getting people through training at home, and then our 90% is holding at 12 months. We only have about 10% patient opt off rate. You do have some death and some transplant that go along with that. But the sliver of patients saying, "You know what, this isn't for me." That's been really steady at 10%. And which is quite remarkable and very differentiated from the existing incumbent technology. And so I think it was really for those 2 reasons, faster training and the ability to keep more patients at home longer that led U.S. rental care to start to offer Tablo in a differentiated or preferential basis.

Got it. And then maybe following up to your point on how you have hospitals and subacute providers, setting up their own home programs as 1 of the path to sending patients home. Maybe if you could talk through a little bit more about why they decided to do this kind of the benefit that they get from setting up the home program?

Yes. Well, I do think another catalyst for the back half of the year is skilled nursing facilities. So catalyst 1 is TabloCart. Catalyst 2 actually is our gross margin for overperformance quarter-over-quarter. And I would say catalyst 3 is the skilled nursing facility above and beyond our normal execution on our pipeline. But the reason why I say that is that the financial -- the economics for the skilled nursing facility is very, very powerful. When they choose to bring dialysis on-site because that's the model, they are able to avoid cost, which is -- that could be $1 million a year, transporting their patients from the SNF to a DaVita or to a Fresenius, all that cost goes away. And since they're usually operating at very thin margins, just the margin expansion alone is material for them. And then the second part of the economic return for them is actually on the top line. Most dialysis treatments are reimbursed. Medicare rate is [ 270 ]. When you fold in Medicare Advantage, it's typically like [ 325 ] per treatment, 3 or 4 times a week. That's also got an attractive revenue profile for the skilled nursing facility as well. And 1 that's new for them in addition to being able to keep their patients in-house and ensure that they're getting kind of the services, the billable services that they need and that they can. They can make sure those patients have access to. So it's a very strong economic ROI. And on top of that, we're now seeing the subacute players extend out of the in-house and into the home for the same reasons, really cost reduction and top line revenue growth.