TransMedics Group, Inc. (TMDX) Earnings Call Transcript & Summary

Ready to go.

Yes. I think it's a morning. Good morning, almost afternoon, but good morning. I'm Cecilia Furlong, med tech analyst here at Morgan Stanley. It is my pleasure to have TransMedics with us, CEO, Waleed Hassanein, CFO, Stephen Gordon. Before we get started really quickly disclosures. For important disclosures, please see the disclosure website at morganstanley.com/researchdisclosures. With that, Stephen, Waleed, thank you both for being here.

Thank you for your invitation.

So I wanted to start with current year outlook for the back half of this year. And during your 2Q call, you called out a lot of factors. You're balancing, though, have a macro that is more challenged while also trying to scale a very unique business model in med tech. And I want to spend more time there. But as you think about just the back half of the year. Where was conservatism more? Is it the macro uncertainty? Or is it really as you think about rolling this out in a very kind of measured manner and getting the outcomes that you really desire, which is the bigger driver among those?

I think the most important driver is it is clear that we are growing extremely rapidly and with solid demand far outpacing our ability to supply at this point. And we want it to be prudent, and we wanted to be careful to make sure that we are setting the proper expectation to give us the opportunity to execute and fill in that gap. That's really it. The demand is at all-time high. And as I've stated in the 2Q call, it's far outpacing our highest demand plan. And we are -- the good news is we have been making significant investments in ramping up our production capacity in infrastructure, building -- tripling the size of our clean room to ultimately quadruple our production capacity, but it takes time and it takes people. And we wanted to make sure that we are -- we have the proper cadence and proper time to do it, to do it right because we want to do this once and it will help us grow for several years to the future. So that's really where the conservatism was built on, the demand is huge, and we want to make sure that we have the time and the capacity to overcome that gap between our ability to supply the product and the huge demand that we're experiencing, especially with NOP. There's no doubt or there shouldn't be any doubt or concern about our efforts and ability to close that gap significantly in -- throughout this year because we want to capitalize on that demand. But that's really where that conservatism is stemming from. As far as the macro piece, we have raw material for the next 18, 24 months. We're not concerned about that. It really is the ability to build in the throughput infrastructure.

Looking at your updated guidance to the top end of the range, and I think, Stephen, you commented on the 2Q call. But should we think about just your capacity, your manufacturing capacity continuing to support upside to that range this year? And then tripling the size of the clean room how far out does that get you in terms of just your capacity longer term before you have to potentially readdress that in the future?

Yes. So let me answer the second one first. So the tripling the size of the clean room and potentially doing a double shift should give us a very long runway, several years of runway to continue to grow at a very fast pace that we're seeing. So we're not worried about long-term capacity though. I think in the short term, what we need to do is make sure that we're growing our throughput like what we said. And I think we're doing a pretty good job of being able to do that. some modest upside to the guidance. I think that's possible. But the things we talked about at the Q2 call were real things. We weren't just being conservative for conservative safe. There are real things -- but I think we're managing through them quite well.

I wanted to ask to just underlying transplant market. You talked about a bit of softness in June, some acceleration in July. What -- if you can speak to just kind of seasonality that you saw on the heels of July, how that relates to kind of a more normal year. And then from a lung standpoint, have you continued to see any improvement there? And what is kind of factored into your thinking for overall lung underlying transplant volumes through the balance of this year?

So the June numbers, we never look at a 1-month transplant numbers and extrapolate for the whole year. I don't think that seasonality transplantation is known to have 1 or 2 months a year where the numbers dipped significantly. We were just up signaling that I know some of our analysts covering us are looking at these transplant numbers on a granular basis. And we were saying, don't look at those. They don't signify much for the year. In fact, I will go out on a limb as I've stated publicly numerous times, that we expect to see an overall increase in heart and liver transplant volume year-over-year in the United States in 2022 over '21, just based on the huge number of DCD and extended criteria organs that we are delivering in NOP for these 2 organs. So we're not looking at June as a signal of seasonality or anything like that. We were just trying to say to the Street that listen that yes, you might hear that June was low, but we've seen significantly rebound in July and August, and we expect that to be the case. There may be another month with [ this ], but overall, we're overall, we're expecting the full numbers for heart and livers to grow year-over-year. As far as the lung is concerned, as we also stated in the 2Q call, the lung is going to take up a little bit more time to recover. The lung has been really down for 2-plus years because of COVID. And we are working on major initiatives to really generate true solid, sustainable momentum into the lung, but that's going to take us into '23. So the rest of this year, we expect to see, I would say, steady lung numbers. I wouldn't dare to even call it, grow normally, I would say, steady to be conservative. But really, what we should be all expecting is in '23, all these initiatives that TransMedics is undertaking now will start bearing fruits, and we'll start seeing some significant momentum into the lung in '23 and carrying over to '24. Our ultimate goal is by end of '24 that all 3 organs are generating, are firing on all cylinders in the NOP with generating nearly equal growth potential for the business. So that's from a lung standpoint.

You talked about 2Q being in between 6 to 12 centers depending on organ heart being, I believe, at the top end of that. But as you think about just what's contemplated as you exit the year? Where does that go? And is your focus really kind of those centers may be of one organ right now, getting another organ onboard or driving deeper penetration in those centers versus expanding your footprint? What's kind of the way you're thinking about it, so?

The way we've always been thinking about our business is follows the same model as I'm going to describe it right now. The #1 order of business is when we enter a center for one organ that we are driving deeper adoption of OCS and NOP for that organ. That's our #1 priority. Why? Because we want to make sure that this is a sticky account that's going to generate more revenue consistently and we can rely on it. That's why we changed the definition of the centers that are involved to centers that are generating a minimum of 2 utilizations of OCS per month during the quarter. So that's number one. Number two is to grow within the same center into additional organs. We go from liver to liver and heart or liver on lung or heart lung and heart and lung and liver. Number three is adding new centers. So these are all 3 catalysts that we follow in that order to make sure that we are growing on solid footing, putting the solid foundation together and then each one of these catalysts is additional catalyst for our growth, adding new organ in the same center, going deeper in the same center, adding new organ and growing the number of centers. Where do we end the year? As I stated at the end of 1Q call that we expect to end the year anywhere between 10 to 12 centers or accounts or programs per organ involved in driving our revenue and NOP in the U.S. The lung may be 1 or 2 lower than that, but heart and liver, we feel pretty confident that we'll be in the 10 to 12 accounts by year-end.

In terms of NOP and heart specifically, and we did see a step-up just in terms of utilization 1Q to 2Q, so below kind of nearly 100% in lung and liver. Where does that go through the balance of this year? How are you starting physicians? What is the mix of DCD specifically that you're seeing go through NOP versus kind of direct acquisition to the extent that still exists?

Sure. So we expect to see growth of NOP in the heart. Our goal is NOP will be 100% of our U.S. business by end of next year. As far as where the mix is between NOP and direct acquisition, all new accounts coming into the heart or liver or lung for that matter, are only going through NOP. We're no longer offering direct acquisition as an even an option. It's very, very few centers use it and even the centers that still has it, they're running NOP in parallel. Our goal is to transition out of the direct acquisition model completely by '23. As far as the mix between [ DPD ] and DCD, it's I've stated publicly numerous times, I would say it's at least 50-50 right now, and we expect it to stay at that level, and we're running it all through NOP.

In terms of to just the lung dynamics in the broader market, what are the biggest headwinds right now still that are limiting those volumes?

It's not a clear-cut headwind like the COVID pandemic coming and nobody knew if we can transplant lungs in the COVID era, and we can -- donors who are COVID negative, but had history of COVID. Could they become a lung donor. All these were big questions that we've been dealing with or the market has been dealing with for the last few years. Now it's just the market is just fatigued by that COVID cloud over lung transplantation. That's the best I can explain it. And this is why I'm saying, we need to invigorate that market through other initiatives that not just focus on NOP, but something that I've stated publicly at the last International Society of Heart & Lung Transplant meeting is we are launching an effort in the United States, teaming up with CMS, teaming up with commercial payers, teaming up with U.S. Congress, teaming up with major transplant program to doubling the lung transplant volume in the United States over the next 3 to 5 years. It's a big goal, but it's a goal that it is intentionally big and it's intentionally bold because that's what the market needs. We need to kind of shock the market into going back to focusing and transplant [ to mark that ]. At least from my perspective, I see the market is just [ to keep ] by the 2 years' worth of COVID kind of black cloud over lung transplantation. And we think that we have a good chance in executing on that vision to really get a lung back firing on all cylinders sometime in '23.

Okay. In terms of your guidance too, I do think conservatism baked in, in very -- a broad range of areas. But as you think about just NOP and the unique dynamic of this business model, I mean, what are the biggest areas. And as you think about to just getting centers comfortable with the pricing strategy, what -- where have been the biggest issues? What have you learned from that process? And where are you sort of addressing those maybe more efficiently today than initially in the process?

So we feel very strongly that NOP is the future of U.S. TransMedics business and, frankly, the future of U.S. transplant. So because of that belief, when we talk with institutions, centers, programs and the only focus or pushback we hear is the incremental $15,000 to $20,000 cost of the NOP portion. They don't question that the $65,000, $70,000 cost of the disposable. We've always stated publicly that the NOP is nothing but a better way to increase adoption of the disposable and utilization of the disposable. So for us, because we believe that this is the future, and it's only a matter of time, we engage with them on highlighting that those $15,000, $20,000, one, you're getting reimbursed for; two, it's dollar for dollar in CMS, and we work with them in educational process to teach them how to do it through commercial payers. So we have a very good track record of converting these centers into NOP centers. Are we being too aggressive right now? No, for a reason because I stated our strategy has always been to go deeper first, grow within the program, then add new centers. So the combination of us trying to kind of manage the kind of manage the deployment of NOP on solid footing with deeper penetration is playing a factor. So we're engaged with all transplant programs in the U.S., all 40 of them per order -- and we are intentionally kind of pacing ourselves to be at the full 40 by end of '24, not before then or if we can, we will bring them in. But right now, it's reporting that methodical approach to approaching these centers. But Cecilia, I want to be clear, the cost, the price, the sticker shock is not a hindrance in our ability to grow NOP and hopefully, the result of the execution of the second half of the year, we'll point to that across all 3 organs.

Okay. You also highlighted chartered flights as a potential headwind. How do you think about addressing that going forward? How do you roll that in, in a broader way to your overall business model?

I want to highlight one point of clarification. We stated that the charter flights will be a bottleneck for '23 growth. because we are on a pace to -- we know we're in a pace to doubling our revenue '22 over '21. We want to be in the same situation in '23 and '24 or very close to it. This is where we're going to see a bottleneck impact of access to private jet for us to be able to be nearly doubling our revenue next year or at that kind of growth pace, we need to get involved. How do we get involved? There are several ways. Our approach is to be less cash-intensive upfront until we have enough firepower and execution to give us flexibility to navigate from there. So initially, we are looking at transplant at specialty transplant logistics companies to enter into an exclusive arrangement with them to be covering NOP 100%, working with them on beefing up their assets or access to airplanes, whether through partnership, through investments and the like. And then as we mature from there, we potentially -- we would acquire that entity into TransMedics, but I'm talking 2, 3 years out, not sooner than that. If that growth is there and the business justified, we might be more aggressive. But our original plan is to be less cash intensive upfront to build the infrastructure and then we can have flexibility down the line. I mean, Stephen, do you want to add anything?

No. I think the main thing for us is to be able to secure confidence that planes are available when we need them. And we're willing to give confidence to the companies that we're working with that, we will give you a certain number of missions a year if you ensure that we have 100% capacity of your planes, something like that in the beginning.

Okay. Also just curious to, in the centers where you have NOP today, where are you seeing OCS used or where conversely are you not today? I know there are a few dynamics I'd love to kind of hear a bit more about just optimizing workflow patterns scheduling. But as people -- as physicians look at kind of the organs, specifically that go on OCS, how was that decision broken out?

That's the next one question, Cecilia. One of the things that excites us the most about NOP is the NOP have changed the dynamic from where OCS is being used from a clinical decision to a more of a of workflow decision, meaning when we enter a new center in NOP, their innate reaction is the first few cases, they're going after DCD, they're going after donors that are far away. But then once they see the results, and once they see how easy the process is, we find ourselves doing their local cases, their nearby cases. And because it's no longer a clinical decision. It's no longer -- is it DCD or marginal or extended criteria or older donor. It's more of capacity. I can go to sleep at night. I wake up in the morning. I have 2 OCS cases to do and transplant becomes more of a scheduled procedure versus without the OCS or without the NOP, it's an emergent procedure that the entire team needs to be assembled at 2:00 or 3:00 in the morning. We're seeing that, and we're seeing that at a big scale in the institutions that adopted the OCS, NOP, -- we're in the 55%, 60% of their volume and their volume has grown. So it's not just cannibalizing their existing volume. They're growing their volume with the NOP. And it's very common today to have 2, 3 OCSs coming into a center. They're staggered overnight, means staged overnight and the transplants are done in the morning. So that's one of the impacts of the NOP that we're seeing, transitioning that decision matrix from a clinical -- pure clinical decision to more of a workflow and life -- work-life balance decision to maximize transplant volume without [ over-testing ] the logistical process within the institution.

You talked about to just the ability to increase volumes on the heart side specifically, how much of DCD as a contributor to the increased [indiscernible].

Huge. This is why, as I said, I'm going on a limb in saying that we should expect the total U.S. heart transplant volume this year to be higher than last year because we're seeing how much DCD hearts are being utilized through NOP and the OCS. We think it's going to be a huge player. But we're also seeing a significant contribution of extended criteria orders, meaning organ that routinely would not be transplanted on -- older donors, donors that are coming from the Pacific Northwest, where they don't have a lot of heart and lung transplant centers there. They were never been accessed before. We're flying to Pacific Northwest almost daily, getting organs through the NOP. So that [ one is also contributing ]. But purely based on DCD, I expect the numbers to grow on heart and liver, '22 over '21.

As you think about further rolling out NOP, how does your -- stepping back, what is your collaboration with OPOs today? But as you roll out NOP, how does that change in your mind over the longer term?

It has already changed. We are supporting OPOs now, but we're not relying on OPOs at all for our NOP growth. Our NOP growth is coming purely through the center, direct center interaction. So we are working with institutions and programs directly. OPO is an important partner and stakeholder and transplantation in the U.S. So by definition, we are engaged with them. But they're no longer a gatekeeper or an important growth catalyst for us. They're mostly just a facilitator of where the donors are coming from. And given that we started working with them a 1.5 years ago, now we have broader and better understanding of the importance of NOP. They've seen it in their own hands. So they're becoming more of a support function rather than an inertia factor in NOP adoption in the U.S.

How do you view just the overall role of OPOs within the landscape evolving over the next --

I think I'm not -- this is not my own view. The dynamic that CMS is leading and HHS and congressional focus on streamlining the U.S. transplant model in the U.S. Clearly, we'll see some transformation of the role of the OPO mainly in the form of consolidation. We don't need -- at least that's what CMS is saying. CMS has signaled that they don't expect to have 50-plus OPOs in 2 years from now. They're more focusing on consolidating those down to a much more manageable number. They're focusing on driving performance metrics in the form of utilization of organ. So this is new to OPOs. OPOs are not used to being held to any center. They're just the operators, they wish and it's going to be different for them. So I suspect there will be smaller number of OPOs and the ones that are going to be active. They're going to be laser-focused on growing transplant volumes. And I'm hoping that NOP and the OCS will be a mechanism for them to continue to drive and grow.

As you think about NOP longer term, I think somewhere, I've heard between 20 to 25 launch points seems about right to cover the U.S. How do you think about to just if that is kind of the longer-term target the cadence of rolling that out? Is it pretty steady? Do you see an acceleration at some point [indiscernible].

I think 2025 is the number I used, I think either in the 1Q call or the earlier call before that. I think we're -- I think if the number might be actually smaller than that, now that we are deep in the U.S., we're finding that the 14 launch points we're active from today are [ sufficient ] to drive growth near term, but we expect to grow somewhere to be around 20% or so. How are we managing that growth? We're managing that growth based on demand, based on hot spots. We're tracking where donors are coming from. So we expect to launch 2 new launch points in the U.S. before year-end to end the year between 16 and 17 launch points. And I think next year, we're going to grow that to 20 plus or minus. But the 2 new launch points coming up, they are based on where we've seeing the areas that our team are flying to like the Pacific Northwest and Southern California for donors to bring back to the Midwest and the Northeast. So that's how we will manage it. So we're guided by where the activities are.

Do you foresee staffing at all as a headwind as you think about growing?

I mean, knock on wood. We've actually been fortunate to be able to access the clinical staffing we need to staff a launch point from nurses, ICU nurses, perfusionist, physician assistants that are kind of burned out of taking care of patients in the hospital because of COVID. So far, it hasn't been an issue, but obviously, we're keeping an eye on that.

Okay. I wanted to turn to longer-term kind of pipeline, a few different topics, but you've talked about a next-gen OCS system. Kidney is an area that I know you've talked about getting into. And then international also as a potential growth factor. As you think about just the balance between those 3 priorities today, how we should be thinking about time lines and when we could hear more about the next gen OCS as well as Kidney?

Yes. These are excellent points. All 3 are focus for us. The cadence or the sequence of events is obviously the next generation is critical because we want to make sure that we stage the next-generation program to eliminate any risk of obsolescence for our current technology. Next will be the kidney because that's our next frontier. It's a huge market. It adds significantly to our TAM. The NOP, it's very NOP-friendly organ. And we have to conduct the trial. We expect the kidney trial in the U.S. to be launched second half of '23. We expect the -- we are already in the process of expanding our next-generation activity. It's already ongoing, but we're going to expand it. And we expect to see the first wave of next-generation development yield to be sometime in second half of '23, early '24. And then we -- every 6 months, there will be a cycle of iterative changes to our program. We didn't want to do a full cycle that takes 5 years to develop. We wanted to introduce new technologies into our system to help expand and facilitate NOP. And then the last one is the international markets. And the reason why it's the last one, it's not because it's not a priority. It's because it's really not under our control. The negotiations on reimbursement is the key. And when you're negotiating with federal governments and national governments and sometimes regional governments, if that's something we cannot control, takes the time it takes. And we expect to see results of that in the next 18 to 24 months. So that's kind of the sequence of these 3 topics. [indiscernible].

I know we have a few more minutes left, yes.

[indiscernible] Finance Committee report that came out, I guess, last month. Are you seeing more activity, more engagement based on sort of things getting serious from the federal government side?

I think you can argue that yes and no. Yes, obviously, this is a big focus, and we're involved in that. We're engaged with Congress. We're engaged with CMS. But we're not relying on federal legislative changes to drive our business. It's a nice to have, but it's not -- it takes time. It takes years for that to materialize. But it's definitely a wind in our sales because it puts everybody on notice that they need to grow the transplant volume. And we -- we're coming in with a positive solution saying, if you want to grow your volume, if you're serious about this, if you want to be in the business of organ transplant next year and the year after that, you need to adopt the OCS or the NOP depending if it's an OPO or a transplant program.

I think last few minutes, Stephen did want to get to a few financial questions too? Gross margin, you've talked about kind of mid-70s at scale, but talk through just the dynamics, NOP, just the impact today. And then as you scale that, how we should be thinking about that?

Yes, that's absolutely right. We think the business is kind of mid-70s at maturity. We got there a little bit early in the first quarter of last year, a little bit ahead of schedule. But I think right now in the low 70s with the combination of the NOP makes sense. We've talked about our product. Our contribution margin is close to 90%. So every time we're selling a product, the disposable portion is contributing a lot. The service portion has a margin that's overall lower than our overall than that 70%. It has margin on it, but really the objective of the NOP is to really drive more of those disposable sales. So maybe I answered that question.

And then just lastly, OpEx. With all of your initiatives going on and also scaling NOP, when should we start to think about more leverage? And as you think about R&D to relative to where you've been, you had a lot of clinical trials, you've gone through a lot of that work, but you have kidney coming up, you have some other initiatives. So just the balance how you're thinking about that?

Yes. I mean I think we still have spending growth in the next several quarters, especially on the SG&A side to build out the rest of the NOP. That's a big use of our capital today. On the R&D side, we are as well and are investing in the next generation. We had a pretty big investment milestone in the first quarter. So that's come down a little bit in the second quarter, and I think it will be at that rate for the next few quarters as well. So R&D is not going to be sequentially growing, but SG&A will be sequentially growing for the next several quarters.

Okay. Got it. I think with that, we are out of time, but thank you both for coming today.

Thank you.

Thank you.