Outset Medical, Inc. (NASDAQ:OM) Q4 2022 Earnings Call Transcript

Outset Medical, Inc. (NASDAQ:OM) Q4 2022 Earnings Call Transcript February 13, 2023

Company Representatives: Leslie Trigg – Chair, Chief Executive Officer Nabeel Ahmed – Chief Financial Officer Jim Mazzola – Head of Investor Relations

Operator: Good day! And thank you for standing by. Welcome to the Outset Medical Q4, 2022 Earnings Conference Call. At this time all participants are in a listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. . Please be advised that today’s conference is being recorded. I would now like to hand the conference over to Jim Mazzola, Head of Investor Relations. Please go ahead.

Jim Mazzola: Thank you and good afternoon, everyone. Welcome to our fourth quarter and full year 2022 earnings call. Here with me today are Leslie Trigg, Chair and Chief Executive Officer; and Nabeel Ahmed, Chief Financial Officer. During the call we will discuss our fourth quarter and 2022 operational and financial results, provide an update on our outlook, and host a question-and-answer session. We issued a news release and filed an 8-K after the close of market today and updated our investor presentation, all of which can be found on the investor pages of www.outsetmedical.com. This call is being recorded and will be archived in the Investors section of our website. It is our intent that all forward-looking statements made during today’s call will be protected under the Private Securities Litigation Reform Act of 1995.

These statements relate to expectations or predictions of future events, are based on our current estimates and various assumptions, and involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied. Outset assumes no obligation to update these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of Outset’s public filings with the Securities and Exchange Commission, including our latest annual and quarterly reports. And with that, let me turn the call over to Leslie.

Leslie Trigg: Thanks, Jim. Good afternoon, everyone and thank you for joining us. We’re very pleased with our performance in the fourth quarter, which capped off an important year for Outset. During 2022 we significantly increased the number of Tablo Consoles in hospitals and homes, surpassed one million treatments and helped health care providers continue to deliver exceptional lower cost care in a challenging labor environment. We also fundamentally strengthened our platform for growth by innovating and extending Tablo’s technological advantages, adding key talent and strengthening our balance sheet. As a result, we have entered the year with a lot of conviction in our plans to further expand Tablo’s footprint with good visibility to continue sales growth across both our home and acute end markets.

And in addition to growing the top line, we also remain committed to meaningfully expanding non-GAAP gross margins this year toward our next milestone of 50%. Beginning with a review of our home performance: At a high level, home represents the single largest market opportunity for Outset. In 2022 we saw growing demand for Tablo as an enabling technology for Hemodialysis programs, fueled by exceptional clinical outcomes, positive patient experiences and retention, and the increasingly recognized economic benefits for patients and providers. While our overall year-end installed base across those markets increased 54% year-over-year to approximately 4,000 consoles, our fourth quarter performance contributed to a particularly strong year for home.

Exiting the year, we achieved a more than doubling of our home installed base to 800 consoles with sales to home care providers at roughly 20% of total 2022 revenue ahead of our original goal of mid-teens as a percentage of total revenue. In addition to Tablo’s continued growth with mid-sized dialysis providers, which we’ve discussed for several quarters, we were also successful in initiating home programs with both health systems and new adjacent specialty providers entering the space. This is an emerging segment of the home market, we believe will continue to be an important growth vector in 2023. As a reminder, we define a home program as a location offering Tablo for home dialysis, and we were pleased to exit the year with roughly 100 such programs in place.

Historically, 60% of home programs have sent between one and five patients home. While early, we are now starting to see multiple programs sending low double-digit numbers of patients home on Tablo. We believe the keys to profitable sustained growth in home moving forward are first, reaching higher than historical home patient numbers per home program; and second, maintaining higher than historical redemption rates. In 2023, we are employing a similar land and expand strategy in the home market, as it has been successful for us in the acute end market. It’s our goal to land the majority of the largest mid-sized dialysis operators and initiate home programs with two of the top national IDMs. We believe the progress we’ve made in 2022 and the new programs who had planned to land in 2023 will provide a foundation from which to further expand the number of patients dialyzing at home on Tablo.

Central to the success of our expansion in the home is a consistently positive and highly differentiated patient experience. We’ve learned over time that the home dialysis experience for patients is tied both to the product and the people behind the product. In other words, the art of how we support patients greatly contributes to Tablo’s success, and we believe it creates a separate protected competitive advantage, along with our technology itself. To that end, in early December we were able to provide a firsthand view into the home patient experience through an educational virtual panel webinar that included two patients currently dialyzing at home with Tablo and a caregiver of one of the patients. Those patients were previous users of the incumbent home hemo device and switched to Tablo for its simplicity and flexibility.

They talked about getting space back from no longer having to store mountains of boxes and getting time back from no longer having to spend hours on end preparing dialysis day in advance of treatment. And more importantly, those patients said they felt better, felt less stress and were quickly able to master Tablo. These patient experiences underscore why Tablo’s controllable attrition rate has been consistently in the 10% range and continues to be roughly half the historical rates on the incumbent home hemo device. We believe one of the key drivers of retention is Tablo’s simplicity, which we see in our training data. Patients are able to master their Tablo learning curve in just 10 days on average versus four to six weeks for the incumbent device.

We see this advantage demonstrated in our 90-day retention rate, which shows the rate of patients choosing to transition back to in-center hemodialysis is less than half the rate of the incumbent device. It is our goal to maintain our markedly higher retention rates even as we substantially grow the number of patients at home on Tablo. Turning now to our results in the acute end market, the fourth quarter was also marked by strong growth, including sequential revenue growth each quarter from Q2 through Q4. Broadly, we saw the macro acute care environment largely stable over the course of the fourth quarter and through the first several weeks of this year. We do expect staffing headwinds will persist and affect providers through 2023, and we’re also keeping a close watch on hospital capital spending, which can affect the timing of deals, but to-date has not proven to be a meaningful headwind for us given Tablo’s strong value proposition.

We did see further evidence during the quarter of third-party dialysis service providers continuing to increase prices, decrease service levels and in some cases, cancel contracts with their hospital customers. As our customers move towards in-sourcing, inpatient dialysis of Tablo, we remain fully prepared to support them as needed with our bridge program. The program is designed as a temporary staffing solution by providing short-term dialysis nurses who deliver Tablo treatment, both in the ICU and bedside on the floor, while the patient completes the process of hiring its own permanent staff. As hospitals continue to manage a challenging staffing environment in 2023, we expect the bridge program to continue to serve as an important staffing stop gap for providers who are eager to move forward and recognize cost savings with in-sourcing initiatives.

From a product innovation perspective, last quarter was our first full quarter in market with TabloCart, a new accessory that provides additional maneuverability around the hospital and incremental pre-filtration capabilities for sites with water quality that is far worse than the national drinking water standards. As a reminder, TabloCart is sold separately at a gross margin accretive ASP. Since its launch in Q3, we’ve been pleased with the strong demand and positive reaction from customers. Throughout 2022 our team continued their very disciplined, determined execution to the same commercial strategy that has worked so well for us in the last two years, which is our land and expand approach. We are low double digit penetrated in our acute base today and beginning to see larger console orders as hospitals expand and transition their dialysis service lines to Tablo.

During the quarter we closed multiple deals involving the purchase of 20 consoles or more including a large Midwest provider who ordered nearly 30 consoles. With recent new acute customers landed in the quarter, our focus for 2023 and beyond will remain on expanding within those networks. Before turning the call over to Nabeel, I’d like to briefly highlight a few operational updates. First, we took a significant step forward in our long-term margin expansion strategy by initiating production of Tablo cartridges in-house at our outset Mexico manufacturing facility. This move also secures an important component of our business model and continues to improve the flexibility of our operations. We recently began production from a state-of-the-art Class A clean room, which our team designed and built within our existing facility in Mexico.

The clean room fully leverages our digital manufacturing infrastructure, and has capacity to carry us well into the future. With this move, we now have three qualified suppliers of the Tablo treatment cartridge. I want to congratulate and thank our exceptional operations team for the work to expand our facility, build the clean room and ensure our readiness to initiate this critical step forward for Outset. It’s another significant achievement from this high-performing team and another example of the type of innovation we continue to drive across the organization. Second, we talked about gaining operating leverage as we scale the business, and we made excellent progress during the quarter. In our sales organization, for example, we are gaining sequential improvements in productivity, increasing account penetration without the need for additional reps.

Importantly, we are also getting operating leverage from the investments we’ve made in our service organization. Service has historically been a very manual process for capital equipment, something we thought to change with Tablo. Our proprietary software and data analytics platform enables our service team to remotely access Tablo with permission, see the system during a treatment and assist users on a real-time basis. At the same time, we increased our installed base by 50%. We also improved our remote resolution rate by 170%, lowering our cost to serve and taking full advantage of Tablo’s two-way wireless communication capabilities. Not only does this approach improve our efficiency, it dramatically improves the customer experience and reduces the support burden for our providers.

Finally, we announced today that Martin Vazquez will retire from Outset after a 30-year career in med tech. We have been extremely fortunate to benefit from Martin’s expertise as we established world-class manufacturing, supply chain, logistics and R&D capabilities and we’re pleased that he will continue to consult with the company. I really want to recognize Martin’s contribution and his legacy of building and mentoring a truly incredible team of leaders, all of whom keep Outset punching above its weight. Taken together, these updates and the progress made throughout the year leave us feeling more optimistic than ever about our opportunity in 2023 and beyond. We are very well positioned in one of the largest segments of healthcare with a highly differentiated product, a growing base of customers and a compelling recurring revenue model.

And aside from our financial and operational goals, we aspire to deliver another year of deep impact for patients and their families. Dialysis patients for too long have been overlooked and served and experience that is just good enough, but they deserve great, and I want to thank the entire Outset team, as well as dialysis nurses, technicians, nephrologists and hospital leaders and ever-expanding community of change agents focused on patients who have fully embraced our mission to change the status quo. With that, I’ll now turn the call over to Nabeel to review our financials and provide more detail on our results and key drivers for 2023.

Nabeel Ahmed: Thanks Leslie. Hello everyone! Our four quarter revenue increased approximately 15.3% sequentially and 13.7% year-over-year to $32 million with a year-over-year change driven primarily by higher consumables revenue and higher service and other revenue. This uptick in recurring revenue is one of the benefits of our expanded installed base and continues to be one of the key drivers of gross margin expansion. Product revenue was up 21.3% from the prior quarter and increased 11.5% year-over-year to $26.4 million. Console revenue grew 22.8% from the third quarter and increased by 1.5% year-over-year to $18.4 million. We saw console ASPs increase again year-over-year, driven primarily by the ongoing demand for Tablo XT and by demand TabloCart, our new accessory launched in the fourth quarter of 2022.

Consumable revenue was $8 million, up 17.9% from the prior quarter and an increase of 43.9% versus the prior year as our installed base grows. Based on data from consoles deployed and connected to our cloud network, we see Q4 cartridge utilization continuing to be in-line with our expectations. Service and other revenue of $5.6 million was down 6.3% from the prior quarter and higher by 25.3% compared to the prior year. Our core service and other revenue increased approximately 90% year-over-year with the growth of our installed base, and was offset by the planned X3 of the HHS agreements. As a reminder, the third quarter of 2022 saw the X3 of the final components of our HHS agreements. Moving to gross margin and operating expenses, I will highlight our non-GAAP results.

I encourage you to review the reconciliation of GAAP to non-GAAP measures, which can be found in today’s earnings release. Our fourth quarter gross margin was 17.1%, a sequential improvement of 7 basis points and an improvement of just over five percentage points versus the prior year period. This progress marks seven consecutive quarters of consistent and substantial gross margin expansion, and once again demonstrates our commitment to our next milestone of 50% gross margin. The primary drivers of our margin expansion has been our ongoing console cost down program, lower freight costs as our Mexico-based cartridge contract manufacturer has taken over the majority of our cartridge production and higher margin revenue mix. We anticipate that our internally manufactured cartridges will start to reach customers in 2023.

Operating expenses in the fourth quarter were $38 million, down $1.5 million versus the prior year period as we trued-up incentive compensation for the year and realize some of the benefit of our efforts to fully manage spending. We reported fourth quarter GAAP net loss of $41.4 million, resulting in a net loss of $0.86 per share compared to a net loss of $41.2 million or $0.87 per share for the prior year period. Non-GAAP net loss was $34.1 million or $0.71 per share compared to a non-GAAP net loss of $36.4 million or $0.77 per share for the same period in 2021. We ended the quarter with approximately $290.8 million of cash, cash equivalents, restricted cash and investments, which includes $100 million of drawings under our term loan. We continue to have access to up to an additional $200 million of capital under our SLR debt facilities.

Moving now to our full year 2023 outlook, starting with revenue. We project revenue for the full year 2023 to range from $140 million to $150 million, which represents approximately 22% to 30% growth over fiscal year ’22 revenue. Our revenue guidance assumes that revenue from both our acute and home end markets will grow and that revenue from our home end market will grow at a faster rate than acute. Given the strength of our XT features, we’re now assuming that XT is in a majority of the units we ship into the acute end market. This will translate into a slightly higher ASP. In terms of consumables, our guidance for 2023 contemplates utilization at the lower end of our four to six treatments per week in the acute setting on average and the three to four treatments per week in the home setting on average, largely due to how we’re seeing our customers’ ramp to full productivity.

Now, to give you some more detail from your models. Based on what we’re seeing in our pipeline and typical Q4 to Q1 capital purchasing trends, we expect that revenue growth will be flat sequentially or slightly down from Q4 to Q1, and will then accelerate from there as we move through the rest of the year. With respect to gross margin guidance for 2023, we expect our gross margin to continue to benefit from our ongoing cost down activities on the console and our higher ASP, as well as the full year impact of the primary place of manufacturer of our treatments to move to Mexico. We have line of sight to non-GAAP gross margin expansion to approximately 20% for the full year of 2023. Given our expected revenue profile, we expect non-GAAP gross margin in Q1 to be relatively flat compared to Q4, ’22 and then expand sequentially such that we exit 2023 with non-GAAP gross margin in the mid-20% range for Q4 ’23.

As a reminder, our gross margin may fluctuate from period-to-period based on the mix of home and acute consoles we sell. Now, I’d like to turn to non-GAAP OpEx. Given our strong progress to date, the large market opportunity we see in front of us, and the tailwinds we continue to see in the home market, our intent is to continue to invest in our business to drive long-term revenue growth, ongoing gross margin expansion and focused R&D to continue to extend Tablo’s differentiation. Having said that, we expect to start demonstrating operating leverage as the investments in people and infrastructure that we made in 2021 and 2022 start to bear fruit. We forecast operating expenses to increase in 2023 relative to ’22 with low double-digit growth in 2023 expected, significantly slower than our expected rate of revenue growth.

And finally, I’d like to make a few comments about our strong balance sheet. We have previously talked about carrying large amounts of inventory as one of our strategies to mitigate the tough supply chain environment we operated in during 2020, 2021 and into 2022. As we look forward and see increasing stability, if not improvement in the macro environment around supply chain, we’ll be thoughtful in terms of managing our inventory levels and expect to be able to reduce our inventory levels relative to what we have exiting ’22. In combination with our expected revenue increase, gross margin expansion and increased operating leverage in 2023 relative to 2022, we expect to burn less cash in 2023 than we did in 2022. In summary, we had a strong finish to ’22 that demonstrated Tablo’s value proposition in our large acute and home end markets.

And we have great momentum in 2023 that gives us a high degree of confidence in our ability to execute through the year as we continue to deliver on our promise to dialysis, patients and providers. With that, I think we are ready for Q&A. Operator, please open the lines.

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Q&A Session

Operator: Thank you. . One moment for our first question please. And it comes from the line of Travis Steed with Bank of America. Please proceed.

Travis Steed: Hey! Good afternoon. Thanks for taking the question. I heard the guidance on Q1 is flat to down sequentially. Curious now that we’re halfway through the quarter, maybe give a little bit more context on what’s shaping that guide up for Q1? And I think you had record patients in December, curious how January is shaping up in terms of record patients. And for the full year, you said home would grow faster. And so you ended the year at 20% of revenue at-home. Curious if that’s like end of the year around mid-20s or if we are lower or a high 20% range for the percent of revenue coming from home in 2023.

Nabeel Ahmed: Yes, hey Travis, its Nabeel. Travis, I missed the second part of your question. I got the first part, which is the Q1 guidance and the back part, which was the home. Can you remind me what the middle was?

Travis Steed: That was just the – I guess December was record patients. I’m kind of curious €“ and for home. So kind of curious where in January and February shaping up in terms of in December?

Nabeel Ahmed: Yes. Got it, got it Travis. So thanks for the question. So on to Q1, look, a couple of things. One, our guidance is always informed by what we’re seeing in our pipeline and what we’re starting to see is that you know these capital purchasing decisions that every company talks about, where you know Q4 is a strong quarter and Q1 comes off a bit softer, that’s starting to affect us as well. And so we’re looking at a softer Q1 with an acceleration through the rest of the year, and that’s only just sort of the trends that we’re seeing in the macro around us. So that’s for the part one. Now on the full year, so last year €˜22, we were pleased that home came in at roughly 20%. You know we had said that home is going to grow faster in €˜23 than in ’22, and so if you look at home growing at even that €“ even contributing 20% of full year revenue, if we even can see that off a higher base, home is going to grow significantly faster and be a big part of €˜23 revenue.

Travis Steed: Okay. And you didn’t give a backlog this year right, in terms of backlog number like you did in the years past?

Nabeel Ahmed: Yes Travis, backlog still continues to be a big part of our business. We run our business in a backlog position, and it certainly is the first thing we look at when we think about guidance for any period. Now as we’ve talked before, our backlog has been shifting more and more to home consoles, which have a longer sort of tenure, longer cadence to deployment and so it’s less and less of a relevant metric to sort of disclose as we move forward. What we did give and what we think is relevant is our installed base, which we talked about growing 54% to 4,000 consoles in 2023 and we talked about our expected revenue growth of 22% to 30% for the full year and that’s sort of given shape in terms of the fact that we expect homes to grow faster than acute, and so we think that those are the right metrics to monitor as we are looking forward.