Ladies and gentlemen, thank you for standing by, and welcome to the Outset Medical Third Quarter 2020 Earnings Conference Call. [Operator Instructions] I would now like to hand the conference over to your speaker today, Lynn Lewis. Please go ahead.

Good afternoon, everyone, and welcome to our earnings call for the third quarter of fiscal year 2020. Participating for the company today will be Leslie Trigg, President and Chief Executive Officer; and Rebecca Chambers, Chief Financial Officer. During the call today, we offer commentary on our commercial activity and review our third quarter financial results, received after the close of market today, after which we will host a question-and-answer session. If you've not had a chance to review the earnings release, it can be found in the Investor Relations section of our website at outsetmedical.com. This call is being recorded and will be archived in the Investors section of our website. Before we begin, I'd like to remind you that 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. Any statements that relate to expectations or predictions of future events, market trends, results or performance are forward-looking statements. All forward-looking statements are based upon our current estimates and various assumptions. These statements involve material risks and uncertainties that could cause actual results or events to materially differ from those anticipated or implied by these forward-looking statements. All forward-looking statements are based upon current available information, and Outset assumes no obligation to update these statements. Accordingly, you should not place undue reliance on these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of our 424(b)(4) prospectus filed with the Securities and Exchange Commission on September 16, 2020, in conjunction with our initial public offering. With that, I'll turn the call over to Leslie Trigg, CEO. Leslie?

Thanks, Lynn. Good afternoon, everyone, and thank you for joining us to review our third quarter 2020 results. I'd like to start by saying that we're very excited to be here on our first earnings call post-IPO and even more excited to start as a new public company with a strong third quarter result. We are pleased to report $13.8 million in total revenue for the third quarter, representing significant growth, both sequentially and year-over-year. Our revenue achievement exceeded our initial expectations for the quarter as Tablo adoption continues to accelerate within the acute market. We completed our initial public offering in September, raising approximately $255 million in net proceeds. So while we had the pleasure of speaking with many of you over the past months and years, for those we haven't engaged with yet, I'd like to provide a brief overview of the dialysis market, Outset and Tablo before discussing third quarter commercial trends. At Outset, we built a first of its kind technology, the Tablo Hemodialysis System, which was designed as a complete enterprise solution to enable dialysis to be done by anyone, anytime, anywhere. One of the main drivers of our determination to innovate in this space was the number of patients who require dialysis, which is a recurring nonelective and typically the only option for those suffering from end-stage renal disease or ESRD. Before Tablo, dialysis looked effectively the same as it did in the '90s, costly, cumbersome and complicated. Tablo modernizes dialysis from the hospital all the way to the home. With Tablo's integrated water purification and on-demand dialysate production, all one needs to deliver dialysis is a faucet and a standard electrical outlet. And this enables providers to overcome traditional delivery challenges and lower their cost of care while simultaneously elevating the overall patient…

Thanks, Leslie. As Leslie mentioned, third quarter revenue grew 423% year-over-year to $13.8 million. This result was driven by strong acute adoption, including the impact of our HHS contracts and COVID-related orders that we received during the second quarter as well as growth in consumables and services tied to our larger installed base. Product revenue grew 349% year-over-year to $10.8 million. Console revenue equaled $9 million compared to $1.9 million in the prior year period. Consumable revenue grew 263% to equal $1.8 million, driven by our larger installed base and increased ASP as compared to the prior year period. Service and other revenue grew $2.7 million compared to the third quarter of 2019 to equal $2.9 million. Growth in service agreements across our larger installed base, including HHS and freight revenue, contributed to the growth. While COVID has been a tailwind for us in the second and third quarter, it is now embedded within the many Tablo advantages that drive our customers' purchasing decision. Therefore, we don't anticipate meaningful revenue driven solely by COVID in the fourth quarter. Our base business is expected to continue to grow significantly. And as a result, we anticipate Q4 revenue to be similar to what we reported in the third quarter. Turning now 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 Q3 non-GAAP gross margin was minus 36.3%, an improvement of 165 percentage points versus the prior year period. This year-over-year expansion was the result of significantly lower console material costs as our R&D and supply chain teams delivered on cost down activities ahead of plan as well as a reduction in our finished goods balance and associated lower…

[Operator Instructions] Our first question comes from Bob Hopkins with Bank of America.

Congrats on your first quarter as a public company. Wanted to start by asking just a little bit about some of the moving pieces to the quarter. I think you suggested, Rebecca, that you did about $1.8 million in consumable revenue in the quarter. And I just wonder if you could talk about that number as it relates to how you did in Q2? And what kind of utilization trends you're seeing per system? And kind of are you -- did the utilization sort of come in as you expected in the quarter?

Yes. Thanks, Bob. Happy to do so. So in the second quarter, consumables were approximately $1.5 million. So a nice pickup sequentially, and roughly in line with expectations. We did see, on a year-over-year basis, very strong ASP, which on a sequential basis, was roughly flat. So the strength in ASP has continued that we were seeing in the second quarter. Utilization on a per machine basis was around 4.5 treatments per week across the installed base. And really a couple of factors there. I would say we did place a number of consoles in the second quarter as you well know. And those number of consoles did include some of the COVID-related consoles that we referred to earlier in the script. Those consoles are trending towards expectations, though a little bit slower of a ramp than the overall installed base. So on a net-net basis, the foundational utilization continues to trend as we'd anticipate. And we do expect those COVID consoles in the fourth quarter to getting back to more normalized trends.

Okay. Very thorough. And then for Leslie or Rebecca, I just wanted to -- no, it's very helpful. Just wanted to kind of talk about your comments on Q4. And how are you quantifying -- and I'm sorry if I missed this, but how are you quantifying that COVID benefit? So we can get a sense for maybe the Q3 to Q4 trend kind of without that COVID benefit.

Okay. Yes, happy to, Bob. And I think Leslie is going to tag on a couple of points here. So we do quantify it. We're happy to. Back over the summer, we talked about $7 million associated with that Q2 order, and we recognize just around $3 million of that in the second quarter. You should think about the vast majority of the delta being recognized in the third quarter. So it was meaningfully significant, if you will, in the third quarter as expected, as expected back when we shared our expectations with you. So that was a large COVID-related order we recognized over those 2 quarters. And if you do remove this impact and look at just the underlying trend of the base business, we saw steady sequential growth not only throughout Q3 and Q4, but really each quarter of 2020. And again, Q4 is no different. Further, I think it's important to note that Q4 is ahead of our expectations for even just a few months ago. And we have a lot of confidence in this given we're operating -- we continue to operate in a backlog environment. So hopefully that elucidates the trends here a little bit more clearly for you. But again, significant growth in the base business as you remove that Q4 -- I'm sorry, that COVID-related impact in the third quarter.

Maybe I'll -- Bob, maybe I'll just add a couple of points to the last part of your question about how we're thinking about COVID in the coming fourth quarter. I think the first important point to make is that dialysis is not an elective procedure. It's not optional. Patients are going to get dialysis 3 times a week or more, 52 weeks a year, whether there's a pandemic or not. So our business is a little bit unique in the medtech sector for that reason. If COVID hotspots continue to pop up through Q4 and in into 2021 in various parts of the country, that does not impact our confidence or our projections in the fourth quarter or beyond. I think in terms of the COVID upside, at this point, COVID is really just embedded within all the reasons that customers are deciding to adopt Tablo. It is a factor, but it's one of many factors driving the Tablo purchase decision versus being, I would say, a discrete stand-alone purchase decision driver, it's one of many. And I think the main reason health systems are adopting, again, goes back to cost reduction. And as you probably recall, there's no DRG for inpatient dialysis, and that means that every time a hospital has to deliver dialysis, they're eating the cost. We talked about on the road show, the national data that shows that about 60% of the inpatient stays that involve dialysis result in a negative operating margin for the hospitals. And so the need for cost reduction has never been more acute. I mean, no pun intended. I do think some of that could be further fueled by COVID as I think we've all been reading in the news that health system executives are bearing down more than ever on cost reduction as a means to improving operating margin, given the continuing uncertainty around the restoration of elective procedure volume. So I think Tablo fits squarely within the strategic mandates and is a pretty powerful solution, COVID or no COVID.

And our next question comes from the line of David Lewis with Morgan Stanley.

Just a few quick ones for me. I guess, Rebecca, just thinking about -- maybe it's for Rebecca and Leslie, but just thinking about the console placements. Maybe just help us out, the second half versus the first half. Will console placements be up in the second half relative to the first half of the year? And then Leslie, kind of related for you would just sort of be, what are you seeing right now in terms of activity as it relates to large national systems versus sort of the regional hospitals? And then I have a couple of follow-ups.

Yes, David, I'll take the first bit. And absolutely, they will be higher in the second half of the year than in the first half of the year, and that is embedded in our guidance.

Okay. So great. I'll take it from here. So yes, regional versus national IDNs. I think as we mentioned in the script, we now have signed master sales and service agreements with 6 of the largest national health systems, inclusive of the VA in the country, and 3 of those new sort of marquee national health systems came on to our roster in the third quarter. I guess, what I'm excited about is how well the national players are understanding the value of a single enterprise solution. What we're seeing typically with these national rollouts is kind of a typical cadence where they'll start with a smaller number of hospitals in their network, integrating Tablo and quantifying the cost reduction impact. How easy it is for them to train their own nurses to deliver dialysis. And then once that data has been established, we've seen their next step pretty quickly to be spreading that model across perhaps a division or a group of hospitals and then fairly quickly over time, network wide. So I would say we have a sales force that is equivalently focused on the top 50 regional hospitals and the national hospital health systems. But in general, we've been very, very encouraged and excited about how quickly the uptake has been occurring with these large national health systems in particular.

Okay. Very helpful. And Rebecca, sorry, I was on mute there, it was like awkward silence. I was also trying to get the -- will acute placements grow fourth quarter? So placements to be higher in the fourth versus the third. And I'll ask buzzy, just a couple here. Just buzzy, just for ESRD bundle payment, kind of the path forward now kind of post the proposed rule a couple of weeks ago, is number one. And number 2 is just on XT. It was nice to see that come through. How do you think that changes the conversation with the average hospital system now that you have XT? I mean you are -- there are some who are doing national rollouts with their system. There are some that were sort of doing more targeted placements. How does having CRRT change the conversation with some of these IDNs and regional systems?

Okay. Rebecca,...

You go first.

Okay. Yes. David, thanks. So on the -- maybe I'll take these in sequential orders. So the proposed rule. So we really viewed the proposed rule to win for innovation, frankly, in the renal space. The open question coming out of the proposed rule was whether CMS would indeed implement a proposal to include capital equipment in the -- what's pronounced TPNIES, T-P-N-I-E-S, which is sort of very similar to a new technology add-on payment. But the question was whether they would include capital equipment in the TPNIES eligibility criteria or whether they would only include supplies in their eligibility criteria. And what came out in the final rule is that, yes, capital equipment is included and only capital equipment that constitute new home dialysis machines cleared by FDA after January 2020. So we were hoping this would be the outcome. And obviously, we're pleased to see the allowance for this kind of capital. We'll have an opportunity to reapply in the future, whether that's '21 or '22. We have some flexibility there because we'll still meet the newness criteria in either a year. I think if we did receive this designation in the future, it certainly would be something we'd consider to be a tailwind as compared to our base case, but not something that we're reliant on or that we baked into our expectations. So that's how we're thinking about the proposed rule. On the -- maybe I'll move to the XT question, then we can certainly double back on the final rule, if we need to. I think on the XT front, maybe let me take a step back and maybe just talk about what this new feature does. So the XT provides a new functionality. It enables Tablo mechanically to run for up to 24 hours.…

And then David, to answer your question with regard to console unit trends sequentially third quarter to fourth, effectively, as we shared with you all over the summer, console units are expected to be down sequentially in total -- across the total console unit placement number. That being said, if you do strip out this large order that we received in the second quarter, that trend is much less -- is not the same. Effectively, the trend will be flat to slightly up in terms of console unit placements on a sequential basis. The other driver to console revenue sequentially that we should think through is the HHS order, which we will benefit from a full quarter of both the console line as well as the service line. So just helping with puts and takes.

And our following question comes from the line of Amit Hazan with Goldman Sachs.

Congrats on all the milestones. I'll add that as well. Let me maybe just start by seeing if I can get you to comment on 2021. And obviously, you're not giving formal guidance, but can you talk just qualitatively to any puts and takes that we should be thinking about, whether it's related to console placements or other items you would want to call out for us?

Yes. Happy to think qualitatively about it with you. And thanks for the question. I think when it comes down to 2021, we're obviously in the midst of our planning process right now as we end out the rest of this year. That being said, the trends that we saw in the third quarter, and we expect to continue in the fourth quarter, we don't view these to be period specific, and we do -- they do give us confidence in our 2021 outlook. So not really willing to comment beyond that, but just to say that we're pleased with how the business is going. Our confidence in the fourth quarter is very high, and that lends itself to also a positive outlook for 2021.

Okay. And just a quick follow-up on home for me and then I'll get back in queue. On the kind of acute to home, you've talked about in the IPO process, leveraging your health system customer base as kind of the entry point into home expansion. Maybe just give some color on how that's going in these early days?

Sure. Maybe I'll comment on that, Rebecca. So short answer is going very well. I think we've been pleasantly surprised at how quickly the pipeline continues to fill, particularly amongst health systems that are viewing this as an opportunity to complement, let's say, their sort of episodic revenue streams in patients with a chronic -- very predictable chronic annuity revenue stream outside the 4 walls of the hospital. And I think another factor that health systems are really realizing is that they have access to all of the assets that make them a good partner for patients, right, from their network of physicians, nephrologists, care extenders, many of these health systems already have nurses and nurse practitioners providing care in the home. They really offer us the full package. And so I think what I've been pleased to see, again, early, early days here, for sure, but what I've been pleased to see qualitatively is the number of, I would say, very well-known thought-leading national organizations that are really leaning forward into the home and excited about setting their reach in managing these patients from the acute-to-the-home setting.

And the next question comes from the line of Danielle Antalffy with SVB.

I have one question for, I think it would be for you, Leslie, and my second question is for Rebecca. So Leslie, my first question is when you think about the acute therapy sale, how should we be thinking about where you -- at the hospitals where you do have some penetration, how should we be thinking about where you are on that penetration curve? So I guess I'm trying to get a sense of how much of the incremental growth -- I know it's still very early. There's lots of incremental growth to be had. But how much is going to be same-store sales versus new centers coming online? And then I'll follow-up with Rebecca after it.

Okay. Sure. Great. Yes. I think maybe a couple of thoughts to share there. I mean, first of all, suffice it to say, we believe we have a -- we're just getting started here. We have a very, very long runway with an emphasis on the top 50 regional health systems. I think we mentioned in the prepared remarks that we are in over a dozen of them. But gosh, that means we've got a tremendous amount of opportunity between over a dozen and 50, not to speak of the smaller hospital networks there on from there. So that's a little bit of qualitative color. And then on the national side, we are really making very good progress there when you think about it being already in 6 of the top national systems. And so what we think about there is our penetration within those networks, right? Because we are very intentionally sort of focused on a national regional strategy, we are paying just as close attention to the number of individual facilities as we are to our total number of customers. And the breadth of the opportunity in each of these national systems is pretty remarkable. So within each of the 6 national customers that we've talked about publicly, we still have tremendous opportunity to expand more broadly in and around their individual hospital facilities across the country.

Got it. Okay. That's helpful. And then, Rebecca for you, just on the gross margin front. I mean you did a little bit better than we expected, and I think the Street had expected. During the IPO process, you laid out this strategy to improve gross margin. Should we be thinking about this as like, okay, this was 1 quarter, we would have a lot of things go our way and the revenue upside contributed? Or are you tracking faster than you expected to get to your sort of gross margin goals over the next few years?

Yes. Thanks for the question, Danielle, and completely fair one. Obviously, we were very pleased with our quarterly results. But I do -- I just caution, 1 quarter doesn't necessarily make a trend, right? We are confident in the plan that we laid out, and we're executing to plan. And to that end, we are confident in our ability to deliver these new manufacturing in-sourcing initiatives for the console and second source initiative on the cartridge side in the second quarter. But I think that, that should remain the base case here, and we'll continue to progress to that plan. But again, 1 quarter doesn't necessarily make a trend we're willing to call yet.

[Operator Instructions] Our next question comes from Rick Wise with Stifel.

Maybe another aspect that you highlighted in terms of investment, Leslie, revolved around the sales organization. I'm just a bit curious to hear your, I'm sure, ever-evolving thoughts about the team, where you're investing and where you are focusing people?

Sure. Yes, Rick, happy to answer that. The -- so yes, people matter and they matter a lot at Outset because, in fact, and we talk about this frequently that what we're really focused on delivering to patients and to providers is not just a device where -- we aim to deliver an experience. And so when you have that mindset to deliver a differentiated experience, you're then heavily reliant on the quality of the individuals that you put around the execution. And so we spend an enormous time, almost sort of an excessive amount of time thinking about the right people in the right places at the right time. So with that as a backdrop and speaking more specifically now, our investments today are probably focused in 3 areas that I'll touch on. One, our national accounts team. We do have capital sales reps that are geographically focused. And we feel that we're making good progress toward ensuring that we have adequate representation in all of the big regions, that contain these top 50 regional health systems. But we put even greater emphasis on a powerhouse national accounts team that we're really proud of. Second is our, what we call the Tablo program specialist team, TPS, for short. And these are our -- sort of our day-to-day quarterbacks for the implementation, not only the installation, but the Tablo program implementation, which is a whole lot more than just installing a device, if you do it right. And so we think of the TPS as the quarterback of each and every hospital facility that adopts Tablo and they're responsible for ensuring from the beginning, for example, that training is done well and that the first patient treatments go well and that the nurses and the techs and the physicians continue to gain confidence quickly. And really understand the who and the how and the what of prescribing Tablo for their patient population. So that's probably our second area of investment focus is expanding that TPS team as our installed base and our new order growth continuum. And then lastly is our field service support team, and this is another absolutely vital group, vital to our success. The field service engineers partner with the TPS, the -- I guess, sort of the co quarterbacks. Maybe they're running back, I don't even know if that's -- I can't go there on a focal analogy. So anyway, let's just say that they're an important co pilot, probably was a better analogy I can actually speak to accurately, in ensuring the success of each and every new facility implementation with Tablo. So those are the 3 groups principally within our -- what we'll call our field organization that we're really focused on investing in as we continue to experience very high-growth in the acute installed base.

Right. You've made a couple of comments during the call that were very compelling. I mean, first of all, you outperformed this quarter. You're sort of indicating that the fourth quarter is starting up strongly, much like the third quarter volume. And you're saying the adoption accelerating in the acute market, your home pipeline is growing. And I appreciate your caution and your carefulness about guiding us and not wanting us to be too far ahead. But sort of -- and I apologize for this in your very first quarter as a public company in the first conference call. But it's hard for me not to ask about 2021. I know you're not ready to give guidance. But we're going to have to all go back and play with our models and reflect on this third quarter outperformance, likely fourth quarter, better numbers than [ I certainly am ] modeling and the implications for '21. So my question after that long wind up is, I mean, it seems like you have a lot of momentum going into '21. Is that the right way to think of it? There doesn't seem to be a reason why growth would slow, particularly given new products on the market, all of the excellent things that are happening. But maybe react to that and maybe at the same time because I know you want to help us balance those positive thoughts with some of the challenges that we should be reflecting on as we contemplate the year ahead.

Yes, thank you as well for the great summary. I think there are a couple of things that come to mind. By definition, with regard to growth rate, we are getting to a point where we're not comping off of low single digits of revenue anymore. And so from a growth rate perspective, I obviously would caution extrapolation. So that would be one comment. But with regard to the trends of the underlying business, we're obviously pleased. We would encourage you to not, again, extrapolate the COVID-related trends from the second and third quarter and think about it more from the base business and the base business continuing to grow year-over-year versus what we saw in 2020. The acute market, as Leslie mentioned, we are in the early stages of penetrating, and that is expected to be the vast majority of the revenue growth driver in 2021. And in home, while we are seeing pipeline growth and new customer or provider contracts, we do need to also just remember that this is a rollout that we are participating and driving in, in a very methodical way. And so I would caution you to get too far ahead of our SKIs on home. We are, as Leslie said, very methodically doing this in a long-term way and not necessarily looking for driving huge patient numbers in the near term, more ensuring that the patient experience is very positive. So hopefully, that brings you back in a little bit, Rick. And we all are excited as we sit here today. There's still a lot to do over the course of Q4 and 2021, but our confidence is strong.

And ladies and gentlemen, I'm not showing any further questions at this time. I would now like to turn the call back to your speakers for any further remarks.

Thank you. And as a reminder, a call -- a replay of this call will be available as a webcast in the Investors section of our website as well as through the dial-in instructions contained in today's earnings release. Thank you again for joining us today. This concludes our call, and we look forward to our next update following the close of the fourth fiscal quarter. Thanks, and good night.

Ladies and gentlemen, this concludes today's conference call. Thank you for participating. You may now disconnect. Everyone, have a good evening.