Good day and thank you for standing by. Welcome to Outset Medical Third Quarter 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. [Operator Instructions] Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today Jim Mazzola, Vice President of Investor Relations. Go ahead, please.

Great, thank you, and good afternoon everyone. Welcome to our third quarter 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 third quarter operational and financial results, provide an update on our outlook, and host the question-and-answer session. We issued a news release after the close of market today and updated our investor presentation, both of which can be found on the investor pages of 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. With that, let me now turn the call over to Leslie.

Thanks, Jim. Good afternoon everyone and thank you for joining us. We are very pleased to share our third quarter 2022 results, which were marked by strong revenue growth and a home re-ramp that outpaced our expectations. On the acute side, we were encouraged by meaningful Tablo expansion among current customers and adoption from new customers despite lingering staffing and inflationary pressures. On the home front, the early success of our rebuilding process validated our strong relationships with home providers and patient preference for Tablo. What’s more just following the close of the quarter, we shift our 1 million treatment for Tablo. I am immensely proud of the impact our team has been able to make in the lives of patients in such a short period of time. Based on Q3 momentum, we are raising our fiscal year 2022 revenue guidance today to reflect our continued confidence in the strong underlying market fundamentals and demand for Tablo across our acute and home end market. Since the third quarter marks the beginning of our home re-ramp, I wanted to start by sharing an experience I recently had visiting a patient using Tablo in her home. This individual had tried every form of dialysis possible from in-center dialysis to peritoneal dialysis to the incumbent home hemo machine. The first thing she said to me when I walked in the door was I love my Tablo. It's quiet. It gives me the flexibility to alter my treatment schedule when I need to. It's super simple to set up. It's been extremely reliable and I feel good on it. As I was leaving a couple hours later, I heard her and her husband discussing a weekend drive up to a festival freedom that home dialysis affords them. This individual is just one of many…

Thanks, Leslie. Hello everyone. Our third quarter revenue increased approximately 11% sequentially and 6% year-over-year to $27.8 million with the year-over-year change driven primarily by higher service and other revenue and higher consumables revenue from our expanded installed base. Product revenue was up 11% from the prior quarter and roughly flat year-over-year to $21.7 million. Console revenue grew 13% from the second quarter and decreased 3% year -over-year to $15 million. As we regained momentum from the home ship hold and worked through the macro headwinds we've previously described. We saw console ASPs increase again year-over-year, driven primarily by the demand for Tablo [indiscernible] which continues to exceed our initial projections. Consumable revenue was $6.8 million, up 6% from the prior quarter and an increase of 6% versus the prior year as our installed base growth. Our Q3 cartridge utilization continues to be in line with our expectations. Service and other revenue of $6 million, was up 11% from the prior quarter and higher by 34% compared to the prior year. Our core service and other revenue almost doubled year-over year with the growth of our install base that was offset by the planned X3 of HHS agreements. As a reminder, the third quarter saw the X3 of the final components of our HHS agreements, which were just under $2 million of total revenue in the quarter. Moving to gross margins 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 third quarter gross margin was 16.4% ahead of our initial projections as sequential improvements of 50 basis points and an improvement of approximately five percentage points versus the prior year period. The steady and substantial improvement we made over…

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions] Our first question comes from Travis Steed with BofA Securities. Your line is now open.

Hi, everybody. Congrats on a really nice quarter. I guess wanted to touch on some of the comments you made Leslie, positive indications of stability in the acute setting, record number of patients in the home in the last 30 days of the quarter, and the healthy backlog. Just I would love if you would expand upon that a bit more. And also how much you have baked down to the Q4 guide because I'm looking at the midpoint of the 2022 guide and it implies about $1 million step up in the Q4? And so I would think you could see a little bit better step up in Q4 if that was actually happening in the macro.

Yes, sure. Thank you, Travis. I'll start maybe with some of the color and then turn it over to Nabeel on the guidance part of the question. So I think that the dynamics in the home in Q3, I think that they got known as we got there in – on the August call was how many, if any of the patients, the home patients that were in the pipeline in early June would end up waiting for Tablo, and that was a card that we just hadn't turned over in August. What we found out as I just said in the scripted remarks is that actually the majority of the patients did end up waiting, which was really quite remarkable. And so the Q3 home growth was fueled by two drivers. One was working through this sort of pent up pipeline, if you will, number one. And number two sort of de novo patients got materialized through Q3 making that choice to go home on Tablo anew. As we look at Q4, we already have worked through the pent-up part of the pipeline. And so as we thought about sort of the Q4 guidance, and again, I'll turn it over to Nabeel for the quantitative color, but as we thought about the Q4 expectations for home growth, we really thought about it in the context of more sort of normalized home growth focus just on part two, those new patients in the quarter that would be choosing home for the first time. So that's how we thought a little bit about home growth. And again, we were really pleased. I mean, one quarter does not a recovery make. I think we're very aware and very humbled by that fact, but I would say it's a so far so good story and I'm really happy with where we landed the quarter and how Q4 is shaping up on the home front. On the acute front, I would say as we sit here today, staffing remains a headwind. It certainly is top of mind for all of the health system executives that we talk to about in-sourcing with Tablo. However, as I mentioned a few minutes ago, we do see indicators that it has stabilized, number one. And number two, we've gotten better as a team. We've gotten better at showing hospitals how to overcome on sort of the fear factor around finding and hiring dialysis nurses for their in-sourcing programs, part one. And part two, we have a new offering in this bridge program solution, which I think more than anything gives hospitals the confidence to move forward with in-sourcing, knowing that they have a staffing safety net available through Outset if needed. So with that maybe I'll turn it over to Nabeel.

Yes, thanks, Leslie. Hi, Travis. So Travis, as we thought about the lower end of our guidance range, we're essentially – that guidance range, by the way, implies a flat Q4 relative to Q3. We're essentially assuming on the home side as Leslie pointed out that the Q4 home population is more normalized, if you will. And on the acute side, we're assuming that our acute patients navigate through these headwinds that we've talked about in a very similar way to the way they navigate it in Q3. As you move through the guidance range to the top, it assumes that home is a little stronger than it was in Q3. And it assumes that our acute customers are better able to navigate through these headwinds either using our bridge program or through their own mechanisms.

That's really helpful. And Nabeel, I did want to touch a little bit more on your 2023 comment expecting much stronger growth, especially given that 2022 was a pressured year. It kind of leaves a big room of outcomes, a range of outcomes for 2023. One of the ways I was thinking about it was beginning in 2022 before the ship hold, you're expecting $145 million to $150 million for this year. And so maybe that's about the right place to be for next year basically just the ship hold pushes things out a year. I'm just curious if that's a reasonable way to think about it for 2023.

Yes. So, Travis, we are obviously not giving a formal guidance for 2023 at this point. We'll give guidance in due course. Now for modeling purposes as you think about sort of – as you think about your models, I'd say a couple of things. One, we absolutely expect to return to much stronger growth in 2023 relative to our expected growth in 2022. However, we don't want to get ahead of ourselves. What we are also sort of very mindful of is these macro factors in the acute setting around nurse staffing and the fact that we expect these factors to persist into 2023.

All right, great. Thanks and congrats on a good quarter.

Thank you.

Thanks, Travis.

Please stand by while we compile the questions. Our next question comes from the line of Joshua Jennings with Cowen. Go ahead. Your line is open.

Hi, good evening. Thanks for taking the questions. I echo Travis's sentiment on the – perhaps on the strong quarter. I was hoping to just start maybe try that may not be able to quantify this Leslie, Nabeel, but just thinking about both the acute and the home channels, your commentary suggests nice recovery as through results. Any way to quantify the recovery and where you think you are relative to prior ship hold you think you're 75% back in terms of the momentum in both of those businesses – both of those channels?

Josh thanks for the question. Let me – I'll give you my two senses. I think we're right where we want to be. In August, we communicated an expectation that we thought the re-ramp would take a couple quarters and that's played out largely according to our plan. Again, if not a bit ahead of schedule, I do think that given the strength of our pipeline when – patient pipeline when combined with our backlog, I think that's what exactly what gave us the confidence to raise the full year 2022 revenue guidance and also to underscore kind of our commentary about 2023 being a much stronger growth year compared to 2022. So I think short story long I'm right where I was hoping we would be on the home front.

Thank you. And just to follow up on the bridge program. I just wanted to better understand where you're sourcing staff for the bridge program. Is there any competitive dynamic with hospitals? Or is there any ability to help these hospitals recruit their own staff through the bridge program? Any further details would be super helpful. Thanks for taking the questions.

Yes, sure. Thanks for the question on the bridge program. So we – over the last many quarters, we already have been adding dialysis nurses to our staff. We have our clinical sales and training team, what we call TCSRs, already was populated by a fair number of dialysis nurses, which is part of what made us realize, hey, we're actually really pretty good at attracting – finding and attracting really, really high quality dialysis nurses. There's no one pool that we've drawn from as we've continued adding dialysis nurses to our team. So there's no real trend line there to comment on. And the second part of your question, are we able to help hospitals recruit their own staff? You know what, I think what we've found is most hospitals really don't need our health on that front. They have taken solace in knowing again that they have a backstop in the Outset nursing team if they need it. But most hospitals as we've done our first few pilots, and again, it's early, have been very successful actually in finding and attracting their own teams of dialysis nurses. It's just held a little bit of uncertainty for some health systems because they've never done it before. But what we found so far is they've been very successful and very competent in adding dialysis nurses to their staff in relatively short periods of time. And then this bridge program again is there as a safety net if they need it.

Right, thank you.

Please standby. Our next question comes from Phil Coover with Goldman Sachs. Your line is open.

Great. Thanks for taking the question. Leslie, I might have misheard you during the prepared remarks. Did you say that you're reestablishing the original home guidance of doubling revenue this year?

Yes, Nabeel...

Yes, yes. So what we said is sort of we are expecting home revenue to get to roughly mid-teens as a percent of our total revenue for this year. Yes.

Okay. So the original comment was mid-teens for this year on the original guidance, and now it's still mid-teens. It's just at a different guidance level. It's not the original doubling of revenues that we heard at the start of the year.

So Phil, it would still imply roughly doubling from 2021 revenue, but you are right in terms of it. The math is on a different base.

And, Phil, what I just said, just to reiterate in the prepared remarks I was just commenting on Q3 and the fact that we enter – we did enter Q4 with a very healthy backlog and had – have Tablo home orders that are more than double compared to Q3 2021 exiting the quarter.

Okay.

So that was where that – that was where that double came in.

Yes, okay. Yes, a great number. On the acute side, I didn't hear that there was a fair amount of discussion on the last call about sort of the capital environment and constraints at the hospital level around capital purchasing notably not in the remarks today, but what's sort of the update in the situation? It maybe misguided last quarter and it was more so around nursing and now you're remediating that issue, or what are you seeing on the capital front in terms of purchasing cycles?

Yes, sure. I'm happy to answer that. I think the short answer is that while it certainly remains a consideration for hospitals, it was not a major impediment to our growth last quarter. We're obviously going to continue to really closely monitor this future forward, I think like all medical device companies, but thus far we have continued to see Tablo prioritize toward or at the top of capital spending budget list. And I think it's probably due to the fact that it in-sourcing with Tablo really does offer immediate and tangible cost reduction. It's kind of a day one, dollar one benefit and the fact that it has a very fast payback period. So I would say Phil, it doesn’t feel like we’re fully out of the woods yet, but more a function of, we don’t know, we don’t know, then because it affected us in Q3. So in general, we’ve got a very, very close eye on this. But I would not cite that. As I just said, I would not cite that as a major impediment for us in Q3.

Okay. Very clear. Thank you both.

Yes, sure. Absolutely.

Please stand by. Our next caller – our next question comes from Rick Wise with Stifel. Your line is open.

Good afternoon, Leslie. Hi, Nabeel. I just really one topic from me for now gross margin, again, it’s great to see the progress there. Congratulations on that. And I heard your comment about the fourth quarter but I think a couple things. One, what are – I appreciate the drop volume, higher volume is going to drive gross margin, but help us maybe better understand the next step forward. And I’m going to say 2023 because that’s just the year ahead. But what steps up beyond just volume, the gross margin, what drives the gross margin in 2023? Cost reduction mix I mean, the bridge solution one time, I think I’ve heard you say it was margin accretive. To what extent is that going to help? And just to wrap up this whole gross margin topic, the 50% gross margin target by 2025. I think in the last few months, given some of the challenges, I sort of might imagine that got put out is how are you thinking about that target now in light of your progress this quarter? Thank you very much.

Yes, Rick, so absolutely happy to talk about this. So on gross margin a few things. Number one, our next milestone is indeed this 50% gross margin target. And from our progress to date, we expect that march forward to be linear, right? And then there’s really four factors, Rick, that drive our margin expansion, all of which we have sort of executed on, all of which we have a lot of conviction in our ability to continue to execute on. And those are number one, as you alluded to, it’s just volume revenue, volume growth. Number two, it’s ongoing console cost down. Number three, it’s consumable pull through as our installed base grows. And finally it’s service leverage. And Rick, it’s been basically these four things that have helped to contribute to the 500 basis points margin expansion we saw in Q3. And it’s those same things that’ll continue to propel us to that 50% gross margin target going forward.

Got you. Thank you very much.

[Operator Instructions] Our next question comes from Suraj Kalia with Oppenheimer. Your line is open.

Good afternoon, Leslie, Nabeel, Jim, can you hear me, all right?

Yes.

Yes.

Perfect. Hey, so let me start on Nabeel. Forgive me, I got a little confused to one of the prior questions. The original guide of 140 to 150, if memory serves me right, 15% or so was supposed to be home hemo contribution. And the comments just made now that the guide is approximately 112 million, is home hemo still 15% of the original number or 15% of the new guide? Sorry, I got a little confused there.

Yes, Suraj, absolutely. So the 15 so home we are projecting can be 15% roughly mid teens of the new guide.

Okay, fair enough. And Leslie or Nabeel, when you look at the original guide right at the beginning of the year versus the current guide and the – and then you layer on your positive commentary in terms of patient retention, some of the big wins, so on and so forth. Can you help us understand that 30 million delta still, is it entirely explained by supply shortages, nursing shortages, are there any other resident factors that we should consider also?

I’ll jump in just qualitatively Suraj. Short answer no, no new factors. The nursing shortage on the acute side, we talked about this again, into kind of Q2 and through Q3. It’s definitely a factor and it remains a factor. And we certainly don’t want to overlook that. I think this past quarter was the beginning of this team going on offense, and having new ways and mechanisms to do that. We’re not going to just stand around and wait for things to get better. This is the – this past quarter we stood up and took action. But in terms of the reasons behind our revisions, those are the same reasons that I think you’re – you and other investors are already very familiar with regard to the nursing shortages on acute some possible concerns about the capital spending environment, and of course most notably the home shuffled. So no new factors that we’re aware of at this time.

Thank you. Please, one minute while we compile our next question. Our next question comes from Drew Ranieri with Morgan Stanley. Your line is open.

Hi, Leslie and Nabeel. Thanks for taking the questions. Just two questions coming out of ASN, if I may. And I’ll ask them both up front, but I guess one thing, just talking to nephrologists last week was just there’s really palpable interest in moving patients to the home, and that’s partially driven from the staffing shortage issue that’s kind of happening across the sector. So one, just as you’re thinking about 2023, could this be an accelerator for potential home adoption? And then second some data that was presented at the conference kind of suggested that PD through the pandemic kind of remain stable, if not increased, while home hemo declined. So just as you’re thinking about PD burnout rates, could that also be maybe another inflection driver in home adoption for you or for others as we’re thinking about next year? Thank you.

Yes, sure. Thanks for the questions. Drew, maybe I’ll take those in reverse order. We have absolute belief that PD will over time become a funnel for home hemo. It just makes all the sense in the world you have a population of people who are already very successfully managing their care in the home and want to stay in the home. Unfortunately, in the past, historically, just only about 3% of patients who come off PD because PD is typically a two or three year sort of transient therapy, only about 3% today do stay at best a stay at home and transition onto home hemo. The vast, vast, vast majority in the past have gone into in-center dialysis. But again today, sort of the dawn of a new day with all of the incentives and all of the tailwinds and you mentioned a new one around staffing shortages really encouraging dialysis providers to push more patients into the home. We do see a future in which many, many more PD patients will be given the active choice of staying in the home with HHD. So yes, I do see and we do feel that the PD to HHD transition will be a very important driver for more home inflection in the future. That’s one. Your first question was about staffing in the in-center environment. And yes, I think we’ve all seen and heard the big and even medium sized dialysis care providers talking about their own challenges with staffing shortages in the in-center environment, home, whether PD or HHD is clearly a way that you can serve the same or more patients in a particular location without having to increase your staffing census at the same time. So I don’t want to be overly prescriptive or precise about the exact extent to which, because I don’t know yet .The exact extent to which staffing shortages in the in-center environment will benefit home dialysis. But generally speaking, we had many of the same conversations at ASN and every day from providers who all seem to see home dialysis as an important answer to the problem of in-center staffing shortages in the future. So we’re bullish on both fronts.

Drew, is there anything else?

My apologies. Yes, please stand by while we compile the next question. Our next question comes from Phil Cooper from Goldman Sachs. Your line is open.

Thanks. I just wanted to follow up on the VA contracting to be an opportunity to talk more about the scope and scale. I did, I heard the word indefinite. I remember from the press release, I think home was used before hospital. And so I’m just interested any other qualitative or contacts you can put around the contract.

Yes sure. So this was, as we mentioned that it is a five-year now why it says indefinite, ask the government. It’s another acronym that does make a whole lot of sense because it is a five year but the, the acronym does have the I stands for indefinite, [indiscernible] but what matters most is, is what it could mean for Outset. And the big win here was the fact that the contract did include home. The VA has had a longstanding interest in making home modalities more available to veterans. And so, we’re very, very excited about the possibility of serving veterans, more veterans in the home. So this contract does enable Outset and our team to expand the use of Tablo both in the acute setting and also to work with various VA facilities around the country to start new home programs or to support their existing home programs with Tablo.

Hey, operator, is there any more questions?

There are no more questions at this time. I would now like to turn it back to Leslie Trigg for closing remarks.

Thanks, operator. And thank you all for joining today. Have a great evening.

Thank you for your participation in today’s conference. This does conclude the program. You may now disconnect.