Leslie Trigg - Chair, Chief Executive Officer Nabeel Ahmed - Chief Financial Officer Jim Mazzola - Head of Investor Relations

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. [Operator Instructions]. 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.

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.

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 1 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…

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 [ph] basis points and an improvement of just over five percentage points…

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

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.

Yes. Hey, Travis, it’s 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?

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 [inaudible] in December?

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, these capital purchasing decisions that every company talks about, where 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%. 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.

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

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 model the business moving forward.

All right, that’s helpful. And then I guess a last question on margins. There’s a little bit of a reset on the 2023 margin guide last month. Just want to make sure if there’s any color you can provide on – does that change the pathway to the 50% over three years kind of linear pathway? When you think about this year’s margins, the four levers that you talked about in driving margins, where do you think you can pull the lever a little harder this year? And if revenue growth comes in a little better than expected, how well that’s going to flow through on the margin for 2023?

Yes. Look, Travis, the levers are unchanged. So it continues to be console cost down. It continues to be consumable pull-through and it continues to be service leverage, as well as sort of scale and revenue growth right, so those levers are unchanged. We continue to have confidence in our ability to get from the 16% we predicted for the full year of ‘22 to roughly 20% for 2023 and exiting the year again in that mid-20% zone.

And sorry, Travis, you’re cutting in and out a little bit for us. I thought I heard him ask, is it still kind of a linear path to 50%?

Thank you. Yes, yes, Travis sorry, you were cutting in and out. Yes, and it continues to be a linear path to that sort of 50% next milestone that we have, yes.

All right. Great. Thanks for taking the questions.

Thank you. One moment for our next question, please. It comes from the line of Rick Weiss with Stifel. Please go ahead.

Hi. Good afternoon, Leslie. Hi, Nabeel. I guess I’ll – let me come back to the question that Travis was asking about, the sequential change, and Nabeel, I totally get that you’re telling us what you’re seeing. But I just want to make sure that I’m really understanding, why the sequential direction first quarter versus fourth, and why you’re so confident in acceleration after that? I mean is that just the way that customers are saying they are going to take systems, i.e., they are going to move a little more slowly in the first quarter and they are committing to accelerating thereafter. And it does seem like a slight in the short-term, slightly greater pressure. I’m just not exactly understanding why and exactly where it’s – who’s moving more slowly to decide about what, the acute setting or the home. If you could just expand on your comments there would be great?

Yes, Rick. I mean, it’s spot-on what you said. Sort of again, when we set guidance for any period, we look at our backlog, how that’s rolling off and then we look at our pipeline, and what our customers are telling us. And it’s exactly what you said in terms of what we’re hearing, is folks are looking for a slower start to the year and then accelerating beyond and that’s based again on the backlog pipeline and the conversion that we have sort of baked in.

Let me – I’ll add - Rick, I’ll add a little bit of color, too. I’ll add that we aren’t seeing any worsening of staffing or any worsening of the capital spending environment. There’s really nothing in the macro that has changed from Q4 or really from our preannounced at JPMorgan. From my vantage point, we are entering – we have entered Q1 and 2023 from a very, very exciting position, and so I am really bullish on the year. We have a lot of momentum, both on the acute and the home, so there’s nothing in this that concerns me whatsoever. I think I’ve seen this a bunch just in other capital equipment businesses. That Q1 sometimes can be a little bit flat to Q4. So I just wanted to add that there’s really nothing in the macro fundamentals that is new or different here.

Yes, good, good. Leslie, the Bridge program has obviously been a huge success based on the customers I’ve spoken with. But I had the sense maybe if we heard when we heard from you, three months ago or so about it, that you thought it was going to be very short-term in nature. I don’t know, am I misreading you? It sounds like it’s going to be a little longer. I think that’s excellent. So I guess my question is, maybe talk about where you are, how long does it go on? Is this maybe in the best sense of permanent program? I just wondered about the impact on margins from this program, good or bad?

Sure yes, I’m happy to talk about that. I think there are two questions when you talk about duration or two aspects to duration. One is the program duration, and then the other is the duration of each implementation, and so when I talked about you know short term in nature so far, that remains true and that speaks to the duration of each implementation itself. We offer our partners the option of using bridge for up to 90 days. However, I think the great news is almost to a customer they have been able to hire dialysis nurses faster than they originally feared it would take, and so most of our implementations have been on the shorter side, well less than 90 days, so that was the point I was making a few weeks ago. In terms of the duration of the program, I you know – I think it’s going to be a part of our portfolio or part of our sales process for as long as it adds value. We in no way shape or form intend to or want to be a staffing company, but we don’t need to be. A lot of the value here, probably the majority of the value is in our ability to just give – help us in executive comfort that sort of I think I said psychological safety in the past, that if they have trouble staffing, if it does take longer than they expected to, we’re there for them. And it’s a stop gap, a lever that they can pull as needed. So I think what I love about bridge is that we’re getting a lot of value for it without – really without much material cost to it at all. So we’ll see more to be revealed Rick, but I could see it a part of our portfolio you know for some time in the future in ‘23, but not necessarily in the form of a lot of implementations, but just giving customers the knowledge that it’s available if needed.

Got you. And one last one for me. I think in recent months you talked and maybe I missed it in your prepared comments. You had said you were something like 30 states and you had hoped to be in – or expected to be in 50 states by year end ‘22. I just want to be clear, did you achieve that? Number one. And number two, maybe relate that back to an aspect of operating leverage that struck me. That you can now, because of the size of your sales force, you can now penetrate accounts if I heard you correctly, without adding new reps. So if you have to add new states, how would you not need to add new reps? And maybe just expand on that, because I think it’s an important point. Will the sales force not need to grow from here? Thank you.

Oh sure, yes sure, I’ll give some color and then kick it over to Nabeel to see specifics. I think what we were trying to point out – well, I’ll start on the acute side with sales force productivity, is that when you have a really, really strong foundation up in a large base of existing customers, as they start to proliferate Tablo programs across other hospitals in their network, you know there’s sort of a formula there. You don’t need to invent the wheel every single time, as a health system is expanding to hospital eight, nine, 10, 12, 25, etc. And so that makes our team much more efficient, because we've really got quite a good recipe book down in terms of how do you insource with Tablo and how do you make it a success. And so that's just an example of how our team has become much more efficient, which therefore allows us to do more with fewer. We do have broad coverage now. Tablo is used widely across the country, and yes Rick, you're right, that also gives us some geographical test across the sales force and yes, it does allow us to expand without necessarily making a lot of additions to the sales force. We absolutely will continue to add to the team as needed, but those will be variable expenses that are tied to expansion revenue. So we don't foresee big, big jumps in the size of the sales force, which is great news, and we've always talked about from an operating margin perspective, the fact that at scale we would start to see advantage from not necessarily needing to employ an army of thousands to reach our revenue target. So, I continue to believe that this model is one that will – has already and will continue to produce operating leverage as we go forward.

Great, thank you.

Thank you. One moment for our next question, please. It comes from the line of Shagun Singh with RBC Capital Markets. Please proceed.

Great! Thank you so much for taking the questions; one for Leslie and one for Nabeel. Leslie, could you talk about your home strategy in 2023 in maybe a little bit more detail; you know maybe the different buckets, the U.S. hospitals expanding to the home as well as how you're thinking about opportunities with the dialysis clinic, perhaps with partnerships and just how you the incumbent in the home setting to respond? And you know as you think about the strategy in 2023, are there any major pushback that you expect? Anything in terms of risks that may be on top of your mind as you think about executing the home strategy? And then I have a question for Nabeel.

Okay. Sure, I'll go ahead and answer this one and then flip it back to you, Shagun. On the home strategy, I think there are sort of two layers I guess that I could describe our strategy. So layer one is what matters most and what matters most is making sure that people have a great experience on Tablo, not only patients, but family members. Dialysis is an experience that ends up affecting a lot more members of the family than just the patient. And so if there's something that I think about a lot or that worries me, it's always our focus of premium on making sure that we retain these super high retention rates, even as we're trying to obviously push the accelerator down further and grow even faster. So is there a risk? Well, maybe that we don't manage to push retention rates up to these historic levels, but I can tell you that every single individual in this company is focused on doing so. So retention is at the top of the list strategically, followed by of course, a never-ending effort to expand channel access. Make sure that Tablo is offered in more and more and more home program locations so that the patients who want it have access to it. And third, we do now have a really pretty nice, pretty exciting base of home locations where Tablo already is offered, and we will be doubling down, really focused on growing and deepening the number of patients who are sent home from each and every one of these already existing home program locations. We offered in the script some early data that some of our programs have 2x and 3x the average number of patients who typically are sent home for a home program, so…

Got it, that's really helpful. And then Nabeel, just for you, can you provide a little bit more color on cash burn, you know in 2022, as well as you said it's going to be lower in '23, any magnitude of that? And just your plans to maybe incrementally draw on the term loan and not have the need to return to capital markets? Thank you for taking the questions.

Yes, Shagun. So cash flow, look 2022 we delivered over $150 million of cash, and our expectation for 2023 is that we'll burn less than that, and that's really you know on the strength of higher revenue, expanded gross margins, lower growth in OpEx year-on-year, and then finally our working capital management. So hopefully, that's helpful there. With respect to our term loan facilities, look we still have up to $200 million that we can draw down on. If we burn less cash year-on-year, you know we're ending last year with just under $291 million of cash. We may not need to draw on the term loan and as we think about that line, we're going to sort of look to optimize cash we have on the balance sheet and the cost of growing on that line, right, because that does not come cost free. So that's sort of what I’ll tell you there. And then look, we will always make sure over the long run that we are thoughtful about making sure that we have the capital we need to run our business and expand into these large end markets that we have. And so we'll always evaluate what makes sense for our business.

Thank you. [Operator Instructions]. One moment for our next question. And it comes from the line of Suraj Kalia with Oppenheimer. Please go ahead.

Good afternoon, Leslie and Nabeel. Can you hear me all right?

Yes.

Yes.

Perfect! So Leslie, one question for you and then one I'll quickly throw in for Nabeel. So Leslie, the one for you, before the home hemo hold guide for FY '22, was it approximately the same that is now for FY '23? So I'm curious, in your commentary then and now there are similarities, but expand more and tell us what specifically has changed? So that's for you. And Nabeel, if the math suggests, new home patients added in FY '22, I was wondering if you could give us some additional color on the average number of treatments for patients at home setting? And also, there is a lot of commentary about crossovers from next stage, if you could shed some color on how many are de novo patients versus crossovers? Thank you for taking my questions.

Yes, so Suraj, so with respect to our guide for ’23, I mean look our expectation is that our home – number one, we expect that both our acute and our home business will grow in ’23 relative to sort of their performance in ’22, right. We also said that home will grow faster than our acute business, and remember, this is off a bigger base, right. And so even if the contribution remains the same, there is still growth, significant growth implied in that statement, right? So absolutely, unequivocally, we are looking for our home business to grow in '23, looking for both of our home and acute businesses to grow in '23, that's part one. Part two, with respect to the average transaction - sorry, average treatment in homes, we've always seen between three and four treatments per console in the home. And that is just based on the physician's prescription for that patient, and it depends Suraj, where we are getting home patients. They tend to be the de novo patients because you know, there are large numbers of newly sort of diagnosed ESRD patients who come in every year, and we're still in relatively small numbers, all things considered.

Well said. I can't top that Nabeel. Well said on the home. Hopefully that answers your question Suraj.

Thank you. One moment for our next question please. And it comes from the line of Drew Ranieri with Morgan Stanley. Please proceed.

Hi, Leslie and Nabeel. Thanks for the taking the question. Maybe actually just to piggyback off of the last question, Leslie you mentioned your now see multiple program sending low double digits of patient's home, and I mean that's really encouraging. I understand that it's De Novo mainly now, but I guess how are you kind of thinking about the PD opportunity and the eventual burnout that kind of results from using that as a first home therapy? And maybe just how are you kind of thinking about like the low double digits growing to even further in '23? Just trying to get a better sense of that and any potential catalysts that you can point us to for '23 for new products or the VA relationships? Just anything on those two topics. Thank you.

Sure. Happy to. I'm just getting those VA new products. Well yeah, let me start with the home and PD. And you said we do have some examples of low double digits and could it grow further? Short answer, absolutely yes. We have not found the ceiling yet, which I find really exciting. I think in the past, maybe there's been a historical assumption that you know oh, you can only ever really send X number of patients homes in a given location, and that's just not been our experience. I think it again speaks to the simplicity of the device. I think it speaks to the experience that our team creates for each patient and our goal has always been to really open up the envelope and cash [inaudible] who can be successful at home. And we’ve seen that over and over again in our demographic and so far we’ve just not found any limits in terms of age or education or income status. We see equivalent ease with Tablo really across the population. So I don’t yet see a ceiling and how could we grow up further and how high could it get, more time on task. I think more to be revealed as time marches forward, but I am very, very bullish on how big these home programs could get over time and obviously as they do, that makes us incredibly efficient with our own team's time. I'm also really very, very excited about PD in the future as a funnel flow into HHC. What I find unbelievable and almost criminal is that the vast majority of patients who are already successful on home with PD end up in clinic. It's like 98% transition of PD in the home into in-center dialysis. It makes absolutely no sense.…

Thank you. One moment for our next question please. And it comes from the line of Joshua Jennings with Cowen. Please proceed.

Hi! This is Brian here for Josh. Thank you for taking my question. Just on pricing in the acute segment, I believe you commented that competitors have either raised or attempted to raise prices in recent months. Is there an opportunity for outset to increase pricing in the current environment as well or do you see your ASP increases this year primarily coming from the continued rollout of XT and TabloCart?

Hey Brian! Look, we don’t comment on pricing matter as you can imagine. I think what I’ll say is a couple of things. Number one, we have absolutely seen ASP increases from the XT attach, which is again adding value to our customers instead of monetizing that value, which we like. We’ve also seen TabloCart be a big driver or be a driver rather of ASP sort of in the quarter here and are really pleased with the performance there. You know the one thing, we have also talked a lot about the fact that we haven’t had to discount very heavily in our past, which we view as again, a testament to Tablo’s economic value proposition. So pricing, we have no complaints about pricing and pricing is favorable, was favorable for us.

Thank you. And I'm not showing any further questions in the queue. I will pass it back to Leslie Trigg for final thoughts.

Great! Thank you, operator, and thanks to all of you for joining us today. Have a great evening!

And with that ladies and gentlemen, we concludes today's program. Thank you for participating and you may now disconnect.