Good day, and thank you for standing by. Welcome to the Outset Medical's First Quarter 2023 Earnings Call. [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, Head of Investor Relations.

Good afternoon, everyone, and welcome to our first quarter 2023 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 first quarter 2023 operational and financial results, and host a 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 Relations 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, I'll now turn the call over to Leslie.

Thanks, Jim. Good afternoon, everyone, and thank you for joining us. We had a strong start to 2023 with revenue growing ahead of our original expectations and margins expanding for the eighth consecutive quarter, also ahead of our plan. The momentum we had exiting 2022 carried through the first quarter and positions us well for continued revenue growth and margin expansion through the remainder of the year. Specifically, revenues for the first quarter were $33.5 million, representing approximately 10% growth year-over-year and approximately 5% growth sequentially. While we did see some of the capital equipment purchasing seasonality we had anticipated on our Q4 call, Tablo uptake remains strong, our installed base grew in both the acute care and home markets, and we benefited from strong mix and pricing across the board. On the operational front, our ongoing cost down and efficiency initiatives continue to pay off, resulting in gross margin that expanded sequentially by another 3 percentage points. We maintain our conviction in the fundamentals of our business, supported by a healthy pipeline and backlog, with interest in and demand for Tablo strong and growing. Our success in the first quarter lays the groundwork for accelerating growth through the balance of 2023, and as a result, we are raising the midpoint of our revenue guidance and also increasing our gross margin guidance today, both of which Nabeel will elaborate on shortly. First, I'd like to begin with a review of our results in the acute market during the first quarter, another consecutive quarter of strong growth. In short, our Q1 results came in better than expected, and we were pleased with our ability to drive upside over our expectations. Our skilled U.S. commercial team continued to deploy our proven land-and-expand strategy during the quarter, closing new sales agreements and expansion…

Thanks, Leslie. Hello, everyone. Our first quarter revenue increased approximately 4.6% sequentially and 9.5% year-over-year to $33.5 million, exceeding our expectations. The year-over-year change was driven by both higher product revenue and higher service and other revenue. The ongoing increase in recurring consumables and service revenues 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 5.4% from the prior quarter, despite some expected capital equipment purchasing seasonality and increased 8.2% year-over-year to $27.8 million. Console revenue grew 2.7% from the fourth quarter and increased by 4.5% year-over-year to $18.9 million. We saw console ASP increase year-over-year, driven primarily by our disciplined approach to pricing, and ongoing demand for Tablo accessories. Consumable revenue was $8.9 million, up 11.4% from the prior quarter and an increase of 17.1% versus the prior year, as our installed base grows. Treatment revenue in cartridge utilization performed well and in line with our expectations. We saw invoice treatments in the acute setting between 4 and 5 treatments per week and just above 3 in the home setting, reflecting the mix of mature consoles and newly shipped consoles that are ramping up. Service and other revenue of $5.7 million was up 0.8% from the prior quarter and higher by 16.4% compared to the prior year. Our core service and other revenue increased approximately 65% year-over-year, with the growth of our installed base and was offset by the planned expiry of the HHS agreements. As a reminder, the third quarter of 2022 saw the expiry 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…

[Operator Instructions] Our first question comes from the line of Rick Wise from Stifel.

Let me start off with the guidance. It's great to see a solid start to the year, and you won't be shocked that we always want more. Apologies for that, with the guide. You all are very thoughtful about providing guidance. But help us maybe think through how to -- I know you don't give quarterly guidance, but help us think through how the quarterly flow is likely to occur. Last year, we saw a step down in the second quarter, but we saw steady sequential improvement in each quarter. This year, I had started the year thinking that we'd see steady sequential increase each quarter, but because of the outperformance and the way you raised the low end and not the high end, it sort of implies maybe flat sequential growth to second quarter, and maybe looking back at past years, the $1 million or $2 million sequential increase in each quarter thereafter. I know -- I apologize for this long [off-putting] statement to the [jury]. But how do we think about it to get the right place to think about hitting that midpoint guidance?

Yes. Good to hear your voice, Rick. Maybe I'll share some thoughts and turn over to Nabeel, if there's anything to add. I think, well, first and foremost, we, too -- we're really pleased with the overperformance and the strong growth that we saw in Q1 and that the strength in the business allowed us to raise the midpoint of the range, now to reflect 25% to 30% growth. So I'll say a couple of things; first and foremost, while we do have increased confidence in our ability to execute to the 2023 plan that we outlined at the beginning of the year as a result of the strong Q1; at the same time, I'm always mindful of the fact that it is early in the year, right? We're reporting on about 90 days in to 365. So I think as always, we're going to stay focused on executing against a really strong pipeline and taking advantage of the momentum that we did create coming out of these first 90 days. So net-net, I feel really good. I think we all feel really good about how we kicked off the year and excited by our growth opportunity both near term and long term. Kind of getting to the second part of your question around kind of shape of the curve, I think you -- I think you hit the nail on the head, steady sequential improvement each quarter. We don't necessarily see any sort of flatness to it, and I think we called out at the beginning of the year, which you noted, that we did expect to see this steady sequential growth rate improvement throughout calendar year, and we don't see that any differently today.

Okay. And I appreciate some of the extra color and detail. I feel like you're giving us this color this quarter. Maybe just turning to the home program. Maybe you can give us even a little more color, if I could be greedy, and I'm not sure -- I'm looking for some granularity that just helps us better gauge the kind of progress you're making. Can you give us any color on how many new programs were established and the kind of increased patient utilization you're seeing in some of your more mature patients -- more mature home programs? Just trying to get a sense of the momentum? It sounds like momentum is building and looking for ways to ask that question.

Yes, absolutely. And you're never greedy, Rick, so you never have to worry about that Yes, maybe I'll comment on those in -- in sort of reverse order. So on the -- what are we seeing in terms of the number of home patients per program, and this is perhaps the one thing I am the most kind of encouraged by and bullish about -- I think one of the challenges of the past on some of the incumbent home hemo devices is that, these home programs would start with some of the earlier home devices and just kind of linger and never really exceed 1, 2, 3 patients per program. That has been the history in the home hemo space for quite some time. That so far has not been our experience. And again, I want to caveat this very clearly, it is early. We're working off of a small base. I acknowledge all of that. But what gives me a lot of confidence about the -- I'll call it the art of the possible here, and the reason why I believe we will have lots of programs over time with 10 plus, and I don't even know what the ceiling is yet, which is great. Is the ceiling 20, could be 30? I mean we do have programs, Rick, that are well in excess of 10, I'll tell you that, I just don't want to be overly promotional about it, in consideration that it is early and it's a small base. But I like what I'm seeing, and what we continue to see are as fast training times regardless of age, regardless of race, regardless of their home status and their education or income, it's very consistent. Patients finding it accessible and not intimidating and hearing a lot…

[Operator Instructions] Our next question comes from Travis Steed from BofA Securities.

Congrats on the quarter. Maybe digging a little deeper on Q1 and expectations for the full year. I know coming into the quarter, you're expecting capital to be soft in Q1 with seasonality and then accelerate over the year. So curious what you saw on the capital side and expectations for the year? And then on the utilization, you'd expect to see utilization come in at the lower end. And so kind of curious with the updates on that as well.

Yes. Hey Travis, it's Nabeel. So with respect to Q1, we did see some of the expected capital equipment purchasing seasonality that we talked about on our last call. But then Travis, we have always talked from a performance perspective. We really have 3 things in any quarter, where we can overperform on, if you will. One is the number of consoles. Second is sort of the treatment volume and third is ASP. In Q1, we saw strong demand for Tablo as we expected. We saw strong treatment performance, and I'll talk about utilization in a minute. And then ASP was where we really shone, we saw stronger ASP both as a result of the disciplined pricing that we've always been able to maintain. And two, we saw really good mix from the uptake of our accessories, the 24-hour software treatment and our TabloCarts, right? So that's kind of -- from a Q1 perspective, played as we expected with some nice ASP upside. Now, on utilization, Travis, we look at utilization in 2 ways. One, we have our consoles that are cloud connected. Most of our consoles are cloud connected. And so for the consoles that are more mature that have been in service, we are seeing utilization, actual treatment utilization right in line with kind of 5 treatments per week per console in the acute, and 3.5 in the home. Now with respect to invoice utilization or what we shipped in the quarter, we have grown our installed base pretty significantly over the last few quarters, and so we're seeing, as these new consoles ramp up, what we're seeing is invoice utilization of between 4 and 5 in the acute, and a little over 3 in the home. Again, all right in line with our expectations.

That's super helpful. And then maybe Nabil on margins a bit, good gross margin outperformance this quarter. You gave a little color in the prepared remarks, but digging a little bit more on the outperformance this quarter and some of the levers that you could pull this year to maybe even get closer to 30% gross margin for the year, if that is even a possible place to get to? And then on OpEx, I heard the comments on low double digits on for this year. Is that the right way to think about it longer term? Is that the kind of leverage we should expect on the operating side, low double-digit OpEx growth kind of long term?

Yes. So Travis, on gross margins, #1, this was our eighth consecutive quarter of gross margin expansion, which we are thrilled with. And sort of for margins, we have long had 3 primary levers, all of which continue to work for us over the -- have worked for us and we expect will continue to work for us. One is our active console cost-down program; 2, is the treatment pull-through, and again, I talked about having a sort of good strength in our treatments; and 3 is service leverage. Those continue -- service, I talked about some of the investments we've made, but sort of those continue. The other thing that gave us benefit in the quarter was the strong ASP that I talked about, in response to your last question, right? Now our focus for margins, Travis are -- they're unchanged. We continue to expect sequential margin expansion. We expect to get margins exiting the year in the mid-20% zone, and that's what we are laser-focused on. It's all the same things that we've been doing, that we're going to continue to do and drive margins to this mid-20% zone. And then Travis, that's not -- obviously, that's only a mile marker on our journey to 50%, right? Good news, the same thing we've done before. Now on OpEx, the thing I would tell you for OpEx is that we are committed to driving operating leverage. In 2023, OpEx is going to grow low double-digit percent on a revenue growth of 25% to 30%, and that theme of driving operating leverage will continue as we move forward in time. I don't want to give guidance on what OpEx may or may not grow at for any period beyond '23. But what I'll tell you is that, we're very focused on operating leverage and very focused on our cash burn.

Our next question comes from Shagun Singh from RBC Capital Markets.

Great. I was a little intrigued that you added about 30 new hospitals, and you called out that it's the largest quarterly growth in new sites since 2021. Can you just elaborate on what drove that? And more importantly, do you expect that momentum to continue, and as customers get more familiar with Tablo and they realize the cost savings, or is it more one-off this quarter? Your guidance increase at the midpoint appears to just factor in the Q1 beat and not an improved outlook for the balance of the year. So just if you can elaborate there, that would be great. And perhaps even touch on staffing. I think some of our checks were suggesting that it continues to be challenging. So just what you're seeing there would be great?

Yes, sure. Maybe I'll jump in on that one. I think the -- and again, in reverse order, I know the thing -- I have a pattern here. But -- so in reverse order, I think that from our vantage point, again, this is just what we're seeing here on the ground, the macro environment has absolutely improved. Now are we back pre-COVID, shiny happy people back in 2017, 2018? No. However, we have absolutely not seen staffing get any worse. And what we're hearing from our hospital customers and even reading some of their prints recently, we continue to hear is that the availability of nursing labor -- particularly, let's call it dialysis nursing labor, because that's what we're talking about here that's relevant for us, is improved and that wages are coming down. So I think as we entered the year and thought about our guidance for 2023, we assumed that we would see stabilized staffing, because we had started to see it stabilize towards the Q3 and Q4 time period of 2022. So hopefully, so far, so good, and it looks like we may have forecasted that correctly to be stable through the year. Now on the 30 new hospitals, I think you were curious about, 'hey, was this kind of a one-off or is this a durable sign of things to come?' I will say, I think it's a durable sign of things to come, and I'll tell you why I believe that. Cost reduction is an evergreen area of interest for hospitals. But as I said in my prepared remarks, perhaps never more so than today, I don't think I've ever talked to a hospital executive who is not interested in improving their operating margins. And again, because dialysis winds up getting delivered as part of hundreds and hundreds of DRGs, it can have an outsized impact on a hospital P&L, if they can save a lot of money there. So I think what we're seeing in the 30 new -- and by the way, when we make a side comment, what I also really liked about Q1 was, in the 30 new, that is a mix of both new customers and existing customers who, because of their results around cost reduction, chose to expand their in-sourcing programs to new facilities and their networks. And that is all tied into Tablo's ability to reduce operating expense and enhance operating efficiencies. And those are durable solutions to, unfortunately, a problem that I think is going to be a durable one as well for the whole system.

Shagun, just a quick thing on guidance. I mean, look, we had a really, really strong Q1 performance. Our business executed really well as we talked about early, and we certainly did what we wanted to do. Now having said all that, it's still early. We did raise our guidance range to 25% to 30%, reflecting the incremental visibility we have through the rest of the year, but we still have 3 quarters of execution ahead of us. We're very excited about this execution. We have the backlog and the pipeline. We need to go and get through this guidance range, but it is only Q1, and we wanted to sort of be thoughtful in our guidance strategy.

Got it. And just a follow-up on gross margin. You expect to deliver in the low 20s for the full year. Where do you think you might exit 2023 and the magnitude of increase in '23, is that a good proxy of how we should think about '24?

For sure, Shagun. So we expect to exit this year with gross margins in the mid-20% zone. So Q4 gross margin in the mid-20% zone. And if you look at our progress, we have delivered now 8 quarters of sequential and steady margin expansion. That trend we would expect to continue to play in the long run, in the medium run through at least this 50% gross margin mile marker. The levers of margin expansion for us, it's the same 3, it's console cost down, service leverage, consumable pull-through, all of which lend themselves to a linear margin expansion, as we've done in the past.

Our next question comes from Suraj Kalia with Oppenheimer.

Perfect. So I'll let either one if you tackle this. Nabeel, in your prepared remarks, you mentioned console growth -- consoles were up 2.7% year-over-year. I just wanted to make sure I got that right?

Suraj, yes. console revenue was up 2.7% from the fourth quarter and up 4.5% year-over-year.

So 4.5%, Nabeel, can you split that up to the next layer? i.e., what was the impact of pricing within consoles, if at all? And also, how did that split off between home and acute?

Yes, Suraj. So a couple of things. One, as you know, we print our installed base annually, which we did entering 2023, and we were exiting this year. Now what I'll tell you, is that the number of consoles we placed was right in line with our expectation, in line with kind of our commentary around capital equipment purchasing seasonality, and we did see higher ASP as we talked about on the call, which kind of helped us from a margin perspective as well. With respect to acute and home Suraj, both of our businesses performed exactly as we would expect. They're both very well set up for us to execute on our goals for this full year and will help us grow into our 25% to 30% guidance range for the year.

Our next question comes from Josh Jennings with TD Cowen.

I was hoping to just follow up on a discussion we had with a hospital executive that had adopted Tablo and in-sourced their inpatient dialysis service line. It seems as if the competition, that DaVita-Fresenius mostly are having a tough time with increased expenses and offering their hospital customers, just kind of no bargaining power, but jacking up the cost for them to run the inpatient dialysis service line. Is that still ongoing, that dynamic where there are many hospitals that are kind of being held ransom to take up their expenses, and how big of an opportunity do you think that is or what inning of that opportunity in terms of the competitors having some issues, do you think you're in right now?

Yes, let me think about that a little bit. I don't -- I want to give a clever answer on the inning, but it's not coming to me right now. So it feels like an opportunity for a witty retort, but I don't have it. Because I don't know, obviously, not being inside those organizations and knowing what their strategic plans look like. But what I can tell you is we did -- of course, we did see some of the moves and the behavior that the hospital systems and hospital started to experience with their outsourced providers in 2022, and that continues through the end of this year. And so we did certainly contemplate that, as we set up guidance for the remainder of the year and our guidance for '23 did assume that, yes, hospitals and health systems, some of them would continue to experience either elevated pricing or a reduction in service level or both -- or in some cases, the hospitals have had their outsource agreements terminated on them unexpectedly. I would not say that those -- any of those actions are driving the uptake of Tablo. It does occur, the hospitals that you're speaking about is one of them. But by and large, the insourcing of dialysis at Tablo is really considered by the majority of the hospitals to be a strategic cost reduction initiative, regardless of what's going on with their outsourced provider. Hospitals, I think, are ready to control their own destiny, not only from a cost perspective, but as a reminder, some of these other benefits are very real and very valuable. When you own your own dialysis, you control your destiny with regard to compliance. The Joint Commission very, very frequently have had health systems tell me it's one of their top 3 citations from Joint Commission. Is where your -- where are all the maintenance records on your dialysis machine. So you take control of your destiny around compliance, you take control of your destiny around length of stay. If you own your own dialysis and it's being done by your own team members, patients are not in the ICU or on the floor waiting hours and hours and hours for an outsourced vendor to come in and provide it for you. So I think there are so many benefits, operational benefits in addition to the cost reduction that are driving the hospitals toward the in-sourcing solution, regardless of whatever behavior they might be experiencing with their outsourced vendor.

Thanks for that. That was a very open answer to an ineloquent question, but that's very helpful to understand this dynamic. And wanted to also ask about just hospitals and hospital systems that are adopting Tablo, retaking control of their inpatient dialysis service line or just bringing Tablo in to swap out their dialysis systems and already controlling their inpatient dialysis service line. But then considering developing a home program, and I just wanted to better understand, I guess, the revenue opportunity and I guess, the return for these hospitals and hospital systems for bringing that kind of home patients under the roof or recouping them. I'm sure there's many elements, including a halo effect on potentially capturing those patients for all of their care, not just their home dialysis. But wanted to just better understand that dynamic and how attractive it is for a hospital, hospital systems to kind of tackle on this home service line as well?

Of course. Yes, sure. I'd love to talk about that. And I would say a little bit of what's changed in terms of the motivation of a health system, to start a home program, actually, it has been enhanced, because early on, that motivation was a top line revenue, a new chronic revenue stream. very predictable, very stable, very complementary, frankly, to maybe a less predictable procedural revenue stream in patients. That still remains true and is attractive. What has changed though and been added is, now it's a solution for a problem. And the problem that I've been hearing, a growing number of health system executives talk about is, we don't have anywhere to discharge our inpatients out into the community, because of these dialysis clinic closures that have been talked about publicly by many of the clinic operators, these hospitals increasingly are seeing extended length of stay, needing to keep patients in the hospital just to dialyze them for longer and longer, because they literally are no chairs available in the community. And so clinics are closing and clinics that are not closing, some of them are just reducing their service days or times, which is exacerbating the challenge. So I think the reason why we're hearing more and more health system executives talking about standing up home programs being very, very interested in engaging in the discussion, is because it is actually solving an acute, no pun intended, but an acute problem and it's offering a long-term revenue upside. The long-term revenue upside, which is what you originally asked me about, is in a couple of different components. Of course, you've got per treatment revenue. You also have training revenue. Physicians have billing revenue that they take advantage of -- and the real advantage for the health system is their lack of overhead. If a hospital is going to start their own home program, it takes very little facility space that does not take -- it doesn't take a village. It does not take very many staff members to just stand this up, and there are variable expenses, but they're variable. And so I think that the margin contribution, which you also asked me about for the hospital is really attractive and pretty significant, because they're not burdened by the weight of big time overhead. So I think for all of those reasons, we are seeing a lot of traction now from the health system.

Our next question comes from Drew Ranieri from Morgan Stanley.

Just maybe to piggyback off Josh's question that he last asked. But as we've talked to nephrologists over -- since covering the company, I mean there's been kind of an increasing sense of urgency in the specialty that the care paradigm just needs to change, and there's been kind of the elevated staffing shortage issues, I think, compounding that issue. So the mortality issue aside for a second that's happening in dialysis, are you seeing customers being a little bit more front-footed in preparing for what's to come, as more dialysis patients are eventually going to back into the funnel? And then just one of the comments that you said early, Leslie, was just you're seeing early green shoots of patients really starting to push the decision. So how is that going to kind of factor into the next couple of years for the company, as there's more of a push from patients versus nephrologists? Just love to hear your thoughts on that?

Sure. Absolutely. So yes, I think that the feedback that you've received from nephrologists about maybe an increasing urgency to change the care paradigm is very, very true. In fact, I was talking to a nephrologist yesterday who made the exact same remarks to me out of frustration, that he was lacking optionality at this point about finding chairs in the clinic. So I do think that, that is a tailwind, not only for hospitals to kind of, again, think about trying these home programs, but also for nephrologists. I think I do think that a sea change is coming. Of course, change -- big change occurs over time. But I do think it's coming, and this is just another pressure point pushing us to that moment around the staffing shortages, which I don't anticipate will abate in the dialysis clinics anytime soon. In terms of the health system perspective, and do I think that they are more front-footed, I not only think that I see it. Just in terms of the -- the cumulative number of conversations that our team is now having with health systems, that want to look at a full enterprise solution, as we call it, using Tablo from [indiscernible] all the way to home. We are having many, many, many more conversations than we had, let's say, this time last year, about deploying a home program, in tandem with an acute program. And that, again, is being driven -- yes, the upside revenue opportunity is great and appreciating, but it's really about kind of solving a near-term problem around length of stay and discharge. So yes, I think it is causing health systems to be much more open-minded minimally, and I do think they're trying to be a little bit more front-footed, as you put…

Really helpful. And maybe just a last question on innovation. You've launched TabloCart. Just maybe talk to us about, what's next on the innovation side? Is it hardware? Is it software? And as you're thinking about developing products, commercializing them, is there more of an emphasis on monetizing these like TabloCart? Or is it more going to be about maintaining kind of a higher retention rate or stickiness with customers? Just any thoughts there on how you're thinking about future development.

Yes. Sure, of course. Well, and the answer may be all of the above, right? So I think -- I'll tell you what I think we feel really particularly interested and excited about. And we've made some -- again, some baby steps to kind of prove to ourselves and our sales team that we can sell, I'll call it, core Tablo and that we can successfully sell add-ons. And I think this commercial team has proved so far, that we're -- we can be really, really good at that. In some cases, these add-ons, it could be hardware. I mean TabloCart is an example of that. I think I would predict more of the examples of these add-ons for which we will assign very margin friendly, margin-accretive ASPs to all of them. You will likely see coming out of the software side, both in terms of new features, functions. You may see us also offering premium versions of the Tablo ecosystem, because the Tablo ecosystem is not just the Tablo console. That's only where it starts. Once somebody buys into the ecosystem, they're also buying access to all of the data that flows to and out of Tablo. They're buying access to data analytics and dashboards. They're buying access to EMR integration. There might be basic versions of that, premium versions of that, and I'm very confident that we have a commercial team that can be exceptional in really selling value around, not only the console, but the ecosystem over time. So that's generally the direction [indiscernible].

Thank you for your questions. And now we'd like to turn it back to Leslie Trigg for closing remarks.

Thanks, and thank you all for joining the call today. I really want to thank the entire Outset team for creating such a strong start to the year. As I see it, the depth of talent and commitment and urgency and intensity that you all display every day is to me, second to none in this industry, and I could not be prouder of what we continue to achieve, together with, very forward-leaning innovation-centered provider partners and clinicians and most importantly, patients. And lastly, to our shareholders, thank you for your continued support. I really look forward to capitalizing on our early momentum and delivering on our promises through the remainder of the year. Have a great evening, and thanks again.

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