Good day, and thank you for standing by. Welcome to the Outset Medical Q3 2023 Earnings Conference Call. [Operator Instructions]. Please be advised that today's conference is being recorded. I would now like to hand the conference over to your first speaker today, Jim Mazzola, Head of Investor Relations. Please go ahead.

Okay. Thank you. Good afternoon, everyone, and welcome to our Third Quarter 2023 earnings call. Here with me today are Leslie Trigg, Chair and Chief Executive Officer; and Nabeel Ahmed, Chief Financial Officer. 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 page at outsetmedical.com. This call is being recorded and will be archived on 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 out public filings with the Securities and Expansion, including our latest annual and quarterly reports. With that, I will now turn the call over to Leslie.

Thanks, Jim. Good afternoon, everyone, and thank you for joining us. A few weeks ago, we provided our preliminary Third Quarter results and share detailed headwinds that will continue to affect our business through this year and into next. Today, we will review our results for the full quarter, share an update on the actions we have taken to adapt and respond to the current environment, and provide our outlook for 2024 and the longer term. We will also discuss what has not changed. Despite some recent setbacks, all the structural tailwinds remain in place. We are on the front end of growth into two very large end markets anchored by 36 million patients living with chronic kidney disease. Our pipeline continues to expand and our value proposition remains compelling. Tablo's ability to disrupt an $11 billion U.S. market with a better solution in the acute and home environment is firmly intact. To begin, revenues for the third quarter were balanced between our acute and home end markets, with a roughly equal number of consoles shipped to acute and home providers. In the acute end market, our land and expand strategy continues to support a strong pipeline and growing installed base. 30% of comps of placements during the first three quarters of 2023 came from accounts we won during 2022. The other 70% are from expansion sites. Tablo is now used in more than 650 acute and post-acute facilities, including contracts with top national health systems where we have about 20% penetration, and also within the top 50 regional IDNs, where we are less than 10% penetrated today. Further, we continue to see success with initiatives such as expanded physician education and published cost reduction data, which are all having a positive impact in the acute study. During 2023, we…

Thanks, Leslie. Hello, everyone. I'd like to talk today about three things. First, 2023, including our Q3 performance, guidance for the remainder of the year, and actions we've taken here early in the fourth quarter to reduce our rate of cash consumption. Second, our 2024 guidance our longer-term view and our path to cash flow breakeven. And third, our balance sheet and our cash position. With respect now to Q3 and 2023. Our third quarter revenue of $30.4 million is a 9% increase over the third quarter of 2022 and a sequential decline compared to Q2 2023. The sequential decline in revenue was driven by fewer console placements for the factors that we outlined in October. Consumable revenue was $11 million, up 14% from the prior quarter and 62% versus the prior year. Cartridge utilization continued to perform well and in line with our expectations, highlighting the strength of our recurring revenue model. Based on our cloud data, we see console utilization in the hospital setting of around five treatments per week and home consoles at just about three per week. Service and other revenue of $6.8 million was up 1.8% from the prior quarter and higher by 13.4% compared to the prior year. Excluding service revenue from our HHS agreement that was included in Q3 '22 and did not repeat this Q3, service and other revenue increased by 42.6% demonstrating the high renewal rates in our recurring service contracts. 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 third quarter gross margin was 25.6%, a sequential improvement of 312 basis points and an improvement of just above 9 percentage points versus the prior year…

Thanks, Nabeel. I'd like to close by going back to the fundamentals of this market, the business model, and our product. We are penetrating one of the largest health care markets in the world with over 85 million dialysis treatments performed each year in the United States alone. And we have two growth platforms within it acute dialysis and home dialysis. Our acute TAM in the U.S. is $2.5 billion. That's nearly 40,000 consoles. By year-end, we expect to have sold just over 4,000 acute consoles. So, a very, very long growth runway still lies ahead of us. The home TAM in the U.S. is nearly $9 billion, and that's assuming only 30% and dialysis patients can or ever want to go home. And from what we've seen across the country with Tablo, this is an incredibly conservative estimate. We have barely scratched the surface. With so many tailwinds pointing toward more care in the home and more dialysis care in the home specifically, we are on the right side of health care with the right technology at the right time. The business models. Just four years into commercialization, roughly half of our revenues already come from recurring revenue. When Tablo consoles are sold and installed their use. Each console sold over time generates between $15,000 and $20,000 depending on a few setting per year, every year. This is a business that produces operating leverage. For example, we have grown revenue more than 70% on a compounded annual basis over the last four years with the same size capital sales team. This is a business that will generate gross margin of 50% and beyond. We have 10 consecutive quarters of gross margin expansion behind us and a clear itemized execution plan that gift is there. This is a business that can be profitable and will be profitable due to inherent operating leverage, gross margin profile and an ever-thickening foundation of predictable, sticky recurring revenue and the product. What we do well goes beyond the technology. Our product is not just the device but change management and customer success expertise that is proprietary and very hard to replicate. There are high barriers to success, and we are actively elevating those barriers by expanding both our technology notes and our regulatory mode. Our economic, clinical, and operational value proposition is Evergreen, saves healthcare providers' money, simplify their operations, and improve the quality of living for patients. These fundamental benefits are unlikely to go out of style and Tablo brings a highly differentiated difficult-to-copy product market fit to them. For all these reasons, this is a market, a business model, and a product that supports double-digit growth rates for many years to come. With that, I think we are ready for Q&A. Operator, please open the line.

Thank you. At this time, we will conduct a question-and-answer session. [Operator Instructions]. Our first question comes from the line of Rick Wise of Stifel. Your line is now open.

Thank you for that very clear -- all those clear perspectives in numbers, the incremental guidance. there's a lot to focus on. But maybe for starters, Leslie, we attended now out that was there. the ASM meeting in Philadelphia this past week. I'd just be curious from your perspective, your high-level takeaways any updates on reactions to the opportunities that emerged at ASM. And maybe just as part of that, we were heard from one of your larger acute customers about the cost savings they're seeing. How are you driving that awareness? Clearly, there's a major customer that high volume that's seeing significant economic benefits. How are you sort of powering that message forward as well?

Yes. Sure. Thanks for the question, Rick. We're creating awareness of the, I would call it, now the proven and reproducible cost reduction benefits in a couple of ways. I mentioned on the descriptive remarks that we have actually reached a lot of people through these peer-to-peer educational sessions. We're doing them now amongst nephrologists, amongst nurses and amongst health system executives, having reached over 400 professionals just in the last, call it, nine months or 10 months. That's been a big new focus for us this year, and I think that's really paying off. So that's one venue. The second venue is by continuing to add to the published evidence base. I mentioned over 70 abstracts, 15 manuscripts. Any number of those actually reference and document the cost reduction benefits and the operational and clinical benefits as well. And I think that's really paying off. And then lastly, in large national and regional medical meetings like the one that you just alluded to, BA have been, where we have the opportunity to not only speak directly to customers, but also connect customers with their peer group. So, I will say that I think we are starting to see a bit of a network effect here that network effect is certainly turning the flywheel on the acute and continues to create momentum for us in that segment.

Great. That's excellent. And just specifically, you highlighted innovation. I was just curious -- are there other products we should be aware of or you want to talk about? But specifically, can you update us at all or adding an additional quarter color? I know it's difficult on your interactions with FDA. Or just where do things stand with Tablo's car?

With Tablo Card sure. Well, no updates on the regulatory path. It is under review and -- we feel that it was a very, very strong submission one that we're really proud of. We aren't factoring in its clearance into 2023. And for the purposes of modeling, assume that Tablo cart is cleared in the second half of 2024. But that's not driven by anything specific or new with regard to our interactions with the FDA. We just think it's a prudent assumption to make. And then I think, yes, what we're still facing and would expect to face in Q4 some of the competitive activity around Tablo cart not being available by our choice and some competitive noise making around the other aspect of the warning letter around some case studies that were on our website. We feel that we have fully satisfied the FDA's concerns around the website. And of course, we filed on 510(k) on Tablo card. Our team is absolutely better prepared this quarter. But there are a lot of customer conversations to have. I mentioned again in the prepared remarks that Tablo is being used in over 650 facilities, that's thousands of users, nurses and health system administrators, and nephrologists that our team has to and want to have conversations with just to ensure that there are no misconceptions or misinformation out there. So, I would expect that that communication process, those conversations will certainly take us through Q4, which again was factored into the guidance that we've provided around year-end 2023.

Great. And just one last one for me. Just maybe an update on your home efforts. Some of the key milestones from your perspective this quarter and the setup for the home outlook for '24 a little bit.

Sure. I appreciate the question. Yes. Home continues to grow. We still expect it to be a very significant contributor to revenue over the long term as we alluded to. What we're really focused on strategically is, number one, I'd say top of the funnel expanding the provider universe, whether those are new market entrants, and we've seen actually the emergence of several new market entrants. These are sort of adjacent healthcare providers that have not previously been in the home dialysis market before and have entered seeing the opportunity there and are using Tablo exclusively to drive more patient adoption in the home. So that's part one, extended the provider universe. And I think we have a lot of nice proof points out of 2023 on that one and heading into '24. The second one is to drive the depth of the home programs that we have. Historically, these home programs with the incumbent device typically tended to peter out at maybe low single-digit numbers of patients in the home. That has not been our experience. With the home programs that are offering Tablo, these are well, well, well into the double digits. And I would say, actually, I don't know yet where the ceiling is for how big a home program can be. Tablo was designed to really accelerate training to really simplify operations and therefore, expand the number of patients who feel that home is accessible to them and feel that they can be successful at home, and we see it doing that. And actually, a couple of our abstracts really demonstrate that as well. So that's point two driving depth in each home program. And then point three is always the retention rate because -- the longer that capital patients stay at home on Tablo, the ticker that foundation for future growth is we have continued through Q3, and as we sit here today, even in Q4, seeing a very steady and stable retention rate that is markedly higher than the retention rate seen with other home devices in the past.

Our next question comes from the line of Shagun Singh of RBC Capital Markets. Your line is now open.

This is Avi on for Shagun. Thank you again for the detailed longer-term outlook. It's very helpful. I had a couple. First is how should we think about the cadence of revenue growth and margin expansion? -- from 2024 to 2027, do you expect it to be linear or more back-end loaded, especially as we get closer to the EPC deadline in 2027?

Yes. This is Nabeel. So, with respect -- let me sort of first start with the annual and then I can dial into the quarters here. So, with respect to the annual, our expectation is roughly mid-teens for 2024 and then getting into the high teens for 2025 and beyond. Now with respect to the quarters within that's on revenue. From a gross margin perspective, again, in the annual, it will be linear our margin expansion has been linear annually, and sort of if you think about the quarters now going back for a while. Now with respect to the quarters, from a top line, from a revenue perspective, we have historically observed this capital purchasing cyclicality where Q1 tends to be the slowest grower and we see accelerating growth as we move through the year. That sort of applies this year that will apply in any year in 2024, given that we expect Tablo cart to get cleared in the second half. This first half, second half effects will be a little bit more pronounced and you'll see more growth in the back half of the year. But again, when you go to '25 and beyond, it will be just the capital purchasing cyclicality impacting sort of a slower Q1 and accelerating through there.

Yes, let me add on to that because I heard also something in there a little bit about home and the ECD model. So, let me address that. I think -- as I think about home, I would expect this home growth again to remain relatively linear. I mean, we'll have quarter-to-quarter variability that's to be expected. But over a period of 24 to 27, let's say, I expected the growth rate to be relatively linear. And I also just want to make a comment on the ECD model, those incentives and disincentives are getting richer as we get closer to 2027, I think by 26, 27, it gets up to either plus 8% over the Medicare base rate or minus 10%. And under the base rate if providers are not growing their home and transplant programs to the threshold that CMS has established. So that is certainly going to remain a powerful tailwind. It is not the only tailwind though. We recently have clinic closures become a tailwind. Both of the biggest service providers in the nation have announced clinic consolidation and clinic closures due largely to their own staffing challenges. And that is, in our experience, really encouraging nephrologists and health systems and other providers to really expand their home and looking at home as a near-term and long-term solution for that problem. So that's another tailwind. And then generally, Medicare Advantage. I think, again, over the long term that this will go far beyond as Medicare Advantage is now available to all dialysis patients and has been reported to be up to 40% now plus of the dialysis population. These payers, again, in our experience, have never been more motivated to send higher and higher numbers of patients home on dials and ensuring that they can reap the benefits, both clinical, economic, and operational to MA plans. So those are my additional remarks on home. I hope that's helpful.

Our next question comes from the line of Josh Jennings of T.D. Cowen. Your line is now open.

I wanted to just ask about the strategy to launch into international markets and just with the updated outlook, does that seem like it includes any international expansion plans? And so, would that be additional? And any updates just on that international strategy would be helping to think through.

Yes. Thanks for the question, Josh. The forward-looking guidance that we provided today is U.S. only. and over the near term and the long term out through 2027. We have filed for regulatory clearance in a small number of by and large English-speaking countries outside the United States, and we have had an effort underway to evaluate those markets. This is -- it's certainly a growth vector -- potential growth sector in the future, but I would call it a longer-term growth vector. Our team and our management team here remains very, very focused today on the largest dialysis market in the world, which is here in the United States.

Understood. And I wanted to ask a follow-up on the event at ASN, the nursing executive from each CA commented that about 145 hospitals adopted Tablo. And I was wondering if that IDN is kind of incorporated Tablo as the best practices’ technology for patient dialysis and maybe you can just share your view on the opportunity at HCA to more deeply penetrate their hospital network in cute setting but also catalyze development HCA memo programs.

Sure. Yes, I appreciate it. Well, let me kind of zoom back up. I mean we talked about roughly the 650 different facilities in the acute and also sub-acute, I think I talked about that more in October as really being a big grower for us. It's post-acute or subacute space as well, inclusive of very large national hospitals and health systems like HDA and others, and these regional kind of top 50 to 100 largest regional IDNs. HCA has been a phenomenal partner to us. They were and remain an innovator in very forward-thinking, both on the acute side and also, I think, on the home side in terms of how they're thinking about the future of dialysis care. As we look at the, let's just say, the national health systems themselves, we are just 20% penetrated there. We're proud of getting to 20%, but that leaves 80-plus percent that we still have ahead of us. And so, we're excited about replicating the success that we've had with many of our customers, again, acute and subacute throughout the rest of the national and the large regional providers as well.

Our next question comes from the line of Travis Steed of BofA Securities. Your line is now open.

This is Stephanie on the line for Travis. Thanks for taking my question. And providing the longer-term guidance. I think that's really helpful. Just wanted to ask about, first, on the preannouncement call, you talked about a few headwinds that are leading to a longer sales cycle. I know that was only a few weeks ago, but if there's any update on those from a competitive noise or capital spending standpoint and what is factored into the 2024 guidance for those? And I think you mentioned that the guidance you put out is maybe a conservative starting point. So maybe more detail on why you think this is the right thought to be for now and any drivers that could get you above this expectation?

Yes, sure. Thanks, Jean. Well, as I said kind of in the prepared remarks, I mean, there is a lot of momentum in both it can come. And I think that's due to the large evidence base now around Tablo kind of this growing network effect we just talked about in the previous question, and I think kind of the proven reproducibility of the cost reduction benefit. So those are all things that give me and us a lot of confidence in the for that we provided here near term and longer term. Having said that, I mean at the same time, we are obviously going to want to be mindful of some of the changes we're noting in the capital purchasing environment. I'll get to that part of your question in one sec and also maybe customers continuing to wait for the availability of Tablo cart potentially well into next year depending on when clearance comes and how that's affecting the duration of our sales cycle. And so, as we look forward, -- we try to be considerate of both the very real upside drivers and then some of the potential lingering headwinds in a way that allows us to have confidence and clarity in our projections. So that's maybe part one. Specifically, about capital spending, as I talked about on our call about a month ago, we're just seeing more stakeholders involved in decision-making kind of at all levels. That's not necessarily -- it's not bad. It's very understandable, and it's prudent on their part. We're seeing kind of more steps in their financial analysis and their processes and just all around more kind of eye dotting and tea crossing. Now the good news is we're not seeing customers or potential customers kind of turn away from expansion or turn away from in-sourcing or backing out of deals. We're not seeing people say that they don't want to move forward. with Tablo in either the acute or the home-end market. It's just rather kind of the extra process depth people deliberation that elongating our sales cycle, kind of maybe towards the outer edge of what we've communicated in the past, which has been about nine months to 12 months, I would say we're probably closer to sort of 12-plus months and then how did it inform our views on 24. Well, I think it is very reasonable and yet conservative to assume that some of these factors kind of carry forward for us both on some of the competitive, we call it, noise-making and also capital is elongated capital spending decision processes into 2024. But that's kind of how we thought about it, clear upside drivers and some and some considerations on the headwind side as well.

That's helpful. And then just one more on the long -- on the long-range plan. Maybe if you could just provide a little bit more detail on the overall thought process of how you put this together just generally what's assumed in the high teens annual growth rate from a macro or micro perspective. I know you talked about some of the reimbursement factors. So, anything else there may be some other drivers within acute and home.

Sure. Well, I'll ask Nabeel to weigh in here, too. I would say I mean the last four years here in the marketplace have given us a lot more data and experience than we had at the time of the IPO. Our first full launch year was 2019. So, we've learned a lot that in a briefer fashion. We also, though, today have a lot more scale from which to build on. And this again, this very predictable, very sticky recurring revenue that provides even greater visibility and predictability than we've ever had before. Our evidence base, the thousands of nurses and physicians, the hundreds of facilities, this network effect all helps a lot as we look forward. And we also have, I'll say, at the same token, we also have better knowledge of the challenges and kind of the timeline associated with true disruption and what we are doing is truly disruptive, not only on the home side, but also in the acute side. So, I guess I'll use analogy and say, we've certainly seen the full movie play out, if you will, which has given us a lot more visibility, both on upside and potential headwinds. So, all of that informs our confidence in describing how we think this business will scale over the next few years and our expectations not only on revenue, but how quickly we will achieve gross margins at 50% and cash flow breakeven getting to this third, very vital goal for us, which is reaching profitability. But anyway, Nabeel maybe I'll ask you for any other comments.

Yes, Stephanie, I would just add a little bit more color here. So, if you think about sort of placing roughly 1,400 consoles, which is what we placed in 2002, well we what we expect to place in '23. If you think about that same 1,400 console sort of overtime and you think about the recurring revenues that we get from this growing installed base that alone will get you to a roughly mid-teens CAGR between now and 2027, right? And then sort of to get to the high teens in any year, you're looking for console growth. And again, for all the reasons that Leslie talked about, we do believe we can drive higher consoles. By the way, we will have placed 400 consoles last year and expect to place this year in years when we have had two exogenous events kind of hit us -- and so we believe that is a relatively conservative assumption as we move forward. So, I say all that to say, getting to roughly mid-teens CAGR over the longer term here is possible with flat consoles, and for all the reasons, Leslie talked about, we believe we can get to high teens.

Our next question comes from the line of Kristen Stewart, CL King. Your line is now open.

Thanks for taking my question. I was wondering if you could expand a little bit more color on the competitive landscape and maybe comment on launch of Quanta's product at ASN as well, and just your thinking on the competitive landscape going forward and your thought process for not only in 2024 but the longer term as well?

Sure. Happy to. Well, we believe we have a better product with pretty deep expertise supporting customers. As I said in the prepared remarks, what I've really learned more than anything over the last four years is the importance of product and programs around the product. What we do when we walk into an acute site, we're not selling a dialysis machine. We're not trying to convince somebody that our dialysis machine is better than somebody else's to help this machine. First and foremost, we're creating opportunities strategic cost-reduction opportunities for that hospital. We showed them the financial analysis showing the cost-benefit in liver and in supplies reduction. And then step two is the how-to Hospitals and health systems have never done this before. And therefore, they, by and large, they don't already have that road map for change management. They don't already have the recipe book for how do you in-source in-patient dialysis. We have developed that in quite a proprietary way over the last several years. And so, it's really kind of the one-to-punch of a superior product, a superior team, and a proprietary playbook that I think makes our offering so compelling and so protectable. I think the other advantage here is that our footprint now is large. The Tablo evidence base is large. We do have thousands of nurses and physicians who have been trained and educated. I'll give you a quick example from ASN. I was talking to our team there at the booth, and I said, "Hey, how many physicians who came up to the booth this year had heard of Tablo or heard about that, and the answer was all. Now that's not probably precisely accurate. But I would say, even two years ago, that answer was probably more like 40% or 50%. So, we made a lot of strides in just pure awareness. And so, I think we have succeeded interacting a pretty substantial commercial note around Tablo and as well as the technology node. For example, Tablo is fully integrated with both Epic and Cerner that interoperability is a big deal, and that is no trivial task to fully integrate with Epic and Cerner. We've just sort of done that quietly in the background. And of course, a regulatory move. We continue to be new and higher bars. And so, I think all of those things help us to further elevate the barriers to success in addition to the barriers that we've already overcome to become the recognized leader here in the space.

Our next question comes from the line of Suraj Kalia of Oppenheimer & Company. Your line is now open.

Good afternoon, everyone. Lastly, a quick question, and I'll just -- I have one question. I appreciate you guys laying out the road map from FY '24 through '27 and firstly, just trying to understand the rationale for this road map at this point in time, you'll do talk about structural tailwinds for Tablo, I'm hoping you could thread the needle for us. We know GLP-1s are at the doorstep. There's a new competitor coming online next year? Just kind of walk us through putting yourself in some -- within certain benchmarks already long term, if you could kindly help us understand the rationale at this point in time. Thank you.

Yes. Sure. Happy to. Thanks for the question, Suraj. So, which I'll kind of interpret as sort of the why now simply put. I think a couple of reasons. I mean, first of all, we have heard investors loud and clear about what they most care about, what matters most to them about outset today, and where Outset going tomorrow. We're listening. And what we've heard from investors is a very strong desire to understand how and when Outset gets to profitability, how and when Tablo and Outset reaches a gross margin of 50%. And then when we start the next leg of a journey, which is going beyond 50%. And so, we felt having listened to all of our important shareholders that we wanted to provide the information, the transparency, and the clarity that our shareholders are seeking. So that's point one. Point two is that as I mentioned, I think three years post-IPO and now four years here in the marketplace. I think we do have the data and the experience, which we didn't have at the time of the IPO at that point just having been in the marketplace there for maybe just a year or two, we just have a lot more insight and a lot more scale from which to build on. As I mentioned a few minutes ago, I think we've got a lot more clarity and confidence around what the upside drivers are and also what some of the challenges are, and what that timeline is likely to look like as we disrupt this market, both on acute and home. So, I think we're in a good position based on our experience over the last four years and also out of our genuine desire to ensure that shareholders have the information that they want and need in the -- about the business and how it's going to scale over the next few years.

This concludes the question-and-answer session. I would now like to turn it back to Leslie Trigg for closing remarks.

Great. Thank you. Well, thanks to all of you for joining today. We look forward to our next update on our fourth quarter call, and have a great evening.

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