Outset Medical, Inc. (NASDAQ:OM) Q3 2023 Earnings Call Transcript

Outset Medical, Inc. (NASDAQ:OM) Q3 2023 Earnings Call Transcript October 13, 2023

Operator: Thank you for standing by and welcome to Outset Medical’s Preliminary Third Quarter Results Conference Call. At this time, all participants are in listen-only mode. After the speakers’ presentation, there will be a question-and-answer session. [Operator Instructions] As a reminder today’s conference is being recorded. I would now like to hand the conference over to your host Mr. Jim Mazzola, Head of Investor Relations. Please go ahead, sir.

Jim Mazzola: Hey, good afternoon, everyone. The purpose of the call today is to discuss our preliminary results for the third quarter and provide updated guidance for 2023. I’m here with Leslie Trigg, Chair and Chief Executive Officer; and Nabeel Ahmed, Chief Financial Officer. We issued a news release and updated our investor presentation after market close today, 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 be protected under the Private Securities Litigation Reform Act of 1995. Factors that cause actual results to differ materially from those forward-looking statements are discussed in Outset’s public filings with the SEC, including our latest annual and quarter reports. With that, I will now turn the call over to Leslie.

Leslie Trigg: Thanks, Jim and good afternoon. During today’s call, we will discuss our preliminary third quarter results, including the headwinds that impacted Q3 and that we expect will carry forward through the fourth quarter and into 2024. We will also discuss what has not changed, which includes Tablo’s wide and growing competitive moat, the clear economic advantages it delivers in the acute setting, and its ability to transform the patient and provider experience with home dialysis. Preliminary revenue for the third quarter was $30.4 million, a 9% increase over the third quarter of last year. The shortfall to the guidance we provided in August was driven by a larger than expected impact in the field from the recent FDA warning letter which served to elongate our sales cycle in several ways.

First, we observed more customers than we anticipated choosing to defer their Tablo console purchasing and installation, until TabloCart with prefiltration is available again. Second, we experienced a strong competitive response which served to create marketplace confusion, particularly regarding Tablo’s use in the ICU. From a regulatory perspective, we did submit our 510(k) for TabloCart with prefiltration and intend to work as expeditiously as possible with FDA to achieve clearance. As we said on our last call, we believe we have addressed the other aspects of the warning letter and look forward to closing it out upon receipt of the 510(k) clearance. We continue to believe the actions we have taken are the right steps toward resolving these observations and further strengthening our competitive position.

On a preliminary basis, non-GAAP gross margin over performed in the quarter, reaching 25.6%, more than nine percentage points over Q3 of last year, and sequential growth of more than three percentage points from Q2 of this year. Our cash position also remained strong, exiting the quarter at nearly $200 million. Turning to utilization and recurring revenue in the quarter, we continue to see consistent use of Tablo in the acute and home setting and strong revenue from software and service. Our preliminary results show treatment revenue increased more than 60% year-over-year, and core service and other revenue, excluding the impact of our HHS agreements in Q3 ’22, increased nearly 45% on a year-over-year basis. Looking ahead to Q4 while we have not seen deals fall out of our pipeline, and we continue to see customers responding to Tablo’s cost reduction value in the acute setting we can do now expect impact from the warning letter and our decision to pause TabloCart with prefiltration shipments to extend through at least the end of the year.

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I am confident these are temporary issues that our sales team will overcome. But they did serve to slow us down and we will need additional time to get past it. Additionally, as the quarter progressed, we also started to observe an increasing number of hospitals and health systems in late Q3, deferring their purchase decisions in an environment of rising interest rates and more cautious capital spending. This deferral is serving to further elongate our sales cycle which we expect to continue into 2024. That said, customers are not turning away from Tablo and its value proposition and in fact, they continue to embrace Tablo’s proven financial and operational benefits and move towards the advantages of an insourced model. We saw a balanced quarter with roughly half of our console sales into the acute setting and half to home providers.

We continue to operate with a growing pipeline in both end markets and consistent console utilization. Further, we are seeing success with initiatives such as the Bridge Program, expanded physician education, and published cost reduction data, which are all having a positive impact in the acute setting. Taking the near term factors into account, we expect revenue for 2023 to be approximately $130 million. We will discuss our outlook for 2024 during our full Q3 earnings call in early November. Looking ahead to the longer term, we remain committed to the following pillars. First, achieving our 50% gross margin milestone. Second, burning less cash each year than the year before and third achieving profitability. On our November call, we will provide an update on our progress against these pillars.

We have a great deal of confidence in the long term opportunities for Tablo and in our ability to execute on them. We are on the front end of growth into large end markets. Our pipeline continues to expand and our value proposition remains compelling. Tablo remains highly differentiated with a growing competitive moat. And conventional dialysis care delivery models are inconsistent with how providers want to deliver care and with how patients want to live their lives. Across the board Tablo and Outset are uniquely well positioned to disrupt the status quo from the hospital to the home with long term structural tailwinds firmly intact. With that, we’ll open up the call for questions. We have a lot to cover. And I didn’t want to burden my prepared remarks reiterating views we’ve already shared publicly about recent GLP-1 data.

But having said that, I’m happy to cover that topic during Q&A if anybody has questions. And with that, operator, if you could please open the line.

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Q&A Session

Operator: Thank you. [Operator Instructions] Our first question comes from the line of Suraj Kalia. Your line is open. Hi, Mr. Suraj Kalia. Your line is open.

Suraj Kalia: Yeah. Hi, Leslie. Can you hear me all right?

Leslie Trigg: Yes.

Suraj Kalia: Perfect. So Leslie, in terms of TabloCart, and what specifically changed about the low-single digit impact to — how do you all quantify the impact now? And specifically on the acute side, if I recall correctly there was not supposed to be an impact. It seems like that too has flowed through. So maybe if you could just walk us through from Q2 to now, what suddenly has changed vis-à-vis TabloCart and CRRT? Thank you.

Leslie Trigg: Yeah, why don’t I — Nabeel, maybe I’ll provide some of the qualitative commentary, and then I’ll turn it over to you for the first part of Suraj’s question. Yeah, so a couple of thoughts on this then, Leslie, we felt very confident, actually in the beginning of Q3 and as we moved through the quarter, and we obviously always provide our very best view at the time based on the information and knowledge we have. We, as we said before, sales in our quarters are very backend weighted, similarly to many, if not most other capital equipment companies in the MedTech space. In this case, we did observe a significant number of deferrals during the last two weeks of the quarter. We did not see deals falling out of our pipeline.

We have not seen customers turning away from Tablo or the value proposition that we did see elongation of the sales cycle late in the quarter, causing some deals to just fall right over that line between Q3 and Q4. Again, that was due to really to several factors. One pertaining to some of the, sort of competitive activity around the warning letter. And also, I would say, a heightened capital spending climate and a rising interest rate environment, which as we’re seeing and hearing from health system executives is serving to sort of extend their internal decision making and the duration of their financial analyses around whether they’re going to purchase or whether they’re going to lease, and what makes sense to them at the time. So again, we did not change the fundamentals or the tailwinds of this business.

Our deal close extended, our deal pipeline did not disappear. But it has served to further elongate our sales cycle. And we do expect that to continue here through the fourth quarter and into 2024. But with that I’ll turn it over to Nabeel for any additional comments.

Nabeel Ahmed: Yeah. Hey, Suraj. Just to sort of bridge, kind of your question on — as we think about guidance where we were in Q2 relative to today, we — if you sort of take the chunks a little bit here, we said that roughly low-single digit million dollars was attributable to TabloCart with prefiltration itself. And then what we expected was that we would get some amount of deferrals, particularly in Q3 from customers who wanted to wait for TabloCart with prefiltration before taking their Tablo console itself. And indeed, we saw some of that, and that was a little bit more deferral than we anticipated. We also in Q3, we saw some of the noise, the marketplace noise related to the warning letter that carries forward into Q4. And then we’ll also start to see the impact of this capital spending. So that’s kind of the trend [ph] Suraj, if that makes sense.

Operator: Thank you. One moment please for our next question. Our next question comes from the line of Shagun Singh of RBC Capital Markets. Your line is open.

Shagun Singh: Great, thank you so much for taking the question. So I guess a couple from me. So on the capital side, can you just elaborate on these early signs that you’re seeing. What gives you the confidence that the capital orders are deferred and will not be canceled? And then with respect to this extended sales cycle, can you give us a look into by how many — how much has this been extended? How many months is it? Is it weeks, like how should we think about it? And then I have a couple of follow-ups?

Leslie Trigg: Sure, yes. Why don’t I take that? Let me — so, I’ll address capital first and kind of what are we seeing and hearing is the first part of your question chain that I heard. And then I’ll move on to parts two and three. We have been keeping a close eye, as I think many MedTech companies have on the capital spending climate and interest rate environment since the beginning of this year. This quarter for us, it really started to manifest itself more tangibly in the form of hospitals talking about pressure on their capital budgets and the impact of rising interest rates which then affects the financial analysis around leasing options. So put together what we’re hearing and seeing is more scrutiny, more justification necessary to allocate capital to specific projects, even for projects like Tablo insourcing which deliver a very tangible economic value with a relatively short payback period.

I think the capital spending climate is leading where we’re seeing more customers to evaluate multiple leasing partners, multiple leasing options, trying to negotiate better terms, weighing the buy versus lease route, maybe not once, but twice and three times in some cases, and certainly facing then longer, more involved, approval processes, with more stakeholders internally. So again, that’s what we’re seeing. Importantly, we have not lost any deals, and customers have continued to reinforce their intent to move forward, while we have seen again, a little bit of a delay in the timeline to get across the finish line on the deal close front. So hopefully that gives you the color that you’re looking for on the capital spending environment. What gives us confidence in hey, how do we know these orders are deferred versus out of the pipeline?

We have and will continue to scrutinize every single deal at a very microscopic level. And we do know what is in the pipeline for close in Q4. We have had very specific conversations with each and every one of those customers. And as I just mentioned, each and every one has continued to reinforce their intent to move forward. Our deal flow cycle is backend weighted to the end — the quarter end. I’ll be a little bit more specific about the sales process, we have around financing. How is it going to be financed? Is it lease or buy, does come at the end of our sales cycle, which means at the end of the quarter, and so you always run the risk that you have a handful of bigger deals that just fall on the wrong side of the quarter. But we do have great confidence in what we have communicated for the remainder of the year and next quarter.

Last you talked about kind of giving or asking for more color around an extension to sales cycle. Our sales cycle actually over the last 12, 18 months has really been quite steady around that 9 to 12 month range. What has extended it from time to time have been specific exogenous events. For example, if I think back, the last year or two staffing shortages for example, did extend it further. In the past, we were able to overcome that. We were able to return back to our steady state kind of 9 to 12 month sales cycle. At present it is looking like the capital spending environment may prove to be a sales cycle extender through Q4 and stretching into 2024. I’ll just tell you that we’ve been very mindful of that, and thinking about our Q4 forecast, and injecting more conservatism into how we call the timing of these deals.

And then we’ll talk about our approach more specifically to 2024 during our November call.

Shagun Singh: Got it. And just as a follow up, I think you’re talking about extending of the capital sale cycle. We did get some news around GLP-1 that’s impacted the stock. I think year-over-year growth this year is somewhere around 13%. Is there any color you can provide into 2024? I think consensus is looking for 35% year-over-year growth at this point. I’m just wondering if you can just put all that into context, and any color you can provide on 2024, and how we should think about the setup for Outset. Thank you for taking the questions.

Leslie Trigg: Sure. Thank you for the question. Maybe Nabeel, I’ll take the first part of that on GLP-1 and turn it over to you. So no, I sort of don’t expect, absolutely no impact from GLP-1 this year, next year or many years to come. Stepping back a bit though from that comment in our market, it’s obviously very important to break this down by prevalence and incidence. The prevalent ESRD population, which stands again, for end stage renal disease, the prevalent ESRD patient population today is 600,000 just in the U.S. alone. Those patients ESRD patients do have irreversible kidney failure. GLP-1 will have no effect on that. They will be on dialysis for the rest of their lives. Now that said there is a 20% annual mortality rate amongst dialysis patients and the number one cause of that 20% mortality rate is cardiovascular disease, cardiovascular events more specifically.

So our view is if GLP-1 significantly reduced CV disease and CV events, it could substantially lower the mortality rate in this prevalent population. And then that would of course imply that the prevalent population could grow substantially over time. So that’s part one on the 600,000 patients prevalent population. Now on the intimate [ph] side, there are 37 million patients with chronic kidney disease in the U.S. alone. It’s the chronic kidney disease population that then feeds what we call the new starts every year. The market model that underpins our $11.5 billion TAM, that market — our market model assumes 130,000 new dialysis starts per year. Again, that means 130,000 chronic kidney disease patients are going to progress on to dialysis every year.

That’s what underpins our $11-plus billion TAM. That 130,000 new start number is 0.36% of the 37 million people with CKD in the United States. In the CKD population as well, the number one cause of mortality is also cardiovascular disease. Where again, GLP-1 has the potential to extend life. So in summary — and I’m happy to take more questions on this, but I want to turn it over to Nabeel, this is a very, very, very large patient population with comorbidities that tie directly to cardiovascular disease. We believe that we’re likely to see an extension of life in the prevalent population, an extension of life in the CKD population. And our market model around $11.5 billion TAM assumes only 0.36% of that very large CKD population ever progressing on to dialysis each year.

So with that, I’ll leave it there for now and I don’t know if you have any thoughts about ’24 Nabeel.

Nabeel Ahmed: Yeah, so just Shagun, with respect to kind of the long term, with the size of our end market as Leslie alluded to $11 billion and Tablo’s differentiated position, we believe we have ample opportunity to grow over the long term to grow in a sustained manner over the long term. Now with respect to 2024, we will give additional color on our November call.

Shagun Singh: Thank you.

Operator: Thank you. I’m showing no further question. At this time, I’d like to turn the call back over to Lesley Trigg, CEO for any closing remarks.

Leslie Trigg: Thank you. We look forward to seeing many of you at the upcoming ASN meeting in November and of course sharing more detail from the quarter and about our forward-looking outlook on the November call. Have a good evening.

Operator: Thank you. Ladies and gentlemen, this does conclude today’s conference. Thank you all for participating. You may all disconnect. Have a great day.