Good morning, everyone. I'm Stephanie Piazzola. I cover medical devices at Bank of America. Next up, we have Outset Medical. We have CEO Leslie Trigg and CFO Nabeel Ahmed. Thank you both for joining us.
Of course.
Thanks, Stephanie.
Since you just reported Q1 last week, maybe that's a good place to start with an overview of the quarter. You had some headwinds to revenue, but sounds like those are behind you now and some other positive updates as well. Maybe talk through those and what you thought the key takeaways of the quarter were?
Sure. Happy to. Well, the two big headlines off the quarter were getting FDA clearance for TabloCart, which has definitely been a headwind, a persistent headwind for Outset over the last three quarters as we saw that affect the timing of orders kind of pushing out from quarter to quarter. Getting that back on track and online was really, really a big deal. And two, probably the second big, big headline was our own restructuring and a very significant amount of cost reduction that we announced we had taken out not only of 2024, but also 2025, 2026, and 2027 that will allow us to reach cash flow break even a couple quarters earlier than we had previously announced, with some potential upsides incremental to that.
We had already taken out about $20 million-$25 million in October on an annualized basis, and this is on top of that. And so I think we felt really good about our ability to kind of right-size our expense profile with the rest of the business. And from that standpoint, I think to me, it's kind of cleared for takeoff. We've cleared out TabloCart. We did have a little trouble in the quarter due to the Change Healthcare cyber attack, oddly, as we saw a couple of our customers deferring purchases, both treatment and console, until their own cash flow normalized. But we saw a really, really strong start to the quarter in April. So we also feel like that very temporal factor is behind us. So just looking forward to executing and growing into our guidance range for the remainder of the year.
Yeah. And then maybe just touching on guidance a little bit more. You guided to Q2 low $30 million, which is maybe a little bit below expectations, but reiterated the full year guide of $145 million-$153 million. So maybe just talk through some of the first half or second half dynamics that give you confidence in the full year guide.
Yeah. So Stephanie, we'd always talked about this year as being kind of the tale of two halves, right, where 1H we expected to look like the back half of last year, given, again, the absence of Cart. Now, we did get that approval a little bit earlier than we'd anticipated. But what's baked into 2Q is our expectation that we're going to ramp back a little bit, if you will. We still have to get customers to sign purchase orders, to sort of we have to redo order agreements activities that we had to stop when we went on hold. So we really think of 1Q as being kind of ramping back up, if you will, setting us up well for a strong second half. And then when we think about the second half and kind of our conviction and the guidance, again, there's two components.
So, one, we will have stronger recurring revenues, consumables and service, off our larger install base. And with those larger recurring revenues, the implied console guide for 2H is roughly the same as the console revenue we actually produced in 1H of 2023, which is when we had TabloCart available, right? So you can sort of think about 1H 2023 gets 2H 2024 into the guidance range. And obviously, we have a bunch of performance levers. We can sell more consoles. We can, again, go sell more Cart into our install base. Folks who've been waiting. ASP is always a lever for us. Tablo Pro+ attach is always a lever. So that's kind of how we think about the second half.
Okay, great. And you kind of just touched on this, but maybe following up on the TabloCart approval, now that you have that, maybe talk through what the process of getting that back out into the market is like. Is everything ready to go from a manufacturing perspective and just the process of reengaging with customers that previously deferred their Tablo orders because of TabloCart?
Yeah. Well, so we're just about a week into this. So with that as a caveat, I would say the customer reaction receptivity has been really positive and really high. We're already generating quotes right now. Manufacturing will not be an issue. We had inventory, and we had continued to produce during FDA clearance, knowing that the clearance was not an if, but a when. So no issues in terms of supply. The variables here are how many hospitals will have to run this through their capital budgeting, their own internal processes. Again, some of them had budgeted the capital. This TabloCart's about $10,000, and most hospitals are buying many or multiple of them. And so it does tend to trigger the capital purchasing approval cycle. How long does that take, and how many hospitals do have to go through that again are unknown variables at this time.
Some of them had budgeted for that back in Q3 or Q4 or even Q1 and choosing to wait. And so that'll be a factor. And then also, we do have deals that are in our pipeline without TabloCart. And sometimes that works to your disadvantage, right, to try to interrupt a staged sale cycle and interject or add a PO for something new can inadvertently push the timing of orders outside of Q2, and that we don't want to do either. And so acknowledging that there are some unknowns that are out of our control, there is a lot that's in our control.
So we have been very aggressive in educating new customers, our existing customer base, making sure even our new sales team members who actually haven't sold TabloCart before because they've maybe joined the team since we pushed the pause button on it, all of that within a week is relatively done. And now we're going through, as I said, kind of the MSSA process, quotes, POs, and working with hospitals to get through their internal approval cycles. So all of this is to say, in our view, the major catalyst for the back half, the second half of the year, is TabloCart. And all the work in Q2 is designed to really make sure that we are right on the launchpad, ready to go for Q3, Q4.
Okay, thank you. And then maybe just last one on TabloCart. Is there a way to think about kind of this backlog that formed when customers were delaying their Tablo orders in the last few quarters and how we should think about that coming back in the second half? Is it all of the orders coming back, some of the orders, or what's the best way to think of that?
Yeah. So number one, we've sort of baked that into our guidance range. And I'd go back, Stephanie, to what I said, where kind of to get into our guidance range is this notion of repeating 1H of 2023. And then we will have some of these, call them backlog orders or what have you, that will move us up through the guidance range. But in addition to, we're not just depending on those. It's also our ability to sell more consoles. It's also Pro+ attach , other factors as well. But that's kind of how we thought about the guidance range.
Okay. And then maybe to follow up on the restructuring, you mentioned earlier a few-part question, why you decided to take that action now, how you thought about the shift and what you're choosing to prioritize investing in, and then the expected cadence of savings through 2027?
Okay, well, I can kick that off and read it for you.
Yeah, I can do the cadence. Yeah.
So, on the why now, okay, so to take a quick step back. So we, as I just mentioned, we did undertake a cost reduction effort in October. And that enabled us to get cash flow break even into 2027 and gave us the time and the space to get there. So that was a really important first step forward. And that was, again, $20-$25 million on an annualized basis rolling forward. But as we thought about it more in Q1, we really just decided to challenge ourselves to figure out if we could get there sooner. We are very well aware that our shareholders, both existing and potential future shareholders, would like to see Outset Medical and all companies get to cash flow break even as quickly as possible and burn less cash. And so it really became a challenge, a thought exercise. Could we figure it out?
Could we make it happen? So it took most of the quarter to determine how to do that in a way that did not jeopardize revenue growth, the guidance that we've given for the coming years. How can we do that without also jeopardizing any of our gross margin expansion initiatives? Because those have been really, really successful for us. That was a big bright spot in Q1. We overperformed again on gross margin and have a lot of conviction on the rest of the march up. So we didn't want to do anything to jeopardize that. We did get there. So how? Holding kind of gross margin as a protective non-negotiable and revenue growth as a protected non-negotiable, we took a really hard look at R&D. Long story short, our R&D and operations. We are a very ambitious, imaginative bunch of people.
And so we had been investing quite heavily, I would say, in ideas and projects on the R&D side that I would describe as future-proofing far into the future, where the spend was high, but the return profile was not short-term. And so that's a big area. That was probably at least half of where we were able to reduce our spend. And I'll say, before turning over to Nabeel, also take advantage of the very, very extensive lead that we already have over the incumbents in the space. And this is another point that had been brought up by many shareholders. And it's a good point. You guys are already so far ahead. Tablo is light years ahead. Why do you need to continue to spend so much on R&D? And this is not to say that we are going to stop being innovative, that far from it.
But we're going to look to be innovative in ways where the return profile matches the spend profile in the same period.
Just on your last part of the question, Stephanie, on cadence, so it's roughly $20 million coming out of this year out of 2024. Then that annualizes to about $30 million in 2025 and a little bit more than 30 in 2026 and 2027. In aggregate, we've identified a little over $100 million in savings. Then, as Leslie pointed out, to the extent that we can accelerate gross margin a little bit better than what we've sort of anticipated, that will deliver even more savings and get us to break even potentially quicker than we've guided.
Got it. Thank you. And then to follow up on gross margins, you've seen nice sequential improvement each quarter. You just reported 31% in Q1 and expect to exit the year in the mid-30% range, which is nice progress toward your goal of 50%. Maybe just give an overview of your three main drivers of gross margin improvement and curious if any of them change or become more or less impactful over the next few years?
Yeah, it's interesting. We went public, and this is now a few years ago, with negative 36% gross margins in that zone. And so we have already expanded gross margins by kind of 60 percentage points. And the path from here to 50 is the slope is narrower or less steep than it has been, right? So we've kind of, I think, just credit to our team, done a tremendous job here expanding gross margins. And we continue to have conviction on that path. The levers are the same three. So 1, it's console cost down. Since we've had consoles, we've taken out the cost of components, either supply chain or R&D programs. Those programs continue. They continue to be funded within kind of the framework we talked about. Number 2 is just natural pull-through of consumables and service leverage as the install base grows, right?
As the install base grows and we pull through consumables, which have a much higher gross margin than console, we get lift. Service on the edges, every incremental service contract is all margin. You don't have to add field service engineers at the same rate. So there's this element of just buoyancy based on the install base growth. And then the final thing I'll say is we have made and will continue to make investments in remote diagnostics, remote repair capabilities to even further enhance service leverage. So it's console cost down. It's consumable pull-through and service leverage. We've been doing it through today, and we'll continue doing it going forward.
Got it. Thank you. And then maybe just touching on one of your other recent announcements was the multi-year agreement with U.S. Renal Care. So maybe just give us an overview of that agreement, what these patients and their home programs are doing today, and now how you expect it to help drive home hemo adoption with Tablo.
Yeah. And I will say we've seen really good growth so far this year in home. And I continue to be very bullish about it. So our go-to-market strategy is two-tiered. So the first, of which U.S. Renal Care belongs, is partnering with what are known as midsize dialysis organizations, MDOs. And U.S. Renal Care is the largest of those. I think that they are probably around 36,000, 40,000 patients that they manage now. So they're operating at very, very significant scale. The second tier strategy is upstream of that. And that's all about expanding the provider universe, expanding channel access, giving patients more options to access home. And we've seen very significant movement in that, executing against that strategy. Two of our fastest-growing home programs were entities that actually were not even in the home business a year or 18 months ago.
These are new businesses that are formed to be home-only programs. The only reason they are in dialysis is to serve patients at home. Those are all to a program, all Tablo only. They are specifically choosing Tablo for two reasons. This is the same for U.S. Renal Care. One, it is immensely faster to train the average person, almost regardless of their demographics, on Tablo compared to the incumbent system. The incumbent system, this is widely reported over their 20-year history, typically takes 4-6 weeks to train one person. That's 5 days a week, 5 hours a day. Our mean training time, and we have closely studied this regardless of demographics, is 8-10 sessions. They're ready to go home.
So that has been a real enabler in getting patients to adopt home, lowering the barriers to adoption there, and really opening up the envelope as to who can be successful in getting through training and home. And that's really measured by our 90-day retention rate, which is 90%. Now, you might think, well, 90 days, that's not that long. That was my first reaction. Kind of, so what? Who cares? And then we looked at the government's data on this, the USRDS. And with the incumbent device, the retention rate at 90 days, their retention rate is 65%. So we are driving a very early difference in 90 days, getting people through training and home. And then our 90% is holding at 12 months. We only have about a 10% patient opt-off rate. You do have some death and some transplant that go along with that.
The sliver of patients saying, you know what? This isn't for me, that's been really steady at 10%, which is quite remarkable and very differentiated from the existing incumbent technology. And so I think it was really for those two reasons, faster training and the ability to keep more patients at home longer that led U.S. Renal Care to start to offer Tablo on a differentiated or preferential basis.
Got it. And then maybe following up to your point on how you have hospitals and subacute providers setting up their own home programs as one of the paths to sending patients home. Maybe if you could talk through a little bit more about why they decide to do this, kind of the benefit that they get from setting up the home program.
Yeah. Well, I do think another catalyst for the back half of the year is skilled nursing facilities. So catalyst one is TabloCart. Catalyst two, actually, is our gross margin for overperformance quarter-over-quarter. And I would say catalyst three is the skilled nursing facility above and beyond our normal execution on our pipeline. But the reason why I say that is that the economics for the skilled nursing facility is very, very powerful. When they choose to bring dialysis on-site, because that's the model, they are able to avoid cost, which could be $1 million a year transporting their patients from the SNF to a DaVita or to a Fresenius. All that cost goes away. And since they're usually operating on very thin margins, just the margin expansion alone is material for them.
Then the second part of the economic return for them is actually on the top line. Most dialysis treatments are reimbursed. Medicare rate is $270. When you fold in Medicare Advantage, it's typically like $325 per treatment, three or four times a week. That's also got an attractive revenue profile for the skilled nursing facility as well, and one that's new for them, in addition to being able to keep their patients in-house and ensure that they're getting kind of the services, the billable services that they need and that they can make sure those patients have access to. So it's a very strong economic ROI. And on top of that, we're now seeing these subacute players extend out of the in-house and into the home for the same reasons, really cost reduction and top-line revenue growth.
You've talked about previously an example where the largest midsize dialysis organization having 25 patients at home on Tablo. But curious what you're seeing on average for these home programs sending patients home? And when you think about the potential ceiling here, what are some of the resource or staffing constraints to consider?
Well, I'm not sure I would cite any staffing or resource constraints right now as we sit here today because it is so much faster to train people on Tablo, right? Staffing becomes a big problem when every patient's going to take you four to six weeks full-time. But we're seeing providers experiment also with training people in small groups. We're seeing providers, some of these new players who are getting into the space, experimenting with actually a lot of the training online and then in their home. And so I think that I see the industry shifting to many more creative types of ways to train and settings to train kind of part one. So I don't anticipate staffing being an impediment, again, right now or an impediment to our growth. In terms of the number of patients per center, I am also sure we haven't found the ceiling.
I am really positive that we have not found the ceiling because when you can maintain a really high retention rate at a year and beyond, it allows you to grow sustainably. I think one of the biggest challenges for home dialysis was about a 50% dropout rate at one year with the legacy device, makes it virtually impossible to grow. You got to grow 50% just to tread water. So the fact that we are keeping the one-year retention rate as high as we are really enables any given clinic to grow their base beyond what they've ever seen before.
And then when you think about kind of the ramp in home consoles, you've been adding 500 consoles a year in the home, and your long-range plan assumes that this pace will continue. So just curious if you view this as a maybe conservative starting point, or maybe why wouldn't you be able to increase the number of consoles being placed in the home each year?
Yeah, I mean, you're right. That's the way we constructed the long-range guidance was essentially, as a reminder, we said, look sorry. As a reminder, we said we place flat consoles, and the recurring revenue growth gets you to mid-teens, and you place a few incrementally more consoles to get to high-teens growth over the long run. Within that construct, Stephanie, we did assume that the composition looks the same between home and acute. But you're right, there's no reason why that couldn't change as we move into the future. That was just kind of our guidance construct.
Got it. And then maybe one last one on home. On the reimbursement side, the ETC model from CMS has been in place since 2021 and has more meaningful incentives as you move through to 2027 to send patients home. So maybe just a quick overview on the ETC model. And maybe now that those incentives are at a higher level than in 2021, how you're seeing that impact treatment choices?
Yeah. So in the ETC model, which is a CMS program designed to incent providers to move more patients home, it's really around home dialysis and transplant. Kind of the richest part of the incentive structure is going to be occurring 2025, 2026, and 2027. And that's really where you get to kind of a +8%, well, +7%, +8% increase over the Medicare base rate. On the downside, you also are seeing in 2025, 2026 kind of a -8%, -9%, -10% decrement under the Medicare base rate if you don't meet minimums, minimum percentages of growth for home. So I would anticipate that the ETC will prove to be an even greater motivator to the industry in 2025, 2026, and 2027 for that reason.
Got it. Maybe turning back to acute, at the end of last year, you talked about how 25% of your provider customers were new and 75% were existing customers who expanded their Tablo use. So just curious if there's any average length of time it takes from getting a new customer to seeing them expand or any anecdotes that you can share there on timing and size of expansion?
Yeah, it's usually actually pretty quick because the economic savings is driven by supplies. The supplies that are used per treatment with Tablo, let's say in the ICU, are hundreds and hundreds and hundreds of dollars less than the incumbent systems that are used in the ICU. And so that's kind of a day-one savings that you don't have to wait to see. Incremental to that is, of course, labor savings because when the hospital takes the opportunity to terminate their outsourced agreement with a third party and utilize their own nurses, obviously, the labor rate is very different. Typically, we'll see hospitals that are paying $1,300-$1,500 per treatment in the ICU, they're paying probably several hundred all in with labor and supplies for Tablo. So the savings is dramatic. Usually, this is more behavioral than anything else.
Hospitals will wait maybe about a quarter, about 90 days, and run their kind of before and after financial metrics. And we're very clear with the hospitals right up front, hey, what KPIs are you most interested in? What do you care the most about? What do you really want to prove or disprove? And then our team is very disciplined about making sure that we're reviewing those results together, not only just in one quarter, but over time.
And then regarding acute penetration, you've talked about the acute TAM as 40,000 consoles, and you have an installed base of just over 4,000 Tablo in the acute setting, so just over 10% penetrated. Curious what you think has been the biggest limiting factor to increasing penetration so far and how you think you can move this higher over time?
Well, as I just mentioned, I mean, the economic value proposition is almost unassailable at this point. That's the first step in our sales cycle is showing them kind of on a model, the before and after picture, here's what you are paying, and we'll pull their invoices collaboratively with the hospital. Most of the time, that's kind of a shock and awe moment because a lot of hospitals don't really know. It's been outsourced for so long that people stop looking at it. But that's the shock and awe moment of the sales process. We move through that pretty quickly because it is so dramatic, the cost savings, that most people are eager to like, okay, now let's talk about how do we do it. So we spend the greatest amount of our time in the sales cycle talking about the how-to. Okay, how do we insource?
What are the steps? And what do we need to be prepared for? And what is the timeline? What do we do? What does Outset do? And that's really where probably our greatest secret asset is put into action, is kind of a proprietary playbook that we've developed over years about how to insource. We have seen things go wrong. We've seen things go right. We've avoided mistakes. We've made mistakes by ourselves and with our customers. And that's all now kind of scooped up and utilized to the benefit of those that are insourcing today. And so that's where we talk about this moat around Tablo being a lot more than the product and the device. I think there is a big knowledge moat around how to do this. It is, of course, like everything in life, not easy. It's not as easy as it looks.
But it has become very scalable, very repeatable for us, in addition to, I think, a growing cybersecurity moat, a growing EMR interoperability moat. And now, as we kind of come into our ninth 510(k) clearance, actually quite a nice regulatory moat, as we have continued to, sometimes painfully, file these 510(k)s because we are innovating and we're iterating and improving the device. It has also forced us to meet and exceed, in some cases, all of the latest FDA guidance standards around human factors and biocompatibility and now cybersecurity in ways that I think increasingly over the next year or two will become very, very, very powerful weapons for us in the marketplace because they will be unique to Outset and Tablo.
A few quarters ago, you called out a headwind for more cautious capital spending, which was elongating the sales cycle. So just curious if you've seen any changes in that dynamic?
No, not material. You're always going to have, I think, on any given quarter or any time of year, a pocket or two of the country that or really specific to a particular hospital circumstances, maybe where they have a little bit more, a little bit less to spend on capital. But there are no broad trends that we observed in Q1 or even as we sit here into Q2.
Then you've also talked about how 80% of your consoles sold in the acute setting are also bought with the Pro+ software. Maybe just give an overview of how this is a differentiating feature and the clinical and economic value of this offering to hospitals.
Yeah, it's really about the ICU use of Tablo. Again, the technology value proposition around Tablo for the hospital is it is the first device that can do a treatment anywhere from 0 to 24 hours at a wide spectrum of flow rates. That still is unique. We're still the only device that can do that. The Tablo Pro+ enables the machine to run for up to 24 hours. That is the feature that's used a lot by ICU staff and provides a lot of the clinical flexibility that's, I think, been well appreciated in addition to the economic advantages.
Pro+ is an upcharge. So we charge for that, and it's very gross margin accretive. And so we're pleased with the uptake of that product.
Okay. And then we just have one minute left here. So maybe I'll leave it to you for any closing remarks or messages you want to end on.
Well, Nabeel may have parting thoughts. I'll just say, I guess, qualitatively, I think Q1 obviously was a really critical quarter for us to kind of clear these overhangs. I think there have been a couple of overhangs that have been weighing on share price appreciation. One has been TabloCart check. That's behind us. The second has been, I think, the perception that we were going to need to get out and do a capital raise in order to reach cash flow break-even. We were very abundantly clear about that on our earnings call that we will reach cash flow break-even without the need for incremental capital raises or incremental borrowing. And we are well on our way to achieving that check. We did have kind of a new headwind that was temporal in Q1 around the Change Healthcare. Our volumes have rebounded in April and normalized.
So that kind of temporal headwind, I think, is behind us in Q1. So the way I'm viewing this is like open road. We do have a technology that is light years ahead. We do not have competitors. Our space has not been particularly innovative. And so I see a large moat with very little chance of anybody else disrupting that in the near term, and a value proposition that continues to show itself economically, time and time again, in a climate for health systems where they have never needed financial efficiencies more than they do today.
Anything you'd add?
Nothing to add to that, no.
Okay, great. Then we'll end it there. Thank you both so much.
Thank you.
Thank you.
Thanks.