Outset Medical - Earnings Call - Q4 2024

Transcript

Operator (participant)

Good day, and thank you for standing by. Welcome to the Outset Medical fourth quarter 2024 earnings conference call. At this time, all participants are on a listen-only mode. After the speaker's presentation, there'll be a question-and-answer session. To ask a question during the session, you'll need to press star 11 on your telephone. You will then hear an automated message advising your hand is raised. To withdraw your question, please press star 11 again. Please be advised that this conference is being recorded. I would now like to hand the conference over to your speaker today, Jim Mazzola, Head of Investor Relations. Please go ahead.

Jim Mazzola (Head of Investor Relations)

Okay, thanks, Kevin, and good afternoon, everyone. Welcome to our fourth quarter 2024 earnings call. Here with me today are Leslie Trigg, Chair and CEO, and Nabeel Ahmed, CFO. We issued a news release after the close of market today, which can be found on the investor pages of outsetmedical.com. This call is being recorded and will be archived on the investor 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 and 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 factor section of Outset's public filings with the Securities and Exchange Commission, including our latest annual and quarterly reports. With that, I'll turn the call over to Leslie.

Leslie Trigg (CEO)

Thanks, Jim. Good afternoon, everyone, and thank you for joining us. The fourth quarter again highlighted the commitment of our entire Outset team to dialysis patients and providers and showcased the financial, clinical, and operational advantages Tablo delivers in the markets we serve. The business performed well in the quarter, driven by our strong recurring revenue business model and continued sales transformation progress. We demonstrated another quarter of sequential revenue growth, a notable increase in gross margins, a decline in operating expenses driven by our cost-down measures, and a significant strengthening of our balance sheet with the financing we announced on January the 6th. Revenue for the fourth quarter was $29.5 million ahead of our earlier expectations, which enabled us to finish 2024 with revenue of $113.7 million.

While this was below our original plan for the year, we were pleased to finish with two quarters of progress and ahead of the updated guidance we provided in August. Strong utilization across the now nearly 6,000 Tablo's in our installed base drove another record quarter of recurring revenue. Recurring revenue grew 13% sequentially and 17% over the fourth quarter of last year. On a console installed base that grew 10% during the year, recurring revenue grew 21% for the full year, reaching $83.9 million. At this pace, we expect recurring revenue exiting the fourth quarter of 2025 to be on a run rate of more than $100 million annually. We also continue to see strong average selling prices for our consoles and treatments, and non-GAAP gross margin continued to expand as we sold more treatments and service across a larger installed base.

Turning to our end markets, during the quarter, we continued to have success with acute care providers ready to insource their dialysis service line. There are now nearly 4,500 Tablo consoles deployed in 850 acute and subacute sites in the United States. We talked about gaining scale in the acute setting as we began 2024, and we exited the year having objectively solidified that presence as we expanded the breadth and depth of Tablo's footprint with existing large health system customers, as well as securing contracts with new marquee customers. Looking ahead to the next 10-plus months of 2025, we anticipate much of our growth to come again from this end market. We are pleased with the size and quality of the later-stage opportunities in our pipeline, and our sales team has made tremendous progress establishing the business case and support for Outset and Tablo within each.

We recently hosted the Chief Nursing Officer from a 350-bed regional hospital in the Southeast to talk about results of their insourcing program one year after its implementation. The driver for change was something we hear often. This hospital was paying what it believed to be an exorbitant cost for subpar care and service from its former outsourced provider. The CNO told us that extra fees were regularly charged as a result of the outsourced provider's poor operations. Our team came in as a partner to help build the business case, support the CNO in establishing a coalition for change, and then rolled up its sleeves to assist in the implementation. One year after stand-up, the CNO reported that treatments had increased by more than 280%, which she attributed to the greater confidence that nephrologists and patients had with the quality and efficiency of the facility's insourced service line.

Their overall treatment completion rate is now greater than 95%, and remarkably, central line bloodstream infections, one of the most serious and costly hospital-acquired infections, were reduced by 75%. Despite hearing stories like this all the time, their impact never diminishes. The clinical, operational, and financial benefits Tablo delivers for dialysis insourcing are clear, compelling, reproducible, and unique to Outset, which is why we are so confident in our strategy and our ability to execute against it in 2025 and beyond. Turning to the home end market, we continue to expand Tablo's use among mid-size dialysis providers and within skilled nursing facilities. We again saw industry-leading retention rates above 90% at 90 days. There are now approximately 1,425 Tablo consoles deployed through home providers.

While change takes longer in this setting, we continue to make steady progress and remain driven by the stories from people who tell us their lives have been changed for the better by having access to Tablo at home or in their post-acute setting. From an operational perspective, we were pleased last week to receive notification from the FDA that the warning letter from July of 2023 had been officially closed. This milestone followed a comprehensive FDA inspection in the fall, which successfully concluded with no 483 observations. Innovation will always be at our core, and therefore our quality system and regulatory compliance are essential at Outset. I am very proud of how our team responded and proud of the commitment to continuous quality improvement that we have embedded across the organization.

In addition to the warning letter closure, another recent accomplishment was the recapitalization of the company that we announced on January 6th. The goal of the financing was to reassure our key constituents, investors, customers, and employees of our ability to reach cash flow breakeven based on our current projections with ample resources to prosecute our mission. We secured $172.7 million in equity financing, of which $168.8 million was from a group of marquee, new, and existing investors, and $3.9 million that will be invested by members of management and the board. An important element of the financing was the significant reduction in our outstanding debt from $200 million-$100 million, which we refinanced with a new, highly regarded credit partner. The new debt agreement pushes out the maturity to 2030 and provides the option to access an incremental $25 million.

We now open 2025 with approximately $210 million of cash, which, based on our current projections, provides the funds expected to capitalize the company through cash flow breakeven and beyond. Related to the recapitalization, we have a special meeting of shareholders scheduled for March 5th. I encourage all shareholders to carefully review the proxy and vote your shares. Among several proposals under consideration at the meeting, we ask for your support to convert the preferred shares already issued to common shares and authorize a reverse split of the shares. We believe the reverse split will benefit the company in two ways. The first is in our ability to attract new investors who may be restricted from purchasing stocks below a certain price threshold. Second, we believe the reverse split may provide commercial benefit by ensuring that how customers perceive the company's financial strength matches the company's actual financial strength.

Our rationale for these and all the proposals are outlined in the proxy, and we're available to answer questions shareholders may have as they consider these important matters. I said last quarter that we expect the full dividends of our sales transformation to be realized beginning in the first half of 2025, and we remain on track to reach that goal. Three weeks ago, we brought the entire team together at our national sales training meeting with the goal of leaving with deeper competency on all aspects of our sales model and go-to-market strategies. During the week, our team learned from one another about best practices and were inspired through the participation of customers eager to share stories of the clinical, financial, and operational benefits they've realized by deploying Tablo.

With the sales training meeting completed, key roles hired, and process improvements in place, we look forward to seeing the results of this highly experienced and motivated team over the coming quarters. Our guidance for 2025, which Nabeel will outline, is intentionally conservative to provide some time to help ensure the benefits of the transformation we've undertaken are durable. However, foundationally, we are very bullish on the competitive advantages Tablo and its established ecosystem can deliver. We've demonstrated time and again that once Tablo is deployed, it is used consistently, and this consistent use drives strong, growing, and predictable recurring revenue. We've demonstrated that Tablo delivers compelling clinical, financial, and operational benefits to providers in the acute, subacute, and home settings. We've demonstrated our ability to expand non-GAAP gross margin, which in 2024 expanded by nearly 12 percentage points.

Finally, we've demonstrated our ability to right-size our cost structure by removing approximately $80 million of annualized debt. These actions taken together have enabled us to reduce our cash use projections in 2025 by more than 50% to less than half of what was used in 2024. With all of these steps behind us, our focus in 2025 with the transformed commercial team is on re-accelerating revenue growth, and we have a solid foundation on which to build. Despite the challenges of 2024, the Tablo installed base grew by 10%, recurring revenue grew by 21%, and we are now on a run rate to perform more than 1 million treatments annually.

With recurring revenue over a seven-year useful life of approximately $15,000 per year for each Tablo console deployed in the home and $20,000 per year for each Tablo console deployed in the acute market, we estimate that there is still $500,000,000 in recurring revenue yet to be realized from the current installed base. As we think about the year ahead, our priorities are clear. We are first and foremost focused on re-igniting revenue growth and specifically console growth. Our sales transformation has been designed and implemented to help us do just that. During the second half of 2024, we saw some positive early indicators such as pipeline expansion and deal progression, but also recognized that our work here continues. We expect to see the full benefits of these changes reflected in console growth as we move through the year.

Next, we are committed to continuing to expand our gross margin. This has been a remarkable success for Outset in an area with significant incremental upside ahead. Finally, with a recapitalized balance sheet, we are focused on using every lever at our disposal to accelerate our path to profitability. While 2024 was a year of challenge and transformation for us, what has not changed is the enormity of our market opportunity, the proprietary competitive advantages of Tablo, and the power of its economic and clinical value proposition. These bedrock strengths are at the heart of how we've driven a 50% increase in the number of healthcare facilities using Tablo in just the last two years, how we have increased our installed base by 47% in the same period, and why we continue to see treatment expansion accelerating.

For example, it took us 4.8 years to reach one million cumulative treatments. By contrast, it took us an incremental 17 months to reach two million cumulative treatments, and we are just getting started. I want to thank our entire team for their commitment to the patients we serve, in addition to their commitment to drive growth, lower expenses, and reach our shared goal of profitability. I will turn it over to Nabeel.

Nabeel Ahmed (CFO)

Thanks, Leslie. Hello, everyone. Revenue for the fourth quarter of $29.5 million grew 3% sequentially, driven primarily by recurring treatment and service revenue from continued strong Tablo utilization. On a year-over-year basis, revenue declined 3% due to lower console sales for the reasons we previously discussed, partially offset by strong recurring treatment and service revenue. Product revenue of $21 million, consisting of console revenue of $5.8 million and treatment revenue of $15.3 million, grew 3% from $20.3 million in the third quarter and declined 8% from $22.9 million in the prior year. Service and other revenue of $8.5 million was roughly even with the third quarter and grew 11% year-over-year. Recurring revenue from the sale of Tablo cartridges and service reached $23.7 million, an increase of 13% from the third quarter and 17% year-over-year.

We continue to see strong console ASP across all end markets as a result of our disciplined pricing, uptake with acute customers of our Tablo Pro Plus offering, and the return of TabloCart with Prefiltration, also with acute customers. Now, moving to gross margin and operating expenses, which, as a reminder, reflect our non-GAAP results. Please refer to the reconciliation of GAAP to non-GAAP measures found in today's earnings release. Gross margin for the fourth quarter of 37.6% increased 119 basis points sequentially and by nearly 11 percentage points from last year. This growth was underpinned by progress in both product and service and other gross margin. Product gross margin was roughly flat sequentially and increased nearly 8 percentage points year-over-year to 44.3%. Service and other gross margin was negative 2.5% in the prior year period and reached 20.9% in the fourth quarter of 2024.

As I mentioned last quarter, gross margin is adversely affected in the short term due to lower absorption of manufacturing overhead as a result of our reduced console build plan and efforts to reduce inventory levels. Absent the impact of under-absorption of manufacturing overhead, which dampened gross margin by approximately 300 basis points in the quarter, we would have seen non-GAAP gross margin of just over 40%. Operating expenses of $26.6 million declined by 27% from the prior year period, driven by our ongoing focus on expense management and the restructuring actions we've taken. Net loss was $19.3 million, or $0.37 per share, roughly 35% lower than the fourth quarter of 2023, reflecting the positive results of our drive to profitability. Moving to our balance sheet, we ended the fourth quarter with $162 million in cash, cash equivalents, short-term investments, and restricted cash.

As Leslie mentioned, following our financing in January, we had approximately $210 million on the balance sheet and have reduced our outstanding debt from $200 million-$100 million maturing in 2030. Based on our current projections, we believe this level of cash gets us through cash flow breakeven. To close out the full year of 2024, we reported revenue today of $113.7 million, which was ahead of our pre-announced in January and the revised guidance we had provided in August of last year. Product revenue was $81 million, a decrease of 22% due to lower console sales for the reasons we have previously covered. Service and other revenue was $32.7 million, an increase of 22% from 2023, driven by high service renewal rates across a larger installed base. Recurring revenue for the full year was $83.9 million, representing growth of 21% compared to our recurring revenue in 2023.

Gross margin for the year increased nearly 12 percentage points to 35.6%, or roughly 37% excluding the impact of manufacturing under absorption. Operating expenses in 2024 were $119.3 million, declining 26% from 2023 due to the focused efforts to restructure and streamline our operations and accelerate our path to profitability. Operating expenses included R&D expenses of $29.1 million, sales and marketing expenses of $61.9 million, and G&A expenses of $28.3 million. Net loss was $93.4 million, or $1.79 per share, a 29% decline compared to $131.6 million, or $2.65 per share for 2023. Turning to our guidance for 2025, as Leslie mentioned, our approach is to be conservative. We expect revenue for the full year of 2025 to be between $115 million-$125 million. The midpoint of this range would imply that the installed base and recurring revenue both grow by roughly 10%.

For modeling purposes, we anticipate revenue to be the lowest in the first quarter and then build as we move through the year. Moving down the income statement, we expect another year of gross margin expansion in 2025, with gross margin for the full year in the high 30% range. As we discussed on last quarter's call, the rate of expansion will be affected as we burn down our inventory levels and under-absorb manufacturing overhead. Excluding the impact of under-absorption, we would anticipate company gross margin exiting the year above 40% in the fourth quarter of 2025. We plan to continue to quantify this impact to non-GAAP gross margin each quarter to help you model the trajectory. Although gross margin may fluctuate on a quarter-to-quarter basis as a result of our product mix, we remain right on track to meet our next gross margin milestone of 50%.

Again, gross margin expansion is driven by recurring revenue from a larger installed base, service leverage, and our console cost-down programs. With the cost reductions we have undertaken, we now anticipate OpEx in 2025 of roughly $90 million, below the $100 million run rate we projected on our third quarter call. This combination of expected revenue growth, continued gross margin expansion, and ongoing OpEx and working capital discipline means that we expect to use under $50 million of cash in 2025, which is less than half the $103 million we used in 2024. Lastly, as it relates to our 2025 outlook, I want to address the potential impact of tariffs that have been proposed on goods imported from Mexico. As you know, we have a state-of-the-art manufacturing facility in Mexico where Tablo, TabloCart, and Tablo Cartridges are produced.

We do not believe we will have exposure to potential tariffs as our products are covered under a special exemption. In addition, we previously said that we are carrying adequate console inventory we believe will satisfy most of our anticipated demand in 2025 and which are already in the United States. We also have treatment inventory staged in the United States to meet near-term demand, and we are able to shift a portion of our future production to Thailand should it be necessary. To close, we operate in large end markets where our strong value proposition continues to resonate, and with two quarters of good progress under our belts, we look forward to returning to growth in 2025 and continuing on our path of gross margin expansion and to profitability. With that, I think we're ready for Q&A. Operator, please open the lines.

Operator (participant)

Thank you. Ladies and gentlemen, if you have a question or a comment at this time, please press star 11 on your telephone. If your question has been answered or you wish to move yourself from the queue, please press star 11 again. We'll pause for a moment while we compile our Q&A roster. Our first question comes from Marie Thibault with BTIG. Your line is open.

Marie Thibault (Managing Director)

Hi, good evening. Thanks for taking the question. It's a nice quarter. I wanted to ask quickly here for both a qualitative and quantitative outlook on the console side. I heard Nabeel's comments about a 10% increase in installed base if we take the midpoint of the guide. If I look at the Q4 console revenues, I think sequentially down from Q3, if I got the math right. I might be wrong. I wanted to understand kind of what you're seeing from the sales force that continues to give you guidance and, I mean, confidence in this turnaround. Any updates on large deals and how you would envision kind of the midpoint of the guidance for console sales working throughout the year, cadence throughout the year? Thanks.

Leslie Trigg (CEO)

Sure. Maybe I'll start, and Nabeel feel free to jump in. Yeah, completely fair question on the console front. Look, we had a lot of change and a lot to change in 2024, and we have a nine to 12 month sales cycle. As we look forward here, number one, we start to annualize that. Number two, the newly hired capital sales reps from 2024 become fully tenured in the first part of 2025 here. Also, we're anchored by what we're seeing in the pipeline. Now, understandably, I believe we want to be conservative as we lay out the year here. What is true is that all of the sales management change management steps are behind us. The regulatory changes are behind us. The balance sheet perceptions are behind us, all of which can really increase our conviction on delivering strong console growth this year in 2025.

Now, it's really a matter of continuing to inspect and ensure that the right disciplines are being practiced consistently across the country. The changes are firmly in place, and there is good evidence of them taking root, which kind of gets to your question about pipeline. Let me go there next. Here's kind of what we're seeing on the pipeline side. First of all, it continues to grow and growing in a high-quality, highly inspected way. Just in Q4 alone, we saw more than 10% growth in the 2025 pipeline. Now, roughly 70% of our top opportunities forecasted to close this year are already in the latest stages of our sales process. That is an advantage we have never enjoyed in the past as we've entered a new year. That's new. The size of the pipeline is new, and the diversification is new.

We've got really good, healthy diversification between existing customers who are now looking to expand their use of Tablo across new hospitals in their networks and also new customers choosing to insource for the first time in 2025 with Tablo. We have good diversification between national contracts and large regional IDN contracts and really good distribution across deal sizes. We are continuing to see a high percentage of potential large console opportunities that we do expect to close in 2025. All in all, again, we've had a lot of change to absorb and for the team to internalize and get good at. Those changes really are behind us, and we are now in the kind of what I call the rinse and repeat part of change management under the new model. Hopefully, that helps, Marie.

Marie Thibault (Managing Director)

Yeah, that's a lot of great detail. Thank you for that, Leslie. I guess on the flip side, treatments continue to be very, very strong with your consumables revenue. I mean, was it higher rates of utilization and turnover? Was there some ASP lift that came along with some of these consumables? What was kind of behind some of the beat, which was a good one or two million higher than we had forecasted?

Nabeel Ahmed (CFO)

Yeah, hey, Marie. We too were really pleased with our recurring revenue performance and specifically treatment sales. We did see very strong console utilization on our larger installed base. As we have seen in previous fourth quarters, we did see a little bit of stocking, but again, nothing that I would call out.

Marie Thibault (Managing Director)

Okay. Very helpful. Thank you.

Operator (participant)

One moment for our next question. Our next question comes from Shagun Singh with RBC Capital Markets. Your line is open.

Shagun Singh (Equity Research Analyst)

Great. Thank you so much. I was hoping maybe we could start on the P&L and gross margins. If you can walk us through the cadence for the year in 2025 on gross margins as well as OpEx. Given gross margins—sorry, sorry—given R&D was about 500 basis points below expectations in Q4, I'm just wondering if you can also walk us through some of the areas of OpEx cuts on R&D as well as SG&A. You're also investing given the commercial focus. Just walk us through some of the building blocks for 2025. That'll be helpful.

Nabeel Ahmed (CFO)

For sure. Yeah. Shagun Singh, so please just keep me on track here. With respect to gross margin, we printed 35.6% here for the full year, and we expect that to expand to the high 30% zone. Now, remember, gross margin will continue to be adversely affected by this under-absorption of manufacturing overhead. Absent that, it has been roughly 300 basis points in the last couple of quarters, so we could think about it in a similar zip code for next year. With respect to the quarters, we tend to generally expect linear gross margin expansion, but that can be affected by our product mix, whether it is home versus acute consoles or treatment sales versus consoles. That might put a little bit of what I will call noise in the quarterly progression on gross margin.

With respect then to OpEx, again, we printed just under $120 million of OpEx in 2024. Based on the annualization of the cuts that we made of the restructuring actions we have taken, we expect OpEx in 2025 to be in the $90 million zone. OpEx for us tends to be relatively linear. We do see a little bit more in the fourth quarter as we true up annual incentive comp, that sort of thing. Otherwise, it tends to be pretty linear. Shagun Singh, with respect to kind of where the cuts came from, our cuts have been focused on making sure that we do not touch our commercial ability to execute and expand consoles. We have kind of cut everywhere around that, but remain convinced that we have the right commercial organization to execute against our objectives for 2025. Let me pause.

Hopefully, that made sense.

Leslie Trigg (CEO)

Yeah, I'll add just a little bit more color on the R&D specific question that you had, Shagun Singh. Let me give you a couple of examples. It starts with discipline prioritization. We are very, very, very clear and have extreme focus around what we need to get done in 2025. At the risk of repeating ourselves, it's reignite revenue growth, continue to expand gross margins, and execute against our very clear path to profitability. That's it. You can put that on a bumper sticker. That's what we're going to do. As we looked at R&D, we took a very disciplined approach to prioritizing kind of only the projects that directly benefited those three goals in the very near term.

Said differently, that meant we had to take a much closer look at R&D projects that were longer dated, things that had a payoff period that fell outside of our LRP or towards the end of our LRP. That is an example of things that projects that we are not undertaking in the near term. We also, on the SG&A side, are just seeing good old-fashioned operating leverage. We are getting more done with fewer people, which is exactly what you want to see as a business scale. Those are hopefully a few additional details to provide you with the context.

Shagun Singh (Equity Research Analyst)

Thank you so much.

Leslie Trigg (CEO)

Yeah.

Operator (participant)

One moment for our next question. Our next question comes from Suraj Kalia with Oppenheimer. Your line is open.

Suraj Kalia (Managing Director)

Hey, Nabeel, can you hear me all right?

Nabeel Ahmed (CFO)

Hi, Suraj. Yes.

Suraj Kalia (Managing Director)

Perfect. Hey, one question from my side. Nabeel, obviously, a lot of positive commentary in your guys' prepared remarks. The greater than 50% reduction in cash outlay for 2025, Nabeel, the industry is very capital-intensive. I think in some way in your remarks also, your commentary, you said you're not touching the commercial organization. Can you help tie both of those together in terms of cutting back so much and the capital intensity required for growth in this business? Any additional color would be great. Thank you for taking my question.

Nabeel Ahmed (CFO)

Hey, Suraj. Yeah. First of all, with respect to our cash guidance, number one, we are expecting revenue to grow as we articulated in our call. Number two, we're expecting gross margin to expand as we talked about. We have taken OpEx down from, again, $120 million to roughly $90 million. That's $30 million of change right there. On top of that, Suraj, we've previously talked about our efforts to reduce inventory levels and reduce our console build plan to accommodate that. Finally, we have taken out a material amount of cash interest expense given our reduction from $200 million of debt to $100 million of debt. That's kind of the bridge on cash burn.

Operator (participant)

Thank you. I'm not showing any further questions at this time. I'd like to turn the call back over to Leslie Trigg for any further comments.

Leslie Trigg (CEO)

Okay. Great. Thanks to all of you for joining today. I'd like to close by thanking our entire team again for the incredible difference they're making every day in the lives of dialysis patients, their families, and the providers who care for them. Have a great evening. Thanks again.

Operator (participant)

Ladies and gentlemen, that concludes today's presentation. You may now disconnect and have a wonderful day.