Outset Medical, Inc. Q2 FY2022 Earnings Call

Greetings, and welcome to Outset Medical Q2 2022 Earnings Conference Call. At this time, all participants are in listen-only mode. A question-and-answer session will follow the formal presentation. As a reminder, this conference is being recorded. I would now like to turn this conference over to your host Mr. Jim Mazzola, Vice President Investor Relations. Thank you, sir. You may begin.

Okay. Thank you, and good afternoon, everyone. I'm here with Leslie Trigg, Chair and Chief Executive Officer; and Nabeel Ahmed, Chief Financial Officer. During today's call, we will provide an update on the listing of our Tablo ship hold discuss our second quarter operational and financial results, and provide an update on our outlook for 2022. After our prepared remarks, we will host a question-and-answer session. We issued a news release earlier today and updated our investor presentation, both of which can be found on the investor pages of outsetmedical.com. This call is being recorded, and will be archived in the Investors section of our website. It is our intent that all forward-looking statements made during today's call will be protected under the Private Securities Litigation Reform Act of 1995. Statements that relate to expectations or predictions of future events, market trends, results, or performance are forward-looking statements. All forward-looking statements are based on our current estimates and various assumptions, and involve material risks and uncertainties that could cause actual results or events to differ materially from those anticipated or implied. Outset assumes no obligation to update these statements. For a list and description of the risks and uncertainties associated with our business, please refer to the Risk Factors section of Outset's public filings with the Securities and Exchange Commission, including our latest annual and quarterly reports. With that, let me turn the call over to Leslie.

Thanks, Jim. Good afternoon, everyone, and thank you for joining us. Today, we are pleased to announce that the FDA completed its review and cleared our previously disclosed 510(k) submission on updates made to Tablo. With this clearance, we have lifted our home ship hold and will resume supporting new patients in the home. Before providing more details on our ramp back into the home market, I want to take a step back and provide comments on our overall business and the guidance we are issuing today. We now expect revenue for 2022 to be in the range of $105 million to $110 million, which reflects growth of 2% to 7% year-over-year. Two key factors are considered in that guidance. The first is the impact of the ship hold, which halted the momentum we had established with our home expansion and also disrupted our sales into the acute market. We had forecasted a significant inflection in sales of Tablo for home use during 2022 and had started to build very encouraging momentum against this goal in the first half of the year. During the ship hold, there were a large number of patients who planned to go home with Tablo and understandably had to make alternative choices. We are now working to ramp back up our commercial activities and reengage with our home provider customers, who we feel remain eager to implement Tablo. While we have not seen any change in provider interest in sending patients home with Tablo, we anticipate it will take us a couple of quarters to rebuild the patient pipeline and regain the lost momentum. In our acute market, the ship hold created some customer uncertainty, which we are actively working to address, and at quarter end pushed out the timing of some of the deals we had expected to close in the quarter. The second factor is the impact of nursing shortages and some early signs of capital spending constraints, both of which are primarily impacting our acute market. While Tablo uniquely enabled hospitals to in-source dialysis and achieve significant cost savings, doing so typically involves the hospital hiring new nurses, which has been a challenge both for national and regional health systems across the country. Toward the end of June, our average sales cycle and the timing of installations out of backlog both lengthened, and we're continuing to see that trend into this quarter. While we are not standing still and are working to help providers mitigate these issues, we expect nursing shortages and potentially tighter capital spending to play an even larger role over the second half of the year and into 2023. I will cover these factors in more detail as I review our progress in the home and acute markets as will Nabeel in the financial section, but suffice it to say that we expect the impact to moderate our revenue growth trajectory over the next several quarters. What hasn't changed is that our total addressable market remains exceptionally large, the end market demand for Tablo remains very strong, and our competitive position remains highly differentiated. Turning now to a more comprehensive update on home, our focus here is all about regaining momentum we established earlier in the year. As we anticipated, many patients who were in training or scheduled for training on Tablo had to make alternate plans, which means largely rebuilding a new patient pipeline. Having said that, we believe we have a solid foundation and reentry point toward engaging with home providers. Before implementing our ship hold, we were tracking ahead of our goal to establish 100 home programs by the end of 2022. As a reminder, we define a home program as a location offering Tablo for home dialysis, and we remain committed to this 100-program goal for the year. In addition, we have a strong contingent of physicians and providers who are eager to expand the use of Tablo in the home setting. We are thrilled that our retention rate with patients at home remains markedly high and that controllable attrition remained negligible through the ship hold. Now more than ever, we continue to believe that a high retention rate is essential to long-term growth, and we are very pleased to see that the benefits Tablo offers continue to enable patients to dialyze at home over the long term. Further, additional encouraging tailwinds continue to advance the shift toward home dialysis. For example, during the quarter, CMS issued its annual proposed rule and in it requested information from stakeholders on ways to improve access to and quality in home dialysis. In the proposed rule, CMS reinforced that dialyzing at home is associated with lower overall medical expenditures than dialyzing in center and concluded by saying, 'We believe that increasing the rate of home dialysis has the potential to not only reduce Medicare expenditures but also to preserve or enhance the quality of care for ESRD beneficiaries.' As we've discussed in the past, we benefit from a very wide competitive moat from both a regulatory and technology perspective. The results of our recent human factors study further enhance our position. As you may recall from our June update call, human factors data was the last remaining item under review by the FDA at the time. With this submission now cleared, we are pleased to share some of the key results. In these studies, healthcare professionals, patients, and care partners completed a three-hour training and were then asked by an independent facilitator to perform thousands of tasks. The breadth and depth of these studies were significant. For example, the total number of tasks covered in our Q study was 10 times greater than the only human factors study ever published by our competitor. Our results were highly differentiated as well. In the healthcare professionals group, there was a 0.5% use error rate, roughly half of what was reported in the competitor's study. In the patient and care partner group, there was a 0.9% use error rate, less than a quarter of what was reported in the competitor's study. What's more, the clinical evidence base supporting Tablo continues to grow as well. For example, this past quarter the highest number of clinical abstracts in the company's history was submitted on Tablo, many by customers to the American Society of Nephrology's Annual Scientific Conference taking place this fall. These abstracts cover a wide range of outcomes from Tablo's performance in the ICU to treatment adherence and retention among home patients. The breadth and volume speak to the growing number of customers recognizing Tablo's clinical benefits in addition to operating advantages both in the acute and home environment. Taken together, these tailwinds validate our conviction in Tablo's clear advantages in the very large and growing home market over incumbent and emergent technology. Now I'll turn to a review of our acute performance. As we anticipated, we experienced disruption in the acute market in late June, which continued into Q3, as customers digested the home ship hold news. We have also started to see a clear shift toward nursing shortages playing a role in the elongation of our sales and installation cycle. As we've outlined before, Tablo generates cost savings in two ways: supply cost reduction and labor cost reduction. Accessing the incremental and significant cost savings related to labor involved the hospital using Tablo to change from outsourcing their dialysis to in-sourcing and owning inpatient dialysis themselves. For example, one large regional player recently conducted an internal analysis of how much money they save today by in-sourcing with Tablo. Their analysis validated nearly 40% annual cost savings by converting from an outsourced dialysis model to in-sourcing with Tablo. As our footprint has continued to expand across the country and hospitals recognize the benefits of in-sourcing with Tablo, the vast majority of our pipeline mix has shifted to in-sourcing opportunities. In-sourcing dialysis delivers powerful cost reduction benefits and it also requires hiring new nurses to implement the program. While the health systems in our deal pipeline consistently report a willingness to hire in order to access the benefits of in-sourcing, they remain uncertain about timing. As a result, we've seen some delays in both hospital purchase decisions and a slower expansion cadence among current health system customers, fueled by concerns about the time it may take them to hire their own staff. That said, we are in the early phases of rolling out some proactive program ideas we believe could help alleviate staffing issues as a headwind in the future. Beyond that, as we adapt to a longer sales cycle and the current hospital operating environment, we're also taking the opportunity to strengthen and sharpen our commercial infrastructure and improve our sales processes to address the substantial opportunities that exist and set the company up for long-term success. We weighed these factors in combination with the cautious commentary from our customers regarding their future CapEx spending in establishing our guidance for the remainder of 2022. Foundationally, Tablo provides a transformative solution in an $11.4 billion US market with an incumbent dialysis technology that is complicated, burdensome, and inflexible. Our footprint in the $2.5 billion US acute care market provides us with a strategic entry point to the $8.9 billion US home market, which remains significantly underpenetrated and lacking innovation. The previous ship hold and current macro factors do not directly impact the magnitude of these market opportunities. In fact, we do not believe we have lost a single deal as a result of them, and no orders have dropped from our backlog today. I also want to emphasize that we see no change in the underlying market fundamentals for strong demand for Tablo in either the acute or home end market. But we have work to do. What we are seeing is our progress slowed, and we now need to regain our home footing and adapt to the current environmental headwinds to the acute setting. We remain confident in the strength of our technology, our competitive position, and importantly, the need for Tablo in our large and growing end market. I want to close by thanking the entire Outset team for all they do every day on behalf of providers and patients. As we work through this challenging period, our team's admirable focus on improving the lives of dialysis patients and their caregivers has not wavered. With that, I'll now turn the call to Nabeel to review our financials and provide more granularity on our updated outlook for the third quarter and the remainder of 2022.

Thanks, Leslie. Hello, everyone. Overall, our second quarter revenue of $25.1 million was in line with our guidance, and non-GAAP gross margin of 15.9% exceeded our expectations. Product revenue decreased 4.9% year-over-year to $19.6 million with the largest driver being the decline in console revenue. Console revenue decreased by 21% year-over-year to $13.2 million, driven primarily by lower console placements. As Leslie mentioned, we saw meaningful disruption in our home and acute customer base from the ship hold, as well as early signs of the broader macro headwinds impacting the business. In addition, the ship hold meant the absence of home console placements during what we anticipated would be a record June. Importantly, we have not yet had any customer cancellations out of our backlog. Consumable revenue was $6.4 million, an increase of 69% versus the prior year, reflecting our larger installed base. Our Q2 cartridge utilization continues to be in line with our expectations. Service and other revenue of $5.4 million was higher by 18.5% compared to the prior year. Our core service and other revenue doubled with the growth of our installed base but was offset by the planned expiry of this component of the HHS agreement. 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 second quarter gross margin was 15.9%, an improvement of approximately 11.5 percentage points versus the prior year period and a sequential improvement of 110 basis points. This improvement compared to the prior year period was primarily the result of the transition of our console manufacturing to our Mexico production facility, our ongoing console cost-down programs, and our revenue mix with a higher percentage of our Q2 2022 revenues coming from our consumables compared to the prior year period. Our cartridge manufacturing transition is well underway and our new Mexico-based vendor continues to ramp up their volumes. Operating expenses in the second quarter were $40.2 million, up $13.2 million versus the prior year period and in line with our guidance. The increase in OpEx was driven primarily by headcount growth resulting from investments in our commercial organization, investments in R&D, and G&A expenses. We reported a second quarter GAAP net loss of $43.8 million resulting in a net loss of $0.92 per share compared to a net loss of $30.2 million or $0.66 per share for the prior year period. Non-GAAP net loss was $36.4 million or $0.77 per share compared to a non-GAAP net loss of $26.3 million or $0.57 per share for the same period in 2021. We ended the quarter with a strong balance sheet anchored by approximately $295.4 million of cash, cash equivalents, restricted cash, and investments and minimal debt. Moving to our third quarter and full year 2022 outlook. Starting with revenue, we are moderating our near-term growth expectations as we work to regain our home momentum and take into consideration our expectation that staffing pressures and potentially CapEx constraints on acute customers will persist through at least the second half of this year and likely in 2023. These factors have elongated both our backlog and pipeline conversion timing. As a result, we now anticipate 2022 revenue in the range of $105 million to $110 million, an increase of 2% to 7% over 2021. We further expect that Q3 revenue will be roughly in line with Q2, and that our ability to move towards the top end of our guidance range is predicated on the pace of the ramp in home customers and on our ability to mitigate the acute headwinds we've spoken about. Margins will continue to expand in 2022 relative to our 7.7% gross margin in 2021 primarily as a result of our cost-down programs on the console, ongoing cartridge utilization, and lower freight costs for cartridges. We expect margins for the year to extend meaningfully on a year-over-year basis and be roughly in the low to mid-teens range as a result of our lower anticipated console and consumable shipment volumes relative to our prior guidance. Further, we expect that margins in the third quarter may step down sequentially before stepping back up in the fourth quarter. We expect our Q3 console mix to move to a higher proportion of home placements as we work to restore our presence in the home market. And we will see the expiry of the final component of our HHS agreement in the third quarter. Over the long-term, we continue to have high conviction in our ability to generate gross margins. As we discussed on our June 13 call, we have implemented cost-reduction measures designed to better align our spending with our anticipated 2022 results, while ensuring that we continue to invest to drive long-term revenue growth and margin expansion. This mix of deferred spending and structural changes, including OpEx and capital spending, will also provide benefits into 2023. While these measures resulted in only a modest reduction in spending during the second quarter, we are expected to deliver a greater benefit in the second half. As a result, we now expect 2022 spending to be roughly $10 million lower relative to our previous expectations. Lastly, turning to our balance sheet. We are fortunate to have a strong balance sheet with minimal debt that gives us the capacity to focus on our home and acute opportunities. Our revised spending forecast will also help preserve our cash runway, and we will continue to evaluate additional opportunities to defer spending in ways that preserve our cash runway without jeopardizing our ability to grow revenue and expand our gross margins. We continue to have conviction in our ability to get to cash flow breakeven, with the timing dependent on revenue growth and reaching our milestone at 50% gross margin. To close, we remain very confident in the value proposition Tablo provides and our ability to further penetrate an $11.4 billion long-term market opportunity over time. I and every member of our Outset team are pleased with the resumption of Tablo shipments in the home market and are excited about delivering on our promise to dialysis patients and providers in the acute and home settings. With that, I think we're ready for Q&A. Operator, please open the lines.

At this time, we’re conducting a question-and-answer session. Our first question comes from the line of Travis Steed with Bank of America. You may proceed with your question.

Hey, guys. Thanks for taking the question. I just wanted to touch on the revenue guidance. There's really no improvement in the second half versus Q2 levels; basically $25 million a quarter is what it looks like. So just why not see better momentum over the course of the year? And the second half guidance is basically about $30-ish million or more versus the last guidance. Just curious, why such a big reduction in the second half. I think staffing used to be more of a tailwind and now it's a headwind. Just want to make sure I understand exactly what's changed in the last three months.

Yes, I'll start with the latter part of your question. Regarding the guidance, we are indeed facing two challenges right now. The first is the momentum we lost domestically due to the ship hold over the past two months. When we made our June announcement, we were uncertain how many patients would wait compared to those opting for other home alternatives. As time has passed, it's become clear that the uncertainty surrounding FDA timing prompted patients to explore other options, which is understandable. Now that this situation is clear, we realize we need to build a new patient pipeline largely from scratch. While I am confident in our ability to do so, it will take time, and we wanted to set realistic growth expectations for the next couple of quarters. The second challenge we are facing is related to the nursing shortage. This issue initially seemed like a tailwind for us earlier in the year. However, by the end of the quarter, it became clear that it was impacting our sales cycle significantly. As our team attempted to close deals, hospitals began delaying contract decisions to ensure they could hire their nurses reliably and in a timely manner. This macro factor was likely intensified by the fact that our pipeline mix has evolved, with nearly all our opportunities now tied to hospitals wanting to purchase Tablo for in-sourcing. In summary, we believe this is not a demand issue but rather a case-related one. Although this situation requires us to adjust our growth expectations in the near term, nothing has fundamentally changed about our market opportunity, Tablo's advantages, or our long-term growth potential.

And then, Travis, just to sort of address the first of your questions, so guidance and kind of the ramp here for the second half. So our guidance really depends on a couple of things. One is our and our providers' ability to ramp back home customers. Remember, as Leslie mentioned, we did have home patients who were trained and set to go on Tablo who've now gone on to other therapies. And so we need to sort of rebuild that patient identification and training pipeline. That's number one. And then with respect to the acute, it depends on our customers' abilities to mitigate these nursing shortages. At the low end of our guidance, Travis, we're assuming that these two factors take longer to sort of work through. And then as you move into the higher end of our guidance, what we're seeing is that look Q3 is roughly a flattish quarter. And then as our home and acute customers, sort of prove that they can work through these issues that we talked about, we get back to growth in the fourth quarter.

Okay. That's helpful. Looking ahead to 2023, while I can't provide guidance at this point, I wonder if the staffing issues and lost momentum will negatively impact the year, or if it could potentially be a year of recovery where you regain some of that lost momentum. It might end up being better than anticipated. I would appreciate your broader thoughts on this beyond just the next couple of quarters. Thank you.

For sure. So Travis, let me first say, that our end markets are large and growing. We're in a strong competitive position. And as Leslie pointed out, we haven't seen any abatement in end-market demand. So our foundational growth drivers are alive and well, as we look sort of far into the future. Now having said that, the visibility we have is for the second half, and we're really focused on executing through the second half on both our home ramp, and helping our acute customers work through the staffing shortages. We will guide to 2023, as we always have which is when we print our Q4 results. But look, based on the visibility, the little visibility we have today into 2023, we would expect that our 2023 growth rates to moderate relative to what we had previously thought.

No, that's helpful color. Thanks for taking the questions. I’ll hop back in the queue.

Thanks, Travis.

Our next question comes from the line of Josh Jennings with Cowen. Please proceed with your question.

Hi, good evening. Thanks for taking the question. I wanted to just start off and ask about the human factors data. And has that been formally submitted to the FDA? I think you had referenced on the prior call in the year that it had, a couple of months ago. But just wanted to make sure that the full submission was in. And is there a timeline for the FDA to sign off on the data set and close out that requirement?

Sure. Yes, let me take that. So Josh, yes we had to formally submit the human factors data as part of that 510(k) submission. And what the FDA communicated to us, back in early June, was that their review of the human factors test data was the final remaining gating item, or the items gating their ability to clear. And so with the clearance that we received here lately on Friday, the FDA is indicating that they have reviewed all of that human factors data formally, and signed off on it and granted clearance on the basis of that.

Excellent. And just any thoughts on pricing, just as you're looking to regain momentum and remove some of the risks associated with the capital spending slowdown in hospitals, in the acute channel? Have you implemented any pricing changes, or considered pricing discount strategy to potentially moderate some of the headwinds you're facing? Thanks a lot.

Yes. Josh. Pricing, is certainly one of the levers that's available to us in our contracts. We are really focused on getting back into both of our home, and acute markets as expeditiously as possible. And there are a bunch of levers that are available to us. I don't want to go into what specific actions we may or may not take, other than to say that sort of we baked all of that into guidance.

Do you mind if I add something? One thought that comes to mind is to provide more insight into the CapEx spending environment. The key takeaway is that Tablo is an important solution with a compelling value proposition linked to capital spending, highlighting immediate savings. While hospitals are currently taking a closer look at their finances and reassessing their budgets, we have not seen any deals drop off our pipeline or backlog as a result. It's important to emphasize that. Earlier this year and last year, discussions regarding capital investments in hospitals focused mainly on basic conversations about Tablo. Now, evaluations are much more detailed and involve a stronger focus on the investment. Nevertheless, we continue to find that Tablo consistently ranks high on hospitals' capital spending priority lists due to its significant cost-reduction benefits. Overall, we don't perceive a demand issue tied to pricing or other factors; it seems more related to the pace of decision-making than anything else.

Great. Thanks for taking the questions.

Our next question comes from the line of Suraj Kalia with Oppenheimer. You may proceed with your question.

Good afternoon, Leslie, Nabeel, can you hear me all right?

Yes.

Yes.

Perfect. Congrats on resolving this whole issue. So jumping in between many calls guys just bear with me. So Leslie, I remember the number 1,200 or 1,251 something in that ballpark in terms of backlogs. And in Nabeel's prepared remarks there was this comment about no cancellations on backlogs. So I'm just trying to connect the dots. What is the home contribution? If my memory serves me right it was expected to double in FY '22. And the math was suggesting roughly around $20 million, a little over that in home revenues. So first can you tell me if we are approximately right? And if you're starting to build the funnel again, I'm curious as to your confidence level, given the remaining four months in the quarter? And where do you still stand on the 100 active home programs by end of FY '22?

Sure, Suraj. There’s a lot to cover. Let me begin, and you can chime in if I miss anything. To start with the backlog, we began the year with 1,251 consoles in backlog, a large portion of which were home consoles. For us, backlog signifies that the provider has a firm commitment to acquire Tablo from us. As we entered the ship hold, we were prepared to deliver consoles from the backlog, but we cannot proceed because of the ship hold. As a result, these patients, who were trained and ready to use Tablo, have sought other therapies. Consequently, the backlog remains intact; no consoles have been canceled, but our provider partners need to find new patients. They have to identify suitable patients and train them for home use. We've indicated that converting the backlog is taking longer than expected. The consoles don’t disappear; they are delivered at a slower pace than we initially thought. Additionally, it's important to note that the home backlog has always had a longer timeline because our partners are making long-term commitments to send patients home. Regarding home revenue contribution for the full year, we previously mentioned that it would be around mid-teens as a percentage of our total revenues. We still believe that within our guidance range, we can achieve that same percentage for home. It really relies on our partners’ ability to identify, train, and get patients home in the next six months and throughout the rest of the year. Does that address your question, Suraj?

Yes, that's understandable. Nabeel, I have one last question before I rejoin the queue. In your prepared remarks, you mentioned a longer sales cycle for hospitals. Also, Leslie, I believe I heard something about staffing pressures. I know someone previously asked about this, and I apologize for jumping in with my confusion. Regarding the acute side, the value proposition for Tablo was essentially aimed at alleviating staffing challenges. However, now we are seeing staffing issues being considered in a guidance reduction. I’m sorry, I’m having difficulty connecting these points. Thank you for addressing my question.

Sure. Thanks a lot. I can jump in and address that. So, looking back, there are two ways that hospitals can reduce costs with Tablo. The first is through supply cost reduction, meaning it costs less to administer treatment with Tablo in acute settings compared to other options. The second way involves labor. Some hospitals have outsourced their dialysis services in the past, while others have always managed it in-house and use Tablo for cost savings. I noted that we've begun to see a shift in our pipeline, particularly from mid-Q2 onward, towards hospitals that are keen to in-source dialysis with Tablo, leading to even greater cost reductions. However, most of these hospitals will need to hire some additional staff to implement the program. While Tablo remains a straightforward solution that enhances operational efficiency, it also addresses staffing shortages in hospitals. For those choosing to in-source dialysis, this can affect the length of our sales cycle because these hospitals need extra time to determine how quickly they can hire the necessary staff. Based on my discussions with customers, there isn’t resistance to making a deal or hiring staff; rather, there is uncertainty about the timeline for hiring. Typically, it’s just a small number of positions they need to fill. This uncertainty in their decision-making process regarding the speed of implementation has extended our sales cycle, particularly in the latter half of this quarter.

Our next question comes from the line of Rick Wise with Stifel. You may proceed with your question.

Good afternoon, Leslie and Nabeel. I've been thinking about aspects that might be more manageable for you regarding some of these uncertainties. Can you discuss the process of rebuilding the patient pipeline? Leslie, could you provide more details on what actions you need to take, the time frame involved, the steps required, and your internal goals for regaining momentum in this area?

Yeah. Sure. And thanks Rick for the question. Well, let’s see. I mean, first and foremost, I’d like to say that our home providers have been incredibly supportive and maintaining their belief around the benefits that Tablo can bring to their overall home dialysis census; their goals around increasing that census and for their patients. And I do want to take the opportunity to thank the home provider customers that we have. This was certainly a setback, but nothing I would describe as permanent damage. And I want to stress that we don’t see any insurmountable barriers to reengaging and rebuilding this momentum. There are no structural delays here in front of us. Now let me get to your question though about well what does that funnel look like? And I’ll try to make it brief. But in short, it looks like providers first identifying patients who they think are candidates for home; broadly educating and influencing those patients to choose home; giving those patients an option between this technology or that technology for home. And most providers really encourage the patients to make their own choice and make their own decision. And then of course the final step is training those patients and getting them home. So those are the basic steps. And my expectations are not that this is years in the making. But because we’ve never been through this before quite frankly, we haven’t had the experience of building up a lot of momentum getting that flywheel going and then having deposits and halted and then having to restart again, I just don’t have the experience under my belt to accurately predict exactly how long that’s going to take. But I guess what gives me a lot of confidence in the theoretical is the strong results that providers have seen and continue to see with their patients who are already home; that very high retention rate. And their experience now with a very fast predictably fast training rate give me a lot of confidence that our home customers will effective immediately start identifying those patients at the top of the funnel and flowing them through as quickly as feasible.

I have two questions to ask. First, can you provide any updates on being ready to ship or to ramp up, considering the ongoing issues with supply chain, chip shortages, component shortages, and electromechanical product shortages? My second question is regarding how conservative your projections are for the second half. Based on what you know now, do you think your outlook reflects the most cautious scenario, or is it more middle-of-the-road? I'm curious about how you perceive your approach in your public communications, which I believe tends to be thoughtfully conservative. If you could offer some insight into that, I would appreciate it.

Yeah, Rick. So with respect to supply chain, the first part of your question, supply chain continues to be tough in the macro, but we continue to have a strong team that's been executing through these headwinds for a while now, and so there's nothing new to report. The big thing we're focused on is our cartridge transition down to Mexico. That's going well. And honestly there's nothing to say, other than that on supply chain. With respect to guidance, I mean, Rick, look, our objective is always to give guidance based on the visibility we have borne by our backlog and our pipeline. I talked to an answer to an earlier question that our ability to execute through the guidance range really depends on two things. Number one is our home ramp back, which as Leslie mentioned we haven't sort of done this before. And so we've modeled what we think the ramp looks like, number one. And then number two, based on the acute setting, on our acute customers' ability to weather or work through the staffing shortages that we've talked about. So again, if both of those go well, we will certainly move up in our guidance range, but our guidance continues like in any period to be based on the visibility we thought.

All right. I appreciate the color Nabeel.

Thanks, Rick.

Our next question comes from the line of Amit Hazan with Goldman Sachs. You may proceed with your question.

Thanks. It's Phil on for Amit. Thanks for taking the questions. Same line of questioning, a couple of slightly different angles if I could. So Nabeel, one of your responses earlier I believe to Suraj's question, it sounds like it's just a few million dollars maybe $5 million to $7 million of the $40 million cut versus our last guidance is going to come from the home side, just a much smaller revenue base. So I'm wondering if we can try and parse out all the different factors that are being talked about, the different variables on the acute side if you can try and parse out what are the factors that were attributable to the disruption from the ship hold that you called out for 2Q, obviously June and then into 3Q if you could try and quantify or just give us an idea, how much of the shortfall in that $30 million to $35 million on the acute side is from that factor versus the broader environment that you've seen evolving in front of you?

Yeah Jamie. First of all, I apologize Phil. As you mentioned, we experienced a couple of factors that affected us. One was the ship hold and its impact on both our business and the acute sector. The second was the lengthening of the sales cycle that Leslie mentioned. We haven’t analyzed each of these elements separately, but to provide some context, we entered Q2 with strong momentum in the home segment and anticipated a solid quarter for home shipments. We expected that momentum to continue through the end of the year, assuming everything remained constant. While it’s difficult to predict what would have happened, we were optimistic about our performance leading into the ship hold. So, you could infer that we were on track to meet or exceed our mid-teens percentage in home sales. As we assess the rest of the year and based on the guidance we provided, we’ve taken all of these factors into account, but we haven’t separated each of them individually.

Okay. I thought it was worth trying. Maybe you can remind us just, kind of, qualitatively what home ship hold drove acute disruption just to give us a flavor again of what caused that disruption if you can quantify it for us?

I can provide some qualitative feedback on that. There were a few things that happened that are understandable from my perspective. Firstly, we had many potential hospital customers who reacted to the news with questions about its implications and applicability. Our sales team dedicated substantial time to address those questions thoroughly, which did impact our sales cycle. If additional conversations are needed just weeks before the quarter ends, it can affect timelines. Additionally, we faced challenges with various enterprise solution contracts related to the use of Tablo in different settings, including acute and sub-acute care, as well as home care. We had to separate home care from these contracts, revisit them, gather signatures, and handle the logistics, which was complicated with a week left in the quarter. These are just a few examples. While this process was difficult, I don't believe there's any lasting damage, and I'm confident that we'll soon alleviate the distraction caused by the home shipments affecting acute care.

Okay. That's helpful. Just one last one if I could sneak it in. Just maybe talk about what's happened in the FDA process since you last updated us in June; how things went, anything unexpected? And then kind of what's been put in place now moving forward so that something like this doesn't happen again? Thanks.

Sure, that’s a completely valid question. Since our update call in June, what happened was exactly as the FDA communicated; they needed more time to finish their review of the human factors data. The human factors review team at the FDA conducted a thorough evaluation. This was the main focus from early June until we received the clearance recently. As I mentioned, the studies were very comprehensive, totaling close to 1,000 pages, which required significant review. Regarding what we would do differently or any changes we plan to make, we are very proud of our track record. Over the last five years, we have filed and received clearance on six 510(k) applications, more than any competitor in both the acute and home sectors. What was different this time was the expectations around human factors, which we learned from, even though it was a tough lesson. This experience is invaluable for us in building a competitive edge at Outset. We accept this learning and realize that we did not fully grasp the extent to which the FDA's expectations had increased. To address this, we have committed to making human factors a core competency, although we acknowledge we are not there yet. Our goal is clear, and we have taken steps, such as hiring experienced leadership in human factors, which we did not have before, to ensure we understand the specifics of how to design and implement these protocols in alignment with FDA expectations.

Our next question comes from the line of Drew Ranieri with Morgan Stanley. Please proceed with your question.

Hi, Leslie, and Nabeel. Thanks for taking the questions. Leslie, maybe just for you. Just in terms of thinking about the patients that might have gone to competitive systems in the near-term, can you maybe talk about maybe what the switching costs would be for them to come back to Tablo? How immediate could that be, if that's factored into any type of your guidance? I know it's not necessarily like maybe the top-of-mind thing because you have a broader market opportunity but just kind of curious about that near-term.

Yes. Yes, I understand the question. Drew, I will say in all transparency and honesty, our crystal ball here is very, very imprecise not having the opportunity to talk to each and every individual. Some patients have chosen to stay in center, some patients have chosen PD, some patients have chosen the incumbent HHD technology, etc. So there’s a number of different pathways here that were available to them, each perhaps has its own switching costs. Is it possible that maybe some of the patients that just chose to stay in center where you would argue that there’s the lowest switching cost at least on a piece of paper, is it possible that some of those could be scheduled back and reenter training and relearning and get ready for home? Yes, it’s absolutely possible. That’s not an assumption that we’ve factored in again. Just based on our lack of visibility quite frankly our lack of data, we always prefer to make data-driven decisions. We don’t have any data or evidence that gives us that sort of confidence that the X percent would come back but it’s certainly possible.

Got it. I have two quick questions. Given the recent changes in the business and guidance, could you provide an update on the current status of the home installed base? I understand you're aiming for 100 programs by year-end, so if you could share that number, it would be great. Lastly, Leslie mentioned high retention rates, but could you provide some specifics? I'm curious about the current figures. Thank you.

Nabeel, you want to?

Yes, certainly. At the beginning of the year, we had 300 patients in the home clinic setting and experienced a strong first quarter. We were preparing for a strong second quarter when the shipping hold was implemented in the third month, which is typically when we deliver the most consoles for both home and acute settings. We did see growth in the installed base during the first quarter, but it did not meet our expectations in the second quarter. We still plan to provide the installed base number when we report our fourth-quarter results, which has been our usual practice. Regarding home growth over time, the key indicator is the number of home programs, and we remain on track to reach our goal of 100 home programs by the end of this year, which will contribute to future installed base growth in the home.

Let me pick up on the retention question here. So the I think the really good news is that retention rates have not changed materially at all and remain very highly differentiated in the marketplace. We've said in the past to anchor that a little bit more specifically. We have talked about observing about a 15% rate of death and transplant; a combination of death and transplant before and that we didn't see any new trends in that category. And with – I would describe it as extremely negligible numbers of patients to date who have just opted off Tablo. And so those trend lines continue. We saw no deviation from that through the course of the home ship hold.

Our next question comes from the line of Josh Jennings with Cowen. You may proceed with your question.

Hi, thanks. Let me circle back I touched on my initial question earlier. I wanted to really just make sure that the 522 order in regards to human factor testing that that requirement has been satisfied with the current submission, or is there another human factors data set that the FDA will require post approval?

Sure. Josh, I'm happy to take that. So, the human factor study that was the subject of the 522 post-market surveillance, that was in connection to the version of Tablo that was cleared in 2020. Since that version is no longer being marketed or used commercially, the FDA has notified us that we no longer have to conduct this study unless or until this old version is reintroduced into the market, which of course we have no intention of doing.

Okay. I think there is some confusion related to your filing. You mentioned submitting the catch-up 510(k) and using that version of Tablo for the human factors study as required in the 522 order, but I'm a bit unclear on that. I apologize, but I'll move on.

No worries. No, no, no. It is a little confusing Josh. And just to make you feel better about yourself, this is new information. So this information will be included in our upcoming 10-Q. The call just happened to occur before the 10-Q. So this is new information about the FDA notification that we no longer have to conduct this study.

Great. And while I have you I might as well just throw one more in. I think maybe the silver lining of this ship hold was learning that some of your orders within your acute channel were tied to home console orders as well and suggesting that maybe you've had some more success convincing hospitals or hospital systems to take ownership of home patients. Any updates there? I know it's probably hard to talk about just getting out of the ship hold, but just in terms of the progress you've made prior to the ship hold and how you see that opportunity evolving? Thanks a lot.

Yes, I'll approach this by discussing what happened before the ship hold. The FDA instructed us not to market or distribute the device, and we adhered to that guidance. Consequently, we haven't had recent discussions with health systems about home since the ship hold. However, before the ship hold, it's definitely accurate to say that interest in establishing home as a service line among health systems was on the rise.

Great. Thank you so much.

Josh, you bet.

Ladies and gentlemen, we have reached the end of today's question-and-answer session. I'd like to turn this call back over to Ms. Leslie Trigg for closing our call.

Thanks operator, and thank you all for joining today. Have a great evening.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation. Enjoy the rest of your day.