Outset Medical, Inc. annual report, FY2022

Outset Medical, Inc. — FY2022 Form 10-K Summary

Reporting period: Fiscal year ended December 31, 2022. The filing is an annual report, not a standalone 2022 fourth-quarter filing. Outset develops and sells the FDA-cleared Tablo Hemodialysis System for hospital, clinic, and home use.

Business Context

Tablo combines dialysis, water purification, on-demand dialysate production, connectivity, remote monitoring, and treatment documentation in one console. Revenue is primarily generated from Tablo consoles, recurring consumables such as cartridges, and service contracts. The company operates as a single reportable segment and manufactures consoles and an increasing portion of cartridges in Tijuana, Mexico.

• Tablo home-use marketing and shipments were placed on hold in May 2022 while the FDA reviewed a 510(k) submission.
• The FDA cleared the submission in late July 2022, after which Outset resumed home-use marketing and shipments.
• As of December 31, 2022, Outset had 518 full-time employees and its largest customer represented 14% of annual revenue.

Financial Performance and Liquidity

Metric	FY2022	FY2021	Change
Total revenue	$115.4 million	$102.6 million	+12%
Product revenue	$93.4 million	$84.3 million	+11%
Service and other revenue	$22.0 million	$18.3 million	+20%
Gross profit	$17.8 million	$7.6 million	+134%
Gross margin	15.5%	7.4%	+8.1 percentage points
Operating loss	$(161.0) million	$(130.5) million	Loss increased
Net loss	$(163.0) million	$(131.9) million	Loss increased
Net loss per share	$(3.38)	$(2.89)	Loss per share increased
Operating cash flow	$(145.7) million	$(130.3) million	Cash use increased

Consumables revenue increased $9.6 million, reflecting growth in the installed console base. Console revenue declined modestly, primarily because $2.7 million of console leasing revenue declined as certain leases expired, partially offset by higher average selling prices. Gross-margin improvement was attributed primarily to console cost reductions and higher console pricing.

• Research and development expense increased 33% to $48.9 million.
• Sales and marketing expense increased 38% to $89.5 million.
• General and administrative expense increased 12% to $40.5 million.
• Stock-based compensation expense was $27.2 million, compared with $17.4 million in 2021.
• Capital expenditures were $8.3 million, compared with $3.1 million in 2021.

Balance Sheet and Debt

• Cash, cash equivalents, and short-term investments were $287.5 million at December 31, 2022; including restricted cash, total liquidity was $290.8 million.
• Cash and cash equivalents declined to $73.2 million from $182.3 million, while short-term investments increased to $214.3 million from $157.1 million.
• Inventories increased to $51.5 million from $39.2 million, partly due to advance purchases to mitigate supply-chain risk.
• Term loan liabilities were $96.3 million net of discount, compared with $29.8 million in 2021.
• Outset borrowed $100.0 million under the new SLR Term Loan Facility and repaid the $30.0 million SVB Term Loan, recording a $1.4 million loss on extinguishment.
• The SLR facilities provide potential total borrowing capacity of up to $300.0 million, but only $200.0 million was initially available and additional borrowing depends on revenue milestones and lender approvals.
• The SLR term loan bears interest at one-month term SOFR, subject to a 2.75% floor, plus 5.15%; the rate was 9.33% at year-end.

Material Changes Versus FY2021

• Revenue grew 12%, driven by consumables and service revenue rather than console sales.
• Gross margin more than doubled to 15.5%, although the company remained substantially unprofitable.
• Operating expenses increased 29%, exceeding the increase in revenue and widening the operating loss.
• Operating cash consumption increased by $15.5 million to $145.7 million.
• Outset transitioned most cartridge production to Mexico and began ramping in-house cartridge production, with the goal of reducing freight and manufacturing costs and improving supply continuity.
• The company entered into new secured debt financing and materially increased its debt burden and interest-rate exposure.
• The home-use shipment hold disrupted bookings, revenue, pipeline activity, and commercialization momentum during most of the last three quarters of 2022.

Guidance, Outlook, Risks, and Unusual Items

Management did not provide a specific numerical revenue or profitability forecast in the filing. Management expects continued significant expenses and operating losses in the near term, while investing in home-market expansion, sales and marketing, research and development, manufacturing capacity, and service infrastructure. Management stated that available liquidity, expected revenue, and currently available debt financing should fund anticipated needs for at least 12 months from the filing date, subject to assumptions that may prove incorrect.

• Regulatory: An October 2022 510(k) submission for a new software version remained pending, with the FDA requesting additional information. The company may need to modify or revert the product configuration depending on the FDA review.
• Home-use surveillance: The FDA previously issued a Section 522 post-market surveillance order relating to home use. The requirement was placed on hold for a prior Tablo version, but the FDA may issue a new or extended order for the current version.
• Tubing analysis: The FDA requested testing of Tablo tubing for certain PCB/PCBA compounds and other toxins. Outset planned to perform the analysis in the first half of 2023; results could lead to additional regulatory actions or a new 510(k) submission.
• Quality systems: In the first quarter of 2023, the FDA issued a Form 483 with four observations concerning a late medical device report, software validation documentation, escalation of nonconforming product, and complaint/CAPA procedures. Management planned corrective actions.
• Recall: In January 2022, Outset proactively initiated a recall to replace a component in Tablo consoles because of possible heat-related damage.
• Reimbursement: CMS increased the CY2023 ESRD bundled base rate to $265.57 from $257.90. Tablo remained eligible for CRA TPNIES through CY2023, with Medicare paying 65% of the Medicare Administrative Contractor-determined pre-adjusted per-treatment amount for qualifying home use for two calendar years beginning in 2022. The benefit is temporary and its effect on adoption and revenue remains uncertain.
• Supply chain: The company relies on more than 200 console suppliers and approximately 30 single-source cartridge component suppliers, as well as contract manufacturers in Mexico and Southeast Asia.
• Customer and market risk: Staffing shortages, inflation, tighter hospital budgets, and increased scrutiny of capital purchases lengthened sales cycles, delayed installations, and reduced bookings and revenue in 2022.
• Legal: A shareholder securities lawsuit filed in July 2022 concerning home-use regulatory disclosures was voluntarily dismissed without prejudice in September 2022 and is concluded. The company reported no current legal proceedings expected to have a material adverse effect.
• Tax attributes: Outset reported $526.8 million of federal and $298.1 million of state net operating loss carryforwards, but maintains a full valuation allowance against deferred tax assets.

Most Important Facts for Investors to Verify

1. Whether home-use bookings, installations, patient volumes, and recurring consumables revenue recovered after the 2022 shipment hold.
2. Whether gross-margin gains from Mexico manufacturing and cartridge insourcing are sustainable and sufficient to offset rising service, labor, freight, and component costs.
3. The status and outcome of the pending FDA 510(k), tubing testing, any Section 522 surveillance requirements, and remediation of the Form 483 observations.
4. Actual borrowing availability under the SLR facilities, compliance with the financial covenant beginning in the quarter ended December 31, 2023, and exposure to variable SOFR-based interest expense.
5. Cash-burn trends, inventory levels, purchase commitments of $66.5 million, and the timing of any need for additional financing.
6. Customer concentration, reimbursement developments, TPNIES expiration, and the effect of Medicare treatment limits on home-dialysis adoption.
7. Progress toward profitability given FY2022 operating expenses of $178.9 million, net loss of $163.0 million, and operating cash use of $145.7 million.