Outset Medical, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion of our financial condition and results of operations should be read together with our unaudited condensed financial statements and related notes and other financial information included elsewhere in this Quarterly Report, as well as our audited financial statements and notes thereto and the related Management’s Discussion and Analysis of Financial Condition and Results of Operations included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020 filed with Securities and Exchange Commission (SEC) on March 22, 2021. In addition to historical financial information, this discussion and other parts of this report contain forward-looking statements within the meaning of the federal securities laws. All statements other than statements of historical fact contained in this Quarterly Report are forward-looking statements. T he forward-looking statements in this report are only predictions and are based largely on our current expectations and projections about future events and financial trends that we believe may affect our business, financial condition and results of operations. These forward-looking statements are subject to a number of known and unknown risks, uncertainties and assumptions that may cause our actual results, performance or achievements to be materially different from those expressed or implied by the forward-looking statements. Such risks and uncertainties include those described throughout this Quarterly Report, including in this discussion as well as in the section titled “Risk Factors” under Part II, Item 1A below. The forward-looking statements in this Quarterly Report are based upon information available to us as of the date of this Quarterly Report, and while we believe such information forms a reasonable basis for such statements, such information may be limited or incomplete, and our statements should not be read to indicate that we have conducted an exhaustive inquiry into, or review of, all potentially available relevant information. These statements, like all statements in this report, speak only as of their date, and, except as required by law we undertake no obligation to update or revise these statements, whether as a result of any new information, future developments or otherwise. These statements are inherently uncertain, and investors are cautioned not to unduly rely upon these statements. Overview Our technology is designed to elevate the dialysis experience for patients, and help providers overcome traditional care delivery challenges. Requiring only an electrical outlet and tap water to operate, Tablo frees patients and providers from the burdensome infrastructure required to operate traditional dialysis machines. The integration of water purification and on-demand dialysate production enables Tablo to serve as a dialysis clinic on wheels and allows providers to standardize to a single technology platform from the hospital to the home. Tablo is also intelligent and connected, with automated documentation and the ability to integrate with electronic medical record reporting, along with streamlined remote machine management to maximize device uptime. We have generated meaningful evidence to demonstrate that providers can realize significant operational efficiencies, including reducing the cost of their dialysis programs by up to 80% in the intensive care unit. In addition, Tablo has been shown to deliver robust clinical care. In studies we have conducted, patients have reported experiencing fewer symptoms and better quality sleep while on Tablo. We believe Tablo empowers patients, who have traditionally been passive recipients of care, to regain agency and ownership of their treatment. Tablo is cleared by the U.S. Food and Drug Administration (FDA) for use in the hospital, clinic or home setting. We designed Tablo from the ground up to be a single enterprise solution that can be utilized across the continuum of care, allowing dialysis to be delivered anytime, anywhere and by anyone. Tablo is comprised of a compact console with integrated water purification, on-demand dialysate production and a simple-to-use touchscreen interface. With Tablo, we are bringing data to dialysis. Tablo is built to live in a connected setting with cloud-based system monitoring, patient analytics, remote treatment monitoring and clinical recordkeeping and the ability to activate new capabilities and enhancements through wireless software updates. Tablo’s data analytics and connectivity also enable predictive preventative maintenance to maximize machine uptime. Unlike existing hemodialysis machines, which have limited clinical versatility across care settings and are generally burdened by specialized and expensive infrastructure, Tablo is a single enterprise dialysis solution that can be seamlessly utilized across different care settings and for multiple clinical needs. Driving adoption of Tablo in the acute care setting has been our primary focus to date. We have invested in growing our economic and clinical evidence, built a veteran sales and clinical support team with significant expertise, and implemented a comprehensive training and customer experience program. Our experience in the acute market has demonstrated Tablo’s clinical flexibility and operational versatility, while also delivering meaningful cost savings to the providers. We plan to continue leveraging our commercial infrastructure to broaden our installed base in the acute care market as well as driving utilization and fleet expansion with our existing customers. While the COVID-19 pandemic has presented opportunities to demonstrate the real-world benefits of Tablo over traditional machines, we believe these benefits, in addition to the other advantages of Tablo, are continuing to drive customer purchasing decisions. Tablo is also well suited for home-based dialysis. Tablo was cleared by the FDA for use in patients with acute and/or chronic renal failure in September 2014. Subsequently, on March 31, 2020, Tablo was cleared by the FDA for patient use in the home. Our ability to reduce training time, patient dropout, preparation and set up time, and the total treatment time required to deliver dialysis in the home can drive efficiency and economic improvements to the home care model. In our home investigational device exemption (IDE) trial, patients reported specific quality of life improvements compared to their experience on the incumbent home dialysis 16 machine. To penetrate and grow this market successfully, we are focused on refining our home distribution, logistics and support systems to help ensure they are ready for rapid scale. We are also working with providers, patients and payors to increase awareness and adoption of transitional care units (TCUs) as a bridge to home based therapy. To demonstrate the cost advantages of Tablo in the home setting, we will also be collecting additional patient clinical experience and outcomes data. We sell our solution through our direct sales organization, which covers most major metropolitan markets in the United States. As of March 31, 2021, our sales organization is comprised of 33 capital sales team members, responsible for generating new customer demand for Tablo, and 57 clinical sales team members responsible for driving utilization and fleet expansion of Tablo consoles at existing customer sites. In addition, our field service team comprised of 82 members provides maintenance services and product support to Tablo customers. The same sales organization and field service team drive Tablo penetration in both the acute and home markets. We believe the ability to leverage one team to serve both markets will result in significant productivity and cost optimization as we continue to scale our business. We are executing a well-defined, three-pronged strategy designed to expand gross margins. First, we have insourced our console manufacturing to help lower console cost. Second, we are adding a second-source contract manufacturer for our cartridges to gain higher efficiency and lower material cost. Third, we will continue to utilize our cloud-based data system, as well as enhanced product performance, to help drive down the cost of service. We generate revenue primarily from the initial sale of Tablo consoles, and recurring sales of per-treatment consumables, including the Tablo cartridge, which generates significant total revenue over the life of the console. We generate additional revenue via annual service contracts and shipping and handling charged to customers. Our total revenue was $22.9 million and $7.2 million for the three months ended March 31, 2021 and 2020, respectively. For the three months ended March 31, 2021 and 2020, we incurred net losses of $30.0 million and $20.7 million, respectively. As of March 31, 2021, we had an accumulated deficit of $524.1 million. On September 17, 2020, we completed our initial public offering (IPO), in which we sold 10,293,777 shares of common stock (which included 1,342,666 shares that were offered and sold pursuant to the full exercise of the IPO underwriters’ option to purchase additional shares in connection with the IPO) at a price to the public of $27.00 per share. We received aggregate net proceeds of approximately $254.8 million after deducting offering costs, underwriting discounts and commissions of approximately $23.1 million. Upon the closing of the IPO, all of our outstanding redeemable convertible preferred stock automatically converted into shares of common stock. On April 13, 2021, we completed a follow-on public offering and sold 2,945,864 shares of our common stock (which included 445,864 shares that were offered and sold pursuant to the full exercise of the underwriters’ option to purchase additional shares) at a price to the public of $53.50 per share. We received aggregate net proceeds of approximately $149.7 million after deducting underwriting discounts and commissions and before expenses. Impacts of the COVID-19 pandemic We believe that the COVID-19 pandemic has highlighted the limitations of traditional machines and the benefits of Tablo, driving an increase in demand for Tablo during 2020. We also believe the advantages of Tablo highlighted by the pandemic are now embedded as one of the many factors driving our customers’ purchasing decisions and do not expect to experience significant revenue driven solely by COVID-19 in future periods. However, the duration and extent of the COVID-19 pandemic remain uncertain, and we cannot predict with certainty the ultimate impact of the COVID-19 pandemic and related containment measures on our business. In order to operate in a safe manner, we continue to follow the health and safety guidelines of the U.S. Centers for Disease Control and Prevention, Occupational Safety and Health Administration, and local and state public health departments where we operate. For employees working on-site, we have and continue to provide personal protective equipment, practice social distancing, enforce mask wearing and increase sanitizing standards, and have also implemented COVID-19 testing at our facilities. We also continue to support remote work arrangements for certain employees. In addition, we have created a business continuity plan and incident management team to respond quickly and effectively to changes in order to offer customers uninterrupted products, services and support while safeguarding the best interest of employees, suppliers and stockholders. Our business may also be impacted by an escalation or a continuation of the COVID-19 pandemic. While the operations at our contract manufacturing partners’ facilities and our outsourced business administration service provider, Tacna, for our facility in Tijuana, Mexico, have not yet experienced significant disruption, the possibility that such disruption may occur remains. Additionally, the COVID-19 pandemic has disrupted the operations of certain of our third-party suppliers, resulting in increased lead-times, higher component costs and lower allocations for our purchase of some components (including certain critical components) and, in certain cases, requiring us to procure materials from alternative sources or incur higher logistical expenses. We have worked closely with our manufacturing partners and suppliers to enable us to source key components and maintain appropriate inventory levels to meet customer demand and have not experienced material disruptions in our supply chain to date. However, we cannot predict how long the pandemic and measures intended to contain the spread of COVID-19 will continue and what effect COVID-19 and the associated 17 containment measures will ultimately have on our suppliers and vendors, in particular for any of our suppliers and vendors that may not qualify as essential businesses and suffer more significant or lengthier disruptions to their business operations. There is no assurance that we will not experience more significant disruptions in our supply chain in the future, particularly if the operations of our contract manufacturing partners, our critical single source component providers, or the facility we operate in Tijuana, Mexico in collaboration with Tacna, are more severely impacted by the pandemic and associated containment measures. Results of Operations The following table summarizes our results of operations for the three months ended March 31, 2021 and 2020 (in thousands): Three Months Ended March 31, 2021 2020 Revenue: Product revenue $ 18,210 $ 5,926 Service and other revenue 4,706 1,264 Total revenue 22,916 7,190 Cost of revenue: Cost of product revenue 20,577 9,562 Cost of service and other revenue 2,050 1,192 Total cost of revenue 22,627 10,754 Gross profit 289 (3,564 ) Operating expenses: Research and development 7,570 5,838 Sales and marketing 13,149 7,282 General and administrative 9,246 3,526 Total operating expenses 29,965 16,646 Loss from operations (29,676 ) (20,210 ) Interest income and other income, net 112 460 Interest expense (422 ) (1,001 ) Change in fair value of redeemable convertible preferred stock warrant liability — 101 Loss before provision for income taxes (29,986 ) (20,650 ) Provision for income taxes 39 — Net loss $ (30,025 ) $ (20,650 ) Comparison of the Three Months Ended March 31, 2021 and 2020 Revenue Three Months Ended March 31, Change (dollars in thousands) 2021 2020 $ % Revenue: Product revenue $ 18,210 $ 5,926 $ 12,284 207 % Service and other revenue 4,706 1,264 3,442 272 % Total revenue $ 22,916 $ 7,190 15,726 219 % Product revenue increased by $12.3 million, or 207% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020 driven by a $9.7 million increase in consoles revenue and a $2.6 million increase in consumables revenue. The increase in consoles revenue was driven by new customer adoption, fleet expansion across existing customers, and a $0.7 million increase in console leasing revenue. The increase in consumables revenue was driven by our growth in console installed base and higher utilization of the installed base. Service and other revenue increased by $3.4 million , or 272% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The increase was primarily due to services associated with our growth in console installed base, including leased consoles. 18 Cost of Revenue , Gross Profit and Gross Margin Three Months Ended March 31, Change (dollars in thousands) 2021 2020 $ % Cost of revenue: Cost of product revenue $ 20,577 $ 9,562 $ 11,015 115 % Cost of service and other revenue 2,050 1,192 858 72 % Total cost of revenue $ 22,627 $ 10,754 11,873 110 % Gross profit 289 (3,564 ) 3,853 108 % Gross margin 1.3 % (49.6 ) % Cost of product revenue increased by $11.0 million, or 115% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. This increase was primarily due to higher console and consumable volume of $15.1 million, higher manufacturing overhead of $0.5 million and higher depreciation expense for leased consoles of $0.2 million. This was offset by a $4.8 million reduction in product costs. Cost of service and other revenue increased by $0.9 million, or 72% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. This increase was pri marily due to additional headcount costs in our service department, which were offset by higher absorption of these costs across our larger installed base. Gross profit increased by $3.9 million, or 108% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The gross margin percentage improved by 50.9 percentage points for the three months ended March 31, 20 21, as compared to the three months ended March 31, 2020, driven primarily by $7.0 million related to higher margin sales of our products and $2.6 million in higher service revenue as a result of our larger installed base, including leased consoles. This was offset by $5.2 million in increased costs as a result of selling more product and a $0.5 million increase in higher manufacturing overhead. Operating Expenses Three Months Ended March 31, Change (dollars in thousands) 2021 2020 $ % Operating expenses: Research and development $ 7,570 $ 5,838 $ 1,732 30 % Sales and marketing 13,149 7,282 5,867 81 % General and administrative 9,246 3,526 5,720 162 % Total operating expenses $ 29,965 $ 16,646 13,319 80 % Research and development expenses increased by $1.7 million, or 30% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The increase was primarily due to a $1.8 million increase in compensation and personnel costs, which includes a $1.0 million increase in stock-based compensation expense, and a $0.2 million increase in consultant services. The increases were partially offset by a $0.3 million decrease in supplies and materials. Sales and marketing expenses increased by $5.9 million, or 81% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The increase was primarily due to a $4.5 million increase in compensation and personnel costs, which includes a $1.7 million increase in stock-based compensation expense and a $1.1 million increase in commission expense , a $0.9 million increase in clinical sales consultant services, $0.3 million increase in facilities and other allocated costs and $0.1 million increase in freight expenses . General and administrative expenses increased by $5.7 million, or 162% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The increase was primarily due to a $5.1 million increase in compensation and personnel costs, which includes a $2.5 million increase in stock-based compensation expense, a $0.6 million increase in professional and consultant services associated with new public company status and a $0.4 million increase in depreciation expense. The increases were partially offset by a $0.4 million decrease in facilities and other allocated costs. 19 Other Income (Expense), Net Three Months Ended March 31, Change (dollars in thousands) 2021 2020 $ % Interest income and other income, net $ 112 $ 460 $ (348 ) (76 )% Interest expense (422 ) (1,001 ) 579 (58 )% Change in fair value of redeemable convertible preferred stock warrant liability — 101 (101 ) * Total other expense, net $ (310 ) $ (440 ) 130 (30 )% * Not meaningful Interest income and other income, net decreased by $0.3 million, or 76% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020, driven by lower interest rates and a lower average balance in cash, cash equivalents and short-term investment securities in the first quarter of 2021. Interest expense decreased by $0.6 million, or 58% for the three months ended March 31, 2021 as compared to the three months ended March 31, 2020. The decrease was driven primarily by a lower interest rate under the SVB Term Loan as compared to the rate under the Perceptive Term Loan, which we voluntarily repaid in July 2020. The change in the fair value of redeemable convertible preferred stock warrant liability was driven by the changes in assumptions used to value the warrant liability. Upon the closing of our IPO in September 2020, all shares of our outstanding redeemable convertible preferred stock warrants were either exercised into common stock or automatically converted into warrants to purchase common stock. Accordingly, we have ceased to incur the change in fair value of redeemable convertible preferred stock warrant liability as the entire redeemable convertible preferred stock warrant liability was reclassified to additional paid-in capital. Liquidity and Capital Resources Sources of Liquidity As of March 31, 2021, the Company had cash, cash equivalents and short-term investments of $277.5 million, which are available to fund future operations, and restricted cash of $33.3 million, for a total cash, cash equivalents, restricted cash and short-term investments balance of $310.8 million. Since our inception, we have incurred net losses and negative cash flows from operations. To date, we have financed our operations and capital expenditures primarily through sales of redeemable convertible preferred stock and common stock, revenue from sales and issuances of debt. In September 2020, we completed our IPO for aggregate net proceeds of approximately $254.8 million (inclusive of the full exercise of the underwriters’ option to purchase additional shares), net of offering costs, underwriter discounts and commissions of $23.1 million. In April 2021, we completed a follow-on public offering for aggregate net proceeds of approximately $149.7 million , after deducting underwriting discounts and commissions and before expenses (see Note 11 to the condensed financial statements for further details). We expect to continue to incur significant expenses for the foreseeable future and to incur operating losses in the near term while we make investments to support our anticipated growth. We may raise additional capital through the issuance of additional equity financing, debt financings or other sources. If this financing is not available to us at adequate levels or on acceptable terms, we may need to reevaluate our operating plans. If we do raise additional capital through public or private equity offerings, the ownership interest of our existing stockholders will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect our existing stockholders’ rights. If we raise additional capital through debt financing, we may be subject to covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. We believe that our existing cash, cash equivalents and short-term investments, and cash generated from sales of our products, will be sufficient to meet our anticipated needs for at least the next 12 months from the date of this Quarterly Report. 20 Cash Flows Summary The following table summarizes the cash flows for each of the periods indicated (in thousands): Three Months Ended March 31, 2021 2020 Net cash (used in) provided by: Operating activities $ (38,616 ) $ (24,893 ) Investing activities (6,807 ) 19,159 Financing activities 2,218 126,770 Net increase in cash, cash equivalents and restricted cash $ (43,205 ) $ 121,036 Operating Activities The net cash used in operating activities of $38.6 million for the three months ended March 31, 2021 was due to a net loss of $30.0 million and a net cash outflow from the change in our operating assets and liabilities of $16.3 million, which were partially offset by adjustments for stock-based compensation expense of $5.9 million, depreciation and amortization of $1.2 million, non-cash lease expense of $0.2 million, non-cash interest expense of $0.1 million, and provision for inventories of $0.1 million. The net cash outflow from operating assets and liabilities was primarily due to an increase in inventories of $7.2 million due to the timing of inventory purchases including advance purchases of inventory due to anticipated demand and to mitigate supply chain disruptions, which partially related to COVID-19 , an increase in accounts receivable of $5.6 million due to timing of collections, a decrease in accrued payroll and related benefits of $4.2 million mainly due to the payment of 2020 annual cash bonuses to our employees, an increase in prepaid expenses and other assets of $1.0 million and a decrease in operating lease liabilities of $0.2 million. The net cash outflow from operating assets and liabilities was partially offset by an increase in account payable and accrued expenses and other current liabilities of $1.8 million due to timing of vendor payments and an increase in deferred revenue of $0.3 million due to the growth of our business. The net cash used in operating activities of $24.9 million for the three months ended March 31, 2020 was due to a net loss of $20.7 million and a net cash outflow from the change in our net operating assets and liabilities of $5.3 million, which were partially offset by adjustments for stock-based compensation expense of $0.6 million, depreciation and amortization of $0.3 million and non-cash interest expense of $0.2 million. The net cash outflow from operating assets and liabilities was primarily due to an increase in accounts receivable of $3.1 million, a decrease in accrued payroll and related benefits of $2.7 million mainly due to the payment of 2019 annual cash bonuses to our employees and a decrease in accounts payable of $1.4 million due to timing of payments. The net cash outflow from operating assets and liabilities was partially offset by a decrease in inventories of $0.8 million due to higher demand and an increase in deferred revenue of $0.8 million due to the growth in our business. Investing Activities The net cash used in investing activities of $6.8 million for the three months ended March 31, 2021 was due primarily to the purchases of short-term investments of $25.8 million and the purchases of property and equipment of $0.9 million, partially offset by the sales and maturities of short-term investments of $19.9 million. The net cash provided by investing activities for the three months ended March 31, 2020 was $19.2 million and related primarily to the sales and maturities of short-term investments of $22.0 million, partially offset by the purchases of property and equipment of $2.8 million. Financing Activities The net cash provided by financing activities of $2.2 million for the three months ended March 31, 2021 was due to the proceeds of $2.2 million from employee exercises of stock options and employee stock purchase plan purchases. The net cash provided by financing activities for the three months ended March 31, 2020 was due primarily to the net proceeds of $126.8 million from the issuance of our Series E redeemable convertible preferred stock. Contractual Obligations and Commitments During the three months ended March 31, 2021, there have been no material changes outside the ordinary course of business to our contractual obligations from those disclosed in “ Management’s Discussion and Analysis of Financial Condition and Results of Operations ” included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2020. Off-Balance Sheet Arrangements During the periods presented, we did not have, nor do we currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC. 21 Critical Accounting Policies and Estimates Management’s discussion and analysis of the financial condition and results of operations is based on the financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements, as well as the reported revenues and expenses incurred during the reporting periods. The estimates are based on historical experience and on various other factors that are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions. There have been no significant changes in our critical accounting policies and estimates as compared to the critical accounting policies and estimates disclosed in the section titled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included in our most recent Annual Report on Form 10-K filed with the SEC on March 22, 2021. For additional information, please refer to Note 2 to our unaudited condensed financial statements in this Quarterly Report. Emerging Growth Company Status We are an emerging growth company, as defined in the Jumpstart Our Business Startups Act (JOBS Act). Under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards issued subsequent to the enactment of the JOBS Act until such time as those standards apply to private companies. We elected to use this extended transition period for complying with new or revised accounting standards that have different effective dates for public and private companies until the earlier of the date that we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our financial statements may not be comparable to companies that comply with the new or revised accounting pronouncements as of public company effective dates. Recent Accounting Pronouncements See Note 2 to our unaudited condensed financial statements included elsewhere in this Quarterly Report for more information. 22 Item 3. Quantitative and Qualitati ve Disclosures About Market Risk Interest Rate Risk Our cash, cash equivalents, restricted cash and short-term investments are held in bank deposits, money market funds, U.S. Treasury and debt securities. Such interest-earning instruments carry a degree of interest rate risk. The goals of our investment policy are liquidity and capital preservation; we do not enter into investments for trading or speculative purposes and have not used any derivative financial instruments to manage our interest rate exposure. We believe that we do not have any material exposure to changes in the fair value of these assets as a result of changes in interest rates due to the short-term nature of our cash, cash equivalents and short-term investments. As of March 31, 2021, we had $30.0 million in variable rate debt outstanding. The SVB Term Loan matures on November 1, 2025, with interest-only monthly payments until June 2023. The term loan accrues interest at a rate per annum equal to the greater of (A) one-half of one percent (0.50%) above the Prime Rate as reported in the Wall Street Journal then in effect (which shall not be less than zero) and (B) three and three-quarters of one percent (3.75%). An immediate 100 basis point change in the prime rate would not have a material impact on our debt-related obligations, financial position or results of operations. Foreign Currency Exchange Risk Our expenses are generally denominated in U.S. dollars. However, certain of our Mexico-based manufacturing operations incur costs that are denominated in Mexican Pesos (MXN), we are exposed to the risk of currency fluctuations between the U.S. dollar and MXN. To date, foreign currency transaction gains and losses have not been material to our financial statements. Unfavorable changes in foreign exchange rates versus the U.S. dollar could increase our product costs, thus reducing our gross profit. We have not engaged in the hedging of foreign currency transactions to date, although we may choose to do so in the future. We do not believe that an immediate 10% increase or decrease in the relative value of the U.S. dollar to other currencies would have a material effect on operating results or financial condition.