Memorandum

Dexcom 3Q12 – Product revenue up 27% from 3Q11; launch of G4 Platinum and pediatric trial completed; Vibe filing pushed to early 2013 – November 1, 2012

Executive Highlights

  • Product revenue totaled $21 million, a 27% increase from 3Q11 sales of $16 million and a 2% sequential decline from 2Q12 sales of $22 million.
  • The G4 Platinum CGM was approved by FDA on October 5 and launched last week.
  • The pediatric trial was completed in 3Q12; the Animas Vibe will now be filed with FDA in early 2013; feasibility work is being completed to integrate the G4 Platinum with a Tandem pump.

This afternoon, Dexcom CEO Terry Gregg led the company’s 3Q12 financial update, which focused on the launch of the G4 Platinum CGM (approved by FDA on October 5). Product revenue totaled $21 million, up 27% from $16 million in 3Q11 and down 2% sequentially from $22 million in 2Q12; results were affected by several one-time charges related to the G4 Platinum launch and Seven Plus 30-day returns. Excluding these, product revenue would have grown 34% year-over-year and 4% sequentially. Product gross margin of 36% fell from 2Q12 gross margin of 49%, though excluding the charges, margins would have been 54%. As a reminder, G4 Platinum is eventually expected to rise to the 65-75% range. Dexcom’s net loss totaled $17 million, up 30% over 3Q11 ($13 million) and up 18% over 2Q12 ($15 million. Management expects product revenues will fall in the middle of their full-year forecast of $85-

$92 million (a conservative estimate), but provided no updates on Dexcom’s timeline for reaching positive cash flow (as of 1Q12, this was expected by the end of 2012). As of September 30, management held $53 million in cash, cash equivalents, and marketable securities. Additionally, Dexcom entered into a non-dilutive loan and security agreement with Silicon Valley Bank and Oxford Finance, which provides a $15 million revolving line of credit and $20 million term loan.

Initial shipments of the new G4 Platinum CGM occurred late last week. As noted in our coverage of the approval call, patients with an in warranty Seven Plus can upgrade to the new system for $399. Out of warranty and new patients can get the new system for an average selling price ~$800 (depending on insurance). Sensors will remain the same price as the Seven Plus (~$260 for a four-pack). The initial focus will be on new patients, though the goal is to get the $399 upgrades processed by year-end. Encouragingly, the number of daily patient calls into Dexcom’s customer service organization is up over 50% vs. the average prior to the G4 Platinum launch. Thus far, there have been no manufacturing problems and sufficient quantities to meet demand.

The G4 Platinum pediatric trial was recently completed and Dexcom expects to file a PMA supplement in the US and update the CE Mark in Europe before the end of 2012. US approval is “on track” for mid- 2013. Notably, the pediatric label update will allow Dexcom to recommend CGM to patients as young as two years old! Filing a PMA supplement for the Animas Vibe will slip into early 2013, and approval is expected in 2H13 with a “stretch goal” by ADA (slightly behind the end-of-2012 submission goal cited in the G4 Platinum approval call). Encouragingly, there’s now a “high likelihood” that Tandem will be able to integrate the G4 Platinum sensor, much ahead of the previous Gen 5 timeline. There was no update on the Insulet integration partnership and we assume work will not start until the second-gen pod is approved by FDA. Last, progress has been strong with FDA on the Gen 5 sensor, which will likely include the extended durability claim (e.g., 10-day wear).

 

FINANCIALS

  • Dexcom product revenue grew to $21.1 million, a 26.6% year over year increase and a -1.9% sequential decrease. While 3Q12 brought in lower product revenue than in 2Q12 and a noticeable drop in year-over-year growth compared to 1Q12 and 2Q12 (~42% growth in both quarters), the approval and launch of the G4 Platinum weighed heavily on results:
    • 3Q12 included a $1.2 million revenue reduction, reserved for sales returns related to the 30-day money back guarantee Dexcom offers on its hardware (and extended sales return offer for patients who purchased the Seven Plus between September 1 and the October 5th G4 Platinum approval). While management anticipates a “significant” number of patients to take advantage of the return policy due to the G4 Platinum launch, they also expect to recognize most of this reserve as product revenue in 4Q12 upon shipping G4 Platinum hardware to these individuals.
    • Management believes patients and providers delayed purchasing Seven Plus during 3Q12 in anticipation of the approval, which had previously been forecasted prior to the end of 2012. We would expect this downtick in 3Q12 revenue to translate to an additional product sales boost in 4Q12. Without the $1.2 million sales reserve, revenue would have reached $22.3 million, a 34% year-over-year increase and 3.7% sequential increase.
 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

Product Revenue (millions)

$15.2

$16.7

$20.9

$18.6

$21.5

$21.1

Year-Over-Year Growth

67.9%

54.2%

53.7%

41.7%

41.6%

26.6%

Sequential Growth

15.5%

9.7%

25.5%

-10.9%

15.5%

-1.9%

  • Dexcom’s 2Q12 product gross profit totaled $7.7 million (a 36% product gross margin) compared to $7.4 million (45% product gross margin) in 3Q11 and $10.6 million (49% product gross margin) in 2Q12. Management attributed the lower gross profit and gross margin to one-time charges associated to the G4 Platinum approval and launch related to inventory write-offs, manufacturing, and supplier contracts for the Seven Plus. Had Dexcom not incurred these charges, product gross profit would have reached $11.9 million (54% product gross margin). Further, as of the G4 Platinum approval call (see our report at http://www.closeconcerns.com/knowledgebase/r/47018008), management remained confident that gross margins for the G4 Platinum would get into the 65-75% range, a marked jump over that achieved with the Seven Plus. It is not clear what volume is required to reach this point. Management does not anticipate any one-time charges during 4Q12; notable 3Q12 one-time G4 Platinum associated charges of nearly $5 million included:
    • $500,000 in costs of goods sold from Seven Plus hardware shipments with no associated revenue due to the increased sales return reserve.
    • $2.5 million write-off in excess and obsolete inventory for the Seven Plus and Seven Plus upgradable product (an unlaunched version of the G4 system that integrated the new G4 Platinum hardware with old Seven Plus sensors).
    • $600,000 related to fixed assets used for Seven Plus manufacturing and testing due to shortened useful life and additional depreciation expenses.
    • $1.2 million sales returns reserve (see above).

 

  • Total 3Q12 revenue was $23.1 million, up 26% year over year. Sequentially, revenue fell 1.7%. Again, excluding the effect of the G4 Platinum approval and launch, Dexcom would likely have recorded higher growth (product revenue accounts for over 90% of Dexcom’s total revenue). Given the initial patient and provider reception of the G4 Platinum, management expects to end the year at the midpoint of its original full year revenue forecast of $85.0-$92.0 million. Considering that 1) year-to-date revenue totaled $63.2 million; 2) one-time launch-associated costs occurred primarily this quarter; and 3) fourth quarter is already a strong one for medical device companies (on top of the G4 Platinum launch seeing its first full quarter), Dexcom’s goal seems very attainable.
 

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

Total Revenue (millions)

$21.4

$18.3

$22.4

$20.1

$23.5

$23.1

Year-Over-Year Growth

81%

57%

43%

42%

9%

26%

Sequential Growth

51%

-14%

22%

-10%

17%

-1.7 %

  • Using the same language as last quarter, the international business continued to “perform well,” accounting for just under 10% of total product revenue. We presume Dexcom has continued with the discontinuation of the Seven Plus internationally, and will be able to greatly improve its manufacturing and cost position upon completing the transition of international (and now US) patients off the Seven Plus and onto the G4 Platinum. [Editors note: When the G4 Platinum was first released in Europe, the system was called the Gen 4. While this call used the terms “Gen 4” and “G4 Platinum” interchangeably, for consistency in our work, we use Gen 4 to refer to the “old” Gen 4 (i.e., the Animas Vibe-integrated CGM that was comprised of the Seven Plus sensor and G4 Platinum transmitter). In both the US and outside the US, the “new” Gen 4 is the G4 Platinum, which is also now sold with Animas pumps in Europe. Dexcom’s Gen 5 CGM will use the G4 Platinum sensor and the new Gen 5 “smart” transmitter.]
  • Management said that consumable sales accounted for 70%-75% of product revenue, with durables making up the other 25-30% (identical figures as in previous calls). Average selling price (ASP) for sensors were consistent (the Seven Plus and G4 Platinum have the same sensor price of ~$260; see launch information below). Considering G4 Platinum starter kit costs are similar to the Seven Plus (~$800), ASPs will likely remain steady going forward. A September-only rebate program for the Seven Plus slightly affected the ASP for durables.
  • Dexcom spent $10.6 million on research and development in 3Q12, up 29% from $8.2 million 3Q11. On a sequential basis, R&D expenses remained flat (2Q12 R&D totaled$10.5 million). Management pointed to development costs associated with the SweetSpot platform, G4 Platinum scale up, continued generation of next generation products, and the ~$1 million-plus G4 Platinum pediatric trial. Considering that the trial has concluded, Dexcom’s R&D expenses are more likely to step down in 2H12 as initially forecasted in 1Q12. The accompanying 3Q12 press release indicated that R&D expenses also included additional salaries and payroll related cost and share-based compensation.
  • Selling, general, and administrative costs were $15.1 million, up 14% from $13.2 million in 3Q11. Sequentially, SG&A spending fell 1.9% from 2Q12 ($15.4 million) compared to the 2.0% sequential SG&A increase from 1Q12 to 2Q12. As in the previous quarter, the rise in SG&A was mainly due to share-based compensation and higher selling and marketing costs. Management did not offer an update on their SG&A forecast, which called for full-year 2012spending to be less than 20% higher than in 2011 (i.e., less than $59.9 million for all of 2012). While management did not anticipate increasing sales forces to sell the Gen 4 as of last quarter’s financial update, the US approval may make the SG&A target challenging indeed – SG&A costs year-to-date totaled $45.6 million.
  • Net loss was $17.3 million in 3Q12, a 30% increase over the 3Q11 net loss of $13.3 million. Sequentially, net loss grew by 18% from $14.7 million in 2Q12. The press release noted that the net loss included $6.9 million in non-cash expenses, consisting mainly of share-based compensation, depreciation, and amortization. Additionally, $4.2 million in non-cash charges and the sales returns reserve increased the quarter’s loss.
  • As of September 30, Dexcom held $53.4 million in cash, cash equivalents, and marketable securities, a cash burn of $7.8 million from $61.2 million at the end of 2Q12. Management did not comment on Dexcom’s timeline for reaching positive cash flow. The most recent update was in 1Q12, when management reaffirmed its confidence that Dexcom would reach positive cash flow on a quarterly basis starting in 2013.
    • A new loan and security agreement with Silicon Valley Bank and Oxford Finance stands to improve the company’s short-term cash position. The agreement provides: 1) a $15 million revolving line of credit; and 2) up to a $20 million term loan for general corporate purposes. Importantly, the agreement came with no warrants or dilution. The term loan includes a $7 million advance on the funding date with up to $13 million available from June 1 to September 30, 2013.
  • Product cost of sales were $13.4 million in 3Q12, up 46% from $9.2 million in 3Q11.

Sequentially, product costs of sales increased 23% from 2Q12 ($10.9 million). The rise was attributed primarily to increased volume of product sales, which of course is encouraging, as well as $3.0 million of additional charges related to excess and obsolete inventory and accelerated depreciation of manufacturing equipment due to the approval and commercial launch plans of G4 Platinum system.

G4 PLATINUM APPROVAL AND LAUNCH

  • The FDA approved the G4 Platinum on October 5 and Dexcom completed the initial shipments to patients late last week. As we noted in the G4 Platinum FDA approval conference call, the initial focus will be on processing orders for new patients. To read our diaTribe #48 test drive on the new CGM, please visit: http://diatribe.us/issues/48/test-drive. The product’s pricing will break down as follows:
    • $399 upgrades to the G4 Platinum for in-warranty Seven Plus users. This group includes those who have acquired/replaced their Seven Plus in the last year. These upgrades will start this month and the goal is complete them by the end of the 2012.
    • ~$800 for out-of-warranty Seven Plus users or new patients looking to get the G4 Platinum. Although the actual cash price is $1,198, most insurers have agreements with Dexcom to pay a discounted price for the patients they cover. The discounted costs for the starter kit (~$800) are roughly the same as the costs to start on the Seven Plus – we salute Dexcom for not asking patients to pay more for the G4 Platinum starter kit or for the new sensors (see below). Management commented during Q&A that most patients are on 80%/20% plans, meaning they will face an out-of-pocket cost of 20% of the ~$800 starter kit (~$200 to get the G4 Platinum). Management doesnot believe it will be necessary to incentivize out-of-warranty Seven Plus users to upgrade given this out-of-pocket cost.
    • ~$260 for a sensor four-pack. This will vary based on insurance contracts and the actual cash price is $349. This represents the same price as Seven Plus sensors, which is highly laudable from a patient perspective and a win-win – the G4 Platinum is cheaper to produce and higher margins for Dexcom, while patients reap the benefits of a better sensor at the same price.
  • The number of daily patient calls into Dexcom’s customer service organization is up over 50% vs. the average prior to the G4 Platinum launch. Management cautioned that it’s too early to determine whether this call volume will be sustained, but it is so high that the team has had little time to process orders. CEO Terry Gregg characterized this as “truly a dramatic increase.” Management also mentioned that many patients were waiting for the G4 Platinum approval before ordering a new CGM, so we might assume that the strong early volume might taper off in the coming quarters as these patients get the new system. Of course, if the new system can expand interest in CGM and bring more patients to the technology, the call volume may indeed be sustained. We also expect that once the FDA approves the pump integration partnerships with Animas, Tandem, Insulet, and Roche, new patient growth should accelerate as well.
  • Things are going well and there have been no major surprises on the manufacturing front, according to management. Management reminded listeners of the “operational challenges” of launching a product the same month as approval – for instance, user guides could not be printed until FDA gave final approval. It is quite impressive that Dexcom was able to pull this off and a testament to the company’s great management team and pre-approval preparation. Dexcom had sufficient inventories to meet patient demand during the quarter. Yields on the sensor lines have been getting better on a weekly basis and manufacturing is on “full blast.” Interestingly, one of the manufacturing challenges has been forecasting demand for the new colored G4 Platinum receivers (“Tickled Pink,” “Ocean Blue,” or “Classic Black”) – thus far, black is most popular (50%), with an even split between blue and pink.
  • The G4 Platinum pediatric clinical trial was recently completed and Dexcom expects to file a PMA supplement in the US and update the CE Mark in Europe before the end of 2012. US approval is “on track” for mid-2013. The pediatric trial cost over $1 million (!), though was less invasive and rigorous than the $2.5 million adult trial (e.g., no intravenous blood sampling – we’re glad to see that this was not required in such young patients). Encouragingly, “FDA is very interested in expediting this” and the Agency was “very happy when we told them that the trial was complete.” In the last few calls, we have noticed a particular emphasis from Dexcom management on FDA’s enthusiasm for a pediatric indication.
    • The pediatric label update will allow Dexcom to recommend CGM to patients as young as two years old – “a first for CGM.” As a reminder, the pediatric indication will also significantly expand the number of endocrinologists Dexcom can call on. While some physicians have historically prescribed the Seven Plus off-label to pediatrics, Medtronic has had a major advantage in the pediatric CGM market to date. Assuming a mid-2013 approval, Dexcom might even be able to exhibit at Children with Diabetes in July for the first time – we couldn’t think of a better place to launch the new CGM in younger patients.

 

  • The G4 Platinum approval has generated strong interest from potential clinical trial partners interested in using CGM; Dexcom will be gearing up for this opportunity next year. According to Dexcom management, this clinical trial segment now represents a “meaningful business opportunity.” Apparently, many pharmaceutical companies have “expressed a strong dissatisfaction with competitive CGM systems used in prior trials to the point that they had ceased using CGM in their studies” (we assume this refers to Medtronic’s CGMs). Dexcom management believes the combination of the 1) G4 Platinum CGM; 2) the SweetSpot cloud-based data management platform (FDA submission by the end of 2012 according to the G4 Platinum approval call); and 3) the Qualcomm communications platform (no timeline since the memorandum of understanding was signed in 1Q12) will offer a solution to potential partners.
  • Dexcom recently received approval of the G4 Platinum in Australia and approval in Canada and India are expected within the next six months. The company is actively exploring opportunities in China, Japan, and other Asian geographies. We’ll be especially interested to hear more about China – while the world’s most populous country does have ~100 million people with diabetes (not to mention many with prediabetes), we wonder what the reimbursement environment for CGM will look like – we expect fairly grim on the government side, though the cash pay market is likely quite meaningfully sized.
  • CEO Terry Gregg believes that the CGM category has 6-7% penetration in the diabetes market, and “the tipping point” could come around 8-9% within the next 12 months. Mr. Gregg emphasized that the G4 Platinum’s “other” features and benefits (e.g., increased transmission range, slimmer receiver profile) have been very well received by patients and could help drive adoption more quickly. We of course wonder what the major barrier to more CGM use is – Hassle using the device? Perceived inaccuracy? Extra time thinking about diabetes? Having something stuck on the body? Required fingerstick calibrations? Low healthcare provider enthusiasm? Hard to download and interpret data? Cost? We expect the G4 Platinum can help overcome at least some of the patient perceptions about high-hassle, low reliability, and inaccuracy.

PARTNERSHIPS

  • Filing a PMA supplement for the Animas Vibe will slip into early 2013, and approval is expected in 2H13 with a “stretch goal” by ADA. This is slightly behind the end-of-2012 submission goal cited in the G4 Platinum approval call. Apparently, the development work required to modify the Animas Vibe for the G4 Platinum is taking longer than expected (as a reminder, the Vibe originally used the “old” Gen 4 (Seven Plus sensor/G4 Platinum transmitter), not the G4 Platinum sensor).
    • The Animas Vibe insulin pump is being “very well received” by patients and physicians in the EU. As of J&J 3Q12, the Gen 4-integrated pump is available in 10 countries: UK, Ireland, Sweden, Italy, France, Germany, Netherlands, Denmark, Australia, and New Zealand. According to management remarks on the G4 Platinum FDA approval call, patients using the Animas Vibe system in Europe are now receiving the G4 Platinum sensor.
  • There’s a “high likelihood” that Tandem will move to integrate the G4 Platinum sensor – the companies are in the final stages of feasibility work. As a reminder, the original Tandem-Dexcom agreement was to integrate the Gen 5 sensor into a Tandem insulin pump. Gen 5 is simpler to integrate with partners because all of the intelligence is in thetransmitter. Conversely, integration with the G4 Platinum transmitter requires pump partners to put additional hardware into the handheld or durable pump. Dexcom management stated during the call that “we’re very, very close to final sign off from both engineering teams that the G4 Platinum system will work inside the Tandem pump.” The companies have actually built prototype pumps that are currently being tested.
    • The advanced timeline reflects Tandem’s desire to more quickly come to market with a CGM-integrated pump. We first heard about Tandem’s potential move from Gen 5 to Gen 4 on the G4 Platinum FDA approval call a few weeks ago. This is a very smart play in our view for two related reasons: 1) new-to-market Tandem can better market against Medtronic’s established line of CGM-integrated Paradigm pumps; and 2) many patients place CGM integration high on their list of priorities for choosing an insulin pump. We will be interested to see if the significant early momentum with Tandem continues – from the sounds of it, we would guess that development is farther along than with Insulet at this point (see below).
  • Management did not give an update on the Insulet or Roche partnerships. When asked during Q&A about the Insulet partnership in particular, management said, “Not really an update. At this point there is nothing going on there.” As of Insulet 2Q12 in August, development work was expected to “commence soon.” We suspect that development work will start back up again once Insulet secures FDA approval of the second-generation OmniPod. As a reminder, Insulet and Tandem both submitted their pumps for approval in May 2011. While Tandem secured approval in November 2011 (an approximately six-month FDA review), Insulet’s FDA review has now been approximately 18 months long.
  • The timeline in the EU was unchanged on the Edwards partnership (CE Mark by end of 2012); due to FDA, there is no estimated timeline in the US and discussions with FDA are expected in 2013. Management commented that Dexcom and Edwards are still waiting on FDA to weigh in on the acceptable approval criteria in terms of system performance. This is very discouraging to hear given the overall positive tone from the FDA at June’s In- Hospital Glucose Sensor Meeting. At that time, FDA’s Dr. Courtney Lias (Director, Division of Chemistry and Toxicology Devices, CDRH) made it abundantly clear that the Agency will not be issuing formal guidelines for hospital CGMs. Instead, the Agency would like companies to submit devices, bring good data, and they will be approved based on their risk- benefit profiles. Dr. Lias highlighted the “promising” and “encouraging” CGM accuracy data presented during the day, emphasizing “we can get these devices to market” and “we hope to see these devices out there soon.” For more information, see our report at http://www.closeconcerns.com/knowledgebase/r/882554b5.

FUTURE PRODUCT PIPELINE

  • The Gen 5 sensor “is in a very strong position to become the first class 3 medical device to communicate directly to a mobile platform.” Dexcom is continuing to have discussions with FDA on this front and the company remains “very encouraged.” We are also optimistic considering the company’s open relationship with FDA (it looks like one of the best in the diabetes device industry from the outside) and the amount of time both parties seem to have invested in this. In addition to the new smart transmitter, Gen 5 will also include an improved applicator that (as of the 1Q12 call) “significantly reduces the number of steps in the sensor insertion process” and improves sensor cost of goods.

 

  • An extended durability claim (e.g., 10-day wear) will now likely come with Gen 5.

Management reminded callers that given the cost of clinical trials ($2.5 million for the G4 Platinum adult trial and ~$1 million-plus for the pediatric trial), the trial for a 10-day wear indication will likely “marry up” with the work on Gen 5. Such a trial is currently in the 2013 planning schedule. As of the 1Q12 call, management believed that Gen 5 would be a PMA supplement rather than a full PMA (i.e., Gen 5 will retain the G4 Platinum sensor but include the new hardware changes).

  • No update was given on the status of the SweetSpot cloud-based data management platform – as of the G4 Platinum approval call, the goal was to file with the FDA by the end of 2012. We continue to believe that cloud-based software is a critical area in which Medtronic has an advantage over Dexcom. Anecdotally, we know of many healthcare providers that choose to put their patients on Medtronic CGM because of the convenience of CareLink. SweetSpot should help level the playing field in this respect, and we look forward to seeing what smart data analysis features it includes. There is a lot of room to make CGM data interpretation easier, and if SweetSpot can indeed make big gains in this area, we suspect many more providers would be willing to recommend CGM for their patients.

Questions and Answers

Q: How quickly can you get everyone upgraded that wants to?

A: We didn’t give an upgrade number. We are starting to identify that now and begin to ship out now. Our goal is to complete that by the end of this year – end of December.

Q: Do you have a sense of what percentage of patients is likely to do that? That would be awfully aggressive to get Seven Plus shut down mostly by the end of the year.

A: No, no this is upgrade. The upgrade program is for those patients who are in warranty and we provide them an upgrade for $399. The next group is patients out of warranty and they would be responsible for the whole initial new starter kit. The number is not as big as you think it is from that standpoint. We certainly have a number of immediate requests of those patients who want to upgrade for $399. We're first addressing the brand new patients – that was the number I gave on patient calls increasing 50% over pre-launch patient calls coming in. Again, our goal is to address both segments, but first new patients followed by the upgrade patients.

Q: Do you have any better sense of what chunk of existing patients want to switch? Do you have a time in mind when you want to get people off of Seven Plus?

A: Our timeframe would be as soon as possible so we can shut down the Seven Plus line. I don't have the optics. I will remind the audience that we've been shipping for less than two weeks. Our phones have been ringing off the hook. There are a lot of moving parts. We'll try to give clarity as soon as we can.

Q: Is the pediatric indication still on track for mid 2013?

A: Our belief is it’s on track for that mid-2013 commitment that we made to the organization and that the team made to FDA in a face-to-face meeting recently. We said we would file with the Agency before the end of the year. Like any PMA supplement, they statutorily have 180 days to review and complete. We’re hopeful that based on it being a supplement to data, they will look at the clinical aspects of it. Obviously it is not to the degree of 9,000 matched pair points that we had with the adult trial. And we’re not doing the rigor of intravenous blood sampling of these patients. They should be able to look at that in straight order.

 

And I know that they are very interested in expediting this. They were very happy when we told them that the trial was complete.

Q: Any new learnings relative to manufacturing as you start ramping up more aggressively with the new product?

A: Every day there are new learnings towards manufacturing. Yields are getting better on a weekly basis on our sensor lines. We turned everything on full blast, literally. We learn everyday and things are going well. One of the more interesting learning experiences has been the mix of colors – figuring out how many people wanted to buy our receiver that’s called "tickle pink." We've had pretty good demand on the color front. It’s all been good and there have been no major surprises.

Q: On Animas, you said there was a slight delay to early 2013. Do you think there’s still a reasonable possibility or probability that you can have this finished by ADA?

A: With that 180-day timeframe, I think the answer is that it is a possibility, not a probability. If we get this filed very early in the first quarter of next year, I think there is still an outside chance. I think what we committed to previously was the second half of next year with a stretch goal of trying to get it by ADA. I think that’s still our plan. As we move from the old Gen 4 to G4 Platinum we had to do some systems upgrading on their side. We have to get through the final systems validation and verification testing. And then it’s literally just getting the paperwork done.

Q: On Tandem, the original agreement was for the Gen 5. Should we plan on the G4 Platinum, or is that still in the negotiation stage?

A: From a business perspective, there is no negotiation. We have already made the agreement with Tandem if we can collectively prove it’s feasible – what I mean is that the Gen 5 architecture is simpler to integrate with potential partners because all of the intelligence is in the transmitter. With the G4 Platinum, the partner is required to put some additional hardware into the handheld or durable pump. We’re just in the final stages of the feasibility testing to make sure, for example, that the transmitter can communicate appropriately – that it can send and receive the RF signal. We’re very, very close to final sign off from both engineering teams that the G4 Platinum system will work inside the Tandem pump. We’ve actually built prototype pumps and we’re testing them today. I think the answer is that it's a high likelihood – I don’t want to tell you for sure – that Tandem will move to the G4 Platinum. It’s really because they want to accelerate their entry into CGM.

Q: Any update on Insulet and combining the G4 Platinum with their next generation?

A: There is not really an update. At this point there is nothing going on there.

Q: On customer service calls, you said there was a 50% increase from pre-launch to post- launch. You said maybe people were waiting for the G4 Platinum – maybe customer service calls were lesser in advance of the approval? What kind of calls are you getting relative to what you’re set up for? And do you need to temporarily boost labor to handle the calls?

A: The comment on 50% was greater than the average of what we were experiencing. Although patients and physicians told us that they were waiting for the approval, if you look at the growth of business, we continued to build that customer base in anticipation all along. We didn’t see any dramatic fall off from that customer call pattern. We continued to fulfill sensor orders as well. The more starter kits we put in the market, the more sensors we put into the market. I would say that this 50% increase was truly a dramatic increase.

Second, I try to caution the audience – we're not sure if that’s going to be sustainable or not. We have not seen any big drop off, but again we’re really only three weeks into this. We just don't have the optics as to what November is going to look like. And then we go into December, which is always our largest month regardless – a durable medical equipment experience for all parties in that world.

Regarding, whether we need to staff up – we're monitoring that. We do have the ability to do some shifting. If you look at the way we train people, we like to have expansive training in the customer service. So for the patient level, we can shift resources as necessary. One of the beauties of the Seven Plus is that we've seen the number of calls to technology services go down over the year. And we certainly expect that with the G4 Platinum calls will further decrease because it’s a better product. We certainly don't want to add to the staff unnecessarily, but we monitor the number of calls every day and make adjustments every day.

Q: You gave an update on Edwards – did you say Gen 2 is near completion and CE Mark would occur before the end of 2012? Were you referring to the US as well when you said that the Gen 2 is nearly complete?

A: The product is complete. The timeline for approval is just for CE mark approval before year-end.

Q: Any update on the US for Edwards?

A: We don’t have an estimate for the US timeline. Quite frankly, we are still somewhat waiting on the FDA to weigh in on what the acceptable approval criteria would be in terms of performance for the system. My guess is that that’s going to be 2013 discussions with the Agency.

Q: Can you quantify the one-time charges for Q4? Will all of this have washed through as we complete 2012?

A: We don't see any one-time charges coming in Q4. We believe we dealt with everything now. And that was our plan. So we believe it will all wash through. It’s our goal to get all those in-warranty upgrades and 30-day returns in the system in the fourth quarter. That way, we can get any effect on margins washed out in Q4 and move forward with clean slate.

Q: Given that we’re moving over to the new product, can you provide any color on what Q4 gross margins will be?

A: As I said, there are a whole bunch of things affecting them. We’ve got a $399 in-warranty upgrade program for hardware. Obviously, the margins on that are not going to be very good – that will affect it negatively. Conversely, we have a whole bunch of manufacturing volume going on that will affect it positively. G4 Platinum sensors cost less to build than Seven Plus sensors. To the extent that we can shift over, that will have a positive impact. We have a whole bunch of factors going in every direction. I wouldn’t give any more color other than saying it will be an interesting quarter. I'll say mostly good – even on the in-warranty upgrade program, to the extent that we’re selling $399 hardware, we're still selling sensors at very positive margins. We look for a good quarter.

Q: Where are you on the 10-day trial and labeling indication?

A: We are still in the planning stages as to what that should look like. As I’ve said previously, here's the landscape. Gen 4 Platinum is actually taking the membrane from Gen 5 and moving it backwards. That’s why it was a brand new PMA. But we didn’t stop all of the work on Gen 5 from the hardware. Gen 5 has two new components: one is a new applicator and one is putting the brains from the receiver into the transmitter. As you look at 10 days, they’re going to marry up – it’s probably going to be a Gen 5 moving forward with a 10-day trial. Part of it is that these trials are not inexpensive. If you look at the G4 Platinum pivotal trial, it was probably $2.5 million. The pediatric trial portion was certainly over a million dollars. So you’re looking at $3.5 million. We want to do that once, not twice. Also, with this G4 Platinum approval, there was no requirement from the Agency to cause patients to actually remove the transmitter  for a restart. So patients will use it as they so desire. We obviously would like them to use it for the labeled indication of seven days. We do have the 10-day trial in our 2013 planning schedule.

Q: So the whole concept of a longer label is going to be more focused on the Gen 5, not the G4 Platinum?

A: Yes.

Q: You have the $15 million revolver, the $20 million term loan. Were there any warrants on the revolver?

A: No warrants, no dilution on anything.

Q: So this definitely fills the coffers up.

Q: What are the economics of clients that are not under warranty going from the Seven Plus to G4 Platinum. What will it cost them to convert?

A: My expectation is that they would use up their Seven Plus sensors. So there’s no new cost factor from that standpoint. Then, they’re going to look at an upgrade to the new durable hardware both in the transmitter and the starter kit. We’ve mentioned before that our average selling price is a little north of $800. So that will depend on their plan. The majority of our patients have an 80/20 plan. From an out-of- pocket perspective, they’re looking at under $200 out of pocket for the starter kit. And then the standard for what they’ve been paying for sensors – there was no increase in the cost of sensors.

Q: So you don't believe you’ll have to incentivize them to convert?

A: No. We’re not expecting that to be a scenario. Even for those in warranty, we long debated on the upgrade. But again, part of our motivation is that we need to get patients into the G4 Platinum format sooner rather than later – if you think about the growth, we’re making more margins on the sensors. That means less margin on the Seven Plus sensors as we go forward. So at some point we need to get everyone converted over.

Q: What percentage of people that are eligible for the 30-day return policy have taken advantage of it?

A: We’re not going to disclose that. We haven’t shipped anything to those patients yet. We came up with an estimate of how many we thought would take advantage of the policy based on our experience in the past, and that’s the reserve we recorded. We’ve had quite a few people request it, but not all of them and certainly not what we've provided in our reserve.

Q: You mentioned increasing discussion on blogs, particularly on the G4 Platinum. Where do you believe that US penetration is at currently? How close are we to that tipping point where you see adoption really start to expand?

A: I still think we’re in that 6-7% penetration as a category. I do believe that we'll now reach whatever that magical point is – I’ve always said it’s around 8-9% – within the next 12 months. I’ve been pleasantly surprised – more than I thought I would be – with the G4 Platinum. We knew from a technological standpoint that it was an advanced sensor in terms of accuracy and things of that nature. But what we underestimated was some of the other features and benefits that would be highly desirable by patient that may in fact drive it to a greater degree and at a faster rate. That’s based on some of the comments from our field sales people of their ability to get into accounts and drive some of the interest at accounts that were somewhat resistant – it’s cumbersome, etc. The [G4 Platinum’s] slimness and the receiver’s extended connectivity are really attributes that are more desirable at the consumer level than we anticipated.

 

Q: What’s the most popular color?

A: It’s still black. I think we’re running 50/25/25.

Closing Remarks (Terry Gregg, CEO): Thank you and I'd like to close with a couple of real life experiences with the G4 Platinum just over the last couple of weeks that have come in to us. This is from both the healthcare sector as well as from patients. As an example, we've had one resistant physician whose only objection to our CGM was lack of integration with a pump. And that's not uncommon. But upon seeing the receiver and accuracy of the G4 stated, “integration doesn't matter anymore,” and gave our sales representative a list of 10 patients to initiate contact with regarding CGM. So, we look at them and we say, “imagine a day when we are able to transmit directly to a smartphone with our next generation?” We totally open the opportunities.

We have also heard from both patients and physicians that the G4 Platinum will enable them to use CGM first before moving to pumps – if they move to pumps at all. And this has been our philosophy and our marketing message. So it is nice to see that kind of traction. And finally, from a parent with the family member playing a soccer game. The highlight of the game was his ability to hold his son's monitor the entire game and keep track of his glucose due to the extended range of connectivity. He added, “There is a helplessness of watching your kid play an innocent game worrying if he got his insulin correct.”

And these are the things that I was just talking about that are the intangibles that are really tangible in terms of driving market awareness and adoption. So this is the power of the G4 Platinum and these experiences validate what we're trying to achieve. Particularly over the next three years as you see this innovation move into a consumer world of how we view the glucose monitoring world. So with that, I'll close and say thank you very much for your participation today.

-- by Adam Brown, Kira Maker, and Kelly Close