Memorandum

Dexcom 4Q19 – Record Sales of $463 Million, “Approaching 650,000” Global Users; Investments in Manufacturing to Lead to DTC Marketing in “Back Half” of 2020 – February 13, 2020

Executive Highlights

  • Dexcom reported record 4Q19 sales of $463 million in 4Q19, rising 37% YOY on a challenging comparison to 53% YOY growth in 4Q18. Growth continues to be driven by new patient adds, with CEO Kevin Sayer specifically citing “growing traction” in the insulin-using type 2 market (and we know there’s a lot of upside in type 2 overall, and heaps of potential). For FY19, Dexcom reported $1.48 billion in total revenue, rising 53% YOY on another challenging comparison to 44% YOY growth in FY18. US sales continue to drive growth, and represented 74% share of growth in the quarter. US sales hit a record $376 million (+34% YOY) in 4Q19, while OUS sales totaled $87 million (+53% YOY as reported).

  • For the first time since 4Q17, we heard an update on the number of Dexcom CGM users: “approaching 650,000 net active patients globally.” In our last update two years ago, the Dexcom user base was still at 270,000+, meaning Dexcom has added 380,000 new patients in just two years. Given Abbott’s 4Q19 update of “approximately two million” FreeStyle Libre users, the number of global CGM users has likely crossed 2.5 million, counting just Abbott and Dexcom CGM users alone. At the end of 2018, we estimated ~1.5 million global CGM users and at the end of 2017, we estimated the user base at “just” 0.7-1 million – wow!

  • Dexcom continues to expand its G6 manufacturing capacity and expects to significantly ramp up its direct-to-consumer advertising in the “back half” of 2020. We hope the power of CGM and what it can enable is in the works. Notably, in 2019, the company doubled its G6 manufacturing capacity and expects to see another doubling by “mid-2020.” As a reminder, G6 has been supply constrained for the majority of 2019. With a meaningfully improved manufacturing capacity and inventory build-up expected by the middle of the year, Dexcom is planning on ramping its investments in direct-to-consumer advertising, which it expects to be “one of the highest” return investments it can make. This is incredibly exciting as broader visibility for Dexcom will absolutely be a win for the entire CGM field.

  • Medicare rollout for G6 is now “fully underway,” with a complete transition to G6 expected by “mid-2020.” EVP Steve Pacelli noted quite a bit of pent-up demand for G6 in the Medicare population – this is expected as G6 brings 10-day wear and no-calibration compared to the 7-day, 2 fingersticks/day G5. Hassle factor is, however, still a major problem in getting people on Medicare on to CGM – this has lots of different angles, but greater evidence generation is what Dexcom emphasized as the greatest need at JPM 2020.

  • Dexcom saw what sounded like very positive momentum in the pharmacy channel, with contracts in place for >75% of covered lives (by our estimate), though we did not hear how much of the business is actually running through the pharmacy. This has always moved a bit slower than patients would like, and it’s another area of upside.

  • G7 was once again reiterated for a limited launch in 2020 and full launch in 2021. During Q&A, Mr. Sayer did put a noticeable emphasis on the full launch in 2021 saying, “We don’t want anybody believing that this rollout is going to happen in 2020 … We want everybody to focus on that launch in 2021.” Though no hard timelines were given on the trial or regulatory submission, Mr. Pacelli did note that Dexcom is “currently focused” on the clinical trial, which will be “much larger” than the trial for G6. Dexcom’s investment in G7 manufacturing remains high and it’s encouraging to see the launch timing affirmed for at least nine updates now. And, from our view – patients are still very excited about G6 – what we are most excited about in terms of G7 is the positive implications from a cost perspective.

Dexcom reported 4Q19 financial results this afternoon in a call led by CEO Kevin Sayer, CFO Quentin Blackford, and EVP Steve Pacelli. The 4Q19 financial slides are available here and our top highlights are below.

Early on in prepared remarks, Mr. Sayer took some time to address the Dexcom Follow and Share server outage in November. After the company was widely criticized for its communication during the outage, we’ve been impressed with the response: a new status page for centralized updates launched just this week.

  • “As many of you heard, in late November, we experienced a temporary server outage that impacted the ability of family and friends, to monitor glucose levels of loved ones via our Share and Follow apps. I told our customers, health care providers and shareholders, that we needed to do better. We needed a system in place to greatly improve communication with our customers. In the weeks since, we have taken significant steps to do just that. We have launched a system status page on our website ahead of schedule. This provides real-time updates on system functionality, 24 hours a day, seven-days a week. We are also in the final stages of rolling out an in-app messaging system that will provide quick communication with our customers. As you can see, we are not sitting still even with the rapid growth that we've experienced since the launch of G6. The reason for this is simple: We believe that there is a huge opportunity still ahead of us for our sensor platform.” – Mr. Sayer

Financial Highlights

1. Global Sales Record of $463 Million, Rising 37%; US Sales of $376 Million (+34% YOY), OUS Sales of $87 Million (+52% YOY); Full Year 2019 Revenue of $1.5 Billion (+43% YOY)

Dexcom reported record global revenue of $463 million in 4Q19, rising an impressive 37% YOY and 17% sequentially. The 37% YOY growth came on a very tough comparison to 53% YOY growth in 4Q18, the toughest comparison Dexcom faced all year. The 37% YOY growth is actually the lowest YOY growth rate Dexcom has seen in seven quarters – a testament to the rapidly growing base driven by CGM awareness and G6 uptake. The growth continues to be driven primarily by new patient adds, with CEO Kevin Sayer specifically citing “growing traction” in the insulin-using type 2 market. Volume growth continues to outpace revenue growth as Dexcom’s average revenue per patient continues to decline. The volume growth was seen across all channels (Medicare, US commercial, etc.) as CGM continues to become the standard of care in the US and across the world. US sales drove three-fourths (74%) of the growth in the quarter.

  • Global FY19 revenue was $1.48 billion, rising 43% YOY on a tough comparison to 44% YOY growth in FY18. The $1.48 billion represents a $450 million absolute increase over FY18 – a number that’s greater than Dexcom’s entire revenue in 2015. For context, Abbott reported ~$1.8 billion in total FreeStyle Libre revenue in FY19, rising 65% YOY. It’s clear how much these two companies are driving the CGM field forward. Mr. Sayer summarized by calling 2019 a “year of continued momentum” after 2018’s “year of milestones” – boy, is that ever true.  

  • US sales hit a record high $376 million in 4Q19, rising 34% YOY on a tough comparison 50% growth in 4Q18. Sequentially, sales rose a strong 22% coming off a blockbuster 3Q19. The launch of G6 in Medicare, now “fully underway” (after shipments began in “early October”) and the growing pharmacy channel helped drive growth in 4Q19. On a full year basis, US revenue crossed the $1 billion mark for the first time, totaling $1.1 billion in FY19 (+42% YOY). 

  • OUS sales totaled $87 million in 4Q19, rising 53% YOY (+54% operationally) on a very tough comparison to a whopping 71% YOY growth (of course, from a lower base) in 4Q18. Sequentially, sales fell slightly from a record $88 million in 3Q19. Still, the 53% YOY growth comes off two slower growth quarters in 2Q19 (+33%) and 3Q19 (+37%). CFO Quentin Blackford specifically highlighted Dexcom’s e-commerce platform in Canada, where the company saw new patients “nearly double” in 4Q19; G6 launched in Canada in September. We look very forward to hearing more about this – we are not sure but we think a prescription is not even required in Canada, similar to through the EU.

  • Worldwide sensor revenue totaled $360 million, growing 42% YOY and comprising 78% of sales. Transmitter revenue totaled $86 million, rising 46% YOY, while receiver revenue came in at $17 million, decreasing 35% YOY. Receiver revenue has seen YOY declines for three straight quarters – as G5/G6 mobile apps become easier to use, these declines are completely unsurprising. G6’s new, lower-cost transmitter rolled out in 4Q19, as a sidenote. We will be curious to see how the sensor, transmitter, and receiver revenue numbers change as the fully-disposable G7 launches.

2. “Approaching 650,000 Net Active Patients Globally”; First Dexcom CGM User Base Update Since 2017

For the first time since 4Q17, when the Dexcom user base was 270,000+, we heard an update on the number of Dexcom CGM users: “approaching 650,000.” When Mr. Sayer gave that update, he reminded investors that the 650,000 number represented users who were “consistently re-ordering product.” From 4Q17 to 4Q19, Dexcom’s revenue rose 109% from $221 million to $463 million. The 380,000 new patient adds from 4Q17 to 4Q19 represent 141% volume growth. Given Abbott’s 4Q19 update of “approximately two million” FreeStyle Libre users, the number of global CGM users has likely crossed 2.5 million, counting just Abbott and Dexcom CGM users alone. At the end of 2018, we estimated ~1.5 million global CGM users and at the end of 2017, we estimated the user base at “just” 0.7-1.0 million – wow! With CGM penetration at 35%-40% in US type 1s, and much lower in some other parts of the world, it’s clear that there is still runway to go even in the type 1 market – during Q&A, Mr. Sayer noted that he believes CGM penetration can hit 80% in the US type 1 market. Considering the hundreds of millions of people with diabetes around the world with diabetes that could benefit from CGM that results in higher savings from fewer short-term and long-term complications, the potential for better outcomes is incredibly high. Looking backward, it’s been an incredible decade for Dexcom, and CGM, more generally, as devices have become better, faster, cheaper, and more widely available. There’s so far to go, and tremendous opportunity as evidence generation expands.

3. JPM 2020 Guidance Reiterated: FY20 Revenue of $1.725-$1.775 Billion (+17%-21% YOY)

As was shared at JPM 2020, Dexcom is guiding for full year 2020 revenue of $1.725-$1.775 billion, representing 17%-21% YOY growth. Mr. Blackford cited five factors baked into the guidance considerations, three positive and two negative: i) higher rates of volume growth driven by increasing Dexcom and CGM awareness; ii) launches of G6 into new markets, e.g., Medicare, new countries; iii) new connected systems, e.g., Tandem Control-IQ, Insulet Horizon; iv) a reduction in average revenue per patient (driven by higher mix of pharmacy and Medicare patients); and v) the competitive dynamics. At 17%-21% YOY growth, the 2020 guidance is suggesting a fairly significant slowdown of growth from FY18 and FY19, which have both seen revenue growth >40%. When asked during Q&A, Mr. Blackford noted that the guidance included ~$150 million in headwinds from lowered average revenue/patient in 2020 compared to 2019. When included into the $225-$275 million absolute revenue growth guided for in 2020, the absolute revenue growth becomes much closer to the $444 million increase we saw in FY19. Still, we would note that Dexcom has consistently surpassed its full-year guidance: the company beat guidance by ~$160 million at the midpoint in FY18 and by ~$300 million at the midpoint in FY19. In 2019, the company raised guidance three times: by $75 million in 1Q19 and 2Q19 and by ~$88 million in 3Q19.

4. First Full Year of GAAP Profitability; Net Income of $93 Million, 67% Gross Margin in 4Q19

Dexcom hit a major profitability milestone in 2019, achieving full year net income on both a GAAP and non-GAAP basis for the first time. Non-GAAP net income doubled YOY from $53 million in 4Q18 to $107 million in 4Q19. On a GAAP basis, Dexcom posted a record $93 million in net income compared to a net loss of $180 million in 4Q18 (this includes a one-time $218 million charge from the restructuring of Dexcom’s agreement with Verily). As a reminder of how far Dexcom has come, the non-GAAP net income of $107 million in 4Q19 is larger than Dexcom’s revenue in 3Q15.

  • Dexcom’s gross margin of 67% in 4Q19 represents its best quarter in two years. The 67% gross margin is an improvement from 62% in 3Q19 and 61% in 2Q19. Though it went unreferenced on the call, the margin improvement was likely driven by a full quarter of G6’s lower-cost transmitter. Gross margin for FY19 came in at 64%, slightly above the ~63% guidance given in 3Q19. Gross margins were previously expected to come in around 70% by the end of 2019; the company fell a bit short of this goal, likely adversely affected by a production line going down in September and investments in manufacturing expansion.

G6 Highlights – Marketing, Medicare, Pharmacy, and International

1. G6 Manufacturing Doubled in 2019, to Double Again by Mid-2020; Direct to Consumer Marketing to Ramp Up in “Back Half” of 2020

As we learned at JPM 2020, Dexcom was able to double its total G6 manufacturing capacity in 2019 and intends to double the capacity again by mid-2020. Dexcom has been capacity constrained throughout 2019, with 4Q19 as the first quarter in which G6 supply was not constrained. This would suggest demand for G6 is even higher than the hyper-growth rates we’ve seen in Dexcom’s revenue and even volume. Abbott went through similar challenges meeting demand with FreeStyle Libre and has also made significant investments in manufacturing. A Reuters/NYT article from July specifically said Abbott’s plan is to increase FreeStyle Libre manufacturing capacity “by three to five times” in the “next few years.” Ultimately, some even see being supply constrained as a “good” problem to have – we disagree with this as it causes massive patient and HCP and Dexcom customer service problems – still, of course it is testament to the excitement for CGM around the world and the difficulty of manufacturing medical devices at a scale for millions, rather than tens of thousands of users.

  • After the next doubling of manufacturing capacity and Dexcom has built up a comfortable inventory, the company plans to “really turn on” spending on direct-to-consumer (DTC) marketing in the “back half” of 2020. According to EVP Steve Pacelli, DTC marketing spend is “one of the highest” return investments Dexcom makes, and at JPM, Ms. Sayer similarly stated intentions to roll out “aggressive marketing campaigns” in the back half 2020. With so much runway left, we see any DTC marketing by CGM companies as a win for the entire CGM field – at DTM 2019, we heard Dr. Roy Beck give kudos to Abbott’s DTC marketing efforts for helping spread awareness for the CGM in general.

  • With G7, we’ve heard Dexcom stress many times that it was designed with manufacturing considerations from the start. The company is already planning for G7 manufacturing and is hoping to avoid the same supply constraint issues that have plagues G6 when the G7 undergoes full launch in 2021. Here’s hoping – one never knows of course what unanticipated questions there are – and this is the management team that has full confidence from the ecosystem. We do hope leaders are asking, however, what is not being considered (especially with closed loop etc that is beyond their control).

2. Medicare Launch Now “Fully Underway,” Complete Transition to G6 by “Mid-2020”; “More than 50%” Increase in Pharmacy Covered Lives in 2019

Following the first shipments in “early October,” the launch of Dexcom G6 with Medicare is now “fully underway.” During prepared remarks, Mr. Pacelli noted quite a bit of pent-up demand for G6 in the Medicare population and impressively, he expects to complete the transition from Dexcom G5 to G6 by “mid-2020.” In July, Medicare issued lower monthly pricing for class II, 510(k) iCGMs – according to one analyst on Dexcom’s 2Q19 call, the pricing is ~13%-14% lower than that of class III CGMs, translating to ~$35 per month per person. Growth of the G6 Medicare channel is a contributor to lowered average revenue per patient, though the 10-day wear G6 will require one less sensor per month compared to G5 (7-day wear).

  • Dexcom is continuing to develop its pharmacy channel, with a “more than 50%” increase in pharmacy covered lives in 2019. As of 4Q18, the company had contracts in place for more than 50% of US covered lives, suggesting the total percentage of covered lives is now >75%. Despite the strong percentage of contracts in place, we’d imagine a majority of Dexcom’s business is still running through the DME channel. For comparison, Abbott reported in 2Q19 that it currently has ~75% of private covered lives under contract in the pharmacy, and we assume close to that level is running through the business. While the pharmacy channel reduces Dexcom’s average revenue per patient, the business is attractive because of the reduced effort from Dexcom to get devise to patients (e.g., paperwork) and makes reordering more convenient for patients.

  • Dexcom’s pharmacy and Medicare channel saw a big win in November with Walgreens’ announcement that it had identified a “billing solution” that would make G6 available to Medicare patients at any retail Walgreens location. Walgreens’ press release does note that the company is working with other CGM manufacturers to bring the same billing solution to other Medicare CGMs, i.e., Abbott’s FreeStyle Libre. 

3. Success with E-Commerce Platform in Canada, to Roll Out to Additional Countries; Launch in Japan and South Korea “Later This Year”

As they did on the 3Q19 call, management expressed specific excitement about the launch of G6 in Canada. The device launched in Canada in September and in 4Q19, Dexcom saw a doubling of new patient adds. The Dexcom Canada online store is Dexcom’s first (and only) e-commerce platform. Users can buy a G6 starter kit (three G6 sensors and a transmitter) for $299 CAD (~$225 USD). With the success of the Dexcom Canada online store, Mr. Pacelli noted that the company is looking to expand the rollout of the platform to “additional markets throughout 2020.” To our knowledge, getting a CGM does not require a prescription in Canada, making it easier for people to obtain CGM. Of course, getting reimbursement for CGM likely still requires documentation. Still, being able to purchase supplies directly from an online store seems like a win for both Dexcom and patients from a convenience perspective.

  • Dexcom plans to bring G6 to more markets, “like Japan and South Korea later this year.” When asked about Japan during Q&A, Mr. Pacelli said that they expect to have G6 approved in the “first half of this year,” though it’s unclear when reimbursement will come. Getting the no-cal, 10-day-wear G6 to more OUS markets will offer nice growth potential for Dexcom’s smaller OUS business.

4. Insulin Delivery Partnerships: Tandem Control-IQ Launched, Insulet Omnipod Horizon on Track for 2020 Launch, Lilly Deal Signed

During prepared remarks, Mr. Pacelli spent time touching on the multiple insulin delivery partnerships that Dexcom has. Most notably, Tandem’s Control-IQ (which uses Dexcom/TypeZero’s algorithm) launched just last month after receiving FDA authorization in December. Insulet began the pivotal trial for Omnipod Dash in December with launch still on track by the end of 2020. Also in December, Dexcom and Lilly officially signed an agreement to use Dexcom’s CGMs in Lilly’s “personalized diabetes management system,” including its smart pens and hybrid closed loop pump projects. Dexcom continues to boast a strong list of insulin delivery partners: Tandem, Insulet, Tidepool Loop, Beta Bionics, Lilly, Diabeloop, Cambridge, Companion Medical, Novo Nordisk, and Lilly.

  • “These are the kinds of achievements that do not happen overnight simply because we obtain the regulatory designation of iCGM or ACE pump or iController. Our relationship with each of the companies I just mentioned goes back multiple years. It takes hard work and significant time to integrate CGM with insulin delivery systems and Dexcom remains the leader in the effort to bring innovative technologies to the diabetes community.” – Mr. Pacelli

Pipeline Highlights

1. G7 Timeline “Reaffirmed”: “Full Rollout” in 2021; Currently Focused on Clinical Trial for G7

For the ninth straight update, Dexcom reiterated a limited launch in late 2020/full launch in 2021 timeline for G7 (see JPM 2020, 3Q19, 2Q19, 1Q19, ATTD, 4Q18, JPM 2019, and December 2018 Investor Day). During Q&A, Mr. Sayer did put a noticeable emphasis on the full launch in 2021 saying, “We don’t want anybody believing that this rollout is going to happen in 2020 … We want everybody to focus on that launch in 2021.” Though no hard timelines were given on the trial or regulatory submission, Mr. Pacelli did note that Dexcom is “currently focused” on the clinical trial, which will be “much larger” than the trial for G6. As we’ve heard before, Dexcom is really focusing on the manufacturing for G7 aiming for a smooth rollout, even as it expects demand to be very high. Mr. Blackford noted that capital expenditures are expected to be higher than those of 2019 as Dexcom invests in G7 manufacturing.

  • At JPM 2020, Mr. Sayer was asked whether having the class II pathway in place for iCGM would reduce the regulatory time to get G7 through the FDA. Mr. Sayer agreed that having the lower-risk class II classification would result in quicker review times, with the caveat that study data must meet the special controls outlined by the FDA. He emphasized the high bar the FDA had set with the iCGM special controls around accuracy, saying, “Making a [CGM] this precise is a challenge…and the FDA has proven it won’t change [the iCGM special controls].”

  • Based on recent updates, the planned G7 features are: a one-piece fully disposable wearable (integrated sensor/transmitter) that is slimmer on the body (see below); significantly lower cost design (presumably similar to FreeStyle Libre or perhaps lower); iCGM accuracy and factory calibration; 14-15 day wear (or perhaps even 16-day?); an applicator that is smaller, lighter, less plastic, and more convenient; and the Android/iOS mobile apps to display real-time data with Bluetooth. Verily head Andy Conrad made some waves at JPM 2020 when he stated that Verily and Dexcom had added a built-in accelerometer to the G7. That announcement has since been qualified, and it’s unclear whether the accelerometer will make it into the final, launch version of G7.

Slide taken from Dexcom’s JPM 2020 presentation

2. No Updates on G6 Pro, Direct-to-Apple Watch, New Adhesive, or Pregnancy

  • Dexcom’s G6 Pro received FDA clearance in October and was, at the time, supposed to begin shipping in “early 2020.” G6 Pro went unmentioned on today’s call and it’s unclear whether shipments have begun. Notably, the professional CGM is indicated for all people (i.e., non-diabetes) in unblinded mode, and all people with diabetes in its real-time mode. The system has the same form factory as the G6, but a fully disposable Bluetooth transmitter, offers both real-time and blinded modes, and gives users the option of the receiver or G6 app for viewing data. Making the device fully disposable also eliminates the HCP burden of having to keep track of and clean transmitters, while also preparing Dexcom for the manufacturing of its fully disposable G7.

  • Dexcom is expected to launch direct-to-Apple Watch data transmission (i.e., without an iPhone nearby) within the next six months. Notably, the direct-to-Apple Watch feature will require the new low-cost G6 transmitter, which saw its first full quarter of production in 4Q19.

  • At DTM 2019, Dexcom’s Mr. Peter Simpson showed same field data from a new adhesive “MA19” that already launched. Mr. Simpson’s adhesive data showed a 10-day survival rate of ~95% for the new adhesive (n=~2,500), compared to ~90% for the original adhesive (n=~388,000).

  • During Q&A, one analyst pointed out that Dexcom will present “some gestational data” at next week’s ATTD; we also highlighted this session in our preview. Mr. Pacelli called pregnancy an “exciting market” and noted that Dexcom has initiatives underway to get that labeling. In our view, far more pregnant women (like, every single one) should be on CGM – the CONCEPTT study showed that it is cost saving (particularly in the neonatal outcomes category), so much so that NHS plans to offer CGM to all pregnant women with type 1 diabetes by 2020/2021.

Analyst Questions and Answers

Q: (Jeff Johnson, Baird): Would love to hear how you feel about the mix of new patient adds this year with MDI versus maybe competitive share gains? And specifically, would love to hear maybe your thoughts with some of the formulary changes we've seen at the start of this year. How you think that might help sensor volumes this year?

Kevin Sayer (CEO): That's a pretty complicated one question. I'll deal with those, as best I can. With respect to the new patient adds this year, there was a majority of our new patient adds, a pretty significant majority of our new patient adds, who are multiple daily injection patients, who are using pens and insulin to control their insulin delivery. We still have a number of pump patients as well. But, to expand the way we've expanded and to grow as quickly as we've grown. Do the math. We have to be getting patients on multiple daily injections.

On the competitive front, we're very pleased with our growth, in the number of intensive insulin-using patients that we're picking up here. It was just a great year all around on the new patient front.

With respect to the formulary and the increased access that we see coming, there's a couple of things we think that will be very good for next year that we see right now. The first is more increased type 2 intensive insulin access, for many of our patients and under many of the plans, plans are starting to open up and follow the Medicare guidelines there. That really opens a lot of doors for us and that will be good.

Then, increased pharmacy coverage. While our pharmacy rollout has been a bit choppy as we're trying to learn here, how to do that best. That has not been our core business going to the drug store, since we started. We'll learn to be better and get better there. But, as we can make the product more accessible and easy to get, over and over again, we see the utilization is higher and retention is better, so all those things point to a very strong 2020 for us.

Q (Jayson Bedford, Raymond James): With G7 timing is your expectation that you get it approved here in 2020?

Mr. Sayer: Our expectation is that we'll launch it full-scale in 2021. And we've spoken several times about a limited launch in 2020 and that's still one of our primary goals and objectives. But, we don't want anybody believing, that this rollout is going to happen in 2020. We need to get the trial done, the filing in and reviewed and our manufacturing scaled up and apply those lessons we learned with G6 to G7. So, our big focus and the focus we want everybody to focus on is that launch in 2021. As we get more information we can share, we'll share it. But that's our timeline and that's our commercialization timeline for now. We're really not giving any filing or trial timelines today. We can talk more about that as we go on.

Q (Travis Steed, Bank of America): You've got goals for operating margins of 15% by 2023, which looks a lot more conservative now than it did before. If revenues end up coming on better than this year you could potentially achieve that this year. So, just trying to think about the long-term profitability of this business, is there anything long-term as you have more business through the pharmacy channel, G7 is at scale. Is there anything that would be structurally inhibiting this business from being at a 25% to 30% operating margin? Additionally, is there anything about G7 launching that where gross margins would step back? Or can you manage through that?

Quentin Blackford (CFO): When we put out the 15% operating margin guidance, at that point in time we were just trying to draw a reference out in the future that we were confident we could navigate towards, but it was never an end goal that we had in mind. It was more along the lines of the progress we thought we could make.

If you recall when we did that, that was 1,500 basis points away from where we were at that point in time. So, to your point, we've closed the gap quite considerably even faster than what we anticipated. But there's nothing structurally in this business that won't allow us to go beyond the 15%. We're not ready to revise kind of those long-term expectations of where we can go.

We couldn't be more bullish and excited about the investment opportunities in these new markets that are in front of us. You think about the hospital, gestational, the non-intensive type 2s, the international expansion. All of these things are incredible opportunities that we're going to make sure we're investing into to make sure that we open them up, but none of that is going to keep us from being able to get to the 15%, and then on beyond that in time.

So no, there's nothing structurally that concerns us whatsoever. G7, I would just remind you that product was designed from the very beginning with cost in mind and the idea was to be able to produce that at a very low-cost profile that will go far below even where G6 we've been able to get it to.

So, from my perspective, all that does is open up even greater opportunity to compete in lower-priced channels if we need to be aggressive in the marketplace to push volumes in a way that we need to. But all of it complements the long-term profitability profile that we're trying to achieve here. So, I think very complementary to what we're trying to do.

Q (Robbie Marcus, JPM): We've looked over the past two years and you've meaningfully exceeded your initial guidance range. We see something similar in 2020. Maybe if you could just help us understand why this is the right place to start off the year? And then, I remember last year you kind of walked us through what volume versus mix versus price would be, if you could do the same and maybe break down US versus international and what's assumed in the guidance range?

Quentin Blackford (CFO): Sure. So, we continue to be very bullish on the opportunity that sits in front of us from a revenue perspective just in the core markets that we participate in today. I think we're very early in the adoption of the technology, which leaves a lot of runway. But we also know there are very different patient profiles in that adoption cycle and how quickly they come on to the technology or how long it takes to convince them. It's hard to predict and we're not going to get ahead of ourselves in that respect. I think, if you look at our guidance, the way we thought about it is from an absolute dollar perspective, our guidance assumes a $250 million to $300 million increase year-over- year. And we've been very clear that there are price headwinds that continue to be contemplated in that guidance as we walk average revenue per patient down over time is contemplated in the numbers we put out there. That's about $150 million in 2020.

So, if you add that back to the net increase that we've guided to, that takes the gross revenue increase on an apples-to-apples basis versus prior year to about $400 million to $450 million increase. You compare that to what we just did in 2019 of a $444 million increase, and I think you start to get your mind wrapped around the guidance that we've provided. So, we feel good about it. We think there's incredible opportunity. It doesn't make sense to get ahead of ourselves at this point in time. And feel like we've got guidance out and appropriately.

Q (Margaret Kaczor, William Blair): I wanted to elaborate a little bit on some of the partnerships and updates that you guys had over the last several months, because there have been a lot including some of the data at JPMorgan and so on. So, how should we think about some of those that are more in the pipeline beyond that this year, especially from Kevin, you talked about thinking really, really big. And how should we think about the timing to those partnerships becoming more material commercial activity?

Steve Pacelli (EVP): I think you need to kind of bifurcate the partnerships into kind of our core intensive insulin business both US and OUS. We've got Tandem currently launching Control-IQ, Insulet launching Horizon later this year, Tandem with Basal-IQ in Europe and hopefully, I don't want to speak for Tandem on their timelines, but hopefully Control-IQ at some point later this year.

So those are all meaningful near-term revenue contributors, right? Because these are folks who are going on – there are many of them are probably already our patients or some portion are already Dexcom patients as they go on these systems. But there will certainly be incremental new patient additions as a result of those product launches. So, those are really exciting. The update with Lilly, we're still some period of time out before we launch the first Lilly product but we're definitely making some progress there.

The partnerships and the data that we talked about, really on the non-intensive side of the business at JPMorgan, that's still really early stage, I mean the way we're trying to frame that, Margaret is that, a year ago around JPMorgan, we kind of talked about this new markets opportunity strategy, particularly in the non-insulin using type 2 space. We kind of followed that up, the goal is that this year JPMorgan was to follow that up with really some early stage, but concrete evidence that there's a real opportunity here, right? Between the work we're doing with United, the cost savings we showed with Intermountain with one of the payer systems we're working with.

So, I wouldn't look to – certainly not 2020 as a meaningful revenue contribution from really that non-insulin using type 2 business, but we're super excited about it. The data supporting that there's a huge opportunity there. And I think in the out-years and you start thinking about 2021, 2022, 2023, I think there's going to be a much more significant revenue contribution from businesses outside of kind of our core intensive insulin business.

Q (Ryan Blicker, Cowen): You talked about strong and growing contributions from the intensely managed Type 2 patient population. Is there anything you can quantify for us on that front, either how big that population is now as a proportion of the installed base or new patient additions? And then, just overall do you expect new patient adds to grow in 2020 versus 2019?

Kevin Sayer (CEO): We won't really break out the Type 2 patients and the patient base. We don't stratify between Medicare, pediatrics, those types of things right now. We did give everybody a patient number this year, and I think it's a good place for everybody to start.

Steve Pacelli (EVP): I think the growth rate probably slows a bit, but the absolute number continues to be comparable if not up slightly is the way to think about it.

Q (Danielle Antalffy, SVB Leerink): Quentin, I just wanted to ask about seasonality as we look at Q1 specifically and how to think about moving through the year. Is there anything we need to be cognizant of as we go into Q1, which I think is usually a seasonally weak quarter?

Quentin Blackford (CFO): Sure. I think at this point in time, historic seasonality that we've seen in the business that generally would have Q1 represent close to 20% of the full year is probably the right way to think about it. We've seen where The Street has modeled currently 2020, I think we feel good about that. So I think you guys have got to dialed in pretty well in terms of how you're thinking about seasonality. I do think over time as the business continues to mature as you get more revenue flowing through the pharmacy channel as Medicare continues to represent a bigger part of the overall business that seasonality may begin to change a bit, but probably not in 2020. I think historic trends are a good way to think about it and roughly 20% is probably the right way to model.

Q (David Ryan Lewis, Morgan Stanley): I look at the implied leverage for 2020 relative to 2018 and 2019, the implied leverage for 2020 is a little lower, just looking at revenue dollars versus operating expense. Is the right way to think about this year kind of the guidance reflects the expenses that are sort of dialed in for the year and that incremental upside that there’s going to be incremental upside to revenue that is likely to fall down at a higher rate?

Quentin Blackford (CFO): Yeah. I think what you'll see is, we'll continue to be very disciplined in how we manage the business. David to your point in the last 24 months we've driven about 2200 basis points of OpEx leverage in this business. The team has been very thoughtful, accountable, discipline in how we steward our resources.

But we also see some significant opportunities sitting in front of us to really pour some investment into. For example, in 2019, we never really poured the fuel on the fire from a DTC spend perspective in the commercial business. We didn't have the capacity from a manufacturing perspective to really open that channel up and support the demand that we thought it might create. We will open DTC up in a meaningful way in 2020 and that is contemplated in our spend.

As that drives revenue, if it drives it beyond kind of how we guided then I think to your point we'd be very thoughtful and disciplined about how we let that flow through. And yeah, I would think that it would drive incremental margin. But we want to make sure we're not passing on the investment opportunities around things like DTC, what we're learning in the new market efforts, particularly around that non-intensive population and knowing that we can take cost out of caring for these patients.

We're going to make sure we set that up for success into the future. So, that's where we're investing at. If revenue outperforms then, I think you'll see us perform well on the margin front.

Q (Kyle Rose, Canaccord): At the Analyst Day you broke out opportunities like, hospital use and gestational use. It looks like there will be some gestational data at next week's ATTD, but just wanted to kind of understand how we should think about, when those potential opportunities start flowing through the model, in 2021 and beyond?

Steve Pacelli (EVP): Yeah. If you're asking specifically about opportunities outside of non-intensive, non-insulin using type 2s there's certainly work being done. There's research being done. You're going to see basically a cascade.

As we've kind of done some preliminary work in the clinical side, we've recognized that type 2, non-intensive would be the next logical kind of lowest hanging fruit for us. So that's where you're going to see go after first with probably hospital being a close second. In terms of gestational, like you said, it's an exciting market. But a little bit more limited in terms of touch points into the OB-GYN's offices and things like that. We’re working on a strategy there as well. We need to update our labeling, certainly for hospital and for pregnancy. There’s some initiatives underway there. But you're going to see a cascade of what I would say incremental increasing contribution over the next several years, in all of those categories.

Q (Matthew O’Brien, Piper Sandler): First of all, you're not signaling any kind of concern about a slowdown in your traditional intensive managed group? Secondly, can you kind of frame up the opportunity that you're thinking about there? There's 1.5 million type 1s, 1.7 million MDI patients. Is this non-intensive group around that level? And can you access that group without some level of reimbursement?

Kevin Sayer (CEO): We do not believe at all that our intensive business is going to slow down. And in fact, as we look at our strategy, our first pillar is to continue to serve that patient base and continue to grow there.

With CGM penetration still on a combined basis in the 35% to 40% range in the US and much less than that in other geographies, there is plenty of room to grow. And as CGM becomes a standard of care here, again I've said for a number of years, I think 80% market penetration is possible. And I will hold to that certainly here in the US. So, there's plenty of room to grow in the intensive business, particularly as we get more automated integrated systems out on the market.

With respect to the type 2 non-intensive business, no we are not talking 1.5 million to 1.7 million people, we are talking 30 million people in the US and hundreds of million people around the world. We believe CGM has a tremendous, tremendous benefit there. We're going to make sure that we can maximize that in the space.

Q (Matthew Blackman, Stifel): Quentin, you called out DTC as an investment priority in 2020, so can you talk about the magnitude of returns you get on DTC investment dollars, and then how quickly do you typically see those returns manifesting in revenues?

Quentin Blackford (CFO): Yep. You'll see us start to turn DTC spend on really in the back half of the year. Our goal from a capacity perspective is to double, where we exited 2019 by the time we get to the mid part of 2020. We will double capacity once again by the mid part. Once we are there, we feel like we've built enough supply that we can handle any demand that might come from the DTC efforts. It's one of the highest returns on any investment we can make in the company. We monitor it very closely. It's not something that I'm going to disclose in terms of exactly what that rate is, but I will tell you, it's one of the best investments we make. And typically, it's going to take a couple of months to start to see that turn back up into real tangible results in the business, but you could see some benefit in the back part of the year.

Q (Raj Denhoy, Jefferies): Coming into 2019, you had talked about kind of absorbing 10 points of  price-mix offset due to the channel mix that you're experiencing. I guess this year it sounds like the $150 million it's roughly another 10 points. When do you imagine that settles out? Is there a point at which the price of the sensor is at a point where you're more normalized and perhaps are not absorbing that level of impact every year?

Quentin Blackford (CFO): Well, I think what we've demonstrated, Raj, is that our strategy to walk price down over time and have volume, more than offset that has played out incredibly well. We started the walk price down really two years ago. And we walked it down again last year, you're going to feel that impact this year, but we've got a price point or revenue per patient point in mind that we're trying to get to and there's probably a couple more years. 2020 being one of those that will continue to feel this from and I think volume will more than offset it, but then we're at a very good price point that we feel great when you consider the fact that we'll be bringing G7 into the market at that price point. We feel like we're set up to compete incredibly well. So, there's probably a couple of years here that we'll continue to navigate through it. And have volume more than offset it, but then we're at a point where we think is quite sustainable into the future with an incredible product being G7.

Q (Ravi Misra, Berenberg Capital Markets): A question on the transmitter revenue: it's pretty strong quarter there on that line item, more so than we had expected. Just walk us a little bit through what was the reason behind that strength in terms of reorders or new patient starts?

Steve Pacelli (EVP): Yes, I think you continue to see the strength of the new patient numbers show up there. I will point out the fact that, if you just look at it from a comp perspective, there was a bit of an easier comp on the transmitter line than there was on the sensor line in the fourth quarter. So, if you go back a year ago and look at sensor versus transmitter revenue, there was an easier comp sitting on that transmitter line that drove a little bit of that growth. I would just make sure you contemplate that.

Keep in mind, as we continue to evolve as a company, as we continue to think through our pricing strategy and position ourselves in a way that we can very easily step into the G7 product which is a very different form factor where the sensor and the transmitter are one unit versus two distinct units in G6. It ends up having a bit of an impact on how we account for the revenue in each one of those buckets. So, we're going to have to contemplate the revenue buckets that we continue to report into the future. We want to make sure we're giving you something that is the right way to think about the business and model it. But what you're seeing play through that right now is just a little bit of an accounting nuance and how we allocate revenue based upon these new pricing strategies.

Q (Steven Lichtman, Oppenheimer): On international, obviously, it's been very strong and there's been a lot of breadth there. As you look ahead, just one of the countries I think later this year, Steve you mentioned is Japan. Can you talk a little bit more about when you think you'll have that launched and what the opportunity is on the personal side in Japan looking ahead?

Steve Pacelli (EVP): The hope is to have a personal use CGM in G6 approved in the first half of this year. The big – kind of the big still unknown, if you will, is whether – and to what extent we get reimbursement for that product. So, if it comes in this cycle. That's great. If not, it could come next year or the year after.

I would tell you that growth, like in all of our outside of the US markets, growth is really instigated by reimbursement. So, we're taking a little bit of a wait and see approach there. And we're certainly going to launch the product in Japan once we get approval. But as you know in the cash pay world, it's not always as easy. So, I'd say wait for updates on the reimbursement front on Japan is really what you're looking for.

Q (Marie Thibault, BTIG): I wanted to hear a little bit more about details on your plans for the third manufacturing site OUS. And what cadence or milestones, we should be looking for throughout 2020 as it impacts the gross margin line?

Kevin Sayer (CEO): Sure. So, we couldn't be more excited about the opportunity that sits in front of us in our core business but as well the international business. We're very early in the stages of really taking advantage of that market. We probably have sub 15% of that opportunity.

And I think over time, you're going to see us put a lot of focus and effort there and standing up a manufacturing capability that gets much closer to the end user is a very strategic move on our part, while also identifying locations where we can ultimately reduce the overall cost of production that will let us compete in a lower price environment. So, strategically it makes a tremendous amount of sense.

You'll hear us talk more about it over the course of the year as we settle in on exactly where we select to start to build out that capability. But what we know is that these things take multiple years to stand up. We won't be producing out of that facility for a couple years here. But we've got to start the work now to ensure that once we get to full capacity in our San Diego and Mesa facilities, we're ready to step right into that international opportunity and ensure that we have no impact on supply. So, we're getting ahead of it, ensuring that we don't hold up the business and we're excited about what it can do for us.

 

--by Albert Cai and Kelly Close