Insulet 3Q14 – OmniPod sales grow 25%; new CEO, CFO Brian Roberts resigns; U500 trial in mid-2015, new PDM filing in 2016 – November 6, 2014

In a call led by new CEO Mr. Patrick Sullivan, Insulet reported 3Q14 results yesterday afternoon. Below, we enclose our top business and R&D highlights.

Financial and Business Highlights

1. Total revenue in 3Q14 reached $75 million, a 23% year-over-year (YOY) increase and up 4% sequentially. We estimate global OmniPod sales grew ~25% YOY to reach ~$70 million. Growth was slower than in the prior two quarters, attributed to the issue with United Healthcare.

2. New CEO Patrick Sullivan took over on September 16, and highly-regarded CFO Brian Roberts resigned on the call. We assume the major leadership changes reflect a change in strategy and a move to take Insulet to a more evolved stage.

3. A goal of new CEO Mr. Patrick Sullivan is to make investments in sales and marketing to really ramp sales; additional commercial resources will be added early next year, building on 20 individuals added in 2Q14.

4. Insulet manufactured a record 3 million-plus pods in 3Q14, and quality has never been higher in terms of yields, which exceeded 98%. The company saw record gross margin improvement in 3Q14, which now stands in the low 60%-range in the US and 51% overall.

5. The reimbursement issue with United Healthcare, first discussed in the 2Q14 call, has now been resolved; a negative impact on new patients starts is still expected in 4Q14, but no impact is expected in 2015.

R&D Pipeline Highlights

6. Based on FDA feedback received in 3Q14, Insulet and Lilly will now need to conduct a clinical trial of the U500 OmniPod prior to filing a 510(k) application; a study of unspecified length will commence mid-next year. This will enable the necessary label update.

7. FDA clearance of the LifeScan Verio-integrated PDM is hopefully expected “very soon.”

8. An FDA filing of the next-gen, touchscreen, Bluetooth OmniPod PDM is expected in early 2016 – this represented the first regulatory timing we’ve heard on this product. The plan is still to show the PDM at ADA 2015 in Boston.

9. The CGM-integrated pod continues to move at a fairly slow clip – Insulet recently completed additional testing around the proximity of sensing and dispensing insulin. The timing on the first human trial has now slipped to “early-to-mid 2015,” back from “early 2015.”

10. Management expressed significant excitement over alternative drug delivery. FDA approval of the Amgen oncology device is hopefully expected before the end of 2014. Insulet’s partnership with Ferring (infertility drugs) is now generating revenue in Europe, and the company announced a new agreement with Capricor Therapeutics (post acute heart failure).

Business and Financial Highlights

1. Total revenue in 3Q14 reached $75 million, a 23% year-over-year (YOY) increase; we estimate Worldwide OmniPod sales grew ~25% YOY to reach ~$70 million. Total revenue fell squarely at the center of the previously issued 3Q guidance ($73-$77 million). Unlike prior quarters, management did not break out OmniPod growth specifically, and indeed, our estimate of ~25% YOY growth is lower than the 35% growth in the two prior quarters (and four consecutive quarters of 30%+ growth). Sequentially, total revenue increased 4% and OmniPod revenue increased ~7%.

• New patient starts increased 15-20% year-over-year in 3Q14, down slightly from 20% in 2Q14. Insulet saw a 5-10% sequential increase from 2Q14 in new patient starts, down from an ~11% sequential gain between 1Q and 2Q. CFO Mr. Brian Roberts said the “trajectory seems very solid,” and the slight slowdown reflects the payer issue with United Healthcare (see below), which is “now put to bed.”
• “About 70%” of Insulet’s initial patient starts are new to insulin pumping, consistent with prior updates. Notably, approximately 40% of new patients starts in 3Q were in <18 years, up from 35% in 2Q14. In a new metric, management shared that the company’s overall annualized attrition rate, 9%, is much lower in those <18 years – just 5%. “Once kids experience the OmniPod, they don’t change,” said new CEO Patrick Sullivan.

*Worldwide OmniPod Revenue as extrapolated based on commentary that: (i) the international business grew 60% year-over-year; (ii) the Neighborhood Diabetes business was “up slightly” (we estimated 2%); (iii) growth was likely down from prior quarters, since management did not specifically break out OmniPod revenue.

• In line with Ypsomed’s results reported last week, OmniPod sales rose 60% YOY in Europe. Insulet’s international business is still set to double in 2014. Share gains in the mid-to-upper teens were cited in the Netherlands, Austria, UK, and Switzerland. Meanwhile, Ypsomed continues to add share in Germany, Sweden, Finland, and in new markets such as Italy (recently launched). Notably, the hope is to launch the OmniPod in France early next year once reimbursement is secured. France is the second largest pump market in Europe, and in the words of CFO Brian Roberts, “Today we sit with a zero there. So getting France over the goal line would allow for a really good growth opportunity in calendar 2015.” China is still far away from approval.
• Notably profitability continued on a positive trend – absent several one-time expenses (CEO transition, debt retirement), Insulet would have reported an operating profit of approximately $4 million in 3Q14, its highest ever. The company reached breakeven results on the net income line and on an earnings per share basis.
• Management tightened the full year revenue guidance to $292-$297 million (18-20% YOY growth) from 2Q14’s $290-$300 million. CFO Brian Roberts emphasized that the midpoint of $295 million remains the same, and the tightening reflects the negative impact of the United Health issue (see below). In 4Q14, total revenue is expected at $76-$81 million (11-14% growth).

2. Insulet has seen fairly dramatic senior leadership changes in recent months, headlined by new CEO Patrick Sullivan (as of September 16) and the resignation of beloved CFO Brian Roberts (effective tomorrow, November 6). Both leadership changes were sudden and caught us off guard.

• Mr. Sullivan conveyed significant excitement in his first call as CEO. Though just 50 days into the job, he seemed confident and fairly up to speed on the company’s business and the insulin delivery market. His major near-term goal seems to be increasing sales/marketing spend, as noted below, to drive topline growth. Mr. Sullivan seemed to express particular excitement over the potential in alternative drug delivery. He brings to Insulet over 30 years of executive leadership experience, though none specifically in diabetes: 13 years as CEO of the women’s health-focused Cytyc Corporation (where revenue rose from $4 million to $750 million in that time), one year as Executive Chairman of Hologic (acquired Cytyc in 2007 for $6.2 billion), five years as CEO Constitution Medical Investors, and most recently Managing Director of Aton Partners. We assume Mr. Sullivan was brought on to lead the company as it evolves to a more advanced stage. While M&A clearly represents an area of expertise for Mr. Sullivan, we hope that Insulet stays independent unless it can find a larger company that truly deserves to be its parent.
• In a separate press release issue with the call, CFO Mr. Brian Roberts formally resigned from his position, effective tomorrow. He had heartfelt remarks on the call, noting that it has been “a great ride” and he has “loved every minute” at Insulet. Mr. Roberts began conversations earlier this year about what was next in his career; he said “it seemed like the appropriate time...to make the next step and transition...to additional opportunities.” Overall, this was negative news for patients and for Insulet, as Mr. Roberts’ was beloved by many and a very highly-regarded and overall stellar Chief Financial Officer. In his six years at Insulet, revenue increased 10x ($30 million to nearly $300 million); the company’s market cap increased to over $2.2 billion; and Insulet achieved operating profitability. He will turn the CFO reins over to Ms. Allison Dorval, his “right hand” since his first day on the job; she has been serving as the Company's Controller since 2008. He is “more than confident that she will do a tremendous job.” Mr. Roberts will remain an employee through the end of 2014 to assist with an effective transition.
• Today, Mr. Brad Thomas was appointed to a newly formed role, Executive VP, Human Resources and Organizational Development (effective immediately). This was hardly mentioned on the call. The new role has a fairly vague description: “implementing strategies that directly improve P&L performance and create a long-term competitive advantage designed to position the Company for continued growth” – we assume he was someone that Mr. Sullivan wanted to have near him that he knew at Cytyc - he previously served as Senior VP of Human Resources at Cytyc Corporation with new Insulet CEO Mr. Sullivan. Mr. Thomas has an impressive background of global HR leadership experience at Citigroup, Pepsi, and GE. Notably, he is a graduate of the GE Human Resource Leadership Program.
• These leadership changes follow the appointment of Mr. Patrick Ryan as Insulet’s Chief Operating Officer in January, replacing Mr. Charles Liamos (Insulet's COO since 2010).

3. “We need to make some investments in sales and marketing to really ramp the sales number,” said new CEO Mr. Patrick Sullivan; “additional commercial resources” will be added early next year. He elaborated in Q&A, noting that in his previous experience as CEO of Cytyc, annual revenues of $300 million came with much more spending on sales and marketing vs. what Insulet is spending today. He did not give specifics.

• In Q&A, an analyst asked perhaps the biggest question in insulin delivery – why are only ~30% of US type 1 patients on pumps, and what should Insulet do differently?  Mr. Sullivan answered that in Insulet’s market research, there are a “large number” of MDI patients that “would never consider a pump if they had to use current conventional pumps.” However, when these patients are provided with the opportunity to use the OmniPod, “the interest level is exceedingly high.” He believes it will be key to focus on the marketing message to endocrinologists in terms of converting more MDI patients to the OmniPod. In addition, he cited the strong growth in the <18 year-old segment.
• “This is the first chance this business has to play offense vs. defense,” said CFO Brian Roberts. He provided a nice historical perspective, noting the challenges that prevented previous investment in sales and marketing: over-running the old pod’s manufacturing capabilities; getting the new pod approved; and transitioning the customer base. The building blocks are now in place, he said, and the momentum from investments in the last 6-9 months is starting to show.
• As a reminder, Insulet added new key account managers in certain territories in 2Q14, allowing territory sales reps to spend more time with new prescribers. The early returns have been positive, with these territories seeing an ~15% average increase in referrals since they were added in Q2 – this number was up from a 10% increase as of the 2Q14 call. Further productivity gains are expected as the resources gain more experience. Insulet has about 135 people in the field right now, broken up into 53 territories.

4. Insulet manufactured a record 3 million-plus pods in 3Q14, and management emphasized that quality has never been higher (yields >98%). The latter has reduced calls for customer support and given reps higher confidence in the field. Notably, Insulet is in the process of finishing a fourth manufacturing line, which it expects to put in service in early 2015. Management noted that with each line, it learns how to make the pod more cost-effectively and at higher quality.

• Insulet saw record gross margin improvement in 3Q14 – gross margins are now in the low-60% range in US, and consolidated margins increased to 51% from 45% one year ago in 3Q13 and ~50% last quarter in 2Q14. Management remains optimistic on pushing more gross margin through the business going forward.

5. The reimbursement issue with United, first discussed in the 2Q14 call, has now been resolved; a negative impact on new patients starts is still expected in 4Q14, but no impact is expected in 2015. As a reminder, United changed its pump reimbursement policies, which delayed new patient starts. The change reportedly stemmed from some type 2s obtaining reimbursement for insulin pumps – apparently, the payer became frustrated in May and shut down all Insulet pump reimbursement, including for type 1s. United has revised the process to eliminate confusion surrounding pod eligibility (we certainly hope they are allowing type 2s to be on pumps but we bet they aren’t), and the payer is currently rolling it out. The pump eligibility form will now allow for a brand name to be included. As noted in the 2Q14 call, the plan accounts for ~15% of Insulet’s new patient starts. The change in policy was expected to lead up to a maximum $10 million reduction in 2014 revenue in the worst-case scenario ($1.5 million in the second quarter, $3 million in the third quarter, and $5.5 million in the fourth quarter).

R&D Pipeline

6. Based on FDA feedback received in 3Q14, Insulet and Lilly will now need to conduct a clinical trial of the U500 OmniPod prior to filing a 510(k) application; a study of unspecified length will commence mid-next year. Management emphasized that the overall timeline has not changed, but it does represent a departure from the initial plan: filing an FDA 510(k) application by the end of 2014, gaining approval, and then completing the clinical trial to update the U500 insulin label. Insulet is working closely with Lilly and management emphasized that “both companies are committed” to the product. We think this sounds like a reasonable approach by FDA.

7. FDA clearance of the LifeScan Verio-integrated PDM is hopefully expected “very soon.” Insulet and LifeScan have responded to all of the FDA’s questions (most were LifeScan-driven according to Insulet). The previous guidance in 2Q14 hoped for FDA clearance by the end of 2014.

8. An FDA filing of the next-gen touchscreen, Bluetooth-enabled OmniPod PDM is expected in early 2016 – this represented the first regulatory timing we’ve heard on this product. While it is certainly exciting from a patient perspective, the timing struck us as quite lengthy, since the plan is still to show the PDM at ADA 2015 in Boston (“A coming out party in our home town”). Management emphasized that a major goal is to “solve the data management challenges” with Bluetooth, “one of the most important enhancements.”

• Once the next-gen PDM is approved, it will be able to share data with Dexcom. As a reminder, this partnership was reinvigorated in 2Q14 and will integrate Dexcom’s Gen 5 with Insulet’s next-gen PDM. This was a major win for patients after the partnership was previously dissolved.

9. The CGM-integrated pod continues to move at a fairly slow clip – Insulet recently completed additional testing around the proximity of sensing and dispensing insulin. The timing on the first human trial has now slipped to “early-to-mid 2015,” back from the “early 2015” timing shared in the 2Q14 call. We continue to be somewhat skeptical about this project, given the slow pace at which it is moving (it was first announced at JPM 2013 and clinical trials were initially expected to start in 2014) and the challenges of developing a CGM, especially given how far ahead Dexcom is compared to this nascent project. Really, we wish Dexcom and Insulet would just go back to their partnership.

10. Management’s commentary on alternative drug delivery continues to build in excitement – new CEO Mr. Sullivan called it an “exciting opportunity,” “quite frankly huge,” and said, “From a revenue perspective, it’s a potentially very large number.” That’s a lot of ways of saying that they are making a big deal out of this. Notably, Amgen’s 3Q14 call publicly discussed use of the Nulasta (oncology drug) on-body delivery system for the first time, which leverages the OmniPod. FDA approval is still expected by the end of 2014. The product will allow patients to leave the doctor’s office with an activated OmniPod programmed to deliver through the following day. Insulet also has an ongoing partnership with Ferring Pharma (infertility drugs), which is approved in Europe and “generating revenue” (not specified). Management said that using the OmniPod for drug delivery could be valuable to extend the patent life of certain compounds.

• On October 9, Insulet announced a research support agreement with Capricor Therapeutics, a biotechnology company focused on developing novel therapeutics for the treatment of cardiovascular diseases. Capricor plans to develop a clinical program using the OmniPod to deliver the phase 2 cenderitide for the treatment of post-acute heart failure. Insulet will support Capricor's research by engaging in certain product development, project management, and design control activities in addition to product supply for the planned clinical trial.

Pipeline Summary

-- by Adam Brown and Kelly Close