Tandem 4Q16 – Sales decline 15% on competitive headwinds; installed base over 50,000; G5 integration launch in mid-2017, new t:lock infusion set connector in 3Q17; PLGS in early 2018 – March 9, 2017

Yesterday afternoon, Tandem CEO Kim Blickenstaff led the company’s 4Q16 financial update, marking its second rough quarter in row – competitive headwinds combined with a very difficult year-over-year comparison. If Tandem can make it through the next year, we see a lot of upside in the pipeline and a loyal user base of over 50,000. Below, we enclose the call’s top financial and R&D highlights, followed by a pipeline summary.

Financial and Business Highlights

1. Tandem’s sales (non-GAAP) totaled $25 million in 4Q16, a 15% year-over-year (YOY) decline relative to blowout record-high 4Q15 sales. This was Tandem’s first-ever YOY decline in its four-year history, though it was a tough YOY comparison (63% growth in 4Q15) and sales did reach their second highest point ever. 4Q16 headwinds included a more competitive market (e.g., MiniMed 630G, 670G) and UnitedHealthCare’s exclusive agreement with Medtronic. Revenue did improve 20% sequentially on an easier comparison to 3Q16. Full-year sales grew 21% to $89 million, on the upper end of the updated guidance ($85-$90 million).

2. Tandem shipped 4,418 pumps in 4Q16, a 29% YOY decline and a 13% sequential increase. The t:slim X2 launched in October and represented 84% of 4Q16 shipments. The installed base is now over 50,000 users, and ~50% of 4Q16 and 2016 shipments were MDIs. Tandem estimates it has “nearly 10%” of the US insulin pump market.

3. Sales for 2017 (non-GAAP) are estimated at $100 million-$107 million, reflecting slower 12%-20% YOY growth from 2016. Sales will be back-loaded, given seasonality and three incremental revenue sources: (i) Tandem’s first pump renewals from early customers (~6,500 pumps shipped in 2013); (ii) a mid-2017 launch of the t:slim X2 with Dexcom G5; and (iii) sales of the new t:lock infusion sets.

4. As of December 31, Tandem had $56 million in cash, reflecting an infusion of $35 million (debt arrangement with CRG) offset by a $16 million cash burn in 4Q16. Though not discussed in detail on the call (SEC rules), Tandem did announce a proposed follow-on public offering of ~$50 million of its common stock, with an additional ~$7.5 million possible.

5. Profitability did not improve in 4Q16: non-GAAP gross margin was just 31%, down significantly from 46% in 4Q15. Tandem believes it can reach “sustained profitability” once the installed base surpasses 15% of the insulin pump market” (gross margin expected at ~55%).

Pipeline Highlights

6. Tandem recently filed an FDA PMA supplement for the t:slim X2 with Dexcom G5 CGM integration. Launch is still expected in mid-2017. Subject to approval, current t:slim X2 users will be able to update their pump’s software for free with the Tandem Device Updater).

7. In new and unexpected news, Tandem has developed “t:lock,” a new custom infusion set connector that will begin shipping in 3Q17 and roll out to nearly all customers by end of year. t:lock replaces the luer lock connection between the cartridge and infusion set and has three advantages: (i) reduces the time required to fill the infusion set tubing by more than 30 seconds; (ii) reduces the amount of insulin used in the process by approximately four units; and (iii)  higher revenue, as distributors will have to buy sets from Tandem instead of other suppliers.

8. Timing on the t:slim X2 with predictive low glucose suspend has slipped a bit: a five-site trial will complete in 3Q17, and following an expected six-month FDA review, launch is expected in “early 2018.” The previous timing called for a 1Q17 trial and launch by the end of 2017, which was far too ambitious in our view. Tandem had a pre-submission meeting with the FDA in December, so hopefully both sides are on the same page now.

9. Tandem’s second-gen automated insulin delivery device with TypeZero (hybrid closed loop) and Dexcom’s G6 sensor is expected to launch “by the end of 2018,” on the latter end of the previous plan for a “2018” launch. The pivotal trial is NIH-funded and Dr. Boris Kovatchev shared early data from the 14-day training protocol phase at ATTD. The main phase of the trial is not yet open for recruitment, but has a start date of March 15 and will randomize 240 patients in a 2:1 ratio of closed-loop control vs. pump+CGM (open loop) over six months.

10. In early March, Tandem finally announced the first remote pump software update using the Tandem Device Updater. This platform was actually FDA cleared in July 2016, though this is the first software update release – allowing users to add convenience and flexibility features that started shipping on pumps in April 2015 (e.g., bolus menu, off-pump cartridge filling, etc.).

Financial and Business Highlights

1. Non-GAAP sales of Tandem’s insulin pumps and supplies totaled $25 million in 4Q16, a 15% year-over-year (YOY) decline relative to blowout record-high 4Q15 sales. Revenue improved 20% sequentially on an easier comparison to 3Q16. This was Tandem’s first-ever YOY decline in its four-year history, though it was a tough YOY comparison and sales did reach their second highest point ever. Management pointed to several headwinds in 4Q16: (i) a more competitive market (“aggressive sales tactics”) that impacted customers’ decision making (e.g., Medtronic’s MiniMed 630G launch, 670G approval, and Priority Access Program); (ii) UnitedHealthCare’s exclusive agreement with Medtronic limiting access to Tandem pumps in most users (went into effect on July 1, but impacted 4Q16 shipments); (iii) a very difficult year-over-year comparison to record-high 4Q15 sales of the t:slim G4 (more pent-up demand than for the newer t:slim X2 launched this quarter); and (iv) distributors’ ordering patterns in advance of the t:slim X2 launch. GAAP revenue totaled a higher $29 million, down a more modest 0.7% from 4Q15 (adding back in $4 million in deferred revenue from 3Q16 related to the Technology Upgrade Program). Non-GAAP sales are a better indication of the business, as we noted in 3Q16.

• Full-year 2016 sales grew 21% to $89 million (Non-GAAP), on the upper end of guidance following the reduction to $85-$90 million in 3Q16. We’re glad to see the company hit the updated guidance, resetting the Street’s expectations appropriately in 3Q16. Tandem’s previous guidance for $105-$110 million in revenue obviously did not bake in the headwinds experienced in the second half of 2016.

• On the bright side, sales of Tandem pump cartridges and infusion sets nearly doubled to $21.7 million in 2016 vs. $12 million in 2015. The 80% increase was attributed to the growth in Tandem’s installed base and greater sales of infusion sets to distributors through some new agreements. Infusion set sales increased 170% YOY in 4Q16 compared to a 39% increase in cartridge sales. More on this below related to the upcoming t:lock connector, which should further improve infusion set revenue.

2. Tandem shipped 4,418 pumps in 4Q16, a 29% YOY decline and a 13% sequential increase. The t:slim X2, which launched in October, represented 84% of 4Q16 shipments. The installed base is now over 50,000 users. Of 4Q16 shipments, 3,699 were t:slim X2, 354 were t:flex, 289 were t:slim G4, and 76 were t:slim. Said management about the t:slim X2 traction, “...people [are] seeing the value and power of a pump that can receive software updates using a personal computer.” We agree that this is compelling, and it will be interesting to see if demand continues in early 2017. For 2016, pump shipments grew 9% YOY to 16,938, a significant downtick from 43% YOY pump shipment growth in 2015.

• Tandem continues to grow the market: ~50% of 4Q16 and 2016 pump shipments were to MDI users, and Tandem believes it has “nearly 10%” of the US insulin pump market. In Q&A, management clarified market share is probably in the “high single digits.” If Tandem has a 9% US market share, it backs out to a US pump population of ~550,000 users. Of course, share depends on estimates for other companies’ installed bases (Insulet’s US base is ~67,000, but we’re not positive about Medtronic or Animas) and which market we are talking about (type 1+type 2).
• Interestingly, “roughly 15%” of Tandem’s base is from Medicare and Medicaid, a higher number than we would have guessed. This is a distinct advantage Tandem has over Insulet, who does not have any Medicare coverage (though some Medicaid coverage).

3. Non-GAAP sales for 2017 are estimated at $100 million-$107 million, reflecting slower 12%-20% YOY growth from 2016. Sales are still expected to be back-loaded, given seasonality (only 15% of 2017 sales are expected in 1Q17 and three incremental revenue sources: (i) Tandem’s first pump renewals from early customers (~6,500 pumps were shipped in 2013); (ii) the anticipated mid-2017 launch of the t:slim X2 with Dexcom G5 integration; and (iii) sales of the new t:lock infusion sets. No doubt Tandem will have a rough 1H17 as the 670G creates customer uncertainty and more competition, though there could be upside to the full-year guidance if the t:slim X2 with G5 launch goes well, Tandem retains most of its early users, Insulet’s Dash PDM comes to market much later in the year, and Animas does not launch the OneTouch Vibe with G5 integration (approved but no launch timing shared).

• As noted earlier this week, Medtronic’s MiniMed 670G launch will be very deliberate: the hybrid closed loop will begin a “Customer Training Phase” in the next couple of weeks, allowing “a small group” of Priority Access program participants (MiniMed 630G users) at a “select number” of sites to get on the new system. In June, Medtronic will initiate the full 670G launch, starting with the rest of the Priority Access Program participants (i.e., those on the 630G), and then opening it up to others interested in transitioning. This is a net positive for Tandem, since it means the hardest competition will come in the second half of the year, at which point the t:slim X2 with G5 will be out.

4. As of December 31, Tandem had $56 million in cash, reflecting an infusion of $35 million (debt arrangement with CRG) offset by a $16 million cash burn in 4Q16. Notably, cash burn is expected to decline in 2017 over 2016’s $68 million burn. Still, this only gives Tandem about a year of runway with current resources, a pretty limited window. Though not discussed in detail on the call (SEC rules), Tandem did announce a proposed follow-on public offering of ~$50 million of its common stock, with an additional ~$7.5 million possible (30-day option for the underwriters). Assuming the offering is successful, it would give Tandem a much-needed cushion to extend its runway into 2018 and perhaps beyond. On the plus side, Tandem’s pivotal trial with TypeZero is NIH funded (the International Diabetes Closed Loop study), saving a significant ~$12.8 million. Still, the pressure is definitely on to execute this year in a very competitive environment.

5. Profitability did not improve in 4Q16. Non-GAAP gross margin was just 31%, down significantly from 46% in 4Q15. Tandem believes it can reach “sustained profitability” once the installed base surpasses “15% of the insulin pump market,” when gross margin is expected to reach ~55%. For context, management believes Tandem’s current share of the pump market is “nearly 10%” with over 50,000 users. To get to profitability, we estimate Tandem’s base probably needs to double, assuming the pump market will continue to grow (Medtronic, Insulet, etc.) and Tandem’s share is currently around 9%. Still, there is a long way to go: non-GAAP operating loss in 2016 was $74 million, up from $69 million in 2015.

• In addition to the factors noted above, the shift in product sales mix also negatively impacted margins: more revenue from pump supply sales (lower margins) and less revenue from pump shipments (higher margins). On the bright side, Tandem achieved a positive gross margin on pump supplies in 4Q16 for the first-time ever. For the full-year, pump supplies saw an impressive 46-point gross margin improvement driven by two major factors: volume increases and reduced variable costs.

Pipeline Highlights

6. Tandem recently filed an FDA PMA supplement for the t:slim X2 with Dexcom G5 CGM integration. Launch is still expected in mid-2017. Subject to approval, current t:slim X2 users will be able to update their pump’s software (via the Tandem Device Updater) to add CGM integration for free. Nice! We’re glad to see the mid-2017 launch timing on this product has not changed, as it’s a critical update to stay current with Dexcom CGM, showcase the software-updateable t:slim X2, and pave the way for next-gen automated insulin delivery products (see below). Management used the phrase “recently filed,” implying the submission may not have gone in as expected by the end of 2016. Still, we expect this review will be pretty quick, given the already-approved t:slim X2 and t:slim G4. Just like the latter, Tandem anticipates very strong demand for the integrated G5 feature – fortunately, this will also have the advantages that t:slim G4 customers lost out on (Software 505 algorithm, remote monitoring, G5 app viewing).

• Who will be first to market with G5 pump integration? J&J received FDA approval in December for the One Touch Vibe Plus pump with G5, though no launch timing has ever been shared – with a potential sale of the LifeScan/Animas business, it’s possible Tandem will still be first to market with G5 integration directly on the pump. Insulet’s upcoming Dash touchscreen PDM is expected to launch by the end of 2017, but won’t include G5 integration on the handheld (only on a user’s own smartphone).

7. In new and unexpected news, Tandem has developed “t:lock,” a new custom infusion set connector that will begin shipping in 3Q17 and roll out to nearly all customers by the end of 2017. The t:lock replaces the luer lock connection between the cartridge and infusion set, and t:lock infusion sets will only be compatible with new t:lock compatible cartridges. Tandem will ship both of these products to users at the same time. The connector reduces the time required to fill the infusion set tubing by more than 30 seconds and reduces the amount of insulin used in the process by approximately four units – both were highly requested improvements from users and both were impossible to address with the luer lock connector. All Tandem infusion sets will be made available with the new t:lock Connector, which will not work with other pumps – of course, this also takes a page out of Medtronic’s book with its proprietary p-cap connector.

• t:lock is expected to bring higher revenue, addressing a “business issue” that has historically hurt Tandem. Said management, “...because our current infusion set has a standard connector [luer lock], distributors typically purchase the compatible infusion sets from a lower-priced supplier.” Margins on t:lock will be similar to current sets, but this proprietary strategy will require distributors to purchase sets directly from Tandem. While this won’t have a massive revenue impact on Tandem – most of its sales are still from pumps – it will certainly help in some way.  

8. Timing on the t:slim X2 with predictive low glucose suspend has slipped a bit: a five-site trial will complete in 3Q17, and following an expected six-month FDA review, launch is expected in “early 2018.” The previous timing called for a 1Q17 trial and launch by the end of 2017, which was far too ambitious in our view. Tandem had a pre-submission meeting with the FDA in December, so hopefully both sides are on the same pages and the updated timing is more realistic. The five trial sites were not mentioned by name, but we assume Stanford is one of them. We expect the FDA review could go much faster than six months, as this will come shortly after an FDA review of the t:slim X2/Dexcom G5 – the only difference will be the added PLGS algorithm. Plus, a PLGS device is far safer than current pumps and less complicated than the 670G (which only had a three-month review).

9. Tandem’s second-gen automated insulin delivery device with TypeZero (hybrid closed loop) and Dexcom’s G6 sensor is expected to launch “by the end of 2018,” on the latter end of the previous plan for a “2018” launch. The pivotal trial is NIH-funded (International Diabetes Closed Loop study), and Dr. Boris Kovatchev shared early data from the 14-day training protocol phase at ATTD (see below). The main phase of the trial is not yet open for recruitment, but has a start date of March 15 and is expected to randomize 240 patients in a 2:1 ratio of closed-loop control vs. sensor-augmented pump therapy over six months. Notably, we learned at ATTD that the FDA IDE approval actually includes a line that this can serve as a pivotal study to support a PMA, assuming the trial goes well and no safety issues arise. This is great assurance for Tandem/TypeZero/Dexcom and NIH.

• In 20 individuals thus far, the training protocol has seen similar outcomes to prior studies: an overall mean glucose of 156 mg/dl (148 mg/dl overnight), just 1.6% of the time <70 mg/dl (0.5% overnight), and 70% of the time in 70-180 mg/dl (79% overnight). Dr. Kovatchev confirmed that the current system uses either a Tandem or Roche pump, Dexcom G5, and an Android smartphone running the inControl AP algorithm, with a planned upgrade in 6-8 months (3Q17) to add a Tandem t:slim X2 with the embedded TypeZero algorithm and Dexcom G6 sensor. We saw the first picture of the latter (see below), which utilizes a similar interface to the t:slim X2 with PLGS, includes new activity settings for “sleep” and “exercise,” and will be indicated for ages six years and up. The slide noted that upon approval, the product will be available as a software upgrade for all existing t:slim X2 users – a very compelling feature that we hope all pumps move to.

10. In early March, Tandem announced the first remote pump software update using the Tandem Device Updater. This platform was actually FDA cleared in July 2016, though this is the first software update release – allowing early Tandem users to add convenience and flexibility features that started shipping on pumps in April 2015. The software update includes an expansion of the reverse correction functionality, the ability to enter a manual bolus directly in the suggested bolus window, off-pump cartridge filling, and other software tweaks. The Tandem Device Updater is done on the web and is Mac and PC-compatible. We’re not sure why this first rollout was so delayed between FDA clearance and now, but presumably getting the software tested took some time.

• We see this as an excellent 21^st century way to keep insulin pump software up to date, to roll out innovations outside the four-year hardware cycle, and a low-cost way for Tandem to improve the product without shipping expensive new pumps. We hope all diabetes devices move in this direction, and as more and more functionality gets shifted to mobile apps, this should happen naturally. Dexcom was the first diabetes device company to really benefit from this, launching its Software 505 algorithm update as an online receiver upgrade in Fall 2013.

Pipeline Summary

-- by Adam Brown and Kelly Close