Dexcom 2Q14 – Record sales rise 64% on improved profitability; hopes for Share and Vibe launches before year-end – August 7, 2014

Dexcom reported 2Q14 results yesterday afternoon in a call led by CEO Terry Gregg. The story was positive on all fronts – record sales, record gross and operating margins, cash-based operating net income of over $8 million, progress with the FDA, and movement on the pipeline. Below, we enclose the top ten financial and R&D pipeline highlights from the call.

Financial and Business Highlights

1. Dexcom’s worldwide product revenue reached a record-high $58 million in 2Q14, a robust 64% year-over-year increase from 2Q13. Management increased the 2014 guidance to $220-$235 million (40%-50% growth from 2013) from the previous guidance of $205-$225 million.

2. International revenue almost doubled year-over year and now represents ~13% of product revenue ($8 million).

3. Absent non-cash charges, Dexcom had a net income of $8.2 million in 2Q14. Dexcom’s product gross margin reached 68% in 2Q14, up four percentage points from 1Q14.

4. Average selling prices rose to ~$72 per sensor and ~$885 for the starter kit, a rise from ~$70 per sensor and $850 per starter kit at the end of 1Q14.

5. Approximately 25-30% of new patient additions in 2Q14 were pediatrics; there is significant upside in this patient segment, particularly as connectivity improves.

R&D Pipeline Highlights

6. FDA has formally advised Dexcom that the Share remote monitoring cradle is “approvable,” and management hopes to launch it prior to the end of 2014

7. FDA submission of the Gen 5 mobile platform is expected by the end of 2014 or in 1Q15. The call shared more product design details than ever before. Management clarified that Gen 5 will indeed include a dedicated receiver, in addition the smartphone app. It’s unclear if Dexcom will file Gen 5 with the new and improved G4AP algorithm (MARD: 9.0%, first presented at ADA 2014).

8. Partnerships: Lots happening! On Tuesday, Insulet announced that its next-gen Bluetooth-enabled PDM will receive and display data from Dexcom's Gen 5 CGM system; Animas is “gearing up” for a commercial launch of the Vibe in the US, which “could come before the end of the year”; Tandem submitted a PMA application to the FDA in July for the t:slim G4. Dexcom recently entered into an agreement with Tidepool to integrate retrospective data from the G4 Platinum.

9. Dexcom is working with the FDA to obtain an insulin-dosing claim for the G4 Platinum.

10. Work continues on Gen 6, which will “start” to reduce fingerstick calibrations.

Financial and Business Highlights

1. Dexcom’s worldwide product revenue reached a record-high $58 million in 2Q14, a robust 64% year-over-year increase from 2Q13. This rose 14% from the previous record-high of $51 million observed in 4Q13 (typically the company’s strongest quarter due to seasonality). Notably, the 2Q14 result was also on a very challenging year-over-year comparison, as sales grew 65% in 2Q13. This now marks five straight quarters where growth has exceeded 60%, and seven straight quarters where growth has been ~50% or higher - the tipping point was the launch of the G4 Platinum in Fall 2012. Sequentially, worldwide revenue in 2Q14 rose 25%, consistent with the 28% rise observed between 1Q13 and 2Q13, from a higher base.

• Management increased the full-year 2014 product revenue guidance to $220-$235 million (40%-50% growth from 2013), a significant increase on both the top and bottom ends from the previous guidance of $205-$225 million (31%-43% growth). At $105 million in revenue through 1H14, Dexcom is about halfway to the bottom end of the guidance. In Q&A, one analyst remarked that the new guidance was still conservative, given the impressive growth already seen in 1H14. – we agree, and although think management is smart to be conservative.  Still, given the pediatric ramp and pending approvals of Share and the Animas Vibe, Dexcom should absolutely come in well above the low end of the guidance.

2. International revenue almost doubled year-over year and now represents ~13% of product revenue ($8 million). Management commented that J&J has done well with the Animas Vibe, but this also reflects standalone CGM growing in several countries, including Germany, the Netherlands Canada, Italy, and Sweden (“a huge market”).

3. Absent non-cash charges, Dexcom had a net income of $8.2 million in 2Q14, an impressive rise from a $500,000 cash-based net loss in 1Q14 and 4Q13’s cash-based net income of $6.7 million. President Kevin Sayer said the company was quite pleased with the cash based operating results. The improvement stems in part from higher sales volume and a nice increase in average selling prices (see below). Cash totaled $61 million at the end of 2Q14, a $4 million sequential increase from 1Q14 – nice to see the business doing so well that cash is moving up!

• Dexcom’s product gross margin reached 68% in 2Q14, a significant jump from 61% in 2Q13 and 64% in 1Q14. Management acknowledged in Q&A that volume is the biggest factor in improving margins further. Management believes that 70-80% is the maximum margin with the current sensor. To increase margins further, Dexcom would need to drive efficiencies in returns, electronics, and new manufacturing techniques (e.g., the sensor applicator). Though constant improvements are happening, a 10-percentage point rise in margins next next year is “probably not happening,” according to President Kevin Sayer. As it is, these gross margins are fantastic.

4. Average selling prices rose to ~$72 per sensor and ~$885 for the starter kit, an increase from ~$70 per sensor and $850 per starter kit at the end of 1Q14. Management attributed the improvement to a favorable mix of payer and distributor contracts, as well as the improvements in pharmacy benefits coverage. The latter could be a big catalyst in the future on many fronts – patients have lower co-pays in the pharmacy and the greater convenience of being able to pick up their supplies at a local pharmacy (e.g., walking into a pharmacy and obtaining a starter kit or sensors). For Dexcom, pharmacies are easier to work with and require less paperwork on the backend, improving costs. Dexcom has already signed Express Scripts and Caremark, as we noted in our AACE 2014 report, and an update is expected sometime next year on other contracts. For every new patient, Dexcom now checks to see if CGM is covered as a pharmacy benefit.

5. Approximately 25-30% of new patient additions in 2Q14 were pediatrics – great news for Dexcom as the percent of kids using CGM is still on the lower side! Notably, the ramp followed quickly after the launch of a pediatric version of the G4 Platinum in 1Q14. Approximately 16% of Dexcom’s revenue comes from pediatrics right now, and the long-term goal remains 30%. Management is clearly happy with the progress of the launch and emphasized that this market is very underpenetrated. Analysts questioned the sustainability of this new pediatric patient growth, to which management remarked, “This is not just a bolus [of new pediatric patients], but the start of something fabulous...When we add connectivity [i.e., Share and Gen 5] to this mix, then the show really starts.”

Regulatory and R&D Highlights

6. Notably, FDA has formally advised Dexcom that the Share remote monitoring cradle is “approvable,” and management hopes to launch it prior to the end of 2014. FDA requested additional documentation related to Dexcom’s contract manufacturer, and as of this call, it had already been submitted to the Agency. The 1Q14 update indicated that Share was in the “home stretch” and the “final stages of review,” so we expect this approval could come any day now. The PMA supplement for Share was filed in July 2013, meaning the review has surpassed 12 months at this point. There were no further pricing updates or launch details. As of the last update in 1Q14, the price of Share was expected to be $400 – management has not commented, but we assume there will not be significant reimbursement for it at launch.

7. FDA submission of the Gen 5 mobile platform is expected by the end of 2014 or in 1Q15. The call shared more product design details than ever before. From a sensor perspective, Gen 5 will use the G4 Platinum sensor built on the same manufacturing line and using the same membranes (consistent with previous remarks). The product’s smart transmitter will be Bluetooth enabled, and in new news, capable of sending data to two devices – (i) to an app on a Bluetooth-enabled device (e.g., smartphone) and (ii) to a dedicated receiver that Dexcom will give to patients (i.e., “in case their backup [device] goes dead”). There had been some ambiguity related to the need for a dedicated receiver for Gen 5, and it was valuable to have this clarified – we would speculate that the FDA was not comfortable with a smartphone as the sole CGM display screen. Dexcom has done “lots of human factors work” to build Gen 5’s new user interface, and management said it will be different from the G4 Platinum’s. The big unanswered question relates to the algorithm that Dexcom will use:

• It’s unclear if Dexcom will file Gen 5 with the new and improved G4AP algorithm (MARD: 9.0%, first presented at ADA 2014). The uncertainty relates to timing and regulatory, and management only said to “stay tuned.” From the standpoint of implementation, Dexcom could roll out the G4AP algorithm using an online software upgrade; this means that current G4 Platinum users could remotely update their own receivers with the new G4AP algorithm once it is approved. Alternatively, it may make more sense for Dexcom to embed the G4AP algorithm into the Gen 5 submission, or even to wait until after Gen 5 is approved. If we had to guess, we believe Dexcom will include the G4AP algorithm in the Gen 5 submission, since a G4AP filing right now would presumably delay or distract from a Gen 5 submission by the end of the year.
• “We separate the Gen 5 filing from all partnership activities.” This had also been an open question of ours, as Gen 5 will use a new transmitter and the Tandem/Animas pump integrations will be approved for use with the G4 transmitter. Management said that the pump partners will independently file their systems, and in the case of Tandem and Animas, Dexcom will continue to support them once those products are approved. Once Gen 5 is launched, Dexcom will “go back and figure out how to integrate the technology upgrades” with Tandem t:slim G4 and Animas Vibe users. In the interim, we presume Dexcom would manufacture two different transmitters – the G4 transmitter for users of the Tandem and Animas integrated pumps, and the G5 transmitter for standalone CGM users and those using the next-gen Insulet PDM (see below).

8. Dexcom’s pump partnerships with Animas, Tandem, and Insulet are all moving along, and a data agreement with software developer Tidepool was also announced.

• On Tuesday, Insulet announced that its next-gen Bluetooth-enabled PDM will receive and display data from Dexcom's Gen 5 CGM system. The announcement expanded upon the initial news announced at ADA 2014, which shared that Dexcom's Gen 5 mobile app would pull data from Insulet's next-gen Bluetooth-enabled OmniPod PDM. With the expansion, Insulet/Dexcom patients will be able to view their pump and CGM data on both their smartphone (within a modified version of the base Dexcom Gen 5 app) and right on the Insulet PDM screen itself (as noted above, the Gen 5 transmitter will pair with two Bluetooth devices). Dexcom plans to first file and launch the Gen 5 mobile platform, and would follow with a PMA supplement for a modified app that would incorporate insulin-on-board and OmniPod pump data. In the first iteration, patients will not be able to control OmniPod insulin delivery using the Dexcom app. Meanwhile, Insulet will file its next-gen PDM handheld on its own, which would display Gen 5 CGM data directly on the PDM screen. Insulet's 1Q14 call suggested the next-gen PDM will be developed in time for ADA 2015 (though not necessarily approved), while Dexcom's Gen 5 mobile platform will be submitted by the end of 2014. With these timelines in mind, we assume a launch of this integration is likely in early 2016 at the soonest. No deal terms have been disclosed. Overall, we thought it was terrific to see this news, since ~25% of Insulet users are on Dexcom CGM (according to Insulet's 1Q14 call), and combining the data in one place seamlessly is a clear desire of both patients and providers. This is a first step, but we hope it also bodes well for the two companies working together in an even more substantive way in the future, perhaps on automated insulin delivery.
• Animas is “gearing up” for a commercial launch of the Vibe in the US, which “could come before the end of the year.” Dexcom management said that if Animas gets “a timely approval” within the next month or two, J&J will make a concerted effort to launch the Vibe in the US in 2014. This was consistent with what we heard in J&J’s Medical Device Day in May – Animas had recently responded to the FDA’s questions and the plan was to bring the product to the US later in 2014. EVP Mr. Steve Pacelli said that he has been “very impressed” with Animas’ efforts in this “pre-commercialization stage.”
• Dexcom management reiterated comments from Tandem’s 2Q14 call, which shared that Tandem had submitted a PMA application to the FDA in July for the t:slim G4. Tandem estimated a 12-18 month review, putting approval in mid/late 2015. In connection with the filing, Tandem paid Dexcom a $1 million milestone payment.
• Dexcom recently entered into an agreement with Tidepool to integrate retrospective data from the G4 Platinum. Management said that the agreement is consistent with Dexcom’s “open architecture approach,” (first announced at ADA 2014 with the Insulet deal) and Tidepool will carry an “Authorized by Dexcom” mark. We would speculate that Dexcom data will be downloadable to Tidepool’s blip app, a web-based data management platform intended to integrate data from various diabetes devices. It’s unclear if this will replace or augment the SweetSpot platform, on which there has not been an update since 3Q12.

9. Dexcom is working with the FDA to obtain an insulin-dosing claim for the G4 Platinum. Management said that the “accuracy, consistency, and performance is there” based on the G4AP data shared at ADA 2014 (MARD of 9.0% vs. YSI in 51 patients vs. fingerstick MARD of 5% vs. YSI). Dexcom has started putting together the information and risk mitigation strategies, and management indicated it will proceed with this label update on the current G4 Platinum system. This was great news to hear.

• CEO Terry Gregg highlighted that obtaining an insulin dosing claim for CGM will be the easiest and fastest way to obtain Medicare coverage of the technology. This has been Medicare’s chief objection to coverage of CGM, as noted in our report from last week on the Medicare CGM Access Act of 2014 introduced in Congress.

10. Dexcom continues to work on Gen 6, which will “start” to reduce fingerstick calibrations. It was not clear if this generation would eliminate calibrations entirely, or simply reduce them to less than two per day. As a reminder, in 2Q13, Dexcom announced a $4 million development grant for Gen 6 from the Helmsley Charitable Trust, with payments based on milestones over the “next several years.” Last we heard, a ~2017 launch was expected.

Pipeline Summary

Questions and Answers

Q: Can you talk about the breakdown of the hardware? You said it was about 13% in the quarter, consistent with what you have seen. In your estimate, what percent of that are new patients versus a hardware replacement for existing patients?

A: It is 30% hardware and 70% consumables. Consistent with our prior calls, we’re not going to disclose or breakdown between new patients and existing patients. You cannot keep going to 60% without adding a whole lot of new patients. When we considered our business is evolving to the point where we’re not going to provide that number on a timely basis. As we mentioned in our remarks, 13% of our revenue is international. We don’t know if those are new or existing patients. Animas buys transmitters for Animas Vibes in Europe. Soon, they’ll be buying them in the US. However, in the EU, in particular, we do not know if those are new and existing patients either. Finally, we’re moving to a pharmacy distribution model where a patient will be able to walk into drugstore and pick up a starter kit. We don’t know if that’s a new patient or an existing one, either. At end of day – until we have a Gen 5 streaming into cloud – we won’t know if these are new or existing patients. Therefore, we’re not going to give you a lot more information than we already give. Our business is moving too fast. By breaking out hardware sales and ASPs, we think we provided you enough information to estimate patient numbers given basic utilization and attrition rates.

Q: There was a comment at ADA regarding the timeline distribution with new software algorithm with the G4. Can you comment on the ability to push that algorithm out to existing patients with the current system versus waiting for the G5? When could that happen? I understand you have the Share coming by year-end, but I would love an update on the algorithm.

A: It’s difficult to estimate when or what we’re going do. It’s a timing issue, and it’s in the hands of the FDA. If you look at iteration of products, we expect to file the Gen 5 before the end of the year. It becomes the timing of what’s most appropriate for patient population and Dexcom. Quite frankly at this point, without greater visibility, we have refrained from saying which version that we will introduce with the new algorithm. When we make that decision, everyone will know.

From standpoint of how we will implement it, we have the ability to upgrade software through the internet. That is one mechanism that is available to us. Much like you would upgrade software, which we issue a code. You will put it in, and we will confirm that you have uploaded it correctly. Stay tuned – that’s the best I can give you at this point.

Q: Pediatrics is growing very quickly. Was there any indication of an impact on the adult ads? It doesn’t seem like there was, but I wanted to verify.

A: Everything is going according to plan, including the patients buying second transmitters, and patients that we’re adding in sensory orders – everything is right in line with what we expected.

Q: The pediatric response was much more rapid than we were expected. Do you have any read on sustainability since it was a bolus you got this quarter? Do you have any sense that anything you saw on the pediatric side this quarter isn’t going to continue?

A: Based on what we’ve seen at the meeting we’ve attended in the field with endocrinologists, if anything, we think that the pediatric market is underpenetrate and that this is not just a bolus – it’s the start of something that can be fabulous.

A: I would echo those comments. We see sustainability of this type of ramp. Obviously, we clearly see a lot of unmet need, and parents in particular are the driver in pediatric adoption for their children. They will of course do anything to keep their children safe. This is an extremely accurate, reliable tool, and it’s a very well educated population – both physicians and parents – and the community communicates.  Touching on Children with Diabetes’ Friends For Life Conference, we were quite pleased that we saw a lot of kids walking around with Dexcom CGM, coming up and thanking us – teenagers, younger children, and, especially, parents. We think there is still a lot of upside opportunity there.

A: When we add connectivity to this mix, then the show really start.

Q: Do the partnerships and timings impact your assumed submission for the G5? Are you still assuming that the filing is maybe late this year, but more likely early part of 2015?

A: It will be late this year, or early next year. We separate the Gen 5 filing from all partnership activities. That is our development effort. The partners will file their systems – Tandem and Animas have filed with Gen 4 – and we will continue to support those companies in all their efforts with the Gen 4 hardware. However, we will file and move onto Gen 5 ourselves when it gets approved. Then we’ll go back and figure out how to integrate our technology upgrades with our pump partners as time goes on.

Q: Based on the data we saw at ADA, is fingerstick replacement still a goal of G6 with elimination of some noise with acetaminophen and other medicine, or is there any possibility to get that with Gen 5?

A: Those are good questions. We’ve discussed this with the FDA. With a 9% MARD, our accuracy is there and the consistency of performance of Gen 4s is there with this new algorithm. We’re going to start putting together information and risk mitigation factors and all the things that the FDA would wan to see. We’ll see what we can do with the Gen 4 system, and then we’ll apply it to Gen 5 since it would theoretically be the same algorithm with the sensor. We’re going to proceed with that in our current system. We’ll label it accordingly with respect to acetaminophen. If the FDA comes back and says something different that’s fine, but we’re going to figure out this path now – we’re not going to wait.

Q: What exactly are the features and benefits you plan on including in the Gen 5? It’s pretty fluid. Where do we stand now?

A: The Gen 5, from a sensor perspective, will be a Gen 4 Platinum sensor built on the same manufacturing line with the same membranes. We won’t change the core manufacturing processes. With respect to the user interface, that will be mobile app, launched initially on an iPhone platform. It will be a different interface than what we have today. We’ve done a lot of human factors work and patient work to make sure that it is a good interface and we’ll through a net benefit to our patients.

With respect to the algorithm, that’s going to be dependent. There’s uncertainty due to timing of the Gen 4 Platinum algorithm – do we include that in Gen 5 that we did earlier? Do we wait until after? We’re working through some of those issues now, and we haven’t made a decision. The key factor in Gen 5 is the transmitter has Bluetooth chip in it, and it will talk directly to a cell phone and another device. Therefore, you could have two devices receiving a signal from the transmitter. We will offer the patients a receiver that receives a Bluetooth signal, as well. So they will have a backup in case their phone battery goes dead. That’s how we’re positioning the basic feature set of Gen 5, and we’ll go from there.

Q: So you don’t know if the factory calibration, or replacement claim, or insulin dosing will be a part of it yet?

A: We don’t know. Those things are independent from each other. We are going to pursue the dosing claim based on the accuracy of the sensor. Actually, it’s assisted in the current Gen 4 platform, and if we can get that claim, we would apply it to the Gen 5 system because it’s the same sensor and the same algorithm that we’re using now. We are looking at that as an independent feature and will move into the product feature set as quickly as we can. We’re not going to hold up the Gen 5 waiting for that. We would love to include it if we could, and we are actively engaged with the FDA on how to get there.

Q: And factory calibration?

A: That won’t happen with Gen 4. We’ll start reducing calibrations with Gen 6.

Q: This is pretty fluid on generations, so this is helpful. What does the insurance coverage for pediatrics look like? I remember initially it was 25 and older, in terms of payers.

A: We never had any pushback from the payers regarding pediatric indication, even though policies say “x,” in reality, they were reimbursing for it. There were no big changes from the standpoint of the reimbursement landscape once we got the pediatric indication.

Q: So it’s all pre-approval?

A: It’s a mix of prior authorization in some cases or just on recommendation, depending on the policy. For example, a physician may recommend this because the patient is failing to achieve adequate glycemic control, as measured by the physician’s position, not necessarily by numbers.

Q: You have a very impressive gross margin. You’re already addressing the levels you expected to hit and max out at. What do you project gross margins can go to off the current sensor?

A: The biggest factor now is volume build. We know that we can apply more overheard. The more sensors we manufacture, we can gain some efficiencies. We’ve always said 70-80% maximum with the current sensor – we would probably fall in 75% for the Gen 4 sensor assuming pricing remains in the $70-80 range. We’re going to need some new advances with respect to new manufacturing techniques and some of the hardware elements of the sensor – particularly the applicator – before we can drive them down even further.

We’re pretty close now. We can get more efficient with returns and electronics manufacturing. We have cost improvement initiatives on all of these things that are currently ongoing. However, picking up 10% more on margin points next year? That’s probably not happening.

Q: Is the applicator part of the Gen 5?

A: Not part of the Gen 5 in the first pass.

Q: We know that CMS Medicare says that CGM is not medically necessary while everyone else in the world says it is – is this one person who can be swayed? Is it a committee? Is a stiff arm that says no way under any circumstances? What do you think it would take to turn CMS around, other than a change in laws?

A: The easiest way to achieve it is to get a non-adjunctive claim for therapeutic dosing, that clears the deck. That’s the quickest way. It’s by committee and not a single individual strong arming the system. You’ve heard about the emphasis on getting the claim. We’ve had open, active discussions with the agency about how to achieve that. We have to identify risks and mitigation of those risks with Gen 4 for an adjunctive claim – however, we’re well on our way down that path. Although I think that legislation effort just bolsters some of the other things that we’re doing and increases awareness, I think that the change in the policy decision will achieve the new claim.

Q: With the NEJM article and all the buzz that went around the Russell system – maybe we’ve gotten too immune to that over the years and hearing data and seeing things come out. But now, you’ve got a major journal, and you get big media attention at ADA. I’m guessing that that didn’t have an impact on 2Q14. Do you feel like that kind of media attention will get you some uplift you expect for the rest of the year?

A: It’s still early in the whole progress of artificial pancreas. Certainly we are the choice of the overwhelming majority of artificial pancreas programs around the globe. However, I would caution the audience that for the most part, outside of the things Medtronic is doing in artificial pancreas, the rest of these are all investigator-initiated trials. They’re not really company sponsored – they are individual companies participating but coordinated by academic centers. I think that there is a lot of work that needs to be done. If we’ve just looked at the different component parts, they have to come together.

Even last month at Keystone, the FDA got up and said in their view that the artificial pancreas will be a combination of different component parts supplied by different companies coming together to create a unique product. There are challenges: for example, pretty much everyone agrees that insulin isn’t fast enough. It’s not predictable enough. If you’re using a bihormonal system you also get glucagon, and that’s never been stabilized. Glucagon’s all the work that has to go into that to get, essentially, a new drug through the FDA.

There is a lot of work that needs to be done. We get the goodwill associated with being a premier product in the space, but, when the rubber meets the road, it’s the performance of the G4 Platinum and the confidence that we have it with is what is driving our 2Q14 numbers – and hopefully the rest of the year, as well.

Q: You have taught us the seasonality between Q4 and Q1. It’s hard to see seasonality when you grow 64% - it covers a lot. Do you think that there is any seasonality – positive or negative – in the summertime?

A: We have July under our belt, and I would only say we’ve got to get August and September. I think summer ends September 21. I’m not going to comment on the seasonality of the summer. There are so many factors that are going to be hard for predictive. I would predict that seasonality in Q1 is going to be different than in Q4. However, remember that as the installed base grows along with the number of sensors, the impact on seasonality lessens as the influence of disposables becomes more prevalent than durables, since patients do need sensors in that first quarter. Stay tuned. The pharmacy benefit also has a mitigating factor because for those patients that do have a pharmacy benefit coverage, the first year seasonality is immaterial.

Q: Can you quantify the pharmacy benefits?

A: We’re holding back on that. We’ll give an update on that in the first of the year, but we are moving rapidly. A good number of patients are getting processed that way, and contracts are falling in line the way we want them to.

Q: You’ve now signed up Insulet to put data on the mobile platform. Describe wher you are. Could you describe a little bit about where you are in that?  For the current generation, the Gen 5 will feed into it off the cell phone. Is that the path we should think about, and as you start the other systems to this as well, is there a revenue component that goes along with that? Some broad thoughts would be helpful on how we should frame that.

A: The Share will be first move into mobile platform. It’s not a truly mobile product in the sense that the Share cradle is plugged into wall – it’s essentially a docking station for the Gen 4 Platinum. When we look at Gen 5, although much of the backend infrastructure is the same for the Share, the Gen 5 is truly the first mobile product, where the patient will interact with their CGM data directly on their smartphone.

With respect to Insulet, you should assume that the mobile app we develop with Insulet will be an iteration of the base Gen 5 app. We’ll file and release a Gen 5 system and, and we will follow with a TMA supplement to our Gen 5 app that will incorporate Insulet’s insulin on-board data. The deal that was announced is all about flexibility and convenience for the patients. The deal announced yesterday was really just to extend where Insulet would be incorporating their insulin on-board data and our insulin data into our mobile app.

The deal we announced yesterday is kind of the reverse of there, where Insulet will be able to develop some software that they will incorporate into their handheld and will enable the patient to have CGM access on their PDM. The architecture of the Gen 5 is such that it can pair the two devices at the same time. So a patient using an Insulet system would be able to pair it with their Insulet handheld and their smartphone at the same time. The key distinguish would be on our smartphone app, the patient out of the gate will not be able to control insulin delivery from their smartphone, where as the software developed by Insulet would be a fully contained medical device system so the patient would be able to interact with their OmniPod as well as their CGM data in one location.

Q: Is it contemplated that Insulet or other partners will be adding data to that type of system as well, or is it really just this local arrangement as you have described it?

A: I’d call that a to be determined. The key factor there is that you need to have network connectivity. I’m not sure that’s a good question for you to ask Insulet tomorrow during their call. I’m not sure if their next generation handheld will have cellular connectivity – the key to that remote monitoring is being able to have a network-connected device and be able to have real-time data transmitted from the handheld device.

Certainly, that is a Dexcom goal, and we’ll certainly be going down that path with the Gen 5. I’m not sure with any of these partners. When you talk about cloud-based data sharing or this open architecture strategy that we’ve adopted, you need to make sure that you declare between what is real-time data vs. what is retrospective data capable of review doing analytics and things by a physician or patient. We’re not opening up our architecture to any real-time transmission, other than potentially to a couple of pump companies. The FDA has been pretty clear that if it’s real-time data being used or capable of use for therapeutic purposes, it will absolutely be a Class III regulated medical device.

For example, when we talk about an integration with Tidepool, which is an organization and non-profit looking to develop some analytical tools and aggregate data from a multitude of devices – the data that Tidepool would be updating and integrating into their software platform would not be real-time data. This is going to be retrospective data that the patient or clinican would be able to use after the fact to potentially adjust treatment – insulin, diet, exercise. It would not be the same as what patients will be using for the real-time data app on the phone. For Insulet, it would be like having access to CGM data with real-time alerts, etc. You have to make sure you draw that distinction between the types of data sharing that we’re going to be doing going forward.

Q: Is there a business model around this? Is there another revenue stream that you contemplate from the data component of this?

A: I would guess probably not, but it’s something that we’re still exploring. I don’t doctors or patients will pay for it. To the extent that, down the road, we can show financial benefits and improved outcomes, payers might potentially be willing to pay for something like this on a monthly basis. I would tell you, however, from our perspective we’re not counting on it. It’s certainly more important to drive utilization that is particularly in the pediatrics market if parents have real-time access to their children’s data. That’s a pretty powerful tool. That will help ensure consistent utilization of in-drive center sales. I don’t think we’re looking to monetize at this point, but we’ll explore it as we move down the path.

Q: Could you give a little more color on pediatrics? It accounts for 25-30% new patient adds this quarter. Is that the mix we should consider going forward? Do you think it should be higher? Is sensor utilization dramatically different among pediatrics versus adults?

A: Being so early in the launch, I don’t have a good indicator for pediatric utilization, and we haven’t run those numbers. My gut feeling, based on the kids we’ve seen, is that utilization is very high with respect to 25-30% of our new patients. That’s where this quarter came out. We’ve often said that we’d like to see our total revenue base get up to 30% of our revenues to arrive from the pediatric market – and we’re up to 16%. This is a good starting point, and it is certainly better than we did in 1Q14. We’ll just keep going from there.

Q: As far as number of endocrinologists that you’re speaking to, have you started touching on the pediatric-only endocrinologists? I think that’s about 800-1,000 that you’ve talked about in the past. Where are you in penetrating those physicians?

A: We’re early in the process, and what we’ve learned is that with some of the physicians we definitely had a running start. With some of the others, we’ve got huge educational efforts. That’s why we characterize this as a very big opportunity – there is a lot of education we have to do. Ultimately what we want to end up with is a lot of happy customers. We’re focusing pretty heavily on that. Our team is in the field, and they are doing a great job.

Comment: It sounds like there’s still a lot runway there.

Q: As far as Medicare goes, is that something where you will be mostly looking for therapeutic indication to drive it or possibly doing a study to look at the benefits and cost-benefit you’ll have from the reduced adverse events, or reduced problems with that important link control?

A: It’s clearly a therapeutic benefit that you would no longer have to rely solely on fingersticks in order to adjust your insulin dose. With respect to doing a large-base clinical trial, I don’t think it’s necessary at this point. Obviously, it’s a patient population that is substantial, and a lot of work that has gone on in the past has been inclusive of age-appropriate patients, but none of them have been stand-along enough to generate an independent analysis of that segment. I think as we go along, once we have that adjunctive claim then the need to do additional clinical work in a specific age populated group is not required.

Q: When can we look for you to really start driving through this – this quarter showed that you are showing great leverage; is that something we can start holding you accountable for?

A: That’s a good question. We strive to achieve leverage. However, we also take opportunities to spend on discretionary basis as we see growth coming. We have a study starting later this year that will have several hundred patients where we’re really going to evaluate the efficacy of CGM with respect to lowering A1c and healthcare costs. It’s going to be a several million dollar effort for us – and something we never would have considered a couple of years ago.

We also take opportunities in R&D and in our clinical trial group over the first six months, as we’ve seen growth, to just spend a little more money. We’ve accelerated our spending on the Gen 6 sensor a bit because our results in our early feasibility studies have been so promising. We’ve accelerated some spending on miniaturizing electronics, as well, because the more we travel, the more we hear to make this thing simple, easy to use, and small. We’re trying to obtain leverage, but we don’t go to bed worrying about that as much as we go to bed worrying about winning the race of getting the best technology to market as fast as we can. That’s how we balance it.

Q: I know J&J is controlling the launch schedule and strategy of the Animas Vibe, but can you comment on if there are any constraints on your end from J&J launching post approval within days and weeks?

A: I cannot comment specifically, but I can say that I’ve been very impressed with their efforts in the pre-commercialization phase, which is where I describe it right now.

Comment: If they get a timely approval, within the next month or two probably, they will likely make a concerted effort to launch the product this year.

A: There are no constraints on this – we’re ready to go.

Q: In terms of international strength, was that from more favorable international coverage in any region or just due to the stronger update of the Vibe or increased marketing for the Vibe?

A: J&J has done very well with the Vibe, but it’s not just the Vibe. We are growing in several countries, such as Germany, the Netherlands, and we’ve done very well in Canada with our launch this year. We do very well in Italy, and Sweden is a huge market for us. We have good physicians in Sweden, and they have figured out some good reimbursement. Those countries are all growing rapidly. The Vibe is included in that mix, but it’s really both.

Q: Is the initial interest in the G4 Platinum Professional coming mainly from existing customers or new endocrinologists?

A: It’s both. The goal here is to replace the Seven Plus Professional with the G4 Platinum Professional. I think additionally, since it’s real time, there is a common theme among endocrinologists that even on a diagnostic tool, having the patient visualize the information is important as part of the training process – whether or not the patient ultimately migrates that to personal use. This is one of the draws of having this. Also, the lessons that patients can learn just in the week that they are on this device versus a blinded unit is driving many physicians to replace their former system.

Q: What accelerated the conversion to the pharmacy benefit strategy? Is there anything specific that you need to provide a single PBM [pharmacy benefit management] before they get on board, or is it just timing? Longer-term, does shifting to the pharmacy channel pressure ASP, or can you withstand that?

A: Our targeted ASPs on sensors are $70-75 per sensor. We’ve modeled these out for the various payers and PBMs, the wholesalers, the entire distribution channel – that’s where we’re focusing to realize our net ASP, at least within that range. We’re assuming pricing to remain the same with respect to driving that. Getting PBM signed up is a function of a number of things. We’ve already announced our Express Scripts arrangement. Our Caremark arrangement is known, as well.

On top of that, we look at individual payers who can then flip the switch and go over to the benefit administered by those groups. There’s also several other payers who administer their own mail-order pharmacies, who we have been in negotiations with. Combine that with even the pharmacies and retail channel in general. What this represents for us is that the sales and distribution opportunity that’s not at all like what we’ve done before. There’s a learning curve for us, and we’re learning as we go – but we’ve had pretty good success. Like we said last call, any patient that comes in here, we ping their pharmacy benefit first; if we can get them products to the pharmacy at a lower co-pay, we run with it. We’ve had some pretty good successes with that program.

On pricing, what we really look at is the reduction in transactional cost. On the pharmacy side, they are doing less paperwork, and, as a result, they have less embedded costs. The same is true for us – if we can run through pharmacy, we don’t have all the paperwork accumulation and submission and cost associated with that; every time we touch a paper, there is a cost associated. This is a streamlined system so from a COGS standpoint in our operating margin on it, we can be a bit lenient in this in terms of negotiation; volume here will more than offset any price concessions that we might have to make in the end.

Q: The expanded agreement with Insulet was a pleasant surprise, especially considering the size of their pediatric user base. Do you have an idea of what percent of your user base is currently using an OmniPod?

A: We have an idea but are not going to disclose it.

Q: You mentioned that sensor utilization has been stronger than ever. Did you see any changes in the quarter as it relates to utilization, relative to the last 12 months? We estimate 10-day wear on average, so that trend up or down, or was it just more patients ordering sensors?

A: This is just more patients ordering sensors. We have not really seen a particular change in days of utilization in last 12 months, per se. I do think that as you add more patients, maybe some of them will use product according to the labeled indication; as they get more experience, they may push to the days you said. Obviously, we don’t recommend that so we really no monitor that, other than what people say on blogs.

Q: You mentioned that non-cash stock-based comp was $13.2 for 2Q14. You said it’s going to be that per quarter for the next three quarters, is that what you are saying?

A: Through the end of 1Q15, correct.

Q: What percentage of users have type 2 diabetes?

A: We don’t have a good number to give you, certainly less than 5%.

Q: What percentage of hardware were transmitters?

A: Nice try. [laughter]

Q: Last quarter, you had talked about transmitters and seeing a bump up in hardware. Was there anything special about that piece of business in 2Q14?

A: It remains very strong.

Q: Are you still around 90 sales force?

A: We’re still at same place. With respect to sales force adds, our typical process is that as we get to the end of 3Q, 4Q, we budget for next year. We start looking at adds in Q4. That would be our plan again this year, that we’ll remain stable through this quarter. We’re starting to see people we added late last year really getting up to speed and firing all cylinders. We’ll wait until the end of Q3, and if we are looking at an expansion next year, we’ll start the ball rolling in Q4 and have them up to speed and hire by early 1Q15.

Q: Will the Gen 5 designed for the mobile environment be regulated as a PMA-type product?

A: It gets back to real-time information versus retrospective information. To the extent that information is real-time coming from the transmitter, it will absolutely be subject to our Class III PMA regulation. What that means for the Gen 5 system is that the PMA system will evaluate a dedicated receiver, a transmitter, and the disposable sensors – this time it would also include a software application as part of the PMA.

To the extent that we could load a PMA-approved software application on a phone or that same or similar PMA-approved software application of a Pebble Watch, for example, we don’t beleeive that the Pebble Watch would be part of the system. It’s just the software application sitting on the device that would be part of the PMA.

Q: But the goal would be for the smartwatch to get the real-time data?

A: Certainly – looking back to our objective, maximum flexibility for the patient, we’d love to be able to put that application on a multitude of devices to let the patient choose where they want to see the CGM readings.

Q: Looking over the model, the guidance of $220-235 million – on the low end – you’d have to do about $114 million in the back half of the year. You did $106 million. Our model has you growing at relatively modest rates sequentially – for example, 1% in Q3 and then a more typical growth in Q4. How conservative is that $220-235 million range relative to the trends we’ve seen?

A: We’ve been waiting for this question all afternoon. As we put guidance together, we typically do annual guidance. We’d committed to 40% growth for the entire year, and $200 million represents a 40% growth. The $235 million is upwards, closer to 50%. We have typically experienced a very slow sequential growth from Q2 to Q3. Last year, that was a bigger growth number. As we put this guidance together, we didn’t anticipate the big change like we did last year.

The other thing to consider is there’s this law of growing on a bigger base. Typically, our first half and second half have been split 45%/55%, respectively; last year, it was 40%/60%. The second half was much, much bigger. As we looked at numbers and looked at what we’re doing, we moved our range up to there on just some broad brush assumptions. We did not go back into every single kit we’re going to sell, new patients, upgrades, or all the other things. We looked at big picture numbers and felt as a low end the 40% growth we’d committed to at the beginning of the year was a good low end, and we took it up to $235 million at the high end.

Similar to what we did last year, we’re going to follow the same pattern we did last year at the end of Q3; if we see something different, we’ll give you an update on guidance and what we think we’re going to do by the end of the year, as the end of the next quarter.

Q: We end up at the high end of the range. That suggests hardware revenue at about $67 million; we probably have about $30 million of replacement hardware baked in – we don’t even need to increase that but we probably could. This does imply a relatively modest utilization rate compared to what you could see as pediatric ramp as a percent. Patients are a little more compliant with label. I appreciate the conservatism in terms of setting expectations, but in terms of what is more likely than not, it seems like $235 million is more a middle range.

A: Okay. That’s good.

Closing comment: There continues to be a growing adoption of CGM as a key tool to better manage a patient’s diabetes. Dexcom enjoys the status as the most accurate and durable CGM ever commercially introduced. It is a testament to our technical staff – of what they have accomplished and the fact that Dexcom continues to raise the bar. As an example, just last week, Becton Dickinson announced that it was shutting down its CGM program due to technical issues when moving into human feasibility testing. We have long stated that developing an accurate and reliable CGM is clearly challenging and very expensive. This is further proof of how difficult our work truly is, and clearly supports our unique position in the diabetes industry.

-- by Adam Brown, Hannah Martin, and Kelly Close