Dexcom 3Q14 – Six-quarters in a row of 60%+ growth; G4AP algorithm FDA approved and launched; Gen 5 submission in 1Q15 – November 6, 2014

This afternoon, Dexcom CEO Mr. Terry Gregg and President Kevin Sayer led the company’s 3Q14 call; we assume this was Mr. Gregg’s last call as CEO, per the plan outlined in 4Q13 for Mr. Sayer to take over as Dexcom CEO in January 2015. Dexcom’s business is stronger than it has ever been, with more revenue, higher profitability, more launched products, and more and a deeper pipeline than ever before. Below, we enclose our top business and financial updates from the call.

Business and Financial Highlights

1. Dexcom’s 3Q14 product revenue grew 60% year-over-year (YOY) and 17% sequentially to hit a record high $67.9 million. This marks an astounding six consecutive quarters of 60%+ YOY growth – all from an increasingly higher base. CEO Mr. Terry Gregg’s shared for the first time Dexcom’s goal to reach one billion dollar per year in revenue. The company is nearly 30% there!

2. The international business accounted for 15% of product revenue in 3Q14, roughly tripling from 3Q13 – although this is lower profitability revenue, this still bodes well.

3. R&D expenses increased  a notable 57% YOY to $18.5 million. Said President Kevin Sayer, “Yes, we are making a significant investment in our future.” It’s great to see R&D increase right in line with revenue.

4. Notably, Dexcom’s cash-based operating profit tripled YOY to $10.1 million.

R&D Pipeline Highlights

5. In unexpected news, Dexcom announced FDA approval of the G4AP algorithm (MARD: 9% vs. YSI), now available to Dexcom users as a free download on Dexcom’s website. Now that’s easy! The major gain in accuracy is a bigger leap than from the Seven Plus to G4 Platinum (16% to 13%), and brings Dexcom closer to an insulin dosing claim and factory calibration.

6. Also in unexpected news, Dexcom has launched a new smaller version of the G4 Platinum transmitter. This should only bolster the ongoing pediatric launch, which began in February. They began sending these last month, and patients are quite happy, though everyone wants it first, which has created a bit of resentment for current patients who will have the traditional one until their current transmitters die. (Kelly’s transmitter died last week and she loves the new size – a “nice to have” not a “need to have” but very positive overall.)

7. As noted in our initial report, Dexcom launched the Share remote monitoring product after announcing FDA approval on October 20. While not a significant source of revenue, it is a criticaln important first step into mobile connectivity and the Gen 5 system – early reports are very positive..

8. Animas believes that the Vibe is “nearing” FDA approval, and the companies are gearing up for a commercial launch that management said could come before the end of the year – we are betting this happens in early 2015 based on how busy we hear FDA is. Tandem still expects approval of the t:slim G4 July 2015-January 2016. There were no comments or updates on the Gen 5 integrations with Insulet or Asante.

9. Dexcom plans to file the Gen 5 mobile platform with the FDA in 1Q15; this was slightly back behind from the end of 2014/1Q15 timing shared in the 2Q14 call.

10. Management alluded to some longer term initiatives with Apple, the DIaMonD outcomes study (n=338, 24 months!), advanced decision support tools, and improved sensor deployment. These build on the company’s continued long-term goal to eliminate fingersticks.

Financial Highlights

1. Dexcom’s 3Q14 product revenue grew 60% year-over-year and 17% sequentially to hit a record high $67.9 million. This now marks six consecutive quarters of 60%+ YOY growth. The result was even more impressive considering the extremely challenging YOY comparison: sales grew a whopping 102% in 3Q13. Dexcom’s goal is to grow at ~40% every year, though the company plans to have infrastructure in place to grow at ~60%. In closing remarks, CEO Mr. Terry Gregg said a goal is to make Dexcom a one billion dollar per year revenue company.

• Management estimates meeting/exceeding the top-end of the previous full-year revenue guidance ($220-$235 million), which was increased in 2Q14 from the prior guidance of $205-$225 million. Revenue stands at $173 million for the year, meaning Dexcom only needs $62 million in 4Q14 revenue to exceed the guidance; that should easily be achievable given the growth trajectory and drivers (pediatric launch, Dexcom Share, G4AP algorithm, etc.) Given 4Q14 is typically a very big quarter, we’re looking for them to exceed guidance in a big way for the year.

2. The international business accounted for 15% of product revenue in 3Q14, roughly tripling from 3Q13. This puts international sales over the $10 million mark, quite a significant milestone for Dexcom. Management said the business is mostly in Europe, especially Italy, Sweden, Germany, and the Netherlands. Reimbursement is improving and Dexcom does have reimbursement in certain European countries (not specified). The company has made investments in “some very large studies” in Europe to drive government reimbursement of CGM. Animas is “doing very well” in Europe with the Animas Vibe, and the 2014 G4 Platinum launch in Canada has also gone well.

3. “Yes, we are making a significant investment in our future.” R&D expenses increased a notable 57% YOY to $18.5 million, right in line with revenue growth. This reflects 27% of product revenue, significantly more than most companies. Management cited further investments in the pipeline and the need to complete clinical trial work for improved outcomes, lower costs, and to drive favorable payer policies – we assume related to the DIaMonD outcomes study getting off the ground. This clearly marks an evolution at Dexcom as the first trial to support reimbursement outcomes (as opposed to a product approval; see #10 below).

4. Dexcom’s cash-based operating profit tripled year-over-year to $10.1 million. The company had $15.2 million in non-cash expenses (mostly share based compensation, unsurprising given Dexcom’s rising stock price and $3.3 billion market cap). Gross margin grew slightly to 68% vs. 65% in 3Q13. Sequentially, product gross margin was flat, and Dexcom is achieving its gross margin targets of 70%-75% on the G4 Platinum sensor and 50%+ on hardware. Management does not expect gross margin improvements until volumes rise significantly with next-gen launches.

R&D Pipeline

5. In unexpected news, Dexcom announced FDA approval of the G4AP algorithm, now available to Dexcom users as a free download on Dexcom’s website (“software 505”). Users run an update tool to add the algorithm onto their existing G4 Platinum receiver, which means that their receivers should be more accurate. This has to be one of the lowest hassle product rollouts we’ve ever seen! New G4 Platinum receivers will ship next week pre-loaded with the new algorithm. As a reminder, this new algorithm demonstrated an impressive MARD of 9% vs. YSI in an 51-patient study shown in late-breaking poster at ADA 2014 (“CGM is not a limiting factor in artificial pancreas systems” – patients love hearing that quote). Management positioned it as an “important next step on the path to obtaining an insulin dosing claim and the potential of factory calibration.” YES!

• We’d note that the improvement from G4 Platinum to G4AP (13% to 9%) is actually numerically larger than the improvement from Seven Plus to G4 Platinum (16% to 13%). Notably, the MARD of fingersticks vs. YSI was 5.6% in the ADA study, suggesting the new G4AP algorithm is very much in the range of BGM accuracy.
• The marketing is brilliant: “Stay One Step Ahead with Software 505, the same software used in Artificial Pancreas Research.” Management expects the new algorithm will help drive new patients to Dexcom, as well as boost satisfaction among existing patients.   
• The download is only available for users 18 years or older; Dexcom will file a PMA supplement this quarter to obtain approval in pediatrics. The update can only take place on a Windows computers. We tried to download it ourselves, but were prompted to call customer support to complete the “registration process” (name, type of diabetes, therapy, account log-in, etc.). As of the call at 4:30 pm EST, several hundred users had already downloaded the new software.
• The Animas and Tandem-integrated pumps under FDA review will unfortunately not be able to upgrade to the G4AP algorithm. Those patients will need to wait for a next-gen version of the pump (e.g., compatible with Dexcom’s Gen 5, Bluetooth-enabled transmitter) or need to purchase a standalone receiver.
• The timing came ahead of schedule; in the 2Q14 call, there was some potential that Dexcom might even wait for Gen 5 to launch the new and improved G4AP algorithm. It was outstanding news for patients to see this come through today, as the even-better accuracy and reliability comes without any hassle (remote download) and no cost.

6. Also in unexpected news, Dexcom launched a new smaller version of the G4 Platinum transmitter earlier this month. It’s not clear how much smaller it is, but weKelly has one, courtesy of good luck associated with her transmitter dying last week. It is  assume it is a bit thinner and more like the size of the smaller, more popularly-sized Seven Plus transmitter. Miniaturization has always been a company goal, and the timing couldn’t be better given the pediatric approval and launch of Share. Management never gave formal timing on making the on-body footprint smaller, so the launch came as a pleasant surprise. Notably, the smaller size transmitter is also cheaper to make; it retains the same transmission range and ability to communicate with the Animas Vibe and Tandem t:slim G4. Thus far, the receptivity has been “outstanding.”

7. As noted in our initial report, Dexcom launched the Share remote monitoring product after announcing FDA approval on October 20. Share is $299 and available on Dexcom’s website without a prescription. The call did not share any launch metrics. In line with previous remarks, management positioned Share as the first of many steps in bringing CGM to mobile devices. The docking station and associated Share and Follow apps were successfully launched within days of approval. Also consistent with prior calls, management does not expect Share to meaningfully drive revenue going forward; the goal is to boost sensor utilization and increase caregivers’ peace of mind. We love it – although there was a bit of noise surrounding Nightscout approvals early on, the feedback has been mostly very positive! Some couples do not necessarily like the extra eyes on their Dexcom all night long (like Kelly) but parents love this capability. While many wish it didn’t need to be plugged in, for the first gen approval, we’d say thumbs very up! diaTribe will have a Test Drive on this soon!

8. Animas believes that the Vibe is “nearing” FDA approval, and the companies are gearing up for a commercial launch that could come before the end of the year. The G4 Platinum-integrated pump has now been under FDA review for ~19 months – give it’s November 6, if we were betting, we’d bet for a launch after the new year but do hope to hear good news from FDA by the end of December.

• Tandem submitted a PMA for the t:slim G4 in July, and a 12-18 month review is still expected. This would put approval in the July 2015-January 2016 timeframe.
• There were no comments or updates on the Gen 5 integrations with Insulet or Asante. We imagine commentary won’t come until well after Gen 5 is submitted, or perhaps until after it is approved.

9. Dexcom plans to file the Gen 5 mobile platform with the FDA in 1Q15; this was slightly back from the end of 2014/1Q15 timing shared in the 2Q14 call. As a reminder, the primary focus of Gen 5 is the Bluetooth transmitter, which will be able to speak to two separate devices via Bluetooth (e.g., a phone and a receiver). Data will be shared through apps on the phone and to the cloud. Users of Gen 5 will have access to the already-launched Share remote monitoring system. Otherwise, Gen 5 will use the G4 Platinum sensor and the just-launched G4AP algorithm. Management is “hopeful for a quick approval,” and indeed, given that the Share backend architecture laid the groundwork for Gen 5, we believe this is a reasonable expectation.

10. Management alluded to some exciting longer term initiatives with Apple, the DIaMonD outcomes study, advanced decision support tools, and improved sensor deployment. These build on the company’s continued long-term goal to eliminate fingersticks.

• DIaMonD study (ClinicalTrials.gov Identifier: NCT02282397): The 338-patient, 20-center study aims to understand CGM outcomes in patients new to CGM. It appears that in the first phase, MDI patients will be randomized to either SMBG alone or CGM+SMBG. In phase 2, all users will move to CGM and be further randomized to add the Insulet OmniPod or stay on MDI. A great design in our view that overcomes a major criticism of the STAR-3 trial (pump + CGM vs. MDI + SMBG, but without separate phases, so hard to tease out the contribution of CGM vs. pump). The inclusion criteria are quite broad (type 1 or type 2, no A1c requirement), and the estimated study completion date is March 2016. President Kevin Sayer said he is “very excited about” the study. We hope it is powered to detect significant improvements in severe hypoglycemia. Notably, cost effectiveness and quality of life will be measured between the two groups in each phase.
• Apple: A new trial approved by Apple will utilize Dexcom CGM technology in the Stanford hospital system. The data will integrate into EPIC (electronic medical record) and Apple’s iOS 8 and HealthKit. Management views this work with Apple “as a long-term opportunistic relationship.” We have always been optimistic about the potential of CGM in the hospital, and it is outstanding to see Dexcom moving in this direction, given the need and the recent negative news from Edwards and Echo Therapeutics.
• Management mentioned “decision support tools” a few times on the call, though shared no specifics. We believe these would be a very meaningful advance for patients, especially if they are available in real time. Dexcom has not approached the FDA to understand the regulatory path.
• Improved sensor deployment is also a goal, in line with previous calls; this sounds like it would come with Gen 6 or beyond.

Pipeline Summary

Questions and Answers

Q: Congrats on a yet another great quarter. I was hoping you could comment on what has been said to be the competitive launch in Europe of Abbott’s Libre, which, from what I understand, is not a true CGM. Could you talk a little bit about what that product is and, more importantly, what you’re seeing so far in Europe from an adoption and potentially market expansion perspective. Also, do you have any comments on pricing with that product?

A: I think you hit it on the head. The Abbott Libre product is not a CGM. It does not have the capability of alerting a patient, for example, to night-time hypoglycemia, which is a critical attribute of the CGM. Therefore, it’s not really fair to have an apples-to-apples comparison between Dexcom CGM and the Abbott Libre product. That being said we long assume that Abbott would come back into the market. They’ve been talking about this product for over a year now so it certainly wasn’t a surprise to us. We’ve been watching the blogs, and I think that they are in the very early stages of their launch. There isn’t a great amount of detail or information out in the marketplace at this point. In terms of pricing, I heard that it appears to be priced favorably to the whole blood CGM, but, again, your patients will be purchasing a product that doesn’t have the full protection of CGM in terms of threshold alerts and alarms.

I think at this point, we’re going to take a wait and see approach – wait and see if and how they develop as a category in the market in the Europe. We have no idea on the timeline in the US – they have been very silent on potential timelines for US commercialization.

The configuration that Abbott has come to the market with is certainly something that we could mimic and potentially make some tweaks to in order to produce a product that would be very competitive to Abbott’s Libre – given that Abbott is able to develop a new category for the product. So I think with that we’re going to take a bit of wait and see approach.

Q: Could you provide some additional color on the Share? How should we think about that contributing to revenue? Is that a subscription-base model? How do we look at that going forward from a revenue top-line driver perspective?

A: The Share system is an upfront charge of $299 and you get cradle and your data to start off. It is not a subscription model at this point of time. Our patients buy the hardware and that’s what they get. However, with respect to driving our revenues – as I said in my prepared remarks – this is really the first step in our mobility platforms. While we expect this to contribute some, it’s not going to be a major revenue driver when we’re already growing at 60%. What we do anticipate is that this will be very helpful in continuing to grow the pediatric market. The other benefit of Share, quite frankly, is not on the top line – it’s a pressure test for all the infrastructure we’ve been building for a long time to manage this data remotely. We have learned a whole bunch in a very short period of time about our patient behaviors, patterns, and glucose readings. All in all, it’s a great launch for us.

Q: If you think about the fact that FDA moved so quickly with the new algorithm, did it give you any information content relative to what that could mean for the Gen 5 approval? I believe it’s really just the transmitter now that’s changing, along with the kind of connectivity dynamic that would represent the Gen 5?

A: I think they’re different. The algorithm is certainly science that the FDA is familiar with in respect to Dexcom, as we’ve been through several sensor launches and even an algorithm change in the past – with respect to the Dexcom Seven system – without changing hardware, and the data was very clear cut. We’re hopeful that we get a quick approval on the G5 system, but it is more than just a transmitter. It is a display directly on the cell phone. It is human factors work on display on the cell phone. It’s all the things we have to mitigate for loss of connectivity and things of that nature. So we’ve met with the FDA on several occasions and have a very good idea of what that file is going to look like, and we believe they have a very good idea what the file is going to look like. However, I don’t think that two are related. But we’re hopeful that we’ll just have to wait and see.

Q: You talked about the R&D spending in inventory as well, allowing you to do some additional things. You mentioned device integration with advanced pumps or delivery systems as well as advanced decision-making tools. What timeframe should we see you moving forward with that commercially? Is this two, three, four years; it seems like it will be an evolution obviously, but does this allow you to accelerate some of that and bring those things forward? Those may represent an additional revenue opportunities as well.

A: Right now a lot of that is infrastructure building and getting ready to develop those types of tools. I think its two to three to four years out where we really have a really good, live decision support tool. We haven’t even been through an FDA path on something like that yet. However, we do know that we have great data and will accumulate more to whereby we can develop those things. We’re just making more investments. We’ve been around the diabetes history for a very long time, and we’ve seen what happens when companies take their foot off the pedals as far as innovation. We’re not going to do that.

A: One of the things we did was become a founding member with Joslin Translational Group. We’re looking at taking data from a predictive analysis to a real-time sense to allow therapy changes on the fly, which patients can do ultimately with the counsel of their physician. The more you look at projections software, it becomes very exciting to us that this disease called diabetes is one that would be particularly benefited by these types of programs.

We’re moving as fast as we can, but once again its Dexcom breaking brand new ground, and we’ve got to go about it slowly. We can only move as fast as the FDA will allow us to move with this because in the end we’re not positioned, and there is a great degree of concern that we don’t cross over that line.

Q: You were kind enough to give us that 30% of the revenues are coming from hardware. Can you give us a sense how that breakdowns at all in terms of replacement hardware versus new patients?

A: We get asked this question every quarter, and we’re not going to add any more color to what we’ve already said. We are having great new patients’ results; you can’t grow as fast as we are without having that, so we’ll leave it the way it is.

Q: We all know a lot of parents that have been waiting for Share, but it also brings up how you have been doing on pediatric expansion – can you provide a little color on that? How are you doing from a penetration clinic standpoint, and is the split pretty much the same with durable and consumable in pediatric, or is there’s a little bit more on the starter kits? Any color there would be helpful.

A: The pediatric launch has been very successful, we are a couple of quarters into it, and as we said last quarter a pediatric patient has the same usage in spending patterns as a regular patient. We’re not going to break that out and continue to report on that every single quarter. I can say, it's certainly been a driver in our growth and has been very successful so far. You're right, a lot of parents are very happy with the Share launch.

Q: The ex-US comes in at roughly $10 million; it’s starting to get significant here. Can you give a little more color there – is it mostly Europe, is it mostly out of pocket, is mostly starter kits as people figure out that the accuracy is worth the investment?

A: It is really very much mostly Europe. We’ve done very well in Canada this year as we launched there, as well. We have some countries that have carried us. Italy, Sweden, Germany are three of the bigger ones, and the Netherlands – those are four large ones in Europe where we’ve done very, very well. Reimbursement is improving. We see reimbursement in some countries in Europe.

We’re also investing in some very large studies over in Europe to drive governmental reimbursement of CGM for patients. We’re making investments over there to get full-on reimbursement for CGM. A lot of it is out of pocket and a lot of it is durable. It is a mix. It’s not the same mix as in the US, and it’s not as predictable. We don’t have as much color on those patients as we have over here, but the business is doing very, very well.

Q: Does Vibe contribute meaningfully to that $10 million or is it still early?

A: No, It does. The Vibe is doing very well. Animas has done very well with that product over there.

Q: Could you give us some more insight into trends – where are the patients coming from? Are the pharmacy benefits helping out, are you taking share from Medtronic, are all of these new to CGM? Is it adult vs. pediatric? Any kind of insight into the trends would be really helpful.

A: All of the above. Pharmacy benefit has helped in some cases, we’re certainly not losing market share based on all the independent data that we look at. We have very significant new patient growth, and we’re not losing patients like we used to in the Seven Plus stage. Our retention rates are very good, our utilization rates appear to be very strong as people trust and rely on this sensor array. I can tell you I’ve had many patients say the worst two hours of my week or two weeks, if they wear the sensor longer, is the warm-up time while I wait for the next sensor to start. So, every variable in there is working. Again, I’ll go back to an earlier statement: To achieve growth as we have, we have to hit all variables. Every one of them is doing well.

Q: At the end of September, Medtronic revealed the Guardian Mobile, their own standalone CGM. How are you looking at this as a competitor to G5? Do you have comments around your take on the product?

A: Medtronic revealed a potential standalone system at a trade show earlier this year. Frankly, we haven’t seen or heard it anything else about it since that time. So, much like the Abbott Libre , we’re going to take a wait-and-see approach. It’s Not clear to us what sensor component would be included whether it’s a current Enlite sensor – which we’ve all seen the performance of that sensor – or some future sensor. So, again it’s somewhat unclear. I think one of the comments that was made by Medtronic was its first-generation Guardian Remote, whatever they’re calling it, would not have a remote monitoring feature; it would simply be just wired to the patient. So, in that respect it’s somewhat different than what we’re going to come to market with with Gen 5, but outside of that I don’t think we know a whole lot about it.

Q: What does the Gen 5 include today, and when do you expect to file that?

A: We expect to file that in the first quarter of 2015. The primary focus of Gen 5 is the transmitter will be able to speak directly with two separate devices via Bluetooth connectivity. You could speak to your phone and your receiver at the same time, or you could speak to just your phone or just your receiver. And then, that data will be shared through the applications on the phone to the Cloud. People will have access to the Share system, which will be pretty much the exact same system that we’ve launched with the Share this year. The Gen 5 will be a Gen 4 sensor with respect to its performance characteristics; it will have the G4AP algorithm – that level of accuracy. We’re not changing the system or the system performance for the Gen 5 platform. We are going to come with the user interface that is very much designed to be a mobile platform for those who look at the data on the phone; we that that is just fabulous. That’s what the Gen 5 system is going to be.

Q: Is it going to address the calibration requirements or the fingerstick replacement or that’s the Gen 6?

A: We will not change the calibration scheme for the Gen 5 system.

Q: It sounds like you’re getting ready to lock that down and submit that?

A: We are working very hard to lock that down, yes.

Q: How many of your new patients were pediatric and how many were adults, if you’re looking at the overall business?

A: We’ve been out for a couple of quarters with pediatrics. Everybody is a patient; they all have the same economic patterns, and we’re just not going to report that every quarter. It’s going very well with pediatrics. We’re very happy. It’s met all our expectations.

Q: How long do you think the G4 artificial pancreas algorithm will take to get into your current install base? I take it that will just be the algorithm going forward?

A: For the purpose of your question, I went and asked how we were doing. It was actually posted on our website earlier today, and we’ve had several hundred users already downloaded and install the upgraded software. It’s going to go fast. We expect to start shipping the new algorithm with the new purchases, with new receivers next week, so we’re going.

Q: Are there any costs that will be associated with that for you?

A: Nothing material, no.

Q: I appreciate the necessity to continue to spend on R&D and sales and marketing to keep the growth as it is. Should we assume that the new $18.5 million R&D level is more or less a new baseline going forward from here?

A: That’s a very good question. With respect to R&D, as we prepared, we sat and discussed that. I started here about three and a half years ago, and R&D is a lot different than it was then. For example, now, whenever we do something new we have to run trials in both adults and pediatrics. The cost of getting anything to the market is now doubled on the trials and execution side. Once we get something that’s developed, we’re spending money on the Cloud infrastructure and a lot of things that we weren’t working on before. Fortunately, we’ve had the acceleration of growth necessary on the top-line data, our performance objectives.

It is important as we look going forward into next year that we look at baselines in Q3 and Q4 of this year. As everybody may remember in Q1 of last year, everybody took our expenses way down from Q4 to lower numbers, and we ended up with much higher expenses than everybody thought. We typically don’t give a lot of expense guidance, but I think you can look at this number and go from there. There’s a lot of stuff going on here, and it’s good.

A: I’m going to weigh in a little bit. I’ve spent a lot of my time thinking strategically for the company at this point. What I’m always cognizant of is as you look around the universe, that cost of care is something that is obviously on everybody’s mind. We heard it as a keynote speech at the AdvaMed, Mike Mussallem (CEO, Edwards Lifesciences) talked about it during the Edwards call. And so, we need to spend some of those R&D dollars to ensure that we know as a category, CGM saves the healthcare system money. I’ve preached to whoever would listen that the first stage as we look at ACA whether or not it gets changed because of an administration change who knows. I will tell you this: In the future, the healthcare providers will get some of their compensation based on outcomes, and it won’t be too long after that – I can’t tell you when my crystal ball says three years, four years – that industry is going to be part of the game that if you can’t demonstrate you’re taking dollars out of the cost of care with your products, your products are not going to be reimbursed. It’s a lot of lip service at this point. I just gave you a $17,000 number for hospital admission, and we’re spending over $250 billion a year in the United States treating diabetes; unfortunately it continues to grow at unparallelled rates that we’ve seen.

So we’ve got to be cognizant of that, and some of that R&D spend is creating and demonstrating to the payer system that we are in fact saving them a lot of money and we’ll save them even more money in the future. Everything we do from a standpoint of building is preach to them everyday to make it better and less expensive. So these are investments for the future with the return being that products are not as price sensitive. We know we have to hit certain gross margins. No matter what we do, regardless of what the price is, we’ve got to hit those gross margins. From that perspective, we need to make those investments today.

Q: You mentioned that one of the things you’re spending on is a new, smaller transmitter – did I hear that correctly?

A: We launched the new smaller transmitter this quarter.

Q: Could you describe a bit about how much smaller that is and what sort of receptivity are you seeing?

A: Well, the receptivity has been outstanding because everybody likes things that are less obtrusive on their bodies when they have to wear our devices. So people have liked it very much. Driving that, we had to make a transmitter that had all the features of the previous Gen 4, particularly the ability to transmit over an extended range, and also the ability to talk to our integrated pump partners, the transmitter does both of those things. It does cost less to make, so it meets all of our objectives; what we do is make it better and make it cheaper. We achieved in both – our guys did a great job.

Q: In your remarks you noted you’ve grown consistently about 65% on average since the Gen 4. It sort of invariably begs a question of how long can you sustain this? It sounds like the Gen 5 is getting filed soon and that should kind of keep things going, but 65% is a pretty high bar.

A: We believe our sustainable growth, and what we plan for, is 40% every year. That allows us to double every two years. We’ve been very fortunate to grow faster than that, but our plans have always been to grow at 40% and have the infrastructure to support 60%. We’ll keep pushing, but this pipeline that we’re developing we firmly believe can drive the business the way it has. However, it takes every one of these innovations to keep it going; it took a pediatric approval. It’s going to take a new algorithm, it’s going to take going to the phone system, and it’s going to take the Share system. It’s going to take every one of these things to continue to drive that growth. We can’t drive the growth just by continuing to market G4 as it sits – we have to be better, and we will.

Q: The professional CGM, did that have any impact in the quarter or how’s the rollout of that product, is it allowing you to convert more patients to CGM?

A: The rollout has gone fine, as we said when we announced that approval a while ago, we don’t expect this to be a huge direct top-line driver of our financials, and it has not been. They do convert some patients; I don’t have the statistic off the top of my head. We know the percentage of people who where wear our sensor on this professionally used system. The percent who convert to purchasing one is very large, it’s very consistent, very favorable. So, it certainly helps us, but it really hasn’t been a measurable driver in direct sales. I don’t have a number to share with you.

Q: With the AP algorithm, is that applicable to the integrated systems that will be coming out, the Animas Vibe and the Tandem?

A: Unfortunately, they neither the Animas 5 nor the Tandem have the ability to upgrade to the new algorithm as does our G4 Platinum receivers. Those patients who have one or two options they would have to wait until a next-generation, really a Gen 5 version of the pump. They would always have the opportunity to purchase a standalone Dexcom receiver – We’ve actually seen this happen in Europe, where patients on the Animas 5 have elected to purchase a standalone Dexcom receiver because they preferred to pull that out of their pocket rather than a pump to check their glucose values. The transmitter would be the same, so the patients who wish to use the new algorithm would be able to use it with a same transmitter if they bought a separate receiver.

Q: You mentioned a collaboration with Apple, and I know with Share, it right now only works on the Apple platform. Is that what you were referring to, or are you going to go beyond that?

A: We’ll go beyond that. As you know, you can buy the app on the iTunes store today for Share. That’s the first stage, and as we have indicated, there is a trial being proposed now, it’s been approved by Apple, that we will utilize the CGM technology Gen 4 through; the first one will be up at Stanford University, at the hospital system, that will integrate into the EPIC system using iOS 8 and their health kit. We view this as a long-term opportunistic relationship. Again, I got back to my part of my comment – as we look at this variable technology, that’s really going to drive companies like Apple, Google, Samsung, whoever in to this digital health world that everybody looks at and says “Wow.” That’s a place we want to play to expand our own platforms from where they’re at now; they see the aging population and the opportunities to engage that population and try to empower them to take better care of themselves. This again reduces healthcare burden that we spend a lot of time looking at. Obviously, anything along those lines benefits what we intend to do. We have always considered CGM to be a consumer product. It has a requirement of a medical device, but the utility of it and its power is as a consumer tool because the technology reads as actionable for a patient that has to have many transactions in their daily life in order to better control their diabetes.

You’ll continue to see these grow as first you see the watch system develop, but that’s only the beginning because that’s easy to do. We’ve demonstrated deploying in our system with Pebble Watch, as an example; A lot of that stuff, from a technology standpoint, is off the shelf with the utilization of Bluetooth low energy. Now, getting into the regulatory challenges is much different, obviously it’s in the news with regard to cyber security and other challenges – risk and risk mitigation. However, you’ll continue to see these grow.

Q: As you look forward to the future with smaller and integrated systems, are you looking to move both sensor performance and quality of life together at the same case, or does one take precedence over the other if you do have to make a compromise?

A: I don't think you have to make a compromise. I think they are simultaneous. A sensor accuracy of 9% MARD is point-of-care kind of accuracy, particularly when you add in the variability associated with the human influence on accuracy. If you take a patient on SMBG, I assure you that it is not 5.6%,it's something far greater than that. We've seen variability in fingerstick measurement; two measurements done on the same finger within seconds of each other have been shown to be widely different. From an accuracy standpoint, we are far better than fingerstick measurements, and we're certainly more consistent. That is something that we will continue to drive. We certainly believe that at 9% MARD, we are at that threshold in which we can dose insulin. We have to demonstrate that successfully to the FDA. However, clearly we believe that accuracy is there. Now, you move to quality of life and it goes hand-in-hand; the patients have more confidence and more trust in the tools that they're using to better manage their diabetes – their quality of life has improved. They're less worried day-in-and-day-out of everything they do. A parent is less worried of sending their child to an overnight because of the Share system. All of these things contribute to an improvement in the quality of life.

Q: It’s just a matter of one stepping forward ahead of the other, but they are both moving forward together.

A: They're both moving forward together.

Q: What trials are you most excited about that are happening with your sensor, and when would you expect data on those trials?

A: We are excited about a bunch of trials. The biggest trial that we started this quarter is what we call our “Diamond Study” internally, which is a study that where we can truly bracket the benefit of CGM from a therapy perspective, from a cost perspective – where we can really do a study that shows how we drive CGM outcomes in patients new to CGM. In particular, with MDI patients – what happens, and what changes in their lives. This is going to be a long-term study for us, the data probably won't be available for 18 months to 24 months. We’re going to use 20 centers and fund this study to really learn about those things that are important in our business through a study of that nature. That's a study I am very excited about. It just cannot happen as fast as I would like.

A: You'll see some interim results at some point during the course of the study, but it is really in our opinion a key study for the future, and certainly for the first time as a company, it's a study that is being conducted without the primary intent to get a product approved. If you look at all the studies we are involved in, it's hard. We're in 20 different artificial pancreas programs, not our studies but we participate and provide some support – those are exciting to see. Those progress with the intent to reduce the challenges of managing glucose levels. However, I would agree and say the Diamond Study – even though it's not a near-term study – is probably one we're very focused on. The magnitude of the study is great, with 20 centers at key sites throughout the US.

Q: Right now, it's great that we're seeing that you're positive on a cash earning basis even though we're not seeing reported positive earnings. Is that something you're putting much weight on, or are you right now just trying to keep your foot on the gas, being responsible with your cash, but paying less attention to the reported earnings number because you think that there is more investment that needs to be made before that to be your main focus?

A: For a long time, we have philosophically operated under the principal of, let's grow the topline fast, and let's grow the bottomline faster. We're certainly doing that. That cash operating income was three times what it was the same quarter a year ago when we add 60% growth on the topline. As we look at our business going forward, we think about three things. How much can we add to the top on a revenue basis, and then we get to an acceptable gross profit number. We then ask our selves two questions, how much do we need to spend to continue to push the agenda and keep growing the top line, and how much do we need to keep to meet our commitments to our shareholders? We evaluate all three of those things at the same time – not just as a management team, but at the board level and throughout the entire organization. So, we look at all of them, and we will continue to evaluate our business that way.

A: I have to laugh because we carry this non-cash based equity that prevents us from being GAAP positive. When cash was king, and it still is, we needed to add to it rather than take away from it. But we did need to attract the right talent. We were low on salary, so we made it up on the equity side. We gave our employees equity and lo and behold our employees don't really want to sell the shares that they hold, because they look at the upside of what this company can achieve from shareholder value improvement. The end result of that is probably $15 million plus a quarter of share-based equity, non-cash, that we have to carry forward. So, you just do the math and say we want to get 20% operating number. We've had to do a lot.

A: And you can't go and tell your employers, hey why don't you all sell shares in order to get this down? I think it's just interesting dynamic. So, yes, we do, we make statements relative to what we think we can do in 2015. But, it's really driven by growing the topline, and then by growing the bottomline faster.

Q: I wanted to ask about the marketing effort around the artificial pancreas algorithm – clearly accuracy matters. It's proven to drive adoption. Your current user base will be ecstatic with the upgrade. Will the software allow you to be more aggressive in going after new patients? Do you view it as a new driver of patient growth?

A: I think it will drive patient growth; when patients hear that we have an algorithm that was designed for the artificial pancreas, and it's now been integrated into a commercial device that they can purchase, it will be very, very helpful. It definitely will be a driver. It was our goal to make our patient base ecstatic because that is how we build the business here.

Q: When you think of the sales team and infrastructure, you have a lot of new products here. I’m wondering what your thoughts are on increasing the team as we look to 2015?

A: We're in the middle of our planning process. Certainly with 60% plus year-over-year growth for the entire year, we have an opportunity to expand next year. We'll give more guidance on that at the end of the year after we get through our process.

Q: You mentioned the thinner transmitter has a lower cost of goods, but I'm wondering, were there startup costs that impacted gross margin in this quarter associated with that?

A: No. There were not.

Closing Remarks: I hope that everyone got a good picture of how excited we are about Dexcom and the opportunities for our company. However, I need you to understand, also, that we are setting our sights on being a $1 billion-revenue company, not a $300 million, not a $500 million, but a $1 billion plus company. And so, our employees believe in our mission. We believe that they know the opportunity – Dexcom is truly a unique company, and they want to participate in that. They are clearly aligned with shareholder value. With that, I again say thank you, and see you in 2015.

-- by Adam Brown and Kelly Close