Memorandum

Insulet 2Q14 – OmniPod grows 35% for second straight quarter; Dexcom integration partnership back on – August 8, 2014

Executive Highlights

  • Total revenue in 2Q14 reached $72 million (a 20% year-over-year increase), driven by 35% year-over-year (YOY) growth in the core OmniPod business (~$65 million) and 11% sequential growth.
  • Insulet’s next-gen Bluetooth-enabled PDM will receive and display data from Dexcom's Gen 5 CGM system.

Insulet reported 2Q14 results yesterday afternoon in a call led by CEO Duane DeSisto. Below, we bring you our top 10 business and R&D highlights from the call, followed by a pipeline summary.

Financial and Business Highlights

1. Total revenue in 2Q14 reached a record-high $72 million (a 20% year-over-year increase), driven by 35% year-over-year (YOY) growth in the core OmniPod business (~$65 million). This now marks five straight quarters of 25%+ OmniPod growth and two straight quarters of 35%+ growth. Given the negative impact of the payer issue (see below), management reduced the full-year revenue guidance to $290-$300 million from the prior guidance of $295-$315 million.

2. A major managed care payer changed its pump reimbursement policies during the quarter, which delayed (and is still delaying) new patient starts. We understand this payer to be United, which is a major shock and surprise. [United Healthcare published a notable July 1 coverage policy on insulin delivery and CGM (more details below)] The impact could be up to a $10 million reduction in 2014 revenue in the worst-case scenario. Insulet is working towards a resolution with the payer and distributor. 

3. Since launch of the second-gen OmniPod in February 2013, “nearly 40%” of prescribing physicians are new to Insulet, up from “over 35%” in 1Q14. Approximately 70% of Insulet’s new patient starts come from MDI.

4. Excluding the patent settlement with BD, Insulet would have reported an operating profit of $1.7 million in 2Q14. For the first time, US OmniPod margins increased over 60% and consolidated gross margin exceeded 50% (up from 47% in 1Q14).

5. Insulet reached a settlement and license agreement with BD related to unspecified patent litigation. The one-time charge was $7 million charge.

R&D Pipeline Highlights

6. On Tuesday, Insulet announced that its next-gen Bluetooth-enabled PDM will receive and display data from Dexcom's Gen 5 CGM system – we estimate a launch is possible in ~early 2016 at the soonest. 

7. Management “hopes” for an approval of the LifeScan Verio-integrated PDM in 4Q14.

8. An FDA 510(k) submission of the special OmniPod PDM for use with Lilly’s U500 insulin is expected by the end of 2014

9. Despite the rekindled CGM integration agreement with Dexcom, Insulet continues to work on its CGM-enabled pod with its unnamed partner. The company is working on prototypes and expects to do the first human trial in early 2015.

10. In non-insulin drug delivery, Insulet and Amgen expect FDA approval for an oncology application of the OmniPod in late 2014.

1. Total revenue in 2Q14 reached $72 million (a 20% year-over-year increase), driven by 35% year-over-year (YOY) growth in the core OmniPod business (~$65 million). The revenue fell squarely at the center of the previously issued 2Q guidance ($70-$74 million). The strong sales growth came on a challenging comparison vs. 25% OmniPod growth in 2Q13. This now marks five straight quarters of 25%+ OmniPod growth and two straight quarters of 35%+ growth. New patient starts increased 20% year-over-year in 2Q14, steady from 1Q14. By our estimates, OmniPod sales were up 11% sequentially from 1Q14.

 

2Q13

3Q13

4Q13

2013

1Q14

2Q14

Worldwide OmniPod Revenue (millions)*

$48

$56

~$58

~$206

~$59

~$65

Year-Over-Year Growth

25%

30%

~30%

~27%

35%+

35%

Sequential Growth

11%

16%

4.6%

-

~1%

~11%

*OmniPod Revenue is extrapolated based on previous performance and the growth rate given during the financial call. Management’s said that OmniPod revenue grew 35% year-over-year vs. 2Q13.

  • The international business with partners Ypsomed and GSK is on pace to double in 2014. Ypsomed is taking share in key markets, including Germany, the Netherlands, and Switzerland, and the OmniPod just launched in Italy. Management said the two biggest international opportunities are France and China – the latter sounds great in particular as pump penetration is so low there. France should also be promising since traditional pump reimbursement is favorable there and presumably OmniPod reimbursement will be great too. With partner Ypsomed, Insulet is working through the French reimbursement process now, which was characterized as “in the final stages.” Insulet also “continues to work” through China’s regulatory process.
  • Given the negative impact of the payer issue (see below), management reduced the full-year revenue guidance to $290-$300 million (17-21% YOY growth), a top- and bottom-end reduction from the prior guidance of $295-$315 million. The dampening in expectations reflects the payer issue that is delaying new patient starts and not any slowdown in the overall business. – hopefully Insulet will be able to “make up” for this. In 3Q14, management guided for revenue of $73-$77 million (19-26% YOY growth).

2. A major managed care payer (that we understand to be United, though management did not specify) changed its pump reimbursement policies during the quarter, which delayed (and is still delaying) new patient starts. Management’s commentary was fairly general, but the change reportedly stemmed from some type 2s obtaining reimbursement for insulin pumps – apparently, the payer became frustrated in May and shut down all Insulet pump reimbursement, including for type 1s. The plan accounts for ~15% of Insulet’s new patient starts. The change in policy could lead up to a $10 million reduction in 2014 revenue in the worst-case scenario ($1.5 million in the second quarter, $3 million in the third quarter, and $5.5 million in the fourth quarter). Insulet works through a distributor for this particular managed care plan and discovered the issue through customers; we’ve heard the distributor is Univera and are trying to confirm this. The company continues to work towards a solution with the distributor and the managed care provider, which sounds like it could wrap up in as soon as two weeks or as long as eight weeks. For now, Insulet is backlogging these new patient starts. Management emphasized that the issue is largely a one-off and highly unique, especially because Insulet does not have a direct relationship with this particular payer. The news sounds disturbing, though in the best case it is a temporary speed bump; investors spent the vast majority of Q&A plumbing for further details. We certainly hope this is not a trend. We didn’t realize that any distributors such as this in the US accounted for that many new patient starts. We were also reminded through our research that Kaiser does not cover OmniPod – we assume this also will change at some point due to patient demand alone – this would obviously represent major upside for Insulet.

  • From some background research, we believe the payer is United Healthcare, based on this July 1 coverage policy. The document contains some black-and-white language and may suggest that reimbursement of the Valeritas V-Go for type 2 diabetes potentially drove the shutdown in pump reimbursement. The report notes:
    • “Nonprogrammable transdermal insulin delivery systems are unproven and not medically necessary for treating patients with diabetes.
 There is insufficient evidence in the clinical literature demonstrating the safety and efficacy of transdermal insulin delivery in the management of patients with diabetes.”
    • "Insulin infuser ports, such as the i-port Injection Port, are unproven for insulin delivery in patients with diabetes.
 There is insufficient evidence demonstrating that the use of insulin infuser ports results in improved glycemic control beyond what can be achieved by using standard insulin delivery methods. In addition, an increase in complications, such as infection at the port site, has been reported when using these devices. Further well-designed, large-scale randomized controlled trials are needed to establish the safety and efficacy of this device."
    • “Devices classified by the US. Food and Drug Administration (FDA) as an artificial pancreas are unproven and not medically necessary. 
Study results fail to provide conclusive evidence that artificial pancreas devices lead to improved health outcomes, such as improved glycemic control or delay in diabetes-related complications, in patients with diabetes. Larger, randomized controlled trials are needed to determine the long- term impact of these devices on diabetes management.”

3. Since launch of the second-gen OmniPod in February 2013, “nearly 40%” of prescribing physicians are new to Insulet, up from “over 35%” in 1Q14 and “over 30%” in 4Q13. In addition, over 75% of these new doctors are repeat subscribers, up from 70% in 1Q14. Approximately 70% of new patient starts have never used a pump before (consistent with 1Q14). Over 35% of new patient starts this year are under 18 years, and nearly 40% of those patients are 10 years old and younger. This all spells lots of opportunity for Insulet as they continue to attract new HCPs and as at least some (perhaps many) of the new HCPs build up into frequent prescribers.

  • As expected, in 2Q14, Insulet expanded its commercial sales team from 110 to 130 people, including the establishment of key account managers. The company has been “very pleased” with the early success, and territories with key account mangers have generated a 10% increase in referrals. The bump in the commercial team is expected to help sales in the back half of the year. As a reminder, the goal of these “key account managers” is to be a third person on the team in high performing territories – they will focus on the set of practices where Insulet has existing relationships. This will free up bandwidth for existing territory mangers to get to more practices and ultimately grow Insulet’s prescriber base further. 

4. Excluding a one-time $7 million charge from a patent settlement with BD (see below), Insulet would have reported an operating profit of $1.7 million in 2Q14 – this represented a significant improvement from an operating loss of $5.8 million in 2Q13 and an operating loss of $1.9 million in 1Q14. Management expects the business to be operating profitable going forward.

  • Notably, for the first time, US OmniPod margins increased over 60% and consolidated gross margin exceeded 50% (up from 47% in 1Q14). This represented a five-percentage-point increase over 2Q13. Management expects a continued 2-3 percentage point per quarter improvement in gross margins for the remainder of 2014. Since the transition to the new pod in 1Q13, Insulet has gained nearly seven-percentage points of gross margins. The company has seen continued reductions in the overall cost to produce each pod, reduced scraps, and higher volumes.
  • Insulet manufactured 2.5 million pods for the third straight quarter. A fourth manufacturing line is scheduled to be producing pods before year-end. Management said that “production is going very well.” An investor pointed out in Q&A that inventory levels are low, to which management noted that 3Q and 4Q will bring an uptick in production.

5. Insulet reached a settlement and license agreement with BD related to unspecified patent litigation. Given the “uncertainty, distraction, and continued expense of a jury trial,” management deemed it was an appropriate time to reach a settlement. The one-time charge to the P&L was $7 million. The nature of the patents was not specified, and we wonder if they are related to BD’s ongoing R&D work in the type 2 insulin delivery area.

R&D Pipeline Highlights

6. On Tuesday, Insulet announced that its next-gen Bluetooth-enabled PDM will receive and display data from Dexcom's Gen 5 CGM system – we estimate a launch is possible in ~early 2016 at the soonest. In yesterday’s call, Insulet management called the news “exciting” and said the company was “very pleased to rekindle the development partnership with Dexcom.” 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 (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 hopes this will be a 510(k) application and not a PMA, though that sounds fairly unlikely to us. Both companies are responsible for their own development costs (Dexcom’s will focus on the app, Insulet will focus on the next-gen PDM).

  • Management reiterated the 1Q14 estimate that the next-gen PDM will be developed in time for ADA 2015 in Boston (though not necessarily approved). For context, Dexcom's Gen 5 mobile platform will be submitted to the FDA by the end of 2014 or in 1Q15. 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 fantastic 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.

7. Management “hopes” for an approval of the LifeScan Verio-integrated PDM in 4Q14. LifeScan has completed additional testing (following initial questions from the FDA in May, reports are being compiled, and a response will be sent back to FDA by the end of 3Q14.

8. An FDA 510(k) submission of the special OmniPod PDM for use with Lilly’s U500 insulin is expected by the end of 2014; the 1Q14 update called for a “late 2014” submission, which could mean the project is taking a bit longer than anticipated. Indeed, Insulet management said that the first round of human factors testing is complete, reflecting no change in status since 1Q14; the second round of testing will start in the coming weeks. Management emphasized that the product will include “full-blown clinical results” when it comes to market, which will be key for obtaining reimbursement.

9. Despite the rekindled CGM integration agreement with Dexcom, Insulet continues to work on its CGM-enabled pod with its unnamed partner. The company is working on prototypes and expects to do the first human trial in early 2015. Management emphasized the all-in-one approach and called it an “incredibly cost effective way to incorporate continuous sensing.” That said, Insulet is approaching this project “cautiously,” given the challenges of developing a CGM.

10. In non-insulin drug delivery, Insulet and Amgen are still awaiting FDA approval for an oncology application of the OmniPod (still expected in late 2014). Management said the partnership has the chance “to be a gamechanger.” The company has an additional partnership with Ferring Pharma for infertility drugs, on which there was no update. We see these partnerships as major upside for the company’s overall business, since they are mostly managed by partners and use Insulet’s existing manufacturing. We do also see competition in the wings for “bolus injectors” from smaller upstart companies like MedPatch, Inc. and others. Notably, Insulet is getting so many other calls on the drug delivery front that it plans to hire a dedicated business development person to manage these opportunities – as we understand it, there are over 100 companies with biologics in development, including major companies such as the ones below as well as heaps of small and medium sized companies:

  • Abbvie
  • Amgen
  • BMS
  • Boehringer Ingelheim
  • Daiichi Sankyo
  • Gilead
  • Merck
  • Roche
  • Takeda

Pipeline Summary

Pipeline Product

Timeline

New OmniPod PDM with integrated LifeScan OneTouch Verio BGM

FDA 510(k) filed in February 2014; response to FDA questions by end of 3Q14; “hope” for approval by end of 2014.

Updated OmniPod PDM for use with Lilly’s Humulin U500 insulin

FDA 510(k) submission expected by end of 2014

OmniPod with integrated CGM

[single on-body device]

Prototype development ongoing. First in-human data in early 2015.

Next-gen Bluetooth-enabled PDM

On track to be developed in time for ADA 2015. Regulatory path unknown.

Integration with Dexcom Gen 5 app and transmitter

Following approval of next-gen PDM

Drug delivery device for Amgen oncology medications

Anticipate approval in late 2014, with launch soon after. Will leverage existing manufacturing with minimal impact on expenses. Expected to have ~2x the per-pod revenue and majority of margin should fall to the bottom line.

Drug delivery device for Ferring Pharma infertility drugs

No recent update.

Additional partnerships for drug delivery with obesity, pulmonary hypertension, oncology, and Parkinson’s medications

No formal agreements announced.

Questions and Answers

Q: What gives you confidence that you will resolve this payer issue? What’s the risk to the business if other payers follow suite?

A: That’s a great question. What makes it different is that all these payer contracts come up for renewal. This is an ongoing issue we’ll make this a little different. We’re in the middle of negotiating with distributor and payer.

I don’t want to go too far, obviously, because we’re working our way through it. But this was a little bit of a knee-jerk reaction. The payers are going through some various codes in categories, so they just shut them all down, putting people at risk – it’s a big deal. As soon as we were made aware of it, we got involved, and we got the reorder business turned back on.

The payer has offered a potential solution in terms of how to handle this going forward. We are not exactly thrilled with it – once again, I don’t want to throw the details on what the solution is. Suffice it to say that it makes the process more complicated – it’s not a price of action at the moment, it just makes the price more complicated.

It does appear that things were going through the category – most notably things that will affect patients with type 2 diabetes – that they were not happy about. We saw that they dug in their first solutions at the door.

Having said that, could it happen again? Yes. This is a little bit of a harsh reaction. Obviously there is not a year that goes by that we are not negotiating. This was a little bit unusual and took us a bit by surprise because we were not the first to be contacted – we noticed that the distributors’ business was being impacted. It took us a little while to get to the bottom of what was happening, but our customers gave us the heads up when we started driving that process. What is clear is that insulin pumping is a better therapy than anything else for patients with type 1 diabetes, and there continues to be more studies proving that.

Q: I wanted to get your thoughts on the partnership with Dexcom – we were happy to see that. How should we think about that from a growth perspective? Is that a big driver in terms of patient additions, or is it just incremental?

A: I didn’t have an opportunity to listen to Dexcom’s call yesterday, but I think that it’s going to help both companies. In the long term, I think the real point is that it really comes down to timing when we start to figure out how it’s going to be dialed in. We’re working out those details. It’s with the Dexcom’s Gen 5 sensor, so that is really the driver in terms of when it’s going to impact the business.

Q: Just to clarify, the re-order has been cleared up? The utilization re-order rate should not be impacted going forward, correct?

A: That is correct.

Q: So it’s only the new patients – would that also affect your NDI?

A: Do you mean the Neighborhood business? There aren’t any patients that go through the Neighborhood with those separate managed care. The managed care payer goes through our third party distributor, but it’s not Neighborhood.

Q: Inventory in the quarter are very low. Are there manufacturing issues or concerns? It tells us that demand is high, but your inventory is burned down a little – I’m curious your thoughts on that.

A: What you don’t see is everything in China moving forward. Having said that, the inventory levels are not where we want them. I think in Q3, you’ll see an incremental uptick in the inventory number – hopefully by Q4, you’ll be closer to where we want to be.

Q: Is your fourth line still on track?

A: Yes, it is on track, and it should be producing product for us before the end of the year.

Q: So, that’s what will help resolve the inventory differential in Q4?

A: Yes, We continue to make good progress. Obviously, the level of consistently we’ve had in production for the past nine months has been unique to our business – we were not doing this for the past six years, at least while I have been around. So, I think that is great. The operations team is doing a fantastic job. I think we’ve seen a little bit of an uptick here in the third quarter in production, and we should be hopefully near 2.75 million, 3 million pods in Q3. Hopefully, we are growing even beyond that in Q4 with the additional the production line. Knock on wood, but the production is going very well.

Q: If you strip out $2 million and $7 million in charges, General and Administrative Expense (G&A) would have been at a level we haven’t seen since 2012 on an absolute nominal basis. Is that the right number to go off of. You’re spending that much on litigation. Is that kind of our new core base rate – how should we think about that?

A: I think that’s right. Again, in total we are talking about $36-38 million of operating expenses per quarter for Q3 and Q4. The Q3 is really the first full quarter where we have incurred all the changes related to sales and marketing hires. On the G&A line – yes, I think that’s accurate. We certainly have worked our way through the Medtronic litigation over the course of the last 12 months. Hopefully this, the BD litigation, and some other odds and ends are all behind us at this point.

Q: Regarding the managed care situation, what gives you the confidence that you won’t see this in other payers?

A: We haven’t seen anything like this and we’ve had our products out since 2005. This is the first time we’ve seen anything like this, and part of what makes this unusual is that we go through three distributors in the US that has this one big healthcare contract. This is one of the few that we don’t have a seat at the table. Like I said, we heard about this from our customers, we had engaged the distributor, and the distributor again engaged with the managed care.

We’ve had good relationships with these managed care providers. If there are changes in coverage or anything going on, we’re usually involved in this discussion. I think that makes this a little bit of a one off. It’s a major provider, so it has been problematic, but I think everywhere else we have a pretty good relationship, people are thinking about changes in policy. You can anticipate these ongoing discussions; you can understand where they’re coming from, and there is a give and take. By the time we started to engage, it had just shut down the whole insulin pump category – that was the solution. This time they’re turning back on.

I’m not saying it would have been different had we had a direct contact – but this is way out of the norm for what we typically see.

A: It’s been well known over the last year or so since Medtronic launched the 530G that there were plans that were not wanting to reimburse for that product and holding it back. That’s been well documented. Our understanding is that this provider impacted companies outside of Insulet. The 530G was impacted. It’s not unique in that sense. However, it is unique in that we don’t hold the direct relationship so it took us longer to get involved. Hopefully, we’ll work our way through it over the next few months and be done with it.

Q: I think you described it as being related to patients with type 2 diabetes being reimbursed – I didn’t get a lot of detail with that; Is it correct that it’s the patients with type 2 diabetes are not getting reimbursed for these pumps?

A: One of the other items they were looking at – beyond higher priced pumps – was why were insulin-dependent patients with type 2 diabetes being reimbursed for the pump. We’re kind of the third man in on this, and, obviously, we’ll step in the driver’s seat if it doesn’t get resolved right away. However, what we’ve heard is that they couldn’t understand why patients with type 2 diabetes were on pumps; given that there are other low-cost solutions for insulin-dependent patients with type 2 diabetes, they were not happy with the fact that some patients with type 2 diabetes were getting reimbursed.

A: These weren’t our patients; these weren’t our charges going through. These were other companies using codes mainly for getting reimbursement for patients with type 2 diabetes, which the plans were surprised by.

Q: One more question about the drug development business. It’s still waiting on the FDA approval of the Amgen pump; however, do you have any updates on that, particularly in terms of when we might expect that product? Also, I would have expected a little uptick in enthusiasm. Perhaps you could update us on your expectations about approval.

A: For us, it remains unchanged. We’ve been in constant dialogue with the Amgen folks, and I think they were working through their process. I don’t want to speak on their behalf, but, overall, I think we’re all feeling pretty confident that the timelines we’ve laid out are still holding true. Overall, I think everything we are hearing is positive and we are moving forward as planned.

Q: I have one point on the payer problem…

Comment: You don’t want to talk about the 35% growth or the 20% year-over-year?

Q: It really gets down to that. We want to be able to understand all of the details to see if this really is just a speed bump for a company that’s growing it’s main product by 35%. The next level of detail that I want to address is based on what you were saying earlier – that this affected all pumps. You have the distributor’s contract as far as OmniPod goes, is that what I’m hearing?

A: It’s a distributed contract. I’m not sure that it affects all pumps – I want to be cautious about that. It does take other pumps.

Q: To correct this, do you need to correct it for all of the pumps that are involved, or can you focus and get this taken care of just for you, so that you are dealing with the things you can control?

A: We are dealing with the parts that we can control. The benefits we have is obviously that we have a separate coding structure than most of the other companies. Although there is seen to be a little bit due to activity on our course by others – which probably caused a little bit of their inks and was unexpected.

We can work through our codes in our parts, and, ultimately, you’ll figure out how to get them a little more comfortable that the patients that are being pushed through our distributor partner are the right patients.

I think one of the questions they are holding is really around medical necessity. In patients with type 1 diabetes, medical necessity is pretty well documented. We just have to make sure we’re clear with people – and clear with the specific provider – of who these folks are, why they need the product, and what do they need to be able to make those approvals in a more timely manner?

Comment: That’s the part that is a little bit of a head scratcher – the DCCT has been around for over 20 years, and there is medical necessity that’s virtually irrefutable for patients with type 1 diabetes. I’m wondering whether or not we are throwing out the bath with the bath water? Or is there somebody who’s got their number next up?

A:  I think we’ve adequately described what it takes to correct this. I think the situation as is as you described it; there is some higher priced products coming into the market that seem to be slipping in to various codes.

There seems to be some lower-end products for patients with type 2 diabetes products that try to kind of slip in under some of our codes. The patients with type 2 diabetes and the higher-end products I think sent this provider, to say the solution is we shut the door and then we'll get everybody to come to us as opposed to asking the question. It's kind of seems to be the efforts they took; it wouldn’t be my preferential approach, but it does seems to be the one they took. Getting the reimbursement cost us a few weeks here in the quarter for getting the reorder turned back on, which is a pretty straight-forward process. We think once some of this gets cleared up here, we'd be able to get this turned back on.

The only thing that was kind of really unusual for us is we started getting customer calls, which led us to call our distributor partner, which led down to call the managed care provider - which is the method I just described to you. That took up some time in the quarter, and we’re working as fast as we can to straighten this out.

Q: I think you’ve said there is ~$10 million of impact on the full year – is that roughly spit across Q3 and Q4, the residual after the $1.5 million.

A: I think it’s pretty much all inclusive. What we’ve said is that it could be p to $10 million. The guidance we’re giving you reflects that, and we’re hoping to get this cleaned up, and, hopefully, next quarter we can come back in and tweak it one more time.

A: Just to add to that, there are these new patient starts, and if you delay those, you delay the timing of when the re-orders come through. That’s the impact – it compounds a bit. The impact in Q2 is about $1.5 million, the impact in Q3 is probably around $3 million, and Q4 could represent the other ~$5 million – that’s in the worst case scenario if we really wound up with the whole $10 million.

Q: Maybe it’s hard to know, but if you lose some of these new patient starts, do you lose them for good to one of those other pumps that weren’t impacted? Or can you not tell?

A: I think it’s hard to tell at the moment. We know who these patients are now, so we’ve opened up a dialog with them. We’ll keep them in the loop. We’re trying to keep them as warm as you can keep them.

I think if it goes on a couple more week, we feel good. If it goes on eight more weeks, some people may lose a bit more interest. One thing that we have going for us is that people chose the OmniPod for the obvious reasons, and so to change to another pump is not something that we necessarily worry about. What we do worry about is if patients say, “I’ll go back to MDI, and I’ll revisit this at the end of the year right before my deductible reset.” I’m not sure we would lose them to another pump, but we may lose them back to their current treatment.

Q: Can you give us a little more granularity on when in this quarter you became aware of this issue and when you were able to start dealing with it?

A: It looked like it happened really in the beginning part of May, but I would say we really didn’t become aware of it until the earlier part of June. I would say really the second week or so in June.

Q: You said gross margin is 200-300 basis points per quarter – is that corporate or OmniPod?

A: That is consolidated. The OmniPod is certainly driving it, but on a consolidated basis between 200-300 basis points per quarter.

Q: Is there any change in OmniPod pricing or utilization for patients separate of this payer issue?

A: The pricing continues to hang in there in the $27-28 range where it has been for the last probably six to eight quarters. With the exception of the patients who were clearly delayed out a few weeks, utilization seems normal.

Q: You have $175 million in cash just turned operating profitable and sustainably well. What do you see doing with that? That’s a fair chunk of cash to have sitting around.

A: Subsequent to June 30, we effectively used about $35 million of that cash - $28.8 million to retire effectively the last part of those 3.75% notes that happened on July 28. The $5 million BD payment happened the first week or so of July.

The number bounces back to about $140 million, which is really where we began the year. We have many initiatives on the plate; I put this in the good problem to have category. We’ll see how the business continues to evolve and develop, and I think you have debt outstanding, and we’ll continue to monitor or manage those.

Q:  Any update on when we might see human data on the CGM partner?

A: We’re full systems go, we’re still trying to get ready for human trials here in the beginning of 2015. That’s a reasonable timeline to think that some of the data will go alongside that trialbut if some of the data will go alongside that trial.

Q: It sounds like your expanded agreement with Dexcom is somewhat dependent on the Gen 5 timeline, but when are you expecting to file approval for the next-gen PDM? You said you would have it on display at ADA next year. Also, does that become a PMA because it will be able to display CGM data, or does a cell phone create redundancy that keeps it a 510(k)?

A: Obviously we have to take that trip with the FDA to your second question. I think form our standpoint, and from talking with the Dexcom people, their app is a PMA. Our argument would be quite simply that if you can display the app on the cell phone – which is obviously not an FDA regulated device – in our logic, there seems to be no reason why our handheld wouldn’t remain a 501(k).

We’ve talked to a lot of people down at the FDA. As you can imagine, with all of these apps and everything else going on, the FDA has the people at the ADA listening to them. Unfortunately, because of this call, I wasn’t at AADE. If there was anything being displayed there, the FDA will also be there. It’s changing fast and furiously. I think they’re trying to embrace the new technology. We feel that we have a very strong argument for why the handheld doesn’t have to be a PMA. In all honestly, if the handheld does have to be a PMA, it’s not the end of the world. IT only becomes a problem if the OmniPod were to be a PMA.

That’s when we talk about integrating sensing technology into an OmniPod. When the time comes we have to have it perfect. We think it may be a 510(k) because if you can display it on a cell phone, then our next generation product isn’t much different than that.

That’s how we are looking at it. I think the big update for us is that the ADA next June in Boston is going to be where we’ll be able to give you a good idea of a timeline and, hopefully, display this next generation product. We’ll have a much better idea of the regulatory process at that time. Being a Boston-based company, that would be a nice coming-out party for us. We don’t have the timeline yet – the FDA is a big part of that.

Q: The 20% of your patient adds is pretty solid, even with this issue in the backend of this year. Are you seeing anything new in the competitive landscape? Tandem had a pretty good quarter, and you also mentioned increased activities from other new players – can you comment on anything there?

A: From our standpoint – and this sounds like a broken record – we fight for mindshare at the doctor’s office. You either want tubing or you don’t want tubing. If you don’t want tubing, then we’re the product. We don’t really compete with the 800-pound gorilla in this space. We fight for mindshare at the doctor’s office, which isn’t really product related.

With the addition of these 20 new reps, this is really the first full quarter that they’re here in the field, and driving new referrals, we’re seeing an uptick in the pipeline. The sales team overall is very engaged. I think they are excited about the new resources; they’re excited about the new OmniPod in their bag. I think overall, we feel pretty good. It’s unfortunate that payers should cause a little drop in our kind of patient conversion at the moment just to get some of those people over the goal line, but we believe that that is temporary and that our pipeline is still very full.

We’re feeling very bullish about the second half of the year and the 20% new patient adds, even given this issue given the size of the payer. We’re still pretty happy about it.

Q: So it’s fair to assume then that the change in guidance reflects really only this issue and the underlying strength of the business is unchanged or on track with what you expected?

A: That is 100% accurate, yes.

Q: Could you tell us what the new patient starts would have been this quarter if you excluded the payer issue?

A: I’d rather not get into taking these numbers and subtracting that. We’re so far year-to-date up about 20% in total; we’re on track for a solid A2 as I talked about at previous conferences. We’re expecting that we’ll be able to continue to hang right around this 20% number a little better throughout the back half of the year.

Q: Should we assume that the 25% number is now off the table for 2014?

A: I think we’ll have to see exactly how this issue resolves, but we’ve adjusted the guidance down the amount we think appropriate to account for this specific issue.

Q: Even with this issue, you are coming very close to profitability. How are you thinking about profitability in 2014 vs. 2015? Are there any benefits for pushing at 2015, and how should we be thinking about shares and the tax rate once you become profitable?

A: We have $56 million shares outstanding. There are certainly some options and other things out here which are all disclosed in the SEC filings. The only other big thing that's out there is obviously this new convertible debt issuance that we did in June; those numbers are all out there. One of the nice things about the convertible debt issuance was that we were effectively able to take dilution down by about 20% as compared to where the old one. So at some point this actually did convert, which is really not the goal of these. It still would have saved about a little over 20% of what the original amount of shares were.

In regards to profitability – again I'll put these into the high-class problems – and turning profitable is ultimately a goal. We will get there. We were operating profitable in Q2, if you back out the BD lawsuit. We'll continue to be operating profitable for the back half of the y ear. There is some of this non-cash expense that goes through; we'll see exactly where it lands. We have a lot of NOLs; we won't be paying Uncle Sam specific – writing a check that much for quite a while to come, but more to come I guess around tax rates and other things as we get further down the line.

Q: You have talked about additional indications – specifically with Amgen. Do you have any update on when we could hear on that? Also, do you have any news of other potential partnerships?

A: On Amgen, the partnership is going very well. It's fair to assume that until this first one gets over the goal line and completes, and we actually get it into the marketplace, we are not going to really move forward with additional projects.

After several conversations with Amgen, we feel like there are good opportunities there and believe the partnership will expand. However, obviously getting off the start line here on this first one in a positive manner will go a long way to making sure that that happens.

That said, since the press release announcing the Amgen partnership, we've had a lot of in-bound inquiries asking about our product; we’ve had several meetings, several calls, and several different exploratory agreements in place where we are working on other initiatives now, and have some other interesting items here in the pipeline.

A: It's to the point now that we're actually out actively recruiting a business development person for that business. I think the best way to describe it is that the phone rang, we answered it – the phone’s ringing a lot, and now we’re actually taking the next step; we’re going to invest the money in terms of a business development person to help us start looking at these opportunities and sizing them up.

We're excited about it. There seems to be a significant amount of interest. Corporately, we're ready to invest in another person. Right now, we now need more feet on the street to really start qualifying this.

Q: The new 20 reps, when did they hit the ground and when do you expect to start producing some returns? Should we start seeing some effect in the back half of the year?

A: Of the 20 people, basically half of them have hit the ground in the first week of may, the other half hit the ground in the first week of June. Again, they averaged half a quarter, basically just the amount of time to probably learn how to drive to various places they were going to. Even with that, we did see a bit of an uptick in these Key Account Manager territories vs., if you will, standard territories. They were up about 10% one vs. the other, which is a positive. We’re still seeing that momentum going into Q3. I believe we will see some positive impact out of these folks in the back half of the year.

Q: Is there any implication or related impact for your pending type 2 diabetes launch with Lilly next year?

A: If you remember what we’ve said, I’m not sure just having a pump for type 2 diabetes and going into that marketplace is what you will get reimbursement for. When we go with Lilly and the drug, we get a full-blown clinical result, and this is a subset of patients with type 2 diabetes that are highly insulin resistant and typically have failed at everything else.

We feel confident, but we think the medical necessity hurdle will be lots of paperwork; there will be a lot of that, but we’re pretty confident that this it the last top on the train for many of these patients. We think it will be very well received. However, I think you have to approach it from the standpoint of how big diabetes is, how expensive it is – it has the potential to bankrupt the US as well as the rest of the world. I think you have to go out with a real clinical impact. That’s what we proposed from day one.

Q: Last week during BD’s financial call, it said it was ending its CGM program because of technology failures within human testing. It seems like this might add one more risk to your all-in-one OmniPod and SGM. Are you thinking of working with Dexcom on the all-in-one, now that you’re working with them on these other developments?

A: We would take nothing to the table. We would work with anyone that has a sensor. I think we’re in lockstep with Dexcom – we wanted to do short-term, and we continue to talk to everybody about what we want to do long-term.

Having said that, I think where we are is that we really do believe in the sterility issue; we do think that there are products out there that can survive this sterility issue. We think that this is an all-in-one app; if you think about where medicine is going, we are talking about adding a sensor to our product. However, we have the base, we have the insertion system, we have the power, we have the communication. We think this will be an incredibly cost effective way to incorporate continuous sensing for insulin dependent patients into an OmniPod, and we approaching it cautiously. We are not running down the street telling everyone we think we have it worked out; however, we are listening and talking to everybody about sensors we have tested. We are moving forward and talking to all those people we think this will work with. We still think that standard of care is someday going to be one thing on the body and one thing either on your phone or on your hand.

Q: Medtronic was going to pursue a disposable pump; is that helping at all in the fields? There may be some who wanted to stick with Medtronic given that they can provide durable today and down the road disposable.

A: Once again, I think it’s depends on the particular end. I’m not going to say that it does – it does not help, I think, from our standpoint. I think what’s pretty competitive in the marketplace is fighting for mindshare in the office. They will morph into whatever the new message is, and they will go back into those offices with that new message. We heard them and will take them at their word. What we are going to do is keep driving hard and, as far as we’re concerned, they are guy to beat.

Q: You’re looking for margin improvement on the second half of the year. What makes you feel comfortable that you are actually going to be able to achieve that goal you set for yourself?

A: At this point, we are locked and loaded. We’ve continued to work with our supply chain on the bill of materials as we work out way through the volume curve. We have a very clear path on kind of reduced, continuing to take costs out of the product. That should drive us the additional 400 to 600 basis points of gross margin we expect to see in the back half of the year.

Q: On the sales force, is the 10% bump just a bump or is that something you will continually leverage over time? Do you see your Key Account Managers getting into a larger proportion of accounts that you have? How do you see that program building?

A: Right now we’re sitting back watching the testing. We like everything we see. What drove us to make this particular decision last year was that we tested in one particular area just to make sure it was the right approach. So what really drive it with some of these Key Accounts is that when the sales representatives have a great deal of success and can no longer expand beyond their current installed base. That’s because there is a correlation between spending time in the doctor’s office and really developing a relationship with them. We’re going to watch it, we’re going to continue to watch it, and it is a program that I think overtime will continue to expand if we keep seeing the results we are seeing.

Q: Are your Key Account Managers going to your largest most important accounts at this point, or have you see a sort of gross slowdown because the sales people there have already gotten to a point where they can’t get much further?

A: We have sales representatives going into a territory that has been wildly successful. All of a sudden, 40% of their business is coming out of three accounts. What you see is the territories that the sales representatives has to back off and spend more and more time there.

What we are doing with those accounts is we’re brining this person to maintain the relationship. We have a clinical specialist, and the Key Account Manager because the farmer, and the sales representative goes back to being a hunter in the territory. We can do that because we’ve been at it a long enough time. In every territory we have 20 top accounts, and then the next 20 accounts, we evaluate where business is coming from, and we evaluate how much time the sales person is spending in those particular accounts.

We have developed a little bit of a model – we can see the relationship between time spend, orders coming out of the office, what the potential office is. That’s how we drove the first handful of Key Account Managers. Like I said, once again we are monitoring it. If it continues to be a successful program, we will obviously roll it out in other areas.

Q: You’re gave generalities for international growth YOY – was it up 100%, 50%, 75% for a nominal dollar amount. Can you give us an idea of what that is? My second question is all modeling related – what was the old NDI business in the quarter?

A: The Neighborhood business was effectively flat with where they were in Q1, and the international feet is on pace to double for the first year. That’s were they’re kind of continuing to track. I probably shouldn’t get more specific than that.

 

-- by Adam Brown and Kelly Close