Dexcom 4Q14 – Sales of $84 million rise 64%, net income for first time; Gen 5 filed with FDA; Share receiver ships in March – February 25, 2015

This afternoon, new Dexcom CEO Mr. Kevin Sayer led the company’s 4Q14 financial update, his first following Mr. Terry Gregg’s transition to Executive Chairman on January 5. Confident on all fronts, Mr. Sayer characterized 2014 as “an amazing year all the way around” – Dexcom saw $100 million in revenue growth, improved profitability, brought CGM pediatric approval to virtually all children, launched the G4AP algorithm (industry leading single digit MARD), and came out with the Dexcom Share cradle, “even though we rendered it obsolete three months later with the Share receiver.” A huge year indeed! The call’s highlights, pipeline summary, and a very insightful Q&A are below.

Financial and Business Highlights

1. Dexcom reported strong 4Q14 product revenues of $84 million, a striking 24% sequential increase from 3Q14 and a 64% year-over-year rise – this had been reported at JPM, as a reminder. This now marks seven consecutive quarters of 60%+ YOY growth. Full-year 2014 sales of $257 million increased 64% from 2013. In 2015, management expects revenue of $340 million-$360 million, representing growth of 32%-40%.

2. Dexcom was GAAP profitable for the very first time in its history (!), reporting a net income of $1.3 million in 4Q14. Said CEO Kevin Sayer, “Our business model is achieving the success we have always envisioned.”

3. Dexcom’s sales force will expand ~20-25% in 1Q15 (~20 people). Management sees awareness as a “tremendous opportunity” for future growth, particularly with HCPs.

4.  Access – Dexcom is currently in discussions with several major payers to migrate CGM to a pharmacy benefit. We anticipate patients would be very happy with this. On CMS coverage, Dexcom is planning a clinical study to obtain an insulin dosing claim; discussions are still ongoing with the FDA, with more clarity expected by August.

5. When asked about Abbott’s FreeStyle Libre in Q&A, management referenced the absence of alarms and the manufacturing challenges in the early days of the launch.

R&D Highlights

6. Dexcom has plans to launch five products in 2015, and depending upon execution, that number could rise to ten! This should include the Share receiver, apps for the Apple Watch and Android, and more.

7. Dexcom has filed the G5 mobile system with the FDA, and management is cautiously optimistic for approval before year-end. G5 includes a new Bluetooth transmitter, an iPhone mobile app, and an optional Share receiver. An Android app is in development.

8. Dexcom’s G4 Platinum Share receiver with built-in Bluetooth secured FDA approval in January; launch is still slated for early March. In-warranty users will be able to upgrade to the Share receiver for $199; those purchasing a receiver this year or who bought the Share cradle will get a free upgrade.

9. Animas has initiated shipments of the Vibe in the US, and Tandem is preparing for a commercial launch of the t:slim G4 in 2H15. There were no comments on the Gen 5 integration partnerships with Insulet or Asante. Dexcom definitely plans to be involved in artificial pancreas efforts; in what extent remains unclear.

10. Following on JPM 2015, management again highlighted the new insertion system and Gen 6 sensor. No timing was shared, but these have major product and business advantages.

Financial and Business Highlights

1. Dexcom reported stellar 4Q14 product revenues of $84 million, a striking 64% year-over-year (YOY) rise and a 24% sequential increase from 3Q14. This now marks seven consecutive quarters of 60%+ YOY growth (all following the G4 Platinum launch in October 2012), and as shown in the graph below, an impressive J-curve sales ramp over the past two years. The 4Q14 performance was particularly impressive considering the challenging comparison to 62% YOY sales growth in 4Q13. Full-year 2014 sales of $257 million increased 64% from 2013  (another tough comparison to YOY sales growth of 69% in 2013). As management expected in the 3Q14 call, 2014 sales handily exceeded the $220-$235 million guidance.

• Looking ahead, management reiterated guidance issued at JPM 2015: sales of $340 million-$360 million in 2015, representing growth of 32%-40%; the lower growth rate is to be expected given the significantly higher base of sales. The company’s goal is 35-40% growth going forward, sustained through iterating new and better products “to increase the size of the addressable market.” We thought Mr. Steve Pacelli put this market expansion strategy (via new products) quite well in Q&A – with each new generation, Dexcom’s adds features and improvements that make CGM more attractive for a larger segment of the diabetes population.

Table 1: Worldwide Product Revenue

Figure 1: Dexcom’s Quarterly Worldwide Product Revenue (2007-2014)

• Echoing comments from JPM 2015, Mr. Sayer said that Dexcom’s patient base grew over 50% in 2014, meaning it totals roughly 90,000 patients right now (60% pumps/40% MDI). During Q4, the company added more new patients and sold more sensors than in any quarter in its history. Dexcom filled virtually every new patient order in the pipeline, so 2015 is on a clean slate. However, Mr. Sayer said that at the close of February, the pipeline of new patients is larger than it has ever been. So is the pipeline of patients interested in better glucose management – we heard at ATTD last week that Abbott had 50,000 people on its Freestyle Libre waiting list.
• Sales in the international business totaled ~$11.8 million, growing over 150% YOY and accounting for ~14% of worldwide product revenue. The company branched out into 10 new countries last year, most significantly Canada and India. While there is tremendous upside here, we acknowledge (as the company does) that India is challenging as there is literally no safety net – patients pay for everything with virtually no government support. Still, Dexcom has large reimbursement studies in Sweden and Germany set to take place in 2015 and reimbursement is already strong in some of the smaller countries like Belgium. Efforts are also ongoing in Japan and China, though the challenge with the latter is determining which product to seek Chinese approval for (this company’s pipeline moves pretty fast!). Dexcom only has four international employees, though as we understand it, there are plans to hire a healtheconomics expert to further drive reimbursement, as well as a clinical research expert. To date, the company has taken a “shotgun approach” to the OUS market, since countries are cash pay (i.e., more countries equals more cash-pay patients and more revenue). Once reimbursement starts to come through, there could be “some significant pickup.” We do also believe in Europe that the sales cycle may lengthen with Abbott Freestyle in the mix.

2. Dexcom was GAAP profitable for the very first time in its history (!), reporting a net income of $1.3 million in 4Q14. Said CEO Kevin Sayer, “Yes, it has happened. We have earnings per share!.. Our business model is achieving the success we have always envisioned. We are quite pleased.” The 4Q14 result compares favorably to a net loss of $2.6 million in 4Q13. Absent non-cash charges, cash operating income was $19 million in 4Q14, which Mr. Sayer pointed out represents 23% of sales. For the year, Dexcom reported a net loss of $22 million, though the company had $59 million in non-cash expenses; absent these charges, cash-based operating income was $37 million for the year. Mr. Sayer put this into perspective – revenue grew by $100 million in 2014, and Dexcom dropped $37 million to the bottom line. “Our business model is truly scalable,” he said. It’s a “stretch goal” to be profitable for all of 2015, though Mr. Sayer cautioned that the high stock-based compensation expense “is not going down.”

• Gross margin was 70% in 4Q14, a marked rise from 68% in 3Q14 and 66% in 4Q13. Dexcom is now hitting its gross margin targets of 70%-75% on sensors and 50%-60% on hardware. There may still be some room for improved margins as volumes increase, manufacturing improves, and cost savings come through in future product designs (e.g., the new applicator will have fully automated assembly). In the first quarter, the financial impact of the Share receiver upgrades (shipping in March) will reduce product gross margin sequentially, but a return to normal is expected throughout 2015.

3. Dexcom’s sales force will expand ~20-25% in 1Q15. As of the last update, Dexcom had a field sales force of 90 reps, which means the expansion will add ~20 new members to the team. Management sees awareness as a “tremendous opportunity” for future growth. Notably, Dexcom saw more than 8,000 physicians prescribe at least one CGM system in 2014 – though the company has several high prescribers (“champions”), there are many doctors who only prescribed one or two systems. The hope is the larger sales force can increase the frequency of prescriptions from the entire spectrum of physicians. The efforts on pharmacy distribution (see below) should help improve the hassle factor for doctors to prescribe CGM.

• Dexcom also expects to grow direct-to-consumer advertising – certainly, the Share receiver, the Gen 5 mobile platform, and Android app offering should be highly marketable products. Anecdotally speaking, out of all the diabetes-related Google ads we receive, Dexcom’s are among the most common.
• On a related note, Dexcom has acquired an additional 90,000 square-foot facility in San Diego to support expansion.

4. Management highlighted both pharmacy distribution and Medicare reimbursement as key access priorities. Comments from Mr. Sayer were especially positive on pharmacy distribution, “We really have a mission to go this way. It’s going to change our business processes. We see our company in a far different place in three years.”

• Migrating CGM to a pharmacy benefit: In 2014, management said it laid a foundation through “several key PBM and regional contracts.” Dexcom is currently in discussion with several major payers and will give additional detail in future quarters – management said it is getting “a lot of traction here” and it sounds like negotiations are in the works. The company’s long-term goal is 70% pharmacy / 30% DME, though it will “take a long time to get there” – management did not share the current split, but we assume it’s ~5-10% pharmacy right now. The advantages of pharmacy distribution are numerous, including less paperwork for providers, much easier pickup and lower copays for patients (like a drug), and lower hassle for Dexcom on the infrastructure side.   
• Medicare reimbursement: Dexcom is planning a clinical study to obtain an insulin dosing claim, though discussions are still ongoing with the FDA; management expects to have a lot of visibility by the 2Q call in August for Q2. The company has a number of meetings with the Agency between now and the end of 2Q to put this trial together – said management, “They want to help us. We’re going to get there.” It’s “not going to be a small trial,” as Dexcom plans to test a variety of things (not specified) in different patient populations. Given the mid-term elections, the Medicare CGM bills in Congress did not make it past the introduction phase. Dexcom expects reintroduction of the bills in early 2015, though the company is not relying on the legislative efforts alone.

5. When asked about Abbott’s FreeStyle Libre in Q&A, management highlighted the absence of alarms and the manufacturing challenges in the early days of the launch. Mr. Sayer acknowledged that “Abbott is a formidable competitor,” though FreeStyle Libre’s absence of alerts and alarms makes it fundamentally different and more limited than CGM. Mr. Pacelli added that alarms at night are “particularly important” for intensively managed patients, something the Libre does not have (though it does capture data at night, provided the reader is scanned upon waking). At this point, Dexcom primarily sees FreeStyle Libre as an “interesting product for the type 2 market” – we would note that based on commentary at ATTD 2015, it sounds like many type 1s in France have latched onto the product as well. Dexcom management also wondered whether Abbott has encountered some manufacturing challenges with factory calibration, given the capacity constraints stemming from extremely high demand. It’s hard to have visibility on that front, though excitement is certainly high in Europe about this product, and it most certainly has the attention of Abbott CEO Mr. Miles White. We agree with Dexcom that FreeStyle Libre is different from CGM, but there’s no question that the two technologies have lots of overlap, and patients may choose one over the other for different reasons. Certainly, MDI users don’t have all the features on a pump, but MDI therapy is still the “competitor” to pump therapy; a similar argument might be made for CGM vs. FreeStyle Libre.

R&D Highlights

6. Dexcom has plans to launch five products in 2015, and depending upon execution, that number could rise to ten! For comparison, the company launched five new products in 2014 vs. zero in the prior two years combined. Some of the potential 2015 products could include: Share receiver (March), Dexcom G4AP algorithm in pediatrics, Android version of Dexcom Share, Apple Watch version of Dexcom Share, G5 mobile system (by end of year), and presumably other apps or download software (SweetSpot, Tidepool, Glooko, etc.). We’re not sure what else the company has in store, and assume the pump partners – Animas Vibe (launched in January) and Tandem t:slim G4 (launch in 2H15) – are not included in this tally.

7. At long last, Dexcom has filed the G5 mobile system with the FDA, and management is cautiously optimistic for approval before year-end. The timing was right on par with expectations in the 3Q14 call. This would represent a remarkably fast PMA review time for a product as significant as Gen 5 (bringing CGM data straight onto the phone, no receiver required), though Dexcom has already done a lot of the legwork through the approval of the Share system. Dexcom has plan to introduce Gen 5 in major OUS markets, though timing will be discussed in the future. Gen 5 will launch on the iPhone to start, though Android is in development. A goal with Gen 5, said management, “is to truly make the cell phone the center of the diabetes universe.” 

• As a reminder, Gen 5 includes a smart Bluetooth transmitter and a mobile app (iPhone to start). The transmitter will be able to talk directly to the Dexcom app running on a nearby iPhone, eliminating the need for a receiver. Notably, the transmitter has the ability to speak to two separate devices via Bluetooth (e.g., the Dexcom app + the Share receiver, a smartwatch, etc.). Said management on the call, “Glucose when you want it, where you want it” – a nice tagline. The Share receiver with built-in Bluetooth (see below) will be optional, though necessary for those on Android or those who don’t want their CGM data on their phone. The app will connect to the cloud and caregivers will have access to the already-launched Share remote monitoring system (up to five followers can receive alerts/notifications of CGM data). Otherwise, Gen 5 will use the G4 Platinum sensor and the just-launched G4AP algorithm. Once Gen 5 rolls out, Dexcom will be able to run real-time analytics across its installed base – that should bring tremendous insight into how CGM is being used in the real world.
• Dexcom conducted “many, many hours of human factors studies” to develop and refine the G5 mobile app’s user interface. Mr. Sayer said it is “completely different” from what current patients experience, and it “looks like other apps in the mobile environment.” We agree based on screenshots shown at JPM 2015. 
• This project has been a long time coming – the first public mention of Dexcom’s Gen 5 mobile system came at JPM 2011, which speaks to the challenge of taking Class III medical device data and sending it to a smartphone (non-dedicated medical device). In addition, communications protocols have been in flux for a number of years, and the emergence of Bluetooth LE as a stable and strong platform has been relatively recent.

8. Dexcom’s G4 Platinum Share receiver with built-in Bluetooth secured FDA approval in January; launch is still slated for early March and all patients will receive this one moving forward. The receiver will be identical to the previous G4 Platinum receiver, but the addition of built-in Bluetooth means it can communicate wirelessly with the Dexcom Share app on a nearby iPhone/iPod touch – no docking cradle required. From there, parents and caregivers can remotely follow patients’ CGM data using the Dexcom Follow app. [And as noted in diaTribe’s test drive, patients will be able to “follow” their own CGM data, provided they run the Share and Follow apps simultaneously.] The PMA supplement was approved in under 120 days (!) and follows on the heels of the original Share docking cradle/app approval in October. Android apps are expected later this year.

• In-warranty users will be able to upgrade to the Share receiver for $199. Dexcom is offering free upgrades for those who purchased the $299 Share docking cradle, as well as anyone purchasing a receiver in the first quarter of this year. We continue to admire Dexcom’s sincere effort to make upgrades affordable, given the cost of CGM.
• Dexcom had always planned to give patients a backup receiver with Gen 5, and the new Share receiver will now serve as that backup. This should enable a very seamless upgrade process, since all patients will be on the Share receiver moving forward. Once Gen 5 launches and the new transmitter comes out, patients will simply need a remote software update to make the Share receiver compatible.
• The call only mentioned developing for the Apple Watch in passing. As we reported earlier this month, a Dexcom app should be available around the time of the watch’s launch in April. The remarkably fast timing is possible because the Watch app will function as a secondary display for CGM data, and will therefore not require FDA pre-market review (consistent with the downclassification that came along with the FDA approval of Dexcom’s Share receiver on January 23). In this first iteration, the Dexcom app for the Apple Watch will utilize the existing Share system – the watch will communicate with a nearby iPhone, allowing parents and caregivers to remotely follow patients’ CGM data on their wrist (and as noted above, patients could “follow” themselves and get their own data, pre-Gen 5).  With Gen 5, CGM data will go straight to the iPhone app from the transmitter (no receiver needed), and then to the watch. 

9. Animas has initiated shipments of the Vibe in the US, and Tandem is preparing for a commercial launch of the t:slim G4 in 2H15. Both were on par with previous expectations. Regarding the Vibe, management said that “patients are quite pleased” with the user interface – you can read diaTribe’s test drive here. As we noted in our Tandem 4Q14 coverage yesterday, the FDA has completed a site inspection for the t:slim G4 PMA filing, and Tandem was encouraged by the outcome. Neither pump is compatible with the new G4AP algorithm, and neither will be compatible with the Gen 5 Bluetooth transmitter. We continue to assume that Dexcom will make two transmitters: one to support Gen 5 (Bluetooth) and one for the G4 pump partners (Tandem and Animas) and international businesses. There were no comments on the Gen 5 integration partnerships with Insulet or Asante.

• “From a revenue generation perspective, we’re treating the pump companies as additive vs. transformative.” Given Dexcom’s fast growing base of sales, this seems sensible, and we have indeed noticed the company downplay the importance of these partnerships over time. On recent earnings calls, the pumps rarely get more than a few sentences in prepared remarks.
• “We will continually evaluate our own path to the artificial pancreas closely. We have the world’s most accurate and reliable system. We intend to play in this arena.” This remark by CEO Kevin Sayer continued some of the positive remarks from JPM 2015 – the question going forward is how the company will engage with the various efforts out there. Tandem announced yesterday that it has started an artificial pancreas R&D project, with plans to use the Dexcom sensor (we assume Gen 5); still, an IDE filing is slated for 2H15, meaning commercialization is likely in the late 2017 timeframe at the earliest. Meanwhile, we wonder if/how Dexcom could engage with academic players like UVA, the Bionic Pancreas, and the DREAM group, who are all thinking about regulatory and commercialization. Said management in today’s call, “We haven’t found anything we want to commit to yet.” It’s definitely a wait-and-see at this point, though Medtronic has definitely made the field stand up and take notice with its ambitious JPM 2015 timelines: MiniMed 640G (predictive low glucose suspend) in the US by April 2016, MiniMed 670G (hybrid closed loop) in the US by April 2017.

10. Following up its JPM 2015 presentation, management again highlighted the new insertion system and Gen 6 sensor. A major goal of both efforts is to automate more of the manufacturing and eliminate some of the variables that hurt yields and lead to outlier sensors. The hope is for a trifecta: improved sensor performance, reduced calibration, and better manufacturing margins. It’s not clear if the new applicator will come before or after the Gen 6 sensor. CEO Mr. Kevin Sayer called the new applicator “by far and away the most complex” of all the operational improvement efforts.

• At ATTD 2015, Mr. Jake Leach (Senior VP of R&D) showed encouraging topline data on the Gen 6 sensor from a 40-patient study (more than we recall seeing at JPM) – a single calibration at startup (two BGM values) resulted in an 11.7% MARD vs. fingersticks (days 1-7) and similar 12.1% MARD vs. fingersticks (days 1-10). The pilot study didn’t use YSI and values were blinded to patients, something Dexcom plans to change in studies going forward. Mr. Leach said the team is “very excited about the performance.” As we noted at JPM, this is slightly worse accuracy than G4AP (MARD: 9.0% with two calibrations per day), but the tradeoff of only calibrating at startup and a longer approved wear time is likely worth it. Gen 6 will block interfering substances with a new membrane, as well as employ new algorithms to detect more outliers.

Pipeline Summary

Questions and Answers

Q: As you look at, as you said, your stronger-than-ever pipeline for new patient flows, is the contribution there similar to 6-12 months ago or has it shifted more towards pediatrics?

A: We’re not going to break out the distribution between adults and pediatrics. At launch, we said that the education effort required with pediatric endocrinologists was slightly greater than we expected. Even the education of parents and patients with their parents was taking longer than expected. By Q2, we felt that had normalized. What we said then was that we were tracking to what we thought was the ratio of adults to pediatrics in US – roughly 25% of new patient adds at that time. Internally, to us, a five-year-old, a fifteen-year-old or a fifty-year-old are the same thing. Our pediatric adds are strong, and we’re quite pleased in the pediatric launch.

Q: Do you expect the insertion device to be available with the G5 platform?

A: Not initially. We like to lump things into generations, but, as you saw with the new algorithm, it might be in between generations. Gen 6 may or may not have the new applicator. It could come before or it could come after – there are a lot of moving parts. It’s definitely not going to be with Gen 5. Of all the things we’re doing operationally, that is by far and away the most complex. 

Q: How much leverage can the pharmacy benefit create on a standalone basis, a year in, when you’re fully implemented – obviously, you eliminate back-office functions and paper work. How does that mix look? You referred to some DMEs sticking around over time with some payers...

A: Our long-term goal is a 70%/30% split, 70% through the pharmacy, 30% through DME. It will take us a long time to get there. We have a lot of major discussions going on right now. We’ll give you more of an update after 2Q. People are very interested, and we’re getting a lot of traction here.

Q: Would that add leverage in the P&L, since you would need a smaller sales organization?

A: We’re not looking to add a bunch more bodies; we can keep staff levels much flatter. The tricky part is, if price erosion comes into play, how much price are we going to give up for the more leverage we obtain? We look at those questions all the time.

Q: Are you capped out until we move on to the Gen 6 on where we sit on the gross margin, or do you continue to get operating overhead leverage?

A: We can continue to get some overhead leverage as we increase volumes. Our volume increase last year was amazing, and that was very helpful in getting G4 sensors through the margin levels we obtained. I think overtime we are going to have to have new platforms and processes. We never thought we’d be above 80%, and we’re clearly in the 70-75% range on sensors now. I don’t know how much more we’ll get, but we’ll see where it goes.

Q: You mentioned there was going to be several one-time charges as you transition from the old receiver to the Share receiver. Could you ballpark what type of charge you’ll see in Q1?

A: Honest to goodness, we don’t have any idea. We have a lot of work before we get there – there are a lot of variables. Patients who want new receiver have to fill out a paper saying they want to upgrade, and we have to measure that response to how many. We also have to see what’s left in the distributor and manufacturing pipeline in terms of G4 write-offs. This is all very early on – we just got approval not too long ago; this is something we weren’t planning on discussing today.  You’re just going to have to give us some time.

Q: J&J stocked a little into the fourth quarter. Can you help quantify that? Just so we know what is normal throughput vs. one time up front from there.

A: J&J doesn’t stock anything. J&J does not serve as a distributor of sensors or transmitters in US. They supply the Vibe, and we support patients with transmitters and sensor disposables. There’s no stocking by J&J.

Q: Good. Who is handling back office, reimbursement? Are you handling the paperwork to get CGM approved? Then you are drop shipping to them?

A: That’s right. As it stands, we treat the patients as our patients from a CGM perspective. We serve all CGM needs, including technical support. We’re exploring some ways to make it more seamless, but as it sits today, that’s the path.

Q: Can you give us an idea of the number of patients you had at the end of 2014? 

A: [Laughter] That is spectacular, Bill. I’ll reiterate what we said at JPM. We grew our new patient base more than 50% last year. It was a great year for us.

Q: Tandem announced they’re going to go for a Predictive LGS or basal closed loop using the Dexcom sensors, presumably G5. Can you give us an idea of how that will impact the income statement, and how you’ll handle the patients?

A: This is a Tandem program, so we really cannot comment on specifics. We are a partner with Tandem and are supporting them with current sensor technology. At this point, we’re not prepared to move forward with the G5 with any partner, because we’re just filing it. It is largely a work in progress at this point. It does not have a meaningful P&L impact at Dexcom; this program is being driven by the partner.

Q: At ATTD, you presented information on the new Gen 6 sensor; a single calibration led to an 11.7% MARD on days 1-7 and a 12.1% days 1-10. Is that good enough to get patients to trade accuracy for fewer calibration? Do you need to come down further?

A: That’s a wonderful question. There are four things driving that decision: (i) Length of time; (ii) calibrations; (iii) performance over time; and (iv) how sensor works. We are working on a dosing claim with FDA. That will be our next tech advancement. We will work on making the dosing claim first, and then continue making sensors accurate enough to serve as a fingerstick replacement. Making no calibration sensors is pretty hard. You have to manufacture within a very, very narrow range. We had similar data with that system with no calibration, that we did not present. We’re going to weigh convenience, calibration, accuracy, and the labeling we want, over time. All those factors play together. As these guys will tell you, I’ll push them for more accuracy. I’m kind of a jerk when it comes to that.

Q: Abbott’s FreeStyle Libre is different from CGM. But it is still doing really well in initial launch, with a significant number of type 1 patients as the percentage of those using it. Have you seen this impacting European new patients. Is this an area Dexcom would be willing to get into?

A: We’ve long said that Abbott is a formidable competitor, and our view on that has never changed. Their system is not a CGM. There are no alerts and alarms; you don’t get the benefits that come with CGM there. We could certainly move to that space if we thought that was what patients wanted, and we could go to a phone instead of a handheld reader. Right now, we’re focused on intensive management – that’s what we do. We’ll watch it very closely. Obviously the form factor everyone loves; they love reduced calibrations. But we’ve heard other things; manufacturing no calibration sensors is very hard. If one in the lot works, they all work – we also heard they have many lots that don’t work and are not adding new patients to manufacturing difficulties. There is a lot of looking at it as we miniaturize our technologies, as we reduce calibrations, and as we go to our mobile platforms – we’ll be in the same space.

Abbott has done great job of creating hype in Europe. They have had a couple of recalls on the device. I understand there is a pretty significant backorder. There may be interest in the product but, I’m not sure that we have data to support that there are meaningful sales. Also, this is not a CGM. It doesn’t provide alerts or alarms. With the Abbott product, we’re going to miss any readings when patients are asleep. [Editors Note: FreeStyle Libre still captures data at night, but it does not alarm patients to lows or highs.] This is particularly important for intensively-managed, insulin-using patients. We said before that this could be an interesting product for the type 2 diabetes market. If this is something that Abbott figures out is an interesting angle in type 2 diabetes with distribution, payment, and education – remember patients with type 2 diabetes are typically seen in primary care or internal medicine – let someone else do some heavy lifting and develop a different category. Today, we’re going to focus on the insulin-using diabetes patients.

Q: Congrats on GAAP profitability. Is that something we should think about Dexcom achieving on an annual basis going forward?

A: That’s certainly a stretch goal for 2015. We had over $50 million in share based compensation in 2014. That number is not going down. We’ll look at it; we measure our results primarily on our cash-based performance. Over time, we know our stock based compensation will come down. That’s a stretch goal of ours. We’re also not going to let that deter us from all the things we want to. We grew $100 million in revenue and dropped over $30 million to the bottom line. That’s a pretty great year.

Q: If we use that metric, given increased spend tied to strong revenue growth, should we see that operating cash number increase significantly this year over last year?

A: We certainly hope so. That is our plan. We went from -$30 plus million in 2012, to positive $5 million in 2013, to positive $30 million in 2014. Our business model is truly scalable. What investments do we make? If we wanted to turn into a cash moneymaker, there are ways to do it – but that doesn’t position us for next half a billion in revenue. We have to continue to invest. But it’s a balance.

Q: Do your partnerships with Animas’ Vibe and with Tandem support the G4 AP algorithm? I think the answer is no. How do you see rapid adoption of artificial pancreas algorithm impacting those partnerships?

A: You are correct on the first – no, neither the current iterations of the Vibe or Tandem product when it launches will accommodate the G4AP algorithm. We’re cautiously optimistic that by the end of this year we’ll be on the G5 platform. I don’t want to comment specifically on how the new algorithm will affect the launch of the pump products. As we’ve said in past earnings calls and at past conferences, from a revenue generation perspective, we’re treating the pump companies as additive rather than transformative. We’ve downplayed them slightly, and they’re not really driving the topline in any significant fashion. I’m not that concerned about it to be honest.

Q: You’ve added more new patients than you ever had in the fourth quarter – I realize that’s becoming a bit of a trend. You also introduced the AP algorithm; do you think the algorithm was a key driver of new patient growth?

A: I think it helped, but I don’t think it was the key driver. I think we increased awareness. It certainly is an easy presentation to clinicians, to say, “this is more accurate than what we had before.” Most patients judge accuracy not from the book but on what they experience day to day. The algorithm does move quicker with glucose information - patients saw that and experienced it first hand. I think it helped, but I think it’s just increased awareness.

Q: Have you filed the algorithm for the pediatric indication?

A: We have.

Q: International, by our math, was just under $14 million for the quarter. Is that correct? You also mentioned adding more key international hires. Are you adding more to an existing team, or are you branching to new countries?

A: We’re going to do both. We branched out to 10 countries last year; our most significant new countries were Canada and India, near the end of year. We actually have an employee relationship in India that works with our distributor. We have four international employees. As I look at key hires, it will be to supplement what we have. In particular, a health and economics expert to drive reimbursement. Also, a clinical research expert as we do more trials overseas to demonstrate effectiveness. We have a couple folks lined up in that area, and that’s where we’ll start. All of our revenue internationally goes through distributors. We monitor that channel very closely and carefully.

Q: What percentage of OUS business is J&J or Vibe related?

A: We don’t break that out. J&J would never let us break that out.

Q: Is that a big part of the growth, or mainly non-J&J?

A: It’s certainly a part. We’re not going to give you a level of materiality. Our network of distributors is obviously a very important part.

Q: Looking at the G5, will that enable direct transmission from BGM to transmitter during calibration? Is it one way?

A: The transmitter can have two -way conversation. We have not written software to take calibration from specific meters. We could. I think as we look at horizon, we’d rather develop more apps for Android and watches, but we could look at it. And we want to get rid of calibrations.

Q: One benefit of Medtronic is that they have both the pump and the CGM and can work on products under one roof. It seems like they are moving a little faster than they have historically when working on diabetes technologies. At some point, is that something that Dexcom needs to start thinking about? Putting everything under same roof to move quickly and go after the artificial pancreas?

A: That’s a great question. As we sit here today, our message has been CGM first, and making CGM systems more accurate and reliable. Those make it better suited to work with the artificial pancreas. We’re very comfortable with the product pipeline. How do we play in sensor-augmented pump arena. As somebody said early, Tandem announced a [predictive low glucose suspend]-type device, and J&J has ongoing efforts. We won’t sit and let somebody else do this. If no one does this, we will get more involved. We haven’t found anything we want to commit to yet. We support artificial pancreas programs with sensors. We support our pump partners, but we are cognizant of this. We need to play here. We have best sensor in the world. Our patients are going to want this, and we’re going to have to offer them something.

Q: First another angle to one of the pharmacy channel questions. Is there a point where you need to be pushing a significant portion of business through this channel to maintain the service and processing support you need to service patients? Or is this something you think you’ll be able to stay ahead of in terms of visibility, in terms of internal resource requirements as you work through the process with payers.

A: We don’t want to build the infrastructure to support the business as it is designed today. We need to move the business through these channels. You can build building after building of employees in the DME environment, and that’s been one of Medtronic’s great barriers to entry in the pump world, and that’s why all the other pumps out there have trouble making money. It’s hard to replicate that structure unless you have a huge amount of revenues. We really have a mission to go this way. We need to make it more efficient. Think about our patients – they call us, get documentation; instead, [with pharmacy benefit] you can get a prescription, drop it off, and get it the next day. When it comes to reordering, if I have 30 days worth of pills, I start getting calls on day 27. I think it makes for a more efficient, better patient processing experience. We’re going to have to give up some control – which is very hard for me – but, in all reality, when that data is all going to the cloud from the phone, we’ll be able to track how many patients are using sensors and when they’re picking up for reorder. This data revolution is going change our business processes. We see our company in a far different place in three years.

Q: You talked about some specific reimbursement studies planned for Germany and Sweden. Are there any updates on these? Really, the question is on the cadence of incremental OUS markets that you’ll be opening up in the next 12-24 months.

A: Right now, we’re opening up smaller countries. We’re in most of the large countries. Certainly in Europe, very little in Asia – we have efforts in Japan. We’re trying to figure out what to take to China because we have to take an FDA approved product over there, but it takes some time to get approved, and we don’t want to bring a product that we don’t build any more. There’s a bunch of dominos that have to fall in place for China approval. We’ve taken a very much shotgun approach in these countries because there hasn’t been that much reimbursement – the more countries with cash-paying product, the more product we can sell. As we get reimbursement – hopefully in Germany, hopefully in Sweden, and other countries over the 18 to 24 months – you could see significant pickup. However, it will be a while; it is not going to happen overnight.

Q: Could you provide more color on the dosing claim? How should we be thinking about what type of trial that would require, from size perspective and endpoints. If we can’t get more color today, when could we expect more color on that?

A: We’ll have a lot of visibility by the call in August for Q2. We have a number of meetings with agency slated between now and the end of 2Q to put this trial together. It’s not going to be a small trial. We’re going to test a whole bunch of things in a whole bunch of patient populations. We’ve done a great job with FDA – it’s been very interactive discussion. They want to help us. We’re going to get there.

Q: With the G4, there was a big step up in new patient adds and the base is larger. As you guys continue to evolve the technology, how do we think about each next evolution starting with G5, G6, the dosing claim, and then calibration? Do you see a steady 35-40% growth? Could it be incremental to that? High level, how do we think about that and what could ultimately drive the inflection point, because at the end of the day, CGM is still at around 15% penetration in type 1s? As this technology moves along, I feel like it could be much, much larger than that. Is there any one obstacle you’d have to knock over to get it there?

A: You hit it on head. You said 35-40% growth. We never said we were going to sustain 60%+ growth. So let’s start with: We need to sustain 40% growth for the foreseeable future. So our real mission internally is over the next several years – two to three to four years – is to be able to continue that 35-40% growth rate. In order to do that, we have to continue to iterate new and better products to increase the size of the addressable market. The way I like to think about it is that way back in the STS3 days, back in 2006, the product didn’t work particularly well and there were, albeit, a very small handful of people willing to put up with a product that didn’t work particularly well. We saw much better performance with the Seven and incremental improvement in the Seven Plus that drove the addressable market to a much larger size. Now, with the G4 Platinum, that’s been a huge catalyst for growth in terms of new patient adds. But to sustain – just to sustain – this phenomenal growth that we’re seeing, you need to get to Gen 5 with our mobile platform. You need to get to Gen 6 to reduce calibration and the duration. You need to get to, call it Gen 7, 8, 9 to eliminate calibration, miniaturization, and new applicator. All of the things that we need to keep talking about in our near- to midterm pipeline, near- to mid-term meaning three to five years. We need to do all these things, in my opinion, just to sustain the growth that we’re trying to achieve. Could there be upside to the numbers? Sure. But I think we’re really targeting trying to do the things and iterate the technology in a way that we can assure ourselves that we can continue to grow at the rates we’ve been growing – or that rates that we’ve said we’re going to grow. 

Q: A follow up on calibration and accuracy. From a manufacturing standpoint, I imagine it would be a little higher-cost manufacturing endeavor. What is Dexcom willing to give up in terms of margins in order to achieve reduced or no calibration coupled with improved accuracy?

A: That’s a great question. Every time we make a sensor more accurate, we improve our margins. As we’ve had manufacturing improvements, they’ve been designed to be more cost-effective and produce more accurate sensors and produce better yields. I think the key to the no-calibration sensor is to have an extremely repeatable manufacturing process. As I discussed earlier, the Gen 6 manufacturing line eliminates some of the steps that cause errors or yield loss in the G4 system. It’s much more automated and much more advanced. There are more steps to automate in this process. So, I don’t think we’ll have to give up much on margins side. Particularly as we go to extended wear, then that becomes quite simple. If we have a 10-day sensor and we can build it at the same rate as the seven-day sensor, we can pick up some more margin and even include a little extra cost in that sensor if that’s what we have to do to get that label. I don’t view it as a tradeoff.

Q: How much room for expansion is there in the US as it relates to adding new practices? Can you provide an update on the average penetration of CGM into existing practices?

A: We have thousands, probably more than 8,000 physicians who prescribed one CGM system in 2014. We certainly have several “champions” and we consider “champions” a certain level of high prescribers. That number has gone up, but not as fast as we would like. We need to move everyone up further. Access drives a bit of that because if a patient can go to a doctor and get a prescription signed and go to the drug store and pick up a sensor, that will take physicians who have to spend an inordinate amount of time doing paperwork for the one CGM they prescribe and get them more accustomed to prescribing CGM for their patients. So, access is going to help with this. Our product improvements are going to help with this. You know that data on the phone and data on cloud-based platforms? If we can show the physicians, you can sit down and pull up Steve’s data on the computer without Steve plugging anything in to his machine, that’s pretty cool. That will help.

We call on every endocrinologist that we can. We’re very, very, very specific as far as calling on those who prescribe a lot of insulin and who have large practices. We’ve worked our way down the food chain. We’ve worked our way further down those lists as we get bigger every year and there’s still more room to grow. But at end of day, we still have too many onesies and twosies, and we’ve got to get out to these other guys and get them to increase what they are prescribing.

Q: I wanted to bring up a clarification on the Share ecosystem. Is that an open architecture where eventually that data can be shared with competing offerings? Or is the data that’s captured with Share only compatible with the Dexcom CGM and inaccessible to competing companies?

A: The data that is stored in the cloud from our Share platform is accessible only by Dexcom devices. We have made a lot of progress over the past few months with respect to data and possibly sharing data with others. We have not designed any agreements with anybody to let them access data in the cloud yet. We will consider it if it meets a patient need that we can’t meet and it’s something that patients want. We are open with respect to our architecture as we demonstrated with our relationships today. We will consider that over time, but we’re not going to run out and sign everybody up all over the world to distract from what we’re doing.

[Closing Remarks, CEO Kevin Sayer]: In closing, I want to address one of the frequent questions we hear as we meet with others on the outside: ‘Now that you’re in charge and Terry has graduated to Executive Chairman, what is going to change?’ It’s easiest to tell you what’s not going to change. That’s our commitment to our patients. Our patient first strategy has put Dexcom in a very enviable position. Even one of our competitors referred to our off-the-charts Net Promoter Score in one of their presentations at ATTD. Our passion for patients is what drives this company. That culture has been put in here by Terry and will never change. I’ve been very fortunate for the past three-plus years to become familiar with the intimate details of our company and helped Terry build an excellent team here. What’s different now is that our business is really undergoing major changes. You heard it in my prepared remarks earlier as we compared the number of product launches this year to our two previous years. We are much more complex, and in addition to our growth, the business has got to be scalable. With this great team we’ve assembled,  I am very confident that we can execute our very ambitious plans and achieve our very simple final goal: We want to replace fingersticks. Thanks everybody.

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