DexCom, Inc.

First Quarter 2019 Earnings Release Conference Call. My name is Adrienne, and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-answer session. During the question-answer session, if you have a question, please press star, then 1 on your touch-tone phone. Also, please limit yourself to one question and one follow-up question. Please note this conference is being recorded. I'll now turn the call over to Matt Dolan. Matt Dolan, you may begin.

Thank you, operator, and welcome to Dexcom's first quarter 2019 earnings call. Our agenda begins with Kevin Sayre, Dexcom's chairman, president, and CEO, who will provide a summary of the quarter, followed by a financial review and outlook from Quentin Blackford, our executive vice president and CFO, and then a strategic update from Steve Pacelli, our executive vice president of strategy and corporate development. Following our prepared remarks, we will open up the call for your questions. At that time, we ask analysts to limit themselves to one question and one follow-up so we can provide an opportunity for everyone participating today. Please note that there are also slides available related to our first quarter performance on the Deskom Investor Relations website on the Invents and Presentations page. With that, let's review our safe harbor. Some of the statements that we will make in today's call may constitute forward-looking statements. These statements reflect management's intentions, beliefs, and expectations about future events, strategies, competition, products, operating plans, and performance. All forward-looking statements included in this presentation are made as of the date hereof based on information currently available to Dexcom and are subject to various risks and uncertainties. and actual results could differ materially from those anticipated in the forward-looking statements. The factors that could cause actual results to differ materially from those expressed or implied by any of these forward-looking statements are detailed in Dexcom's annual report on Form 10-K, quarterly reports on Form 10-Q, and other filings with the Securities and Exchange Commission. Except as required by law, we assume no obligation to update any such forward-looking statements after the date of this presentation or to conform these forward-looking statements to actual results. Additionally, during the call, we will discuss certain financial measures that have not been prepared in accordance with GAAP with respect to our non-GAAP and cash-based results. Unless otherwise noted, all references to financial metrics are presented on a non-GAAP basis. The presentation of this additional information should not be considered in isolation or as a substitute for results or superior to results prepared in accordance with GAAP. Please refer to the tables in our earnings release and the investor relations portion of our website for reconciliation of these measures to their most directly comparable GAAP financial measure. Now I will turn the call over to Kevin.

Thank you, Matt, and thank you, everyone, for joining us. We are off to a great start in 2019 with much of the momentum that we experienced in 2018 continuing into our first quarter. First quarter revenues grew to $280 million, a 52% increase over the first quarter of 2018. Once again, this strong performance was broad-based as increased volumes in both our U.S. and OUS businesses drove results above our expectations. even as we absorbed the pricing headwinds that we have anticipated. We have spent years developing our innovative technology and demonstrating real-world clinical outcomes, and as awareness builds, demand for Dexcom CGM is very strong among both new and existing patients. We remain confident that the company is well-positioned to drive toward our long-term targets, particularly as we expand the rollout of G6, and improve access to CGM. With this growing demand in mind, we are on track to meet our goal of doubling our G6 capacity by the end of 2019. From a cost perspective, we are demonstrating good expense control, with revenue growth outpacing the increase in operating expense growth by more than two times. We continue to believe that patient outcomes demonstrate the true value of a CGM. In the first quarter, we showed real-world data that demonstrates the effectiveness of our urgent low soon alert in the G6, which provides an actionable warning in advance of a dangerous hypoglycemic low. Not only have we seen a further decrease in hypoglycemia among G6 users with this feature, but this has been achieved regardless of a user's frequency of screen views. We also showed a correlation between users of Dexcom's share and follow-ups and better time and range for children and adolescents with diabetes, once again highlighting the importance of this feature to our user base. It is outcomes such as these that have contributed to Dexcom's great reputation among clinicians and allow us to capitalize on the increasing global awareness around CGM technology. The kind of demand we are experiencing can also bring certain challenges. This is especially the case in the first quarter of every year as we must reconfirm benefits and document clinical necessity for each patient. The process can be burdensome at times, with our teams going back and forth with clinicians and payers on the patient's behalf. To our customers, we understand the fundamental importance of Dexcom CGM in your life and are working around the clock to make sure that you are cared for. We saw improvement in our ability to meet demand and serve our customers effectively. As the quarter progressed, I believe that the initiatives that we introduced to expand our customer support infrastructure are progressing well, with several areas showing meaningful productivity improvements. Considering the significant level of demand for Dexcom CGM and the strength of our first quarter, we are very pleased to be able to increase our revenue outlook for 2019. I will now turn the call over to Quentin, who will provide detail on this outlook, as well as a review of our financials.

Thank you, Kevin. As a reminder, unless otherwise noted, the financial metrics that I discussed today will be presented on a non-GAAP basis. Reconciliations to GAAP can be found in today's earnings release as well as on our IR website. Today we reported worldwide revenue of $280.5 million for the first quarter of 2019 compared to $184.4 million for the same quarter in 2018, representing growth of 52% on a reported basis and 53% on a constant currency basis, or $96 million of absolute dollar growth. Clearly, the growing awareness for CGMS continued into the new year. Geographically, U.S. and international revenues both demonstrated strong growth of 45% and 79% respectively over the first quarter of 2018. International revenues grew 86% excluding the impact of currency and reached 25% of total company revenues in the first quarter, representing a high watermark for the business in tracking towards the long-term expectations that we highlighted at our investor day late last year. We have seen continued success in shifting to the pharmacy channel consistent with our expectations at the start of the year, and we will continue to prioritize this initiative as we seek to drive improved access to Dexcom's CGM. Our first quarter growth profit was $168.8 million, or 60.2% of sales. The sequential decline from the fourth quarter of 2018 was consistent with what we have seen in prior years. Relative to the first quarter of 2018, gross margin was negatively impacted by incremental investments to scale infrastructure as we drive significant capacity expansion in 2019 and the continued shift in our mix towards the U.S. pharmacy and international business. As demand continues to exceed expectations, we are accelerating investments to increase capacity, which is putting some additional pressure on gross margins. We now expect gross margins for the year of 64% to 65% as we speed up our capacity ramp to meet the growing demand. We remain confident in our ability to bring costs out of the system as the year progresses and over the long term, beginning with the introduction of our new G6 transmitter and continued implementation of automation into the manufacturing process, which will allow us to exit the year with gross margins approaching 70%. These improvements provide us with the strategic flexibility to be proactive with payers and to navigate future uncertainties in the pricing environment as we continue to push for greater access to CGO. Operating expenses were $176.4 million for the first quarter of 2019 compared to $147.6 million in the same period last year. This reflects an increase of 20% year-over-year and compares favorably to our 52% revenue growth in the quarter, resulting in significant operating expense leverage from the prior year. Operating loss was $7.6 million in the first quarter of 2019 compared to $28.7 million in the same quarter of 2018. Our improved operational discipline resulted in a 1290 basis point improvement in operating margins from the prior year. Adjusted EBITDA was $26.1 million, or 9.3% of revenue for the first quarter compared to $4.5 million, or 2.4% of revenue for the first quarter of 2018. As we've said throughout 2018, we believe that there is an opportunity to drive significant operating leverage toward our long-term targets. and both our first quarter adjusted EBITDA and operating margin reflect great progress towards these goals. However, we are not pursuing this leverage at the expense of the growth in our business. We remain confident in the opportunity that lies ahead, not only for our core business, but also the application of CGM technology to new markets. We will continue to invest in these initiatives, our R&D pipeline, and other strategic opportunities in order to maximize Dexcom's long-term potential. Our net loss was $4.6 million, or 5 cents per share, and our balance sheet remains strong, having ended the quarter with approximately $1.4 billion in cash and equivalents and no barring against our $200 million revolving line of credit. As mentioned, we continue to prioritize investment into our capacity expansion initiatives and automation of manufacturing, which led to $39 million of CapEx in the first quarter. Looking at the remainder of the year, given the strength of our first quarter performance and the growing demand that we are seeing for Dexcom real-time CGM, We are increasing our full-year revenue expectations by $75 million and now anticipate total revenue of approximately $1.25 billion to $1.3 billion for the year, reflecting reported growth of 21% to 26%. As I mentioned previously, we anticipate full-year gross margins to approximate 64% to 65% for 2019, showing meaningful improvement in the back half of the year as we look to exit the year approaching 70%. We now expect operating margins of approximately 6% and remain comfortable with our original target of adjusted EBITDA margins of approximately 18%. Our restructuring efforts associated with setting up operations in the Philippines are progressing well with nearly 200 employees now on the ground in Manila. We have been extremely pleased with early indications demonstrating significant efficiency and scaling benefits. We now expect the restructuring-related costs to come in at approximately $15 to $20 million for the year, with the majority in the first half and now slightly below our original estimates. With that, I will now turn the call over to Steve for a strategic update.

Thank you, Quentin. As our first quarter performance indicates, global awareness and demand for real-time CGM continues to increase dramatically, not only in the U.S., but also in international markets like Germany, the U.K., and Australia. In February, Dexcom stood front and center at the annual Advanced Technologies and Treatments for Diabetes, or ATTD, conference, with Dexcom products utilized in numerous clinical studies and presentations from key leaders in the diabetes community. As anyone in attendance can attest, there is genuine excitement toward our efforts around decision support, app enhancement, and, of course, the G6 platform. The global rollout of G6 remains a key strategic objective in 2019. As Kevin noted, we are doubling G6 capacity by the end of 2019. Given the level of performance and ease of use that the G6 system brings, we expect G6 to continue to function as a platform product for Dexcom for many years to come, even in certain markets beyond the launch of our next-gen G7 product. Yet, as we push the rollout and production of G6, our teams are also making significant progress toward finalizing G7, and we remain on track for a late 2020 or early 2021 initial launch. As a reminder, G7 will be an entirely new sensor platform for Dexcom, one that meets the ICGM standards and further extends our leadership with a significantly reduced form factor and extended wear and a fully disposable one-piece wearable. Strong, therapeutic, cost-saving outcomes utilizing CGM continue to present themselves across the healthcare landscape. For several quarters, we have discussed CGM usage in non-intensive type 2 diabetes, prediabetes, gestational diabetes, broad potential deployment in the hospital, and application in overall wellness. Well, it is now time for an increased focus and investment in these areas, particularly since we know that these opportunities will require completely different business models and distribution channels. In order to lead this effort, I'm pleased to announce that we have appointed Matt Dolan as General Manager of New Markets. As many of you are already aware, through his involvement with our investor relations and corporate development efforts, Matt is a great leader, and we are confident that he and his dedicated team are the right people to guide these key growth initiatives for Dexcom. Turning back to our core business, we have proven ourselves to be early advocates of the principle of interoperability and patient choice. having established partnerships with multiple insulin delivery players, and we will continue to leverage the ICGM designation. We are seeing significant progress from these collaborations and look forward to the launch of a few of these connected products over the next 12 months. We are especially thrilled for our patients as these innovative products stand ready to minimize the burden of diabetes management, and we are proud that Dexcom stands at the center of this progress. With that, I will pass it back to Kevin.

Thanks, Steve. This is obviously an exciting time to work at Dexcom. Not only are we working hard to bring our technology to the increasing number of people with diabetes who see the benefit of real-time CGM, but we are very actively exploring possible applications of our sensor technology to additional populations. My personal expectations for our new markets group are very high. We need to gather as much clinical and cost-based evidence as possible with our G6 platform so that we are truly prepared to attack these markets in a big way with G7. In the meantime, we are capitalizing on the continued momentum in our core business, leading to a significant increase in our annual revenue guidance. With this success, we have put everybody on the Dexcom team through a lot in the first quarter. From the commercial team to manufacturing to customer support, to R&D and beyond. We know you have worked incredibly hard and we thank you. In summary, we are very pleased with Dexcom's performance to start the year and believe that we are well positioned for another great year of revenue growth, technology advancement, and increasing profitability. I would now like to open the call up for Q&A.

Matt? Thank you, Kevin. As a reminder, we ask our audience to limit themselves to only one question and one follow-up. Operator?

Thank you. we'll now begin the question and answer session. If you have a question, please press star, then 1 on your touchtone phone. If you wish to be removed from the queue, please press the call sign or the hash key. If you're using a speakerphone, you may need to pick up your hand first before pressing the numbers. Once again, if you have an audio question, please press star, then 1. And as a reminder, please limit your questions to one question and one follow-up. Our first question comes from Jason Besford from Raymond James. Your line is open.

Good afternoon, and thanks for taking the questions. I'll ask my question and related follow-up up front here. First, Quinton, just implied in the initial guidance was about $100 million in assumed pricing headwinds due to the mix in the pharmacy, international, et cetera. Is that what's still baked into the new guidance? And then second, in terms of The move to the pharmacy, I realize the inherent benefits for existing users migrating to what should be a lower-cost setting, but receiver growth continues to be quite strong. So my question is, do you think the move to the pharmacy has stimulated incremental growth in new patient ads? And any color that you could provide around the pharmacy dynamic in the quarter would be great. Thanks.

Sure. So, yeah, Jason, to your point, the $100 million that we talked about on the initial call for the year setting the original expectations, that's still consistent with how we think about it over the course of the year. So, no change there. Obviously, you know, we've got a concerted effort in place to move to the pharmacy channel, and that's playing out about just like we anticipated that it would. You know, your point on new patient growth, I am certain that, you know, the pharmacy channel makes access more easy and more convenient for folks. I'm I'm certain that's a part of the driver. And when you look at the overall growth in the company, there's no question that the primary driver of our growth is new patient volumes. So I am sure it's connected.

And our next question comes from Travis Steed from Bank of America. Your line is open.

Hey, thanks for taking the questions. Just looking at your Q1 revenue, you know, typical seasonality suggests 20% of Q1 for the full year. Just trying to think about, you know, that suggests about $100 million more than you're guiding to for 2019. So is that just the typical conservatism that you have, or is there anything else we should consider as we model out 2019? I think that...

The right way to think about it, and I know we talked about 20% back on the last call, I think a few things came through in the quarter. We talked about the strength in the fourth quarter being really driven by new patient additions that came in late in the quarter, and if you recall, at that point in time, we had shared that we expected those folks maybe back with their next reorder really early in the second quarter. We saw a lot of that end up coming through in the month of March, which was a bit ahead of our expectation, a great signal and great outcome. But at the end of the day, that was a bit of the upside surprise. I think the other thing to keep in mind just around seasonality is that as we continue to move more into the pharmacy channel and as we continue to see the OUS business become a bigger part of the overall business, And as that Medicare continues to grow faster than the commercial business, all of those have very different seasonal patterns to them, generally which might have more revenue early in the year. So we're just trying to be thoughtful around all of those different dynamics in the business as we set expectations for the full year. Certainly not trying to signal anything. We know what your math would indicate that you laid out there, but we're just being mindful of some of the shifts in the mix of the business.

All right, that's helpful. And then I want to make sure I heard you correctly. You're exiting the year with 70% roughly gross margins. Just kind of give us a little bit more info on how you're going to get there and is that sustainable into next year? And also, does it give you a little bit more flexibility on pricing if needed?

Yeah, so I think, you know, this is the 70% ability to get into that number by the end of the year is in line with the plans that we've always had around our gross margin progression into the future. You know, go back to our investor day, and we laid out the path that arguably could take us up north of 70%, and then you have the headwinds that continue to play in with the revenue per patient mix challenges that we envision as we continue to move into the pharmacy or OUS becomes more significant. So there's nothing out of the ordinary here. It's right in line with what we plan to be able to do. The big enabler for us, and we've talked about this lower cost design transmitter for some time now, you're going to see that start to play through in the fourth quarter. So the teams have done an incredible job of designing cost out of the system. We'll start to produce that in the back half of the year. You'll actually see it start to get produced in the third quarter. That'll get hung up in inventory a bit. We'll start to sell through it in the fourth quarter, and the benefit will start to play through. So You know, it's in line with the plans that we've had. I think in terms of next year, I would just tell you let's stick in the mid-60s at this point in time. I think it absolutely gives us the flexibility to continue to navigate the pricing environment and do what we need to do to ultimately generate the most significant growth for the company. But it's these kind of things that give us the strategic opportunity to be flexible in how we think about positioning ourselves.

And our next question comes from Robbie Marcus with J.T. Morgans.

Oh, congrats on the great quarter. Thanks for taking the question. You know, I want to address a question that's, you know, been impacting the stock and clearly top of mind for investors lately, and that's the potential impending approval of your competitor's Libre 2.0 product. You know, and there's a lot of questions out there about what does it look like, does it get ICGM, and how those alerts and alarms will compare as a product versus G6 today and eventually G7. So I'd love to get your thoughts here, and any clarity or insight you could give us would be much appreciated.

Robbie, this is Kevin. I'll take that one. Thanks. Let's go back a bit. It was about a year ago at this time that we talked about the ICGM standards for the first time, and we remain very bullish on the fact that the FDA did give us guidance and standards by which we can develop products in the future that will be safe and in the best interest of our patients. And we stand by that. We've wanted standards and guidance for years so we know what the bar is to shoot at and we actively look at that. We never assumed when we started this process that we would be the only ICGM company in the world, that eventually others would up their game to get that approval. And in the event that Abbott does get approval on the ICGM standards, that's, you know, they've obviously provided enough clinical evidence to do so with the FDA. If you look back at the history of our company, and we were reminiscing about this today as we were preparing for the call, ever since I've been here, we've always had a competitive offering from another company in the field that claimed to be as good as a Dexcom. But you'll notice the claims of those companies have always been we're as good as a Dexcom, never as good as somebody else. We're as good as a Dexcom. Real-life use in the field has proven over and over again that our technology leads the way. and that our actual real-world clinical performance on body and on patients has always been the best and has always survived and given us a position to do that. We're very confident that our product will remain top of the line and will be extremely well-received. We have not seen a lot of Libre 2 in Europe where it's been launched, so we don't have a lot of answers, and we're not going to speak to the characteristics of their product. We know a lot about ours. We have enhancements coming for G6. over the course of the year that will make it an even better product offering and over time as we offer decision support and other things for our patients we intend to have the best experience that a patient could possibly have with g6 when we move to g7 and its size advantage the body wearable the one piece component uh where we don't have to put a transmitter in the system anymore the lightweight nature of it uh and many of you know i where the G7 quite a bit now has always been a sensor snob. It is a patient experience that's a bigger leap than from G5 to G6 has been in our previous history. So, we know that product will be wildly competitive and have all the features and benefits of the current G6 system and more. So, our pipeline is fabulous. it's a great market opportunity, and there's room for a number of participants and a number of products, not just one.

That's really clear. I appreciate your thoughts, Kevin. And then just a follow-up, you know, maybe not too far off of this, but can you give us some flavor of what your discussions with payers are like? Are the payers focused on cost avoidance of diabetes, adverse events, and improving patient outcomes? or are they just simply focused on moving reimbursement to the lowest cost denominator?

Appreciate it. It depends on the meeting, and it depends on the payer. We've been very successful in our payer discussions over the past several months and have had wins on numerous payer discussions. For example, Cigna just gave us pharmacy coverage and pharmacy benefit. We do not issue press releases every time we have a win because that's our job. That's normal course of business. for us, but we have great coverage there and some local payers in pharmacy coverage. We do spend a lot of time discussing outcomes and educating payers, and I think over time, as we get more data and as we can build a better case, we can get those types of contracts in place. I would put the onus for that back on us rather than on the payers. We just need better measurables and better data. It's taken us years to develop that clinical evidence set. The Diamond study that we talked about uh for the first time a couple years ago was really our first endeavor to do that and now with all this data coming to our our servers through our mobile platforms we believe we'll be able to make some very strong real world evidence just from our patients as we look at time and range statistics and compliance with the system and how well they do at hypo avoidance you know i gave an example in my prepared remarks of the uh Predictive alert that we have in the G6 system and how we're seeing a significant reduction in hyperglycemia because of that alert. That type of evidence is something we really haven't presented in the past, and we will do that going forward now that we have so much data from the mobile systems. We're very comfortable playing in that realm because we know the outcomes that our device provides to patients are outstanding.

And our next question comes from Danielle. The light is open.

Hey, good afternoon, guys. Thanks so much for taking the question. Congrats on a really good quarter.

Thank you.

Just a question, and this is sort of following up on the question around the impact of a competitor potentially getting ICGM, but just curious if you can give any color directionally or what have you on the percent of your installed base domestically today and or new patient ads that are MDI versus pumpers. I think historically you've said the majority of the patients coming on to Dexcom are MDI and not actually pumpers. Anything you can say to that?

The majority of our new ads now are MDI patients, Danielle, by a reasonable margin. As we're getting a much larger patient base, we're going over into those who are not on the pump systems for more of the new ads. But I – I anticipate, as our partners get new systems out, that we will see significant growth in that segment as well, as these systems do more than just deliver insulin but actually have algorithms that can improve outcomes. Right now, our new patient ads are primarily NVI patients. That's what I see. That's most of them.

Got it. Okay, that's helpful. And then just a question on the G7, and I want to make sure I'm understanding correctly how pricing – is going to change with G7? I know you guys haven't sort of outlined your go-to-market strategy per se, but I think you've said in the past that, you know, at some point you're expecting to be at – well, tell me if this is correct. Are you expecting to eventually be pricing at parity with the competition as we look further down the line to G7 and beyond? Or do you think that even with G7 you'll still be pricing at a premium? Thanks so much. Thank you.

I'm not going to outline all the specific details regarding that, but here is our strategy and here's how we look at that. We look at the annual revenue per patient per year and what is the appropriate amount to charge a patient. For example, as we've gone from G7 to G6, that's how we look at that product offering is annual revenue per year rather than pricing on the individual components. With respect to how we price G7, You know, there's a lot of variables involved here. If we have decision support tools that lead to better outcomes, does that justify a premium? Does it not? I think we'll have to see it over time. What's most important for the investment community to know is from a cost basis, we have a lot of flexibility with G7. We designed that product for manufacturing. We designed that to be a lower-cost product offering than we have today, particularly with the extended wear. We're prepared for what the market will do, but we will study this at great length and have a very detailed go-to-market strategy before we go. But I can't commit to anything specifically now. We're very optimistic about all the directions we can go.

And our next question comes from J.P. McKim from Piper Jaffray. Your line is open.

Hi, good afternoon. Thanks for taking the question. I wanted to ask one just – Kevin, you made a comment that I think you're wearing a G7 now, so it feels a little more real to me. And so – I don't know, maybe initial thoughts on it, and then will we see a trial start for G7 this year, or is that still something that will happen in 2020?

Look, we run trials with G7 all the time, but they're small trials that we're gathering data to learn and fine-tune the features of the system. With respect to the experience, regulatory people are probably going to kill me if the legal guy does it first, but it really is spectacular. The wearable is is pretty much non-existent on your body. As I look at projects we've started and innovation that we've attempted during my term at this company, this is the biggest leap we've ever taken, and it's a huge leap. And kudos to all the people involved in it, because if I were to design what I'd hoped CGM would have been when I started in this business 25 years ago this week, I would have designed this. And so we're finally here.

That's really helpful. And then maybe just if I could ask one on just the non-intensive programs. There's several trials that we should see some data at ADA around. I mean, either Matt or Kevin, how do you define success in those trials? Are payers really keen on reducing the amount of medications, or is it going to be the time and range of the metric? How should we look at those trials as successful?

Yes, I would say you have to take the individual markets and kind of look market by market. So certainly in the non insulin using non intensive type two market, reduction of drug costs is paramount, right in the hospital, things like length of stay, you know, reduce nursing time is important, but you know, reducing length of stay getting people out of the ICU down to a step down ward into the general ward and out of the hospital and actually As important these days, prevention of hypoglycemia in the hospital setting is becoming increasingly important. It's on CMS's radar as a key metric for hospitals. So, reduction of hypoglycemia is going to be important going forward in that market. You know, gestational diabetes, we're still early in exploring opportunities there. I'd love to tell you that at some point, you know, the CGM session will actually replace the oral glucose tolerance test. That's going to take some time and effort and some clinical trial work on our part. There's no kind of one-size-fits-all in the new markets development opportunities, but MAPS has developed and will continue to develop a pretty robust team to tackle all these markets. And, you know, clearly over the next several years, you know, three- to five-year time horizon, those markets become increasingly important for us.

And our next question comes from David Lewis from Morgan Stanley. Your line is open.

Great. Thanks for taking the question. Just two for me. Quinn, just I want to come back to gross margins. I appreciate your commentary about 70% for the back half of the year and mid-60s next year. But if I take the LRP, which I was usually aware was 65% 2023, scaling and innovation are about 700 basis points of that. So it actually feels like both of those factors are playing a pretty powerful role in the back half of 19. So is it safe to assume the 65% 2023 number, given you're seeing earlier scaling and innovation, is a is now a conservative number, and we should think about that number being kind of materially higher.

Yeah, I don't want to get out to, you know, five years out from now and talk about whether it's conservative or aggressive. I think what we tried to lay out for you is that we have very clear lines of sight to some very specific improvement efforts that will drive the gross margin higher over time. What becomes a bit more of a variable that we're prepared to be able to address is the whole revenue per patient headwinds. And as the mix shifts between different channels, we're going to have more than enough leverage flowing through the COGS profile of our business to be able to address that very aggressively and still produce a very attractive gross margin profile. So we're happy with where things are at. You know, the lower cost transmitter coming in the back half of this year has always been something that we've planned for and knew that we'd see a nice benefit from. To Kevin's point earlier, you're going to see an incremental benefit coming from G7 as well as that's been designed to be even more cost effective. So there's a lot of nice levers in front of us that give us the opportunity to to combat some of the headwinds that might be out there.

Okay, just a quick follow-up on just the pharmacy benefit and the payer dynamics. Can you just update us, Steve, maybe on where you are in terms of pharmacy benefit coverage? I think it was 50% last quarter. More specifically, a lot has been made sort of inter-quarter about first provider or primary provider relationships. Can you sort of talk about whether preferential provider or formulary relationships are having any impact on U.S. demand and sort of how you see the future for provider relationships? in the channel, so where you are in mix and what you would say on preferred provider. Thanks so much.

I'll answer the second part of that question first, which the answer is no. I mean, we've seen some isolated instances of companies trying to negotiate for preferred status, but that's certainly not something we're seeing as a trend as we move to the pharmacy benefit. As for commercial lives under coverage, we're certainly north of 50%. We haven't given a more granular number than that, and we're still We're still not processing, in terms of our commercial business, we're not processing close to 50% through the pharmacy channel at this point. We're working hard to move more and more patients into that channel. So when we say we have more than 50% of the commercial lives covered, we're certainly still not processing 50%.

And our next question comes from Joanne Wensch from BMO Capital Markets. Your line is open.

Thank you for taking the question in a very nice quarter. Two questions, really. At the ADA meeting in June, Can you give us a feel for what we should be looking for there?

Yeah, Steve, why don't you take that one?

Yeah, I mean, I would say the most exciting data set, if you will, that we hope to see at ADA will be really a combined data set together with Tandem, where we should get at least a first peek, if not a full-blown view of the IDCL data. So that's, again, that's Tandem's. X2 pump with the, you know, the Dexcom G6 and the Dexcom slash Type 0 algorithm running, you know, a hybrid closed-loop system. So that's probably the highlight for us and for Tandem collectively at ADA. There will be a number of additional kind of poster and some podium presentations, but from a data perspective, that's really what we're looking forward to.

Yeah, I'd just add the other thing, Joanne, that we're going to continue to see is anybody who stands up to speak starts talking about CGM. Every outcome, every trial, everything going on, CGM is clearly becoming the standard of evaluating diabetes care across the board. And I believe that that trend is going to continue at ADA, and you will see CGM pretty much interwoven everywhere with everything that's done.

That's helpful. And then my second question has to do with CGM. growth was strong there again this quarter. And I'm just trying to get an idea of sustainability and into what other regions you might be looking to venture into. Thank you.

You were talking about the OUS market? Internationally, yeah. Clearly the growth was strong there. And I think, you know, you look at overall, adoption of CGM in that overall marketplace is probably still sub 10% in terms of the long-range opportunity. And so there's a huge amount of runway that continues to exist in front of us. And our core markets continue to drive the primary growth for us today. Germany was another standout performer in the quarter leading the way for us. But there's significant other new markets that are coming online. We just saw significant growth coming out of the Nordic markets, for example. We saw incremental growth. reimbursement approved in Australia that'll add significant amounts of contribution over the course of later part of this year and into next year. And then you get into some of the Asian markets where we haven't started to see the contribution yet, but expect nice tailwinds coming out of Japan and Korea, for example. So there's several new market opportunities or even markets that we're in today that are just growing at incredible rates and paces of growth in a relatively untapped market opportunity. So I think there's several channels for overall growth in that international business to get it to the point where in our long-range plans, we talked about it being, you know, closer to 30%, 35% of the overall business, which means it's going to be growing faster than the U.S. business. I think there's a lot of channels that will continue to make that available to us.

And our next question comes from Margaret Cazor from William Blair. Your line is open.

Hey, good afternoon, guys. Thanks for taking the questions. So first one for me is more a bigger picture perspective because we've now seen several quarters of strong patient growth. So what I'm curious about is whether you guys are seeing a change in prescription patterns in the market, whether it's endos or patients and irrespective more of pharmacy or G6, but is CGM really becoming widely accepted and a go-to for most type 1 patients?

Margaret, this is Kevin. I believe it's becoming much more widely accepted in prescription patients patterns are rising across the board. It's just becoming the tool to manage your insulin delivery. And it's not, you know, while it is becoming a tool and more accepted, penetration rates are still not at the point where we need to step back and worry. In the type 1 market, we think the penetration rates in the U.S. are still in the 30% range across the board. And Type 2 intensive insulin using is still not that big a number either. So over time, there's plenty of market runway here to continue to grow on the international front. Penetration rates in the intensive population aren't close to being that high. But we think it is much more accepted than it was before. We think G6 has had a very positive impact for us in these new markets because it's much easier to use. The no calibration feature, the easier insertion. the direct-to-phone connectivity, all the things we've built into G6 were designed to drive this market, and we're seeing the benefits of that as we go forward.

So just to follow up on that, it seems like you guys have got nice improvements. Are the endos self-selecting patients that they think will see the most benefits from that? And what else maybe do you need? I know you mentioned some new connected product launches this year. I don't know if those are digital, software, or hardware. Thanks.

You know, it's interesting. I just spent some time with several of the folks from the field, and I would tell you a lot of this varies territory to territory. It varies practice to practice still. There's not a standard guideline where all the doctors are identifying different patients and having different criteria. I would say, like anything, it's changing rapidly. When I first went out in the field, when I started here, the only patient recommended for CGM was a pumper I would ask doctors, who do you put on CGM? They'd say somebody with a pump is where we start. That certainly is not the case anymore. And so it varies across the board, but it is much more prevalent than it used to be. There's still plenty of room.

And our next question comes from Jeff Johnson from Barrett. Your line is open.

Thank you. Good evening, guys. Kevin, I want to go back and ask you a question on the MDI versus pump mix that was talked about earlier. Especially within the MDI category, are you seeing any change in that patient base? Are you winning any competitive converts there? Are those all native first-time users of CGM that you're winning on that MDI side?

You know, I don't have a good piece of data here.

Yeah, I would say anecdotally, just honestly coming out of our national sales meeting and talking to our field force who really are on the front lines, that you hear anecdotal stories that, yes, people would try Libre, and then if they are content with an on-body experience, with a sensor experience, that they do migrate to a Dexcom. But we don't have any real metrics to kind of give you as to what sort of conversion rate we have on Abbott to Dexcom. With respect to Medtronic, you know, they've launched a standalone system, but we honestly, we just don't see that system out in the marketplace at all.

Yeah, fair enough. And then on Medicare, we didn't get much color on that this quarter. Any update there on stick rates, on demand trends, things like that? I know G6 is pushed till later this year in that channel. Has that been impacting on near-term demand? Just any updates would be helpful. Thanks.

No change in trends there, Jeff. I would say our stick rates remain very, very high. I mean, we're incredibly encouraged by what we're seeing there. And the new patient funnel continues to be very full. So, you know, pushing the G6 launch out into later in the year has not impacted any trends that we've seen in that Medicare business right now.

And our next question comes from Doug Schrenkel from Cowan. Your line is open.

Hi, this is Ryan. I'm for Doug. Thanks for taking my questions. And first off, Matt, congrats on the new role. You referenced G6 enhancements coming this year earlier in the call and talked about new algorithms on the last quarterly call. Can you provide any more details? Should we expect a new algorithm to noticeably improve the performance metrics of G6 during 2019? And then should we expect extended wear for G6 during 2019?

You know what? We're going to keep that close to the vest and not lay out the roadmap. In the U.S., I can tell you in 2019, we don't expect extended wear. for the G6 in 2019, the decisions that we are making around things that would require extensive trials of that nature are very interesting. Do we commit those resources to G6, or do we commit those resources to accelerating G7? And in many cases, we're choosing the G7 acceleration over that. But there are new features coming out in the fall on G6, and we'll kind of wait a while before we lay what all those are out to everybody.

And our next question comes from Chris Pasquale from Guggenheim. Your line is open.

Thanks. I just want to follow up on the comments about gross margin in Clinton and why, you know, we shouldn't assume that 70% is a good number going forward. I'm assuming some of that has to do with the continuation of the pharmacy dynamic next year. But just kind of flesh out how much you have to sort of swim upstream to maintain margins in the mid-60s and what you're thinking about over the next, call it, 18 months.

Yeah, without getting into specifics around 2020, maybe I'll just point you to one of the dynamics that we feel in the business right now, which is somewhat considerable to what we saw last year as well. For the full year, when we set margin expectations, we talked about there being roughly a 200 basis point headwind relative to the revenue per patient impact of moving into some of these other channels, both pharmacy and OUS. Yes. I think based on what we know at this point in time, that's probably the right way to continue to think about that headwind as we roll into next year. Clearly, we'll refine that as we learn more as we exit the year. But, you know, as we start to push up into the 70s with the lower price transmitter, it clearly gives us opportunities to be more thoughtful around pricing strategies into the future. So that's why I come back into the mid-60s for the time being. But, you know, in terms of the pressure we're feeling from the mixed channels, A couple hundred basis points right now is what we're seeing. So you can model from there where you want, but I still think the mid-60s is the right way to think about it over the long term.

Thanks. That's helpful. And then on the new markets, I'm assuming it's going to be a little while before we see some real data and some of these new indications. But at this point, is there a lead candidate that you guys think is most promising or that you think you want to go after first?

I would say we're, you know, look, we're already commercial to some extent on the non-intensive type 2. I mean, we've characterized some of the work we're doing, particularly with UnitedHealthcare, as pilot studies. But, you know, we're talking about multiple thousands of patients, so they're large pilot studies. With respect to the work being done by United on Duo, et cetera, you know, you're not going to see any data. In fact, they hold some of the findings and the learnings there to be highly proprietary, so they're not going to share that with anybody. To the extent we want a more formalized clinical protocol for a hospital indication or a gestational indication or something like that, that data may become available. But right now, I don't think we have any plans to really to tip our hat to our potential competitors in those markets as well.

And our next question comes from Raj Denhoi from Jefferies. Your line is open.

Hi, thanks. I just really want to ask about the leverage, you know, in the middle of the income statement you guys are talking about. And I appreciate the comments on the increase of the folks in the Philippines now. So a couple questions there. You know, one is, you know, if you think about the environment getting potentially more competitive, you know, one of the concerns is that, you know, customer service for you guys has always been such a really strong suit. And as you move that now offshore and how you maintain that. And so I'm curious if you have any kind of early data or anything you can offer in terms of how that transition is going forward.

Yeah, Raj, we've been incredibly impressed by the team that's being built over there. And we pay very close attention to not only quantitative assessment and performance metrics, but also qualitative. And so we try to take the opportunity with every single patient as they work with our folks over there to get feedback from them on how the calls went and what we can do better. And I can tell you out of the gate, our qualitative scores are higher than what we've seen on our domestic patients. So, you know, we're seeing great results in something that we're paying very close attention to. From an efficiency perspective, we've been beyond, to be quite honest, what we anticipated we might have been able to recognize in the early stages there. You look at some of the work coming out of our customer advocacy or complaints area, our tech support. and other back office functions and the efficiencies are significant that lead us to believe that it's going to make it much easier to scale much more quickly and clearly more effectively. So we couldn't be more encouraged by what we're seeing out of that effort there. I believe that over time that becomes a real strategic asset to this company and allows us to be more aggressive in how we think about other strategic opportunities and markets we might want to pursue or how we just compete in the local markets that we're in already. So very encouraged by what we're seeing there. That's great. Thank you.

And our next question comes from Ravi Massara from Barrenburg Capital.

Hi. Thanks for taking the question this afternoon. So my first one is, again, on gross margins. Just hoping, Quentin, maybe you could give us a little bridge between the first quarter and fourth quarter ramp. And then on the first quarter, what are the headwinds that, showed up in that margin that are going to fall away and maybe break it down versus year-over-year versus mixed shift or underutilized overhead.

And, Ravi, when you're talking fourth quarter, you're talking about from Q1 this year to Q4 of 19? Yeah, exactly. Sure. So I think let me just talk year-over-year real fast, Q1 to Q1, around some of the headwinds that we had. There was about 200 basis points of impact related to the continued shift towards pharmacy and the OUS business being a bigger part of the overall contribution. And then there's about 200 basis points associated with really our focus on doubling capacity. And we talked about the fact that with demand being beyond what we had anticipated, we're accelerating some of that spend. So we pulled some of that forward. Not all of that is capitalizable or inventoryable. And so it's run through the P&L a bit earlier than what we had anticipated. So I think you'll see Q1 will be that low watermark. I think you'll start to see it improve a bit in Q2 and see some real improvement in Q3 and on to Q4. And really what drives that, in Q3 you're going to start to get just the benefit of levering the fixed overhead that we put in place right now to design the automated manufacturing capabilities. In Q4, while you're getting some of the benefit of that leverage of the fixed overhead, you're really going to start to get the playthrough of the benefit on the low-cost transmitters. So hopefully that gives you a bit of a bridge over the course of the year in terms of what the contributing factors are. But I think for us, you know, we can see a clear line of sight of getting close to that 70% range as we exit the year.

Great. Thanks. I can add some follow-ups offline. Then my second question is just around type 2 usage and kind of some of the commentary you had around moving patients from ward to ward. Just curious, what's the take on the proposed rule changes around new technology add-on payments? I mean, do you see a space for your CGM products to fit into that designation? And what could that mean from a reimbursement or payment perspective? Thank you.

Yeah, absolutely. Particularly in the hospital setting, as I mentioned, CMS has a renewed focus and has identified hypoglycemia in the inpatient setting as a huge problem. And so, you know, you're not going to detect hypoglycemia with finger sticks, even if you're taking, you know, a couple finger sticks an hour, right? So I think that the CGM plays perfectly into that into that environment. And, you know, we've long known that recurring hyperglycemia in the hospital is a problem. It leads to, you know, reduced healing times. You know, we can get CGM put on these. The idea would be to get CGM put on these patients, potentially pre-op, get them into the hospital with a sensor already on, get their blood sugar under control before a procedure, and get them in and out of the hospital as quickly as possible. So, yeah, we think there's great application here. We think also the disposable nature of G7 is the perfect product opportunity there.

And our next question is from Matt Taylor from UBS. Your line is open.

Hi. Thank you for taking the question. So I wanted to ask Quentin a question to see if he could give us a little bit more detail on, you know, what changed here sequentially in terms of some of the assumptions that are embedded in in the revenue guidance for the year. You did address a little bit of this in the earlier question about the pricing headwinds, but can you just give us a sense for what has changed and if you could provide broad strokes on the different components, that would be helpful.

Yeah, I think it's really quite simple, to be honest with you. It's not a lot of different moving pieces. It comes down to new patient volume more than anything else. I think the demand that we continue to see in the business coming off the Q4 and the strong Q1 this continues to increase our confidence in the adoption of the technology in the marketplace. And so it's really new patient volumes that are driving the incremental growth. I think that you'll see a lot of that come through on the commercial business through the pharmacy channel, from our experience that, you know, we believe that's where the majority ends up showing up. And then the international business is a bit stronger as well. So those two channels are the primary drivers. And at the end of the day, it's all new patient volumes that are driving it. You know, the pricing assumption I talked about earlier, no change in terms of the $100 million headwind.

Okay. And then maybe just to follow up with the head of new markets here or just for the team, can you talk about which of the new markets you think is really going to be able to bear fruit for the company in the near term? Anything that you can share on the strategy there that's changed since you talked about some of the things at Investor Day?

You know, this is Kevin. I'll take that. I'm not as concerned about bearing fruit on the revenue side. as I am building a long-term case. So our efforts this year, you know, as we roll this stuff out, as I said earlier in my prepared remarks, are to develop the outcomes, the cost-based evidence that show these are markets where we're going to save patients money and deliver better outcomes. So we'll be largely developing that evidence and those business models, establishing the relationships we need to go distribute into these markets. and taking some steps like that over 2019 and early 2020. And then when we roll out G7, we expect to roll that out to these other places as well. And that becomes more of a commercial thing right now. And again, I will echo something that Steve said earlier. We haven't just been sitting around on this and not working. We've had some of our best people working on these efforts for quite some time. Now what we've done is formalized the structure and said, You guys have a home. You have a group. You have some goals. Go get this done. And we're going to start measuring that progress more rather than just as projects. And that's what we're expecting in the near term.

And our next question comes from Steve Lippman from Oppenheimer. Your line is open.

Thank you. Hi, guys. Kevin, on intensive type 2s, where do you think we're at penetration-wise today? And any updated color on your discussions with commercial payers on expanding access to those patients?

We continue to pursue that with the payers, and certainly using the CMS ruling as a basis for that gives us a very good start. I don't think penetration is very deep there right now. I can give you a number. I think it's less than 10% in general. However, a lot of those type 2 intensive patients are Medicare patients. And as we look at launching G6 into Medicare later in the year, for example, we think we have an opportunity to grow that significantly, and that's a nice opportunity for us going forward in the future. I can tell you that the type 2 intensive patients on the system, Quinton referred to the stickiness of our Medicare patients. It's been extremely good so far, so they're getting very good outcomes, those who use it. So we're happy with it. It is a tremendous opportunity for us, and we look forward to more coverage. It's a chore. Getting the insurance companies to pay more and spend more money is never simple.

Got it. And then you also talked about the positive results you're seeing from the predictive hypoalerts. When do you think we could see data aggregated and published around the benefits there?

I believe, Steve, the predictive hypo alert paper was presented at ATTD. So that's already out, the G6 system, the patients that experience less hypoglycemia with the predictive alert.

And our next question comes from Suraj Kalyas on Northland Security.

Good afternoon, everyone. Congrats on a great quarter. um so quentin a lot of my questions have been asked maybe i'll just kind of lump uh both my questions into one uh and forgive me if you all have mentioned this on the call what are the expectations for us versus ous contribution in fy19 i'd love to get some perspective on how you'll see the margins for these two different buckets. I mean, roughly speaking, the math tells me that, you know, roughly 400, a little over 400 would be OUS. The remaining would be US. Maybe you can kind of parse out for us, you know, how we should think about this, how the gross margins for the different buckets would be. And finally, this transmitter that is expected to bump up gross margins to 70% in Q4 2021, What is the incremental gross margins contribution from this transmitter? I'd love to get some color if possible. Thank you for taking my questions.

Sure. So in terms of U.S. versus OUS split, on the full year, you know, our OUS business is expected to grow in the mid to high 30s range, which infers the U.S. business is growing in the teens to 20% or so. That's about what we've expected on the course of the full year. We haven't given – specific gross margin data points on the U.S. or O.U.S. business. And we're not going to put that out there. And that shifts, honestly, quarter to quarter just based upon the mix of the revenue within, say, O.U.S., where you've got a direct market and you've got a distributor business as well. So it just fluctuates based upon the mix. But we haven't put those data points out there, nor are we going to right now. In terms of the incremental benefit associated with the transmitter, the G6 low-cost transmitter, Without giving you the exact specific cost differential, we can tell you it's more than 50% cheaper than what the G6 existing transmitter is today. So in terms of orders of magnitude, I think it's clearly a very significant benefit for us that drives the overall improvement in the gross margin in that fourth quarter timeframe we've talked about.

And that concludes the question and answer session. I'll now turn the call back over to Kevin Sayre for final remarks.

Thank you very much. And thanks, everyone, for being on the call today. I actually wanted to stop the call at 52% growth and 95 million plus in incremental revenue over Q1 of last year, but we decided we would keep going. You know, much of the discussion around this call in recent months has focused upon two things, the pricing environment and anticipated competitive offerings in the space. And I think too often we forget one thing. This market opportunity is huge. It is extremely large, not only in the intensive insulin space, but ultimately in the type 2 space and the other areas that we're looking at all the way down to health and wellness. We continue to see people now buying our system, getting a prescription because they want to manage their nutrition on the side and they're paying cash and using it, but seeing some very interesting things. We truly see a day when CGM in multiple configurations informs becomes a very useful tool across all of healthcare and truly the standard of care and the intensive management of diabetes. With respect to pricing, our channel and payer teams are doing very well at Dexcom. I talked earlier about the recent win with Cigna. We are hitting on all cylinders here, and that team has gone very well. Given the size of the opportunity with respect to the competitive environment, as I said earlier, we didn't expect to remain the sole voice of CGM forever. We always knew others would come. And increased awareness generated by all parties move patients to the technology that best meets their needs. And that technology remains Dexcom. With G6, our plan enhancements coming later this year, our next Gen G7 offering and the technologies that will be following that, we expect to be the leader in this industry and this space for a very long time. Thanks again, everybody, and have a great day.