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Insulet Corp. (NASDAQ:PODD)

Q2 2009 Earnings Call

August 04, 2009; 5:00 pm ET

Executives

Duane DeSisto - President & Chief Executive Officer

Brian Roberts - Chief Financial Officer

Analysts

Gerald Hoss - Thomas Weisel Partners

Kim Fustier - JP Morgan

Ben Andrew - William Blair

Bruce Cranna - Leerink Swann

Mimi Pham - Soleil Securities

Zager - BWS Financial

Bill Plovanic - Canaccord Adams

Suraj Kalia - SMH Capital

Derek Leckow - Barrington Research

Operator

Good day ladies and gentlemen, and welcome to the second quarter 2009 Insulet Corporation earnings conference call. My name is Jerry, and I’ll be your coordinator today. At this time all participants are in listen-only mode. We will facilitate a question-and-answer session towards the end of the conference. (Operator Instructions)

I would now like to turn the presentation over to Mr. Brian Roberts, Chief Financial Officer of Insulet Corporation. Sir, you may proceed.

Brian Roberts

Thank you. Good afternoon everyone and thank you for joining us for our second quarter conference call. I’m Brain Roberts, Chief Financial Officer of Insulet. Joining me on the call today is Duane DeSisto, our Chief Executive Officer.

Before we get started, I’d like to remind everyone that our discussion today may include forward-looking statements as defined under the securities laws. There are risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements.

Information concerning the company’s potential risks and uncertainties is highlighted in the company’s press release issued earlier today, and in the risk factors section of the company’s SEC filings, including the company’s Form 10-K for the year ended December 31, 2008.

These risk factors apply to our oral and written comments. I’d also like to remind you that the guidance we are offering today represents a point-in-time estimate of our future performance. You’ll find a link to the webcast of this call, as well as to today’s press release at www.myomnipod.com in the investor section.

Now, I’ll turn the call over to Duane.

Duane DeSisto

Thanks Brain. Good afternoon everyone and thank you for joining us. I’m very pleased to report to you the results of our strong second quarter. Despite the challenging economy, we drove impressive top-line growth, delivered continue improvement in our gross margins and launched the second generation product, our new PDM 200 into the market.

For the quarter, we reported revenue of $14.6 million, an increase of 97% year-over-year and the17% sequentially. The easy-to-use OmniPod System continues to deliver on our promise to make diabetes a smaller part of life for our customers.

I’m going to focus my comments today on three major areas of opportunity for our business; product innovation, domestic and international market expansion opportunities, and manufacturing and operational efficiencies. Let me now take few minutes to provide you with an update on these three critical areas.

First, let me speak about product innovation; as a leader in tubing-free insulin pump technology, innovation is at the heart of who we are as an organization. At the American Diabetes Association Conference in June, we launched our second generation PDM, with improved features, such as the sleek new look, colored LCD screen and enhanced data download capabilities.

To-date the launch has exceeded our expectations with over 20% of our customer base taking advantage of the special limited time introductory upgrade price. The new PDM 200, not only provides a better product to our customers, but will also help us improve our margins in 2010 as we expect to see reduced production and warranty costs.

We didn’t stop listening to our customers in innovating with the design of our product. We heard their feedback that they wanted a way to reduce the impact of their used pods on the environment, so last month we announced the first environmentally safe disposable program in the insulin pump industry.

The Eco-Pod program will reduce the impact of used Pods on the environment by preventing hazardous waste from unnecessarily entering landfills. Pods are disassembled and metals are recycled. The program launched this week and we are grateful for the tremendous response we are seeing from our customers who are willing to partner with us in taking care of the environment.

While we are proud of these recent accomplishments, we continue to invest in additional innovative products and research. We continue to make progress with our next generation pod and with the version of our PDM which will provide integrated continuous glucose monitoring capabilities. We remain on track to be into the FDA by year end, with an integrated CGM solution.

We are also pleased to be involved in the innovative scientific research within the industry. At the June meeting of the ADA, research was presented demonstrating exciting progress in the Juvenile Diabetes Research Foundation’s Artificial Pancreas project. The OmniPod System continues to be sought after by leading researchers and institutions is being used at the majority of the Artificial Pancreas Project study sites.

Studies using the OmniPod System from the Sansum Diabetes Research Institute and UC Santa Barbara, as well as the University of Virginia showed advances in automating and refining the algorithms necessary for a closed loop system. We are proud to be a part of this important research and to be recognized by these thought leaders as a cutting edge technology partner.

We are also advancing our efforts to outside the diabetes. The request for CE Mark approval has been filed ahead of schedule for our first non-diabetes application in partnership with Ferring Pharmaceuticals. We expect to receive approval this quarter.

Next, let me turn to domestic and international market expansion. When we last spoke in early May, we noted that we had seen the number of referrals increase in March and April. That trend continued throughout May and June as sales team generated a record quarter of referrals and remained strong through July. The increased sales productivity was a key factor in our strong Q2 results.

We are encouraged that the positive trend we’ve seen over the last five months will continue throughout the remainder of the year. We also see great opportunities to expand the market for OmniPod internationally. In April, we announced that the OmniPod System have received CE Mark approval, giving us the license required to begin to distribute in Europe and other key diabetes markets.

We have already received enthusiastic feedback from key opinion leaders in Europe. We are in active discussions with perspective partners across the globe and anticipate having agreements in place over the next few months, and order for us to begin capturing revenue in revenue in 2010 and beyond.

Finally, let me turn to manufacturing and operational efficiencies. As the business continues to scale, we remain confident that we will gain additional manufacturing leverage. Gross margins increased to 22% in the second quarter, compared to 16% in the first quarter, representing a 60% increase in gross profit. Impressively, over $0.80 of every incremental dollar of revenue added in Q2 of this year as compared to Q2 of last year fell to the gross profit line.

As we look towards the third quarter, we are confident that the cost per-unit will be below $20 million per Pod, and that the gross margins will reach in access of 30%. As we previously discussed, we continue to aggressively look for opportunities to put our operating expense dollars to higher ROI initiatives.

One example of this has been in the area of patient outreach. In the second quarter, we invested an additional patient outreach capacity as a program to reduce attrition. The early results of the initiative are encouraging. Despite the higher levels on unemployment across the country, attrition decreased by a full percentage point in Q2 to approximately 11% from 12% in Q1.

We will continue to look for additional operating efficiencies in the coming quarters, while being mindful of not allowing the back office functions to constrain our ability to generate growth.

With that, I’ll turn the call over to Brian, to provide additional details about the quarter, and our expectations for the third quarter and full year.

Brian Roberts

Thank you, Duane. As Duane noted, our second quarter results exceeded our original expectations for the quarter. Revenue increased by 97% year-over-year to $14.6 million as compared to $7.4 million in the second quarter of 2008 and grew sequentially by 17% from $12.5 million in the first quarter of 2009. The stronger than expected revenue result was due to a record level of referrals and a better than anticipated initial response to our new PDM 200.

Looking ahead, we expect the pipeline of referrals and PDM upgrades to remain strong, resulting in an expectation of as $16.5 million to $17.5 million in revenue for the third quarter. This represents 13% to 20% sequential growth from Q2. Gross profit for the quarter was $3.2 million or 22% as compared to a gross loss of $2.4 million or negative 32% in the second quarter of 2008, a $5.6 million improvement year-over-year.

As Duane noted, we expect that the cost comparable will fall below $20 in the third quarter as Flextronics ramps production to meet our anticipated higher levels of demand. In total, we expect the third quarter gross margins in north of 30%. As expected, operating expenses of $19.6 million remained relatively flat with last quarter, as efficiency savings in area such as G&A were offset by higher sampling cost relating to the release of the PDM 200.

Operating expenses for the second quarter of 2008 were $19.8 million, reflecting last year’s ramp up of headcounts in the commercial organization. We are working hard to identify areas where we can gain operating efficiencies, across our support functions in order to better utilize those dollars on higher return on investments, such as research and development, customer outreach and product support.

We reported the second quarter 2009 net loss of $20.2 million or $0.73 per share as compared to a net loss of $24 million or $0.87 per share for the second quarter of 2008. The year-over-year change is a result of the significant improvement in gross profit, offset by higher interest expense related to the company’s convertible notes issued in June 2008, and the credit facility issued in March 2008.

Our Q2 operating loss of $16.4 million, decreased by $5.7 million or 26% from the second quarter of last year, as a result of the improvement in gross profit. As of June 30, cash and cash equivalents totaled $52.4 million, as compared to $56.7 million at December 31, 2008.

We used approximately $13 million in cash for operations in the second quarter, down from $15.5 million in Q1. Total cash burn was $16 million in the quarter with the remainder related to interest payments. We remain focused on reducing our cash burn as the business continues to grow.

Finally; turning to guidance, as I mentioned we expect third quarter revenues of $16.5 million to $17.5 million. For the full-year 2009, we are tightening our revenue and operating loss expectations. We now expect revenue of $58 million to $65 million for the full-year as compared to our previous estimate of $55 million to $65 million, and operating loss of $55 million to $60 million as compared to our previous estimate of $50 million to $60 million.

With that, let me turn the call back over to Duane.

Duane DeSisto

In summary, we’re pleased with our second quarter progress. Our strong second quarter results reflected Insulet’s focus on innovation expansion and efficiency. We drove a record level of referrals and improved our gross margins, and launched our second-generation PDM. The easy-to-use OmniPod System continues to deliver on our promise to make diabetes a smaller part of life.

With that operator, please open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from line of Ben Andrew with William Blair, you may proceed.

Ben Andrew – William Blair

Good afternoon guys, just a couple of quick questions if I may. First; the Cosmo patients that have been up for grabs, how big a contributor can you estimate that’s been to your business in the last quarter?

Duane DeSisto

I think Ben. I think we have a significant amount in interest. We have a significant amount of order in the backlog. I don’t think it was material to this quarter that we just went through. There is some of that upgrade, but it’s not material to the quarter, as we just completed second quarter.

Ben Andrew – William Blair

Okay and then the PDM program that you’ve been involved with, both the sampling and kind of the upgrade, Brian how much revenue would that have contributor? Because you talked about that having an impact on sampling costs, but also there was a revenue opportunity there?

Brian Roberts

The PDM that’s been in the market for a couple months as Duane mentioned, 20% or so, of the customer base is upgraded. It had some impact in Q2, probably in the neighborhood of about $0.5 million and then on the other side for sampling expenses, it probably was three quarter of $1 million of expense.

Ben Andrew – William Blair

Okay, and how long it tailed on that PDM opportunity? Do you get the 00% of the patients, what is sort of your forecast, and how long to get to that maximum penetration?

Brian Roberts

I think we’ll have to see. I think your typical upgrades or so, a lot of people believe is in somewhere from an industry basis around the third or so, but we are pretty encouraged with the pace so far.

Ben Andrew – William Blair

Okay and then talk a little bit if you would, Duane about the back office and sort of where you are with way you’re with [Inaudible] forcing that versus the ability to automate it. Do you feel like you’ve come half way through or more in the process of getting the payers kind of cleanly onboard with handling your patients or is there a long way to go there?

Duane DeSisto

To be honest with you, we are very cautiously optimistic, but we are pretty excited. We made a lot of progress in last quarter, as we said we had changed out some of the management there and that groups really taken over. We’ve kind of added some upgrades from the computer side.

So, we’re pretty excited that the group can continue to handle the increase in volume that we are seeing. So, it was a very positive bright spot I think in the quarter four. Although, we haven’t seen all the benefit from it, but it really was not an impediment or it was like I said, we are cautiously optimistic that we really finally have this right.

Ben Andrew – William Blair

Good. Last quick question, you mentioned you have a CGM going to the FDA by the end of the year, I assume that's with Abbott with DexCom.

Brian Roberts

Yes, one of those two.

Ben Andrew – William Blair

Are you not disclosing or…?

Brian Roberts

Yes, look at the end of the day, we have agreements in place with both and we are charging ahead with both of them.

Ben Andrew – William Blair

Okay, thanks.

Operator

Your next question comes from the line of Mike Weinstein with JP Morgan. You may proceed.

Kim Fustier - JP Morgan

Hi, there. It’s Kim for Mike. How are you?

Brian Roberts

Hi, Kim; how are you?

Kim Fustier - JP Morgan

Good, thanks. A couple of quick ones just on the quarter, was there any change in the number of sales reps out there?

Brian Roberts

No, we remained at 50 reps for the quarter.

Kim Fustier - JP Morgan

So, I assume based on the result that your new patient adds had to have increased during the quarter, is that right?

Duane DeSisto

Without a doubt.

Brian Roberts

Yes, as compared to Q1, absolutely.

Kim Fustier - JP Morgan

Okay, great and can you talk a little bit about how the percent of distributor based revenues might have changed at all in the quarter?

Brian Roberts

No real change in Q2. We are probably still averaging high single digit right now from distributors. The good news back to the question that Duane just answered, from a managed care perspective between distributors and our direct contracts we are well covered.

Kim Fustier - JP Morgan

Okay, great and then just one last. You had talked a little bit about the OUS build out and getting ready for product shipment I think in early ’10. How should we think about that ramp in our models?

Brian Roberts

I think it’s still a little bit to be seen, as we work through over the coming months here to get a couple of deal signed. I think the plan has been that it will still be a small component of 2010 revenue as a lot of markets. We haven’t seen mark approval enhance, but a lot of markets will still take time to work through their various individual reimbursement channels. So, we’ll expect to have some revenue impact us in 2010, but not a number yet.

Kim Fustier - JP Morgan

Okay, thanks guys.

Brian Roberts

Thanks.

Operator

Your next question comes from the line of Gerald Hoss with Thomas Weisel Partners. Please proceed.

Gerald Hoss - Thomas Weisel Partners

Thanks a lot. Can you talk about the SG&A leverage in the model going forward? Especially given the potential impact of competition from one smaller player here, and also one much larger over the next few quarters?

Brian Roberts

Let me handle the G&A leverage size and then I’ll turn it over to Duane to talk about the competitive environment, but from a G&A leverage perspective I think you see in a couple of things.

One, we started to achieve some of that in the quarter, as we noted both we were able to cover the PDM, the additional PDM sampling costs in Q2 for the rollout of the PDM 200, as well as launched a customer outreach program that Duane mentioned that kind of helped combat attrition in both of those, I think very well in the quarter.

We also feel pretty good right now in the back office side, that we’ve got the right folks in place. We still have work to do around processes and systems, but I think we’ve made a lot of headway across the organization over the last few months. So we’re feeling pretty good that we can continue to handle the increasing demand for the OmniPod System.

Gerald Hoss - Thomas Weisel Partners

Anything on competition there?

Duane DeSisto

I think at the end of the day here is the thing I think that you have to put in perspective. We’ve created this category Disposable Insulin Pump. I think we are aware, last count there is probably a dozen companies out there looking at trying to get into this space, whether it is from a type two, type one combination.

So I think we are uniquely positioned that we understand the space. We understand what is going to take to compete in this space and I think we’ll deal with the competition when they finally arrive. Look, I’m not going to get into the business, at tilting at windmills here. When we see, we are in every major institution, every large practice in the U.S.; we are knocking on the door. To-date we have yet to see a product in those spaces.

We think we understand what all the competitors and potential competitors are doing, but right now, it’s our marketplace and we continue to build our credibility with these practices.

Gerald Hoss - Thomas Weisel Partners

Is there going to be a price increase for your smaller or the next generation smaller Pod?

Duane DeSisto

I don’t think we have thought that all the way through yet. I think the good news is that we believe that product will be a major step down in cost to produce. So I think we’ll gain significant leverage. I think the one particular area, where we may take a hard look at pricing is when we integrate, we’ll continue with Sansum. To me that will be more kind of on the handheld side as opposed to the disposable side.

Gerald Hoss - Thomas Weisel Partners

Then you mentioned gross margins are likely to be above 30% next quarter? For the year, do you think it will average above 30%?

Brian Roberts

No, I mean I think we’re averaging 19% through the first six months. So I’d say, it’s unlikely that we’ll be able to average 30% for the full year. For Q3 we’re expecting it to be north of 30% and hopefully we’ll continue to see some momentum into Q4 in the margins.

Gerald Hoss - Thomas Weisel Partners

Okay, then just lastly. Can you tell us what the product revenue was in the quarter? Is there are another a couple line of [Inaudible] payment and there’s like lumpiness in that deferred revenue side. Can you just give us a sense of what the product revenue was?

Brian Roberts

I think the Abbot revenue was about $1 million in the quarter, which is pretty consistent with where it’s been running over the last couple of quarters, beyond that I would say from a cost of goods sold side, we’re obviously adding in all of those costs into our total numbers. So I’d certainly have the perspective that you have to include the Abbot revenue in that as well. So, the rest of it I’ll assume, it’s the way you’re breaking it out will just be product.

Gerald Hoss - Thomas Weisel Partners

Okay, thanks a lot guys.

Duane DeSisto

Thanks.

Operator

Your next question comes from line of Bruce Cranna with Leerink Swann, you may proceed.

Bruce Cranna - Leerink Swann

Hi, good afternoon guys.

Duane DeSisto

Good afternoon.

Brian Roberts

Hi, Bruce.

Bruce Cranna - Leerink Swann

Duane you mentioned, I think you said a record number of referrals in the quarter. Can you give us a sense as to conversion rates there, exactly or roughly how many those referrals are you converting?

Duane DeSisto

Sure. It’s a little unique, and here is the one place I will tell you that the economy is impacting some of this. We had a significant number of referrals. We probably converted in the mid-60% range; typically we’ve been running about 70%. We’ve had a lot of people don’t want to get that co-pay knocked out of the way, a lot of them have the $500 co-pay, a $300 co-pay.

So, they put in the information, they’re in the queue here, probably be a fourth quarter event for a lot of these people. So the good news is, even with that conversion rate, I would tell you a lot of the people are just, they wanted to get in the queue. We had some of these people with the Cosmo that wanted to get in the queue before the offer expired, but they want to get their insurance straightened out here.

So, I think the economy is impacting people in that, paying $300 million, $400 million and $500 million of co-pay out of pocket all at once is not what they want to do. They want to pay a little bit at a time. So, I think that’s kind of where it was.

I think for the quarter, we are in the mid-60% tile range. Typically we’ve been running closer to 70%, but the good news is that delta is not going away, that’s more of patients wanting to get into queue, get inline for the product and then really kind of take care of their piece of the financial puzzle here.

Bruce Cranna - Leerink Swann

Okay, so maybe a little bit of a slip on the percent.

Duane DeSisto

I think conversion was down a little bit, but I would tell you the good news is, I would tell you, I think the back office was at no point in time, the bottleneck in any of that. I think it really was two-fold. One I think, the people coming over from the SMISS program wanted to get into queue, wanted to take advantage of the offer.

Now, some of those people, if you remember how the insurance works. You come for renewal every four years, on some of the managed care companies that when we know SMISS is going out of business. So, we won’t pay for the handhelds, but we’ll pay on an ongoing basis.

So, we’re working through a lot of stuff with a lot of people. Like I said, that the good news is the slip, really had some more to do I think a little bit with the economy and what’s going on out there and how people want to manage their money, as opposed to the back office.

I would tell you, most quarters; it would have been in the back office. Its absolutely not, I think we are making real good progress there. It can get better, but I think we are making real good progress there.

Bruce Cranna - Leerink Swann

Thank you, that’s helpful, and how do think about retention rate? I know you’ve been struggling a little bit last quarter and maybe the quarter before and you don’t have to comp up the numbers if you don’t want to, but is that sort of holding steady, are you seeing any kind of change in retention rates?

Duane DeSisto

The interesting thing, kind of reset the bar to everyone. What we said is, about half the people drop off in the first 90 days and then the other half kind of drop off overtime. The ones that drop off beyond that first 90 days, typically because they loose their job, they loose their insurance coverage, the vast majority of those.

So, the up from part piece what we did is, we started making some outbound phone calls. We started calling people in conjunction with them being trained and we knocked that down to four points in the quarter. So one quarter does not make a trend, but we think we have a means even in this economy to get people comfortable with the product early on. So, that’s the piece we’re really attacking.

At the end of the day, people are unemployed. If the cobra runs out there’s not a lot I’m going to be able do about that, but that piece upfront getting people comfortable with it. I guess that we dropped at a full point and went from 12% to 11% in the quarter, and all of that was really in the upfront piece.

Bruce Cranna - Leerink Swann

Alright that’s real helpful, thank you. Then Brian just again, I heard your color on G&A. I’m just looking at my model and can you kind of remind us why -- I understand there’s leverage in the business model, but why in a whole dollar basis it’s down sequentially?

Brain Roberts

Why is G&A down specially or overall operating expenses?

Bruce Cranna - Leerink Swann

No, G&A specifically.

Brain Roberts

Again, I think it’s a combination of a couple of things. When we took a hard look at some of our G&A costs coming in here for Q1, we had a little bit of leftover I would say from 2008 that was accrued and expensed in the first quarter of 2009, mainly around like some professional fee accruals. So, there is some leverage for us there and we are able to take some that then move it over to as you can see, more of an up tick in the commercial organization, both for the sampling cost that Duane mentioned, as well as the outreach program.

I think we talked about it now for the last couple of quarters. We are just trying to really look at the dollars we’re spending and figure out ways for us to use them in a smarter means, and frankly G&A is not the spot, we’d rather be putting those into R&D and commercial.

Bruce Cranna - Leerink Swann

Okay, but I mean that type of numbers is somewhat reasonable going forward or at least as a percentage of sales to think about.

Brain Roberts

Yes, I think it’s somewhat reasonable going forward.

Bruce Cranna - Leerink Swann

Okay and then last one for me; Duane I’m sorry you’re kind of going fast and I missed what you said about Ferring. In terms of timing, can you run that bias again, what their filing and the timing their?

Duane DeSisto

Sure, if you remember, we had signed a deal a while ago for a fertility drug in conjunction with Ferring. We should receive a CE Mark approval for this now. If you saw the two handhelds, while the pods are the same, the actual handheld is completely different than anything we make for diabetes, just kind of icon driven, it’s really kind of innovative.

So we created this new handheld. We needed CE approval for that. We found out last week that within the next 30 days we believe we’ll get models. Until it’s is done, it’s not down, but we think within the next 30 days to 45 days we’ll get approval and that will allow Ferring to start marketing the product.

So, nothing material, but we’ll start seeing a little bit of revenue here in the fourth quarter and then it will start picking up next year, but it’s a non-diabetes application that we have gone from kind of concept, working with a pharmaceutical company to the actual delivery of the product. So we’re pretty excited. We’ve learned a lot in this process working with Ferring. They’ve been a terrific partner and we’re excited about all the potential opportunities.

Bruce Cranna - Leerink Swann

So at this juncture we’re just talking, we’re envisioning EU only introduction of this drug and device?

Brian Roberts

Yes, Ferring is going to run through this product that currently exists. So we don’t need drug approval, but the actual -- the approval of the handheld in conjunction with the drug is what’s being done.

Bruce Cranna - Leerink Swann

Then as we kind of move forward with this, how should we think about the P&L impact to you guys, to the extent you want to discuss?

Brian Roberts

I think right now, we’re dealing with lots of pharma companies. I would tell you that business is significantly slower than the one we’re having, so I don’t think there’s anything material that’s going to come of it. I think we will measure progress in small steps with these guys.

Having said that, we’re doing some studies with various drugs and they’re healthy patient studies and then if that goes well, they move onto other things. So it’s a completely different timeframe. I don’t see anything material happening here in the short run. If we see any of that, obviously we’ll give everyone an update.

Bruce Cranna - Leerink Swann

Understand, I’m just trying to figure out philosophically if this is you selling them empty product or some sort of registered?

Duane DeSisto

That I can give. Look, at the end of the day what we’re selling is basically an empty product with a user interface and that handheld device is tailor made to potential application that they are looking for. I mean there have been requests for kind of pre-filled devices and pods and we’re paying attention to all that and we’re walking that path very, very slowly. In the short run it is our traditional pod with the same size reservoir and typically a unique handheld associated with whatever the potential drug application is.

Bruce Cranna - Leerink Swann

Got it. Thank you.

Operator

Your next question comes from the line of Mimi Pham with Soleil Securities. You may proceed.

Mimi Pham - Soleil Securities

Hi, thank you. Duane you addressed competition, but can you specifically talk about Medtronic’s patch pump, they unveiled it last month. Based on what you’ve heard about the features, can you just talk about their product relative to your current and next generation Pod?

Duane DeSisto

Mimi, I probably saw what you saw, I saw it on CNN and maybe you got to see the live plastic buck. Our stance has been pretty simple. When we see it in the marketplace, we’ll deal with it, here’s our belief though. I will reiterate it to everyone on this call and I think we’re spot on, but we’ve had the opportunity on multiple occasions in designing of this product to come up with multiple pieces and part Pods, all kinds of different things.

There is nothing unique that we’ve seen out in the marketplace that we haven’t looked at one point in time or the other. I think the key to success, keeping in mind that we are growing the market; we’re not trading off with the existing pumpers. I think the key to success in this space is ease of use. No one I believe will have an easier product to use than ours.

So in the long term, I think I firmly believe we’re going to win and in the short term, if you put enough marketing dollars, then you may be able to convince some people that the sun rises in the west and sets in the east, but in the long term people figure it out. So I am very, very confident with our ability to compete in this space.

We are very, very cognizant of the market leader though. They’re a very, very big company, a very aggressive company, so we’re paying attention, but I think without a doubt, I think ease of use. Not defined by the company, but ease of use defined by a patient is ultimately what’s going to win all this and I think we are uniquely positioned to take advantage of that.

Mimi Pham - Soleil Securities

Okay, so it sounds like some of the features they have like being a [Inaudible] to the pod or remove the pod the easy use you think is going to prevail.

Duane DeSisto

Mimi, we can take this offline, but if you think about all those features, there’s a lot of complication associated with a lot of those feature sales. There’s a lot of complication associated with pieces and parts that are sampled. When you take apart and then you put back together again in the awarded tight nature of that product, there’s a lot going on; and like I said that, I would not underestimate them for a minute.

But having said it, we’ve had that opportunity when we first came out with the product. We had that opportunity again when we developed in our next generation product. We went back into the marketplace. We listened, we looked, we observed, we understand where our customers come. They’re people that walked away from pumping from the beginning, right.

We are growing the market. People have come into our product because we were making diabetes a smaller part of their life. There’s less things; they have to be able to read and they have to be able to take a syringe out and put some insulin in the product and after that, it takes over. We think ultimately, long term that’s the right solution.

Mimi Pham - Soleil Securities

Okay and then for your guidance for next quarter, does that take into account I guess what typically is a slow August till summer?

Duane DeSisto

Yes, absolutely. I mean we feel comfortable with the $16.5 million to $17.5 million guidance for Q3.

Mimi Pham - Soleil Securities

Okay and then last, I wonder if you actually said, how is the magnitude of the Eco-Pod program. Is there like a set cost that you expect for the year from that to show up?

Duane DeSisto

To be honest Mimi, this will be cash neutral to us. It will not impact the P&L in anyway, say performance and it’s an outside firm that’s doing the recycle. Our patients have signed up for postage on a quarterly basis. I think we said about $3 a months for them to send it back and based on the precious metals and the metals that are in the actual pod itself, it all pretty much pays for itself.

Mimi Pham - Soleil Securities

Okay, thank you.

Operator

Your next question comes from Hamed Khorsand with BWS Financial; please proceed.

Zaheer - BWS Financial

Hi, this is actually Zaheer [Ph] calling in for Hamed, a couple of questions. What kind of progress are you seeing there and what operating costs are being associated with the expansion in Europe?

Brian Roberts

To-date not a lot. I mean as I think everyone is aware, my predecessor Carsten Boess is heading up all of our international operations and he’s really been the person driving. He’s spending a lot of time abroad across both Europe and Asia and identifying partners and putting in all of that leg work necessary. He deserves a tremendous amount of credit for the work uncovered so far.

Then, internally working through what we think the ultimate best strategy is for us, is the work that we’re doing. Our goal with the international expansion as we’ve discussed previously is to effectively make as close to a turn key as possible for us, where we’ve gone in direct and we don’t have the build the level of infrastructure internationally that we have here in the U.S.

Zager - BWS Financial

Okay. Do you have a Taiwan before pod that’s available in Europe?

Brian Roberts

I think from our standpoint right now we’re talking to several potential partners about that. My guess is we’ll start seeing product in Europe, probably by the time they get reimbursement approval. If we can get something done here before the end of the year with a couple of these players, then it’ll probably be maybe a little bit in the first half, but it’ll really probably start up-ticking in the back half of 2010. That’s really when we think we’ll see the first significant up tick in business.

Zager - BWS Financial

Okay and with regards to your customers and new users, what was their mix?

Duane DeSisto

It’s still running about. It’s roughly still about 70%. It’s the first time that we’ve ever been on a pump or a Pod.

Zager - BWS Financial

Finally, my last question, what is the status on the competition gap? Is it narrowing or is it expanding or is it still the same?

Duane DeSisto

I’m assuming everyday that goes by, these guys are getting closer and closer. At the end of the day once again, I feel very good about where we are. I think we’ve created this space. I think we understand all the inherent problems that come with the disposable product, so we’re ready. When these guys are in the marketplace we’re willing to compete, until then like I said, I’m not going to spend a lot of time until we know.

Zager - BWS Financial

Okay, thank you.

Duane DeSisto

Thanks.

Operator

Your next question comes from the line of Bill Plovanic with Canaccord Adams.

Bill Plovanic - Canaccord Adams

Great. Thank you, Good evening.

Duane DeSisto

Hey, Bill.

Brian Roberts

Hey, Bill.

Bill Plovanic - Canaccord Adams

A couple of questions for you here; first, how much of an impact do you think UNH policy change in the beginning of the year has had on your business?

Duane DeSisto

We are going to have to get that offline. I don’t know how much of the united piece is that. I mean without doubt its health, I’m not arguing that in for a minute, but off the top of my head I don’t know Bill. I don’t know if you know Brian?

Brian Roberts

No, I think United is obviously a relatively large healthcare plans, so it certainly has a positive impact for us, but we really don’t look at it on the plan-by-plan basis that way.

Bill Plovanic - Canaccord Adams

Okay, and then I know that your inventories were down significantly on a sequential basis. Kind of what’s going on with the manufacturing shift in China? The shutdown that’s been talked about and how did you burn off so much product and still be able to maintain your gross margins?

Brian Roberts

Sure, great question. A couple of things happened on the inventory front. We learned probably in the middle of May or so, there’s some discussions we obviously have folks in China on a daily basis; that the proposed shutdown of Flex that we though was going to happen right about now, was going to be pushback and is likely right now looking more towards Q1 of 2010, in conjunction with the Chinese New Year.

When we learned that, we said “Well, this provided us a really good opportunity to do two things.” One, to right size the inventory a little bit, because we didn’t want to continue to carry that rate of inventory for the remainder of the year. Second, our R&D team has been working on some different designs in several different components, hopefully to be able to reduce some cogs and continue to improve the overall quality.

So we use that time and Flex to be able to test some of those instead. So yes, we have created a nice opportunity for us to be able to kind of do both of those things in one shot, right size the inventory and then keep moving forward.

Bill Plovanic - Canaccord Adams

Duane, what, is manufacturing already shutdown then?

Duane DeSisto

No, it wasn’t shutdown, it was ultimately the shutdown that we talked about for them to relocate facilities is likely to happen in the winter.

Bill Plovanic - Canaccord Adams

Okay, but I guess let’s provide you with some concessions that you’re not in negatively impacting for the gross margins, because your volume production per month had a drop for you to burn inventory. So I’m just trying to understand, how that all worked?

Duane DeSisto

Bill, this is Duane. I mean we’ve absorbed that in the numbers that you said. So as the inventory ramps up, that’s part of the next step up improvement in margins.

Bill Plovanic - Canaccord Adams

Okay, and just looking at the Ferring deal. Well Ferring, did they pay you a milestone upon approval, or did they buy pods from you upon approval; how does that work?

Duane DeSisto

What will happen is, we’ve manufactured this kind of unique PDM for them. So they’ll be buying them and they’d be buying pods and there’s minimum quantity guarantees and as it goes forward.

Like I said, I think we said at the time it was a great opportunity to stick our toe in the water with a major pharmaceutical company. Obviously this year it’s not going be material to anything we have. Even next year it may not, but it was a great learning experience. It helped us kind of come up with an icon based PDM, so we think we can leverage that and all kinds of other business and we think on a go forward basis, it’ll be a steady piece of revenue for us.

Bill Plovanic - Canaccord Adams

Okay and then on Abbott, as you upgrade customers from the old PDM to the new PDM, they don’t pay, do they, on that upgrade?

Duane DeSisto

It’s none of that in those numbers that you see.

Bill Plovanic - Canaccord Adams

Okay, and then how much does the customer pay for an upgrade? What’s the deal right now?

Brian Roberts

We’re running a limited time promotion through the end of this quarter, I believe, which is at $149 upgrade plus.

Bill Plovanic - Canaccord Adams

Okay and then, just as we look out into 2010 and beyond, I mean your sales force is 50. Do you think you’re going to be expanding that distribution channel in 2010 or is the 50 the right number and you’re just going to keep running with that for the near term?

Brian Roberts

I think Bill, I think if we’re talking maybe 50 going to 60, maybe that’s it, but we’re not doubling the sales force. I think what we found is, what we’re very, very excited about is, there was a little bit of culling out in the sales force. We think we got some very, very good people.

We have some unbelievable clinical specialists working hand-in-hand with that group. So, we haven’t seen the top end of the productively yet, so I’m not sure what the right number will be eventually, but it’s not a material increase in what we have here.

Bill Plovanic - Canaccord Adams

Does the approval that you’re looking for through the combination device, just remind us again, is that a PMA or a 510-K with the CGM?

Duane DeSisto

It would be a PMA supplement with the manufacturer of the sensor. So what will happen if the engineering gets done, our plan will be worked out with the regulatory agency and what they want to see in terms of testing and then that testing will be completed, the results would be submitted and then based on the results the FDA will determine if it’s approved for marketing.

Bill Plovanic - Canaccord Adams

Okay and just modeling questions, D&A in ’09 and ’10, and stock comp in’09 in ’10?

Brian Roberts

Hang on a second. Go ahead and I’ll get those numbers for you.

Bill Plovanic - Canaccord Adams

Okay and then just the last question I have is, just the parity issues that you hit in the first quarter, where you had some guys that were slow to pay or not paying. Are we basically 100% through that at this point?

Duane DeSisto

100% mean there’s never going to be another issue, so I’ll leave that one on the table. We’ve made huge progress and I’ll leave it at that. Our gut reaction to everything we see, we made very, very large strides in the quarter, a 100%. Bill I think 10 years from now we won’t be 100% through that. I think that’s just nature of how the home managed care works, but we made significant progress from where we were in the first quarter.

Brian Roberts

So Bill just to answer your other question, depreciation year-to-date has been about $2.6 million, again most of these numbers I think you can just pretty much double, so I’d assume about $5 million to $5.5 million on depreciation by the end of the year. Stock comp has been $2.2 million through six months and that is probably somewhere in the range of $4.5 million by the end of the year?

Bill Plovanic - Canaccord Adams

Then a big increase for 2010 or roughly the same or?

Brian Roberts

Probably, I’d say some increase as a percentage of sales, but nothing material.

Bill Plovanic - Canaccord Adams

Okay that’s all I had. Thanks and good quarter and we’ll see you next week.

Brian Roberts

Thanks Bill.

Operator

Your next question comes from the line Suraj Kalia with SMH Capital, you may proceed.

Suraj Kalia - SMH Capital

Congrats Duane and Brian.

Duane DeSisto

Thanks.

Brian Roberts

Thanks Suraj.

Suraj Kalia - SMH Capital

Duane, in terms of the inventory pull through for gross margins, you showed pretty nice bump sequentially in gross margins, how much would you attribute that to the life of pull through price increase with the PDM 200 and unit implants. I guess I’m just trying to extrapolate, for Q3, how much of the rise that you said is going to be greater than 30%, is being factored in because of price increase versus the inventory pull through and basically versus what you see in the market?

Brian Roberts

Suraj, this is Brian. I mean no price increases I’d say that kind of talk about. I mean as you know, the managed care process that push through price increases is long and lengthy. So we’re seeing a little bit of an up tick due to the PDM upgrades that we’re receiving back from payers directly.

So again, probably $0.5 million bucks or so that we talked about in Q2, but really nothing else coming from pricing. I mean the rest of it’s going to come from just the sale of normal products, clearly by us being able to right size our inventory a little bit more. In Q2, that’s going to allow us to continue to push through a lower cost pods into the P&L in Q3.

As we talked about in Q3, we think pods are being produced under $20 and that’s certainly one of the drivers for why we think we’re very confident that the margin will hit 30% in the third quarter.

Suraj Kalia - SMH Capital

Okay, and Duane, in terms of the sales and marketing line item, at what point do you envision. You earlier mentioned that we are still not at full potential if I remember correctly the word or maybe something else was used, but at what point do you envision the leverage in the sales and marketing line item to kick-in? What all things need to happen from now, to maybe two quarters or whatever down the line, where you would say, “Now we are running at full potential?”

Duane DeSisto

I think the interesting thing for us is kind of to take a quick step back. We basically had full sales force. In effect I think we had them all onboard April last year, so we’ve had about four quarters under our belt.

I think every quarter the productivity per rep has continued to increase. Once we’ve had this group in place and we had another step up in Q2, we’re pretty excited about how the month of July looks here, usually the summer kind of slows down, and then it starts picking up in September, but July looked very, very good; the first couple of days of August looked very good. So we’re pretty excited about that.

I think for us to determine, what’s the right size for the sales force in the clinical specialist, what we want to do is we’re paying very, very close attention to these metrics. I think we have a very good reporting system, so we can see things before they happen now out there in the field. So if we see at some point in time, we start seeing the territory maybe flattening out, then I think we’ll be in a position where we can say “Okay, have we matched out the territory? Have we matched out the capability, the people in the territory or how should we look at this?”

So I think the interesting thing for us though, is for the most part we’ve seen improvement across the board and the exciting part for us is if you think about China improved the whole productivity in the entire sales force, it’s not necessarily the top 10 guys getting better, it’s the bottom 10 guys moving up and that’s really been.

With the kind of management we have in place now, it’s been a very, very concerted effort to put in the support structure for a lot of these guys who are struggling a little bit, and we think we are making real progress. Like I said, the top sales guys are the top sales guys, but the real trick for this is to bring the lowest performing guy up. If we can make him the top sales guy, then we have beyond the home run.

Suraj Kalia - SMH Capital

This might be not a major question Duane, but the concept of Eco-Pod and recycling, is that other costs high for recycling and if so who is bearing the costs?

Duane DeSisto

So the way the program works is, it is cost neutral, since it really costs us nothing. We had a lot of feedback from our customers’, we’ve had people who have been on the product now for three years that saved every pod, because they didn’t want to throw it in the landfill. Going to Europe it’s a question on everyone’s mind, so we spent a lot of time exploring with the lot of these recycling companies.

The unique part about that, with the batteries in our products and some of the metal on the circuit board and the coating, it’s enough metal and precious metal in the product that that pays for the recycling and we’ve asked our customers and it works out I think roughly $3 a month. They’re paying for the freight to send it to the recycling company. So it is completely and totally cost neutral to us.

Suraj Kalia - SMH Capital

Fair enough and last question guys. Is it safe to say that based on the existing synergies and efficiencies you see, let’s say over the next two, three quarters, cash on hand is sufficient for two to three quarters?

Duane DeSisto

Yes. I mean in our regard, we guided that.

Brian Roberts

Yes.

Suraj Kalia - SMH Capital

Gentlemen congrats, Thanks.

Brian Roberts

Thanks.

Operator

Your next question comes from the line of Derek Leckow with Barrington Research, please proceed.

Derek Leckow - Barrington Research

Thank you. Good afternoon.

Brian Roberts

Good afternoon.

Duane DeSisto

Good afternoon.

Derek Leckow - Barrington Research

Question on the European expansion and ultimately the Asian expansion here. You said that we shouldn’t expect any structural operating costs ahead of that launch, but what about marketing expenses. Should we anticipate some ramp up in those kinds of costs, ahead of the revenue?

Duane DeSisto

I think Derek the way to look at this, we are dealing with one of the criteria that costs and how money went out there and started talking to these companies. They had to have the infrastructure to basically handle all the marketing materials and the piece that we’re dealing with; for instance, if we are going to go into Germany, then we are creating the German interface inter-phase on the PDM.

The marketing materials, the user guide will all be done by whoever our partner is here. To give you some sense, from a software standpoint, it’s probably about $25,000 to turn in English, not following to the exact number, but roughly to turn an English PDM, maybe into a German PDM. So, we are responsible in the stuff related to the product, it’s all part of the negotiation.

Then the one other potential cost that could creep into the whole thing is who is responsible for the actual regulatory submission and as we go with these various countries-by-countries, we are learning a lot here.

So that might be, but our goal is quite simply to make pods, provide all the marketing material, have it all be converted to whatever language is necessary. Have that company carry the day for reimbursement and then we’ll take on whatever regulatory responsibility we have to have so. Our real plan here is not to put a huge infrastructure idea to support that, absolutely not.

Derek Leckow - Barrington Research

Okay and I think you said sometime mid to late next year is kind of what we should anticipate, because first you have to get these country-by-country regulatory approvals. Is that how it works?

Duane DeSisto

Yes, the way it works is, it’s one thing to have seen market in Europe, it’s a whole another thing to get reimbursed. So in that regard, it’s not all that different than the U.S.. For instance, in Germany there is five sates that you have to go in, do a submission, buy clinical data and then they approve it.

I think regulatory approval is probably not the way we work today. In order to insure this gets reimbursed, that process is going to take a little bit of time and it’s different for every single country. For instance, if you’re going to China, it’s probably about 12 months from the day you start to the day you can get paid in China. So it’s different country-to-country, so that’s kind of why we are looking at it.

We think we will have this thing hopefully buttoned down here in the next few months. The tough part of dealing in Europe, a lot of those companies are on vacation for the month of August, which slows you down a little bit here. So we’re hoping the end of the Q3, beginning of Q4 we’ll get something pinned down and then we’ll get that process going and China being kind of an exception, it looks likes it’s three to six months to get setup, so you can get reimbursed in the various countries.

Derek Leckow - Barrington Research

Then from a capacity point of view, if the timing of these things happens to be a lumpy sort of thing, what sort of capacity do you have currently? Are you in a position to meet the kind of demand that one of those markets might need initially?

Duane DeSisto

What we’ve done is, we’ve gone out to all the people were talking to and we have minimums that people feel comfortable that they’ll be willing to guaranty. We kind of have a midpoint and then we have our top end. So based on those various ranges, we believe that we’re in good shape for 2010, that the current operations in China can handle that alone.

Derek Leckow - Barrington Research

Okay, great. Thanks a lot. I appreciate it.

Duane DeSisto

Thanks.

Operator

This does conclude the question-and-answer potion of your conference. I would now like to turn the call over to Mr. Duane DeSisto for closing comments. Sir, you may proceed.

Duane DeSisto

Thanks every one for joining us today and we look forward to updating you about the progress for our next quarter. Thanks.

Operator

We appreciate your participation in today’s conference. This concludes your presentation. You may now disconnect and have a great day.

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