Insulet's (PODD) CEO Duane DeSisto on Q1 2014 Results - Earnings Call Transcript

May. 7.14 | About: Insulet Corporation (PODD)

Insulet Corporation (NASDAQ:PODD)

Q1 2014 Earnings Conference Call

May 7, 2014 5:00 PM ET

Executives

Duane DeSisto – President and Chief Executive Officer

Brian K. Roberts – Chief Financial Officer

Analysts

Danielle J. Antalffy – Leerink Partners LLC

Bill J. Plovanic – Canaccord Genuity, Inc.

Robbie J. Marcus – JPMorgan Securities LLC

Ben C. Andrew – William Blair & Co. LLC

Thomas J. Gunderson – Piper Jaffray & Co

Jayson T. Bedford – Raymond James & Associates, Inc.

Anthony C. Petrone – Jefferies LLC

Mimi Pham – ABR Healthco

Operator

Good day, ladies and gentlemen. Thank you for standing by. And welcome to the Insulet Corporation Q1 2014 Earnings Conference Call. At this time all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time (Operator Instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference to our host, Mr. Brian Roberts, Chief Financial Officer. Sir, you may begin.

Brian Roberts

Thank you. Good afternoon, everyone. Thank you for joining us for our first quarter 2014 conference call. I’m Brian Roberts, Chief Financial Officer of Insulet and 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. We intend these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in section 27A of the securities law and Section 21 E of the securities exchange act and are making this statement for the purposes of complying with those safe harbor provisions.

These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies and prospects which are based on the information currently available to us and on assumptions we have made. 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 Factor section of the Company’s SEC filings, including the Company’s Annual Report on Form 10-K for the year ended December 31, 2013. These risk factors apply to our oral and written comments We assume no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise.

I’d also like to remind you that the guidance we’re 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 myomnipod.com in the Investor Section.

And now I’ll turn the call over to Duane.

Duane DeSisto

Thanks, Brian. Good afternoon everyone, thank you for joining us today. We are pleased to report that 2014 is off to a strong start with first quarter revenue up 21% year-over-over to $69.2 million. Despite typical first quarter challenges such as the resetting of patient deductibles, OmniPod revenue accelerated by more than 35% compared to the first quarter of 2013 resulting from stronger than expected international sales.

Recently, Insulet reported an increase of 117% year-over-year in their diabetes direct business driven primarily by the sales of the OmniPod. They also noted that the OmniPod has achieved market share north of 10% in key countries such as the Netherlands, Switzerland and in the UK. With aggressive growth plans in place in these markets as well as other countries such as Germany, the Nordics and Italy, we continue to expect our international business to more than double in 2014.

The new OmniPod reached its one-year anniversary in the first quarter and we couldn’t be more pleased with the overall results, the smaller, lighter OmniPod has resonated with patients, especially those who have never used an insulin pump before. Our patch style pump the no cumbersome tubing continues to attract new customers that’s over 70% of our new starts in the first quarter who are new to insulin pump. Also consistent with previous periods, our fastest growing segment continues to be patients under the age of 18.

As anticipated, new patient starts in the first quarter slowed to a rate of about 20% year-over-year. However, initial shipments have increased significantly in the second quarter running at over 40% higher rate than at the same point in the first quarter. We remained confident that we will see year-over-year new patient growth north of 25% in 2014.

That confidence is driven by the addition of so many new healthcare practices to our prescriber base. Since launched, new doctors accounted for over 35% of the total prescribers. And we are very happy to report that approximately 70% of these new prescribers have already come back to us with additional orders demonstrating their happiness with the OmniPod product and our level of service. And we are dedicated going forward to continuing to support them at levels they expect.

With these new doctors already showing commitment to the OmniPod, the time is right for us to expand the commercial team. This expansion will ensure we are providing an appropriate level of support to engender long-term relationships. We have spent a significant amount of time evaluating our territories to understand the relationships between territory, managers, nurse educators and our key healthcare practices.

What is clear is that to best serve our target practices our commercial team members need to have a recurring presence in their offices. To maintain this level of support, we hired a third commercial team member, a key account manager to the team in several territories. These new key account managers are helping the teams maintain the vital day-to-day relationship with key prescribers. While our territory managers can continue to open and serve new practices.

To-date, we’ve added approximately 15 key account managers to commercial team and we expect to add another five to 10 in the coming couple of months. We believe this commercial expansion will pay off quickly. We chose to expand the teams mainly in a highest performing territories and believe that the additional resources will provide our existing teams more bandwidth to drive further adoption.

Critical to our commercial success is our ability to produce the OmniPod in increasing quantities. With a year’s worth of experience behind us, we have made significant progress regarding the consistency of our manufacturing process for the new OmniPod. Our daily production has become much more predictable and our tolerance is better defined.

In the first quarter, we made approximately $2. 6 million OmiPods, a slight increase over the fourth quarter. We achieved this level of production despite a two-week shutdown for the Chinese New Year and our performance reflect continued efficiencies gain in manufacturing. Inventory levels have increased significantly as compared to the last half of 2013. Quality levels have improved and scrap costs, which remained higher than planned in the first quarter, have started to decrease.

We continue to build approximately 40,000 OmniPods per day or approximately 1 million OmniPods per month plus all three manufacturing lines. In addition, our fourth manufacturing line is progressing as planned and all equipment should be in place in the third quarter of the year, boosting capacity to nearly 1.4 million OmniPods per month.

Our U.S.-based OmniPod gross margins improved to the high 50s in the quarter and will continue to improve in the second quarter as scrap costs have reduced. On a consolidated basis, gross margins improved by about 350 basis points year-over-year year and will remain relatively flat with last quarter as lower margin international revenues offset the U.S.-based revenues.

Based on our current assumptions, we expect U.S. margins to reach 60% and consolidated gross margins to reach 50% in the second quarter. We take great pride in being the innovative leader in the diabetes pumping market and are investing in R&D accordingly. As we discussed last quarter, we have a very robust pipeline of initiatives across type 1 and type 2 diabetes and we continually explore collaborations in new target markets for our unique, improved and pod-based drug delivery technology.

Let me provide you some brief updates. As you know, we partnered with LifeScan to integrate this OneTouch Verio Blood Glucose Meter into our PDM and submitted the combined price to the FDA for 510(k) clearance earlier this year. We have received initial feedback to our submission and are working collaboratively with LifeScan to respond to the agency’s questions and comments.

Our development of the OmniPod to be used in combination with Eli Lilly’s Humulin U-500 Insulin is also progressing on schedule. We have finished our first round of human factory testing. We remain on track to file 510(k) approval later this year.

As we’ve discussed over the past year, our development efforts under this collaboration are focused on modifying our PDM for delivery of this concentrated insulin while Lilly works with regulators to update its labeling for use of the OmniPod.

As type 2 diabetes gains more attention due to higher diagnosis rates and its impact on rising healthcare costs, we believe the acceptance of public therapy as treatment option will continue to increase. Target market for this combined product is a subset of people with highly insulin-resistant form of type 2 diabetes. We believe this type 2 product is a real opportunity with potentially to nearly double our reachable market.

We continue to make significant progress on our initiative to integrate a continuous glucose sensor to the OmniPod. As we mentioned on our last call, we have found a viable solution to the sterilization challenges that delayed us in 2013. We also have recently completed the testing for a pain study focused on various insertion concepts. We are working to compile the data to this study now, but early indications are that various approaches around cannula insertion are viable options.

The path to an improved product is a long one, but we’re making strides in the right direction. Once approved, we believe this is a game changer in the type 1 diabetes market With the OmniPod being the only approved patch style pump on the market for people with type 1 diabetes, integrating CGM into the pod will only set us further ahead of anyone trying to enter the space.

The OmniPod is the only pump on the market where the electronics, insertion and battery power to allow for incorporation and sensor into the on-body space. Approximately 25% of our existing patient base uses continuous sensing today and we believe this number could grow dramatically when we’re able to provide them with an all in one solution.

Finally, we have commenced a project for the development of a new hand-held control of the OmniPod System. We believe this next generation device will allow our customers innovative hand-held that will mesh with our innovative OmniPod. We remain on track as we see (indiscernible) American Diabetes Association conference next year and look forward to sharing additional details with you in the coming quarters.

Outside of diabetes we continue to support our existing partnerships with Xeris Pharmaceuticals and with Amgen. We are working closely with Amgen in an anticipation of an approval later this calendar year and expecting to launch soon thereafter.

We believe that the OminPod has the potential to be a platform technology that can deliver many types of growth in various disease areas. We continue to see other project in such areas as oncology, obesity and Parkinson’s to name a few.

In summary, we are very pleased with our first quarter results, revenue growth were strong in first quarter as OmniPod and consolidated revenue accelerated on a year-over-year basis for 2013. However, with the addition of approximately 15 new key account managers to our commercial team we are excited of what is ahead.

As I mentioned earlier, new patient starts to run more than 40% higher than at the same point in the first quarter. And new resources are just getting into the field. With the incremental resources and increased bandwidth we expect that we would be able to drive deeper penetration across our new healthcare practices as well as we continue to add more new doctors.

With a full pipeline of opportunities, we are building the foundation which will continue to drive strong growth over years to come. And finally the gross margins improvement we expect to return to operating profitability in the second quarter and will be operating profitable for the full year of 2014.

With that I will turn the call over to Brian.

Brian K. Roberts

Thank you, Duane. Consolidated revenue increased by 21% year-over-year to $69.2 million from $57.4 million last year. As Duane mentioned typically the first quarter is our slowest of the year as patient deductibles reset and many new customers from the fourth quarter delay their initial training. Additionally, our first quarter results include a reduction of over $4 million in Neighborhood Diabetes testing supply revenue compared to the first quarter of last year related to the impact of Medicare competitive biddings which took effect on July 1.

Adjusting for the impact of competitive bidding year-over-year revenue growth in the quarter would have been near 30%. Driven by higher than expected international revenue in the quarter OmniPod revenue surged over 35% compared with the first quarter of 2013.

Gross profit increased by 30% in the first quarter to $32.8 million, as compared to gross profit of $25.2 million in the first quarter of last year. Gross margins increased by about 350 basis points, 47% in the first quarter, compared to the prior year.

Subsequently – sequentially gross margins remained relatively flat as a result of lower margin international revenue, the absorption of remaining costs associated with the transition of the customer base and higher than planned scrap which offset the savings achieved on the Pod. The cost for OmniPod will continue to decrease and we remain confident that we will achieve the U.S based margins in the low to mid 60’s in the coming quarters. We expect consolidated gross margin to reach 50% in Q2 as well.

Operating expenses increased by $3.3 million or 11% year-over-year to $34.7million in the first quarter from $31.4 million in the first quarter of 2013. This increase is primarily a result of increased stock-based compensation expense.

As we noted in our Q4 call, we expect operating expenses in the range of $36 million to $38 million per quarter for Q2 through Q4, the selecting the investment team to the sales and marketing functions. Operating loss was $1.9 million in the first quarter of 2014, compared to $6.2 million in the prior year, an improvement of $4.3 million or approximately 70%. Excluding non cash expenses such as depreciation amortization and stock based compensation we generated an operating profit of $5.5 million in the quarter.

We anticipate returning to operating profitability in the second quarter as revenues increased and gross margins improved. Interest and other expenses $4.2 million in the first quarter of 2014 and $4.3 million in the first quarter of 2013, approximately $2.85 million of this expense is non-cash.

Our net loss for the first quarter of 2014 was $6.1 million or $0.11 per share as compared to a net loss of $10.7 million or $0.20 per share for the first quarter of last year. Our cash and cash equivalents balance was $145.6 million at March 31 compared to $149.7 million at December 31.

Our net spend was approximately $4 million in the first quarter, mainly as a result of timing of accounts receivable, inventory and the payout of employee bonuses in March. As of March 31, we had approximately 55.3 million common shares outstanding. As Duane noted, we’re pleased with our performance in the first quarter and have high hopes for the remainder of the year will bring. We remain confident, especially in light of the number of new healthcare practices added to the prescribing base as well as with the addition of 20 new sales resources you will see new patient starts grow 25% year-over-year. New shipments are up over 40% in the second quarter as compared to Q1. Further the operating team’s hard work to reduce the bill of materials and improve efficiencies is paying off in a more cost effective PODD.

Consolidated gross margin should reach 50% and the U.S. margin should surpass 60% in the second quarter. Finally, we expect our international business to remain strong in the second quarter and throughout the year. Taking all of this into consideration, we expect second quarter revenues to be in the range of $70 million to $74 million and we remain unchanged with our full year expectations of $295 million to $315 million. As always, our highest degree of confidence is to the midpoint of these guidance ranges.

And with that let me turn the call back over to Duane.

Duane DeSisto

Thanks Brian. In summary, our tubeless insulin pump gives our customers the freedom, discretion and lifestyle they want by providing them with the best-in-class therapy. Our 2014 focus is primarily on growing our existing business with our current product offering. While execution commercially and operationally this year key to our success, we are also continuing to develop the next-generation of products across type 1, type 2 and other drug delivery.

We remain committed to innovation and development and our future enhancements, product offerings, and entry into additional therapies will allow us to maintain our competitive advantage over anyone in the patch pump space. And with that, operator, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from Danielle Antalffy Leerink Partners. Please go ahead.

Danielle J. Antalffy – Leerink Partners LLC

Thanks so much. Good afternoon guys. Thanks for taking the question. Brian, maybe this question is for you as we think about the commentary you made in the second quarter thus far and the additional sales team adds. How do we think about that relative share guidance, I mean is fiscal guidance but it is a modest growth deceleration versus guidance for the first quarter and the first quarter is a seasonally weak quarter I’m looking at guidance – the second quarter guidance at about growth of 16% to 23%, which not trying to complain, but just trying to put it the context of first is seasonally weak. You have the incremental sales force folks that hit the ground running in April. You’ve given positive commentary on new patient starts, so are you just being overly conservative there, and, if so, why?

Brian K. Roberts

Hi Danielle, how are you? I think it’s a combination of a couple of things. One, we mentioned a couple of times in the script that international revenues were a little stronger than planned in the first quarter. Our expectations are those will probably level off a little bit in the second quarter, just a little bit of timing for which they were taking their shipments and again there is a little bit of catch up related to the end of last year that you guys will recall as we planned around the shutdown in January for Chinese New Year. So there is a little bit of a timing difference, I think it’s the midpoint of the guidance range that we provided.

Year-over-year growth would be about 20%, which is in fact we’re seeing it where we were in the first quarter and hopefully again there is certainly some upside from there. I do want to note that we’re putting these 20 new resources into the field literally most of them as Jeff said in the field within the last month or so. So it would take them a little bit of time to kind of get up to speed here and be able to hit the ground running. But they are doing a great job so far.

So I think all in, we are very confident, very bullish about where they year is tracking. New patients, start so far this quarter being up over 40% from where we were at this point in mid-February, I think it’s a big plus for us, and now we’re just going to see where the rest of the quarter delivers both around the U.S. base and then exactly what international will be in Q2.

Danielle J. Antalffy – Leerink Partners LLC

Okay. Great. That’s helpful. And then on gross margins, Brian, it looks like you’re getting very solid gross margins on the OmniPod itself, but obviously some dilution from Neighborhood. You guys came in a little bit below what you were looking for, so you might be missing something here, but could you talk about the cadence of the gross margin ramp as we move through the year so that we don’t get ahead of ourselves here given the fact that there is the dilution from Neighborhood. Maybe help us understand how the consolidated gross margin could look as we move through the year?

Brian K. Roberts

Yes, sure. So again I think there is a couple of contributing factors to overall gross margin Q1. The two being is the mix with international because certainly international is at a much lower gross margin for us, but frankly most of that gross margin turns right in the operating margin. So it still remains most profitable piece of our business today.

And second as you talked neighborhood diabetes has experienced some, I’d say some pricing erosion around testing supplies as contracts start to renew. Certainly nowhere near as dramatic as what we saw with competitive bidding, but there is, on the edge, there is certainly been a few margin points that have escaped there.

I think from a modeling side going forward, we are looking to be 50% plus here in the second quarter. And then I would expect that we can add a couple of 100 basis points call it 200 to 300 basis points per quarter in the back half of the year each quarter, so that would get us somewhere around a 54 or 55 consolidated by the end of 2014.

Danielle J. Antalffy – Leerink Partners LLC

Got it. Okay, thank you so much.

Operator

Our next question comes from Bill Plovanic from Canaccord. Please go ahead.

Bill J. Plovanic – Canaccord Genuity, Inc.

Great, thanks good evening. Can you hear me, okay.

Duane DeSisto

Hey, Bill, how are you?

Bill J. Plovanic – Canaccord Genuity, Inc.

Good, good. Thank you, gentlemen. A couple of things. One is on the international, if I remember correctly, you had some backlog. You’ve talked about that a little. Have you burned off – it’s not just international, but even in the U.S., have you built up enough inventory that you’ve supplied all that backlog to this point?

Duane DeSisto

Yes, I think consistent with what we’ve talked about the last couple of quarters, that backlog that was originally built up at the end of Q3, we’ve talked about being effectively, using your words burned off in the course of both Q4 and Q1 and we’ve achieved that.

So, Pat Ryan our new COO has done a great job of getting us to speed with the team and we produced more positive in the first quarter than we’ve ever done historically, including the effect of a two-week shutdown for Chinese New Year, the typical ramped up time when everybody returns. So, we were really well positioned on inventory for the quarter. We built inventory a little bit and we worked off all of that backlogs.

Bill J. Plovanic – Canaccord Genuity, Inc.

Okay. And then there’s been some commentary regarding how strong international was. I mean, by my math you’ve exceeded 10%, which makes it material. What percent of your total revenues is international for you now, 2011, 2012?

Brian K. Roberts

We’re not going to comment specifically on what the revenue number is, but it’s certainly picked up in Q1 a little bit from where we were in Q4 on an absolute dollar basis.

Bill J. Plovanic – Canaccord Genuity, Inc.

But if it’s over 10%, it becomes material and it will be in the Q, correct?

Brian K. Roberts

That’s a 10-K requirement. So it’s an annual look at what the level of revenue ultimately will be.

Bill J. Plovanic – Canaccord Genuity, Inc.

Okay. And then my last question is just, when do you expect the LifeScan approval? So you’ve gotten questions back, you’re responding. How many rolls at the FDA do you think this will take before you get that product on the market?

Duane DeSisto

So, Bill, this is Duane. I would tell you that we’ll put the FDA comments into two buckets. The handheld bucket, I would tell you, in terms of our actual handheld. Those comments are pretty straightforward. We’re ready to turn those. There seems to be some new guidance in what’s required for a strip and LifeScan is now starting to wrestle with those. So we’re waiting to hear from them on when they think they can turn the document.

I would tell you, as we sit here today, we’re ready on the hand-held side. There was no surprises for us, but there does seem to be a renewed interest at the FDA in terms of –there’s some draft guidance out there that I think that LifeScan is going to be held accountable to. So we’re waiting for them, but its all strip based, I would tell you is the issue. So, I don’t have a good answer for you, but we’ll know a little more here. I think there’s a meeting at the end of this week or the beginning of next week to try to wrestle that to the ground.

Bill J. Plovanic – Canaccord Genuity, Inc.

Great, thank you. I appreciate you taking the question.

Operator

Our next question comes from Mike Weinstein from JPMorgan. Please go ahead.

Robbie J. Marcus – JPMorgan Securities LLC

Hi, this is Robbie Marcus in for Mike. Congrats on the good Q.

Duane DeSisto

Hey, Robbie, how are you?

Robbie J. Marcus – JPMorgan Securities LLC

Good. How are you?

Duane DeSisto

Good.

Robbie J. Marcus – JPMorgan Securities LLC

So, as you’re getting approval toward the end of the year and filing for Amgen and Lilly, can you maybe help us frame how we should be thinking about these two opportunities heading into 2015 and beyond and maybe walk us through how they might impact the different lines of the income statement?

Brian K. Roberts

I think overall, Robbie, it’s probably still little premature for us to get too detailed into the thinking around 2015. I mean, at the moment, as we’ve discussed the Lilly 510(k) or the U-500 510(k) is planned for this calendar year. Our expectation certainly remains the same around the Amgen product that towards the end of this calendar we’ll hopefully see an approval there, and Duane just talked a little bit about the PDM. So, within the 2014 framework, certainly I don’t think any of those things will really have a material or pretty much any impact on the 2014 numbers. As we get a little deeper and I think calendar year 2014 we can start to frame out a little bit more what our thinking will be for 2015.

Robbie J. Marcus – JPMorgan Securities LLC

Okay. Great. And maybe just a follow-up. Can you provide us maybe where you exited the quarter in terms of how many sales reps you had total and how should we be thinking about rep productivity going through the rest of the year now with the addition of the key account managers?

Duane DeSisto

For the commercial team, as we sit right now we’re probably around 125 or so, give or take a couple. And again, we’re looking to probably add another five to 10 here in course of the next call it 30 to 45 days.

So that wouldn’t allow us to be in the 130 to 135 range. Again, I think consistent with Duane’s remarks, the goal of these folks are kind of third men in on the team, third men or women in on the team, and so they come with experience and you’ve typically you’re going to kind of focus on a set of practices where we have existing relationships. And so, I certainly think our hope is that, you know, post their initial training that they’ll be able to get u p to speed up fairly quickly.

The goal then becomes that the existing territory managers have more bandwidth to be able to get to more on more practices and that’s hopefully something that will allow us to kind of continue to increase this new prescriber base as we get into the back half of this calendar year. Anything to add?

Brian K. Roberts

No, I think – I guess that we kind of tested this. If you remember our comments last year, we kind of tested it in two accounts. We really think it’s kind of key to where we want to go and the only reason we didn’t do this earlier is we just want to make sure that the production side of the business was stabilized. So we feel good about it. We’ll see here over the next probably this – a little bit this quarter and then third quarter should be really kind of the thing where we can get a pretty good benchmark and how this is all going to work for us. But we’re pretty excited about what we’ve seen so far.

Robbie J. Marcus – JPMorgan Securities LLC

Okay. Great. Thanks a lot, guys.

Operator

Our next question comes from Ben Andrew from William Blair. Please go ahead.

Ben C. Andrew – William Blair & Co. LLC

Good afternoon, guys. Thanks for taking the questions. For me, just following on the key account manager’s notion, can you give us some sense, Duane, what kind or what magnitude of productivity gain you achieved in those couple of accounts or maybe in some of the early accounts where you’ve added this because it looks like it’s about a 10% to 15% overlay so far?

Brian K. Roberts

Yes. I would tell you in the couple of test accounts we had, we saw 20% to 25% uptick in the business.

Ben C. Andrew – William Blair & Co. LLC

In new patients or total revenues, or is there much difference?

Duane DeSisto

In new patients. No, in new patients. Look, the revenue, the great part about our model is if I get you under the curve, it’s like compounded interest. If I get you under the curve, it continues to come every quarter. So, but we’ve seen 20% to 25% increase very, very quickly and in those accounts that more importantly, I think than just the increase in the headcount is I think it’s helping us – it would be nice to say every products going to be perfect, but when we do have a hiccup those relationships are helping us manage through all of that, all of the stuff that normally goes on in this space.

So we just went through this whole recall with the Abbott FreeStyle strip which really had nothing to do with us. But having those people on those accounts help immensely because if you read all the stuff that was out there, it was about as clear as mud from some of the releases that were sent out. Having those people on the ground to help these people was immensely and I think ultimately you build these relationships with these people and they last north, it’s more than just a quarter, it really strengthens the bond between the practitioner and the company. So, we’re pretty excited about what we think it can do for us.

Ben C. Andrew – William Blair & Co. LLC

Okay. And then back on the gross margin discussion, you talked about I think there were three things, but – one of them you mentioned was the scrap costs that were up. Was that only in manufacturing or did you – did any of that kind of product that had to be scrapped or led to increased costs make it out into the field?

Brian K. Roberts

No, it was only in the manufacturing process

Ben C. Andrew – William Blair & Co. LLC

And what went wrong? Was there some new issue or continuation and you didn’t get the yield improvements you had expected? What exactly happened?

Brian K. Roberts

I wouldn’t say anything went wrong to say, I think it’s just kind of normal course of running the lines and ultimately, as you go through the process there are few components where, a product would come in and maybe it was a little bit more on the edge of a tolerance or so, and we saw a higher output of scrap than we were hoping to see and that’s now allowed us to kind of revise the tolerance a little bit with the supplier, but there’s some costs that you have to eat as part of that.

I think there’s a piece of it that goes to the fact of we did experience the Chinese New Year effect, if you will, which is a lot of people leave and then you have a new group of folks that come in and have to be trained and while Flextronics did I think a nice job of trying to get ahead of that, there’s always a training component that tends to lead to a little bit more incremental scrap, as well as those lines kind of restart themselves, but I wouldn’t point to anything specific, saying that anything went wrong in the quarter. To achieve, $2.6 million pods that actually adds a lot of rate.

Ben C. Andrew – William Blair & Co. LLC

Sure, sure. And then, Brian, what was the third thing that you mentioned? There was scrap, there was kind of carrying some of the transition of existing patients, and then another gross margin, and I missed that one as you were discussing it.

Brian K. Roberts

Yes, I mean the third one really is on the other side which did this, as we had a little bit higher international revenue plan. That comes with a much lower gross margin profile in the, kind of mid-teen type of percent type of a range which brings down the margin a little.

Ben C. Andrew – William Blair & Co. LLC

Right. And if you had to put those three things in buckets, were they roughly equal hits to gross margin or disproportionate?

Brian K. Roberts

They are probably roughly equal maybe I think the manufacturing size of scrap plus transition costs would have been little bit more than the international revenue piece, but, you know, they all balance out.

Ben C. Andrew – William Blair & Co. LLC

Okay. Great. And then last for me is if you’re going to file the 510(k) and you ponder it and Lilly is working through its issues, and I may have missed this answer before and so I apologize, is that like a year-end 2015 launch or can that come earlier?

Brian K. Roberts

I think, the real plus for us, I hope this year we get this thing filed in the back half of the year and then we’ll go down the whole regulatory response thing. So we’ll wait and see. I have tried, if you remember the AROs pod was around the corner for two years. So I thought that I will never go down that path again. So we can tell you the piece under our control and then we’ll see what the agency has to say.

Ben C. Andrew – William Blair & Co. LLC

Fair enough. Thank you much.

Operator

Our next question comes from Thom Gunderson of Piper Jaffray. Please go ahead.

Thomas J. Gunderson – Piper Jaffray & Co

Duane, when did you say the FDA is going to approve the combo CGM device?

Duane DeSisto

Hi, Tom how are you?

Thomas J. Gunderson – Piper Jaffray & Co

I’m good, I’m good. You and Charlie and a whole gang of people did a good job of getting up to a million pods a month, but if growth continues and you’re adding new products, you could need two or three million in the next few years. Is there anything from a capacity standpoint other than adding lines? Do you run out of real estate? Does Flextronics just keep expanding? Any constraints at all or is it just cookie cutter?

Duane DeSisto

So I would tell you, for lines four and five, it’s cookie cutter. After that we probably would be – I think would it be in the best interest of the company long-term would probably within the Flextronics umbrella find a different facility. So it’s not all in one place or we’re spread over – I think with four and five, we’re spread over a couple of different areas within the same campus, but I think once we get beyond that, I mean, one of the things Pat’s looking at in his team is, okay. Where are other facilities? What’s the cost associated with that? But I do think we moved.

The good news is what we’re excited about is three, is the best line that we’ve ever developed, built in terms of productivity, in terms of minimizing the labor associated with it. So we can replicate that. Flex was integral in that and installing that. They’ve seen it from beginning to end. So we’re pretty excited but that’s kind of a fixed cost in the industry and that piece. And like I said, lines four and five are pretty cookie cutter and once we get beyond that, I would tell you I think it’s probably be in our best interest that look for a different facility most likely within the Flex umbrella, but the great part about doing business is, they’re everywhere, from Switzerland to Mexico to Malaysia. I mean, they’re all over the place so.

Thomas J. Gunderson – Piper Jaffray & Co

Got it. And then my last question is since the introduction of the next gen pod, the AROs, I would argue that you have maybe a little bit different new customer. You’ve got new docs that weren’t in before prescribing to new patients that weren’t in before. You’ve got higher growth in international markets. I’m just curious, have you noted any change in the usage up or down from what you had in old gen versus new gen?

Duane DeSisto

Yes. That’s an excellent observation because the answer, you’re spot on. And we knew with the old generation products that there were areas, there were bastions of doctors or institutions that given our insulin onboard calculation, given the size of the path, but we knew there were places that we weren’t going to be able to penetrate until we came out of the next generation product.

And so as a result of that those were the first guys we immediately went back to with the next generation product. So you remember all the reasons you gave us, you wouldn’t let us in the door. Well, look what we have. So it’s I would tell you the – from day one, I always thought our product was the perfect product for any kind of active child, define that whatever age you want. My wife would define I’m an active child, so that’s 50 something and below, but I think it’s the perfect product of that and when we shrunk the size and changed the insulin on board calculation, I mean a lot of these guys flung open the door and I am very excited about where the business has come up from.

If you kind of think about this long-term, if you’re taking a 13 years to 18 years old and your introduction to insulin pumping, it’s our product you never going on one with a tube? You’re just never going to do and you’ll whatever you can not to go on the shots, so we got the right audience, we got the right people, I think we have a lot of the right doctors. So that’s the mix.

And I would tell you we are seeing the same thing internationally, I think people spend enough taking notice. Our last step in terms of the AROs product is we are diligently working on our next-generation handheld which I think is going to be pretty cool and pretty surprising once we get that. And then, I think you’ll have – there is no such thing as perfect product, you can always make it better, but I think that combination is going to be really, really exciting. It will be fun to everybody in the market. We feel good about where we are and where we’re going.

Thomas J. Gunderson – Piper Jaffray & Co

Got it. Thanks. That’s it for me, guys.

Duane DeSisto

Thanks.

Operator

Our next question comes from Jayson Bedford from Raymond James. Please go ahead.

Jayson T. Bedford – Raymond James & Associates, Inc.

Good evening. Just a couple of quick ones here. Just for clarification. The new patient starts, when you referred to 40% growth this quarter, that’s on a sequential basis, not on a year-over-year basis? It may be the same number, but I’m just trying to reconcile your comments.

Duane DeSisto

Yes, comments were Q1 new patients starts were up a little over 20% year-over-year. The comment of north of 40% new patient starts so far here in Q2 is a comparison to Q1 of 2014.

Jayson T. Bedford – Raymond James & Associates, Inc.

Got you. Okay. Has the recall of FreeStyle impacted your business at all?

Duane DeSisto

I think, for probably a period of about three, four weeks we handled lots and lots and lots of questions, but I wouldn’t say – I’d be pretty disingenuous if I said it impacted the business, but there was no question. We had a three, four-week disruption in which lots of people were calling us. It really didn’t impact getting new customers or really impacted the existing customer base, trying to wrestle to the ground what the right date is, beyond which date are the ones I can use in my meter. And so, it’s like anything else. The last thing in the world you need is people to be distracted by something, but I would tell you that’s pretty much in the rear view mirror now, but it was a three or four-week – probably a two to three-week period where there was a lot of confusion and then space.

Jayson T. Bedford – Raymond James & Associates, Inc.

Okay. And then lastly for me, just a follow-up on that. What’s the transition plan to the new LifeScan PDM? Meaning when it’s approved, do you upgrade for free, is this an automatic rollout? What does the rollout look like?

Duane DeSisto

I don’t want to upgrade for free and it was the most painful experience of my life. So we’re never updating anything for free. So you can hear it here, you can write that. As long as I’m here, I’m never doing anything for free, because it hurts too much. I would say I think, once that product is approved then we will just start transitioning new customers and we’ll go from there with it.

Brian K. Roberts

I mean we haven’t solidified any commercial plans yet, but…

Duane DeSisto

We solidified one.

Brian K. Roberts

Except for the free part. But most likely what we will do is, new customers will ultimately transition directly to the new product, to the LifeScan Verio PDM and these customers, existing customers who wish to get that PDM, I’m sure will have some kind of an upgraded path for those customers, very similar to what we did back probably about five years ago or four years ago when we moved from the PDM 100 to at the time what was the PDM 200.

Jayson T. Bedford – Raymond James & Associates, Inc.

All right. Thank you.

Duane DeSisto

Thanks.

Operator

Our next question comes from Anthony Petrone of Jefferies. Please go ahead.

Anthony C. Petrone – Jefferies LLC

Thanks. Just a couple of questions here maybe for Brian and/or Duane. Can we just go back to maybe existing penetration in type 1, just overall where you kind of see that today? All I know is we have 25%. And then, as you look forward and you look at the continued migration with MDI patients, but now you have the key account manager overlay. Does that migration sort of accelerate and where do you think it can go over time?

Brian K. Roberts

This is Brian. At a high level, I mean again and I think everybody has numbers that are approximates of this. We’ve always kind of used – there’s about 1.7 million or so people in the United States living with type 1 diabetes today and pump penetration is probably somewhere around 25% of that number, maybe a little more, which would get to imply somewhere around 400,000 to 450,000 people on insulin pumps. So we’re in the country right now. There is certainly – when I started with Insulet, now five years ago. That pump penetration those numbers are probably more like 1.5 million people and it was about 22% penetration. So certainly the numbers have gone up over that period of time and I think, to Insulet’s credit, a lot of that has been on the back of this company. As you have seen, others out there in the market who have, you know, kind of talked about their numbers or so will be relatively modest increases or relatively flat over time. Obviously, our growth has been primarily from the multiple daily injection patient and we’ve basically gone more than zero to north of 60,000 in that period.

So I think a lot of it has been here. Certainly as we continue to add more prescribers and it’s probably packed up in your new resources to commercial being some quarter and it gives us more reach and frequency to be able to get to these doctors which we know is a tried and true piece of how you are from the go-to business. Certainly there is an awful lot of people out there still for Insulet Company we believe makes an awful lot of sense.

So I think our view is that Insulet can certainly continue to be the driver of you accelerating this overall market penetration by bringing more and more MDI people to pumping in general.

Anthony C. Petrone – Jefferies LLC

That’s helpful. Maybe a couple of follow-ups on gross margin. Maybe not specifically for 2015, but as we look ahead to CGM enabled pod and then maybe even the pod for drug delivery, can you maybe give a high-level overview of where you see the gross margin for those two specific products settling over time?

Duane DeSisto

Again little earlier on CGM-enabled pod to probably talked about I mean, certainly what’s intriguing about the space is because – and I think what makes us very unique in it is because we have so much of a commonality of components, if you will, between what makes up a CGM center and what makes up our pod. There is an awful lot of leverage to be gained by effectively integrating that center directly into the product, insertion, battery power, the ASIC all of these different pieces. I think it’s unique to us in trying to be able to put these two devices together which allows us a kind of gross margin leverage play.

If you look at reimbursement of the two products individually today, the average probably is somewhere in the neighborhood of $9 to $10 per day of revenue. If you look that over a three day period you are talking about somewhere between $54 to $60 of revenue. And we’ve commented it historically that you think we could add the center into the pods for – call it somewhere probably in the dollar range or so, which would allow us to be a mid-teen price pod by that point with a higher revenue potential.

Specifically, around the other drug delivery product, we talked about one of the benefits – in general of that space, is that we think we can leverage and awful lot of what we do on diabetes products and therefore again be able to keep the cost basically the same with where we are – little bit of increase but not a lot and be able to charge a higher revenue number for that hopefully on average somewhere in the 2X plus kind of a range. So the other big benefit there is no a lot of operating expenses. So the majority of that margin should ultimately fall to the bottom line.

Anthony C. Petrone – Jefferies LLC

Helpful. And the last one for me is just a little bit more detail on Amgen and the supply agreement there. Is Insulet exclusive in those specific drug categories that you mentioned, so for instance in oncology, or can you sign with another pharmaceutical partner, whether it’s in oncology or another drug category? Thanks again.

Duane DeSisto

Yes, can’t see the pretty wide categories so there is exclusivity but it’s pretty narrowing upon. So we see a plenty of opportunities there.

Anthony C. Petrone – Jefferies LLC

Great.

Operator

Our next question comes from Mimi Pham from ABR Healthco. Please go ahead.

Mimi Pham – ABR Healthco

Hi, good afternoon. Can you just clarify your comments about the 70% of additional orders coming back from your new doctors? Does that mean regarding new prescribers in last year like through 2013, 70% of them have put in a new prescription during the first quarter?

Brian K. Roberts

Not necessarily all in the first quarter, but, I mean, certainly since these new doctors have come on. So, it includes new doctors who started a new patient in the first quarter. So we’re kind of penalizing ourselves a little bit there in the sense of those doctors won’t necessarily add their second patient in the same first period, but 35% plus of our prescribing base that are new doctors, over 70% of them so far have now placed additional orders since their initial.

Mimi Pham – ABR Healthco

Okay. And so then the 30% that haven’t come back yet, I guess some of it will be taking more time since some of them are from the first quarter. Do you think any – have you lost any new prescribers for any reason?

Brian K. Roberts

I can’t tell you definitively that every single doctor will prescribe again, but some of whole I think again the feedback across the country, across the commercial teams, across the prescriber base has been extremely positive. So we think the trends are in the right direction.

Mimi Pham – ABR Healthco

And then in terms of the Type 2 Lilly pump, if it’s approved by mid next year, will reimbursement be all in place or is there anything that has to be – would there be some delay or anything that has to be done on your or Lilly’s side?

Duane DeSisto

Far be it for me to speak – this is Duane, far be it for me speak from the Lily perspective, I think today U-500 is approved today, the OmniPod is approved, and if a doctor writes for Type 2, the hurdle rate in terms of requirements that a carrier may want to see is greater, but they do reimburse for it.

So, I don’t think there is, I don’t know if we’re going to need any code. I don’t think so because, like I said, we know for a fact that both products are approved and from a carrier’s standpoint if there’s a need they will approve

Brian K. Roberts

Yes and keep in mind that today somewhere between and again it’s modest, but 3% to 5% of our overall patient population are Type 2s. So, Type 2s can get approve on insulin pumping whatever drug they’re using inform of insulin we don’t have visibility too. But we just follow the same process that we do with Type 1s. And typically, what you see is there is some additional paper work requirements that we have to go through, but on the whole people are getting approved.

Mimi Pham – ABR Healthco

Okay. And then on the competitive front, Tandem mentioned last night that now half of their patients or new patient adds were all new to pumping. Are you seeing them more in – at centers, patients choosing their (inaudible) over the OmniPod in terms of the new to pumping patients or do you get a sense that they’re taking these new patients from potential Medtronic or J&J.

Duane DeSisto

Okay, I guess this is Duane. I would say, I think there is for us, there is one major competitor in space. And we all know who that is and the competition occurs in mine shares at doctor’s office. At a customer level, I’ll use the old analogy, we’re selling a motorcycle, everyone else is selling a car, if you like a motorcycle, we get the business. If you want a car, there’s two or three guys selling the car. So like I said, our focus is on the big guy.

Mimi Pham – ABR Healthco

Got it. Thank you very much.

Duane DeSisto

Thank you.

Operator

And there are no further questions. I’d like to turn it back over to Duane DeSisto for closing remarks.

Duane DeSisto

Thank you everyone for joining us on first quarter call and we look forward to updating you in Q2. Have a good night.

Operator

Ladies and gentlemen, this concludes today’s conference. Thank you for your attendance you may now disconnect. Everyone have a great day.

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