DexCom (DXCM) Kevin Ronald Sayer on Q1 2016 Results - Earnings Call Transcript

| About: DexCom, Inc. (DXCM)

DexCom, Inc. (NASDAQ:DXCM)

Q1 2016 Earnings Call

April 27, 2016 4:30 pm ET

Executives

Kevin Ronald Sayer - President and Chief Executive Officer

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Jess Roper - Chief Financial Officer & Senior Vice President

Analysts

Michael Weinstein - JPMorgan Securities LLC

Ben C. Andrew - William Blair & Co. LLC

Danielle J. Antalffy - Leerink Partners LLC

Kyle Rose - Canaccord Genuity, Inc.

James Francescone - Morgan Stanley & Co. LLC

Tao L. Levy - Wedbush Securities, Inc.

Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker)

Ryan Blicker - Cowen & Co. LLC

Operator

Welcome to the DexCom First Quarter 2016 Earnings Release Conference Call. My name is Bianca, and I will be your operator for today. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded.

I will now turn the call over to your host, Mr. Kevin Sayer. Mr. Sayer, you may begin.

Kevin Ronald Sayer - President and Chief Executive Officer

Thank you, Bianca, and welcome everybody to our first quarter 2016 earnings call. I'd like to turn the time over to Steve Pacelli for our Safe Harbor statement.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Great. Thanks, Kevin. Some of the statements that we will make in today's call may constitute forward-looking statements. These statements reflect management's intentions, belief, expectations and strategies about future events, operating plans and performance. All forward-looking statements included in this presentation are made as of the date hereof based on the information currently available to DexCom. The future events are subject to various risks and uncertainties and actual results could differ materially from those anticipated in the forward-looking statements.

The factors that could cause actual results to differ materially from those expressed or implied by any of these forward-looking statements are detailed in DexCom's quarterly report on Form 10-Q, for the period ended March 31, 2016 as filed with the Securities and Exchange Commission and our other reports filed with the SEC. Except as required by law, we assume no obligation to update any such forward-looking statement after the date of this presentation or confirm this forward-looking statements to actual result.

Additionally, we will discuss certain financial information that has not been prepared in accordance with GAAP with respect to our cash-based operating results. This non-GAAP information is provided to enhance your overall understanding of our current financial performance. The presentation of this additional information should not be considered in isolation or as a substitute for results or superior to results prepared in accordance with GAAP. Kevin.

Kevin Ronald Sayer - President and Chief Executive Officer

Thank you, Steve. Joining me today are Jess Roper, our Chief Financial Officer, and Steve Pacelli, our Executive Vice President of Strategy and Corporate Development.

Sticking with our usual format, Steve will start with a detailed review of our 2016 first quarter financial results and I will follow with our customary operations update and offer some concluding thoughts before opening the line for questions.

I'll now turn the call over to Steve.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Thanks, Kevin. DexCom reported revenue of $116 million for the first quarter of 2016 compared to $73 million for the same quarter in 2015, a $43 million or 60% increase. Sequentially, revenue for Q1 was down approximately 11% from the prior quarter, which was expected as the first quarter is traditionally a seasonally slow quarter for our business.

Our first quarter gross profit was $75 million, generating a gross margin of 65% compared to a gross profit of $47 million and a gross margin of 64% for the same quarter in the prior year. Our gross margin in Q1 was affected by several factors. Obviously gross margin was negatively impacted due to lower sales volumes in Q1 as a result of seasonality.

Compared to Q1 of last year, our gross margin on hardware was impacted by sales of the G5 Mobile transmitter, which has a shorter useful life and therefore a lower ASP. And to a lesser extent, our gross margin was impacted by lower yields on our G5 Mobile transmitter, which is also expected with any new product launch. Finally, our gross margin was impacted by an increase in warranty expense.

The impact of the increased warranty expense has crafted a lower yield, accounted for approximately 3 margin points in Q1 and absent these expenses, our gross margin would have been approximately 68% for the quarter. Kevin will provide some additional clarity momentarily.

For the full year, we expect our gross margin to return to our normalized operating range of 67% to 70%. However, depending on ongoing remediation efforts surrounding our receiver recall, margins could be negatively impacted in future periods during the year.

Some final thoughts on our revenues and our gross profits. Our mix between durable and consumable products shifted slightly in Q1, to approximately 28% in durable and 72% consumable. Sensor pricing has remained constant with the ASP for sensors within a range of $70 to $75 per sensor, and the ASP for our hardware has also remained stable.

Finally, our international business continued to perform, generating $19 million in revenue during the quarter. Research and development expense totaled $32 million for Q1 of 2016, compared to $20 million in Q1 of 2015, with the increase due primarily to additional payroll related expenses and expenses related to work on our near-term product pipeline, particularly with respect to our next generation insertion system and work on our advanced product pipeline, including expenses associated with our Verily, partnership.

Selling, general and administrative expense totaled $62 million in Q1 of 2016 compared to $39 million during the same quarter in 2015, with the increase due primarily to year-over-year increases in head count in our customer support organization as well as a ramp in marketing expenses in connection with our DTC awareness campaigns, investment in our OUS expansion efforts, and investment in our IT infrastructure.

With respect to our operating expenses, I want to remind investors of a few key points. As we said during our fourth quarter call, we did not anticipate that Q1 cost would go down sequentially and our OpEx was up only approximately 5% from Q4 2015. Our non-cash expenses and taxes related to equity compensation, included in our operating results, were up $10 million year-over-year and $4 million sequentially, representing the bulk of our sequential OpEx increase.

Our net loss for the first quarter of 2016 totaled $19 million, which included $28 million in non-cash expenses, centered primarily in non-cash share-based compensation expense across all functional areas of our business. Absent these non-cash charges, cash based net income was $9 million for Q1. Our loss per share for the quarter was $0.23.

With respect to our balance sheet, we ended the first quarter with a $107 million in cash and marketable securities. Our Q1 revenue performance fell within our range of expectations, but consistent with past practices, we will stick with our current guidance of $540 million to $565 million in revenue for the year. However, also consistent with prior years, we will reevaluate our guidance during the Q2 earnings call and update as appropriate.

Before I turn the call back over to Kevin, let me add some color around our OpEx spend during Q1 for the balance of 2016. As we mentioned during our last earnings call, we've indicated that we plan to spend up to $40 million this year on four key incremental strategic initiatives, including our Verily partnership, expanded manufacturing capacity, international expansion and investment in our advanced data platforms. Our outlook for these investments remains unchanged, but expenses on these projects will be choppy on a quarterly basis. For example, Q1 expenses on these initiatives were less than $10 million with the biggest spends on Verily product development and our international expansion.

With that, I'll turn the call back over to Kevin for a business update.

Kevin Ronald Sayer - President and Chief Executive Officer

Thank you, Steve. So far in this reporting season, we have seen the big diabetes players report their performance and here is what they've said. J&J diabetes down 15% operationally year-over-year in the U.S. Abbott U.S. diabetes down 32%. Roche diabetes down 49% in North America. And for Medtronic, we only have global numbers, but their diabetes only grew around 11% in its most recent quarter. We grew 60% in the first quarter of 2016 on top of 55% last year.

Our new patient growth remains phenomenal and our perspective patient pipeline remains robust. While our growth has enabled us to make significant investments for the future, we have experienced some growing pains in the past few months, that I would like to address.

I'd like to start with some words regarding our recent FDA action on our plans to get through this. By way of background, we had noted an increased number of speaker failures in our MDR reporting over a number of months.

Accordingly, together with the FDA, we determined that the appropriate course of action was to initiate a customer notification, which was consistent with Class II recall procedures. In compliance with the FDA's directives, DexCom issued this notification letter on February 23, 2016. The letter was posted on our website and sent via certified mail to all U.S. patients either directly by DexCom or by means of our distributors.

Additionally, we implemented procedures to provide the same notification to DexCom patients globally through our distributor network. For those of you who have not read the customer notification, it reminds patients of the importance of alerts and alarms and encourages them to test the audio functionality of the receiver regularly.

The local FDA office inspected DexCom in late March and determined that we had complied with our agreed upon Class II recall procedures. FDA continued to review this matter and subsequently determined that due to the extreme importance of alerts and alarms in CGM, this matter was more appropriately classified as a Class I recall. After this determination and to increase awareness in the patient community, we issued a press release dated April 11, 2016 and the FDA posted the Class I recall notice on their website.

Given all of that information there are two questions that we must address today. How is DexCom going to fix this and what does this means to our business going forward? As for the fix, we are implementing several corrective actions. We have identified a new speaker for the current receiver that will be more robust. This replacement speaker and associated manufacturing change has already been filed with the FDA. As we've discussed on many of our previous earnings calls, we have a completely new receiver in our product pipeline and it will be filed with the FDA before the end of the second quarter. We believe this receiver will greatly improve the patient experience.

Additionally, we are evaluating a software upgrade for the current receiver to systematically test its audio functionality on a regular basis. While the agency has not approved any of our proposed actions, the FDA is aware of them and we are confident that they will continue to work with us to implement features to improve patient safety.

With respect to the business, Steve noted previously that we have experienced an increase in warranty expense this quarter. Certainly, some portion of that increase relates to the recall situation and we have experienced a slight increase in the percentage of receivers returned due to speaker failure. Absolute numbers increased simply because of the size of the patient base and the fact that we sent out a patient notification letter also increased the number of returns.

But, our product returns across the board have increased this quarter. Some of the increase relates to the fact that the patients received a letter, some relates to the fact that we're in the middle of our most complicated product launch ever, some relates to the fact that we have not been able to address all patient concerns in a timely manner through our tech services group and we made the decision to ship replacement product quickly to take care of our customers. We should have anticipated better.

We currently have a very large number of receivers in stock as we built up inventory in anticipation of redeploying our manufacturing resources on the next generation receiver later this year.

The timing of FDA's approval of our proposed corrections, combined with whatever additional actions we may implement, could have a financial impact in future periods. For example, we may be able to implement our proposed software upgrade for the receiver to include the systematic speaker test. While that may require some work, the costs would not be extensive if that is our corrective action. On the other hand, we may be required to implement the new speaker configuration going forward, as soon as it is approved, which would require us to rework or scrap some or all of the current receiver inventory.

We believe this example would be the worst-case scenario. While, it's impossible to predict the total impact of any corrective actions we might take, we currently estimate the potential write-off related to rework all of our current receiver inventory to be approximately $5 million.

For patients it's business as usual. We continue to ship our current products and believe there is no safer way to manage the day-to-day treatment of diabetes than the world's most accurate connected continuous glucose monitor. And we continue to hear this over and over and over again.

I now want to take the opportunity to address our patient community. March of this year marked our 10th anniversary of commercialized CGM. We've come a very long way over the past several years and the momentum is not slowing down as you can see by our continued revenue growth.

During the past 15 months, we have more than doubled the U.S. patient base. And it's one thing to double a patient base, when you go from 2,500 to 5,000 patients. It's a completely different thing, when you start talking about adding tens of thousands of new patients each and every quarter.

When you combine the sheer number of new patients added to the DexCom family, it was the most complicated product launch in the history of our organization, then add the customer notification process to this. You can imagine things have been very hectic here. And we've learned many lessons over the past several months. While we felt that we plan the Gen 5 launch very well from a product and messaging perspective, we fell short from an infrastructure perspective. The G5 launch has been more complex on a number of fronts. For example, even though the pricing is the same, the process of purchasing two transmitters for six months of use versus one transmitter has taken an inordinate amount of customer service time, causing patient delays and inconvenience. The same can be said for patients that were required to purchase a G5 receiver, after buying a G4 receiver in a previous time period.

On top of that, we have learned that our technical support calls on the G5 system are approximately 40% longer than they are for G4. G5 technical support calls are also much more complex. For example, in addition to supporting our CGM system functionality, we spent a lot of time discussing things like Bluetooth pairing, Bluetooth range, what app are we supposed to download, how do we pair the app, how do we share data and so forth.

So, now, we are providing medical device and consumer product support all at the same time, to a much broader group of patients. DexCom has been the highest rated CGM manufacturing customer loyalty and satisfaction for seven years in a row and we will fix this. Couple of examples that will be implemented shortly. We have added and trained a number of people to work in customer service, and believe that we will be right-sized within a couple of weeks.

We are also in the final stages of several IT efficiency projects, including a new phone system, that we will turn on over the next 30 days. These actions combined with several other things that we've already put in place, will take us where we need to be. We apologize for slipping and we'll make this right for our DexCom users.

Now, I'm going to talk a bit about our G5 commercial launch. We continue to be very pleased with the feedback we received on our G5 Mobile system and the lives we're able to impact with our technology. Response in the diabetes community for mobile connectivity has been exceptional. This past quarter, we launched an app that enabled the Apple Watch. This enhancement has been very beneficial to a number of patients.

We are still on track to launch the Android version of G5 Mobile later this year and note that the Android follow application is already available. We are also planning to submit several additional enhanced versions of our G5 Mobile app to provide additional features and functionality this year, including a mute override on the alerts and the alarms and the possible incorporation of insulin data into the app.

I'd now like to speak about our non-injunctive claim. For several quarters now, we have discussed our efforts to obtain a non-injective or dosing claim for our CGM system. For purposes of background information, labeling for our current system requires that patients take a confirmatory finger stick to support the information provided by CGM prior to making a treatment decision.

We have always believed that the information provided by CGM provides much better information for making an insulin dosing decision at a single finger stick, particularly when we look at the accuracy and performance of our system with our Software 505 algorithm. We also want to remind investors that CMS is requiring this type of labeling for Medicare approval. We began discussions with the FDA regarding this claim almost 18 months ago.

Last fall, at the request of the FDA, we filed a PMA supplement, seeking approval of non-injunctive labeling for the G5 system based upon the following. Clinical data obtained using our software 505 algorithm. Thousands of simulations of CGM treatment scenarios, multiple human factor studies, revised labeling language and ultimately a new G5 app for non-injunctive claim. As a reminder, we received CE Mark for this labeling in August 2015. Over the past several months we have had multiple discussions with the FDA regarding this filing and we have continued to supply them with additional data.

Earlier this quarter, the FDA notified us that this PMA supplement would be subject to an advisory panel review, which has been scheduled for July 21, 2016 in Gaithersburg, Maryland. We are obviously preparing very thoroughly for this extremely important panel meeting. We are very pleased that the FDA has worked so closely with us during the PMA supplement review and we look forward for the opportunity to present our case.

In the event that we receive a positive recommendation from the panel and ultimately FDA approval, we anticipate a very significant post-market study will be required to support this labeling. The panel meeting could very well set the tone for all future CGM products.

Now I'd like to address things on our product pipeline front. We continue to make progress on our G6 sensor technology. Our IDE application is in the final stages of review and we expect to obtain approval in the coming weeks. We anticipate initiating our pivotal trial either late in Q2 or early in Q3 depending upon the timing of the IDE approval.

In addition, we expect to work with our Artificial Pancreas partners to incorporate Gen 6 into their research and clinical studies as soon as possible, providing us with very robust data set on the performance of this product. As a reminder, the G6 sensor will have a reduced calibration scheme, one per day after startup, driven with a completely new advanced algorithm platform. It will have the ability to block acetaminophen interference, a labeled indication of up to 10 days of sensor life and a number of other features that will make the CGM experience better for our patients.

Overall performance should be consistent with G5 Mobile on the 505 Software even with the reduced calibration scheme and the extended ware. The G5 product will also leverage our new applicator and receiver technologies.

We believe that by combining our best-in-class sensor accuracy with an enhanced patient experience, G5 will again raise the bar in the CGM marketplace. Looking ahead, our plans for advanced sensors continue to include a no calibration system. We know that we can run our G6 sensors with no calibrations, but what we don't know is the FDA regulatory path for this configuration, especially for intensively managed patients.

We may well see the day when we have a more robust product for intensive insulin using patients that will continue to require some form of calibration and a lower cost diagnostic for non-insulin using patients that would require no calibration.

As some of you have noted the clinical study for our new insertion system and transmitter has been posted by clinicaltrials.gov. We are in the middle of analyzing the study data. We will tell you that patients absolutely love the experience of this system. Our biggest variable with respect to the new applicator and transmitter system launches scale. We have never built this system in quantity and all of our manufacturing procedures change when we launch it.

We must be completely ready for this launch and with a three-month life on the transmitter, it will be much easier to cut patients over that has been for us in the past. We're currently preparing our submission and will provide you with more color on timing next quarter.

With respect to our pump partners, Animas and Tandem continue to report positive results from their integrated pump offerings with G4 PLATINUM. And we believe all of our pump partners are making excellent progress on the development of more advanced integrated systems. We continue to make progress beyond our pump partnerships as we explore opportunities in connectivity with smart insulin pins as well as other interconnected diabetes management platforms.

Finally, on the product pipeline front, our partnership with Verily is going extremely well. Verily has already completed a first generation transmitter, it is beginning to test its performance with both G5 and G6 sensors. Initial results have been very promising. And launch of our first combined product appears to be very much on schedule.

Finally, our advanced sensor research program remains on track to deliver a sensor intended to work with the targeted bandage-sized disposable transmitter that we are co-developing with Verily. On the international expansion front, we are very close to opening our European headquarters in Scotland and we will begin to expand the European team on all fronts.

Over the next several years, we expect the transition to a direct commercial presence in multiple European countries, including the UK. We continue to believe that reimbursement could come in Germany and France and the UK in the near future and we will be ready to capitalize on that opportunity.

In conclusion, our results speak for themselves, with 60% sales growth in Q1 we believe DexCom's competitive position is as strong as it's ever been. And as I look at the innovation in our pipeline, we are only scratching the surface of the opportunity ahead. We're all very proud of what we've accomplished so far and look forward to further changing the diabetes landscape. I would like to take a moment to thank all of our hardworking employees and our physician and patient community and shareholders for all of their continued support.

I would now like to open the call up for Q&A.

Question-and-Answer Session

Operator

Thank you. We will now begin the question-and-answer session. And our first question comes from Mike Weinstein from JPMorgan. Please go ahead, sir.

Michael Weinstein - JPMorgan Securities LLC

Thank you. Kevin, there's a lot to cover here, so let me start first off by congratulations on obviously a very, very strong quarter and strong start to year. Thinking just about the FDA advisory panel and obviously it creates another hurdle, which you guys hopefully will crossover. So, that creates a little bit of uncertainty for investors here. But I think the positive side of it is the bar for anybody else getting the finger stick replacement claim just went up that much higher. Love just to get your additional thoughts on that? And then a couple of other topics I wanted to cover.

Kevin Ronald Sayer - President and Chief Executive Officer

You know, Mike, this is so important in such a paradigm shift in diabetes care to have that replacement claim. We're okay going to panel and we will just prepare and be the absolute best that we can. And it's important that we learn exactly what we have to do because we do have to get this claim to get Medicare coverage. And as I've gone out in the field and met with physicians, question number one every time I walk in an office is when are you going to get Medicare? So, we need this labeling. So, we look forward to the opportunity and will take what comes, but we will be ready, rest assured. We will not lack for preparation here.

Michael Weinstein - JPMorgan Securities LLC

Okay. A couple of other topics I was hoping you could touch on. One is DIaMonD trial and specifically what data do you think we will see at ADA now that there is a scheduled presentation? And two, all the discussion around some of the challenges with the G5 launch and really the learning curve on some of it. How has that impacted the timing for G6?

Kevin Ronald Sayer - President and Chief Executive Officer

Let's start with – we can start with that one, that really hasn't impacted our G6 timing. We have continued to work on our G6 IDE. I can tell you the FDA is putting our IDE through a very rigorous process and standards are not getting easier, they are getting harder. And I think some of this, is in anticipation of the non-adjunctive claim that as they look at G6, they look at this, is this going to be a non-adjunctive sensor. And while we have multiple years of data on that G5 system with 505 Software, we don't have multiple years of data on a new sensor. So that trial is going to be very, very robust, that would be the first one. What were the other two, I'm sorry I...

Michael Weinstein - JPMorgan Securities LLC

Yeah, the question was, number one question on DIaMonD trial?

Kevin Ronald Sayer - President and Chief Executive Officer

Oh, DIaMonD, yeah, I'll take that quick. We haven't seen the data yet. This is an independent study certainly and the results will be (26:32) we don't know. Honestly we do not know how this study is going to read yet, I believe the data will come in certainly a month or six weeks before the presentation so they will come in soon. Certainly our hope for the DIaMonD study was to show improved outcomes through the use of CGM in this patient population. And we anticipate there will be that, but we don't know what those outcomes are. This is a very independent group of diabetes thought leaders, who are going to tell us what happened and what they saw.

Michael Weinstein - JPMorgan Securities LLC

Okay. Last question, I will let some others jump in, could you just – you didn't spend any time on this call talking about the attempt to develop the pharmacy channel. Could you just – you made a lot of progress here particularly in the back half of last year. Can you just talk about where you are with that and will there be a point where you'll start to talk about the percentage of your business that's going to the pharmacy?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yeah, Mike this is Steve. We're not going to disclose that today but you're right we – frankly because there was so much information in this call. We didn't really have a specific update on pharmacy. We've continued to say it's progressing, going a little slower than we probably anticipated out of the gate. We'll certainly update you as we see more progress, but yeah, there's not a whole lot to talk about there today.

Michael Weinstein - JPMorgan Securities LLC

Okay. I'll let some others jump in and congrats again on the quarter, guys.

Kevin Ronald Sayer - President and Chief Executive Officer

Thanks, Mike.

Operator

And our next question comes from Ben Andrew from William Blair. Please go ahead, sir.

Ben C. Andrew - William Blair & Co. LLC

Good afternoon, guys. Kevin, at the panel, will it just be DexCom submission being discussed?

Kevin Ronald Sayer - President and Chief Executive Officer

To our knowledge for our panel meeting, that is correct.

Ben C. Andrew - William Blair & Co. LLC

Okay, interesting. And then as you think about the competitive dynamics coming out of that, let's say it does go positively, they approve it towards the end of the year, how will your messaging change and how material do you think that that is as you talk to clinicians, as you talk to patients compared to the other products that are available or what might come out in 2017?

Kevin Ronald Sayer - President and Chief Executive Officer

Ben, that's really a fascinating question and it's subject to debate all the time. Obviously, I can tell you one segment where this plays very well. There still are physicians who are not overly familiar with CGM, who don't recommend it regularly because they say you still have to stick your finger anyway. With this claim, we will be able to go to that group and say, look, recommend this for your patients, they don't have to take finger sticks before they make the treatment decision, this will be a very, very good outcome for us and we'll be able to get deeper and into more physicians.

With respect to the rest of the community, I think it certainly sets us as a standard above everybody else, which we're already at out there anyway. So, it will give us an advantage that we'll continue to market and continue to push. And I think it will be helpful, there is certainly no downside here at all.

Ben C. Andrew - William Blair & Co. LLC

Sure, sure. And then the sequential decline in patient adds in the first quarter, seemed like it was smaller than previous quarters, obviously this is your second print after the G5 launch. How would you characterize kind of the pipeline and the tone of business going through the quarter. Was it a typical Q1 progression or did it surprise you?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yeah. I think it was – Ben, this is Steve. I think it was a typical Q1 progression, similar seasonality to prior years. I would say, one thing we're – we might be starting to see, it's a little early to tell is maybe a reduction in seasonality over time as we move more of the business to the pharmacy channel because they're less sensitive. Now those are certainly not – more attributable to sensor purchases as opposed to hardware purchases. But other than that, I mean it was a very typical Q1 for us.

Ben C. Andrew - William Blair & Co. LLC

And then finally, maybe for Jess, how would you guess the sensor mix exiting the year, you obviously came down a couple of points this quarter. Should we look for that to keep moving or how do you look at that? Thank you.

Jess Roper - Chief Financial Officer & Senior Vice President

No, for the year, Ben, I would look it to probably normalize and be in the 70%, 30% range. In prior years, we have had some fluctuation of consumables being in the 69% to 71%, 72% mix.

Ben C. Andrew - William Blair & Co. LLC

Great, thanks.

Operator

And our next question comes from Danielle Antalffy from Leerink Partners. Please go ahead.

Danielle J. Antalffy - Leerink Partners LLC

Good afternoon, guys. Thanks so much for taking the question. Just a question on some of the receiver issues. Did you see any change in patient attrition during this or – time of – or sensor days per patient?

Kevin Ronald Sayer - President and Chief Executive Officer

Danielle, that's a very good question. Our internal checks would indicate we haven't seen any attrition and one of our larger distributors was in last week had said, they see retention at an all time high. I would tell you in all candor I've taken a couple of frustrated patient calls because of wait times and I do that from time to time and in no case has somebody called me and said, I want to get rid of your product, I just want you to answer the phone and get on the line quicker and help me. So, we haven't seen that, but if we don't fix our – the things we're working on we would and that's why we're so committed to making the improvements and getting through these issues.

Danielle J. Antalffy - Leerink Partners LLC

Okay, great. That's helpful. And then, second question for you on the adjunctive claim, can you give us some color into what exactly is FDA looking for here. I mean, you're already at an algorithm that 9% MARD, our checks with regulatory folks, not that work for FDA, but imply that, that should be good enough. So, I guess, what more does FDA need to see, I'm happy to hear you guys are going at panel, but also kind of feel like that's overkill, why can't we just get this approved without a panel. So I would love to hear some color on what FDA is looking for.

Kevin Ronald Sayer - President and Chief Executive Officer

Danielle, this is such a paradigm shift, I think they truly want to make sure we have the public panel and everybody can digest the information. As we've gone through this process, it's not only the MARD, it's overall patient safety and as we talk about simulations, for example, we built thousands, hundreds of thousands of used cases, where if the CGM reads, X and the finger stick reads, Y and the finger stick is right, but the CGM is wrong, what could happen or vice-versa. And what they wanted to see is how we protect patients.

And in all cases and all reality, the best way to protect your patient is with the CGM, because if they make a decision, even if the CGM for whatever reason is off and you know about our accuracy and reliability, the only way you know, you've made a bad decision is with an alert or alarm.

And so, with our alerts and alarms and with our system, we believe that's much safer than the decisions patients make today with only finger sticks. So we've had to simulate and build those cases and make sure we have a very strong actual data platform to build this on.

So, when you're going to make a change this big, I think what the FDA looked at and said with all caution, we need to make sure, we get this out on the public and we proceed down the proper path.

The accuracy issue is fine, the other thing that we have to approve and support and again our 505 Software is the best ever found for this, is outliers. You really want to eliminate outliers sensors more than anything else. And our system does that and we need to show that it does. And so, all those things are being considered by them. And listen, we're going to comply.

Danielle J. Antalffy - Leerink Partners LLC

Good. Thank you so much.

Operator

And our next question comes from Jayson Bedford from Raymond James. Please go ahead, sir.

Unknown Speaker

Hi, guys. This is Mike (34:08) calling in for Jayson. Can you hear me okay?

Kevin Ronald Sayer - President and Chief Executive Officer

Hi, Mike (34:09). Yeah.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yeah.

Unknown Speaker

Great, thanks. First I wanted to ask you about the G5 upgrade cycle. Can you give us a sense what percent of your user base is either converted to G5 mobile or is on the G5 mobile now?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yeah. We've decided not to break that out. What we've said before is still holding true that we've always offered a low cost cash upgrade to the next generation platform and frankly very few patients take us up on it. So, what we're seeing is a transition from G4 to G5 as people's warranties expires and they're eligible for a new system, they're just processing it through insurance. So, kind of status quo there, but we're not aggressively pursuing an upgrade at this point and you should just assume over the next 12 months to 18 months that the vast majority of patients will transition.

Unknown Speaker

Okay, great. That's helpful. And then...

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

It's the same sensor remember, that's – Mike, just real quick, one point I do want to make. Remember that from a sensor perspective, so 72% of our revenue in the quarter, the G4 and G5 sensor configuration is identical. So, you're really just talking about some hardware upgrade.

Unknown Speaker

All right. That makes sense. Okay. And then anything new with the alternative paths to Medicare, we've been hearing a little bit about individual successes on the judicial front and is there an option to maybe escalate that to a broader scale? And then similarly anything on the legislative front?

Kevin Ronald Sayer - President and Chief Executive Officer

We're doing the best we can with those individual cases and on the judicial front. The legislative front is a little slow right now. We continue to work and try and get it through that channel. But we feel we've got to get the labeling when all said and done to get there. So, that's where we are right now.

Unknown Speaker

Okay, great. Thank you.

Operator

Our next question comes from Kyle Rose from Canaccord. Kyle, please go ahead.

Kyle Rose - Canaccord Genuity, Inc.

Great. Thanks a lot. Can you hear me all right?

Kevin Ronald Sayer - President and Chief Executive Officer

Absolutely.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yes.

Kyle Rose - Canaccord Genuity, Inc.

Congrats on a strong start to the year. Wanted to talk a little bit about the patient dynamics that you're seeing and then also what do you think about the pipeline. Robust new patient growth over the last several years, you talked about the pipeline has never been stronger from a new patient perspective. Can you talk a little bit about what do these patients look like, it feels like there – you've moved past the early adopters and you're now feeling some of the pain from a customer service standpoint of maybe a higher maintenance patient. Can you just talk about how do we think about the strength of that pipeline from an attrition standpoint, from the type of new patients that are coming on? And also, how that could potentially affect your utilization of the product as well?

Kevin Ronald Sayer - President and Chief Executive Officer

Sure. I'll take that and I think you're absolutely correct, we are moving past – the early adopters are those who would wear a product and absolutely put up with anything we had to offer because it was so much better than what they've had had before. And we have to take more care to service those patients. So, I think from an attrition standpoint, I don't think we're going to lose them because all in all their experience has been remarkable.

Again, I'll go back to parents. We run into parents who say, I ran into one the other day, we were just able to go out on our first date and watch our child while we were at dinner, send our kids off to college. This share feature and this connectivity is huge. The other thing has been huge in our kids population is the ability to look at this on your phone. There are many, many 11-year-olds around United States, who need to thank DexCom for getting a cell phone two years earlier than their parents were going to let them have one. Because kids are willing to look at their phone and to look at the insulin data there. So, I think the patient base there is going to be every bit as sticky as what we've had before. And the quality of the pipeline is very, very good because and as many of you have heard around the country, CGM is becoming the standard of care for type 1 diabetes. It is absolutely essential to be safe and to achieve the outcomes the patients need to achieve.

Kyle Rose - Canaccord Genuity, Inc.

And then switching over to the CMS side, I understand that, that's probably going to rest on the dosing claim. Assuming we get a positive panel and you do get approval before year-end. I'm just wondering, what are your expectations for positive coverage turning on at CMS. I mean is it a month, is it a couple of quarters afterwards, just trying to understand, could this be a first half 2017 event, is it more like a back half 2017 event and then I'll hop back in the queue. Thank you.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

So, it's somewhat to be determined. I will tell you it's a multi prong strategy in the sense that, we haven't made the decision to immediately go for a national coverage decision, the more likely event is that we will target the individual max first and try to obtain coverage on a regional basis. And that can happen much more rapidly, the national coverage decision process can take a year or more. And so, my expectation – again, these plans are not solidified at this point, but my expectation is that we would probably do this in parallel, but you'd see us going after the max first, I don't want to try to guide you on specific timing as we just don't know yet.

Operator

And our next question comes from James Francescone from Morgan Stanley. Please go ahead, sir.

James Francescone - Morgan Stanley & Co. LLC

Hey, thanks for taking the question. First I wanted to touch on the impact of the recall to sales momentum exiting the first quarter. I mean you talked quite a bit about the strain that managing the recall had put on your organization. We actually saw a very, very strong sales results in the first quarter. Is there any risk that disruption or distraction of the organization in the first quarter or will actually end up disrupting momentum into the second quarter or we'll see a bit of a delayed impact of the recall in maintaining that sales momentum?

Kevin Ronald Sayer - President and Chief Executive Officer

We have not experienced that to date, but we manage and watch it closely, that has not been our experience so far.

James Francescone - Morgan Stanley & Co. LLC

Okay, understood. And second just on gross margin. Would you be able to breakout how much of the three point delta was scrap versus warranty? And as we look forward to the rest of the year today, is there anything that we know about that we should be putting in our models if it's going to be non-recurring in terms of those additional scrap or warranty expenses. Are those still unknown risk at this point?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Sure. The incremental cost we experienced this quarter was about two points due to warranty – extra warranty cost and about one margin point due to scrap that Kevin mentioned before.

Kevin Ronald Sayer - President and Chief Executive Officer

As far as anything unknown in future quarters, we don't. If we knew, we would have recruited, we don't know.

Jess Roper - Chief Financial Officer & Senior Vice President

Yeah. We tried to outline the worse – what we believe today as the worst case scenario, this could be zero to up to – we said up to $5 million if we had to rework the entirety of our inventory.

James Francescone - Morgan Stanley & Co. LLC

Okay, understood.

Kevin Ronald Sayer - President and Chief Executive Officer

And let me make through some – we haven't had any impact on the company's result of the recall. The impact we've had has been as a result of the G5 launch and that's not being ready for everything. We needed to be a little more ready and prepared from an infrastructure perspective. The recall and the patient notification did not impact our business or our sales, but it did impact our ability to serve our customers in the way we wanted to.

James Francescone - Morgan Stanley & Co. LLC

Understood. Thank you.

Operator

Our next question comes from Tao Levy from Wedbush. Please go ahead.

Tao L. Levy - Wedbush Securities, Inc.

Yeah, hi. Good afternoon. I was wondering the rate of the events that you're seeing with the speakers, do you have a figure you'd like to share?

Kevin Ronald Sayer - President and Chief Executive Officer

No.

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Not that we're going to disclose, no.

Tao L. Levy - Wedbush Securities, Inc.

Got you. I mean one of the things that was surprising when you kind of look at the – read the blogs and so forth, this is hardly mentioned. And when it is mentioned, so it'll vibrate and you just put it next to your bed, you put your – the receiver next to the bed, it will vibrate and kind of wake you up, if that's an issue, it's not – again it doesn't sound so alarming, but again, I might be wrong.

Kevin Ronald Sayer - President and Chief Executive Officer

We additionally dealt with it in that manner and notified patients to retest the speaker. Obviously the FDA had a different opinion. And I think what this tells you again is how important alerts and alarms are in the system and we continue to emphasize that as we look at future product offerings and we need to make sure we meet people's alerts and alarms perspectives, I mean their expectations there. So it really relates more than anything else to the importance of the alerts and the alarms and then patients can hear them.

Tao L. Levy - Wedbush Securities, Inc.

Okay. And in terms of impact on the sales force, does the sales force deal with this at all or are they completely separate so they can continue doing their thing?

Kevin Ronald Sayer - President and Chief Executive Officer

I'm sure they deal with it in phone calls they get from customers and dealing with it and discussing it with the physicians. They don't have to deal with the actual execution of this at all, no.

Tao L. Levy - Wedbush Securities, Inc.

Got you. And then just lastly, you mentioned incorporation of insulin data into the next generation sort of app that will come out. Is that in collaboration with any specific pump manufacturer or is it not necessarily pump related, it could be from an injection?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

It could be from – you're thinking about it the right way, it could be from an intelligent insulin pen that has either near-field or Bluetooth connectivity to a phone, it could come from one of the existing or potential or even future pump partners. Our belief is again, it's back to being able to aggregate the patient's data in a single place on the phone is going to be key to diabetes management going forward. And so, we're making this available to patients and really evaluating any partner who is willing to come and participate here as a meaningful partner.

Tao L. Levy - Wedbush Securities, Inc.

Great, right. Thanks a lot.

Operator

Our next question comes from Jeff Johnson from Robert Baird. Please go ahead.

Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker)

Thank you, guys. Good afternoon. Kevin, on the panel itself, July 21, it meets then. Could you paint in broad strokes for us just kind of how you think the timeline could play out from there and when we might then see the dosing claim this year?

Kevin Ronald Sayer - President and Chief Executive Officer

I really can't. I'm not going to anticipate what the panel is going to do.

Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker)

If it is a favorable decision, do you think that comes – approval and launch could come quickly, are you prepared for that or just again, anything from a high level you can provide?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Well, we certainly will have designed the app and the user guide and things of that nature. But as far as launching immediately, we're going to have to go print things and get a new app file and do a lot of stuff. It's not going to happen immediately, but we can prepare very rapidly for it after panel approval, but I can't give you a timeframe as to how quick after it's going to be (45:36).

Kevin Ronald Sayer - President and Chief Executive Officer

Look, we try and be ready for launch every time we get an approval and we try and be as ready as we possibly can, and we will behave in that manner. You saw with G5, we got approved and launched very shortly thereafter, same in Europe. Our Share receiver that we launched in 2015, we got approval on one week and were shipping it two weeks or three weeks later. That's our culture around here is to be prepared – as prepared for an approval as we possibly can. This is a little bit different kind of net, because we are going to panel and that approval maybe different than the typical approval we get from the agency.

So we will prepare every bit as much as we can, but we need to make sure we do it prudently, we don't want to do things twice, we want to do it once.

Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker)

Yeah. Makes sense. Thank you. And then, on the DIaMonD study, when we do get that data at ADA, as I keep thinking of this study, I think it could be very helpful in the long run or even intermediate long-term, if we go into an era of bundling or something, where healthcare costs are an even greater focus and maybe it shows that CGM without pump is just as good or better than with pump. So I get that, but how would you think about kind of the near to intermediate term impact, is it just if CGM shows better A1c control and what have you, it's just better data, you can take out to the field to show patients, to show docs, things like that, is that really kind of the near intermediate benefit we could see from DIaMonD?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

Yeah, that's right and, Jeff, we mentioned we haven't seen the data yet. But yeah, this is really the – this is going to be the preliminary portion of the DIaMonD study, so don't expect anything, the full blown study results. But yeah, this is really to put to bed for once and for all that CGM versus traditional finger stick, there is no question that CGM provides bigger benefit. And we'll be able to take that message, we – one of the things we hear in the field is that there is not sufficient data to support the efficacy of CGM and this should put that to bed for physicians, for payers et cetera and then some of the other data that you're talking would come at a later date.

Jeff D. Johnson - Robert W. Baird & Co., Inc. (Broker)

Okay. Very helpful. Thanks, guys.

Operator

And our next question comes from Doug Schenkel from Cowen & Company. Please go ahead, sir.

Ryan Blicker - Cowen & Co. LLC

Hi, this is Ryan Blicker on for Doug. Thanks for taking my questions. So, another strong international quarter, growing faster year-over-year than the overall company. Do you believe, this is sustainable moving throughout the rest of the year, do you think that international maybe reverts back a little bit closer to the corporate average?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

I think it depends on, really depends on reimbursement. Yeah, I mean if we get reimbursement, we mentioned that we're seeing positive signs in Germany, France and the UK if we were get all three of those even one or two of them this year that opens up a huge opportunity for patients, that we're operating today in a cash pay world. So if that happens – if two or three of them happen this year or even in the first half of next year, I believe will help continue to accelerate European growth.

Ryan Blicker - Cowen & Co. LLC

Okay. That's helpful. And then on the G5 transmitter, I know, in the past you've talked about capacity constraints, are you guys fully passed out at this point?

Kevin Ronald Sayer - President and Chief Executive Officer

We are, with the G5 transmitter, yes. But again, getting through that as Jeff talked about earlier, we had some scrap and some yield issues, as we watch that product and built it out. Yeah we are through that right now.

Ryan Blicker - Cowen & Co. LLC

Okay. And lastly on Medicaid, you've talked about some impressive progress in public forums over the past several months. Can you give us an update I guess on where that stands today and how you guys think about I guess the total patient opportunity there?

Steven Robert Pacelli - Executive Vice President-Strategy and Corporate Development

I don't have great numbers for you on total patient opportunity, but we're pushing close to 25 states now, with Medicaid coverage. We obviously know it's without specifically quantifying it, we know that in the ObamaCare regime, the number of eligible patients for Medicaid in the various states have gone up pretty significantly. So, it is an important opportunity for us. We'll continue, we have to admit it like the private payers, have to go state-by-state to negotiate and knock-off coverage. So, we're as focused on that as we are on the private payers and on Medicare.

Ryan Blicker - Cowen & Co. LLC

Okay. Thank you.

Operator

We have no further questions at this time. I would like to turn the call back over to Mr. Kevin Sayer for closing remarks.

Kevin Ronald Sayer - President and Chief Executive Officer

Thank you very much. It continues to be a very interesting time here at DexCom, particularly as we start to merge the world with medical devices and consumer devices, as I talked earlier about us supporting tech services phone calls related consumer products.

Another thing to know with respect to our speaker is, with the receiver, a lot of these receivers are very, very old and will drop multiple times. And so, we're even dealing without a warranty product as well, but we will get through that. But our G5 launch and everything going on here, even with our mistakes, everything has been going extremely well. And as we look forward, our product pipeline offers a feature set that is very much going to delight all of our current patients for years to come, but we're not going to stop there.

We've been very upfront with our discussions around future markets, such as type 2 diabetes, gestational diabetes in the hospital. And as we begin to run small studies in those areas and talk with patients, the things we're hearing are remarkable.

Let me give you a couple of quotes I've heard. I didn't know what diabetes really was. I had no idea how to titrate my meds, I wasn't even sure that they worked. No one has ever given me any feedback before I just stick my finger once every day and thought I was okay. Who knew? Exercise makes a really big difference. And my favorite one, do you have any idea how many patients in this hospital have diabetes? Our diabetes opportunity is enormous. The healthcare communities realizing that improved outcomes cannot be achieved without better real-time information. And our competitive environment consists of many large aggressive well-funded entities on one side and many startup technologies on the other, all focused on one thing, catching DexCom.

Now, it's now the time for us to slowdown, but the time to increase our focus and execute our amazing plans. Thank you.

Operator

Thank you. Ladies and gentlemen, this concludes today's conference. Thank you for participating. You may now disconnect.

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