德康醫療 (DXCM) 2014 Q3 法說會逐字稿

Hello, and welcome to the DexCom third-quarter 2014 earnings release and conference call. My name is Joe and I will be your operator for today's call. (Operator Instructions). Please note that this conference is being recorded.

I will now turn the call over to the CEO of DexCom, Mr. Terry Gregg. Sir, you may begin.

Thanks, Joe, and thanks, everyone, for joining DexCom today on our third-quarter 2014 investor conference call.

I'm going to have Steve Pacelli read our Safe Harbor statement to kick things off.

Thanks, Terry. Some of the statements that we will make in today's call may constitute forward-looking statements. These statements reflect management's expectations about future events, operating plans, and performance, and speak only as of the date hereof. These forward-looking statements involve a number of risks and uncertainties. A list of the factors that could cause actual results to be materially different from those expressed or implied by any of these forward-looking statements is detailed under risk factors, and elsewhere in our annual report on Form 10-K, our quarterly reports on Form 10-Q, and our other reports filed with the SEC.

We undertake no obligation to update publicly or revise these forward-looking statements for any reason.

Additionally, we will discuss certain financial information that has not been prepared in accordance with GAAP, with respect to our cash operating performance. This non-GAAP information is provided to enhance your overall understanding of our current financial performance. 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.

Terry?

Thanks, Steve. Joining me today are Kevin Sayer, our President and Chief Operating Officer; Jess Roper, our Chief Financial Officer; and you just heard from Steve Pacelli, our Executive Vice President of Strategy and Corporate Development.

So today's call will follow our traditional format. Kevin will review our third-quarter 2014 financial results and provide a business update. And I will then follow with some concluding thoughts. But before I turn the call over to Kevin, I'd like to comment briefly on our results for the quarter.

Our product revenue growth is unparalleled. We have grown over 60% annually for six consecutive quarters, and our average year-over-year quarterly revenue growth has been 65% since the launch of G4 PLATINUM. In Q3, our cash-based operating income increased by approximately 3 times over Q3 2013. Clearly, our business model is working as planned.

All the while, we are in the midst of three simultaneous product launches: first, a new, smaller version of our G4 PLATINUM transmitter; second, DexCom SHARE, our first step into mobile remote monitoring; and, third, our new G4AP algorithm, with an unprecedented 9% MARD. Things could not be better for us.

With that, I will turn the call over to Kevin.

Thank you, Terry. I'll start with the financial update. DexCom generated $67.9 million in product revenue for the third quarter of 2014 compared to $42.5 million for the same quarter in 2013, a $25.4 million or 60% increase. Sequentially, product revenue for Q3 of 2014 increased 17% from the prior quarter. Total revenue for the third quarter of 2014 was $69 million compared to $42.9 million during the same quarter in 2013.

Our product gross profit totaled $46.1 million, generating a product gross margin of 68% for the third quarter of 2014, compared to product gross profit of $27.7 million and a product gross margin of 65% for the same quarter in the prior year. Sequentially, our product gross margin in Q3 2014 was flat. As we've said previously, our gross margin target for the G4 PLATINUM sensor is between 70% and 75%, and our gross margin target for G4 PLATINUM hardware is 50% or better.

With a blended gross margin of 68%, we are achieving our targets. While we may see minor incremental gross margin gains in future quarters, we do not expect to see continued large improvements in gross margin until we introduce new products and achieve even greater sales volumes.

I would like to share some additional thoughts on our product revenue and our gross profits. During Q3 2014, our revenue mix between durable and consumable products was again approximately 30% durable and 70% consumable. ASP for sensors was flat for the third quarter, at approximately $72 per sensor. And the ASP for our hardware was approximately $850 per starter kit, with a little more than half of our hardware ASP attributable to the transmitter; while we continue to target ASPs in a range of $70 to $75 per sensor, and a range of $850 to $900 for a starter kit, going forward.

Finally, our international business continued to exceed our expectations in Q3, with international product revenues representing approximately 15% of product revenue during the quarter.

On the expense side, research and development expense totaled $18.5 million for Q3 of 2014 compared to $11.8 million in Q3 of 2013, and $14.8 million in Q2 2014. Yes, we are making a significant investment in our future. As Terry mentioned in his opening remarks, we have seen exceptional growth since the launch of G4 PLATINUM. And we have clearly demonstrated that superior product performance has been key to driving this growth.

Yet, as we evaluate what we believe will be required in terms of improved sensor performance and advanced system features and functionality to meet the ever-increasing demands of our patients and clinicians, we must continue to invest in the near-term. In addition, we need to complete the clinical trial work necessary to demonstrate improved outcomes and lower cost to drive favorable payer policies.

We will look to take advantage of near-term opportunities such as advanced integrated pump, CGM systems, simplification of sensor deployment, mobile and cloud-based data platforms; and additional system performance improvements such as improved accuracy, extended duration, and reduced calibration.

Over time, we will focus on miniaturization and advanced decision-support tools, all with an eye on increasing patient convenience, improving outcomes, and lowering costs. We will not lose sight of our ultimate goal of replacing finger sticks entirely.

Selling, general, and administrative expense totaled $33.7 million in Q3 of 2014 compared to $21.6 million during the same quarter in 2013, an increase of $12.1 million. The year-over-year increase in SG&A expense relates primarily to increased sales costs driven by our robust sales, increased marketing spending, and IT expenses for our commercial infrastructure as we scale of the business for continued revenue growth. SG&A expense also includes a $4.4 million increase in non-cash share-based compensation expense over the prior year.

SG&A expense for the preceding quarter was $30.9 million. The sequential increase of $2.8 million includes $600,000 in incremental non-cash share-based compensation expense and commercial expenses to support our 17% sequential growth in product revenue. Our net loss for the third quarter of 2014 totaled $5.2 million, and included $15.2 million in non-cash expenses centered in share-based compensation, depreciation, and amortization. Absent these charges, our cash-based operating income would have been approximately $10.1 million for Q3 2014.

Obviously, we are quite pleased with our cash-based operating results. This compares very favorably to a cash-based operating income for Q3 2013 of $3.5 million. Our basic loss per share for the quarter was $0.07.

With respect to our balance sheet, we ended the third quarter with $74.9 million in cash and marketable securities, up almost $13.6 million sequentially. We remain quite comfortable with our cash position. Finally, consistent with past practices, we take this opportunity to update our full-year revenue guidance. We now expect product revenue for the full year to meet or exceed the top end of our range of $235 million.

Now for our business update. Over the past few weeks, we have had a very exciting string of news related to our product portfolio. First, in mid-October, we were very pleased to announce the approval of DexCom SHARE, the first FDA-approved remote monitoring system developed to address the unique challenges faced by caregivers in assisting people with type 1 diabetes.

As a reminder, the DexCom SHARE system is a docking station for the G4 PLATINUM receiver, which enables wireless transmission of glucose information, such as a patient's trend graph, from the G4 PLATINUM to designated recipients, allowing the recipient to view the patient's data today on their iPhone or iPod Touch; and, in the future, on an Android platform as well.

We view DexCom SHARE as the first of many steps in bringing CGM to mobile devices. We successfully launched DexCom SHARE within days of approval. And we couldn't be more excited about the early feedback we've received from patients using the system.

Just this morning, we were pleased to announce that FDA has approved a new algorithm for the G4 PLATINUM system that we dubbed the G4 Artificial Pancreas, or G4AP algorithm. The clinical data from this new algorithm was first presented at ADA in June in a late-breaking poster entitled, CGM is not the limiting factor in artificial pancreas systems. In this study, we demonstrated that our technology is approaching fingerstick accuracy, with an overall G4AP MARD versus YSI at an impressive 9.0%, compared to a fingerstick MARD of 5.6% versus YSI.

The new algorithm will be made available free of charge to existing adult patients using the G4 PLATINUM. They can simply go online and download the software to update their receiver. Additionally, we expect to file the PMA supplement for a pediatric indication for the G4AP algorithm this quarter. All new adult patients, going forward, will receive the software preloaded onto their DexCom receiver with new orders.

We believe this new algorithm represents an important next step on our path to obtaining an insulin-dosing claim and the potential for factory calibration, both of which support our ultimate goal of replacing fingersticks altogether.

Shifting to our integration partnerships, Animas believes that the Vibe is nearing US FDA approval, and we are gearing up for a commercial launch of Vibe in the US which could come before the end of this year. On our last call, we shared that Tandem had submitted a PMA application to the FDA for the t:slim G4 Insulin Delivery System, which integrates the Tandem t:slim pump with our Gen 4 PLATINUM system. As Tandem reported this morning, they are extremely pleased with the level of interaction with the FDA since the filing, and they are confident in their ability to bring this device to market.

That being said, timing of product approval is at the discretion of the FDA, and Tandem continues to estimate a 12- to 18-month review cycle for the t:slim G4.

Finally, on the data integration and data management front, there seems to be a considerable amount of confusion in the marketplace as to where, and to what extent, DexCom is a participant. When it comes to retrospective display of our CGM data, we have announced an open architecture policy, whereby we will allow third-party software developers -- companies such as Tidepool, Diasend, and others -- to display retrospective data from our G4 PLATINUM system within their data aggregation platforms.

When it comes to our mobile app platform, we have stated a desire to incorporate insulin onboard data and other potential relevant data into our mobile platform. To that end, we have entered into agreements with Insulet and Asante, and are considering others to integrate data from their insulin delivery systems into our Gen 5 mobile platform. This platform will enable us to aggregate glucose and other diabetes-related data from patients' devices, and display the integrated data on a smartphone. This will be DexCom-driven software development process, and we expect these apps to be PMA products.

With respect to real-time display of DexCom's CGM data, we have thus far elected to maintain tight control, due in large part to the regulatory and quality systems requirements imposed upon CGM devices by the FDA. Obviously, our stand-alone products will provide patients with real-time information. To date, we have only granted rights to commercialize display of our real-time data to a select few insulin pump companies.

Going forward, we will consider, on a case-by-case basis, whether we open up real-time data displayed for commercialization to other third parties, such as other insulin pump companies or groups working to develop an artificial pancreas utilizing our sensor technology where it makes commercial sense.

Prior to doing so, however, we would want to assure ourselves that any such third party has a robust quality system and regulatory resources required by FDA to develop and maintain a Class III medical system.

With that, I would now like to turn the call over to Terry for some concluding remarks.

Thanks, Kevin. Well, our third-quarter performance did not entirely surprise us, as we continued to see momentum for the G4 PLATINUM build in the diabetes community. One needs only to read the diabetes blogs and chat room discussions to know what a tremendous difference we are making for patients, as well as their parents and loved ones, as they strive to improve control over their diabetes.

We must continue to innovate, never resting on what we have accomplished; which, of course, today, is the industry-leading CGM technology. We will never be satisfied until we reach our goal of replacing fingersticks. And upon achieving that milestone, we will simply develop new goals to continue to drive DexCom to remain the dominant name in continuous glucose monitoring.

We recently received approval for our SHARE system. And we believe this is the first step in the connectivity pipeline we are developing to ease the burden of trying to better control glucose levels safely. But even more important is that SHARE actively engages the patient and his or her support team, which are parents, spouses, and loved ones. For the first time with an FDA-approved device, you can be in the next room, the next state, or across the globe, and someone has your back, remotely. We are changing the paradigm of managing diabetes for the better.

Kevin mentioned our recent approval of a new algorithm, the G4AP, that we will begin to distribute shortly. I can remember how happy and satisfied patients were with the improvement and accuracy from the 16% MARD of the SEVEN PLUS to the 13% MARD of the G4 PLATINUM. So I'm even more excited to get this new algorithm, with an MARD of 9%, into the hands of patients. We have learned the importance of accuracy in CGM. It translates into confidence and trust in the G4 system. It also translates into freedom for the patient to live a more normal life. And it moves DexCom a step closer to our goal of replacing fingersticks.

Our pipeline is very robust, and we expect to introduce a steady stream of product innovations on our sensor technology as we look at Gen 6 on the durables with an improved sensor deployment system, and especially on the connectivity side, as we introduce our Gen 5 system. We will continue to make the appropriate investments to achieve these goals.

As I have often commented, being in the CGM space is extremely difficult and expensive. Many have tried, and most have failed. And yet, we continue to prosper and drive adoption by providing superior technology in a patient-friendly format.

Kevin touched on the reimbursement challenges facing the med tech world, as cost of care becomes front-and-center for the payer universe, and we believe we are well positioned to demonstrate improved outcomes while saving the system money.

A single severe hypoglycemic event with a hospital admission can cost on average $17,000, and yet we can reduce or eliminate hypoglycemia events. And the compendium of positive outcome data associated with continuous glucose monitoring continues to grow. And one of our near-term goals is to harness that data to enable payers and healthcare providers to better manage treatment modalities, and, ultimately, further reduce cost of care.

The world is waking up to the potential benefits of connectivity, with wearables for improved health. DexCom has been a pioneer in this area since our inception, so we are excited we have a partner with companies like Apple to accelerate our efforts. And you'll be hearing more about these collaborations in the future.

With that, we will take questions.

(Operator Instructions). Danielle Antalffy, Leerink Partners.

Congrats on yet another great quarter. I was hoping you could comment. There was some talk in the quarter about a competitive launch in Europe. Obviously, I'm talking about Abbott's Libre, which, from what I understand, is not a true CGM. So I was hoping maybe you could talk a little bit about what that product is; and, more importantly, what you're seeing so far in Europe from an adoption -- potentially market expansion -- perspective. And also, any comments on pricing with that product.

Danielle, this is Steve. I'll take this one. I think you hit it on the head. Look, the Abbott Libre product is, first and foremost, it's not a CGM product. It does not have the capability of alerting a patient, for example, to nighttime hypoglycemia, which is a critical attribute to CGM. So it's not really fair to have an apples-to-apples comparison between DexCom's CGM and the Abbott Libre product.

That being said, we long assumed that Abbott would come back into the market. They have been talking about this product for over a year now, so it certainly wasn't a surprise to us. We've been watching the blogs, frankly, but I think they are in the very early stages of their launch, so it there isn't a whole lot of detail or information out in the marketplace at this point.

Again, I've heard -- pricing, it appears to be priced favorably to a full-blown CGM. But again, your patients will be purchasing products that doesn't have the full protections of CGM in terms of alerts and threshold alerts and alarms. So I think at this point, we're going to take a wait-and-see approach; wait and see what, if and what, they develop as a category in the market in Europe. No idea. They've been very silent as to potential timelines for US commercialization, so we'll take a wait-and-see approach here.

And I think the net-net for us is, look, the configuration that Abbott has come to market with is certainly something that we could make it potentially -- make some tweaks to the Abbott product that would be very competitive to an Abbott Libre product, to the extent that they are able to develop some new category for the product. So I think, with that, we're going to take a bit of a wait-and-see approach.

Okay, great. That's helpful. And then I was hoping you could give some more color on SHARE -- congrats on the approval -- how we should think about that contributing to revenue. Is that a subscription-based model? Or how does SHARE work? And how do we look at that going forward, from a revenue topline-driver perspective?

Sure, Danielle. I'll take that one. The SHARE system is a -- it's an upfront charge of, I think, $299, and you get the cradle and your data to start off. It is not a subscription model at this point in time. Our patients buy the hardware, and that's what they get. With respect to driving our revenues, as I said on the prepared remarks, this is really the first step in our mobility platforms. And while we expect this to contribute some, it's not going to be a major revenue driver when we're already growing at 60%.

What we do see -- what we do anticipate is that this will be very helpful, and continue to grow the pediatric market. And the other benefit of SHARE, quite frankly, isn't on the top line; it's a pressure test for all the infrastructure we've been building for a long time to manage this data remotely. And we have learned a whole bunch in a very short period of time about our patients' behaviors and patterns, and their glucose readings. So, all in all, it's a great launch for us.

All right. Thanks so much, guys.

Ben Andrew, William Blair.

So, a few questions for me. If you think about the fact that FDA moved so quickly with the new algorithm -- obviously, the benefits it provides are material -- does it give you any information content, relative to what that could mean for the G5 approval? Or does that transmitter -- because it's really just that transmitter now that's changing, I believe, and the connectivity dynamic that would represent the G5.

I think they're different. The algorithm is certainly science that the FDA is familiar with, with respect to DexCom, as we've been through several sensor launches, and even an algorithm change in the past with respect to the SEVEN system without changing hardware, and the data was very clear-cut. We're hopeful that we get a quick approval on the G5 system. But it is more than just a transmitter. It is displayed directly on the cell phone. It is human [factors] work on display on a cell phone. It's all the things we have to mitigate for loss of connectivity and things of that nature, Ben.

So while we've met with the FDA on several occasions, and have a very good idea of what that file is going to look like, and we believe they have a very good idea what the file is going to look like, I don't think the two are related. We're hopeful, but we'll just have to wait and see.

Okay. And then, Kevin, you talked about the R&D spending -- I think, Terry as well -- the allowing you to do some more things. And you mentioned device integration with advanced pumps or delivery systems, as well as advanced decision-making tools. Over what timeframe should we see you guys moving forward with that commercially? Is this two, three, four years? It seems like it will be an evolution, obviously, including the current portfolio. But does this allow you to accelerate some of that, and bring those things forward? Because those obviously may represent additional revenue opportunities as well.

You know, Ben, right now a lot of that is infrastructure building, and getting ready to develop those types of tools. I think it's two to three to four years out, where we really have good -- a really good live decision support tool. We haven't even been through an FDA path on something like that yet. But we do know that we have great data, and we will accumulate more to whereby we can develop those things.

And we're just making more investments. Terry and I have been around the diabetes industry for a very long time. And we've seen what happens when companies take their foot off the pedal as far as innovation. And we're not going to do that.

I don't know, Terry, if you have anything you want to add to that.

Sure. One of the things we did -- you know, we're the founding member, with Joslin translational group, as we look at taking data and not only using predictive analysis, but in a real-time sense to allow therapy changes on the fly that patients can do, ultimately, with obviously the consult of their physician. And all of this becomes -- the more you look at prediction software -- becomes very exciting to us that this disease called diabetes is one that would be particularly benefited by these types of programs.

So we are moving as fast as we can. But, once again, it's DexCom breaking brand-new ground. And then we've got to go about it slowly. We can only move as fast as the Agency will allow us to move with this. Because we are -- in the end, we are not physicians, and there is a great degree of concern that we don't cross over that line.

Okay. And last thing for me -- Kevin, you were kind enough to give us the 30% of revenues coming from hardware. Can you give us a sense how that breaks down at all, in terms of replacement hardware versus new patients? Thank you.

We get asked this question every quarter, and we're not going to add any more color to what we've had. We're having great new patient results. You can't grow as fast as we are without having that. So we'll leave it the way it is.

Tom Gunderson, Piper Jaffray.

So, my first question is around the pediatric indication. We all know a lot of parents that have been waiting for SHARE. But it begs the question of, oh, yes, that other approval that you had recently on pediatric expansion. Can you give us a little color on that; how you're doing, from a penetration of clinic standpoint? And also, is the split pretty much the same right now with pediatric and -- I'm sorry, with durable and consumable with pediatric? Or is it a little bit more on the starter kits? Any color there would be helpful.

You know, Tom, the pediatric launch has been very successful. We're a couple quarters into it. And as we said last quarter, a pediatric patient has the same usage and spending patterns as a regular patient, so we're not going to break that out, and continue to report on that every single quarter. But I can say it has certainly been a driver in our growth and been very successful so far. And you're right, a lot of parents are very happy with the SHARE launch.

Okay. And then O-US coming in at roughly $10 million, it's starting to get significant here. Again, can you give a little more color there? Is it mostly Europe? Is it mostly out-of-pocket? Is it mostly starter kits, as people figure out that the accuracy is worth the investment? Thanks.

It is really very much mostly Europe. We've done very well in Canada this year as we have launched there as well. We have some countries that have carried us -- Italy, Sweden, Germany, are three of the bigger ones; and the Netherlands. That there's four large ones in Europe where we've done very, very well. Reimbursement is improving. We see reimbursement in some countries in Europe.

We are also investing -- I talked about the study investment in my prepared remarks. We're investing in some very large studies over there to drive governmental reimbursement of CGM for patients. And so we're making investments over there to get full-on reimbursement for CGM. So a lot of it is out-of-pocket, and a lot of it is durable. It's a mix. It's not the same mix as the US, and it's not as predictable. We don't have as much color on those patients as we have over here, but the business is doing very, very well.

And just a quick follow-up, Kevin. Does Vibe contribute meaningfully to that $10 million, or is it still early?

No, it does. The Vibe is doing very well in Europe. Animas has done very well with that product over there.

Got it. That's it for me. Thank you.

Mike Weinstein, JPMorgan.

This is actually Robbie Marcus in for Mike. Congrats on the great quarter. I was hoping maybe you could give us some more insight into trends, into where the patients are coming from. Is the pharmacy benefit helping out here? Are you taking share from Medtronic? Are these all new to CGM, adult versus pediatric? Any kind of insight into the trends would be really helpful.

All of the above, I mean, literally; pharmacy benefit has helped in some cases. We're certainly not losing market share based on all the independent data that we look at. We have very significant new patient growth. Combine that with the fact that we're not losing patients like we used to in the SEVEN PLUS days. Our retention rates are very good. Our utilization rates appear to be very strong, as people trust and rely on this sensor array. I can tell you I've had many, many patients say the worst two hours of my week, or two weeks if they were the (technical difficulty) is that warm-up time while they wait for the next sensor to start.

So, every variable in there is working. And, again, I'll go back to our earlier statement -- to achieve growth like we have, they all have to hit. So every one of them is doing well.

Okay, great. And then at the end of September, Medtronic revealed the Guardian mobile, their own stand-alone CGM. How are you looking at this as a competitor to G5? And any comments around your take on that product would be really helpful. Thank you.

Yes, Medtronic revealed a potential stand-alone system at a trade show earlier this year. We haven't seen or heard, frankly, anything else about it since that time. So, much like the Abbott Libre, we're going to take a wait-and-see approach. Not clear to us what sensor component would be included, whether it's the current Enlite sensor -- which we've all seen the performance of that sensor -- or some future sensor. So, again, it's somewhat unclear.

I think one of the comments that was made by Medtronic was that the first-generation Guardian remote, whatever they're calling it, would not have a remote monitoring feature. It would simply be displayed to the patient. So in that respect, it's somewhat different than what we're going to come to market with Gen 5. But outside of that, I don't think we know a whole lot about it.

William Plovanic, Canaccord Genuity.

So, a couple questions. Gen 5 -- what does that include today, and when do you expect to file that?

We expect to file that in the first quarter of 2015. The primary focus of Gen 5 is the transmitter will be able to speak directly with two separate devices via Bluetooth connectivity. So, it could speak to your phone and your receiver at the same time. It could speak to just your phone or just the receiver. And then that data will be shared through the applications on the phone to the cloud. And people have access to the SHARE system, which will be the exact same system that we've launched, pretty much with the SHARE that was launched this year.

So the focus of Gen 5, it would be a Gen 4 sensor, with respect to its performance characteristics. It will have the G4AP algorithm. It will have that level of accuracy. So we're not changing the system, or the system performance, for the Gen 5 platform. We are going to come with a user interface that's very much designed to be a mobile platform, for those who look at the data on the phone, that we think is just fabulous. So, that's with the Gen 5 system is going to be.

Okay. And on that, is it going to address the calibration requirements, or the fingerstick replacement -- or that's a G6?

We will not change the calibration scheme for the Gen 5 system.

Okay. So it sounds like you're getting ready to lock that down and submit that.

We are working very hard to lock that down, yes.

Great, thank you. And then on the pediatric mix, as you think about the new patients coming in the door in the quarter, how much our peds and how much are adults, if you're looking at what was coming in, in the overall business?

You know what, peds are -- Bill, I'll go with what I said earlier. We've been out for a couple quarters with peds. Everybody is a patient, and they all have the same economic patterns, and we're just not going to report that every quarter. So it's going very well with peds. We're very happy. It's met all our expectations.

Great. And then my last question just is how long -- with the new G4AP algorithm - how long do you think that will take to get into your current installed base, number one? And then number two, I take it that will just be the algorithm going forward.

Bill, this is Steve. For this purpose, for the purpose of your question, I went and asked the ops guys how we were doing. It was actually posted on our website earlier today. We have had several hundred users already download and install the upgraded software. So, it's going to go fast. We expect to start shipping the new algorithm with new purchases with new receivers next week, so we're going.

And then are there any costs or anything that will be associated with that for you, that would be incremental material to call out, or not really?

No.

Not material.

Nothing material, no.

Okay, great. Congratulations on the phenomenal quarter.

Raj Denhoy, Jefferies.

Wondered if I could ask just one about the spending levels. And I appreciate that the necessity that you continue to spend on R&D and sales and marketing, to keep the growth as it is. But should we assume that the new $18.5 million R&D level, likewise with SG&A, is the new baseline we should assume going forward from here?

Raj, that's a very good question. With respect to R&D, as we prepared, we sat and discussed that. And I started to hear about 3.5 years ago, R&D is a lot different than it was then. For example, now, whenever we do something new, we've got to run trials for adults and for peds. The cost of getting anything to market has now doubled, on the trials and execution side, once we get something developed. And we're spending money on the cloud infrastructure and a lot of things that we weren't working on before. Fortunately, we've had the acceleration of growth necessary on the top line to hit our performance objectives.

It is important, as we look going forward, that as we look going forward into next year that we look at baselines in Q3 and Q4 of this year. As everybody may remember, in Q1 of last year, everybody took our expenses way down for Q4 to lower numbers, and we ended up with much higher expenses than everybody thought. We typically don't give a lot of expense guidance. But I think you can look at this number and go from there. There's a lot of stuff going on here, and it's good.

I don't know -- Steve, Jess -- you guys have anything else?

I'm going to weigh in a little bit. This is Terry. So, I spend a lot of my time thinking strategically for the Company, at this point. And what I'm always cognizant of is, as you look around the universe, the cost of care is something that is obviously on everybody's mind. We heard it as a keynote speech at the AdvaMed. Mike Mussallem talked about it during the Edwards. And so we need to spend some of those R&D dollars to ensure that we know, as a category, CGM saves the system money.

And I have preached to whoever would listen that the first stage, as we look at ACA -- whether or not it gets changed because of administration change -- who knows? But I will tell you this, that in the future the healthcare providers will get some of their compensation based on outcomes.

And it won't be too long after that -- I can't tell you when my crystal ball says -- three years, four years -- that industry is going to be part of that game. That if you can't demonstrate you are taking dollars out of the cost of care with your products, your products are not going to be reimbursed.

And so, what we have to do is -- we know, and it's a lot of lip service, at this point -- everywhere we turn, I just gave you a $17,000 number for hospital admission. We're spending over $250 billion a year in the United States treating diabetes. And, unfortunately, it continues to grow at unparalleled rates that we have seen. So we've got to be cognizant of that. And some of that R&D spend is creating and demonstrating to the payer system that we are, in fact, saving them a lot of money, and we'll save them even more money in the future.

And as Kevin mentioned, everything we do from the standpoint of building is -- they hear it preached to them every day: Make it better. Make it less expensive. So at that level, as well. So these are investments for the future, with the return being things that are not as price-sensitive. We know we have to hit certain gross margins. And no matter what we do, regardless of what the price is, we've got to hit those gross margins. And so from that perspective, we need to make those investments today.

No, that's helpful. If I maybe just ask a couple follow-ups. You noted -- I think you mentioned that one of the things you were spending on is a new, smaller transmitter. Did I hear that correctly?

Actually, we launched a new, smaller transmitter this quarter.

Okay.

It's already out.

I guess I just wasn't appreciative of that. But maybe you can describe a bit about how much smaller that is, and what sort of receptivity you're seeing with that.

Well, the receptivity has been outstanding, because everybody likes things that are less obtrusive on their bodies when they have to wear our devices. So, people have liked it very much. Driving that, we had to make a transmitter that had all the features of the previous Gen 4 one, particularly the ability to transmit over an extended range; and also the ability to talk to our integrated pump partners. The transmitter does both of those things. And it does cost less to make, so it meets all of our objectives. As Terry stated, what we do -- make it better and make it cheaper. They achieved them both. The guys did a great job.

Okay. And just one last one, sorry. I looked back, I think it's been almost exactly 2 years to when you got the Gen 4 approved. And as you noted, I think, in your remarks, you've grown consistently roughly 65% on average since then. And it invariably begs the question of how long you can sustain this. And it sounds like the Gen 5 is getting filed soon, and that should keep things going. But 65% is a pretty high bar to keep having to jump over, 60% even. Do you have any thoughts just around that?

You know what, Raj? We've typically said that we believe our sustainable growth, and what we plan for is to grow at 40% every year. And that allows you to double every two years. And so we have been very fortunate to grow faster than that. But our plans have always been to grow at 40%, and have the infrastructure to support 60%. So we're doing both, and we'll keep pushing. But this pipeline that we're developing we firmly believe can drive the business the way it has.

But it takes every one of these innovations to keep it going. It took a peds approval. It's going to take a new algorithm. It's going to take going to the phone. It's going to take a SHARE system. It's going to take every one of these things to continue to drive that growth. We can't drive the growth just by continuing to market G4 as it sits. We've got to be better, and we will.

That's great. Thank you.

Tao Levy, Wedbush Securities.

The professional CGM -- did that have any impact in the quarter? Or how is the roll-out of that product? Is it allowing you to convert more patients to CGM? Any color there would be helpful.

The roll-out has gone fine. As we said when we announced that approval a while ago, we don't expect this to be a huge, direct topline driver of our financials, and it has not been. They do convert some patients. I don't have the statistic off the top of my head. We know the percentage of people who wear our sensor on this professional use system. The percent who convert to purchasing one is very large. It's very consistent and very favorable, so it certainly helps us. But it really hasn't been a measurable driver in direct sales. And indirect sales, I don't have a number to share with you.

Okay. And with the APM algorithm, is that applicable, also, to the integrated systems that will be coming out, the Animas Vibe and the Tandem?

This is Steve. Unfortunately, they will not have the ability. Neither the Animas Vibe or the Tandem t:slim pump have the ability to upgrade, as we do our G4 platform receivers, to upgrade to the new algorithm. So, those patients would have one or two options. They would have to wait until a next-generation, really a Gen 5 version of the pump. Or they would always had the opportunity to purchase -- and we've actually seen this happen in Europe -- where patients, even patients on the Animas Vibe, have elected to purchase a stand-alone DexCom receiver. Because they prefer to pull that out of their pocket, purse, backpack whatever, to check their glucose values, rather than pull their pump out.

So, the transmitter would be the same. So the patients who wish to use the new algorithm would be able to use it with the same transmitter, if they bought a separate receiver.

Okay, great. And then just lastly, Terry, you mentioned at the end here the collaboration with Apple. And I know with SHARE it's right now -- it only works on the Apple platform. Is that what you were referring to? Or is it potentially going to go beyond that, and you start thinking (multiple speakers).

We'll go beyond that. As you know, you can buy the app on the iTunes store today for SHARE. So, that's the first stage. And as we have indicated, there is a trial being proposed now. It has been approved by Apple that we will utilize CGM (technical difficulty) on the G4 through -- first one being up at Stanford University at the hospital system; that will integrate into the Epic system using iOS 8 in their Healthkit. So, we view this as a long-term, opportunistic relationship.

Again, it got back to my part of my comment, too, is so we look at this wearable technology. That's really going to drive companies like Apple, Google, Samsung, whoever, into this digital health world that everybody looks at and says, wow, that's really something. That's a place we want to play to expand our own platforms from where they're at now. Because they see the aging of the population, and the opportunities to engage that population, and trying to empower them to take better care of themselves; and, again, reduce this healthcare burden that we spend a lot of time looking at.

And so, obviously, anything along those lines benefits what we intend to do. We have always considered CGM to be a consumer product. It has a requirement of a medical device, but the utility of it and its powers as a consumer tool -- because this is actionable for a patient that has to have many transactions in their daily life in order to better control their diabetes.

So you'll continue to see these grow, as first you see the watch system develop. And that's only the beginning, because that's easy to do. We've demonstrated deploying our system with Pebble watch, as an example. And a lot of that stuff, from a technology standpoint, is off-the-shelf with the utilization of Bluetooth low energy. Now, getting this through the regulatory challenges is much different. Obviously, it's in the news with regards to tighter security; and other challenges, risk and risk mitigation, that Kevin mentioned during his presentation.

But you'll continue to see these grow. That's really what I was focused on in my comments.

Okay, great. Thank you.

Erica Layon, Benchmark.

I'm on for Jan Wald, because he had to hop. Looks like a great quarter, so congratulations there. As you are looking forward to the future, smaller and integrated systems, are you looking to move both sensor performance and quality of life together at the same pace? Or does one take precedence over the other, if you do have to make a compromise?

Well, I don't think you have to make a compromise. I think they are simultaneous. Right now, we focus -- look, sensor accuracy of 9% MARD, that is point-of-care kind of accuracy, particularly when you add in the variability associated with the human influence on accuracy. If you take a patient on SMBG, I assure you that it is not 5.6%. It is something far greater than that. And we've seen variability in fingerstick measurements upwards -- two measurements done on the same finger, within seconds of each other, to be wildly different.

And so we actually, from an accuracy standpoint, are far better than fingerstick measurements. And we're certainly more consistent. So that is something that we will continue to drive to. We certainly believe that a 9% MARD, we are at that threshold in which we can dose insulin. We have to demonstrate that successfully to the Agency. But, clearly, we believe that accuracy is there.

Now you move to quality of life, and it goes hand-in-hand. And the patients have more confidence, more trust in the tools that they're using to better manage their diabetes, their quality of life has improved. They are less worried, day in and day out, of everything they do. A parent has less worry of sending a child over to an overnight because of the SHARE system. All of these things contribute to an improvement in the quality of life.

Okay. So it's just a matter of maybe one will step forward ahead of the other, but they're both moving forward together, just to (multiple speakers).

They're both moving forward together. That's an accurate statement.

And what trials are you most excited about that are happening with your sensor? And when would you expect data on those trials?

You know, we're excited about a bunch of trials. The biggest trial that we started -- and it started this quarter -- is what we call our Diamond study internally, which is a study where we can truly bracket the benefit of CGM from a therapy perspective, from a cost perspective, where we can really do a study that shows how we drive CGM outcomes, in patients new to CGM; in particular, with MDI patients, and what happens and what changes in their lives.

This is going to be a long-term study for us. The data probably won't be available for 18 to 24 months. But we're going to use 20 centers, and fund this study to really learn about those things that are important in our business, through a study of that nature. That's a study I'm very excited about. It's just going to not happen as fast as I'd like it.

I don't know, Terry, if you have any other --.

No, and you'll see interim results at some point during the course of the study. But it is really, in our opinion, a key study for the future. And certainly for the first time as a company, it's a study that is being conducted without the primary intent to get a product approved, from that perspective.

If you look at all the studies we're involved in, it's hard. We are in 20 different artificial pancreas programs -- not our studies. We participate; we provide some support. Those are exciting to see those progress along that intent to, again, reduce the challenges of managing glucose levels.

But I would agree with Kevin. And the Diamond study is, even though it's not a near-term study, is probably one that we're very focused on. And just given the magnitude of the study, with 20 centers at key sites throughout the US.

That sounds like a very powerful study, and sometimes you have to wait for the right science to happen. So, thanks for working on that one. That probably will help the growth even in those out years continue, hopefully outpacing your 40% goals. And you definitely gave us some good color towards, not quite guidance, but helping us look at the big picture here. There's one more that I was hoping that I could ask you.

Right now, it's great that we're seeing that you're positive on a cash earning basis, even though we're not seeing reported positive earnings. Is that something you're putting much weight on? Or you're right now just trying to keep your foot on the gas, being responsible with your cash, but paying less attention to the reported earnings number because you think that there's more investment that needs to be made before that can be a main focus?

Erica, for a long time, Terry and I have philosophically operated under the principle of let's grow the top line fast, and let's grow the bottom line faster. And we're certainly doing that, as Terry said in his remarks, that the cash operating income was 3X what it was what it was the same quarter a year ago, when we had 60% growth on the top line.

As we look at our business going forward, we think about three things: how much can we add to the top on a revenue basis, and then we get to an acceptable gross profit number? And we ask ourself two questions. How much do we need to spend to continue to push the agenda to keep growing the top line? And how much do we need to keep to meet our commitments to our shareholders? And we evaluate all three of those things at the same time, not just as a management team, but at the Board level and throughout the entire organization.

So, we look at all of them. And we will continue to evaluate our business that way.

I have to laugh, because here we are -- thank you, FASB -- but we carry this non-cash-based equity that prevents us from being GAAP positive. So we've got -- when cash was king, and it still is -- and we like to add to it, rather than take away from it -- but we did, in order to attract the right talent in this Company, we were low on the salary side and we made it up on the equity side. So we gave our employees equity; and, lo and behold, our employees don't really want to sell the shares that they hold, because they look at the upside of what this Company can achieve from shareholder value improvement.

So, the end result of that is this probably $15 million-plus a quarter of share-based equity that we -- non-cash -- that we have to carry forward. So you just do the math, and say, if we want to get to 20% operating number, we've got to do a lot.

Just to cover the non-cash (multiple speakers).

The shares that people aren't selling. And you can't go out and tell your employees, hey, why don't you all go sell shares, in order to get this down? It's just a [sense routine] dynamic. And so yes, we do; we make statements relative to what we think we can do in 2015. But it's really driven, I think, growing top line, again, and by growing the bottom line faster.

That's very helpful. And since you are so close to the number, I don't want us to focus too much on something that actually goes counter towards the goals for the Company. So, thank you so much on that. That was my last question. Thank you.

(Operator Instructions). Jayson Bedford, Raymond James.

I wanted to ask about the marketing effort around the AP algorithm. Clearly, accuracy matters. It's proven to drive adoption. Your current user base will be ecstatic with the upgrade. But I'm just wondering if the software allows you to be more aggressive in going after new patients. And I guess the question really is, do you view it as a new driver of patient growth?

I think it will drive patient growth. When patients hear that we have an algorithm that was designed for the artificial pancreas, that's now been integrated into a commercial device that they can purchase, it will be very, very helpful. It definitely will be a driver. It was our goal to make our patients ecstatic, because that is how we build the business here.

Okay. When you think your sales team and infrastructure -- you've got a lot of new products here. Wondering your thoughts on increasing the team, as we look to 2015.

We're in the middle of our planning process. Certainly, with 60%-plus year-over-year growth for the entire year, we have an opportunity to expand, to grow next year. And we'll give more guidance on that at the end of the year, after we get through our process.

Okay. I guess last one. You mentioned the thinner transmitter has a lower cost of goods. But I'm wondering, were there startup costs that impacted gross margin this quarter associated with that?

No, there were not.

All right, thank you.

And at this time, I'm showing no further questions from the audience.

I would now like to turn the call over to Mr. Terry Gregg for closing remarks.

Thank you. Well, I hope everyone got a good picture of how excited we are about DexCom and the opportunities for our Company. I need you to understand, also, we are setting our sights that this will be a $1 billion revenue company -- not a $300 million, not a $500 million -- a $1 billion plus. And so our employees believe in our mission. We believe that they know the opportunity at DexCom is truly a unique one, and they want to participate in that. And they are clearly aligned with shareholder value.

And so with that, I again will say thank you, and see you in 2015.

And thank you, ladies and gentlemen. This concludes today's conference. Thank you for your participation, and you may now disconnect.