Insulet Corp (PODD) 2009 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Second Quarter 2009 Insulet Corporation Earnings Conference Call. My name is Jeri, and I will be your coordinator today. (Operator Instructions) As a reminder, this conference is being recorded for replay purposes. I would now like to turn the presentation over to Mr. Brian Roberts, Chief Financial Officer of Insulet Corporation. Sir, you may proceed.

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

Before we get started, I would like to remind everyone that our discussion today may include forward-looking statements as defined under the securities laws. There are risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Information concerning the Company's potential risks and uncertainties is highlighted in the Company's press release issued earlier today and in the Risk Factors section of the Company's SEC filings, including the Company's Form 10-K for the year ended December 31, 2008. These risk factors apply to our oral and written comments.

I would also like to remind you that the guidance we are offering today represents a point in time estimate of our future performance. You will find a link to the webcast of this call, as well as to today's press release at www.myomnipod.com in the Investor section. And now I will turn the call over to Duane.

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

For the quarter we reported revenue of $14.6 million, an increase in 97% year-over-year and 17% sequentially.

The easy-to-use OmniPod system continues to deliver on a promise to make diabetes a smaller part of life for our customers.

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

First, let me speak about product innovation. As a leader in tubing-free insulin pump technology, innovation is at the heart of who we are as an organization. At the American Diabetes Association Conference in June, we launched our second generation PDM with improved features such as a sleek new look, colored LCD screen, and enhanced data download capabilities. To date, the launch has exceeded our expectations with over 20% of our customer base taking advantage of the special limited time introductory upgrade price. The new PDM 200 not only provides a better product to our customers, but will also help us improve our margins in 2010 as we expect to see reduced production in warranty costs.

We didn't stop listening to our customers in innovating with the design of our product. We heard their feedback that they wanted a way to reduce the impact of their used Pods on the environment, so last month we announced the first environmentally safe disposable program in the insulin pump industry. The Eco-Pod program will reduce the impact of used Pods on the environment by preventing hazardous waste from unnecessarily entering landfills.

Parts are disassembled and metals are recycled. The program launched this week and we are grateful for the tremendous response we have seen from our customers who are willing to partner with us in taking care of the environment.

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

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

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

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

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

We also see great opportunities to expand the market for OmniPod internationally. In April we announced the OmniPod system had received CE Mark approval, giving us the license required to begin to distribute in Europe and other key diabetes markets.

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

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

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

One example of this has been in the area of patient outreach. In the second quarter we invested in an additional patient outreach capacity as a program to reduce attrition. The early results of the initiative are encouraging. Despite the higher levels of unemployment across the country. Attrition decreased by a full percentage point in Q2 to approximately 11% from 12% Q1. We will continue to look for additional operating efficiencies in the coming quarters while being mindful of not allowing the back office functions to constrain our ability to generate growth.

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

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

Looking ahead, we expect the pipeline of referrals and PDM upgrades to remain strong, resulting in an expectation of $16.5 million to $17.5 million in revenue for the third quarter. This represents 13% to 20% sequential growth from Q2.

Gross profit for the quarter was $3.2 million, or 22%, as compared to a gross loss of $2.4 million, or negative 32% in the second quarter of 2008, a $5.6 million improvement year-over-year.

As Duane noted, we expect that the cost per Pod will fall below $20 in the third quarter, as Flextronics ramps production to meet our anticipated higher levels of demand. In total, we expect third quarter gross margins north of 30%.

As expected, operating expenses of $19.6 million remained relatively flat with last quarter, as efficiency savings in areas such as G&A were offset by higher sampling costs related to release of the PDM 200. Operating expenses for the same quarter of 2008 were $19.8 million, reflecting last year's ramp-up of headcount in the commercial organization.

We are working hard to identify areas where we can gain operating efficiencies across our support functions in order to better utilize those dollars on higher return investments, such as research and development, customer outreach, and product support.

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

Our Q2 operating loss of $16.4 million decreased by $5.7 million, or 26% from the second quarter of last year as a result of the improvement in gross profit. As of June 30, cash and cash equivalents totaled $52.4 million as compared to $56.7 million at December 31, 2008. We used approximately $13 million in cash for operations in the second quarter, down from $15.5 million in Q1.

Total cash burn was $16 million in the quarter, with the remainder related to interest payments. We remain focused on reducing our cash burn as the business continues to grow.

Finally, turning to guidance, as I mentioned, we expect third quarter revenues of $16.5 million to $17.5 million. For the full year 2009, we are tightening our revenue and operating loss expectations. We now expect revenue of $58 million to $65 million for the full year, as compared to our previous estimate of $55 million to $65 million, and an operating loss of $55 million to $60 million as compared to our previous estimate of $50 million to $60 million. With that, let me turn the call back over to Duane.

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

And with that, Operator, please open up the call for questions.

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

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

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

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

The PDM now has been on the market for a couple of months, as Duane mentioned. You know, 20% of the customer base is upgraded. It had some impact in Q2, probably in the neighborhood of about $0.5 million. And then on the other side, for sampling expenses, it was probably about $0.75 million of expense.

Okay. And how long a tail on that PDM opportunity? I mean, do you get 100% of the patients, or what is sort of your forecast as to how long to get to that maximum penetration?

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

Okay. And then talk a little bit, if you would, Duane, about the back office and sort of where you are with reinforcing that versus the ability to automate it. Do you feel like you have come halfway through or more in the process of getting the payers kind of cleanly onboard with handling your patients? Or is there a long way to go there?

To be honest with you, Ben, we are very cautiously optimistic. But we are pretty excited. We made a lot of progress in the last quarter. As we said, we had changed out some of the management there and that group has really taken over. We have added some -- we kind of added some upgrades from the computer side.

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

Good. Good. Well, last quick question. You mentioned you have a CGM going to the FDA by the end of the year. I assume that is with Abbott, or is that DexCom?

Yeah, it's one of those two.

Are you not disclosing or --

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

Okay, thanks.

And your next question comes from the line of Mike Weinstein with JPMorgan. You may proceed..

Oh, hi there. It's Kim in for Mike. How are you?

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

No, we remained at 50 reps for the quarter.

Okay. And so I assume, based on the result that your new patient ads had to have increased during the quarter; is that right?

Without a doubt.

Yes, compared to Q1, absolutely.

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

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

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

Well, I think it is still a little bit to be seen. As we worked through over the coming months here to get a couple of deals signed, I think the plan has been that it will still be a small component of 2010 revenue as a lot of markets -- we have the CE Mark approval in hand, but a lot of markets will still take time to work through their various individual reimbursement channels. So, we will expect to have some revenue impact in 2010, but not a number yet.

Okay. Thanks, guys.

And your next question comes from the line of Jared Holz with Thomas Weisel Partners. Please proceed.

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

Well, let me handle the G&A leverage side and then I will turn it over to Duane to talk about the competitive environment. But from a G&A leverage perspective, I think you are seeing a couple of things. One, we started to achieve some of that in the quarter. As we noted, we were able to cover the PDM -- the additional PDM sampling costs in Q2 for the role out of the PDM 200, as well as launch a customer outreach program, that Duane mentioned, to kind of help combat attrition, and both of those, I think, went very well in the quarter.

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

Anything on competition there?

Yeah. Look, I think that the end of the day, here is the thing I think that you have to put in perspective. We have created this category, this disposable insulin pump. I think we are aware of, I think, last count there are probably a dozen companies out there looking at trying to get into this space, whether it is from a type 2/type 1 combination. So, I think we are uniquely positioned that we understand the space, we understand what it is going to take to compete in this space, and I think we will deal with the competition when they finally arrive.

Look, we're not -- I'm not going to get into the business at tilting of windmills here. When we see we are in every major institution, every large practice in the US, we're knocking on the door. To date we have yet to see a product in those spaces. We think we understand what all the competitors and potential competitors are doing. But right now it is our marketplace and we continue to build our credibility with these practices.

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

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

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

No. I mean, I think we are averaging 19% through the first six months, so I would say it is unlikely that we would be able to average 30% for the full year. For Q3, we are expecting it to be north of 30%, and hopefully we will continue to see some momentum into Q4 in the markets.

Okay. Then just lastly, can you tell us what the -- just the product revenue was in the quarter, because there are another couple of line items, the Abbott payment, and then there is like a lumpiness on the deferred revenue side. Can you just give us a sense of what the product revenue was?

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

Okay. Thanks a lot, guys.

And your next question comes from the line of Bruce Cranna with Leerink Swan. You may proceed.

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

Sure. We are probably -- it is a little unique and here is the one place I will tell you that the economy is impacting some of this. We had a significant number of referrals. We probably converted in the mid-60% range. Typically we have been running about 70%. We have had a lot of people that want to get that co-pay knocked out of the way. A lot of them have $500 co-pay, $300 co-pay. So, they put in the information, they are in the queue here. There will probably be a fourth quarter event for a lot of these people. So, the good news is, even with that conversion rate, I would tell you a lot of the people are just -- they wanted to get in the queue. We had some of these people with the Cozmo that wanted to get in the queue before the offer expired, but they want to get their insurance straightened out here.

So, I think the economy is impacting people in that paying $300, $400, $500 of co-pay out-of-pocket all at once is not what they want to do. They want to pay a little bit at a time. So, I think that is where it was. I think for the quarter we are in the mid-60 percentile range. Typically, we have been running closer to 70%. But the good news is, that delta is not going away. That is more patients wanting to get in the queue, get in line for the product. And then really kind of take care of their piece of the financial puzzle here.

Okay. So, many a little bit of slip on the, I guess, percent.

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

Now, some of those people, if you remember how the insurance works, you come up for renewal every four years. On some of the managed care companies, we know Smith is going out of business, so we won't pay for the -- we won't pay for the handheld, but we will pay on an ongoing basis. So, we are working through a lot of stuff with a lot of people.

Like I said, the good news is the slip really has more to do, I think, a little bit with the economy and what's going on out there and how people want to manage their money, as opposed to the back office. I would tell you, most quarters it would have been the back office is absolutely not. I think we are making real good progress there. It can get better, but I think we are making real good progress there.

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

Well, the interesting thing, you know, kind of reset the bar for everyone. What we said is about half the people drop off the first 90 days, and then the other half kind of drop off over time. The ones that drop off beyond that first 90 days are typically because they lose their job, they lose the insurance coverage, for the vast majority of those.

So, the upfront piece, what we did is we started making some outbound phone calls. We started calling people in conjunction with their being trained, and we knocked that down a full point in the quarter. So, one quarter does not make a trend, but we think we have a means even in this economy, to get people comfortable with the product early on. So, that piece we are really attacking.

At the end of the day, if people are unemployed or the COBRA runs out, there is not a lot I'm going to be able to do about that. But that piece upfront, getting people comfortable with, like I said, we dropped it a full point. We went from 12% to 11% in the quarter. So, in all of that was really in the upfront piece.

Right. That's the number I was after. Thank you. And then, Brian, just, again, I heard your color on G&A. I'm just looking at my model. Can you kind of remind us why -- I understand there is leverage in the business model, but why on a whole dollar basis is that down sequentially?

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

No, G&A specifically.

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

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

Okay. I mean, that type of number is somewhat reasonable going forward, or at least in the percent of sales to think about?

Yes, I think somewhat reasonable going forward.

Okay. And then last one for me. Duane, I'm sorry, you were kind of going fast and I missed what you said about Ferring in terms of timing. Can you run that by us again, what they are filing and the timing there?

Sure. If you remember, we assigned the deal a while ago for fertility drug in conjunction with Ferring. We should receive CE Mark approval for this now. If you saw the two handhelds, while the Pod is the same, the actual handheld is completely different than anything we make for diabetes. It's kind of icon driven. It is really kind of innovative.

So, we created this new handheld. We needed to see approval for that. We found out last week that within the next 30 days we believe we will get -- until it's done, it is not done, but we think that within the next 30 or 45 days we will get approval, and that will allow Ferring to start marketing the product.

So, we will start seeing -- you know, nothing material, but we will start seeing some revenue -- a little bit of revenue here in the fourth quarter, and then it will start picking up next year. But it's a non-diabetes application that we've gone from kind of concept working with a pharmaceutical company to the actual delivery of the product.

So, we are pretty excited that we think we've learned a lot in this process working with Ferring. They have been a terrific partner and we are excited about the potential opportunities.

At this juncture we are just talking. We are envisioning EU-only introduction to this drug and device.

Yes. The drug that Ferring is going to run through this product currently exists, so it's not -- we don't need drug approval. But the actual -- the approval of the handheld in conjunction with the drug is what is being done.

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

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

Having said that, we are doing some studies with various drugs and they are healthy patient studies. And the if that goes well, they move on to other things. So, it's a completely different time frame. I don't see anything material happening here in the short run. If we see any of that, obviously, we will give everyone an update.

I understand. I am just trying to figure out philosophically if this is you selling them empty product or some sort of --

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

Got it. Thank you.

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

Hi. Thank you. Duane, you addressed competition, but can you specifically talk about Medtronic's (inaudible) pump. You know, they unveiled it last month. Based on what you have heard about the features, can you just talk about their product and some of the -- you know, relative to your current and next generation Pod?

Mimi, I probably saw what you saw. I saw it on CNN, or maybe you got to see the live plastic block. I think our stance has been pretty simple. When we see it in the marketplace, we will deal with it. Here is our belief, though. I will reiterate it to everyone on this call and I think we are spot on. What we have had the opportunity on multiple occasions in designing of this product to come up with multiple piece and part Pods, all kinds of different things. There is nothing unique that we have seen out in the marketplace that we haven't looked at at one point in time or the other.

I think the key to success, keeping in mind that we are growing the market. We are not trading off with existing pumps. I think the key to success in this space is ease of use. No one, I believe, will have an easier product to use than ours.

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

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

Okay. So, it sounds like some of the features they have, like being able to (inaudible) the Pod or remove the Pod, the ease of use you think is going to prevail?

Yes. Mimi, if you think all of those -- and we can take this offline -- but if you think of all those features, there is a lot of complications associated with a lot of those feature sets. There are a lot of complications associated with pieces and parts that are assembled and you take apart and then you put back together again. And the watertight nature of that product. There is a lot going on. And, like I said, you know what? I would not under-estimate them for a minute.

But having said it, we have had that opportunity. We have had that opportunity when we first came out with the product, we had that opportunity again when we were developing our next generation product. We went back into the marketplace, we listened, we looked, we observed, we understand where our customers come. They are people that walked away from pumping from the beginning, right? We are growing the market. People are coming to our product because we are making diabetes a smaller part of their life. There are less things they have to be able to do. They have to be able to read and they have to be able to take a syringe out and put some insulin in the product, and after that it takes over. And we think ultimately, long-term, that's the right solution.

okay. And then for your guidance for next quarter, does that take into account, I guess, what typically is a slow season, a slow August for the summer?

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

Okay. And then last, I wasn't sure if you said, how does the magnitude of the EcoPod program did you -- is there like a set cost that you expect for the year from that?

To be honest with you, Mimi, this will be cash neutral to us. It will not impact the P&L in any way, shape or form. It is an outside firm that is doing the recycling. Our patients have signed up for postage on a quarterly basis. I think it works out about $3 a month for them to send it back. And based on the precious metals and the metals that are in the actual Pod itself, it all pretty much pays for itself.

Okay, thank you.

And your next question comes from the line of Hamad Dorsen with DWS Financial. Please proceed.

Hi. This is actually [Vaheath] calling in for Hamad. A couple of questions. With regards to your -- what kind of progress are you seeing there and what operating costs are being associated with the expansion in Europe?

To date, not a lot. I mean, as I think as everyone is aware, my predecessor, Carsten Boess, is heading up all of our international operations and has really been the person driving -- he is spending a lot of time abroad, across both Europe and Asia, and identifying partners and putting in all of that legwork necessary. So, he deserves a tremendous amount of credit for the work uncovered so far. And then internally working through what we think the ultimate best strategy is for us as the work that we are doing.

Our goal with the international expansion, as we have discussed previously, is to effectively make it as close to a turnkey as possible for us, where we have gone in direct and we don't have to build the level of infrastructure internationally that we have here in the US.

Okay. Do you have a timeline before Pod is available in Europe?

I think from our standpoint, right now we are talking several potential partners about that, so my guess is we will start seeing product in Europe probably by the time they get reimbursement approval. If we can get something done here before the end of the year with a couple of these players, the it will probably be maybe a little bit in the first half. But it will really probably start upticking in the back half of 2010, is really when we think we will see the first significant uptick in business.

And with regards to your new customer, new users, what was their mix?

It is still running about -- it is roughly about -- it is roughly still about 70%, it's the first time they have ever been on a pump or a Pod.

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

Well, I am assuming every day that goes by these guys are getting closer and closer. At the end of the day, once again, I feel very good about where we are. I think we have created this space. I think we understand all the inherent problems that come with a disposable product. So, we are ready. When these guys are in the marketplace, we are willing to compete. Until then, like I said, I am not going to spend a lot of time tilting at windmills.

Okay, thank you.

Thanks.

And your next question comes from the line of Bill Plovanic with Canaccord Adams. Please proceed.

Great, thank you. Good evening. Just a couple of questions for you here. First, how much of an impact do you think UNH policy change at the beginning of the year has had on your business?

We are going to have to get that offline. I don't know how much of the United piece is that. I mean, without a doubt it has helped. I'm not arguing that even for a minute, but off the top of my head, I don't know, Bill. I don't know if you know, Brian?

I mean, United is obviously a relatively large healthcare plan, so it certainly has a positive impact for us. But we really don't look at it on a plan-by-plan basis that way.

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

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

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

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

So, then, was manufacturing already shut down, then?

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

Okay. So, did -- I guess, did Flex provide you with some concessions that you are not negatively impacting for gross margins? Because your volume production per month had to drop for you to burn inventory. So, I am just trying to understand how this all works.

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

Okay. And just looking at the Ferring deal, will Ferring, do they pay you a milestone upon approval, or did they buy Pods from you upon approval? How does that work?

What will happen is they will be buying -- we have manufactured this kind of unique PDM for them, so they will buying that and they will be buying Pods, and there is minimum quantity guarantees as it goes forward.

Like I said, I think we said at the time it was a great opportunity to stick our toe in the water with a major pharmaceutical company. I don't think, obviously, this year it is not going to be material to anything. Even next year it may not, but it will be -- it will be -- it was a great learning experience. It helped us kind of come up with an icon-based PDM. So, we think we can leverage that and all kinds of other businesses. And we think on a go-forward basis it will be a steady piece of revenue for us.

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

There is none of that in those numbers that you see.

Okay. And then how much does a customer pay for an upgrade? What's the deal right now?

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

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

I think, Bill, I think if we're talking maybe 50 going to 60, maybe that's it, but we're not doubling the sales force. I think what we found is what we're very, very excited about, is there was a little bit of culling out in the sales force. We think we've got some very, very good people. We have some unbelievable clinical specialists working hand-in-hand with that group. So, we haven't seen the top end of the productivity yet, so I am not sure what the right number will be eventually, but it is not a material increase in what we have here.

And does the approval that you are looking for through the combination device, just remind us again, is that a PMA or a 510(k) with CGM?

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

Okay. And just a modeling question. D&A in '09 and '10 and stock comp on '09 and '10?

Hang on a second. I will get those numbers for you.

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

You know, 100% means that there is never going to be another issue, so I will leave that one on the table. We have made huge progress, and I will leave it at that. I do not think it will be -- our gut reaction to everything we have seen, we made very, very large strides in the quarter. 100%, Bill, I think 10 years from now we won't be 100% through that. I think that is just the nature of how the whole managed care works. But we made significant progress from where we were in the first quarter.

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

And then a big increase for 2010, or roughly the same, or --

Probably be, I would say some increase as a percentage of sales, but nothing material.

Great. That's all I have. Thank you. Good quarter, and we will see you next week.

And your next question comes from the line of Suraj Kallia with SMH Capital You may proceed.

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

Suraj, this is Brian. Really no price increases, I'd say, to kind of talk about. As you know, the managed care process to push through pricing increases is long and lengthy. So, we are seeing a little bit of an uptick due to the PDM upgrades that we are receiving back from payers directly. So, again, probably $0.5 million or so that we talked about in Q2. But really nothing else coming from pricing, and the rest of it is going to come from just the sale of normal product. Clearly, by us being able to right size our inventory a little bit more, in Q2 that is going to allow us to continue to push through lower cost Pods into the P&L in Q3.

As we talked about in Q3, we think Pods will be produced under $20, and that is certainly one of the drivers for why we think very confidently that the margin will hit 30% in the third quarter.

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

I think, Suraj, I think the interesting thing for us is -- kind of take a quick step back. We basically had a full sales force in effect. I think we had them all onboard April last year. So, we have had about four quarters under our belt. I think every quarter the productivity per rep has continued to increase once we have had this group in place. And we had another step-up in Q2.

We are pretty excited about how the month if July looks here. Usually, the summer kind of slows down, but -- and then it starts picking up in September. But July looked very, very good. The first couple of days of August look very good. So, we are pretty excited about that.

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

So, I think the interesting thing for us is, for the most part, we have seen improvement across-the-board, and the exciting part for us is, if you think about trying to improve the whole productivity and entire sales force, it is not necessarily the top 10 guys getting better; it is the bottom 10 guys moving up. And that has really been -- you know, with the kind of management we have in place now, there has been a very, very concerted effort to put in the support structure for a lot of these guys that were struggling a little bit. And we think we are making real progress.

Like I said, the top sales guys are the top sales guys, but the real trick for this is to bring the lowest performing guy up. If you make him the top sales guy, then you have beyond the home run.

And this might be not a major question, Duane, but the concept of EcoPod and recycling, are the costs high for recycling and, if so, who is bearing the cost?

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

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

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

Oh, yes. I mean, without a doubt.

Yes.

Gentlemen, congrats. Thanks.

And your next question comes from the line of Derek Leckow with Barrington Research. Please proceed.

Thank you. Good afternoon. Question on the European expansion and ultimately the Asian expansion here. You said that we shouldn't expect any structural operating costs ahead of that launch, but what about marketing expenses; should we anticipate some ramp-up in those kind of costs ahead of the revenue?

I think the way to look at this, we are dealing with -- one of the criteria that Carsten had when he went out there and started talking to these companies, they had to have the infrastructure to basically handle all the marketing materials. And the piece that we are dealing with, for instance, if we are going to go into Germany, then we are creating the German interface on the PDM. But the marketing materials, the user guide would all be done by whoever our partner is there.

So, you know, to give you some sense, I think it is about, from a software standpoint, it is probably about $25,000 to turn an English -- you know, don't hold me to the exact number -- but roughly to turn an English PDM maybe into a German PDM. So, we are responsible for the stuff related to the product. It is all part of negotiation.

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

So, that might be. But there is not -- our goal is quite simply to make Pods, provide all the marketing material, have it all being converted by whatever -- to whatever language is necessary. Have that company carry the day for reimbursement, and then we will take on whatever regulatory responsibility we have to have. So, our real plan here is not to put a huge infrastructure in here to support that. Absolutely not.

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

Yes. The way it works is, it is one thing to have CE Mark in Europe, it's a whole other thing to get reimbursed. So, it is not -- in that regard it is not all that different than US. So, for instance, in Germany there are five states that you have to go in, do a submission, provide clinical data, and then they approve it. So, I think regulatory pool is probably not the right word. In order to ensure that you get reimbursed, that process is going to take a little bit of time, and it is different for every single country. For instance, if you go into China, it is probably about 12 months from the day you start to the day you can get paid in China. So, it is different country-to-country.

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

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

Based on what we have done is, we have gone out to all these -- you know, all the people we are talking to, and we have minimums that people feel comfortable that they would be willing to guarantee. We kind of have a midpoint and then we have a top end. So, based on those various ranges, we believe that we are in good shape for 2010. That the current operation in China can handle that fine.

Handle that, okay, great. Thanks a lot. Appreciate it.

Thanks.

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

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

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