Insulet Corp (PODD) 2013 Q2 法說會逐字稿

Good afternoon. My name is Sharon. I will be your conference operator today.

At this time, I would like to welcome everyone to the Q2 2013 Insulet Corp earnings conference call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer session.

(Operator Instructions)

Mr. Brian Roberts, Chief Financial Officer, you may begin your conference.

Thank you. Good afternoon, everyone. Thank you for joining us for our second quarter 2013 conference call. I'm 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. We intend these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in Section 27A of the Securities Act, section 21E of the Securities Exchange Act and are making the statements for purposes of complying with those Safe Harbor provisions. These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies and prospects, which are based on the information currently available to us and on assumptions we have made.

There are risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Information concerning the Company's potential risks and uncertainties is highlighted in the Company's press release issued earlier today. And in the Risk Factors section of the Company's SEC filings, including the Company's annual report on form 10-K for the year ended December 31, 2012. These risk factors apply to our oral and written comments.

We assume no obligation to update publicly any forward-looking statements, whether as a result of new information, future events or otherwise. I 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 today's press release, at 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 today.

This was an outstanding quarter for Insulet with demand for the new OmniPod exceeding our expectations with a greater than 50% year-over-year increase and more than a 40% increase from the first quarter of 2013. We shipped a record-setting level of initial orders of the OmniPod in the second quarter. This robust demand drove strong financial results. Quarterly revenue surpassed $60 million for the first time and we generated positive quarterly cash flow for the first time in Insulet's history.

Enthusiasm for the new OmniPod has been strong as the simplicity of the OmniPod's smaller design, coupled with the updated insulin onboard methodology, is appealing to both customers and healthcare professionals alike. We commenced transition of our existing customer base to the new OmniPod in June and expect the vast majority of customers to be transitioned by the end of the third quarter. As anticipated, the launch of the new OmniPod has also provided our commercial team with an opportunity to engage healthcare professionals on different levels, either by deepening our relationship with current supporters or broadening our reach to additional potential prescribers.

While we are still in the early days of the launch we are exceedingly pleased with the progress to date. Let me share a couple of examples with you. You may recall that last quarter I spoke about a significant practice in the northeast region that averaged one shipment per month in 2012. However, since the launch of the new OmniPod we have added nearly 50 patients from that one practice alone.

In another instance a nurse practitioner at a pediatric clinic in the mid-Atlantic noted that all of the pump starts prescribed so far this summer were OmniPods. She further stated that she expects all further pump placements this summer will be on our OmniPod. We also learned this clinic is particularly pleased with the combination of the smaller size and the change to the insulin onboard methodology.

Finally, a clinic in the central region announced back in early 2012 their intention to only offer one brand of pumps to the patients--a tubed pump. With the new OmniPod in hand one of our territory managers embarked on an aggressive plan to demonstrate its key benefits to doctors and clinical diabetes educators at the practice. The result is that not only are one of the doctors and educators at the practice now wearing the new OmniPod, but they are actively recommending the product. As a result, having these critical influences on board, we have seen 19 new shipments over the last few months from the same clinic.

These are just three of the many other examples of the early success of the new OmniPod. In fact, since the launch late February, nearly 20% of our initial shipments were generated by new practices, which we define as an office or clinic that has not prescribed an OmniPod in 2012. Even more impressive, when we look at our existing practices, over 15% of them have seen 100% or greater increase in initial shipments as compared to the prior year.

The excitement around the new OmniPod is growing outside the United States too. Ypsomed, our partner in Europe, has seen a nearly 50% increase in patient base -- in its patient base since the end of December as they continue to take significant share in key European markets. We are pleased Ypsomed's progress and continue to work closely together to broaden OmniPod's reach in additional European markets such as France and Italy.

It is not only our new customers that are excited about the next-generation OmniPod. As planned, we began the conversion of our existing customer base to the smaller product in June and are aggressively working to transition the majority of them to the new product by the end of September. We are pleased to report that with approximately 40% of the customer base now transitioned, we are on track to achieve that goal.

That being said, the timing of this transition did have some impact on our revenues this quarter. As expected reorder customers either planned to use up remaining supplies or ordered one box of pods at a time, thereby postponing reorder dates in anticipation of the new pod. We expect similar disruption in the third quarter as we continue to transition customers and manage payer cycles. We expect reorder utilization rates to normalize back to our more predictable reorder patterns with the transition complete in the fourth quarter.

Supporting our high levels of demand and rapid growth has been the outstanding work of our operations team and partnership with Flextronics and our suppliers. With early demand for the product exceeding our initial expectations, the manufacturing team has been working nonstop to meet our supply requirements. We are currently running two full manufacturing lines with an output of more than 20,000 OmniPods per day. In July, we produced nearly 500,000 OmniPods and we expect that number to increase to approximately 600,000 per month in August and September.

Ramping in the manufacturing lines is not an easy task. As we accelerated production, we have had to overcome some minor hiccups over the last few months. Some of these normal cost challenges have been resolved within a matter of hours. Yet with inventory levels low, the team remains keenly focused on assuring that we are producing at a rate to satisfy our growing demand.

Our third manufacturing line remains on track to be qualified and operational in the next couple of months. The third line will boost our overall capacity to approximately 1 million pods per month, allowing us ample supply for additional demand and to start building inventory in the fourth quarter.

While the priority of our engineering team is currently the production of the new OmniPod, we are also investing in innovative future products that we believe to be unique in the diabetes marketplace. At the American Diabetes Association annual conference held this past June in Chicago, we noted that much discussion was focused on three key topics--the type two diabetes population, concentrated insulin and the role continuous glucose monitoring. We believe we are well positioned in each of these areas to realize commercial success.

As we noted last quarter we have recently entered into a partnership with Eli Lilly and Company to create a version of the OmniPod which will be specifically designed to deliver Humulin U-500 insulin, a concentrated form of insulin used primarily by people with highly insulin-resistant type two diabetes. The potential market is large with more than 20 million people living with type two diabetes in the US. Of this population we estimate that up to 10% could potentially benefit from an insulin pump that delivers Humulin U-500 insulin.

We believe that the powerful combination of a product as simple as the OmniPod along with its ability to deliver U-500 addresses the needs of patients and doctors alike. For the patient, the easy-to-use system can improve adherence to therapy. For the doctor, it is a new tool to help patients manage their diabetes and improve outcomes. The project has officially launched and development is underway.

In regards to continuous glucose monitoring, we continue to make steady progress in development of the CGM-enabled OmniPod. With simplicity and easy use being so important to a person living with diabetes, we continue to believe we are uniquely positioned in ultimately being able to provide the customer with a one OmniPod on the body solution that includes a CGM sensor. By leveraging the components already contained in the OmniPod, we believe that we can develop a cost-effective solution that will increase utilization by customers as they no longer need to wear two separate devices. Much of our work today and for the remainder of 2013 will focus on the sterilization process as well as efforts associated with the insertion system for the delivery of insulin and the sensor.

We are also very active in developing several projects that use OmniPod outside of diabetes. Our partner, Ferring Pharmaceuticals, continues to cite excellent results with the delivery of its fertility drug [Leutralef] with the OmniPod. Ferring is currently working on its documentation package including clinical data for an FDA submission later this year.

In the oncology space we are also making steady progress with a large pharmaceutical partner. Clinical work is proceeding and they expect to be in a position to file this fall with an anticipated approval in 2014.

In addition, several smaller earlier stage projects have launched that we hope will continue to fill the pipeline in future years. Although our primary focus is in the diabetes space we do expect to remain active in these other delivery opportunities where the OmniPod as a technology platform can make a difference in lives of people living with other medical conditions.

It is clear that we are making great strides in business both commercially and operationally. Just as important we also making tremendous progress financially. In addition to our third consecutive quarter of operating cash profitability, for the first time in Company history we generated positive cash flow. Our cash balance on the end of June 30 improve to approximately $151 million from $148 million as of the end of March. While many factors influence cash utilization in a given quarter, we are proud of this accomplishment as we continue to drive towards operating profitability by year end.

As we look to the second half of 2013, I'm encouraged by the outlook for the remainder of the year. The response to the new OmniPod has exceeded our early expectations and we believe this momentum will continue throughout the third and fourth quarters. The new OmniPod is resonating in the marketplace and driving demand especially in key demographics such as children and women.

Since its launch, new shipments of the OmniPod to people age 18 and under have increased by more than 60%. Shipments to women have increased by nearly 50%. We look forward to completing the transition of our customer base to the new OmniPod and the addition of the third manufacturing line. We will continue to make progress across our various R&D efforts, including the Lilly partnership, our oncology partnership and with the integrated CGM-enabled OmniPod.

Financially we expect to see revenues continue to increase despite, as we have discussed on prior calls, the headwind from CMS competitive bidding program, which went into effect on July 1. As a reminder, CMS enacted an approximate 70% rate cut to certain diabetes supplies including blood glucose testing supplies to Medicare patients.

At this point, we are no longer providing Medicare patients with testing supplies through Neighborhood Diabetes. This results in about a $5 million per quarter revenue impact. We have taken the steps necessary to appropriately transition these patients as well as to mitigate the cost impact. This includes the re-negotiation of several relationships with blood glucose test strip suppliers and right sizing certain headcount to meet ongoing needs. We expect to remain cash-operating profitable in the back half of the year and expect to achieve operating profitability by year end.

With that, let me turn the call over to Brian.

Thanks, Duane. Consolidated revenue increased by 18% to $60.1 million in the second quarter of 2013 compared to $51 million in the second quarter of 2012. OmniPod revenue improve by nearly 25% as compared to Q2 2012.

Revenue was positively impacted by higher than anticipated initial shipments which increased by more than 50% year-over-year and more than 40% sequentially from Q1. However, this was offset as expected by a decrease in reorder utilization as customers delayed orders in anticipation of the transition to the new OmniPod. We commenced conversion of the customer base in June and we believe that we are on track to have the base predominantly converted by the end of September. Some reorder disruption has continued into the third quarter as we work with customers to convert them to the new OmniPod. With the transition effectively complete we anticipate returning to normal utilization levels in the fourth quarter.

Consolidated revenue for the first six months of 2013 was $117.4 million compared to $98.8 million for the first six months of 2012, an increase of approximately 19% year-over-year. Gross profit grew by 20% for the second quarter to $26.8 million as compared to gross profit of $22.3 million in the second quarter of last year. Gross margin increased slightly in the second quarter to 45% as production of the new OmniPod started to ramp.

With a significant portion of our customer base expected to transition in the third quarter, we anticipate margins to remain relatively unchanged for Q3 and improve towards 50% in Q4. By early 2014, we believe that the new OmniPod will drive US gross margins in the low to mid 60s, translating to a consolidated gross margin north of 50%. Gross profit for the first six months of 2013 was $52 million, an increase of $9.4 million or 22% as compared to $42.6 million in the first six months of last year.

We continue to gain significant leverage in the business through prudent management of our operating expenses. Operating expenses of $32.7 million in the second quarter were down slightly from the second quarter of 2012 although revenue increased by nearly 20%. Operating expenses increased by $1.3 million from the first quarter due to timing of spend on research and development activities, legal expenses and higher than planned stock-based compensation. Operating expenses should remain around $33 million per quarter for the back half of 2013.

Operating expenses were $64 million for the first six months of both 2013 and 2012. Our operating loss for the quarter declined by 45% to $5.8 million as compared to $10.5 million in the second quarter of 2012. We were also profitable on an adjusted EBITDA basis for the third quarter in a row.

Interest and other expenses, $4.6 million in the second quarter of 2013 compared to $3.9 million in the second quarter of 2012. Of the $4.6 million net interest and other expense this quarter, approximately $3.2 million was non-cash. In the quarter, we retired the remaining $15 million of our 5.375% convertible notes which matured in June. We paid consideration of approximately $2.3 million in cash and about 640,000 shares of common stock to retire the convertible debt.

As part of the transaction we recorded a one-time non-cash charge of approximately $300,000 as a loss on extinguishment of debt and included it in interest and other expense. Net interest and other expense was $8.9 million for the first six months of 2013 compared to $7.7 million for the same period in 2012.

Finally, we reported a net loss for the second quarter of 2013 of $10.5 million or $0.20 per share compared to net loss of $14.5 million or $0.30 per share for the second quarter of last year. Net loss for the first six months of 2013 was $21.2 million or $0.40 per share compared to $29.3 million or $0.61 per share for the first six months of 2012.

We are pleased that for the first time in Company history we generated positive cash flow as our cash and cash equivalents balance increased to approximately $151 million as of June 30 compared to approximately $148 million as of March 31. As of June 30, we had approximately 54.3 million common shares outstanding. As Duane noted we remain excited about our prospects for the second half of 2013. Momentum for the new OmniPod has continued to accelerate as evidenced by the more than 50% growth in year-over-year shipments both here in the US and in Europe.

The conversion of the base is in full swing and we expect that the majority of the transition to be complete by the end of September. As Duane mentioned, effective July 1 the CMS competitive bid program too effect for certain diabetes supplies such as blood glucose test strips. As a result Neighborhood Diabetes is no longer serving Medicare patients with these supplies. As we discussed last March this will reduce Neighborhood Diabetes revenue by approximately $5 million per quarter in Q3 and Q4. With these factors taken into consideration we have tightened our full-year 2013 revenue expectations to be in the range of $242 million to $252 million.

For the third quarter we expect revenue of $60 million to $64 million as OmniPod growth offsets the Neighborhood decline. With that, let me turn the call back over to Duane.

Thanks, Brian. Our innovative product is discrete and reliable, characteristics that make it an attractive option for potential customers including those who have never considered pumping before. We continue to see approximately 70% to 75% of our new customers be first-time pumpers. The OmniPod remains the product of choice for those people living with diabetes who want freedom, discretion and ease-of-use of tubing-free pump therapy.

We are very pleased with the tremendous and growing excitement for the new OmniPod. With the enthusiasm from both new and existing customers and the dedication of our team, we are well positioned to further penetrate the insulin pump market. We are confident that our commercial teams will continue strengthening existing relationships and opening doors with new practices and customers and are excited for the second half of 2013.

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

(Operator Instructions).

Kim Gailun with JPMorgan.

Good afternoon.

Hi, Kim.

Hey there. A couple of questions. The first is just as you think about converting your base over. It sounds like no real change for the plans to have that done by the end of September. But it sounds like maybe you're expecting a little bit more reorder disruption than you might have previously thought in the third quarter. Is that the right way to interpret what you're saying?

Yes, Kim, that's absolutely correct. At this point basically everybody who reorders in the third quarter is moving to the new pod. For sure we'll have some stragglers in the fourth quarter and that's the predominantly and majority and all of those kinds of words. But basically everybody will be moved over by the end of September.

We did continue to see some reorder disruption in July. It is a combination of a couple of things. One is, as demand has been extremely high, our ability to make sure that we are getting the product to that customer at the time of their reorder.

We have seen a lot of customers who had been holding off for a few months all come in effectively in one fell swoop. And really we have to work through a lot of those managed care payers to make sure that we can get them in the right cycle. So in certain cases we have a customer who is ready but because of managed care requirements, we may have to delay that slightly and -- or change the quantity that we are providing them. Those are some of the disruptions at this point we are just continuing to work our way through. It will have some impact really here in the first half of this quarter, and then it should be over and we should be normalized as we look into September and beyond.

Okay. So you are seeing what you saw in terms of the reorder disruption in July hasn't really dissipated yet? You're still seeing it here into the first week of August?

That's correct. It's starting to dissipate, but a lot of it is really driven around managed care cycles and really when we're able to reorder a customer. And in certain cases where a customer may have taken one box or a couple of boxes in the second quarter, it has disrupted the timing of their reorder cycle such that we can't get to them right away.

Okay. Makes sense. Got it. The other one was on Neighborhood Diabetes. Could you just let us know what was Neighborhood in the quarter, because I'm just trying to get a sense of -- we certainly had already modeled that $5 million step down. But I want to make sure we know what level we are stepping down off of from --?

Yes, we saw a little bit of that start, I think, as planned in the second quarter as well as some customers started to move away in the latter half of the quarter,, especially. They were around $12 million in Q2 and then were dropping off from there.

Okay. Great. Thank you.

Danielle Antalffy with the Leerink Swan.

Hey, guys. Good afternoon. Can you hear me okay?

We can. How are you, Danielle?

Good. Thanks so much. Duane and Brian, on the last call you guys gave some good commentary around new prescribers. Could you provide some -- an updated commentary in the second quarter as to new prescribers, new accounts that the next-gen pod has allowed you to get into?

Yes. Sure. This is Brian. I will start and then Duane can jump in as well. One of the interesting things as we just run some analytics and look at the amount of initial shipments coming has been the number of new practices that have been opening up. I think what we are really excited about it is really across the board. So some of it is within -- I think as we have talked about before, the commercial team has done a really nice job of trying to segment out what I would call their top 60 or so accounts in a given territory. And then there is this bucket of everybody else. Within that top 60 accounts, it is not that all 60 of those were prescribing the OmniPod, it was that the accounts within the territory that we wanted to be prescribing the OmniPod. And I think what is really exciting about it is we are seeing across the board doctors from all of those different levels now coming aboard -- onboard and prescribing.

So at the end of the first quarter about one out of ten of our shipments were from these new prescribers. But it was pretty early days. Now that we've had three more months of the commercial team being able to get in front of these doctors, ask for a couple of patients and be able to try and sample the product, if you will, we've seen that move almost to one in five. That is a really great trend for us, especially when you combine it with fact that our existing prescriber base, those relationships seem to be deepening, and we are seeing a lot of incremental sales from them, as well.

So two things, right. One, as we mentioned in the script about 15% of those doctors have seen a doubling to date of their number of shipments, as well as one of the examples Duane pointed out, literally one practice that would've done in the first six months of last year maybe four or five shipments has done I think it is 48 or 49 shipments through July.

Okay. That's great. Thanks so much. As far as the gross margin expansion goes, obviously very much contingent on transitioning that existing customer base. We're about two months in now. Obviously you guys are feel good about end of September having it fully transitioned. My question is, what's sensitivity of the gross margin to, say, if that slips by a month or two, what does that mean for the gross margin ramp?

Good question. One of the things that is very unique about this whole upgrade, obviously, is that we're effectively trying to do this for free. And so it has created some challenges around exactly trying to time the demand to when we are converting the patient or where we have them planned to convert. It's certainly -- we are certainly in the period right now where everybody wants to get there as fast as we can. Hopefully, we won't see any slippage in the transition. I think we're going to basically be done by the end of September.

I don't think we're going to have a choice. At this point we really don't have any of the older pod inventory on hand. So we are really at this point all AROs. It is just a matter of getting through all of those calls and making sure that we've touched base with everybody. So I wouldn't be too worried about it. I think what we are seeing in the quarter is just as the production continues to ramp up and we get that much more experience under our belt, it's stabilizing that much more and we're able to reduce scrap and increase yields. And those are the piece that will drive a little bit of incremental margin one way or the other in the fourth quarter. I think we feel very comfortable that as we get into Q4 we'll see that benefit start coming through and we should be basically at or pretty close to 50% for Q4.

Okay. Awesome. Thanks so much, guys.

Ben Andrew with William Blair.

Hi. Good afternoon. Duane, maybe talk a little bit more about some of the clinics that have really stepped up their performance with the pod. You gave some good details earlier in the call. What other sort of things have you heard in terms of people's use of the product across broader groups of patients that can help us get a sense of patient growth from here?

Okay. I think, Ben, the most telling statistics are as Brian just described. We are -- about 20 -- one in five customers now are coming from clinics that we had no business with in 2012. I think our growth in the pediatric side of the business, and my definition of pediatric is 18 and under, is being very -- is very, very rapid. I think all of those prospects, like I said, for us, we are very excited about. I think the one thing we are butting our head into, as Brian pointed out, is because we're doing the transition for free, everybody wants the new product now. We -- they want to jump their reorder cycle. They want to -- so we are -- right now we are basically going hand to mouth in terms of production.

The other thing to give everyone on the call some sense, we are producing over 20,000 pods a day, which is more of the new product that we ever produced of the old product in any given day. We have come up the learning curve very, very fast. We've got to get to that next lineup and go and start building some inventory. But like I said, for us, I think the best thing for the customer for our Business was to, obviously, do this transition for free. But it hasn't been without some logistical hiccups here in terms of chasing -- the customers just trying to jump their reorder cycle and they want the product -- everybody wants it now because it doesn't cost them anything.

The demand is there from all over. It is particularly strong, like I said, and a lot of these pediatric clinics who really wanted us to clean up that insulin onboard calculation from the old product. I won't bore you with the details of that even, though we thought we had it pretty good. But it really is, like I said, I would say, under 18 and the female side of the population, the smaller size and that IOB calculation is really driving that business.

All right. Okay. And then, Brian, given the supply -- I'm sorry, the disruption in Q2 in terms of reorder and then into Q3, can we actually see patient growth accelerate in Q4 and then into 2014 as that constraint on supply comes off?

I certainly don't think it's constrained upon supply, especially as we get into Q4. I think Charlie and the team feel very confident that we are on schedule with the third line. That third line then gives us really the -- that ample cushion that we need if you will around capacity. It gets us closer. We need to ramp it up, obviously but it gets us up to that million pod per month capacity.

I think that the nice thing about this is, as Duane just pointed out, it is the expansion of the prescriber base. And it's sustaining and it grew in the second quarter as compared to the first. So what we are starting to see, and again it's early, but what you're starting to see is those doctors who ordered for the first time in March have repeat business, right. They are having new patients come on in May and in June as those first customers are reporting back to them and saying, hey, this is great and we are doing super with it.

From that perspective, I think we look at this as there's a huge opportunity for us to continue to accelerate. That said, I'm sure Q1 will still have the same seasonal aspects Q1 always has. But certainly here as we go through the third quarter and into the fourth, I think people are feeling pretty excited about the prospects.

Okay. Not to give 2014 guidance but there's no reason if, again, the supply is ample that you guys couldn't see some at least steady if not even accelerated patient growth next year?

Correct.

Okay. Finally on CGM, you talked about a couple of development things that you are working in terms of the inserter, etcetera. When do we get a chance to see some data on the sensor and/or maybe some human clinical work with the product?

The timing of that will probably be sometime middle to back half of next year.

Okay. Great. Thank you.

Bill Plovanic with Canaccord.

Great. Thanks. Good evening. Can you hear me okay?

Hey, Bill.

I was wondering a couple of things. One is international, I think you made the comment that it's up about 50% year-over-year. I'm wondering -- I think the way we thought about this ramp would be similar to the US where this year we have a doubling versus 2012. Would you say you are on track for that?

I think we are on track or even a little bit ahead of it. I think the question in the shorter term is making sure that we can like the rest of the US business, I think they've seen a huge acceleration in demand. We just want to make sure that they have appropriate amounts of supply, as well.

And on the supply topic your inventory seemed pretty low. What -- just any commentary would be helpful.

The distribution we're able to do a nice spring cleaning of the warehouse. (laughter) Bill, it is -- the fundamental aspect when you go into a conversion to a product that we knew would resonate with customers and you do it for free is everybody wants it immediately. Although we had a plan and we laid out a plan, everybody has jumped into the queue, as Brian articulated. If you got your last reorder in March, you can't get your new reorder in April. But what people were trying to do was jump start on that system, so they'd only order a box in March. They'd call us up and say, I only want one box because they knew the new one was coming.

What it's done is it's really put us in a hand-to-mouth situation in terms of manufacturing. Charlie and his guys, like I said, we are now producing more of the new product than we've ever produced on a given day of the old product. But we are still hand to mouth. We are still working from a backlog all over the place, every aspect of the business here. We're hoping, like I said, by the fourth quarter we will start putting some more inventory back on the balance sheet. There is always -- you look at all of these kind of normal little interruptions that happen everyday all across the world in every manufacturing company, it is not a big deal.

When you go in hand to mouth you have to pay attention to it. That is the challenge in front of us right now. It is not demand, it's not orders, it is really just continuing to ramp this thing up. I will tip my hat to Charlie and the crew. It has been a pretty impressive ramp up all the way through the supply chain. But we have to keep going. We're not there yet. And like I said I think Q3 -- if you look at Q3, our single biggest challenge is going to be executing on that. The demand is there, the interest is there. But we are chasing that and, you're right, there is very little inventory there.

Does that mean --

Comes in, gets cleared and goes out. It's that -- there's no dust.

Can that be a constraint for new patient growth in Q3? Are you going to pull in the reins, or would you rather pull in the reins of conversion of your existing customers?

Our hope is not to pull in the reins on any of this. We are continuing to push. I would tell you, I think the one obstacle we have come across is as the example I gave you, which is the perfect one, which is someone was due for an order in March. We hadn't started converting it. They only ordered one box of the old version knowing the new one was coming out. Now in April they're saying, okay, I want the new one and I want it now. Well, their insurance company said, well, you got your reorder last quarter so we have to go through the process saying, well, they only got one box.

That process in and of itself, I guess, is helping us manage our way through the people that are being converted. It is a lot a paperwork. It is a lot of headaches. And we should be through it here by the end of third quarter. But right now, the plan is to -- we have not slowed down the horses. We've got the jockeys whipping them and we're continuing to go. The real trick is here is, I think, Charlie and his guys are feeling pretty good about what they have in. But we've got to execute everyday to do everything we want to do.

And given that, this is on that same topic, where exactly are you on line three? Is all of the equipment in? Are you validating? Are you building inventory? Are you waiting for anything? Where exactly is that today?

All the equipment is there. Like we said, within the next one to two months here it should all be up and working. It's the plan.

Great. Thank you.

Raj Denhoy, Jefferies.

Hi, good afternoon. I wonder if I could ask a little bit more about the integrated product, the CGM product. There continues to be quite a bit of question in terms of your partner in that product and the CGM technology you're using with that. Is there anymore you are prepared to share at this point. If not, when do you think you might be able to share some more around that?

Like I said I think from our standpoint right now the primary focus is worrying about sterilization, the insertion and obviously the accuracy in the sensor. We are looking to the middle to the back half of next year where we think we will be developing clinical data and at that point in time we will go through it with everybody.

Okay. But just even in terms of the technology you are using or words coming from anything like that even in the absence of any clinical data, you're just not prepared to share?

I don't think -- look -- I would -- here's how I characterize where we are. We are still very much in the R&D phase so there's -- I don't want to mislead anyone. We are very much in the R&D phase. We do think it is the right format for patients as we continue to poll people. One thing on the body with an integrated CGM sensor I think can become standard of care because anyone that needs insulin is -- understands they have to get insulin somehow into their body.

And if you can incorporate that -- so we think it's the right form factor. We are excited about it. We're excited about the possibility of being able to execute on that. But in terms of who we are working with and stuff, at the moment, it's still just way to early. It is still very much an R&D project.

Okay, but they need to be on it though. But in terms of those critical paths as you describe them in terms of the sterilization and then the integrated insertion of both devices, where are you in that? Do these represent very difficult engineering challenges or are you feeling comfortable that these are simply things that will take time to work through and then you will move forward from there? I'm trying to gauge you level of confidence it's going to become a real product for you?

Look, I think from our standpoint we're trying to do something that no one has really done before, okay, in terms of combine an insulin delivery system with continuous sensing. And so as a result of all that, I think we wouldn't be spending this money if we don't think -- if we didn't think we had a path there. But we are still not far enough along where I can sit here and tell you, yes, we will definitely get it done. It is still a work in progress. We are intrigued by what we are seeing, but I would not sit here and tell you it is just a question of when not if. It is -- there's still some if's in here.

Okay, that's fair. And then just on Neighborhood, obviously a big step down in terms of what is happening on the strip side. What are your current thoughts on that business? I guess it has been a couple of years now. It clearly, I don't think, has performed as you thought it would. How integrated -- how integral is it to your strategy going forward?

Okay. I think there's two parts to this. If you remember way back when when we talked about acquiring Neighborhood, one of the things we were faced with as a Company is our infrastructure was not adequate to handle the way our Business was growing. So a big piece of the Neighborhood acquisition was, okay, they had focus. Here you had a DME supplier that flat out was focused on diabetes and they were just much better at what we wanted to do than we were as a stand-alone pump company. So a big piece of us integrating that was to be able to leverage those economies to scale.

And then, obviously, the other thing is, if we could do all that and, just add expense to the P&L but had the ability to pick up these incremental supplies and the other stuff so it was accretive to the bottom-line, that was really the launch behind it. I think while we always anticipated an impact to the Strip business, I'm not going to sit here and tell you we thought it would be 70%. I don't think anyone thought it would be 70%. So it's material. We are reacting to it.

I still think -- and we are going through a long-term strategic planning process internally to really look at the various opportunities. We have uncovered some interesting stuff with that business. But having said all that, as soon as we knew what the new strip price was going to be, we've right-sized the business. It is helping us in terms of the one aspect that we were really concerned about, which was our infrastructure. It has worked as we had hoped.

I think -- on the other side, I think it is fair statement. We never anticipated a -- we were thinking maybe a 30% cut in Medicare, not picking ten people and doing all they did. So, we didn't anticipate that. We've right-size it, we're moving forward with it. We do think it uncovered some interesting opportunities along the way, but I think, as you describe, I think it is going to morph into something a little different than we originally anticipated.

Okay. Last thing on sales force. Obviously you are seeing very strong demand for the new pod. What are your plans on expanding the sales force?

I think -- once again I think for the rest of this year, if we add people it will be later in the fourth quarter of this year to get them ready for next year. But right now we are going through that process. I would tell you we are very, very pleased with the productivity of the group that we have out there. We are pretty excited about it. We are looking at all of this and taking a hard look at all pieces of that business.

There is no question that we could use some more people. I am not going to argue that for a minute. But we want to do it in a smart, financially sound way so that is how we are going through it. If you think about, as Brian described, if you think about when would the opportune time for that to be would be, once we get through this transition and get those additional margin dollars -- I'm not saying you would use all those margin dollars and spend them. I'm saying that that's giving you more money coming in to the Company which gives you the opportunity to spend a portion of that on sales and distribution.

Very good. Thank you.

I'd only add to that, Raj, real quick that the sales force, if you can imagine, you are coming off of really five months now of blowing the door off its hinges initial shipments. A lot of the promise for them too is coming true where would they be able to increase their prescriber bases? Would they be able to see the growth within their specific doctors and clinics? Would that translate ultimately into bigger commission checks? I think what we have seen so far by the results of the last five months is that coming true. It is a very, very motivated, I think very excited and very happy sales force right now that is driving an awful lot of patient demand and the last thing we want to do is slow that down.

Okay. Very good. Thank you.

Tom Gunderson, Piper Jaffrey.

Hi. Good afternoon. Let me be quick here. Just two questions. One, there's a lot of talk on manufacturing and inventory and you guys have done an incredible job. But if we look back over the timeline, it is an incredible job but it took a lot of work by a lot of people. So my question is as you talk about the U-500 product and you talk about a cancer product, is that the same pod, same hardware and maybe there's a little different software, different -- obviously different drugs going in? But are you able to use all of the manufacturing capabilities that you have established now or do you have to set up a whole separate line?

Tom, great question. It is the -- from the pods standpoint it's the same manufacturing line, and the U-500, obviously the hand-held would be different, because you are delivering five times the strength of the drug. In terms of the chemo drug, there is [nothing to tell]. So we are leveraging the manufacturing -- any prerequisite for anything we do, I think we probably know better than most what it takes to get the manufacturing. We are not doing anything that would require us to build a new manufacturing line at the moment.

You don't want to tell Charlie to do it all over again? (laughter)

If I tell Charlie to do it all over again, he will strangle me. (laughter)

What is clear though, is after line three is built, here in the short-term then we will be quickly on within the next few months to line four. There are certain tools and pieces of equipment that have long, long lead times where we have already ordered for line four and frankly for volumes to be able to reach a line five. We do still have some line building to come, but it's -- that is a good problem to have.

And then, Duane, you mentioned again a number that we know, but I am curious if it is changing and that's the 70% to 75% of users that are first-time pumpers? The new-gen OmniPod is -- it's got a lot of buzz to it. It opens doors with your -- with new accounts. Is it opening any doors such that you are starting to think maybe you can get more into that, not first-time pumpers, the reorder business that is significantly larger?

That's another good question, Tom. Right now I would tell you the single biggest area that we are seeing, as I described you, the growth is coming from the whole pediatrics side and the female side who has chosen shots over anything else. So there's a significant amount of growth there.

Do I think long term we can get there? Yes. But right now I would tell you the business is coming from the same segments, which is people that define themselves as active and don't want to be tethered and on and on and on. It really is that group. It will be interesting to see -- we haven't plotted it out yet but over time here we're going to start taking a look in that pediatric group with the average age going down as a result of the smaller size allowing younger and younger kids to put this thing on.

Yes. Actually anecdote that I could add to that is we looked at -- for -- in preparation for looking at our data for the last three months, we looked at the zero to 10 group. That group would be a little bit of a smaller number. That group more than doubled compared to the same period over the prior year. I think that is absolutely true.

I love the way you guys are going after the zero. That just -- the opportunity is there for somebody to step in. Good job. (laughter) I'm just kidding. That's what it feels like when you talk to people out there is the size -- you can talk about it, we can put a number on it but when you see it side-by-side or when you wear it, the size really is attractive to those peds and to the smaller women. It is pretty amazing. That is it for me.

Thank you.

Amy Fong with ABR Health Co.

This is Mimi.

Hi, Mimi.

How are you? Regarding the record level of new OmniPod shipments, we estimate you hit 5,000 for the first time in second quarter? Is that ballpark or accurate?

Amy, again I'm not going to give -- we're not going to give a count number but certainly, hopefully, between the 50% year-over-year number and the 40% growth sequentially from Q1, you guys can go and do the math.

Okay. Just regarding the conversion of the installed base, were you hearing about any attrition from the slight delay or any centers or endocrinologists upset in any way over the -- how the conversion was handled with existing --?

Mimi, this is Duane. I will tell you if you -- the two biggest complaints that we are having at the moment, which is pretty simple, is I want it and I want it now and I don't care what the insurance says because -- and like I said, that is all being triggered by the fact that we are doing this for free and we try to explain it to them. The second piece is as soon as we started sending out notices for the first group of people, so people that were eligible for a reorder in June, we would send a notice out because we're looking at their insurance. So just to help everyone on the call, the way we decide who gets upgraded, as soon as we had the manufacturer we want we said, okay, who's eligible for a reorder in June? Who's eligible for a reorder in April? Who's eligible for a reorder in May?

So we used that as a list trigger. As soon as we sent out that first batch what we asked patients to do is go to the website, because there are differences in the particular product, this one versus the other, how you start it up. Obviously you've got to get the new PDM -- you've got to use the new PDM. Don't use the old PDM with the new product. It all seems relatively simple. What I will tell you, as soon as word went out that we started that conversion, everybody in our customer base, I think called because it is for free, right?

So, in hindsight I think long term it's absolutely -- we are doing the right thing for the patient. We are doing the right thing for everybody. But it was like a tidal wave that rolled in here. And our average length of our phone calls are going up because people are calling up and say, well, I want it and I want it now and we're saying you're not eligible for a reorder until September. And they are like, I don't care. I want it and I want it now.

So I would tell you I'm not sure what we do differently. I'm still trying to work through that. But I think the only complaint that we have heard is our customer service lines are been jammed solid. We have doubled the number of people answering the phone calls. And we are starting to make inroads into all that. But that magic word, free, has triggered an avalanche to us.

Okay. That sounds like people still may be just frustrated about wanting it now versus later but not anyone upset (Indiscernible - multiple speakers).

Listen, I can sit here and explain to you all the logic you want to throw at somebody but if they want it now, they want it now. I would tell you if there's any frustration out there -- and, look, I appreciate it. I'm thrilled that people really want the product. But we have got to work our way through it.

And as described we are not holding anything back. We're going hand to month. The lots are coming in, they're clearing and then they're going right out. So we have just got to manage our way through that process. We're hoping here over the next 60 days, more or less, that we'll be through that and we'll be back to the normal reorders, the phone calls will subside, we can let all the temps go that we had to hire just to answer the phone and we can get back to where we want to be.

My last question, we estimate in the US your share of pump fills for the new patients, which include injections to be about mid 20%, does that match your math and what could this share of the pump -- new pumper segment reach with your second gen do you think?

I guess we look at this in a broader way. I think it is hard to tell at any point in time how many people are probably in that denominator. But if you just think about the overall market,. And pump penetration two years ago was probably a low 20% range. Now we're probably in the upper 20%s and hopefully starting to push towards 30% penetration. I know some of you guys on the phone have done different surveys in the past and think the penetration can get into the 40% to 50% range. For us, when we look at that I can't see why people wouldn't come onto this product, especially this new version, the smaller, lighter pod.

To me it's, again, not to borrow it, but it is the iPod versus an eight-track tape cassette. It's -- this is the new technology, this is something that I think is a game changer. From that, I certainly do think we are taking a disproportionate share of new pumpers. Again, the data so far, while not knowing exactly what percent that may be, the data is backing it up by just seeing how many new doctors and clinics we are bringing into prescribing the product, as well as the growth level of within the existing base.

What we're seeing now that we're five months in, that fear of, well, there's just a little, to borrow the word, bolus of customers coming that are going to come through on the launch of the new pod, we are seeing the levels of growth sustained, right? That to me is, I think, a good point because we're sitting there saying, instead of being at, I don't know, five patients a month at a clinic, and we went up to 15 patients a month maybe for a couple of months, we're settling between 10 and 12. That is not a bad place for us to be in any of these places.

Helpful. Thank you.

Stephen Whitman with Oppenheimer & Company.

Thank you. Hi, guys. First question on Lilly -- I think last quarter you mentioned, obviously, you guys will be distributing the product. But any way to be able to leverage their obvious marketing muscle as this product, hopefully, gets approved?

I think from our standpoint the agreement we have with Eli Lilly at the moment is purely on the development side. That is the agreement. If something comes about down the road after the two companies work together, that would be terrific. But right now all we have in place is basically an R&D kind of joint development agreement.

Okay. And then on the oncology side, at what point will we be able to get a little bit more information about the partner on that one? Is that around year end or early next year?

I think that is a fair time. And as we mentioned in the script, the plan is for them to file, hopefully, before the end of the year here. And so that may be a trigger where we can talk about it more.

Okay, great. And then lastly just, Brian, just to clarify on the OUS number for this quarter, what was it as a percent of total non-Neighborhood revenue approximately? The international number?

Non-Neighborhood revenue, huh? (laughter).

Or total. Whatever you got there. I thought that would be easier, but whatever --

Mid single digits percent for us total. Again, to end point we probably could have -- if we weren't a little inventory constrained, we probably would have been able to ship them some more before the end of the quarter but we had to hold back a little bit to make sure we were meeting the needs here too.

Okay, great. Thanks, guys.

Jayson Bedford with Raymond James.

Guys, can you hear me okay?

Hi, Jayson.

First off here, you're obviously having a lot of success so far with the new patient adds. Can you comment on the stickiness of the device. Are you seeing maybe better retention rates or lower attrition?

It is hard to -- a lot of these patients will have just gone through a first reorder if they were added in the March type timeframe. Around the specific new set of patients it is early days. But our overall attrition rate has been pretty constant, down a little bit over the course of the last few months, trending downwards such that we've been slightly under 9%. That trend seems to be continuing and going in the right direction.

Okay. And then sort of in the same vein, Brian, I know in the past you've talked about in Europe the AROs pods have had roughly half the failure rate of the old pod. Are you starting to see that in the US so far?

Again, I think it is pretty early days. What we've seen so far, as Duane pointed out little bit, there are some nuances and differences in start-up. From customers who are transitioning to the new pod, sometimes they think they have had a couple of failures that once we have spoken to them it is really just that change in training. And we work them through that and they are good to go. In Europe, the rate has been holding pretty consistent so far.

Okay. And then, lastly, I think on the fourth quarter call when you gave initial guidance you said you expected that new patient add number to be roughly 40% growth. I don't think you commented on it last quarter. Obviously it's been above that so far in the second quarter. Do you expect that to be roughly around that 40% level? Higher, lower? Do you care to comment on that?

I certainly think the last five months we've effectively been at this 50% quarter, 50% year-over-year rate. I am certainly hopeful that that's going to continue through the back half of 2013.

Okay, perfect. Thank you.

At this time there are no further questions. Presenters, do you have any closing remarks?

No. I just want to thank everyone for joining us. I look forward to updating you on the next quarter call. Take care.

This concludes today's conference call. You may now disconnect.