Insulet Corp (PODD) 2013 Q3 法說會逐字稿

I would like to welcome everyone to the Q3 2013 Insulet Corporation earnings conference call. (Operator Instructions) Mr. Brian Roberts, CFO, you may begin.

Good afternoon. Thank you for joining us for the third quarter 2013 conference call. I am Brian Roberts, CFO of Insulet Corporation. Joining me on the call today is Duane DeSisto, our CEO.

Before we get started I would like to remind everyone our discussion 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 27A of the securities act, and section 21E of the securities exchange act. I am making this statement for the purposes of complying with those Safe Harbor provisions. These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies, and prospects, which are based on the information currently available to us, and on assumptions we have made.

There are risks and uncertainties which 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 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 like to remind you the guidance we are offering today represents a point in time estimate of 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. Now, I will turn the call over to Duane.

The third quarter was one filled with tremendous accomplishments for Insulet as the new smaller OmniPod continues to receive an extremely enthusiastic response in the market place. Demand for the OmniPod continues to exceed our expectations with new patient starts more than 40% higher than a year ago, with no signs of this growth slowing in Q4.

We have transitioned over 90% of our existing direct customer base to the new OmniPod. We now have capacity to produce nearly a million OmniPod's per month. The robust demand for the new OmniPod shows strong revenue growth in the quarter, as OmniPod revenues increased by approximately 30% year-over-year.

In addition, we generated positive cash flow for a second consecutive quarter as our cash balanced increased to $154 million, from $151 million.

Enthusiasm for the new smaller OmniPod remains high as our easy to use, tubeless design appeals to customers, and health care professionals alike. OmniPod's design with it's automated and painless insertion is particularly attractive for children, the key demographic. In the third quarter alone we experienced nearly 70% year-over-year increase in pediatric patient starts, and more than 100% increase in children under 10-years-old.

We are also making terrific progress expanding the base of healthcare professionals prescribing the OmniPos. Our ability to broaden and deepen our subscriber base has always been a key to sustain and maximize our growth potential with the new OmniPod. Nearly nine months into the launch, I believe we have made significant strides in this area which puts us in great position as we look towards 2014. Since the launch of the new OmniPod, more than one in four practices are new prescribers. Orders from these officesrepresent approximately 20% of our initial shipments.

Importantly, these practices are coming back with additional prescriptions, an indication they are happy with how their initial patients on the product, have performed. The sales team is also leveraging the new OmniPod to deepen our relationship with existing prescribers. More than 20% of our existing practices year-over-year initial shipments have more than doubled. Demand for the new OmniPod has also been extremely high from our existing customer base.

Commencing in late June we embarked on an ambitious plan to transition to base over one reorder cycle. In addition to getting the smaller pods, all in warranty customers received the systems new PDM at no additional cost. Over the past several quarters, we have commented that we experienced disruption and reorder patterns ahead of this transition.

As customers utilized the remaining first generation OmniPods, and tried to time their reorders to receive the new OmniPod as quickly as possible. As people ignored their normal reorder dates and attempted to move ahead in line, we had a significant spike in call volume to our reorder team in the third quarter.

In July alone, we fielded approximately four times our normal re-order call volume. Although this taxed internal resources, the teams worked diligently to catch up and execute the transition as quickly as possible.

Currently, we estimate that more than 90% of our direct customer base has transitioned to the new OmniPod. We continue to work closely with our distributor partners as they complete their conversion as well. We're also pleased to note that customer service levels have stabilized as call volumes have normalized back to the pre-transition levels. Re-order utilization appears to have returned to more normal pattern thus far in the fourth quarter. International demand for the new omni pad is strong.

International demand for the new OmniPod also continues to be strong. It was noted earlier this week that since the beginning of the year, diabetes revenues have increased by more than 100% as compared to the prior year. Omani pod continues to take share in key markets such as the Netherlands, Germany, and Switzerland, just to name a few.

It is worth noting that potentially competitive products that have either recently approved, or expected to be approved in coming quarter here in the US, have been on the market in Europe for quite sometime. Despite these product offerings, we have been able to effectively more than double European business year-over-year, and like the US,have increased the rate of patient additions each quarter.

Our partnership with Glaxo-SmithKlein also continues to perform well. With (inaudible) approval now in hand we will commence the transition to the new OmniPod in Canada this quarter. Once the conversion is finished in Canada, all patients world wide will have been transitioned to the new OmniPod.

To meet the growing levels of demand, we put our third manufacturing line into operation in late August, slightly ahead of plan. The operation team continues to execute at high level as we have doubled production from a level of 20,000 OmniPods per day in July, to current levels of 40,000 OmniPods per day. We now have the capacity to produce approximately 1 million OmniPods per month.

Our expectation is that we will continue to run the lines at, or near, capacity through the first quarter as we rebuild inventory levels and take into account the shutdown in late January for the Chinese New Year. Inventory supply was limited in the third quarter as we managed inventory levels closely with a goal of ensuring customers did not run out of product.

As a result, we held inventory levels at distributors to absolute minimum, and left with more than $4 million in distributor orders unfulfilled. With supply increasing, thanks to the third manufacturing line, we have filled these orders and currently do not have any past due backlog.

In October, we announced that we settled the patent infringement with Medtronic. As part of the settlement, we made a payment to Medtronic and have agreed to (inaudible) license certain patent claims. Importantly, we agreed with Medtronic, that neither company will sue the other for patent infringement based on any of our existing products, features or components of our existing commercially available products. We are encouraged by the terms of the settlement agreement as it provides us significant freedom to operate and innovate off of our current offerings with comfort that additional claims will not be asserted against us.

Turning to the pipeline of future products, we are thrilled to have hired Dr. Howard Zisser as the Company's first Medical Director. Dr. Zisser's clinical expertise, background and reputation as an innovator in current and emerging diabetes technologies, are unparalleled he we believe he will make a significant contribution to Insulet. Howard has been spending his first few weeks getting up to speed on all of our future products and clinical initiatives and will be spending a considerable amount of time going forward to help us to define and develop products such as our CGM enabled OmniPod, and our OmniPod specifically signed to be used with concentrated insulin, our first entry into the type two space.

In regards to CGM efforts, we are making progress with our partners around our goal of enabling and OmniPod with CGM technology. Our partner continues analyst and review data related to the sterilization process, and we are working closely together to determine the best path forward. Additionally, we continue to parallel path other parts of the project such a work around our insertion design and work with research partners around algorithms that will help make the CGM enabled OmniPod. A system that will continue to be the easiest to use on the market.

Our partnership with Eli Lilly was signed in May, and although still in the early days, we are progressing as planned. Teams are meeting regularly, and we have commenced work related to modifying the software in our personal diabetes manager to account for the higher concentrated insulin.

We remain excited about the potential of this project with an estimated market potential of approximately two million people living with highly insulin resistant type two diabetes. We have also continued work on several projects toto use the OmniPod for drug delivery outside of the diabetes space.

Our partner in the oncology space is expecting to submit to the FDA in the coming months. Our earlier stage drug delivery projects and other disease states are on track as well. The OmniPod has proven itself to be an effective drug delivery platform. We will continue to identify and seize new opportunities as they arise.

In summary, we had an exceptionally strong performance in the third quarter. The transition of basically the entire customer base in such a condensed time period was nothing short of moving a mountain. We are pleased to have that hurdle behind us. It is clear the new OmniPod is appealing to new health care providers and potential customers, including people with diabetes who never considered pumping before. New patients (inaudible) remain extremely strong and we continue to see more than 70% of the customers to be first time pumpers. The OmniPod remains the product of choice for people living with diabetes who want freedom, discretion, and ease of use of tubing free, pump technology.

Looking ahead, we expect to finish 2013 on a strong note with three manufacturing lines near capacity to support the increased demand for the new OmniPod, and the rebuilding of inventory levels. In total, we expect revenues of $65 million to $71 million, equating to approximately $244 million to $250 million of revenue for the full year. We continue to expect we will be at or near operating break even by the end of the year. Let me turn the call over to Brian.

Consolidated revenue increased by 12%, to $61.1 million in the third quarter of 2013, compared to $54.8 million in the third quarter of 2012. As a reminder, our third quarter results includes a reduction of more than $4 million in neighborhood diabetes revenue related to the impact of Medicare competitive bidding, which took effect on July 1st.

Adjusting for the impact of competitive bidding, year-over-year revenue growth would have been approximately 20%. We had another strong quarter of OmniPod revenue growth which improved by nearly 30% over Q3, 2012. Additionally, we left over $4 million in unfilled distributor orders at the end of Q3.

Taking these open orders into consideration, OmniPod growth would have been 35%. New customer additions continue at a rate in excess of 40% year-over-year since launch, and we expect to continue to achieve these levels in Q4. The transition of our customer base was a significant effort during the third quarter. While wework through the transition, we continue to experience reorder utilization disruption with that rate appearing to normalize in September.

With the customer transition now nearly complete, we expect reorder utilization to normalize to a more predictable pace as expected in the fourth quarter. Consolidated revenue first nine months of 2013 was $178.6 million,compared to $153.5 million for the first nine months of 2012, an increase of approximately 16% year-over-year.

Gross profit grew by 12% for the third quarter to $27.4 million,as compared to gross profit of $24.4 million in the third quarter of last year. Gross margin was consistent quarter-over-quarter, at 45%.

We are extremely pleased with this result given the cost incurred to switch the existing customer base to the new OmniPod. We expect to drive growth margin expansion in Q4 toward 50% as we reach the pay back point during the quarter for many of the free PDMs. We continue to believe in early 2014 the new OmniPod will drive US gross margins in the low to mid 60s translating to a consolidated gross margin in the low to mid-50s.

Gross profits for the first nine months of 2013 were $79.4 million, increase of $12.4 million, or 18%, as compared to $67 million in the first nine months of 2012. Operating expenses increased $11.8 million, to to $44.7 million in the third quarter 2013, from $32.9 million in the third quarter 2012.

This increase was attributable to over $10 million in certain non-recurring charges, primarily related to our patent litigation settlement with Medtronic. We believe the third quarter results are one time in nature and continue to manage our operating expenses closely.

Operating expenses should return to Q2 levels in the fourth quarter which will allow us to be at, or near, operating break even by the end of the year. Operating expenses were $108.7 million for the first nine months of 2013, and $96.9 million for the first nine months of 2012.

Operating loss for the third quarter increased to $17.3 million,as compared to $8.5 million in the third quarter of last year. Excluding amounts related to the non-recurring charges, operating loss would be approximately $6 million in the third quarter, an improvement from both the third quarter of 2012, and the second quarter of 2013.

Interest and other expense was $4 million in the third quarters of both 2013 and 2012. Approximately $2.6 million of this expense was non-cash. Net interest and other expense was $12.9 million for the first nine months of 2013 compared to $11.6 million in 2012.

We reported net loss for the third quarter of 2013 of $21.3 million, or $0.39 per share compared to $12.4 million, or $0.26 per share last year. Net loss for the first nine months was $42.5 million, or $0.79 per share, compared to $41.7 million, or $0.87 per sharefor the first nine months of 2012.

We generated positive cash flow for the second quarter in a row with cash and cash equivalents balance increasing to approximately $154 million at September 30, compared to approximately $151 million as of June 30. As of September 30, we had approximately $54.5 million common shares outstanding.

Finally, as Duane noted, we remain very positive about our prospects for 2013 and beyond. The new OmniPod continues to generate excitement in the industry and with the existing customer base transition behind us, we are solely focused on growing the business. We expect Q4 revenue to be in the range of $65 million to $71 million, equating to $244 million to $250 million of revenue for the full year. With that, let me turn the back over to Duane.

Thanks, Brian. The excitement for the new OmniPod continues to exceed our expectations.

One in four practices now prescribing the OmniPod are new. Over 20% of our existing practices have grown in excess of 100% year-over-year. Pediatric starts were up nearly 70% year-over-year, and we have seen more than 100% increase in children under the age of 10.

These statistics demonstrate that the new OmniPod is a game changer in the area of continuous insulin infusion therapy. The promise of OmniPods simplicity, ease of use, and small, discrete size, resonates with people living with diabetes. Short of a cure, people do not want to be constantly thinking about their diabetes. The OmniPod is helping them achieve this goal. With that, please open the call to questions.

(Operator Instructions) First question there Kim Gailun, from JPMorgan. Your line is open.

Thanks. First question is just on the new patient ads. Congrats on another solid quarter, a lot of heavy lifting for you guys. Curious, as you look at the fourth quarter what you are forecasting for growth in new patient ads? You commented the 40% plus momentum had continued to the fourth quarter.

Kim, I think that is correct. That is how we feel. We are excited about it. I would tell you, when we laid out this year, the quarter we worried about was the quarter we were going through this transition. It was every built as painful as we imagined. We are happy with how it turned out. We are in a good spot and focused on go forward.

Okay. Then a follow-up. You talked about $4 million in distributor stocking orders falling out of the quarter and you filled those already. That is in the fourth quarter. Does that mean that the third quarter would have been closer to $65 million and as we look at the fourth quarter you are looking at the mid-points of $67 million. What I am asking is, why not a bigger step up sequentially in the fourth quarter with those adjustments in there?

There are a couple things to take into consideration. The third quarter also had the impact of competitive bids as well. If you want to adjust for both of those. In the perfect world that would have got us to $69 or $70 million. Not all of those orders are stocking, right?Our guess is, some initial shipments and a few other things that would have probably got done in a normalized pattern by the end of Q3 probably spilled into the beginning of Q4. We will see exactly what distributors want to have on hand at the end of Q4.

At the same time, we do have all three lines cranking. We want to make sure we have a prudent amount of inventory here on the shelf to be able to handle demand as it's coming through. The goal at the end of the quarter isn't to necessarily to ship out every pod we have to maximize exactly a revenue number and have those pods sitting on shelves. We want to be sure we are prudently doing it around the business. We have to plan and Chinese New Year at the end of January, and make sure we can meet the demand and needs throughout the world.

Okay. That is helpful. Thank you.

Danielle Antalffy, from Leerink Swann, your line is now open.

Thanks. Good afternoon, guys. I was hoping you could comment on competitors launching low glucose suspend pump. I know it's early days but we are four weeks into a launch, they got late September approval. Are you seeing them in the marketplace and what the feedback is and how that could be impacting, if at all, new patient ads for you guys?

I think they are targeting their installed base right now and once again 70% of our customers are coming from MDI. They are out there. They will be talking it up. If you look at the marketing literature produced by Dexcom in terms of performance of the sensors, we are more than happy to tell people they should be using the Dexcom. Short term, we really don't see that their product being a big disruption in terms of patient ads. In doctor's offices where they will try to leverage that, we compete for the share of the physician office.

The thing we are encouraged about is we've been selling against that product for months in Europe. By we, I mean us and our partner Ypsomed. It hasn't slowed us down. It's anecdotal but we think we know what the pitch is and we think we understand the performance of that product because we have been watching it over there from the various countries.

Okay. Great. Just wanted to follow up on the comments and your censor partnership. When can we expect to hear more about that? Is it possible to hear more before year end, or via press release? Or is this something we have to wait for next year at a conference or during another earnings report?

If I had to guess right now based on where we are in the progress, it is probably once again just to level set everyone, this still is kind of in the R as opposed to D phase here. We think we will be in a much better position by the middle of next year.

Got it. Thanks.

Your next question from Bill Plovanic, from Canaccord. Your line is now open.

Great. Thanks, good evening. Couple questions. Trying to nail this down a little tighter. If the core OmniPod business was up about 30% year-over-year, that gives us just shy of a $55 million number, maybe a hair over $6 million for the old supplies business. Am I close enough, or fairly close on that?

Bill, I don't want to get too more specific than what we've talked about. The OmniPod business did about 30% year-over-year growth. We left some revenue on the table with production that we couldn't get filled by the end of the quarter. In all it was a pretty solid quarter.

Clarify the GM on the sensors. I caught the statement but I wanted to be sure. The overall gross margin will approach 50% in Q4 and then head to mid-50s in 2014 and that is the overall gross margin?

We are driving toward the 50% gross margin for the fourth quarter with the transition behind us. I would say probably by Q2 of 2014 we would expect that gross margin to be in the low to mid-50s consolidated. That consolidated number obviously is impacted by both the level of the international revenue as well as neighborhood. It would imply that our US gross margin at that point there time would be in the 63% to 65% range.

Considering that you are now up and running your full capacity, what do you think on the disposable? What is the gross margin that you are going to max out on at that disposable at the pod at this point?

We have consistently for years been saying we are targeting the mid-60s number. Certainly we have plans within the operations team where we think we can pull that number even higher. Over the next couple of quarters we have to eliminate a little bit of excess scraps that we will see go away as well as just some final shut down related costs to the older line. Once we get to mid 2014 or so we will have a clear picture of exactly how high we can drive it. Hopefully we will be able to drive it higher than that.

Last question, as you look at your growth, Ypsomed had huge growth. They reported over 100%. What was the USgrowth if we back out that contribution?

Again, we are going to stick to overall OmniPod growth as far as the way we have been presenting this. Year-over-year OmniPod was 30% and if correct for the distributor stuffwe are probably 35% or so, in that range.

Great. Thank you.

Next question is from Tom Gunderson, from Piper Jaffray. Your line is now open.

I just have two quick questions. One, is you talk about the 70% increase in pediatric starts. That makes sense the smaller, all of the things you have said in the past. What percentage of starts are coming from under 18 or under 17, or whatever you use,and what percentage of your overall business is pediatric?

At this point, Tom, our overall base is some where in the 35% to 40% range of our patients being under the age of 18. It is still our fastest growing segment. Hard to say exactly what percent we are winning. Right now pediatric starts make up half of what we are winning in a given quarter over the last couple of quarters.

Thanks. Just kind of a housekeeping. It's just absolutely amazing to me watching you over time that you are making a million of these things a month and all I want to do is simple math. I understand you have to rebuild inventory, and I understand the Chinese New Year, and you want to have some on hand for whatever happens out there. Still a million a month would imply 100,000 users at some point if they are using 10. Does that carry you from a capacity standpoint through 2014 and into 2015, or do you have to get that fourth line going?

If the number runs more than 10 on average, because some people switch out every two days. You are not crazy off. It is probably about 85,000 users or so. I will tell you our plan. Our plan is to have line four up and working in Q3 of next year.

Line four up when?

Q3 of next year. We want to have that capacity. Having been so close for pretty much 120 days here. It obviously is no way to run a rail road, trust me.

We joked that we have a very clean warehouse.

Those are my two. Thanks, guys.

Next question comes from Benjamin Andrew at William Blair & Company. Your line is now open.

Great. Good afternoon, guys. Following on Tom's question. Talk about the cadence of sales rep ads, and to what extent you are still holding back so we could see material accelerations whether it shows up in Q4, or Q1 or Q2, (inaudible) to get you to that level, at which point you would need that fourth line?

You know, certainly we have been very open discussing that as we get this gross margin to the P&L that our thoughts are to take roughly a third of it or so and invest that back into sales and marketing. We are knee-deep in 2014 budgeting now. I don't have an exact number of heads that we are looking to add at the moment. We are going to add I think a chunk of heads. If I had to guess, maybe 15 or 20 people into the commercial organization. Ideally, a lot of those people will start recruiting later this quarter so they are on board in Q1 which really gears us up for starting the March timeframe is when sales start to crank up again into the Spring and summer. January, February tend to be the slower periods seasonally that is the perfect time to have these folks on board, let them finish out year end at whatever company they are at, and bring them here and get them up and running and hard charging for Q2.

The one thing we have seen is the last time we did this, last year, we saw those reps absorb at a pretty rapid pace and effectively pay for themselves quickly. We expect the same thing this year. We are putting the final touches on what that plan should look like. That is holding true. Clearly,there is a huge opportunity ahead of us and we want to be on offense and go and grab it.

Second question. If you look at the conversion MDI's over the pumping, the bulk of your target market, what is the constraint on that? Is that a standard number coming in every quarter and whatever products are out there are competing to get that as we see the effect it is going to have and maybe targeting those patients as well. You start to worry about delusion of you all. Is that a number that can be moved as the products improve and you can accelerate the conversion of MDIs?

Great question. The reality is if you look at that MDI population, they know insulin pumps exist and they, for the most part, most of these people, have had diabetes for an extended period of time. They are not interested in tubing no matter how cool the actual devise may look. For us, what we are finding is the more time we are spending in the office, the more time we spend with those prescribing physicians, the more comfortable they are at giving us more people. I would tell you it is focused at the top 20 accounts in the territory, the next 20 accounts in the territory. Part of what we are looking at in the plans is described in the region looking at more capacity as we bring out more sales people. We think we now have a model that we feel comfortable with and we will have production to support it.

For us to bring on more sales people in the middle of the year. There would have been more people yelling at me they didn't get the product on time. From our standpoint it really is about spending that time in these offices with these physicians, getting them comfortable. They all have the significant number of MDI patients. It is really is from a sales process standpoint, we feel good. A product with our tubing appeals to this group of people. I know we have a low glucose suspend, and all these other things. These people were giving themselves injections three to five times an day. They knew pumping was out there and chose not to do it.

Our form factor resonates with this group. It is about us executing the physician offices. What is becoming clear to us in modelling as we go forward, we want to have more people because we can do the ROI, and it is clear that as long as we can support these guys with product we think the opportunity is there. Like I said, that is the focus of the last few months. Getting those lines up, getting the quality level up where we want it.

I would add to what Duane said,if you take away one metric from the prepared remarks which is important it goes to the heart of the question is, one out of every four doctors who have prescribed the product since March 1st, are brand new doctors to us. A lot of those doctors have gone through the trial process with a patient on for three months or six months. They want to see how they are doing. Now they come back and prescribe more. To continue to push more and more people through the infrastructure, or the pipeline, a big key is to have more doctors prescribing the product. To me, the sales team has done a phenomenal job since launch and has gotten in front of a lot of doctors who, for whatever the reasons may have been, weren't prescribing the OmniPod now, they are prescribing it. That first decision point is tubed or no tubes. If it is no tubes we are the only game in town. We talk about competitive products, for example, the 530G.

There is no pediatric label on that product, it's 16 or above. We are seeing huge growth and those people are pediatrics. Those are important factors for us. The doctor number is key it increases the overall group of prescribers. That is how you make sure it wasn't a group of people waiting for the new pod to come and they have come on now and that is done and we are still seeing the big sustaining power from the launch. The other piece, now that the transition is behind us, doctors wanted to get customers to the same platform or patients to the same platform to make sure that went off seamlessly. We went through customer service bumps and bruises. We think the patient base is happy with the product and things are going great.

Thank you.

Next question comes from Jeffreys. Your line is now open.

Good afternoon. You mentioned in the last question the 530G hasn't been approved for pediatric patients. My understanding is that Medtronic has applied for that. I don't know when they expect to get it but, does the 530G with a pediatric approval give you more pause,or do you continue to view that as something not to worry about?

This is Duane. We are competing with those products, all of that stuff in Europe and so we think we understand the positioning. We understand the marketing. I mean, look, competing with MedTronic on a day to day basis. We pay attention to everything we do. It is a different group of people. For the most part and I think we feel pretty comfortable about it. If I was the parent of a child that had diabetes and I was really interested in CGM I would go to the most accurate sensor which is our friends at Dexcom. I would not take one not as accurate. All you have got to do is pull out the marketing literature that is out there. We feel pretty good about having a nice offering that if you are the parent of a pediatric child we comfortably can make you feel good about those two products combined.

That is fair. Maybe I could ask about the CGM enabled pod. I think you continue to note that sterilization is critical and work continues to be done there. Are there updates there that move you one way or the other in terms of your views on that?

I think we are, now, in complete candor. We are still poking around this. I would love to tell you we have the answer and we have that part figured out. To me, that is the R in this. I don't have the answer yet for that. In the meantime, we are running experiments on assertion. We have done studies in proximity in terms of insulin delivering sensing. We are doing a lot of different stuff. That is one that we are still working our way from various cycles. There is not a quick answer to that. We are not there yet. I can't sit here and tell you I got a solution that I am comfortable with yet.

Lastly, (inaudible). I am curious of your thoughts on the business going forward. What will you do at this point?

I think from our standpoint to reset everything. When we acquired Neighborhood it was a make first buy. We needed a big addition to the back office. We thought we had the ability by bringing Neighborhood on board we could leverage our base business. We were aware of the fact that competitive bidding was coming in. We had no idea it was going to come in the way it came in terms of Medicare. Our view is simple. The thing is thrown off a little bit of cash. It has helped us with the back office. We are talking to the various strip suppliers. If you look at the strip suppliers that didn't get competitive bids they are starting to come up with creative ways to do business. I am not yelling uncle yet. It is more complicated than we thought. The initial reason we really drove for this was really on this back office which is the key piece to our business of customer service in the back office.

I do apologize. One other housekeeping question. The attrition rate at 9% or so, have you seen any move in that with the launch of the new pod?

I think we are probably right now I am calculating to 9% using an annualized number over the last month or two that number is trending downward. There has certainly been through the transition and why I say this is over 90% complete as compared to 100% complete,some people have come out of the woodwork where we thought maybe they weren't on product any more or more using it more sporadically and they have jumped back in the queue to take a reorder and get back to the shipment list. That is a big positive. Those haven't calculated their way through the number yet, if you will.

Thank you.

Next question comes from Mimi Pham. Your line is now open.

Good afternoon. Can you confirm your third quarter new ads increased in the high single digit range sequentially from the record levels you saw in the second quarter?

Definitely up over Q2s numbers. North of 40% year-over-year increase from Q3. I will let you guys complete the math on top of that. You are probably directionally right.

In terms of the new center at 25%, are they having a similar 70/30 split, or are they more comfortable than your overall prescriber population?

We don't break it down at that level so I don't know the exact answer. In the whole I would tell you that it is still north of 70%, our MDI patience. There's nothing to tell me the doctor's offices are different.

The oncology partner submission, how close are you on that? Should we bank on some announcement by December?

It is a big pharma company so I wouldn't bank on anything. We continue to push forward. We feel good about our piece of it but it is a big company with a lot of people, a lot of business people, a lot of lawyers and a lot of people that you have got to check off the box.

You can put that out in a press release versus waiting for the next conference call?

Yes, if we get to a commercial agreement, yes, we will announce it for sure.

Great. Thank you.

Next question from Jen Wall, from Benchmark Company. Your line is now open.

Thank you. This is Erica. First question, housekeeping. You said operating expenses are going to return Q2 levels. Are you speaking on dollar basis or margin bases?

Dollar basis.

Fantastic. I know that in the past you have updated us on the fertility drugs process. Is that something that you think will be filed by the end of the year or is that forward?

We haven't heard anything differently to say they won't have it filed within six to eight weeks. I would expect that to still hold true but something we don't completely control. If not it would be closely thereafter.

Thanks for updating us. We are looking forward to seeing you post next quarter and in the future.

Next question from Steve Lichtman, from Oppenheimer and Company. Your line is now open.

It is Rosemary, in for Steve. Can you hear me okay?

Sure can.

Great. Just a quick clarification on the OUS number. Really strong demand there. I think you mentioned you guys were holding back some shipments to ensure adequate supply in the US. Was there still some supply constraints in Q3? If so, could we expect a little small (inaudible) in international in Q4?

We were equal opportunities hold backers. We did it in the US and internationally. We wanted to make sure that we were getting the pods in the hands of all of the patients as compared to sitting on our shelves or somebody else's. We will see. Certainly had some lofty production goals in the fourth quarter where we think we will produce north of probably 2.5 or 2.6 million OmniPods in total. That will help us to be able to ship a little more and allow them more comfort with inventory levels. To my earlier comments. We know that we have got to plan ahead here through the first quarter as well. We'll have to if there is backlog at the end of the year so we can keep an adequate supply on hand.

That makes sense. Thank you. Just a quick follow up on Tom's question. When the fourth line is up,how many pods will you manufacture per month?

That fourth line should produce 350,000 or 400,000 pods per month. It should put the monthly production around 1.4 million by then.

Great. Thank you.

Your next question comes from Chris Cooley, from Stevens. Your line is open.

Thank you for taking the questions. Just two quick ones if I may here. When you think about launching into Canada here in the current quarter, would you mind reframing that opportunity for us and expectations for how that will ramp up? Clearly, there is a supply issue globally. Think about that in terms of the contribution to growth. Then I have one quick follow up after that. Thanks.

We are moving the Canadian patient base into the new OmniPod in Q4. We received the healthcare approval in the Spring. We wanted to get through the USfirst. The Glasgow-SmithKlein guys have done a fantastic job. An interesting thing about the Canadian market is there is a strong push in several provinces, Ontario being one of them, to get pediatric onto insulin pumps. One of the challenges we see in the Canadian market, unlike the US is that to be able to get the governments paying for the pump for pediatric to go on,they have to go to certain centers to be able to receive those government reimbursement benefits.

There is a wait list. We have worked with the Glasgow folks quite a bit to figure out ways through diabetes education, or other programs, to facilitate that and open up the spigot more. Overall, Canada has met our expectations and doing a really good job. I think the GSK guys are happy. That is the difference in the Canadian infrastructure, if you will, compared to US. Overall, we have planned the volume of pods they need in Q4 to be able to transition everybody over and no concerns on being able to get those to them and getting it done before the end of the year here.

If I may just maybe try to fish on 2014. You have had two great quarters now being positive on cash flow. How should we think about cash flow as we think about 2014? Clearly, you are still investing from a rep standpoint. You will have the additional line, but you will have pretty steep acceleration in new patient starts and pod consumption. Help us think about how cash flow looks as we go into next year. To the extent I can get a preview of 2014 guidance.

Sure. I think from the remarks you talked about we have seen no signs whatsoever of patient starts slowing down. We feel very bullish about patient starts. We want to make sure that we are staying very aggressive on being able to continue to increase the number and invest the investment into the sales team that we talked about. I think the nice part for us is that the whole goal is that we are able to self fund it. Q4 is the first quarter in a long time where we are confident we will see gross margin expansion and the dollars being able to help us leverage the investments. The nice part has been we have effectively been operating cash profitable for over a year without the benefit of that gross margin expansion.

We have shown a lot of leverage within the operating side of the P&L. The gross margin helps accelerate that more. Q4, we did make our payments to MedTronic as part of the patent settlement in the fourth quarter. That will come off the cash balance. Q4 will have the convertible debt payment. Q4 tends to eat a little more cash than the typical quarter. For all of 2014 we certainly expect to be EBIT profitable as well as cash flow positive.

Thanks so much.

Next question comes from Jayson Bedford, from Raymond James. Your line is now open.

Good evening. A couple on the transition. You are making progress here. I wonder why isn't it 100%? Is it solely a function of supply or are there hold outs? Those folks that still are ordering old pod?

We are not making any more old pods. The reason it is not 100% is we have go through distributors to get to those people and transition them out. What you will find is the typical diabetes patient has extra product so all we were doing now is working through the distributor. As Brian pointed out. We have had people that we would have argued we had put in off the category that popped up and looking for it. I think from our standpoint, we feel good about it. We think we have most of them. I can't sit here and tell you it is 100%. We are close. We are pretty close with it.

You mentioned that 90% of the existing direct customers have transitioned. What about the non-direct customers? Is it similar number?

That is the piece. We work through the distributor when we say non-direct it is people going through distributors that have particular alliances with healthcare plans. We work with the distributor, and distributor works with customer. They may have been converted and we may not have received the feed back yet, or they are in the process.

We do receive imperfect data back from distributors. I don't think we can say 100% done. The mound is behind us. Which I think overall is great news. To be clear on one point. All customers who call in in needing pods have been getting with all of the new pods we haven't sold an old pod in the US in five months now. Effectively, from our perspective, we are basically done.

Just looking at pediatrics. What percent of those under 18 years old with type one diabetes use an insulin pump?

The overall metric in the USis probably high 20s in total. I don't know. Just a gut feel says that number is going up there because the benefits of being on the insulin pump is something that a lot of people focus on to say this is good for my child. It is hard for parents to want to deliver a lot of needles every day. Myguess is higher. I don't think we have a statistic to back that up.

We'd be guessing. Last data is a year and-a-half old. It has been awhile.

Thank you.

Next question comes from Suraj Kalia, Northland Securities. Your line is now open.

Good evening, gentlemen. Diabetes is the buzz in town today. Maybe an unfair question but let me reverse this question and ask it. When let's say, OmniPod and the (inaudible) compete and OmniPod loses business, what is the primary reason according to you that you will lose the business? The reason I ask, and you correctly said it, the tubing pump has a fancy user interface. It is quite intriguing to see if you will lose business, why would you lose business.

Probably you are going to snicker. Honestly, when we sit in the meetings with the sales people, there is really only one guy we compete with at the doctor's office that we see head to head everywhere. That is honestly that is Medtronic. We know the new guy is out there. They are out there running and they are going to raise some money. It is all good. Look, in the end. We don't really see them as a direct competitor. It really is, and I know it sounds a little arrogant. You just don't see them, that is the fact. We talk about what is going on.

We see MiniMeds with the 530G and how they are spinning it. That is what we focus on. Maybe three years from now will be different. I am not saying we don't lose to them on occasion. I don't have a single sales rep and I have 100 plus saying you have got to come up with a solution for them. That is never in the conversation or the e-mails or discussion at the moment. It may change over time, but not now.

Finally, Duane, you all have done a fabulous job in terms of this concept, the penetration and numbers speak for themselves. At what point do we start seeing the SGS start picking down faster than the top line growth? I am trying to understand at what point does operating leverage really kick in? Not necessarily asking for guidance but what you think, on a strategic bases, is it 70,000 patients, is it 20/50, or how do you see this?

When we look at it, and I will have Brian comment on it. The real trick for us, in this model, based on all of modeling we do,when we start getting the USbusiness, the non-distributor and non-international business in the 65% margin range, we have the ability to take a third of that uptick and grow the sales force in an adequate amount to continue to drive the top line and the rest of the money can come to the bottom line. We think, the real trick for us is over the next couple of quarters now we are through the moving the mountain to transition thousands of people almost overnight for free, by the way, the real trick for us is to keep focused on the production, the margin and that is going to supplying everything else. I will let Brian pick it up from there.

I'll let the results speak for themselves. We've beenoperating cash profitable over a year. Backing up the non-cash expenses, we can have a different conversation on the black schoals model and the value that creates within the P&L. Our view is that we will be effectively EBIT break even, positive, by the end of this year here. I said a few minutes ago I said EBIT positive next year. We have two quarters of positive cash flow. We have done a tremendous job being able to manage both sides of growth and getting ourselves to the point where profitability is on the horizon. On the whole, from our perspective, we are creating that leverage and certainly where we have had a relatively flat gross margin for a couple of years, waiting for this day to come with the new pods transitioned and now in the hands of the customer base and making north of 2.5 million of these things in the fourth quarter, I think we are positioned really well.

Thank you for taking my questions.

There are no further questions at this time. I will turn the call over to the presenters.

Thank you for joining us today. We look forward to updating you on a future call. Have a good evening.

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