Insulet Corp (PODD) 2016 Q3 法說會逐字稿

Good day, ladies and gentlemen and welcome to the Insulet Corporation third quarter 2016 earnings conference call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions). As a reminder, this conference call is being recorded. I would like to turn the conference over to your host, Deborah Gordon, Vice President Investor Relations and Corporate Communications.

Thank you and good afternoon and thank you for joining us for our third quarter 2016 earnings call. Joining me today are Patrick Sullivan, Chairman and Chief Executive Officer, Shacey Petrovic, President and Chief Operating Officer, Michael Levitz, Senior Vice President and Chief Financial Officer and Daniel Levangie, President, Drug Delivery. The replay of this call will be archived on our website. Our press release discussing our third quarter 2016 results and fourth quarter and full year 2016 guidance is also available in the IR section of our website.

Before we begin, we would like to inform you that certain statements made by Insulet during the course of this call may be forward-looking and involve known and unknown risks and uncertainties that may cause actual results to be materially different from any future results implied by such statements. Such factors include those referenced in our Safe Harbor statement in our third quarter earnings release and in the Company's filings with the SEC. With that, let me turn the call over to Pat.

Thank you, Deb and good afternoon everyone and thank you for joining us today. I'll begin with a brief review of our third quarter performance and recent business highlights. And then Mike will discuss our financial results and provide our fourth quarter and full year guidance. Shacey will provide an update on our exciting commercial and R&D progress. Dan will then give us an update on our drug delivery business. We'll then turn the call over for questions.

Before we get started I would like to first recognize November is National Diabetes Awareness Month. We are very proud of what we do every day to simplify life for people with diabetes by providing them with an easy to use and convenient technology to control their diabetes. We took part in the closing bell ringing ceremony at NASDAQ on November the first to continue to raise diabetes awareness. I am once again thrilled with Insulet's continued strong performance in all aspects of our business.

Our momentum this year remains very strong and our team is making significant progress on all of our key initiatives in every facet of our business. As a result of this strong performance, and our confidence in the future, we are raising our full year revenue guidance $13 million to $363 million at the mid point, up from a previous mid point guidance of $350 million, a growth of 38% year-over-year. Our gross margin continues to improve to 58.6%.

We are reporting strong and impressive financial results in all product lines for the third quarter. Total revenue grew 30% year-over-year with total revenue of $95 million and $5.5 million higher than the mid point of our guidance range. Third quarter US Omnipod revenue was nearly $60 million representing a strong 18% year-over-year growth. International Omnipod revenue of $19 million was stronger than we expected, primarily due to growth in existing markets and significant traction in new markets, particularly France.

Our drug delivery revenue of approximately -- was approximately $16 million, was also above our expectations. As you know, a large portion of this business includes sales to Amgen with Neulasta Onpro kit which continues to gain adoption in the United States. Amgen noted on its earnings call last week that the Onpro kit now represents between 44% and 45% conversion of its Neulasta business and they expect to finish this year around 50%.

I am very proud of the team's tremendous accomplishments. We are growing our top line and making thoughtful investments in the business while ever mindful of our profitability goals. We are focused on driving and delivering meaningful innovation to our customers that we believe will leapfrog competition. As Shacey will describe, we had another study published last month demonstrating the significant quality of life benefits of Omnipod.

We will continue to invest in clinical studies and publications to continue to build the bibliography of scientific evidence demonstrating the clinical and economic benefits of Omnipod to physicians, payors and patients. We made significant improvements during the first half of this year and continued in this quarter in our manufacturing operations global supply chain logistics. This improved efficiency resulted in gross margins of 58.6% in the third quarter, up over 14 percentage points versus Q3 of last year and sequentially from last quarter.

This performance improvement was due in part to increased daily output with fewer head count as well as reduction in scrap. These improved efficiencies drives not only reduced costs but also improved quality of the product. We remain on track to achieve our gross margins of 65% or greater over the coming years and a clearer line of sight to get there. The manufacturing and operations team are doing a great job in executing on our key initiatives of improving number one; our operating efficiency and yield in the factory.

Number two; our supply chain by providing for redundancy at a reduced cost and three; our logistics and distribution efficiencies to further reduce costs. In September, we announced plans to establish an automated manufacturing operation in the United States with production beginning in 2019. This investment will provide redundancy and additional capacity to support our growth. We expect this highly automated operation to be a meaningful contributor to push our gross margins to 65% and higher.

We are very excited with this new phase of our manufacturing and operation strategy and we'll provide you with additional details during our November 16 investor day. We'll also provide detail on the technology progress we're making on our innovation road map including our plans to introduce a truly different shaded mobile system at next year's ADA and following that, a best in class automated glucose control system. We will also discuss our pathway to profitability and our long-term plan to achieve $1 billion in top line revenue.

Finally, I would like to briefly discuss the changes within our senior management team that we recently announced. I would like to congratulate Shacey on her well-deserved promotion to President and COO. Shacey has made a tremendous impact since joining Insulet in 2015 and through her commercial leadership delivered record results. In her new role, Shacey worked closely with me to further improve our operational capabilities and capitalize on our new growth opportunities. Her responsibilities will also include the drug delivery product line.

Also Dan Levangie has decided to retire from his position with Insulet at the end of this year. Dan has been with Insulet for over five years, first as a member of the Board of Directors and then as part of our senior leadership team. I would like to personally thank Dan for his contributions to Insulet over the years, particularly his efforts to advance our drug delivery business and set us up for continued success. He will remain with the Company through the end of this year to assist with an effective transmission and has agreed to remain available to Insulet in a consulting role.

With that, let me turn the call over to Mike. Mike?

Thank you, Pat. I will review the third quarter 2016 results and then introduce our fourth quarter and updated full year guidance. Our prior year results for comparative purposes exclude neighborhood diabetes which we divested in February of this year. As I review our results unless otherwise stated, all commentary regarding changes will be on a year-over-year basis. We are very pleased to report third quarter revenue growth of 33%. With revenue of $94.9 million. Compared to $71.4 million.

All three of our product lines contributed meaningfully to this increase. Our results this past quarter once again demonstrated significant growth driven by the success of the ongoing commercial initiatives within our US diabetes business. Rapid volume growth internationally and strong growth in drug delivery. We exceeded the mid point of our stated guidance by over $5 million, primarily due to strong demand for Omnipod from a growing install base in the United States and existing markets in Europe as well as higher than expected penetration in new markets such as France.

With the remainder driven by continued strong adoption of the new Neulasta OnPro system. Our gross margin increased to 58.6%. Up over 14 points from 44.2%. And higher than our expectation as our investments in improving manufacturing and supply chain efficiency and effectiveness as well as improving the overall product quality are paying off. The improvement compared to last year reflects $7.7 million of costs in the third quarter of last year associated with product that did not meet our quality expectations which negatively impacted prior year third quarter gross margin by 9 points.

The remainder of the year-over-year improvement was due to the supply chain operations improvements that we have made in 2016. We expect our gross margin for the remainder of this year to be in line with the third quarter. And therefore we now expect gross margin for the full year to be in the upper 50%, up from our previous guidance of mid to upper 50%. We are also confident in achieving our longer term stated goal of gross margin of 65% or higher. Operating expenses increased to $53 million compared to $46 million.

Half of which was due to increased research and development costs related to our innovation projects. The other half was primarily due to investments in 2015 and 2016, expanding our commercial and operational infrastructure in support of continued strong growth from our commercial strategy. With the significant growth in both revenue and gross profit, we generated operating income of $2.4 million. Compared to a loss of $14.8 million. We are very pleased with the growth and gross profit and sustainable positive EBIT is within our control. Impacted by the level and timing of planned investments.

Consistent with what we have said previously, to drive near and longer term value creation, we plan to continue to make substantial investments in product development, clinical data, commercial expansion and operating improvements. And therefore we do not plan to be in a sustainable positive EBIT position before 2018, though individual quarters may be above break even depending on the timing of expense.

We ended the quarter with $283 million in cash and investments. Compared to $123 million at the end of 2015. The increase in our cash balance was driven by our successful private placement of 1.25% convertible notes in the principal amount of $345 million. Offset primarily by the repurchase of a portion of our existing 2% convertible notes in the principal amount of $134 million. As well as equipment purchases to support our US manufacturing initiatives and an increase in inventory to support our growth and our initiative to move from air freight to ocean freight during 2017.

We are very pleased with our financial position coming out of the third quarter and the stability provided as we make use of strategic investments in support of our near and longer term growth opportunities. I'll now walk through our outlook for the remainder of 2016. Given our better than expected third quarter revenue, and the continued strong momentum in our commercial business, we are raising our full year revenue guidance. We now anticipate full year revenue in the range of $362 million to $365 million.

Up approximately $13 million at the midpoint from our previous range at $345 to $355 million. This compares to 2015 revenue of $264 million and represents growth of approximately 38% at the midpoint. The raise in our guidance factors in our strong third quarter performance, our expectation for continued global Omnipod growth in both existing markets and new markets and the retirement of risk as we're now close to the year end then when we last gave you guidance which has resulted in our tightening of fourth quarter revenue range.

We expect strong annual year-over-year growth across our business line with US Omnipod growth of approximately 20%. Up from our previous guidance of upper teens. International Omnipod growth of approximately 80%, up from our previous guidance of 65%. And drug delivery growth of approximately 90% which represents $4 million more than our previous expectations. For the fourth quarter, we expect revenue in the range of $99 million to $102 million compared to $83.8 million representing growth of approximately 20% at the midpoint.

This is driven by Omnipod revenue in the United States of between $61 million and $62 million, representing mid-teens growth on a percentage basis. International revenue of $20 million to $21 million representing growth of approximately 35%. And drug delivery revenue of $18 million to $19 million, representing growth of approximately 25%.

We look forward to providing you additional color on our progress and our long-term outlook at our upcoming investor day on November 16. We also look forward to sharing with you in greater detail our pathway to $1 billion in revenue, gross margins of 65% or higher and the main drivers of our near term profitability targets of being sustainably EBIT positive beginning in 2018 and our longer term drivers of profitability expansion.

With that I will now turn the call over to Shacey

Thanks, Mike. Consistent with the first half of this year, we are converting market opportunity at record rates. And we (inaudible) to deliver strong revenue and new patient growth. We're on track to grow our 2016 worldwide installed base by 20% and generate approximately 20% growth in our US new patient starts, consistent with our previous guidance. The growth we've seen in new users and the significant loyalty in our existing customer base of Podders is driven by Omnipod's truly unique technology and its ability to simplify and improve the lives of people living with insulin-dependent diabetes.

This quarter we achieved yet another record setting number of new patient starts in both the US and international markets. And I'm confident that this momentum will carry us through to a strong finish for the year. The four key drivers of Omnipod's growth have remained consistent throughout the year. First; targeted clinical messaging and a growing body of data demonstrating the benefits of Omnipod, particularly for multiple daily injection users.

Second; strong adoption of tools like Insulet provided gluco and our Omnipod customer mobile app which improved training and support for our clinics and patients. Third; our focus on a world class customer experience and fourth; continued strength in our international markets. First our targeted clinical messaging. We continue to grow our body of clinical evidence supporting the many benefits of Omnipod.

In addition to the six presentations at the ADA scientific sessions in June of this year, and two subsequent publications of compelling clinical studies demonstrating the benefits of Omnipod, just this last month, Dr. William Polonsky's manuscript, Impacts of Omnipod Insulin Management System on Quality of Life was published in Diabetes Technology and Therapeutics. This study included more than 1200 current adult Omnipod users with type one diabetes. They completed a questionnaire designed to examine perceived changes in quality of life and glycemic control of Omnipod versus their previous insulin delivery system which included both MDI and traditional tubed pump.

The key findings of this study are fully impressive. The vast majority of patients reported significant improvements in quality of life, glycemic control and diabetes distress. With 73% of study participants reporting an improvement in perceived control over their diabetes. And 70% reporting a reduction in diabetes distress. This data is a remarkable testament to the power of Omnipod to reduce the burden of diabetes and to dramatically improve quality of life. The second growth driver, our digital Insulet program including Insulet provided gluco and our Omnipod mobile app is also increasing customer satisfaction.

Our Omnipod mobile app has been downloaded about 8,000 times and we now have more than 22,000 Omnipod users using Insulet-provided gluco which enables insight into diabetes management for these users and their care team. These easy to use tools are being rapidly adopted because they deliver improved training and support for our customers and clinicians. Third; we remain committed to providing an exceptional customer experience.

To continue to raise the bar, we are now measuring and driving improvement on all facets of the customer Insulet interaction. Including product support, customer service, and new patient training. I'm very pleased to report strong results with customers rating us a 95% in overall satisfaction with customer care. And finally, we continue to experience exciting growth in our international markets and we once again experienced higher than expected demand in a number of markets including France and Canada.

The international opportunities for Omnipod are enormous and offer near and long-term growth potential. There is widespread clinical evidence and acceptance that continuous subcutaneous insulin infusion provides improved short and long-term outcomes versus multiple daily injections. Despite this, across the United States and Europe, less than 30% of people living with type one diabetes are using pumps.

Market research clearly demonstrates that this is because traditional pumps are extremely complex with steep learning curves and the thought of being tethered to a pump deters people from switching from MDI. So while the insulin pump market is becoming more fragmented and competitive, we remain focused on our MDI customer segment. Those people who want the benefits of continuous insulin infusion but do not want to adopt traditional tube pumps.

As we have heard this week, there is competitive noise in the marketplace and while we've observed this dynamic, it appears that this has had a more significant impact on other traditional tube pump companies. In fact, it seems to have had little impact on our leading indicators and of course our business model offers unique protection. Omnipod's target market and value proposition are unique and there are many reasons why traditional tube pumps including 670G are not serious or sustainable obstacles to Omnipod's growth opportunity.

As we have stated many times, we are laser focused on new patient starts coming from multiple daily injection patients, not from patients already using competitive pumps. This is the most significant remaining market opportunity, and it is the market segment in which simplicity and convenience of Omnipod resonates most clearly. The bottom line is that in spite of the recent noise in the market, we believe we will continue to grow at 20% year-over-year by converting these MDI patients to a more effective treatment for their disease.

Just last week we held a scientific advisory board during the Canada Diabetes Association Annual Meeting. A number of distinguished endocrinologists participated to provide feedback and guidance on our product development and clinical strategies. Two quotes from that meeting struck me as encapsulating Omnipod's value. One physician said to us "if Omnipod had been first on the market, the tubed pump would never have existed." The second sentiment expressed in a number of ways from these physicians was that people living with the burden of diabetes are not seeking more complex technology.

What they really want is less work. Omnipod's differentiated technology along with our exciting product pipeline do just that, reduce burden and simplify life. Along with commercial execution progress, we have and made significant progress on our innovation road map, and we are thrilled to have an opportunity in a couple of weeks at our investor day to unveil some of the exciting features of our new technology platform.

As we have previously shared, we will deliver a Bluetooth connectivity platform that will provide our customers with more data and functionality on their mobile phones. The first steps along our digital Insulet pathway were Insulet provided gluco and our Omnipod mobile app and we are strongly encouraged by the adoption rate and the excitement that our users have for this new technology. Our research and development and commercial teams continue to work diligently to deliver an innovative new system and we remain on track to debut this platform at ADA in San Diego next year.

We will have more to share with you in a couple of weeks, including a demonstration of the new platform. But for now, I'll say that we are very excited about offering even more ease of use and simplicity for our Podders. This next-gen mobile system is the platform for our artificial pancreas program and the program's first product, our Omnipod Horizon Automated Glucose Control System. We have now completed our first IDE trial and performance of our algorithm was very strong as we predicted.

The FDA just approved our second phase IDE which will evaluate our algorithm performance in adolescents and pediatric patients. We anticipate completing this study before the end of the year. And we are thrilled to have the leadership of our new medical director, Dr. Trang Ly over this important development program. Trang joined us from Stanford University and she's been involved in research for all of the major artificial pancreas trials and systems.

She has a deep expertise in acceleration and successful completion of AP clinical development. She's already making quite an impact on our AP program and really other clinical development programs here at Insulet. We also worked with Lilly to complete enrollment for our U500 clinical trial this quarter. This program along with its sister program to deliver Lilly's U200 out of the pod are on track. As a reminder, comps traded insulin with Omnipod is a particularly attractive opportunity for us.

U200 and U500 effectively increase the capacity of our reservoir and enable Omnipod to better serve people with higher insulin requirements such as people living with insulin-dependent type two diabetes. Omnipod U500 and Omnipod U200 will double our addressable market. Our innovative product development pipeline is making exciting progress and will accelerate adoption of Omnipod over the next few years and will drive long-term sustainable and profitable growth.

We are very proud to see the team's hard work over the last two years begin to pay off. It's really an honor and a thrill to be a part of this passionate team that's so well positioned to provide our shareholders with increased value while significantly improving the lives of people living with insulin-dependent diabetes.

With that, I'll turn the call over to Dan.

Thanks, Shacey. As we reported earlier, we've had another very strong quarter of performance in our drug delivery business. As reported by Amgen, the Onpro system continues to be adopted by oncologists and oncology clinics throughout the United States. And the professional and consumer campaigns being conducted by Amgen are clearly being effective. Third quarter drug delivery revenue was $16 million and we believe we're on track for full year 2016 revenue of approximately $64 million.

Our business development team in the field continues to make inroads in their discussions with additional drug delivery partners and I'm very pleased with our progress in building a pipeline of projects that will generate growth for our business. As Pat announced earlier, I've made the decision to transition out of my position with Insulet at the end of this year. I've been involved with Insulet now for five years, having joined the Company as a member of the Insulet Board in late 2011 and transitioning into a full-time operating position two years ago.

As I reflect on the last five years, I'm very proud of the progress we've made in establishing Insulet as a growth company serving so many patients with life saving products. And I look forward to working with Shacey to complete a smooth transition. I'll also be available to Pat and the team in a consulting role as the need for my assistance dictates. I would like to thank all of our employees, our customers and our investors for your support of our efforts during my tenure with the Company.

And with that I'll turn the call back to Pat.

Thanks, Dan. Operator, we would like to now open the call up for questions.

(Operator Instructions). We ask that you keep your questions to one with one follow-up but please feel free to go back into the queue and if time permits, we will be more than happy to take your other questions at that time. Our first question comes from the line of David Lewis with Morgan Stanley. Your line is open. Please go ahead.

Good afternoon. Congrats on the quarter and Dan, congrats on retirement. I feel like you're leaving as I arrive so I'm trying not to take it personally. But two quick questions here. First, for Shacey maybe or Pat, if the quarter guidance in the commentary suggests you are obviously seeing little impact from this competitive channel dynamics that many are talking about. Are you seeing any impact, Shacey and is there any reason to believe that your competitive insulation will change in any way as you get closer to this competitor's launch? And I had a quick follow up on profitability.

Okay. I would say we're really seeing very little impact. There is of course noise in the marketplace and customers are doing their research. But I think where we benefit is that it's not the same target segment. 670 is very much focused on patients who are willing to wear a tubed pump, well controlled adults who are willing to put the work in to get the incremental improvement with that system. And our target patient population, as we've talked about I think for many quarters now, is the multiple daily injection user. And so we are targeted towards different segments.

The other thing that I would say is that as you know, I'm sure, 670 is not approved for people 14 and younger and it's actually black boxed in seven and younger. So the pediatric patient population, which is our fastest growing segment, is not really eligible or appropriate for this technology. And as we get closer to this actually becoming available on the market, I actually would say that in that instance when people start to learn more about the technology, we're probably going to feel this a little bit less in the marketplace. But we're very confident in our growth and our opportunity and feeling good about the finish for this year and 2017.

Okay. Very helpful. And then Mike, I guess I should ask you how it feels to make some money but I'll ask a serious question. Margins have been obviously the investor surprise this year in gross margins obviously have been heading higher. You've been driving dramatic leverage. I think this is the fourth straight quarter where operating expenses continue to sort of fall. It sounds like based on your commentary looking forward I think at some point we have to expect that operating expense growth to tick back up. Is that sort of a safe assumption from the press levels? And then in terms of gross margins, I'm expecting radical improvements from here into 2017 and beyond but obviously not the step function we saw here in 2016. Thanks so much.

Well, what I would say about profitability, yes, it was wonderful this quarter to be in positive EBIT territory. That's, as we've said before, we're almost familiar with being. And we continued to expect to be positive in EBIT beginning in 2018. And as we've said before, it's within our control to move and be sustainably positive before then. But the opportunities in front of us with this product are significant.

And when you think about the new product opportunities with the U200, U500, our concentrated influence which double our addressable market in addition to the artificial pancreas and then the mobile Omnipod that precedes that, that we'll talk more about at our investor day in the next couple weeks. These are very straightforward value creation opportunities from our perspective and we want to make sure we make strategic investments in the product development in the clinical support and data, and in the commercial organization, operational organization to drive that.

So we will see an uptick in spending, but, really mostly in those areas that I just described. As far as gross margin, we were pleased last quarter to say that we were at the new normal level and we've improved from there. Really principally driven by improvements in yield production effectiveness and efficiency. With really driving down the amount of labor we needed to use.

We'll give more clarity around the gross margin improvements but on the pathway to 65% and higher gross margins, we will be making regular improvements in that and there are some different drivers along the way that we'll talk more about in a couple weeks at investor day, like the US manufacturing and otherwise. But we're not waiting for that. We continue to expect regular improvements in gross margins.

Investing for growth.

Thanks so much. Thanks Pat.

Thank you. And our next question comes from the line of Brooks West with Piper Jeffrey. Your line is open. Please go ahead.

Hi, can you hear me?

We got you, Brooks.

Great, thanks, Pat. Congratulations on a great quarter. I had kind of a follow-up question on the market influence of 670G maybe looking at it from a different direction. I think there's a perception on the street that maybe the Omnipod is sometimes looked at as a starter pump on a progression from a patient to a more complex technology. So I'm wondering, Shacey or Pat if you would comment on that. And then as you look at your attrition rate and where those patients go after Omnipod, I'm wondering do you have a sense for are they progressing to a tubed pump? Are they dropping off pump therapy? That would be a helpful clarification. And then I've got a follow-up.

Sure, I would say I think that's a great characterization of our technology. We are very much the pump that patients from MDI go to and we're able to get people to transition from MDI therapy to pump therapy just because of Omnipod's form factor and its simplicity and ease of use. And so I think that's a great way to describe us. And in fact, we've got a fairly strong retention rate and loyalty in our customer base.

So remember in any given time period, we really only have 9% of patients fall off the product. And of those I wouldn't say we see transition to tubed pumps. When people get used to relying on a system that isn't tethered and gives them that freedom of life and that ability to exercise and sleep and run busy lives with that freedom, they generally don't want to move to a tethered product.

Okay. That's helpful. I was hoping you were going to say that a lower attrition rate but you still said the 9%.

Half of that, Brooks, is due to the economics and product performance and we're making improvements in all of those to really improve the attrition rate. So it's an area we're focused on by improved market access and in our manufacturing to continuously improve product quality.

Okay. That's helpful. And then my follow-up was on the Lilly. I thought I heard you say that Lilly finished the trial for the U500, and I wanted to make sure that was correct. And we've been kind of speculating on a product timeline to market of maybe late 2017 or early 2018. Is that set? I know that's not 100% in your control but it feels like maybe the trial got done a little bit earlier than we thought.

I should clarify. So thanks for giving me that opportunity. We finished enrollment. So the trial will go actually through the better part of next year. So we really are looking, projecting this to be late 2018, 2019 in terms of market entry.

Got it, okay. Thanks so much.

Sure.

Thank you. And our next question comes from the line of Mike Weinstein with JPMorgan. Your line is open. Please go ahead.

Thank you. And I'll add my congratulations. I apologize if I missed this. We have four earnings calls happening at the same time so it's hard to catch everything. I just wanted to come back to a couple of your comments. One, you said that are you on track for 20% growth in US new patient starts this year. Two, Shacey, I thought I heard you say that the bottom line is that despite the receipt sent noise, we believe continue to grow 20% year-over-year and I just wanted to clarify were you talking about US new patient starts next year or were you talking about revenues?

Maybe just clarify that. And maybe the third item, could you just talk about the cash rate. Now you have a lot more cash, obviously more debt too than you had previously. How much is that going to the facility investments you're making and is there anything else you're planning on doing with it? Thanks.

I'll take the first two and then I'll punt to Mike for the third one. So we are very much on track for 20% growth in new patient starts in the United States and when I was referring to 20% growth I just meant global new patients, I wasn't referring to revenue.

And with regards to the cash raise, so we ended up with a net cash raise of about $180 million because we used the $345 million of new notes which were at a wonderfully low coupon of 1.5%. We used a portion to buy back two-thirds of our existing 2% note so net wind it was $180 million and we intend to use that for the US manufacturing investment and there's still roughly $67 million of the 2% notes out there.

So there's also the opportunity to consider buying back some of those over time. And, as we've talked about, there are a number of opportunities across the business to make investments and we want to make sure that we're not really thinking about the cash when we're doing that. That's how we intend to use the cash.

Okay. Let me just clarify a couple items. Shacey, on the 20%, obviously, in light of the activity in all of the diabetes stocks over the last week and really the last month or so, just want to clarify your view on the sustainability of new patient starts in the US. I don't think people really worried about outside the US, particularly in the back what's happening in France for you were guys.

But can you just give us your view on the sustainability of the growth rate we're seeing in new patient starts in the US and just maybe one last question for Mike and then I'll drop. Just the inventory levels continue to rise here to new levels that we weren't expecting. Could you just talk about where those are headed? I know you're trying to support this transition from air freight to ocean freight but could you set expectations? Thank you.

Sure, Mike. We believe that the growth is eminently sustainable. I don't know how else to say it. I think there is noise in the marketplace but that's our job to clarify and educate around the noise. And we believe we have a very unique value proposition that's targeted towards a different segment of the market. People that are relying on multiple daily injections today and that is not an appropriate segment to transition to a product creating this competitive noise in the market.

And I would just add, Mike, that I think as evidence of our confidence in our diabetes business, we are raising guidance $13 million at the midpoint. And that's across all business lines, international, drug delivery and US diabetes so we're very confident of our ability to continue to grow the diabetes business in the US.

And this is Mike. With regards to your question on inventory levels, the growth in inventory is exactly as we planned and as we expected. This is entirely consistent with what we've talked about of making sure we have enough product for the transition to the lower cost mode of transportation with ocean freight as well as supporting the growth of the business. So in terms of expectations, I really -- we don't expect it to grow a whole lot more as we get into year end but as we're making these transitions, this is what we believe is the level that we're comfortable at the support of the growing demand.

Thank you. And our nest question comes from the line of Tao Levy with Wedbush. Your line is open. Please go ahead.

Thanks. Congratulations on a great quarter. Maybe I could ask about the Lilly program. Is it possible that we can see that data presented at next year's ADA? It seems like it has completed enrollment early, it's 27-week follow-up. Is that in the realm?

I think it's possible, but it is Lilly's clinical trial. So we'll certainly support them in getting this clinical data out into the community as quickly as possible. But it really is their data to collect, analyze and publish when they see fit.

Okay. And as a follow-up, you spoke very specifically about the US opportunity as being huge. Outside of Europe, what's the -- is there a strategy in place? Is there a plan that you can go after?

There is a strategy in place in terms of geographic expansion over the long term with the business. But our focus in the more near term is on a US, Canada and Europe. But I would say even within Europe we are not by any means fully penetrated or even half the way penetrated into the countries with opportunity in Europe. So we see a tremendous opportunity just in terms of expansion in Europe.

And then beyond that of course there are attractive markets across the globe that would benefit from Omnipod. So that's a longer term plan I would say. But in the near term we really see great opportunity for continued growth within the MDI segment here and abroad. And also with our partner with Ypsomed in Europe and across those markets, both in our existing markets to continue to grow but also in terms of market expansion across Europe.

And do you help Ypsomed on that market expansion in Europe or is that really on their responsibilities?

It's their responsibility from a commercial standpoint. We do the development work to be able to enter into new markets and the regulatory work to be able to enter into new markets. And, of course, we do market research with key opinion leaders to get input into our product development and clinical plans. But in terms of entering into a market in the commercial activities, that's primarily Ypsomed.

Okay, great. Thanks a lot.

Sure.

Thank you. And our next question comes from the line of Danielle Antalffy of Leerink Partners. Your line is open. Please go ahead.

Hey, good afternoon guys. Thanks so much for taking the question and congratulations on an excellent quarter. Guys, I just wanted to ask you pretty high level, sorry if I missed this. I'm also on a few earnings calls at once. But just the diabetes market as a whole, I mean a few tough quarters for some of the competitive diabetes companies, J & J called out a difficult quarter in their, actually specifically in their pump business but of course the strip business, tandem also, Dexcom called out some noise around the competition. What are you guys seeing in the market?

I mean clearly you guys put up a really great number. So is this something that you, Insulet, are just immune to or perhaps this are other factors that we're not considering that the market's actually still growing but maybe there are issues with those specific companies.

Danielle, I would say that we are somewhat immune to it just based on which market segment we're focused on. The fact that again we're focused on that MDI segment. Second of all the pediatric patient population is such an important fast growing component of our patient population, and that is not a population that will be eligible for or appropriate for competing products that we're talking about. And I think also the fact that we have geographically diverse revenue streams and this is very much I think US noise that's happening at this point. I think we really have just been impacted less than some of the other companies out there.

And Danielle, this is Mike. I would just add that we have a recurring revenue model and that is different from some of those other parties that you described. So, it provides us a greater degree of stability.

Understood. That's really helpful. So just a follow up on that. Do you see the pump market, is the insulin pump market growing and you guys are growing significantly faster than that, or do you think the pump market has decelerated at all?

I would say that we're growing fast and we're helping the pump market to grow. We don't really consider ourselves as taking share within the pump market. We're looking at the entire type one diabetes patient population. But we are definitely growing faster than the pump market but at least all market estimates are that the pump market is growing between 5% and 10% CAGR, annual CAGR, at least in the United States.

Great. Thanks so much.

Thank you. And our next question comes from the line of Jayson Bedford with Raymond James. Your line is open. Please go ahead.

Good afternoon and thanks for taking the questions. Apologize if I missed this. But gross margins continue to be strong here. You signed the new manufacturing agreement with Flextronics during the quarter. Just wondering, are the economics more favorable to Insulet versus the old contract? And I'm wondering if that had an impact on gross margins over the last couple quarters?

Jayson, it's Mike. What drove the improvements in gross margins was the improvement in yield, the effectiveness in our manufacturing and the quality with which we're doing it and the efficiency with which we're doing it. Pat mentioned that we've been able to reduce head count while we've been growing daily volumes while we've been reducing scrap and increasing yield. That's what's been driving the improvement. In terms of the arrangement with Flextronics, we're very pleased in December to renew that arrangement.

The way that the arrangement worked is we've really been working together to drive incentives together. Where both parties are really driven to improve the efficiency and effectiveness of the operation. And so I wouldn't say that it's economics built into specifics in the agreement as much as it is that we're well aligned together to really drive these types of improvements. And that's what we're seeing.

Okay. That's fair. Pat, apologize again if I missed this. Any update on Medicare reimbursement?

I would be disappointed if somebody didn't ask me that.

Yes.

Not any new updates other than we continued to work very closely with CMS. Washington has been busy as you might expect but we are working very closely with them on the two initiatives we talked about and I hope to get it before my sixty-fifth birthday which is coming up pretty soon.

Fair enough. And then maybe just to spread the questions here. Dan, you mentioned new partnerships. I think you may have just been referring to going after new partnerships. But just to be clear, did you sign any new ones during the quarter?

Yes, Jayson, what I said was I'm really pleased with the pipeline of projects that we have at hand. And didn't identify any new projects. We're not going to talk about individual projects because of the confidential nature of those agreements with our pharmaceutical partners. I will just leave it at that. Really happy with the progress we've made in developing a pipeline of opportunities that I think will pay off handsomely down the road for the Company.

Fair enough, thank you.

Thank you. And our next question comes from the line of Raj Denhoy with Jefferies. Your line is open. Please go ahead.

Hi. Good afternoon. Lots been asked but I'm curious about, you mentioned pediatrics is kind of a defense against 670G and some of the limitations with that product. Is there anything you're willing to sort of share in terms of how many of your patients, your new starts at this point are pediatric?

So Raj, I wouldn't say defense. I just think it's a reason why it's a separate segment and a separate target and separate value proposition. I'm not sure how much we shared before but pediatric patients are approximately 30% of our total patient population.

And what about of the new patients that are coming in? Are pediatrics, I guess I won't ask you for a full number, but is it a higher number than that 30% in the sense is your pediatric volume growing?

I think it's in that neighborhood. I don't really know it off the top of my head and I don't want to give you a wrong answer but it's in that neighborhood.

Okay. That's fair. And then just in terms of things you're on the sales force side, in terms of continuing to grow that effort. Clearly your numbers are good so I imagine you're adding salespeople but anything you can provide with that?

Sure. We're very pleased that sales force productivity is now at the pre-expansion level, just where we thought it would be, from the previous sales force expansion. So we are evaluating and likely we'll expand the sales force as we look at the growth opportunities before us in 2017 and maybe even before then.

Great. Thank you.

Sure.

Thank you. And our next question comes from the line of Ben Andrew with William Blair. Your line is open. Please go ahead?

Good afternoon. And maybe a question for Shacey first on the attrition. We've talked over time about trying to take some of the lessons learned in new patients and translate that to the installed base. Can you break down the sources of attrition for us as they are different somewhat in the installed base and then what initiatives you guys are looking at over what timeframe?

Sure. So we do track this very closely, by the way, and we have made progress on new patient attrition. It's just that I don't want to get too far ahead of ourselves and it is kind of a lagging indicator. But we do see encouraging signs that we are providing a better customer experience and that should lead of course to satisfaction and retention. There are two main drivers to patient attrition. The first is just the product quality and experience so I think part of what's driving the improvements that we see in retention is the just improving product quality in the field.

And then the other main driver is market access reimbursement and coverage. So for example, we have sadly Podders that age into Medicare and lose coverage for Omnipod. That's just one example. When we lose coverage that's just obviously a driver and just one of the reasons we why we've invested in market access and why we continue to invest in clinical data on the outcomes and costs economics of Omnipod because that's what can help us secure and expand our market access position and address that side of retention.

Okay. And then my follow-up is on the international side. And obviously you've got the partnership with Ypsomed that runs for a couple more years. What other direct or perhaps distributor-based international opportunities are there aside from where you're already working with Ypsomed that you're particularly excited about that could be incremental as we move into 2017 and 2018?

For example, we're not heavily penetrated into Central and Eastern Europe. So, most of our business today is in Western Europe, so there's opportunity there. But I would say that there's opportunity everywhere across Europe. I mean Ypsomed has done a nice job growing the business and they've been a great partner for us over the years. But still, as in the United States, there is relatively low penetration of pump utilization. So there's an opportunity to continue to grow that market and continue to penetrate into our existing markets as well as growing into some newer countries.

Are there reimbursement challenges there or just you need to get feet on the street and kind of detail the product successfully?

It just really depends on the market. Obviously it's fragmented in Europe, so it just depends on the particular country. There's a mix of both. And ultimately I think anywhere you sell Omnipod, you're going to need to build an expertise in market access just like we're doing in the United States

Great, thank you.

Thank you. And our next question comes from the line of Doug Schenkel with Cowen & Company. Your line is open. Please go ahead.

Hi. This is Ryan Blicker on for Doug. Thanks for taking my questions. So, another really strong quarter across the entire diabetes business. I think even when assuming a pretty high reorder rate, it's pretty tough to get to these revenue numbers without assuming that you're tracking to higher than 20% installed base growth for the year. Any comment about that?

No. ( Laughter).

Okay, fair enough. Okay. Sorry, go ahead.

I think it's fair to say that what we've said before, what we expect for the year, the 20% growth in new patient starts in the United States and 20% global growth. Yes.

Consistent with our previous comments on the installed base growth is the 20% number is the one we're very comfortable with.

Okay. That's helpful. And then, one of the pipeline, I apologize if I missed this. But did you begin on body trials of your artificial pancreas product late in the quarter or early this quarter? And is 2019 the right way to think about the U.S. launch of that system?

Yes, and yes. In fact we started on body trials I guess when was the first -- it was September. So that was the first IDE. And then we've just gotten the second phase IDE approved by the FDA to look at that on body system and the algorithm performance in pediatrics and adolescence. And I think 2019 is the right way to look at the system entry.

Okay. Thank you.

Sure.

Thank you. And our next question comes from the line of Suraj Kalia with Northland Securities. Your line is open. Please go ahead.

Good afternoon, everyone. Thank you for taking my questions. So, first, Dan, let me just start out, congrats to you and the team. You guys have executed a phenomenal turnaround in the last seven, eight quarters and kudos to the entire team. That having said, let me start out with two questions for Shacey. Shacey, obviously a lot of questions have been asked on the 670G. And I thought I heard you say that you all are not being affected. It's a different target market, especially in pediatrics. At least I thought I heard that.

I guess my question, Shacey, is why do you all feel you are not being affected? My understanding is the 670G is 14 years and older indication on label. Are you all seeing no impact simply because of Medtronic's current marketing efforts, they are trying to convert their existing users to the 670 or any - if you could help me reconcile why you all are not seeing the impact?

Right. Sure. So right. One reason is the one that you alluded to which is that the product is not appropriate or indicated for the pediatric segment. I think the other reason that you're alluding to is that the data for 670G included well controlled patients on existing pump therapy. So I don't know Medtronic strategy but it would seem like a likely target that they will focus on tubed pump patients who are well controlled. And then the third reason is it's just not our segment. We are sales strategy, our commercial organization. Our messaging is focused on the multiple daily injection patients. That is not where 670G is focused.

And so I guess that's part of what's protecting us. We do - I don't want to underestimate. There is a tremendous amount of noise in the market. And so we are spending time clarifying what this new technology is and what it is not. And I guess we're just resonating and getting through that noise. But that's going to be with us for a while and we're fully prepared to do that. We have a different market segment and what we think is a very unique value proposition with Omnipod.

And for my follow-up question, Shacey, I know you all - you mentioned something about the FDA just approved the second IDE. Shacey, can you give us some additional color on your artificial pancreas program? I guess what I'm really trying to understand is, is it Hybrid or is it true closed loop? Are you looking at hyperglycemic events? Are you looking at - there's so many variables as we all know and I think 2018, 2019 keeps coming up. That's a pretty fast ramp-up from trial to launch and any color on - what is this product eventually going to be looking at? Thank you for taking my questions.

Sure. You're welcome. So I would agree. Artificial pancreas means a lot of different things to a lot of different people. And in fact I'm getting a little unenamoured with the name itself. It's an artificial pancreas research program. Our first product is the Omnipod Horizon Automated Glucose Control System. This is a Hybrid Loop Control System. But I think what we've done is taken a step back and said, what do people living with type one diabetes really want in an Automated Glucose Control System.

And so we're focused less on features and technology and more on the user experience and how do we provide better control and better user experience. So we are anticipating that our system will be a fully closed loop system overnight with Hybrid Loop Control System during the day.

Thank you. We have time for one more question. And our last question will come from the line of Jeff Johnson with Robert Baird. Your line is open. Please go ahead.

Thank you. Good afternoon, guys, and congratulations on the quarter. Shacey, let me just follow-up on that question. The Hybrid Closed Loop during the day on the Horizon System, I think I might have asked you this question before, but I'm going to ask it again. Would that have an auto bolus component as well maybe a high, medium, low carb choice or something like that, but a meal time auto-bolus, something like that, in it as well?

The patient will still be required to bolus. So we are looking at ways to reduce the burden of carb estimation as you just alluded to, but the patient will be required to bolus.

Okay. That's helpful. Thank you. And then, Dan, just one question for you and congratulations on the retirement. But question for you on the drug delivery pipeline. And that is timelines change in a lot of these things. I know you guys say you're making a lot of progress there. I guess what I'm wondering is, as those timelines change, I think the last update you gave or commentary you've made in the past is the next drug delivery product could be a few years out, three years to four years out. Could you update that timeline? When might we see another drug delivery product outside of the Onpro system contributing to your revenues?

I would say we're kind of in the same zone here of four to five years would be my best estimate.

Kind of four to five years from where we are today, is that how you -- just to clarify?

Yes.

Thank you.

I'm showing no further questions at this time. And I'd like to turn the conference back over to Pat Sullivan for his closing remarks.

Thank you, operator. Let me summarize by saying again how pleased I am with the progress and the performance of the Company. Not just during the last two quarters of remarkable growth, but our employees' commitment and focus during a time of significant transition over the last couple of years.

We still have tremendous opportunities for growth in front of us. And I am impressed every day by the team's passion and execution. Our line of sight to sustainable and profitable growth comes more into focus each and every day. We will continue to build on our foundation and execute on our strategy and we are more confident than ever we will deliver long-term sustainable and profitable growth for our investors. Our Q3 results simply speak for themselves.

I'd like to close by thanking the Insulet employees for all your hard work and dedication in doing what you do every day to simplify life for people with diabetes. Terrific job, well done, and keep up the great work. We look forward to sharing much more with you in a couple of weeks at our Investor Day in Boston on November the 16. Thank you for your participation today. And, Dan, good luck.

Thanks, Pat.

Ladies and gentlemen, this concludes today's conference. Thank you for your participation and have a wonderful day. You may all disconnect.