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Edited Transcript of PODD earnings conference call or presentation 5-Aug-19 8:30pm GMT

Q2 2019 Insulet Corp Earnings Call

BEDFORD Aug 15, 2019 (Thomson StreetEvents) -- Edited Transcript of Insulet Corp earnings conference call or presentation Monday, August 5, 2019 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Deborah R. Gordon

Insulet Corporation - VP of IR & Corporate Communications

* Shacey Petrovic

Insulet Corporation - President, CEO & Director

* Wayde D. McMillan

Insulet Corporation - Executive VP,CFO & Treasurer

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Conference Call Participants

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* Danielle Joy Antalffy

SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst

* David Ryan Lewis

Morgan Stanley, Research Division - MD

* Jayson Tyler Bedford

Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst

* Jeffrey D. Johnson

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

* Joanne Karen Wuensch

BMO Capital Markets Equity Research - MD & Research Analyst

* Malgorzata Maria Kaczor

William Blair & Company L.L.C., Research Division - Research Analyst

* Matthew Charles Taylor

UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices

* Ravi Misra

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Robert Justin Marcus

JP Morgan Chase & Co, Research Division - Analyst

* Ryan Blicker

Cowen and Company, LLC, Research Division - Associate

* Suraj Kalia

Northland Capital Markets, Research Division - MD & Senior Research Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Second Quarter 2019 Insulet Corporation Earnings Conference Call. (Operator Instructions)

As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Ms. Deborah Gordon, Vice President, Investor Relations and Corporate Communications. Ma'am, please go ahead.

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Deborah R. Gordon, Insulet Corporation - VP of IR & Corporate Communications [2]

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Thank you, Lauren. Good afternoon, everyone, and thank you for joining us for our Insulet's Second Quarter 2019 Earnings Call. Joining me today are Shacey Petrovic, President and Chief Executive Officer; and Wayde McMillan, Executive Vice President and Chief Financial Officer.

The replay of this call will be archived on our website. And our press release issued after market closed today, discussing our second quarter 2019 results and third quarter and full year 2019 guidance, is also available in the Investor Relations section of our website.

Before we begin, I 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 risks and uncertainties, in addition to the inherent limitations of such forward-looking statements, include those referenced in our safe harbor statement in our second quarter earnings release and in the company's filings with the SEC.

Please note that we assume no obligation to update these forward-looking statements even if actual results or future expectations change materially. Also, unless otherwise stated, all financial commentary regarding dollar and percentage changes will be on a year-over-year GAAP basis.

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

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [3]

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Thanks, Deb, and good afternoon, everyone.

The second quarter of 2019 was another important and exciting one for Insulet, and we are extremely pleased to have made great progress on our strategic imperatives as we crossed the midpoint of the year. We entered 2019 from a position of operational and financial strength, after working throughout 2018 to solidify our foundation for long-term, sustainable and profitable growth.

We remain focused on our strategic imperatives: first, driving innovation across our business; second, expanding market access; third, strengthening our global footprint; and fourth, ensuring operational excellence throughout our organization. Thanks to our disciplined focus on these imperatives and the team's great execution, Insulet achieved another quarter of accelerated revenue growth.

As a result, we are raising our full year 2019 guidance. Our market opportunity is large. It is growing, and it is underpenetrated. Today, we estimate our addressable market in the countries we currently serve, almost 10 million people living with Type 1 and insulin-dependent Type 2 diabetes. Globally, both the incidence of diabetes and the use of technology to manage the disease are growing.

These trends provide strong tailwinds for our business. We have a number of near and long-term growth catalysts, such as our new product innovation and global expansion, which will -- which we expect will both increase our addressable market and our penetration into that market. These growth drivers will make us confident in our 2021 financial targets and our ability to drive continued long-term growth.

On today's call, I'll share financial highlights from the quarter and review the progress on our strategic imperatives. I will then turn the call over to Wayde, who will provide additional detail on our second quarter financial results and share an update to our 2019 outlook. We will then open the call for questions.

In the second quarter, we delivered $177 million in revenue, exceeding our guidance by $12 million at the high end and representing a 43% increase year-over-year. This was driven by 51% growth in our global diabetes revenue, including the onetime benefit of our go-direct strategy in Europe.

As we said last quarter, after years in the making, we had a significant number of initiatives coming to fruition in Q2.

Our team executed extremely well across all of them, resulting in our overachievement. We continue to make progress across our core strategic initiatives and remain laser focused on improving the lives of people living with diabetes.

Starting with innovation and market access. Since last quarter's full commercial launch of our next-generation platform, Omnipod DASH, we have had thousands of patients get started on DASH. Customer feedback has been superb. In an internal survey of our first DASH users, approximately 90% were very satisfied with the ease-of-use of DASH and would recommend DASH to a friend. The new DASH PDM was designed as a mobile app on a locked-down Android phone. There is clear customer appreciation for how intuitive the user interface is and how Insulet has advanced toward our vision of customers being able to control their pods from their personal smartphone.

DASH utilization is growing commensurate with our work to establish access and reimbursement. By the end of Q2, we had expanded U.S. coverage for DASH to approximately 50% of all covered lives. Also this quarter, more than 1/3 of our new Omnipod customers received DASH, and the vast majority of DASH was shipped through the pharmacy channel. We are working to continue to expand access in this channel because the pharmacy provides several advantages and a best-in-class customer experience for physicians, their patients and payers. Our focus on this channel is delivering results.

We ended Q2 of 2019 with 15% to 20% of our total U.S. customer base, receiving their pods through the pharmacy channel, up from 10% to 15%, previously.

There has been enthusiastic customer response on DASH's innovative pay-as-you-go business model. Omnipod DASH is the only insulin pump with no upfront charge and no 4-year lock-in period. We believe it is game changing to remove barriers to adoption for our stakeholders, and these efforts should drive more use of pod therapy. Patients who otherwise might not have afforded new technology because of the upfront cost or industry lock-in periods can now choose Omnipod. Because of its simplicity, low cost and low commitment, physicians can feel confident recommending Omnipod for more patients and earlier in the treatment pathway.

And on the payer side, we have reduced the risk and cost of member attrition. There are early indications that our DASH strategy is paying off. U.S. patient demand and new patient starts are at all-time record highs. We have established significant market access in a relatively short period of time. And physicians have told us they are now considering multiple daily injection users and Type 2 patients for DASH that they otherwise would not have recommended for pump therapy.

Thanks to its simplicity, discretion and ease-of-use, DASH is showing to be a particularly appealing and valuable technology for people living with insulin-dependent Type 2 diabetes.

We have launched messaging and educational initiatives to ensure that physicians and patients understand DASH's unique benefits for Type 2 users, and we expect this customer segment to continue to grow.

In addition to broadening access to Omnipod DASH, we continue to successfully secure expanded coverage for Medicare and Medicaid beneficiary. By the end of this second quarter, we expanded coverage to greater than 50% of all Medicare lives, up from just over 1/3 at the end of last quarter, and we ended Q2 with coverage for approximately 60% of all Medicaid lives, up from over half at the end of Q1.

The foundation we are building in terms of leveraging our powerful business model, building access in the pharmacy and moving Omnipod up the treatment pathway will all be advantageous for Omnipod Horizon when it launches next year.

We are making great progress with Horizon's clinical and product development and remain on track to start pivotals in the fourth quarter of this year. Omnipod Horizon will improve glycemic control with both hybrid closed-loop and personal smartphone control. Because Horizon's algorithm resides on the pod itself, users will benefit from an on-body, waterproof system that keeps them in closed loop without having to disconnect daily for activities like bathing or exercise.

This is a crucial differentiator from traditional tube pumps. It means that the pod is always in direct communication with the CGM. Omnipod Horizon System architecture is designed to provide more time-in-loop and more time-in-range.

At June's American Diabetes annual conference, compelling data was presented on Omnipod Horizon, in which study participants, children ages 2 through 6, were shown to spend significantly less time in hyperglycemia, spend significantly more time in the target glucose range and to have better overnight glycemic control compared to their usual therapy, which included MDI and sensor-augmented pump therapy. During the study, glucose control was maintained in the target range for 73% of the time overall and 85% of the time during the overnight period. This is a remarkable given the many challenges of maintaining proper glycemic control for children this young, and it is a powerful early indicator of the impact Horizon can have. We are aware of growing the off-label use of the loop algorithm. And while we cannot condone or support it, we want to make sure that this system is well studied and safe and effective for a broad population of users. We are working with Tidepool to get the DIY community's iOS-based loop algorithm and automated insulin delivery system cleared by the FDA and commercially supported in the marketplace on Omnipod.

This system, which will be accessed through the App Store from a user's iPhone, provides yet another level of convenience to insulin management. This is additive to our internal Omnipod Horizon program, and we are pleased to have the opportunity to support patient choice and the passionate and driven DIY community.

In addition to product innovation and market access, we continue to focus on strengthening our global footprint and solidifying our leadership position outside of the United States, where the addressable market is large and growing. Our direct operations in Europe has been in place for just over 1 year. And as a result of the market insights we have gained through our direct engagement with stakeholders, we are increasing our penetration in existing markets. Some examples of the team's successes include France, where today, the majority of all new patient starting pump therapy, are choosing Omnipod; and the United Kingdom, where approximately 20 clinics are now prescribing Omnipod regularly for the first time ever. We also have been awarded new tenders that are broadening access to Omnipod throughout our existing European markets.

We are well positioned to drive continued growth in our existing markets; to expand into new geographies where we see long-term strategic value and additional opportunities for growth; and to drive innovation, including the launch of DASH in 2020. We will focus on the significant opportunities in our existing markets during 2019 and expect to begin to expand our global footprint in 2020.

And finally, turning to operational excellence and our new U.S. manufacturing. In the second quarter, we began production on our first highly automated U.S. manufacturing line in Massachusetts.

While this ramp is a headwind to gross margin, we expect to realize significant efficiencies and gross margin expansion over the long term, given the lower landed cost of production. We remain on plan to install our second U.S. manufacturing line later this year and begin production in 2020.

This investment further supports our rapid growth, provides manufacturing redundancy and supports efficiency -- efficient and effective technology transfer of our new product innovation into manufacturing.

In summary, we've made significant progress on our strategic imperatives, including innovation, increasing market access, strengthening our global footprint and ensuring operational excellence throughout Insulet.

This focus and the team's great execution delivered another record quarter of revenue dollar growth.

In fact, Q2 marked Insulet's 4th consecutive quarter of greater than 20% revenue growth and our fourth consecutive quarter of positive operating income and net income.

With that, I will now turn the call over to Wayde.

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [4]

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Thank you, Shacey. As Shacey noted at the beginning of the call, we had another strong quarter as we continue to execute across our strategic imperatives. We are realizing improved financial results each quarter by accelerating revenue growth profitably as we scale, while remaining focused on carrying out our mission of improving the lives of people with diabetes through our innovative solutions.

In the second quarter of 2019, we had revenue of $177.1 million, representing growth of $52.9 million or 43%, which was $12 million above the high end of our guidance range.

By product line, U.S. Omnipod revenue grew 26% to $98.1 million, which was $7 million above the high end of our guidance range. This was the third quarter in a row of accelerating growth in the U.S., while managing the transition to pharmacy and the launch of a new product. This acceleration resulted from growth in our customer base, driven by expanded market access and the launch of Omnipod DASH, primarily through the pharmacy channel and the mix benefit of the premium from the shift to the pay-as-you-go model. In the quarter, we exceeded the high end of our guidance range because we're able to successfully navigate through the DASH launch and business model shift, including a no charge PDM. International Omnipod revenue grew 120% to $62.7 million, exceeding the high end of our guidance range by $4 million, primarily due to growing demand for Omnipod within our existing European markets and the benefit of our direct business model in Europe.

As a reminder, Q2 international Omnipod revenue growth reflects the final quarter of the year-over-year incremental 50% uplift in price in our European business from converting to a direct model.

Additionally, we have an easier comparison in Q2 due to the negative impact from the inventory buyback when we transitioned from our former European distributor in the prior year.

Drug Delivery revenue was $16.3 million, a reduction of 8% and $1 million above our expectations.

Turning to gross margin. We delivered 65.7% in the second quarter, down 30 basis points year-over-year and 120 basis points, sequentially. As we communicated on last quarter's earnings call, we guided to a sequential decline in gross margin in Q2, given the partial quarter impact of our U.S. manufacturing ramp.

As we increase production, we incurred certain period costs, including training and startup costs as well as working through the normal inefficiencies of a new plant start-up. We expect these headwinds to continue for some time as we add future manufacturing lines and establish the first manufacturing facility and capabilities for Insulet.

Operating expenses were 61.4% of revenue and increased 40% over prior year. R&D included an increase of 71.6% year-over-year as a result of accelerating investments in innovation and U.S. manufacturing period expenses prior to starting production.

We ended the quarter with operating income of $7.6 million, representing 4.3% of revenue, in line with full year expectations, and net income of $1.4 million, representing just less than 1% of revenue.

We ended the quarter with $372 million in cash and investments compared to $393 million at the end of the first quarter and $430 million at the end of last year, and we generated positive operational cash flow.

We continue to use cash for planned capital expenditures as we invest in our U.S. manufacturing and supply chain operations.

In summary, we are pleased with the acceleration of revenue growth, level of investment and profitability in the quarter. And we are confident this momentum will carry us through the second half of 2019. We are well positioned for continued revenue growth and profitability over the long term.

Next, an update on our 2019 guidance. As a result of our strong first half of the year and anticipated momentum through the rest of 2019, we are raising our guidance expectations for the full year by $25 million at the high end of guidance and $33 million at the low end. We now expect 2019 total revenue in the range of $700 million to $715 million, representing growth of 24% to 27%. By product line, we're raising our U.S. Omnipod revenue range to $391 million to $399 million, representing growth of 21% to 23%, up from our previous expectation of $376 million to $385 million.

This reflects our confidence in the strong growth of our customer base, given market access wins and record new patient starts.

We're off to a great start with our recently launched Omnipod DASH product, and this is fueling our already-strong growth. We continue to expect the PDM headwind of $6 million to $8 million for the full year, resulting from our no-cost DASH PDM, and expect this to neutralize during the year due to the mix benefit of new and existing users purchasing DASH pods at a slight premium. For international Omnipod, we are raising our revenue to a range of $246 million to $250 million, representing growth of 43% to 45%, up from our previous expectation of $236 million to $244 million.

This includes the higher year-over-year revenue growth in the first half of the year resulting from the Q2 2018 inventory buyback and our higher-than-expected customer base growth this past quarter.

We continue to expect normalized growth for the year in the midteens to low 20% for our international product line. We are in a great position to capitalize on our strong growth in our existing markets given our direct European presence.

Lastly, for Drug Delivery, we're raising our revenue to a range of $63 million to $66 million, representing a decline of 3% to 8%. This has improved from our previous expectation of $55 million to $61 million. For the third quarter of 2019, we expect to deliver revenue in the range of $174 million to $181 million, representing growth of 15% to 20%. This includes U.S. Omnipod revenue of $98 million to $102 million, representing growth of 20% to 24%. We also expect international Omnipod revenue of $61 million to $63 million, representing growth of 22% to 26%. Lastly, we expect Drug Delivery revenue of $15 million to $16 million, representing a decline of 15% to 21%.

For the rest of the P&L, we are reaffirming that we expect our full year 2019 gross margin to be relatively consistent with prior year. This reflects the benefit of going direct in Europe and continued operating and supply chain improvements and the mix benefit of the pay-as-you-go model, offset by headwinds from the ramp of establishing our U.S. manufacturing. We further expect gross margin for the second half of the year to be lower than the first half due to the impact of U.S. manufacturing ramp during the remainder of the year and into 2020. We also expect Q3 to be the lowest quarter in 2019, given the timing of period costs and ramp-up within the year.

As most of you are aware, we are developing a core competency within Insulet around operational excellence and best-in-class global manufacturing. It is a significant advantage to now have our own manufacturing operations colocated with our innovation teams. Manufacturing a product of this complexity at scale is difficult to implement and also to replicate. We're managing through the early ramp process and remain confident we will scale to our plan production levels to continue to serve our growing customer base.

We now expect 2019 operating expenses to increase approximately 25%, up from our prior expectations of 20%. Our change in estimate is a result of our higher revenue expectations for the year, resulting in the corresponding increase in associated variable costs and an opportunity to increase our investment in innovation. We still expect to deliver full year operating margin in the mid-single-digit percentage range, and we continue to expect capital expenditures to be relatively consistent with 2018, as we invest in U.S. manufacturing to drive redundancy, cost reductions and contributions to our margin expansion over the long term.

To wrap up, we are proud of the team's successful execution of our strategy and the performance we delivered in the first half of 2019. Looking ahead to 2021, we remain confident in our targets of $1 billion in revenue, gross margin of 70% and operating margin in the midteens. We have the right strategy and momentum to achieve these goals, and Insulet is well positioned to deliver long-term, sustainable growth and value creation.

I'll now turn the call back to Shacey for her concluding remarks.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [5]

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Thanks, Wayde. I speak on behalf of the entire team when I say that I am excited about the opportunities ahead for Insulet. Our financial outperformance in the first half of 2019 and continued execution of our proven strategy ensure we are in a great position to continue our strong track record of shareholder value creation.

Now I would like to turn the call back to the operator for Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Jeff Johnson with Baird.

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Jeffrey D. Johnson, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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Congratulations on the quarter and quarterback news, I guess. So 2 questions here. One, just on the mix of patients in the quarter, Shacey, are you seeing any increased mix to T2? Obviously, a little bit easier through the pharmacy channel to get a T2 coverage with DASH. So any change there or any change on competitive wins versus MDI conversions?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [3]

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Yes, I think it's a great question, Jeff. So the rate of competitive wins from MDI versus tube pumps pre-study, so still approximately 80% of our new patients coming from multiple daily injection. Where we have started to see some early indications of what I think is -- could turn into an exciting trend, is the Type 2 mix in our new patient starts on DASH. So there, we have started to see a tick-up, and it's too early really to call it a trend. But I think we are encouraged that our messaging and our focus on that population is starting to resonate with physicians and with users.

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Jeffrey D. Johnson, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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All right. That's helpful. And then Wayde, maybe a manufacturing question for you. I don't want to read between the lines too much on some of your comments. But are we seeing anything where manufacturing cost may be a little bit higher than initially expected? Or would you say the startup and the ramp-up costs are pretty much right in line kind of with how you are thinking? And just to make sure, what percentage of your U.S. demand can you service out of the U.S. manufacturing facility over the next 6 months to 12 months? Or I don't think there's any tariff issues to consider, but I just want to confirm that.

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [5]

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You bet, Jeff, so regarding manufacturing cost, they are right in line with our expectations. We have not changed our guidance for gross margins since the beginning of the year. And so very much in line. What I would say is, it makes it lumpy, right? As we manage through the volume, and we have a lot of scenarios running for volume between our legacy plant in China and our -- ramp-up of our new U.S. manufacturing here. And so as we work through that, we have lots to deal with, right? We have the period costs, period expenses as we initially start to ramp up. And then inventory made in U.S. manufacturing is at a higher cost because it's absorbing a lot more overhead across a very small -- in the beginning, small amount of volume. And so we put more product into inventory at a higher cost.

So it's going to take us a while to work through that. It's going to be lumpy. But having said that, we're right in line with our expectations. And the team has been working on this for several years. It's a big part of our strategy.

We get the redundancy from it. We also get long-term efficiency out of it. And so it's just something that we're going to have to work through here in the medium term and working through the financials. But at the end of the day, it's the right strategic move. And then regarding U.S. demand, we won't be at full scale for U.S. demand in the next 6 to 12 months. It will take longer than that. We'll have to get into our second line and that will come in 2020.

And then last, the third part of the question, if I caught it all, was regarding tariffs. And the team still is doing a great job mitigating the tariff impact, to date, it's immaterial, and that's why we're not calling it out to this point. And I think like everybody, we're waiting to get the details on the latest round of tariffs and what exactly those mean. But I think the team has done a really nice job here of mitigating to date.

And then although obviously not part of the strategy for U.S. manufacturing, it was driven by redundancy and increased capacity for the team. But as it turns out, once we do get to scale here in our U.S. manufacturing facility, we'll be able to serve the U.S. from the U.S., and the tariffs won't be an issue at all. So very happy with how our long-term manufacturing strategy is coming together.

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Operator [6]

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Our next question comes from David Lewis with Morgan Stanley.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [7]

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Congrats on clearly an inflection quarter. And Shacey, I wanted to start with, obviously, the U.S. inflection is where people are going to be focused tonight. So I wonder if you can give us more detail, Shacey. It's hard for you to move your business this quickly historically, but yet you did it. So when you think about the drivers of this particular quarter in the U.S., it greater access because of the pharmacies are just lowering access to getting on the system? Is it enthusiasm around DASH, payer access, would be helpful. And I just have a quick question for Wayde.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [8]

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Thanks, David. And really it is all of the above. I highlighted the pharmacy as really helping to improve the customer experience. Our strategic rationale for the pharmacy was that, combined with pay-as-you-go, it would be a better customer experience, that over time, it would be a more attractive channel for us, that you could lower barriers to adoption. And so I think what you're seeing is clearly, DASH is an appealing product for patients and for physicians. But this idea that physicians can now prescribe a product for a patient without having to worry so much about locking a patient in for 4 years, I really think that that's helping to change the way that both patients and physicians are thinking about Omnipod and this ability to prescribe it earlier and maybe for a subset of patients that you might not otherwise have done. And just a little bit more color, we're starting to see that in terms of the complexion of our user base. Starting to see more Type 2 users, certainly more Medicare H users, so that increased access there is also helping to expand the patient population.

So it really has combined the strength of the product platform, really the strength of the business model, the pay-as-you-go business model. And then the increased access, both in pharmacy and in Medicare and Medicaid, helping to drive that record new patient starts and installed base growth.

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David Ryan Lewis, Morgan Stanley, Research Division - MD [9]

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Okay. Very helpful, Shacey. And then Wayde, can you just give us the underlying ex U.S. growth this quarter adjusted for inventory and direct gross up? And any comparisons we should be mindful of as we head into the third quarter, which is really the first apples-to-apples quarter? How should we be thinking about second half ex U.S. growth on an apples-to-apples basis?

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [10]

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Yes, you bet. David, so the biggest impact for the Q2 growth rate and the sequential decline to our guidance is the process around converting to our distributor in Europe last year in Q2. And there's a -- basically boil it down into 2 big pieces. One on a positive note, we had the 50% price increase from going direct; and then also the challenge or disruption moving through the direct process where we have to buy back inventory as well as work through some tougher comps that were out there in Q2 last year, which become an easy comp for Q2 this year. So if you put all that together, normalizing it, it's about a 90% to 100% impact, David.

So you can think about working from Q2 to Q3, down about 90% to 100% just for the international transition. And other than that, really we -- when you look at our guidance range, at the high end, we're really anchoring that to the performance that we've had over the first half.

And so pretty strong growth. And that's really across both U.S. and all OUS regions. And then I think I would just add, for Q3, we're actually a little higher than we've talked about on a normalized basis.

So we've said several times and again in the guidance this quarter that we think the normalized growth rate internationally is high teens, low 20s. And looking at the guidance here for international, we're above that. And there's a couple of reasons. There's a small hangover from the disruption in Europe last year that gives us a slight increase. And then we've got good visibility into our pipeline in Q3, and it looks strong. And so we took the momentum, the strength of our pipeline and a small impact of a slightlier easy comp compared to Q3 last year, and that's what gets us to the 22% to 26% here in Q3.

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Operator [11]

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Our next question comes from Robbie Marcus with JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [12]

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Congrats on a really nice quarter. Wayde, maybe you good help us understand kind of similar vein of question that David just asked on international but for the U.S. If you stripped out all the price increases that we're seeing, you said there was a good portion of patients that were getting the higher-priced DASH in the quarter. What do you think underlying patient volume was in second quarter? And how do we think about that for '20

[Technical Difficulty]

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Operator [13]

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I do apologize. It looks like we did just lose the line of Robbie Marcus. We'll go on to the next question. Our next question...

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [14]

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Yes. Why don't we do that? Then when Robbie comes back in queue, please let us know, and then we'll get to his question.

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Operator [15]

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Until then, we'll take the next question from Joanne Wuensch with BMO Capital Markets.

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Joanne Karen Wuensch, BMO Capital Markets Equity Research - MD & Research Analyst [16]

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Two questions. The first one is the steps to the Horizon launch. You're talking about starting clinical trials shortly, and then it sounds like it's still on track for the end of next year. How do we get from clinical trials to full launch?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [17]

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Thanks, Joanne. Yes, we are excited. I think as we've said, with Horizon, we're focused on 3 areas. So the first is we're really focused from a development perspective on just ease-of-use and ensuring that we have a system that multiple daily injections users can transition to. We're focused on phone control, which all the market research indicates is going to be a game changer for our users. And then the third is we are focused on launching with a pediatric indication, which is why we are so excited about the data that was presented at ADA. So the work that's left between now and pivotals is to complete the commercial development of the product and then to enter into pivotals and achieve those outcomes that we're looking for.

We believe that we're going to benefit from the Breakthrough Devices designation at the FDA of an accelerated review, and we are hopeful that because we'll have entered pivotals with the commercial system, that we'll be able to either leverage that as a limited market release or do a somewhat protected limited market release and then move into full market release with the system. So our goal is to be on the market in the second half of next year.

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Joanne Karen Wuensch, BMO Capital Markets Equity Research - MD & Research Analyst [18]

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And then a question. And this is such a small percentage of your revenue, but I did want to ask about it. Drug Delivery was a little bit better or less worse, either way you look at it. Is there something just to call out there or just normal course of business?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [19]

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It's normal course of business. Our guidance for and performance for Drug Delivery is always based primarily on the forecast from our largest customer. So that's what that reflects, both from a guidance and performance standpoint.

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Operator [20]

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And Robbie Marcus has rejoined the queue. Our next question does come from him, Robbie Marcus, JPMorgan.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [21]

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And hopefully the second time will be a little better. Wayde, I just -- I don't know how much you heard. But I just wanted to ask kind of what David asked on underlying volumes and international growth. We know that DASH comes at a higher price. But without the PDM, it appears that there was a substantial portion of your underlying base that upgraded to DASH that didn't need to get a PDM. So just pure price increase year-over-year. Can you help us understand what the underlying U.S. patient volume growth was and how to think about the installed business growth for 2019? I know you gave the metric in '17 and '18. Just help us understand that this year.

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [22]

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Yes, you bet, Robbie, glad to have you back. So the customer growth is not significantly different than what we experienced overall. And a reminder, for DASH, it's a new product. And so for people coming on to DASH for the first time, our new patient starts, there isn't a price increase. But as you mentioned, we are getting some mix benefit on the premium of existing customers that move from another channel into the pharmacy and so -- where we don't have to give them a PDM. And so when you net all that out, we believe that our -- the PDM headwind as well as the benefit from it was just a slight unfavorable for the quarter and really not a material impact on our results, so netting the PDM headwind with the benefit of the mix and people moving on to DASH in the pharmacy. And so I think you can think about our growth rate as not significantly different from our overall customer growth, plus the mix or premium benefit of people moving onto -- or new patients onto DASH that we didn't previously have. Because they're not moving from another product, so we don't have a price increase on those.

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Robert Justin Marcus, JP Morgan Chase & Co, Research Division - Analyst [23]

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Great. And then if I think about guidance for the balance of the year, it seems like price headwind from the lost PDM and the benefit of DASH are offsetting each other to a degree. I don't know if you've commented on it, if there's any stocking in the pharmacy. When I look at guidance for the balance of the year, it does appear to have pretty decelerating trends from the second quarter.

So just help us understand if underlying volume growth is pretty reflective of the second quarter results, new patient starts don't have a huge benefit in each individual quarter. Help us understand what gets you to the slower growth in the second half.

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [24]

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Sure. Yes, you bet. Well, there's a lot there, Robbie, so I'll work through it. Let me know if I missed any of it. So regarding the PDM. So we had a pro rata. We talked about a pro rata amount over the 3 quarters, Q1 to Q4. As I mentioned, we had a slight unfavorable in Q2. We're assuming the same for Q3, and then we're still planning for a net neutral across 2019. So that assumes that as we accrue more patients in the pharmacy on DASH that we will start to offset the PDM fully here in 2019 and, on a net basis for 2019, be neutral.

So from a guidance standpoint, if you look at the high end of our U.S. growth rate for Q3, 24%, that's the same growth rate as we've had in the first half. So the way we're thinking about it is if we continue with the acceleration that we've seen in the first half, we'll end up the high end of our guidance. If we end up growing more like we did last year in 2019, which was still accelerating and doing very well, we'll end up more like the lower end of our guidance range. So it's really just thinking about how we've been accelerating through 2019 and how we're accelerating here in the first half of 2019.

And at either end of the spectrum, we believe it's strong growth. Having said that, we have a lot of things we're working through. Shacey talks a lot about years in the making. Well, we just had 1 quarter of managing through a new patients -- a new product launch as well as our shift in our business model. And the U.S. teams are doing an incredible job here, just working with them here for the past few months and seeing all that they're doing in the U.S. but they're also sharing capabilities and helping our European teams build capabilities and ramp up and then obviously getting pulled into U.S. manufacturing and all that has to happen to make our U.S. manufacturing run. So just an incredible amount of things happening here at the same time and very proud of the team, how we work through it and actually exceeded our expectations here in Q2. So that's what gives us confidence that we can hit the high end but also just being realistic that we're working through a lot of things. And frankly, if we end up at 20% in the U.S. at the low end of the range, that will still be above what we did all of last year in 2019.

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Operator [25]

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Our next question comes from Danielle Antalffy with SVB Leerink.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [26]

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Congrats on a really great quarter. Just a follow-up question as we think about the -- Shacey, to follow up on your commentary around better customer experience with DASH, et cetera. Can you talk about what that could mean? Or -- and maybe you already have some sense of what that has meant from an attrition perspective. Have you seen the needle start to move there? Or where do you think that can ultimately go over time with DASH and also, I guess, the -- going through the pharmacy?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [27]

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Danielle, I think it's a great question, and it's something we've been monitoring closely. We actually predicted that as we lower barriers to get onto the product that we could see attrition pickup. On balance, all of our analysis demonstrated to us that, that was the right decision because we were ultimately going to grow the customer base. And even if we end up with a slightly higher attrition rate, we'll be able to grow the customer base at a higher rate. There's no evidence this quarter that the attrition rate was higher. And so what we're seeing is early indications that our expectation that the customer base would grow in an accelerated way because of DASH and the business model, both how appealing the product was but also just how differentiated the business model was.

So I think early indications are good that we were right about the business model attractiveness. I think we're going to be watching the attrition rate very carefully just to see what happens as we lower these barriers to get onto the product. So stay tuned on that front. We'll certainly provide color as we get it.

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Danielle Joy Antalffy, SVB Leerink LLC, Research Division - MD of Medical Supplies & Devices and Senior Analyst [28]

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Okay. And then just one quick follow-up. Wayde, probably this one's for you. Lots of transitioning from a manufacturing perspective. Were you guys at all supply constrained here in the quarter? And did that have any impact on sales? Was that a headwind you might -- maybe actually could have done better?

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [29]

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Danielle, no, we're in really good shape from a supply standpoint, and that's part of the redundancy plan here. In fact, heading into the DASH launch, we built inventory. And heading into the Acton manufacturing ramp-up, we built some inventory just to make sure we're ahead of it. So we're feeling very good about the situation we're in from a manufacturing and supply standpoint.

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Operator [30]

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Our next question comes from Matt Taylor with UBS.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [31]

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So I just wanted to ask one question about Horizon. Just want to make sure that you are still targeting late 20. I don't know if you said that today. And when you think about combination systems, can you talk about your plans or ability to drive to other combination systems with other sensors in the future with the ACE designation?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [32]

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Sure. Thanks, Matt. Yes, I did confirm that we still plan to be in the market in the second half of next year, and we're on track to enter pivotals at the end of this year. And so I'm very excited about that progress. We do fully expect our system to be interoperable. And it's one of the rationales behind partnering with Tidepool that we have a system that can work with other algorithms, other sensors, et cetera. So we see the value in interoperability and are planning for that down the road. But at this point, our partner is Dexcom, and we're very excited about the value of Horizon with the Dexcom partnership, their sensor, which is terrific, and phone control.

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Matthew Charles Taylor, UBS Investment Bank, Research Division - Equity Research Analyst of Medical Supplies & Devices [33]

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Could you just talk about the trends that we're seeing in the pump market more broadly? Your competitor was talking about the accelerating trends. Clearly, you've had very strong growth here too. Can you talk about what you think the underlying growth for the market is and how that could be sustained over the next couple of years as these new technologies come out?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [34]

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Sure. Matt, we always say that the pump market is growing, and it has accelerated in the last few years, in part due to accelerating adoption of CGM. And as CGM has grown, that's been terrific for us because what happens is the patients get visibility to their glucose trends. They recognize that there are opportunities to get better control and then they look for tools to get better, tighter control. And Omnipod is obviously a big piece of that. So the increasing adoption of CGM has certainly helped to fuel the overall growth of the pump market. And in particular, Omnipod has been a big part of that too because the other thing that CGM does is get a patient comfortable with a wearable. And so that's one of the hurdles to Omnipod adoption that CGM growth has helped to address.

And of course, the vast majority of our patients are coming from multiple daily injections. So overall, we're helping to grow the category. We believe in the United States that the market itself is growing somewhere around 10% CAGR. And outside of the United States, in the markets that we compete in, which are primarily these more mature European markets, it's growing somewhere less than that, somewhere between 5% and 10%.

So nice growth overall and obviously, we're getting a bigger share of that market.

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Operator [35]

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Our next question comes from Margaret Kaczor with William Blair.

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Malgorzata Maria Kaczor, William Blair & Company L.L.C., Research Division - Research Analyst [36]

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First off, thank you, guys, for all the helpful metrics on the front of the call. That was helpful. Maybe just a follow-up on some of those. As you guys have gained some of the new coverage for DASH, you're at 50% now, I think is what you referenced. Should we assume that these are all under pharmacy and inclusive of the Type 2 patients? And then as we see kind of that mix benefit start ticking up higher, why shouldn't we see that continue to benefit numbers if you're about 15% to 20% of patients on pharmacy today?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [37]

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Thanks, Margaret. So DASH is covered both on pharmacy and DME but the vast majority of the coverage today is through the pharmacy. So obviously, we've spoken in the past about the reduced barriers for adoption in the pharmacy, particularly for the Type 2 patients. And so that's true for the vast majority of the coverage that we established for DASH users in the pharmacy.

In terms of acceleration of adoption, I would expect that DASH adoption will accelerate, commensurate with the establishment of access, and we're starting to see that already. As I think Robbie mentioned earlier, it takes a long time for us to move the needle on the overall base, but we're seeing indications already in new patient starts, where we obviously ramped access throughout the quarter, but we landed the quarter in 1/3 of our new patient starts being DASH, and so that's an indication of -- kind of an early indicator of where adoption is going. So that's exciting from our perspective. I think the early indications are very strong.

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Malgorzata Maria Kaczor, William Blair & Company L.L.C., Research Division - Research Analyst [38]

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Okay. And part of the question was kind of understanding the revenue model because as you guys get mix benefit, maybe going from 1 channel and maybe having more direct control of that patient yourself and maybe moving some of the existing installed base into that channel, why shouldn't we continue to see that again going into the second half of this year and into next year? And then just kind of on a Type 2 side, any kind of update of your coverage there with any notable changes maybe either that happened this quarter or going forward?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [39]

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Yes. I think we would expect to see that continue to grow in that tailwind as we head through the rest of this year and going forward as we transition into the pharmacy. That was part of the strategic rationale, but it was a more attractive channel for us, for the patient, for the physician, et cetera. And the same thing is true for Type 2, which is why I shared that in my opening remarks that we expect that population to continue to grow, as we establish access in the pharmacy, that is a great channel for people living with Type 2 insulin-dependent diabetes to access Omnipod. And so as we establish more access there, we do expect that population to grow as well.

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Operator [40]

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Our next question comes from Jayson Bedford with Raymond James.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [41]

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Just a couple of quickies here. I wanted to ask about U.S. growth. Is there any way you can comment or quantify the number of new prescribers, meaning an expansion on the prescriber base, if that is indeed a source of the faster growth you're seeing?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [42]

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Thanks, Jayson. We don't -- we haven't shared that in the past. I will say we track both new prescribers or new clinics as well as penetration into our existing clinics, and both are increasing significantly. So we are getting -- I guess to put it in a more colloquial term, we're getting more same-store sales and more new store sales both across the board.

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Jayson Tyler Bedford, Raymond James & Associates, Inc., Research Division - Senior Medical Supplies and Devices Analyst [43]

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Okay. And then when do you expect to file for the ACE designation?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [44]

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We haven't shared that. We have said that we fully expect to take advantage of that pathway. But for us, it's really not necessary until we have additional sensors that are iCGMs. So we're not in a hurry, but it is part of our strategy for both Tidepool and likely Horizon.

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Operator [45]

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And our next question is from Ryan Blicker with Cowen.

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Ryan Blicker, Cowen and Company, LLC, Research Division - Associate [46]

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Maybe just starting with the installed base growth. Do you still expect U.S. installed base growth in 2019 to be consistent with revenue growth? And similar question for international. I guess given the higher second half guidance, do you now expect the international installed base to grow at least in the low '20s per year? Or is it still in that range that you mentioned previously?

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [47]

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Sure. So this is Wayde. I can start Ryan. The -- we're assuming that the installed base is growing similar to the overall sales growth rate. And it's a bit of a tough number to gauge right now because it bounces around a little bit. But at this point, we don't see a significant deviation. And just one clarification there is I think a lot of people think about the change in pricing in DASH. But for people who are new to DASH, that were not on a product before, it's not a price increase because they are new to DASH and are not moving from anything.

So although we are getting a premium for the pod and -- with DASH because it's primarily in the pay-as-you-go model that, that is an uplift to our overall average selling price but it's not a price increase for us.

From an international standpoint, we think it's going to -- the customer base should also grow on that high teens, low 20s growth rate. And so that's our expectation as the primary driver for growth in the region.

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Ryan Blicker, Cowen and Company, LLC, Research Division - Associate [48]

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Great. Okay. And then just sticking with international. You talked about starting some new market expansion in 2020. It doesn't sound like it will be any major new markets. But how should we think about that maybe that incremental growth off of that high teens to low 20s base that you've talked about. Could it be significant? Or should we think about it as only a slight incremental benefit to 2020.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [49]

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Thanks, Ryan. Yes, I think, for us, the business model is all about the long term. So any one market in any given year isn't going to be a major contributor at all. It's really all about retaining and building that business and that customer base over the long term. So we really want to be thoughtful about that. I wouldn't expect it to be a significant contributor at all in 2020. It's really about the long-term story and how that can contribute over a number of years.

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Operator [50]

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Our next question comes from Ravi Misra with Berenberg Capital.

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Ravi Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [51]

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Can you hear me, okay?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [52]

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Yes.

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Ravi Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [53]

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Shacey, just one question on Type 2, and then I had a follow-up for Wayde. So on the Type 2 commentary that you mentioned, can you just help us think about, do these patients have the same reorder patterns as Type 1? And kind of how does this early success it seems fit into your strategy with some of the more concentrated insulin delivery systems that you're working on?

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [54]

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Yes, I think it's a great question. So there's no indication really that utilization or reorder patterns differ with the Type 2 insulin-dependent patient versus Type 1. But again, it's really early days. So we're just starting to see indications of strength in this patient population, in our new patient starts.

As we gather a larger base over time, we'll learn more about utilization and retention and reorder patterns in that base.

As it relates to concentrated insulin, making great progress there. I think we had mentioned either at ADA or the last call that we have submitted U-500 to the FDA. And that has never -- we never really intended that to have a major contribution to revenue. It's more of a niche product. U-200 probably has more potential. But we have also been saying for about a year now that market research and now this early experience with DASH is showing us that concentrated insulins will be helpful but definitely not required to see significant growth in the Type 2 insulin-dependent patient population.

And in fact, with Omnipod's ability to reduce the total daily dose of insulin and with how appealing the product is from a simplicity and discretion standpoint, we probably have access to the majority of people living with insulin-dependent Type 2s. And we're certainly making an effort to demonstrate the value of this technology in that patient population today and not wait for concentrated insulins, those come to market.

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Ravi Misra, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [55]

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Great. And then Wayde, just one for you. Just maybe a little bit accounting language. But just curious, as you kind of flow through the PDM or give that away or phase that out, just curious how should we think about the warranty expense associated with that? And then is that built into your kind of 3-year targets around that 70% gross margin approaching? Or is that incremental upside?

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Wayde D. McMillan, Insulet Corporation - Executive VP,CFO & Treasurer [56]

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It is built-in. And we would assume, depending on the experience level. So as our experience levels change, then we change our warranty accrual. But we wouldn't see it as upside or benefit because we accrue the warranty at our cost of goods sold, and that's still what we're issuing the product at. So we don't see a change to the warranty materially as a result of the new product unless our experience factor changes on the new product. And it's early days on that, so we don't have an updated estimate.

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Operator [57]

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Our next question comes from Suraj Kalia with Northland.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [58]

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Congrats on a nice quarter. Shacey, let me start out with ADA. And one of the things that at least on a fundamental level, we all kind of try to understand the competitive advantage rendered with any of the closed-loop systems. TIR for, I think, Control-IQ was 71. You guys have preliminary data at 73. Medtronic seems to be in that ballpark. I guess where I'm headed, Shacey, I'd love to get your thoughts. Would you think -- and this was also raised at last year's ATTD about the clustering and the relative lack of advantages. I'd love to get your thoughts what do you think is the key thing that needs improvement? Is it the pump? Because you did mention the architecture of Omnipod. Is it the algorithm? Or is the CGM? Where does -- there seems to be a disconnect somewhere in terms of 1 system breaking free from the remaining.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [59]

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Thanks for the question, Suraj. I would say that 73% time-in-range, especially in children, which is a very, very challenging population, ages 2 to 6, that's a remarkable improvement from average time-in-range today. The average person living with Type 1 diabetes, I think, is sitting in the 40s, maybe 50% time-in-range. So this is a marked increase that automated insulin delivery and the addition of great sensors and algorithms and great pumps are bringing to the community, and it will make a difference in terms of outcomes and quality of life. When I think about a breakthrough system, actually it would come down to ease-of-use because all of these systems in well-controlled clinical trials are going to deliver great outcomes. But what's going to actually deliver great quality of life and great outcomes in the real world is just how easy these systems are to use.

And that's one of the reasons why we focus so much on the MDI user, on ease-of-use and on phone control, which we think can help drive more adherence, more convenience and more ease-of-use. So that's really where we focused, and where we think we can get differentiation and kind of breakthrough to use your words.

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Suraj Kalia, Northland Capital Markets, Research Division - MD & Senior Research Analyst [60]

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Got it. And finally, Shacey, in terms of -- and I know a number of comments were made, 1/3 of the patients, please correct me if I misheard it, 1/3 of the new patient starts had DASH. The other thing I heard was a number of DASH patients were T2s. Can you parse out what percent of your new patient adds were T1s versus T2s? I guess just trying to put our arms around the current penetration of T1s in the U.S. Tandem obviously gave some numbers. Medtronic, we know. You guys, we have some rough idea. But I'd love for you guys to parse out T1s and T2s, and see the level of penetration, especially within T1s. Congrats on a great quarter.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [61]

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Thanks, Suraj. Yes, we don't break that out but I will say that this was a, as I mentioned, just an all-time record high for us in terms of new patient starts. And so we did have great adoption across both Type 1s and insulin-dependent Type 2s. It was just notable in the DASH population that T2s had ticked up significantly in new users, and that was an interesting leading indicator we're going to tell everybody if it turns into a trend.

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Operator [62]

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And I'm not showing any further questions at this time. I would now like to turn the call back over to Ms. Shacey Petrovic for any further remarks.

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Shacey Petrovic, Insulet Corporation - President, CEO & Director [63]

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Thank you, and thanks, everyone, for joining us on today's call. We are building just great positive momentum from a strong start to the year and delivered better-than-expected results in the first of 2019 and now expect a stronger second half finish.

None of this progress would be possible without the tremendous Insulet team around the world who works day in and day out to improve the lives of people living with diabetes. Thank you all for your hard work and dedication to our company and to all of us impacted by diabetes.

With that, I look forward to updating all of you on our continued progress in the months ahead. Thanks and have a great evening.

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Operator [64]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program, and you may all disconnect. Everyone, have a wonderful day.