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Dexcom Inc
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Welcome to the DexCom Fourth Quarter and Full-Year 2018 Earnings Release Call. My name is Adrienne and I'll be your operator for today's call. At this time, all participants are in a listen-only mode. Later, we'll conduct a question-and-answer session. [Operator Instructions] Please note this conference is being recorded.
I'll now turn the call over to Matt Dolan, Vice President, Corporate Development. Please go-ahead, sir.
Thank you, operator, and welcome to DexCom's fourth quarter 2018 earnings call. We will begin our prepared remarks with Kevin Sayer, DexCom's Chairman, President, and CEO, who will provide a summary of the quarter and fiscal year. This will be followed by a review of our financials and 2019 outlook from Quentin Blackford, our Executive Vice President and CFO; and then a strategic update from Steve Pacelli, our Executive Vice President of Strategy and Corporate Development.
Following our prepared remarks, we will open up the call for your questions. At that time, we ask the analysts to limit themselves to one question and a follow-up so we can provide an opportunity for everyone today.
With that, let's review our Safe Harbor statement. Some of the statements that we will make in today's call may constitute forward-looking statements. These statements reflect management's intentions, beliefs and expectations about future event, strategies, competition, products, operating plans and performance.
All forward-looking statements included in this presentation are made as of the date hereof, based on information currently available to DexCom, and are subject to various risks and uncertainties, and actual results could differ materially from those anticipated in the forward-looking statements.
The factors that could cause actual results to differ materially from those expressed or implied by any of these forward-looking statements are detailed in DexCom's Annual Report on Form 10-K, quarterly reports on Form 10-Q and other filings with the Securities and Exchange Commission. Except as required by law, we assume no obligation to update any such forward-looking statements after the date of this presentation or to conform these forward-looking statements to actual results.
Additionally, during the call, we will discuss certain financial measures that have not been prepared in accordance with GAAP with respect to our non-GAAP results. The presentation of this additional information should not be considered in isolation or as a substitute for our results or superior to results prepared in accordance with GAAP.
Please refer to the tables in our earnings release and the Investor Relations portion of our website for a reconciliation of these measures to their most directly comparable GAAP financial measure.
Now, I will turn it over to Kevin.
Thank you for joining us today as we discuss our year-end results. Simply put, 2018 was an incredible year for DexCom on several fronts. First and foremost, we broke through $1 billion in annual revenue. Very few, if any, medical device companies have reached the $1 billion revenue mark while growing revenues organically at greater than 40% year-over-year.
Clearly, the fourth quarter exceeded our expectations, delivering growth of over 50%, compared to the same period a year-ago. The company also posted its most profitable non-GAAP fourth quarter and full-year on record as we continue to focus on growth while demonstrating leverage. Beyond the numbers, we received FDA approval for our G6 system in late March.
With G6 becoming a Class II system and being the first to meet the agencies newly established special controls for iCGM. We launched G6 in the U.S. around mid-year and continue to roll it out to additional markets globally. Initial patient feedback for G6 has been outstanding. G6 has truly redefined best-in-class CGM and provide this with a platform that we believe will drive continued growth opportunities for DexCom.
Beyond G6, we saw significant increases in adoption in both the Medicare and International markets, both of which remain significantly underpenetrated. We advance our inoperability in decision support initiatives, including the acquisition of TypeZero and we solidify our product pipeline by amending our agreement with Verily; and strengthen our balance sheet with a convertible note financing that we did late in the fourth quarter.
All of these accomplishments have positioned us for continued success in 2019 and beyond. The team at DexCom is working incredibly hard for these achievements and I must recognize all of the effort needed to make this happen. The organization is achieving milestones that few companies every do, which is gratifying and come to a significant dedication and determination from our team, but going forward, that will not be enough.
We must put the infrastructure in place for this businesses scale to its full-potential. This need in part drove the additional announcement that we made today. In light of our meaningful uptick and demand, we have set the aggressive internal goal to double our G6 production capacity by year-end. We need to expand our foot print dedicated to manufacturing within the Arizona facility, both to meet our G6 goals and in anticipation of a late 2020 launch of G7.
Similar to our scaling of manufacturing capacity, we have had to rethink how we build our customer facing infrastructure to better serve our rapidly growing patient base, not just for today, but also to build a sustainable infrastructure for the future.
We have therefore expanded and reorganized our customer support efforts, which includes an increase of resources on our new Philippines location, as well as outsourcing other functions through third parties. This move will provide the ability to serve our customers with the same high-level of quality that they have become accustomed to and grow in a much more efficient manner.
This expansion will result in organizational changes, including a reduction in certain staff at both our San Diego and Arizona facilities, despite an expected overall increase in employee numbers in these locations this year.
These types of decisions are always difficult as we’ve had to increase our support staff significantly over the past several years and have relied on such individuals to meet the demand of our customers. This is a necessary step to continue to adapt and further differentiate our business while maintaining our focus on the patient experience.
These changes will occur during a transition period and we have taken the necessary steps to ensure that they occur seamlessly as possible while being open with our employees and supporting those impacts over the next several months. Quentin will walk you through the financial implications in this effort.
To sum up, Dexcom continues to deliver strong results and our recent initiatives leave us well positioned to execute over the next several years.
I will now turn the call over to Quin for financial update.
Thank you, Kevin, as a reminder some of the figures that I will refer to on a non-GAAP basis in reconciliations to our GAAP results are available on our website. Today, we reported record worldwide revenue of $338 million for the fourth quarter of 2018, compared to $221 million for the same quarter in 2017 representing growth of 53% over the same quarter a year ago on both reported and constant currency basis. A clear acceleration that drove us to $1.32 billion in revenue for the year.
Sequentially, revenue was up 27% over the third quarter. This growth was driven by the sustained ramp in awareness that we saw building throughout 2018, particularly in our U.S. commercial business, which was the primary driver of the upside. Notably, this growth materialized despite a decline in revenue per patient, which was in-line with our expectations provided on the third quarter call.
As a result of our continued shift and channel mix, including continued growth of the international and Medicare businesses, as well as our proactive attempt to move commercial payer contracts into the pharmacy channel, we expected to see some overall pressure on revenue per patient.
Nonetheless, we realized accelerating growth throughout the back half of the year as we saw these headwinds begin to play out and delivered an outstanding 2018, and we’re particularly pleased with achieving 50% growth in our U.S. business in the fourth quarter. International sales in the quarter were consistent with our expectations and were up 72% of our Q4 2017 on a reported basis or 75%, excluding the impact of foreign exchange rate changes.
Consistent with the first three quarters of the year, our fourth quarter growth continue to be driven by our direct markets. Fourth quarter gross margins improved from the third quarter as expected to 66%, resulting in a gross profit of $223 million. Operating expenses were $387 million for Q4 2018, including a $218 million one-time noncash research and development charge related to the amendment of our Verily agreement.
Apart from this non-returning charge, fourth quarter operating expenses were $170 million, compared to $142 million in Q4 of 2017. This reflects an increase of 20% year-over-year and compares favorably to our 53% revenue growth in the quarter. For the full year, we realized growth of 44% for non-GAAP operating expenses, which adjust for the non-cash charge related to the amended agreement with Verily through less than half of that rate at 18%.
In addition to the better than expected revenue result, this organization did a great job of controlling spend in 2018 and delivered meaningful improvements in our profitability profile. Importantly, adjusted EBITDA, which excludes the impact of share-based compensation and the non-cash research and development fee was $86.3 million or 25.5% of revenue for the fourth quarter.
Demonstrating a profitability profile that this business is capable of consistently producing over time. Our non-GAAP net income was $48.9 million or $0.54 per share. We’re incredibly happy with the progress being made on the profitability front and remain comfortable with the long-term financial goals laid out at our Investor Day back in December of 2018.
We fortified our balance sheet having ended the quarter with nearly $1.4 billion in cash and equivalents, which includes roughly $700 million in net proceeds following our convertible note offering in share repurchase in Q4 2018. This offering provides the financial stability and flexibility we need to invest in our key strategic initiatives. We continue to have full availability of our $200 million revolving line of credit.
Turning to 2019, as we provided in early January, we anticipate full-year revenues of between $1.175 billion and $1.225 billion. This outlook assumes a higher rate of patient volume growth offset by headwinds associated with the decreased revenue per patient related to shifting channel mix. As you saw in our press release and as Kevin summarized, we announced a corporate initiative earlier today that will better position us to meet the increasing demands of growth in our business.
As a result, we expect to incur roughly $25 million in restructuring related charges that will primarily be incurred in the first half of 2019 and will be excluded from our non-GAAP financial results going forward. With that consideration, we anticipate the following full-year 2019 non-GAAP financial results. Gross margin improving to approximately 65%, operating margin increasing to approximately 5.5%, and adjusted EBITDA margin expanding to roughly 18%.
We have included a reconciliation of GAAP versus non-GAAP results on our website, as well as a historical trend presenting non-GAAP financial results on a consistent basis for comparability purposes.
With that, I will now turn the call over to Steve for a strategic update.
Thank you, Quentin. The continued roll-out of G6 remains a primary strategic priority for DexCom at the outset of 2019. In the U.S., we plan to begin shifting G6 to our Medicare patients in the near-term and we have multiple U.S. introductions planned for the balance of the year. 2018 was a year of great progress for our insulin delivery partners and we look forward to the launch of Tandem’s Control-IQ system later this year, which includes our G6 sensor platform, as well as our recently acquired Hybrid Closed Loop algorithm from TypeZero.
We are excited about the continued progress we are making with Insulet on the Horizon platform, as well as Lilly as they look to bring both connected pumps and pens to market. Our smart pen and integration program with Novo Nordisk continue to advance since we announced that partnership in October. We will continue to push these and other collaborations forward in 2019 and expect to see Dexcom integrated smart pen systems that are commercially available in 2020.
As many of you saw in November, we amended our collaboration agreement with Verily strengthening our product development goals and further aligning our interests as we work toward the commercialization of a fully disposable real-time CGM. This amendment eliminates all future royalty payments, significantly improving our long-term profitability outlook.
Our next generation or G7 system remains on track for a late 2020 or early 2021 release. With G7 on the horizon, we continue to collaborate on pilot efforts in the non-intensive Type 2 population working with United Healthcare, Onduo, and others as they utilize CGM as a core tool in programs to drive health and economic benefits for people with Type 2 diabetes.
In addition, we are on track to kick of studies this year for applications in both the hospital and gestational markets. Both of these represent new markets, in which uncontrolled glucose presents a major impediment to patient health and an economic burden to health system.
While we remain in the early stages, we are well positioned to leverage G6 as a platform technology that enables us to answer key questions and determine next steps. We look forward to providing updates as these studies progress. As you can see, we continue to drive a number of importance strategic initiatives and we are excited about the pipeline and market expansion opportunities ahead.
With that, I will pass it back to Kevin.
Thank you, Steve. 2018 will stand as a year of historic milestones for DexCom and in diabetes technology in general. Our outlook for 2019 contemplates the growing awareness and the value of CGM. Our leadership position based on G6 technology, the increasingly competitive landscape, and our own proactive moves to optimize distribution channels and position Dexcom for long-term operating efficiency. Given the growing awareness of the benefits of CGM and our accelerating growth throughout 2018, we enter 2019 with excitement around the opportunity that lies ahead.
I would now like to open up the call for Q&A. Matt?
Thank you, Kevin. As a reminder, we ask our audience to limit themselves to only one question with a follow-up. If you would like to ask additional questions, please requeue and we will attempt to address as many as possible in the time allotted. Operator, please provide the complete Q&A instructions.
Thank you. [Operator Instructions] Our first question comes from Jeff Johnson from Baird. Your line is open.
Thank you. Good evening guys, can you hear me, okay.
Yes. No problem.
Alright, great. Thanks for taking the call. I’m sure there is going to be some revenue questions and things like that, so I was thinking I was going to be deeper in the queue, so my question is pretty simple, just if you heard anything from Medicare on any kind of updated hospital CGM use initiatives that they could be looking to put in place that you guys could participate in over the next year or two?
Jeff, this is Steve. Nothing specifically in terms of programs, but we are aware that CMS has a particular focus on glucose control in the in-patient setting that we think will absolutely lend itself to that business evolving in the relatively near-term. You’ve heard mention before of readmissions as a result of poor glucose control, not being paid for. We’re seeing hyperglycemia as a new focal point for CMS and then you should expect that that would obviously trickle down into the core commercial payers as well. So, it’s a pretty exciting opportunity, it’s still yearly, but we’re all over it.
And then Quentin, you know we’re two months into the quarter and obviously the 2019 guidance looks to a lot of us to be at least somewhat conservative here, just any kind of updates on gating and should we be thinking of kind of higher first half growth versus second half or just how we should be setting up models at this point? Thanks.
Yes. We feel good about where we’re at as we start into 2019 here. I think just given the tougher comps that we are up against in the back half of 2019 given the accelerating growth we saw over the course of 2018, you naturally would see lower growth rate. So, I think you should expect higher growth rates in the first half lower than the back half.
In terms of the cadence, I would just point out we would expect the seasonal trends in the business to reflect more of what we saw in 2016 and 2017. 2018 was a year of tremendous acceleration and the growth profile over the course of the year, which caused the seasonality trends to look a little bit different. So, I think – thinking about 20% or so of revenue in the first quarter, which is in-line with 2016 and 2017 is probably the right way to think about it.
And our next question comes from Margaret Kaczor from William Blair. Your line is open.
Hi. Good afternoon guys, thanks for taking the questions. Maybe just to start off with just a follow-up on the guidance question, you guys obviously delivered to 2x the original 2018 growth guidance. So, as you look at 2019 and the assumptions that you guys made, how do those defer this year relative to last year, including kind of third risk weighting as you are looking into last year relative to this year?
I think as you go back to the beginning of last year, we laid out some of the headwinds that we anticipate it may show up in the business over the course of the year. I think when you look start to look back at that those headwinds did in fact show up, but they showed up much later in the year than what we originally anticipated. So, we were very clear early on. We expected that there could be revenue per patient headwinds in the business. We didn't start to really see those until the third quarter and then really a full quarters worth in the fourth quarter.
So, I think we were contemplating all the right things as is the timing of when they started to be impactful is probably a little bit later than we originally expected. When I think about 2019, we’re approaching the year in a somewhat similar manner with respect to how we think about the revenue by per patient headwind that we know are in the business although what’s different now is, we know they are playing out. We saw it in Q4, we expect they are going to continue to play into 2019, and so when you look at the absolute dollar growth in our guidance, we’re guiding to about $150 million to $200 million of absolute dollar growth, but we’ve been clear there’s about $100 million of revenue per patient headwinds in that guidance.
So, if you were to normalize back for that, you’ve actually got a gross increase of about $300 million over the course of the year, which is more or less right in line with what we just delivered in 2018. So, the absolute dollar growth is pretty consistent. The growth rate is coming down obviously on a much more difficult base that we're growing off of, but I think it starts to make a lot of sense when you look at it that way.
Okay, that’s helpful. And then just kind of, I guess a little bit going on that thing as a follow-up, can you guys give us an update on the [percent-lives] that are under pharmacy rate now? I think it was about 20% last quarter, and then as you are seeing that grow as a percentage of the mix coverage, have you seen any change in terms of the patient ad mix driven by pharmacy yet and how do you expect that to ad plays out throughout 2019?
I’ll take that Margaret. This is Kevin. Our covered lives were over 50% now, slightly above that, and again let me remind you just because we have recovered lives over 50 it doesn't mean they all processed through pharmacy, most of our pharmacy plans have a dual benefit with DME and pharmacy. And it’s up to us to drive awareness of physicians and patients and also, they can be covered through that vehicle. We expect that to continue to accelerate over the course of the year.
We’ve had some very good discussions and some wins, you know at the local, regional and national peer level over the past several months and have some really exciting things untapped going into 2019. And I think as Quentin talked about earlier, channel mix, we are expecting channel mix to ship in that direction. We see a tremendous opportunity for patients as they can pick their product up in the drugstore rather than call us and go through the DME process, which is alive and well in the first quarter, we’re in a much better position. So, we're definitely driving and shifting the business there and encouraging our field team to do so as well.
And our next question comes from Raj Denhoy from Jefferies. Your line is open.
Hi, good afternoon. Wondered if I could ask about the international performance and again very strong in the quarter, are there other countries contemplated in the near term in terms of establishing reimbursement or just still mostly coming from Germany and some of the markets you're already in?
Yes. The growth in our guidance is primarily coming from the existing countries that we are operating within. I think we’ve talked about the fact that we're seeing opportunities open up into countries like Japan, Korea where there’s been regulatory approval more recently. We don't expect those to be big contributors to the overall revenue number in 2019 and I think we will let the product get into the market and see how it performs and then we can start to think about how it becomes additive to the overall numbers, but it’s all incremental opportunity as far as we're concerned when we look at into the future.
Are there specific countries here that you’ve targeted here for 2019 where you expect to establish more routine reimbursement that could be larger contributors? I think in the past you mentioned UK and some other large markets that might open up?
We’re certainly making progress in the UK. We continue to make progress in Italy. There are a couple of geographies where there are large government funded CGM initiatives, where they are announcing funding over several years and expanding the available population where CGM is available. For example, many of these countries will fund CGM for [indiscernible] only and now they are saying, okay we will expand this to adults and cover more, so we will take advantage of those opportunities. They are a competitive bidding situation, and so I'm not going to go into those details and say where they are all are, but we will aggressively pursue those opportunities.
We had a situation, for example, in Australia several years ago where they opened up for bid and said, they were going to cover not even 10 million in CGM, and within 60 days, we had eaten up pretty much that entire budget as patients flocked to DexCom CGM. So, we take advantage of those opportunities rapidly and we’ll take care of the advantage of those where we can next year.
And our next question comes from Steven Lichtman from Oppenheimer. Your line is open.
Thank you. Hi, guys. You’ve talked in the past that your discussions with payers revolve around the pharmacy of course and I think also extending into the intensive Type 2’s, I want to ask about that second opportunity, how much progress are you making on getting coverage for intensive Type 2 and could that start becoming more of a revenue contributor this year?
We think it will become more of a revenue contributor. The Medicare coverage decision has been helpful, but it takes a while to get that Medicare coverage decision pushed down to all the individual players and expand access. A lot of this is in conjunction with all of our pricing and overall access discussions as we ask our access to more patients than what is the pricing model, what is the business model for these people. And so, all of these variables are unplanned and they’ve been – we've been talking to all of them.
We believe we will increase our Type 2 intensive access. I’d love it to be faster than it is. But in all candid with Medicare Type 2 intensive insulin access you have a very large portion of the Type 2 insulin intensive using population covered already. We just need really to increase awareness within patients and physicians that they can have access to that technology now under Medicare coverage.
Got it. And then as a follow-up. Will we potentially get any update on the United non-intensive study in outcomes there this year?
Again, we’ve said this before Steve. It’s not really a – don’t think of it as a study with a principle investigator and something that is going to be published into a Medical Journal. This is real world. The work we’re doing, not just with United, but on a number of fronts on the Type 2 non-intensive kind of Type 2 non-insulin taking patients is really real world, they have become as real world, but very reasonably large pilot studies. And frankly, the last thing you guys want to do is share their findings with the rest of the world.
If these guys are all competitors and they hold this data and the programs that are evolving out of these pilots to be very proprietary. And so, I don't think you're going to see or certainly we're not going to be permitted to publish anything about the United pilot and I can't imagine United is going to be too vocal about it. So, I think the answer is probably not.
And our next question comes from Danielle Antalffy from Leerink. Your line is open.
Hi, good afternoon guys, thank you so much for taking the question. Just curious and I guess it’s more specific to Europe right now than the U.S, but any change in the competitive landscape that you’re seeing? I mean, obviously it’s not impacting your growth trajectory. That’s the first question, specifically as it relates to the updated Abbott product? And then the follow-up question I have is, how do we think about pricing longer-term in the U.S.? So, I appreciate what you're seeing here for 2019, is it right to think that that sort of pricing headwind will repeat itself each year and get incrementally worse or is this kind of like at and we’re at the bottom for price increase guys? Thank you so much.
This is Kevin. I’ll try and take that Danielle. That’s a very good question. With respect to competition, we take competition seriously all the time. While it hasn't slowed on our growth trajectory, I would say if anything our vision and our focus on the competitive environment is much greater than it has been before and as we design our products and our future pipeline, we want to take advantage of those things that we do well to continue to forward competition.
With respect to pricing in the U.S., as Quentin often says, pricing by channel for us has remained relatively consistent, but as we move more business into other channels, for example the pharmacy channel and currently the Medicare channel has lower price than we recognized in the past. We’re preparing as we talked in our Analyst Day over the long-term to be a viable competitor in the pricing environment whatever it turns out to be.
We talked about doubling the capacity of our Arizona factory for G6. We talked about building at the G7 lines. As we look at our cost profile going forward, we’re preparing for whatever the market brings. We believe CGM is a very valuable technology and the fact is what we’ve seen in Europe so far is the reimbursement as the reason to recognize the value of our technology over others on the market and we continue to get a premium price.
We will work to those models. We will work to those models in the U.S. We will grow and adapt to where it ends, but we do think our product with its accuracy, its performance, its connectivity and its features has been worthy of the premium price that we have received and so far, the payers have been amicable to that. That being said, as we’ve also talked about, if we can increase access and make it easier for patients to get and decrease our operating expenses through better channel mix, we’re all for it and we will take advantage of those opportunities as well.
Yes. Danielle I would just add. I think, we’re so early in the opportunity of converting folks from traditional finger sticks to CGM that the opportunity in the way of volume growth from the adoption of CGM technology is so significant that while there is going to be revenue per patient headwinds over time, I think the volume opportunities significantly more out ways any of those headwinds, and I think as you open up some of these other markets that go beyond the intensive world of diabetes you may see a different revenue per patient profile there, but the volume numbers again are so significant that I think there’s tremendous runway in front of us from a growth perspective for years to come.
Got it. Thank you so much guys.
And our next question comes from Kyle Rose from Canaccord. Your line is open.
Great, thank you very much. Can you hear me alright?
Yes.
Great. Just wanted to dig back into the product cadence here over the course of the next 12 months to 18 months, I mean obviously the G6 roll-out globally and in the Medicare is a priority, I think you reaffirmed the G7 timelines for late 2020 or early 2021, I’m just kind of wondering is there anything that we should be expecting over the interim period there, whether it be the lower cost transmitter, you know G6 professional version, potentially getting an extended wear time on the G6, just kind of help us understand what some of the near-term of product milestone may be? And then I just have one more question on longer-term margins.
That’s a great question and certainly a fun one for me. We always look at interim improvements of our product. If you look at everything we’ve ever done, every generation we launch we come with – for example with an algorithm that significantly improves performance. Not long after we launch because once we have all this data, we can really go model and figure out where it is. So, we are exploring new algorithms with our G6 technology. We are also exploring longer wear time.
We have the caveat around meeting iCGM standards with our longer wear time. We got to make sure we can meet iCGM standards for that full longer period whatever that may be. We do have the lower cost transmitter that will be out certainly in broad scale during the second half of 2019. We’ve got talked through the inventory they have now, but that will certainly be a cost reduction and help for us and remember, one of our key features and differentiators is the patient experience and our ability to iterate through software changes. We are really focusing tremendously on software development and offering our patients a better experience and better tools to manage their condition.
Certainly not tomorrow, but as we look at the TypeZero acquisition and the tools they’ve developed for decision support and offering patients information to manage our condition better, we intend to bring those tools to market. If we can get them done with G6, we will get them done and get them in there if we have to wait till G7, we will do so, but make no make no mistake about it, we want to make this patient experience more meaningful and better for them each and every day.
Thank you. And then from an operating perspective, I mean obviously taking some near-term charges to expand some of the operations internationally, but maybe Quentin can you kind of help us understand how we should think about going to a lower-cost region when you’re building on some of those operational capabilities just how that should impact margins over the long term and then any CapEx guidance this year as you invested manufacturing the capacity?
Sure. I think consistent with what we kind of talked about back at our Investor Day in December, gross margin expectations for us are to continue in that mid-60s range over the next five years or so. There is several levers that will allow us to improve that in terms of taking cost out of the product, including this lower cost transmitter that we expect later in the year, but we also assume that there is going to be lower revenue per patient headwinds that we're going to be dealing with as well. So, I think the cost savings will ultimately offset – those benefits will offset the headwinds that come from the lower revenue per patients.
So, think about that as being relatively consistent with where we’re at now and if we can deliver or execute better than great there’s upside to it. I think one of the big areas of opportunity and Kevin hit on it is really focusing on how we double about capacity over the course of the year. We see tremendous opportunities in the markets in front of us. Markets that were not yet in, but believe there is real potential to be in and we want to make sure that we have the capacity to address that.
So, you're going to see some significant CapEx spend over the course of this year well north of 100 million to build out automated lines, stand up incremental clean rooms in our Mesa facility, and ensure that we’re building out capacity just as fast as we possibly can. So, I think that’s the way to think about it. In terms of operating margin, cadence, we laid out a plan to get to 15% over a five-year horizon. That’s roughly 300 basis points a year.
We’re not committed to 300 basis points necessarily each and every year, but I think we're making great progress towards here in 2019 with our guidance that delivers roughly 200 basis points and that’s in the midst of a year that we’re incredibly focused on getting G7 far down the pathway and getting that to market in late 2020, as well as the fact that we laid out this of reorganization today.
And I think it’s important that we all understand, you know we are committed to ensuring that the patient experience is a good one through this transition, and therefore we’re not looking at any reduction in workforce along the way until we’re performing at the equivalent or better levels than where we are performing in the company today, and then resources can start to come down.
And so, you got a better cost in the P& L this year that I would call duplicative just to ensure that there’s a smooth transition here. Otherwise, you’d see more leverage coming through the P&L this year alone. But we feel great about where we are at. We're confident we can get to that long-term plan that we laid out and feel good about it.
And our next question comes from David Lewis from Morgan Stanley. Your line is open.
Hi, this is [indiscernible] for David. Congrats on the quarter. Just one for me and one follow-up. I have got – is there any update on the trials for the 14-day sensor for G6 and is that something we could see an approval for later this year?
We’re not going to comment specifically on the timing, but it’s certainly something that’s in the near-term pipeline.
Okay. And then the pharmacy channel. That you had 50% covered lives today, 40% last quarter, should we think about 10 percentage point increase quarterly going forward or would you expect that pace to increase over the course of the year?
It’s just not that predictable. I mean, we continue to push as hard as we can to transition the business into the pharmacy channel and remember an important thing Kevin said, that the important thing to remember is when we say we have 50% of the commercial lives that have a pharmacy benefit that doesn't mean we’re processing 50% of our commercial business through the pharmacy channel yet. So, it’s not just the addition of additional covered lives under contract it is also than transitioning those folks into the pharmacy channel through education and otherwise.
And our next question comes from Travis Steed from Bank of America.
Hi. Thanks for taking the questions. I had a question about iCGM. I think we can debate all day if another competitor can get better or not, but just wanted to ask on the big picture, if one of your larger competitors does get iCGM, how do you think that changes the conversation for payers, patients and patients does it have an impact on the conversation you are having with those customers?
Yes. This is Kevin. I’ll take it. In all honesty, the iCGM designation set some wonderful standards for us to get products approved and get in through the system quicker. I don't believe as I sit here today as we bought up against our competitors in the various payer channel and payer meetings that they really know that much about what iCGM means, other than they know about the performance of DexCom's sensor. Where iCGM becomes extremely relevant is on two fronts. As I said earlier, standards for us to shoot for when we get future product iterations approved. For example, the 14-day product we’re talking about, we know exactly how many data points we need to have and how that product needs to perform before we file with the FDA to get that designation.
We love that clarity and we intend to operate in that space. Number two, when we get into interoperability for various software systems, there’s software around insulin pens, software around the sensor augmented pump systems, and sensor assisted pump systems and various AP algorithms. Then with an iCGM you can drop in a different CGM into different systems that they’re already approved. And this will give us and others if they can attain that designation, the opportunity to go partner with more people.
We’re evaluating that designation, we already partner with a number of people and it helps us go faster, but in all honesty, we try and help our partners go faster all the time now anyway. Where it becomes significant is when we change our technology. So, when we go to the G7 platform for example, or we go to a 14-day platform, somebody like tandem because we’re iCGM or Insulet when they are at on the market can immediately incorporate our iCGM technology into the system without running another clinical study just showing that the center works properly in the past.
We literally sat in meetings with former partners and they choose not to integrate our technology with future offering because they don't want to try and run a filing. So, that’s where the iCGM comes in. I don't know that it is a big driver on the sales side. DexCom performance has always been a driver and we’ve always led with that.
And a question, one of your competitors is also talking about preferred co-pays, is that something you’re seeing gaining traction into the payer committee at all and how important do you think that is in changing customer behavior?
I think there is some of that that probably goes both ways quite honestly between the different competitors that are out there. I think, keep in mind there is well north of a thousand different payer policies and contracts that we’re all working through. There is nothing of significance that we could point to in either direction where we’ve been advantaged or any other competitor has been advantaged to our knowledge. So, we hear rumblings of it here or there, usually it’s on a very small scale. So, I’m sure it’s out there in pockets, but nothing of significance and nothing that concerns us.
And our next question comes from J. P. McKim from Piper Jaffray. Your line is open.
Hi. Thanks for taking the question. I wanted to ask, just given kind of tandem strength from days like you – now, that you are connected with that and then the income and control like you, have you seen any difference in your patient adds from MDI, pumps, any notable shift in the recent months?
No. I think what we’ve been seeing, we did see a shift over the last several years where historically we had been more heavily weighted to pump users. I think, again it’s most anecdotal. We don't have perfect data, but it appears that we're basically tracking our patient ads to what the market represents, which is in the U.S. kind of 65%, 70% of our new patients are MDI patients and the balance are pump patients.
Okay. That’s helpful and just one on the pharmacy. You hear more and more of these walgreens in these large centers that are actually stocking the G6 in-house, and so, I’m wondering how much of the, I want to say revenue contributor or how much of a strategy push that this is, is that material enough to call at this point or is it just kind of the strategy you have and you will see how it evolves going forward?
Look, there has been no shift in our business model toward stocking distributors or no incremental contribution that would skew the results in any way from stocking type relationships or orders that would have come through. As a matter of fact, if they were significant enough and meaningful enough, you’d see us call those out in our MD&A of our Qs and our Ks and that’s not the case.
So, we don't have any of that driving the results at this point. You go back into the fourth quarter, I think what was most encouraging is the number of new patient additions was well beyond what we had anticipated and honestly, it’s accelerated every single quarter of the year. So, the momentum has been tremendous there. And I think that’s really the driver. There is not anything from a stocking perspective that’s drove any of these results.
And our next question comes from Joanne Wuensch from BMO Capital. Your line is open.
Yes, hi, this is [Matt] in for Joanne. My question is with regards to the – expanding the capacity in Arizona, how is that going to impact gross margins in 2019 and 2020? Are you guys able to quantify that?
What I'll lay out for you is kind of how we think about the different moving pieces. In 2019, if there is not a lot of incremental weight being put on the gross margin profile from standing up that Mesa Arizona facility it's already been stood up to a degree and we're just adding incremental capacity into there at a faster clip, but the unit production is increasing with it.
So, you're absorbing all that incremental cost. So, you don't get any incremental weight put on your gross margin. What you have playing out over the course of 2019 is really you're going to get a benefit as a result of this lower cost transmitter that we've designed and will roll-out in the back of the year. That benefit though will be offset by the headwinds associated with the revenue per patient impacts as channel mix continues to shift.
Not getting to far ahead out into 2020, but now you are going to have a full-year of 2020 with the benefit of the lower cost transmitter, you're going to have more full year impact of the Mesa facility, but you will continue to have some of the channel shifts as the international business grows faster, as you now have a full-year of pharmacy transitioned probably baked into the results. And again, I think the right way to think about the long-term gross margin is in that mid-60s, but you will have those different levers playing out over time.
That's helpful. And then just my follow-up. One of your competitors made an announcement that they’re partnering up with Novo Nordisk, as well. Does that have any impact with your strategy with them and thank you for taking the questions?
No. Not at all. I mean, as you know they just announced that relationship. We announced our relationship with Novo back in October. And I can tell you we've been working with Novo for far longer than that. We continue to push forward to develop software tools, robust software tools to integrate our CGM together with their intelligent insulin pen technologies that will be coming to market. So, I don't think that announcement earlier this week has any impact.
And our next question comes from Robbie Marcus from JP Morgan. Your line is open.
Hi, thank you. This is actually [Christen] on for Robbie. Just had a question on how you think about the development of the overall CGM market. Abbott put out that they now have 1.3 million active users. I know it's been harder for you to track user numbers. But where do see overall penetration levels for Type 1 diabetics for CGM in the markets you compete in? And where do you see that moving to over the course of 2019 versus the very rapid acceleration, we saw in 2018? Thanks, and then I just have one follow-up.
I mean, I'm not going to comment specifically on Abbott's patient numbers because I think much of that will come down to how you actually define what is an active patient using your technology. But what we've seen we contract the Abbott prescriptions here in the U.S. and kind of what we know about our patient base I think from a Type 1 perspective, we're probably pushing 30% penetration, far lower than that in the intensive and non-intensive Type 2 space.
It's a little harder to track in Europe. I think Abbott has been a bit longer in Europe, so their patient install base is probably a little larger over there, but kind of hard to tell. I think we still, really the story is that we're all still in our infancy here in terms of addressable patients. So, we've got a long way to go.
And then my follow-up is just you know you have the launch of Control-IQ coming up midway through this year with Tandem. How should we be thinking about that launch in terms of ASP of sensors that you will sell through that system? And have you baked in any incremental sales for the launch of Control-IQ of, uptick in the business that you do with Tandem versus your other partners? Thanks.
Yes. So, we're not going to break down the components of our guidance. Certainly, that launch is one of the many things that is anticipated in the guidance that we gave you for this year. But in terms of ASPs on the sensors there will be no change whatsoever. I mean, the way we process through either the pharmacy or DME won't change with respect to the product, at least in the relatively near term so there wouldn't be any delta there.
And our next question comes from Ravi Misra from Berenberg Capital. Your line is open.
Hi, thanks for taking the questions. So, Quentin, just wanted to kind of get you – you have a kind of a range on revenues, but a point figure on gross margin. So, I guess, my first kind of question is, how do we think about that between the kind of bottom of the range, top of the range, any of the cadence there? And is it right to kind of think of okay, well you're taking a little bit of a haircut on the per patient revenue, but your margin year-over-year is essentially flat because of these lower cost transmitters. I mean, is that kind of a like-for-like reduction? And then my follow-up is around the restructuring. If you could just help us understand a little bit more around, give us the upfront investment that you're putting forward in the severances there. What kind of savings are you expecting there? And then how does that tie into as you look at risk to continue the tremendous growth that you have in driving? Thank you.
Yes, so there is a lot there. I'll try to hit on it and you can remind me if I don't hit on a part of it. With respect to the lower cost transmitter and how that's playing through the margins, we're only getting the back half of the benefit for that and that's kind of offsetting a full year impact of the continued transition through the pharmacy channel or towards the pharmacy channel. So, it's not a like-for-like one-for-one necessarily if it was a full-year annualized basis of all items being considered. In terms of the range on revenue and the point on the gross margin, I think we came out and said approximately 65%. I think, you'll find it's going to round into their based upon the different revenue ranges.
So, we could flex a little bit but we feel pretty good it's going to right around that 65% whether it was on the low end or the high end of that range. With respect to the reorganization that we talked about today, there's going to be about $25 million of restructuring cost that we will incur this year that's primarily related to both severance and retention. Most of that's going to be incurred in the first half of the year as we work through the transition. And most of those costs are triggered when we identify the individuals impacted and we've set a date, which most of that has now happened or happened today.
So, you've triggered a good part of that expense upon that communication. Therefore, it's going to happen or the expenses is going to be recorded in the first half although those people will continue to be with us over the course of some part of the year until like I mentioned earlier, we get performance metrics in line or better than what we currently run at today. So, we did not separate out any of the duplicative costs. We’ve left all of those in our non-GAAP results. We're holding ourselves accountable to those to managing those well. But first and foremost is ensuring a good experience for the patients through this transition. And then we'll start to remove costs where it makes sense.
We're not going to quantify exactly what that is. We’re not going to quantify that benefit for 2020 at this point, but it certainly will be a nice enabler of helping us to achieve that longer-term 15% operating margin goal and 25% EBITDA margin goal we’ve put out there over that five-year horizon.
And our next question comes from Doug Schenkel from Cowen and Company. Your line is open.
Hi, this is [Ronald] for Doug, thanks for taking my questions. It appears like your install base grew 50% in 2018. Is that correct? I'm looking at 2019, even factoring in the revenue per patient headwinds, the high-end of your guidance seems to imply that install base growth, decelerate the decent amount versus that 50% this year. Is that correct? And if so, why would that occur? I know it's a tough comparison, but it doesn't seem like momentum is slowing?
Yes, we're not going to talk about the install base or the patient number. I think Steve laid out earlier the differences in how each of the different players in the market tend to look at it and everyone has got a different definition tied into it. I think the way to think about it and we've been pretty clear in our guidance, our volume assumptions in our guidance is about 25% to 30% growth. We've layered on top of that the 10 points of potential headwinds coming from revenue per patient or price headwinds that take that down to the 15% or 20%. So, our guidance from a volume perspective up 25% to 30% on yes what was much stronger in 2018, but I think you got to keep in mind a couple different things.
You got a much different base that you're growing off of. It was much more difficult in 2019 growing off of 44% growth base than what 2018 was that grew off of 25% base. And you also had the G6 launch in 2018 that we don't repeat in 2019. So, there is couple reasons why it might slow a bit. I still think 25% to 30% volume growth is something we're going to be very happy with. And if you can deliver more than that then terrific. There's a lot of opportunities there.
Okay. And then can you talk about on Onduo's expansion plans for 2019? How broadly do you expect them to expand in the U.S.? And can you talk about how they're using DexCom CGM within their program? How often annually per patient on average? And is this only for specific high-risk patients or more broadly? Thank you.
We are not privy all of Onduo's plans. We do talk to them. Work with them. We provide them sensors. I believe they'll go as quickly as they possibly can. Their use of CGM is very much as an educational tool and something to reset the bar for people with Type 2 diabetes. Similar to other programs that we work with the Type 2 patient typically has not had any information like a CGM ever to help the manager condition their tool. He loves to exercise more and take your pills. And when you get on a CGM you can figure out well, gee, this is what exercise more does, this is what Eli Lilly different does. And this is what happens when I take my medications or when I change my medications. We believe CGM will be a critical component in all Type 2 diabetes management.
There's nothing that can give a patient the information that CGM does. Absolutely nothing. And if we present it properly in a manner where patients can implement this information to make changes in their lifestyle and routines, it's going to be fantastic. The question then becomes how many a year do they use and what is the business model. And I think that's going to be worked out by a number of players through studies over time. And will be worked out by us as we look at potentially different product offerings to serve this market. We view it as a big one and we view it as something that can make a huge difference.
And our next question comes from Isaac Ro from Goldman Sachs. Your line is open.
Good afternoon, and thank you, guys. Maybe first question, if you can just give us an update for – on the Verily program. In loose terms, what some of the key milestones are for development this calendar year in terms of what's making your expectations that will be a great starting point.
Yes, so Isacc, this is Steve. What you heard us talk about in the prepared remarks was G7 and committing to the time line of launching G7 by the end of next year or the first part of 2020 and that remains on track. That will be the first launch of a product that incorporates our technology together with Verily. We're not referring to it specifically as the Verily platform anymore. It's really, it's a DexCom product and we're going to call it G7 going forward. In terms of milestones we're not going to comment specifically on the – in terms of clinical trial or regulatory filings at this point, but we'll probably update you guys as the year goes on.
That's fine. Thank you. And then Quentin, a question for you on the guidance. Just given the velocity of top line growth, if we combine that with all the moving parts on the P&L from pharmacy and just funding the growth of the business. Can you help us think a little bit about the quarterly cadence of operating margin this year? Can you say that may or may not be kind of aligned with revenue seasonality? Can you just help if there's any kind of revenue to expense mismatch this year that could be a little bit non-obvious to us here in the beginning of the year? Thank you.
Yes, I think back to this whole point of ensuring that we have a smooth transition in the workforce into our Philippines and third-party service providers, we're going to be willing to run duplicative cost through the P&L for a period of time, which really starts in the first half of the year and is going to continue to be that way through the first half and then start to alleviate towards the mid part, the late part of Q3 and into Q4. So, with those headwinds I don't think that you should necessarily expect you're going to have significant improvements in operating margin year-over-year in the first half of the year, but you ought to see sequential improvements in operating margin take place over the course of the year.
Your next question comes from Matt Taylor from UBS. Your line is open.
Hi Matt, are you there?
Okay. We will move on. Next question comes from Chris Pasquale from Guggenheim. Your line is open.
Thanks. I appreciate the sensitivity around the install base number, but you guys have also provided some new color on new patient adds in the past. And I would think at least there, definitions would be pretty consistent. Anything you're willing to share for 2018 to help us true up our models on that metric?
I would tell you that new patient adds were the primary driver of overall growth, but very similar to the install base. I think the definition of a new patient is very different across the players in this space. We don't consider a new patient really a patient of ours until they are actually repurchasing and buying a normal purchase patterns for a period of time. I'm not sure if that's consistent across the universe. So, even how we define new patients I think is very different across the players in this space.
Okay. And then Quentin, just trying to nail down the impact of the transmitter and how that flows through. Can you share anything in terms of actually quantifying the magnitude of the cost reduction on the transmitter from where you're today to what this next gen looks like?
Yes, we haven't quantified where it can go. It's significant I'll tell you that. The problem with it is the more volume that you're able to push through the plant and the more that you're absorbing in the way of cost, the better it gets. So, we're not going to see the full benefit of it in 2019 as we get the full production capacity with it in 2020 it becomes more meaningful to us. But we're not going to identify the complete difference or the total difference in that new structure – new cost structure.
And our next question comes from [Matt Lismund] from Raymond James.
Hi, thanks for the questions. I'm on for Jayson Bedford. My question is really about retention levels. So, are you seeing with the G6 increased complaints among user base relative to G5 and G4 and how is it here trended? And do you still kind of see room for improved retention levels going forward maybe with the G7? Thanks.
Our retention levels we've been very pleased with what we've seen with G6 and the teams here have done a really nice job being focused on it and watching it. We have seen some improvements in our ability to retain folks although we've always done a really nice job retaining patients once they've got on to our DexCom technology. But there has been a bit of improvement there.
This is Kevin. The one thing I will add is our retention is largely been a factor of economic circumstances as well. And what will be interesting for us is as we map and charge G6 particularly as the majority of those patients use the phone app much more than our G5 patients before, I think we can have better pictures going forward in time as we look at what happens in the first quarter where our co-pays and deductibles reset. I think G6 anecdotally we hear everybody likes it a lot better. We still need more data. I mean with all those sales in Q4 we don't know whether those patients are coming back yet. And the biggest reason we lose a patient is money. It's not been the product performance. It's what they can afford and what they can do. Are we still there?
Oh, thanks, that was my only question, I'm sorry.
I'm sorry. Your next question comes from Suraj Kalia from Northland Securities.
Sure, good afternoon everyone. So, Kevin, a lot of pointers you'll have provided and I'm trying to get my hands around it. Let's assume FY 2019 around [$1.025 billion] right revenues. Can you give us directionally in terms of what the expectation is for the pharmacy channel? And the subpart of that question is, I don't remember you guys giving us a delta between the DME and the pharmacy channel. I guess the reason I'm trying to ask is, from let's say six quarters ago to now, gross margins are down roughly 500 bps. I understand the channel mix. I understand the movement of manufacturing, how you're all trying to move OpEx line item agreed. Help us understand or reconcile how your outlook is for the pharmacy channel? And what the price delta is so that we can at least kind of put it into a model and makes sense of that. Thanks for taking my questions.
This is Kevin. I'll take that one. I'll go back to my old CFO days Quentin, but I won't throw a bunch of numbers out. At the end of the day, when we talk about channel mix and channel shifting and the effect on margin, average revenue per patient is not just the pharmacy channel. Again, a larger percentage of our business continues to go through foreign markets. And those foreign markets do have lower average revenue per patient per year. And as that increases, our margins in fact do come down.
Medicare as we started was a lower-average revenue per year per patient based on the goods that we ship them versus other. And that was kind of a margin deterrent in the beginning. We think over time as our costs come down Medicare margins will be very good. With respect to pharmacy and DME mix, we've never disclosed that and there is no magic formula for what the difference is between DME and pharmacy. It literally varies contract. The contract and how we structure each of these arrangements. I think we can do it over time.
Yes, Suraj, I would just add to it. The pharmacy model is a very attractive model to us. From an operating margin perspective, we're convinced we can make more profit dollars in that business than we can at the DME channel. So, we will continue to push for it hard. And while it might weigh on the gross margin a bit, it's going to ultimately be a tailwind for the operating margin. So, at the end of the day it's the right thing to be looking at and it's going to be of value creator for us over the long term.
And the next question comes from Matt Taylor from UBS. Your line is open.
Hi, this is [indiscernible] on for Matt. Sorry, I was on mute. Thanks for taking my questions. I have two quick ones. So first, what's the percentage of patients currently on G6, versus earlier generation of device? And also, can you give us more color on the feedback you received so far for your pilot activities, with if possible G6 CGM? Thank you.
Well, I can tell you the G6 in the U.S. business, the majority of folks have moved towards G6 in our U.S. commercial business. Obviously, Medicare is still a G5 product. And then the international space we still have a lot of markets that utilize G5, but transitioning to G6. But in the U.S., it's now moved into the majority of folks on G6 in the U.S. You're going to have to repeat your second question. I didn't get it.
I'm sorry. So, the second question is just the feedback you've got so far from your pilot activities with your disposable G6 CGM?
It's really very small. Nothing really to report there.
Okay, thank you.
And that concludes the question-and-answer session. I'll turn the call back over to Kevin Sayer for final comments.
Thank you everybody for participating in our call today. Something you may not know is this year is actually DexCom's 20th birthday anniversary. We launched our first product in 2006 and after 10 years of commercial activity we hit the $500 million mark in annual revenues. But we picked up the next $500 million in annual revenues over the last two years. We're positioning the company for the next billion dollars in revenues and beyond and I know it's going to go much faster. This is never easy, but we are fully, fully committed to having the ideal technology in our pipeline to capitalize on this massive opportunity.
As you heard today much of our focus this year in addition to growing our business and pushing the product pipeline is to build the infrastructure necessary to enable us to meet those goals. We look forward to a great 2019 and want to thank everybody once again. Have a great day.
Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating and you may now disconnect.