DXCM JPM研报

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North America Equity Researc13 September 2013

Dexcom

Initiation

OverweightDXCM, DXCM US

CGM Approaching the Tipping Point; Initiating atOverweight

Price: $27.51

Price Target: $32.00

Medical Technology & Devices

Kimberly GailunAC

(1-617) 310-0740

[email protected]

Michael Weinstein

(1-212) 622-6635

[email protected]

Bloomberg JPMA WEINSTEIN

Christopher Pasquale

(1-212) 622-6590

[email protected]

Ross Comeaux

(1-212) 622-1895

[email protected]

J.P. Morgan Securities LLC

YTD 1m 3m 12m

Abs 98.6% 0.4% 0.4% 100.4%

Rel 78.6% 0.9% -7.4% 76.3%

Dexcom, Inc. (DXCM;DXCM US)FYE Dec 2012A 2013E 2014E 2015EEPS - Recurring ($)Q1 (Mar) (0.21) (0.16)A (0.10) -Q2 (Jun) (0.21) (0.14)A (0.10) -Q3 (Sep) (0.25) (0.11) (0.03) -Q4 (Dec) (0.12) (0.07) 0.04 -FY (0.79) (0.48) (0.20) 0.18Bloomberg EPS FY ($) -0.81 -0.52 -0.17 0.14Source: Company data, Bloomberg, J.P. Morgan estimates.

Company DataPrice ($) 27.5Date Of Price 12 Sep 152-week Range ($) 28.48-12.0Market Cap ($ mn) 2,009.6Fiscal Year End DeShares O/S (mn) 7Price Target ($) 32.0Price Target End Date 31-Dec-1

See page 33 for analyst certification and important disclosures.J.P. Morgan does and seeks to do business with companies covered in its research reports. As a result, investors should be aware ththe firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a singfactor in making their investment decision.

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Sep-12 Dec-12 Mar-13 Jun-13 Sep-13

Price Performance

DXCM share price ($)

RTY (rebased)

We are initiating coverage of Dexcom with an Overweight rating and $32 December

2014 price target. Dexcom is the leader in the rapidly growing market for continuous

glucose monitoring serving Type 1 and 2 diabetics. The stock has had a great run this

year, and while a better entry point would be nice, we simply don't see the event that

causes a pullback. We expect 2Q momentum to continue in 3Q13 and beyond.

CGM technology is approaching a tipping point, in our view, with Dexcom best

positioned. CGM has been available to diabetics since 2005, but we are only today

at a point where the technology is ready for prime time. Accuracy for G4 Platinum

is meaningfully better than the competition (primarily MDT), particularly in the

hypoglycemia range, and Dexcom in turn has seen its prescriber base expand

significantly to 6,000 physicians and educators in the last 6+ months, including a

step-up in scripts from the general practitioner as patients are asking for the product.

This is a large, underpenetrated market, with CGM used today by only 7% of

Type 1 diabetics and well under 1% of Type 2s. Our latest physician survey and

recent interviews with key opinion leaders point to continued strong growth for

CGM, with Dexcom the leader. Penetration today is comparable to where insulin

pumps were in 1999, and if we use the insulin pump adoption curve (1999-2005) as

a guide, we arrive at a 2018 market potential of $1.5B. Our current forecasts are

lower, but likely to prove conservative given recent technology leaps and

reimbursement strides for CGM therapy.

Reimbursement has improved significantly over the last several years, both for

Type 1&2. Humana recently updated its CGM coverage to include all insulin-using

Type 2 diabetics, opening a big opportunity for Dexcom. We expect other payers

will follow, representing a population that is ~2.5x the size of Type 1s in the US.We also see market expansion for Dexcom from a pediatric indication (YE 2013E)

as well as sensor-augmented pump partnerships with Animas and Tandem (2014+).

Dexcom has an experienced management team and a profitable model. CEO

Terry Gregg and CFO Kevin Sayer led MiniMed's development of the pump market

in the 1990s and have built an even stronger case at Dexcom, in our view. The

company has a clear path to profitability, driven by GM expansion and SG&A

leverage. We forecast cash profitability in 2014, followed by GAAP earnings in

2015. Our $32 December 2014 price target values Dexcom at 7.8x our 2016 revenue

forecast (on par with the companys current forward multiple), discounted back to

2014. We use a DCF model as a secondary metric, which gets us to a per share value

of $35.

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North America Equity Research13 September 2013

Kimberly Gailun(1-617) [email protected]

Table of ContentsInvestment Thesis ....................................................................3

Risks to Rating and Price Target ............................................4

Company Description ..............................................................5

Company Overview ..................................................................6

The Diabetes Epidemic............................................................................................6

The Dexcom Solution: CGM First............................................7

The Product Pipeline: Whats Next?.....................................14

What the Docs Are Saying about Dexcom ...........................17

Propriety Survey ............ ............. .............. ............. ............. ............. ............. ........17

Survey Details.......................................................................................................17

Barriers to Market Adoption..................................................19

Financial Outlook ...................................................................20

Valuation.................................................................................22

Diabetes 101 ...........................................................................25

A Debilitating, Deadly Disease..............................................................................25

Diabetes Therapy: Controlling Glucose Levels Is Key ............. .............. ............. ...26

Continuous Glucose Monitoring............................................................................27

Insulin Pumps.......................................................................................................28

Models.....................................................................................29

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Investment Thesis

CGM Adoption Is Approaching a Tipping Point; Dexcom Best Positioned

Continuous glucose monitoring devices have been available to patients since 2005,

but the technology is just now approaching a tipping point for adoption, in our view,

with improved accuracy, comfort, and reimbursement. Dexcom is the technology

leader with the G4 Platinum sensor and is seeing an increase in the depth and breadth

of its prescriber base, with patient referrals now driving prescriptions from the GP (in

addition to endocrinologists). Competition will likely intensify, but we think Dexcom

remains the technology leader and see room for multiple players to succeed in this

market.

Large Underpenetrated Market Opportunity

CGM today is used by ~6-7% of Type 1s in the US and well under 1% of Type 2s.

We forecast CGM moving to 16% of Type 1s by 2018, but note that using the insulinpump adoption curve as a guide would imply CGM penetration closer to 20% come

2018. Couple this with incremental penetration into the Type 2 market, and we see a

market potential of $1.5B+ in the next 5 years. We think Type 1 CGM adoption

from here can progress more quickly than pumps given: (1) protection against

hypoglycemia; (2) physician feedback suggesting CGM will play a bigger role;

(3) low penetration for non-pumpers (~2%); and (4) the potential for Animas and

Tandem to expand this market with DXCM.

The Market Is Getting Bigger: Reimbursement Opens Doors for Type 2

Humana (6.7M lives) recently updated its CGM coverage policy to include all

insulin-using Type 2 diabetics, a huge step forward for access to CGM therapy in the

US. The line is blurring between Type 1 and Type 2 diabetics, and it is getting easier

for Type 2 patients to use CGM. If Dexcom and other CGM players are successful in

moving the market toward a CGM First model, the size of the Type 2 market (28M

people in the US, 10-15% dosing insulin) creates a multi-billion dollar opportunity

for CGM players. Lastly, CGM usage amongst pediatric patients (20-25% of Type

1s) is low, but a pediatric indication for G4 Platinum with better accuracy in the hypo

range represents a real opportunity.

Solid Management and Profitable Model

Dexcoms management team is best in class, in our view, with CEO Terry Gregg and

COO Kevin Sayer having led the MiniMed organization prior to its 2001 takeover by

Medtronic. Terry Gregg was President and COO of MiniMed from 1996-2001,

staying on as President until 2002. Mr. Gregg is well recognized and respected in the

diabetes community and, along with Kevin Sayer, has positioned Dexcom as themarket leader in a rapidly growing category. Kevin Sayer was CFO at MiniMed from

1994-2001 and President of MiniMed until 2002. The team understands the diabetes

patient and provider, and has developed proprietary manufacturing and technology

which, in our view, creates high barriers to entry for competitors. Dexcoms

manufacturing expertise has the company on track for cash EPS profitability in 2014

and GAAP profitability in 2015, with gross margins approaching 70%. Management

has set targets for 30-40% revenue growth, doubling its sales base every 2-2.5 years,

which is essentially what the same team did at MiniMed with pumps in the late

1990s.

Dexcom, Inc

(DXCM)Overweight

We think CGM adoption will

progress more quickly thanpumps did over the last decade

given: (1) protection against

hypoglycemia; (2) physicianfeedback, which suggests CGM

will continue to play a bigger

role in diabetes management; (3)low penetration amongst non-

pumpers; (4) only one pump

company currently offers CGM;

and (5) a real opportunity in

Type 2.

Management has set targets for

30-40% revenue growth,

doubling its sales base every 2-

2.5 years, which is essentially

what the same team did at

MiniMed with pumps in the

1990s.

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December 2014 Price Target of $32 per Share

We are initiating coverage on Dexcom with an Overweight rating and a December

2014 price target of $32, which represents 16% upside potential from current levels.Our target is based on 7.8x our 2016 sales estimate (on par with the companys

current multiple on 15E sales), discounted back over one period at 11%. This is a

premium to the companys peer group, but closer to in line when adjusted for the

companys top line growth rate. Dexcom is the only company we are aware of in the

space with a 30%+ revenue CAGR expected over the next five years with a huge

market opportunity and a clear path to profitability, all of which we think warrant a

premium multiple. We see the current multiple as sustainable over the next 12+

months, and see upside to both our and Street estimates. Worth noting is that our

DCF analysis turns in a value of $35/share on what we view as a fairly conservative

set of assumptions. However, we still think meaningful EV/Sales multiple expansion

is unlikely from these levels and, as such, use this as the primary construct for our

valuation work.

Risks to Rating and Price Target

Market Adoption Could Track Below Our Current Expectations

We currently forecast a ramp in CGM adoption from 6-7% penetration today to 16%

in 2018. There are still many barriers to starting new patients on CGM, including:

(1) cost to the patient and other socioeconomic factors; (2) limited reimbursement for

the physician practice; (3) inadequate staffing at many endo practices; (4) patient

compliance; and (5) many diabetics dont want to be constantly reminded of their

disease. Reimbursement also remains a significant barrier for Type 2 diabetics, but

this is improving, and we note that our CGM penetration projections do not assume

meaningful near-term traction amongst Type 2 patients.

Competitive Launches Could Be Detrimental to Dexcoms Market Position

Medtronics next generation CGM system, Enlite, is likely to be approved in the US

within the next 6-12 months. While Enlites performance is not as good as that of

G4, its better than the current system, and Medtronic could have success in

switching current Dexcom patients to its own product, particularly those who are

currently on a Medtronic pump. We view meaningful disruption as unlikely, but this

can not be ignored as an incremental risk, and we note that Medtronic is already

showing early data from next gen sensor technology. Abbott is looking to bring next

generation sensing technology to market, with a launch in Europe planned in the

second half of 2014, and both Roche and Becton Dickinson are in the prototype

phase. Meaningful success for any of these could have an impact on the Dexcom

growth trajectory.

Dexcoms R&D Pipeline Could Be Negatively Impacted by FDA Delays and/or

Unexpected Clinical Failures

Dexcom has a healthy product portfolio lined up over the next several years, and

failure to deliver on labeling expansion and new product timelines could have a

negative impact on the companys ability to grow the CGM market and on

competitive positioning.

Worth noting is that our DCF

analysis turns in a value of

$35/share on what we view as a

fairly conservative set ofassumptions. However, we still

think meaningful EV/Salesmultiple expansion is unlikely

from these levels and, as such,

use this as the primary constructfor our valuation work.

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Dexcom Manufactures Its Products in House

We view Dexcom's manufacturing operations and expertise as a key competitive

advantage for the company. However, as with any medical device manufacturer,supply chain disruptions or manufacturing failures could negatively impact the

business, both on the top line and in terms of profitability, including a slower-than-

expect gross margin ramp.

Outstanding Litigation with Abbott

These issues date back to 2005, before either company had a product on the market,

and potential fees and/or damages from the litigation could be greater than expected.

There has been a series of back and forth requests on patent reexamination and

potential interference filed by Abbott, but nothing meaningful has come of these

filings. Dexcoms intellectual property has expanded meaningfully since the time of

the original 2005 filing, and we think the two parties may ultimately settle on the

outstanding matters, but the company has not reserved for any potential damages.

Premium Valuation Could Suffer from Any Stumbles

Dexcom trades at 7.8x our CY15 sales estimate of $254M, making it the most

expensive name in our small cap group. While we think a premium multiple is

warranted given the company's projected growth rate as well as the size of its end

market opportunity, the shares appear priced for execution and any near-

(manufacturing, etc.) or longer-term (competitive inroads, failure of the CGM market

to develop) hiccups could have a negative impact on the stock price.

Company Description

Dexcom is a San Diego-based manufacturer of continuous glucose sensors for Type

1 and Type 2 diabetes patients. The companys primary market today is in personaluse for Type 1 patients, which we estimated is about 7% penetrated by continuous

glucose monitoring (CGM). Having said that, insulin-dependent Type 2 patients are

moving toward more intensive management, particularly as reimbursement and

awareness improves. Dexcom was founded in 1999 and launched its first sensor

product (the STS, first generation) in 2006. Since that time Dexcom has marketed a

series of glucose sensors and today sells its G4 Platinum sensor, which is the most

accurate sensor on the market.

Dexcom shares the personal CGM market primarily with Medtronic's MiniMed

division. The company has developed partnership agreements with Animas (part of

J&J) and Tandem Diabetes (private) to integrate its CGM technology into insulin

pumps, with the Animas product (Vibe) currently approved in Europe. Dexcom also

has a partnership with Edwards Lifesciences in the critical care space. Dexcom isworking through clinical data to spread the message of CGM First, with the idea

that informed insulin delivery is crucial to better management of the disease.

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Company Overview

Dexcom was founded in 1999 based on the research of two physicians, doctors

Updike and Hicks, who in 1967 published research on implantable glucose sensors

that measure the concentration of glucose in the body. In 2004 the companys first

sensor project (STS) began and in 2005 Dexcom completed its initial public offering,

listed on the NASDAQ as DXCM. Dexcom introduced its first continuous glucose

sensor in 2006, which was a 3-day sensor. In 2007 the company launched its Seven

(7-day) sensor, which was followed in 2009 by the Seven Plus system launch (Gen

3). In late 2012 Dexcom received FDA approval for its current sensor technology,

the best-in-class G4 Platinum. G4 Platinum is a brand new system that includes:

(1) improved accuracy and reliability; (2) smaller size with patient friendly features;

(3) open architecture (facilitating pump partnerships); and (4) advanced membrane

technology with less immune responsiveness.

Dexcom has a best-in-class management team, dating back to the 2007 hire of Terry

Gregg, former president and COO of MiniMed (now part of Medtronic), to the CEO

seat. This was a transformational hire for Dexcom, with Mr. Gregg recognized as one

of the most influential executives in the diabetes community. Mr. Gregg then hired

former MiniMed CFO Kevin Sayer in 2011, who currently serves as Dexcoms

President and Chief Operating Officer.

The Diabetes Epidemic

In the US alone, we estimate there are approximately 29 million people living

with diabetes (Type 1 and 2) of which only approximately 20 million have been

diagnosed. We estimate there are about $1.6 million people in the US living with

Type 1 diabetes formerly known as juvenile diabetes in which the body produces

little to no insulin. The complications associated with poor management of diabetes

are well documented. The landmark DCCT study (Diabetes Control and

Complications Trial) was published in theNew England Journal of Medicine in 1993

outlining the elevated risk of heart disease and stroke, high blood pressure, blindness,

kidney disease, neuropathy, and amputation for Type 1 diabetics with poor glucose

control. Subsequent studies have shown similar risk for Type 2 diabetics, particularly

those who are insulin dependent with poor control. According to the American

Diabetes Association (ADA), average medical expenses for those with diabetes were

2.3x higher in 2012 than for those without diabetes, and the total cost of undiagnosed

diabetes was $245 billion.

Type 1 diabetics require intensive insulin therapy for survival and, as such, are

recognized as the primary target market for device-based diabetes management.Having said that, Type 2 diabetics are today increasingly dependent upon insulin

injections to survive. Furthermore, improving reimbursement trends have started to

make device-based therapy a real possibility for Type 2 patients. Just under 30% of

Type 2 Diabetics today are taking insulin, with about 10-15% of Type 2s dosing with

insulin at mealtimes. Today, CGM is thought of for both Type 1 diabetics and

insulin-dependent Type 2 patients. We believe that longer term, CGM will be an

important technology for all diabetes patients.

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The Dexcom Solution: CGM First

Continuous glucose monitoring (CGM) devices allow patients to monitor their

glucose levels over time, importantly looking at trends rather than single points in

time. Current generation devices must be calibrated with a finger stick every

12 hours. While early adoption of CGM was tempered by a lack of reimbursement as

well as technological shortcomings of first generation devices, we believe we are

approaching a tipping point for CGM therapy in both Type 1 and Type 2 patients.

Dexcom is today the clear technology leader, offering in G4 Platinum an accurate,

reliable, and comfortable sensor. Dexcom is communicating its "CGM First"

strategy to providers, patients and the broader Endo community, with the

premise that no matter how you deliver your insulin, informed delivery based

on CGM output should be the starting point for management of all diabetics.

The CGM Market: Approaching a Tipping PointWe estimate the Worldwide CGM market which is primarily shared by

Medtronic and Dexcom at approximately $350M in 2013, growing at a 20%

CAGR through 2018 to nearly $900M. We note that some revenues from

professional CGM devices are likely in this number, particularly for Medtronic, but

the driver going forward will be personal use CGM. Type 1 patients still represent

the primary market for CGM today, and in the US we estimate that approximately

7% of Type 1 patients are active users of continuous glucose monitors. We expect

US Type 1 penetration to grow from 7% today to 16% in 2018. Worth noting is that

amongst non-pumpers, CGM penetration is much lower (we estimate less than 2%),

pointing to a meaningful opportunity for expansion of Dexcom's "CGM First"

strategy. Continuous glucose monitoring is viewed by many thought leaders in the

Endocrinology community as the next workhorse technology in diabetes

management, particularly now with the availability of an accurate and reliable sensor

in Dexcoms G4 Platinum. We think our current estimates for both Dexcom and the

market could prove conservative as: (1) better hypoglycemia detection drives higher

penetration amongst pediatrics (20-25% of Type 1s); (2) technology improves; and

(3) the Type 2 opportunity unfolds.

While our market models project a current market of $350M, moving to nearly

$900M by 2018, we think these estimates are likely to prove conservative. If we

apply the US insulin pump adoption curve to CGM, CGM therapy today is at about

the same penetration level for Type 1 as insulin pumps were in 1999. If we just

assume that CGM follows the same trajectory, Type 1 penetration in 2018 would be

closer to 20% versus the 16% we model. We also note that the Type 2 opportunity is

becoming more real for CGM, which was not the case for pumps in the late1990s/early 2000s due to both reimbursement and applicability. If we instead assume

CGM at 20% of Type 1s in 2018 (versus our current 16%), as well as a modest step

up in Type 2 usage, we arrive at a 5-year market opportunity of $1.5B+. Dexcom

generates ~$2,400 per patient annually, which we expect to hold on the Type 1 side.

Lower sensor usage is likely for Type 2s, and for this group we use per patient

revenue of $1,500/year.

Dexcom is communicating its

"CGM First" strategy to

providers, patients and the

broader Endo community, with

the premise that no matter how

you deliver your insulin,

informed delivery based on CGM

output should be the starting

point for management of all

diabetics.

If we assume CGM at 20% of

Type 1s in 2018 (vs our current

16%), as well as a modest step

up in Type 2 usage, we arrive at

a 5-year market opportunity of

$1.5B+.

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Table 1: CGM Market Penetration Outlook, 2013E-2020E

2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

US CGM Penetration - Type 1 (JPME) 7% 8% 10% 12% 15% 16% 17 18%

Implied Penetration using Pump adoption curve (99-06) 8% 11% 13% 16% 17% 19% 22 23%

Delta 1% 3% 3% 4% 2% 3% 5 5%

Source: Company reports and J.P. Morgan estimates.

The insulin pump adoption curve suggests current CGM market estimates will

likely prove conservative over the next 5-7 years. As mentioned, CGM adoption in

the US today is about where insulin pumps were in 1999 at ~7%. MiniMed brought

the first insulin pump to market in the 1980s, but the early pumps were inaccurate

and very difficult to use. Insulin pumps became smaller and smarter in the 1990s but

still had accuracy shortcomings which limited adoption. In the late 1990s/early

2000s, insulin pump technology improved meaningfully led by MiniMed, which

was acquired by Medtronic in 2001. It was a combination of technology

improvements, improved reimbursement, clinical data and marketing that took

insulin pump penetration from 7-8% in 1999 to 17% in 2003 and 19% in 2004. If the

US CGM adoption curve were to follow the same trajectory as insulin pump

therapy over the next four years, the market would reach nearly 20%

penetration by 2018, ahead of the 16% we currently model.

With improved technology, CGM is approaching a tipping point

Patient-oriented continuous glucose monitors have been around since 2005, but the

reality is the technology has only just arrived with the G4 Platinum sensor. Feedback

on G4 has been overwhelmingly positive, as the prescriber base is increasing

exponentially, patients are wearing their sensors more frequently, and new patients

are asking for the technology. There are approximately 5,800 endocrinologists in the

US, only about 3,000 of who actively see patients. Dexcom indicated on its last

conference call that the number of prescribers of its sensor technology more thandoubled in 1H13 versus 2012 to about 6,000, including nurse educators and general

practitioners some of whom are now prescribing based on patient demand.

Following the G4 launch, Dexcom is seeing increased sensor usage across all three of

its major patient buckets: (1) super users, or those who are using sensors 100% of the

time; (2) those using most of the time; and (3) those using periodically. The main

driver of increased usage is better accuracy and performance, with heavy users

relying on their sensors to prevent dangerous hypoglycemia episodes and to inform

their insulin delivery decisions. Endocrinologists rely on CGM to help lower

patient A1c (a measure of long-term glucose control) and reduce the frequency

of hypoglycemic events, improving overall quality of life for diabetic patients.

Dexcom is the clear technology leader

While Medtronic has more patients with access to CGM (as the company's insulin

pumps are CGM enabled), we believe Dexcom is the market leader with a greater

number of patients actively using its CGM devices due to better comfort, accuracy

and durability. Usage patterns were highlighted in a user evaluation study (n=89)

published this year in Clinical Diabetesby Chamberlain et al, showing significantly

higher satisfaction and u sage of Dexcom sensors versus Medtronic sensors. Worth

noting is that the survey primarily included Medtronic MiniLink users and Dexcom

Seven Plus wearers. While the Seven Plus was a good sensor, Dexcom has made big

Continuous glucose monitors

have been commercially

available since 2005, but the

reality is the technology has

only just arrived with the G4

Platinum sensor.

Usage patterns were highlightedin a user evaluation study (n=89)

published this year in Clinical

Diabetes by Chamberlain et al,

showing significantly higher

satisfaction and usage of

Dexcom sensors versus

Medtronic sensors, albeit with

earlier generation DXCMtechnology (Seven Plus)

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strides with G4 Platinum with improved accuracy and reliability, smaller size, and

improved transmitter range.

Endocrine Group recommendations favor CGM

In October 2011, the Endocrine Society updated its recommendations for CGM

(published in the October 2011 issue of theJournal of Clinical Endocrinology and

Metabolism). The society recommendation suggests the use of approved CGM

devices for detection and management of hypoglycemia, even if on an intermittent

basis. It is suggested that: (1) Type 1 patients age 8+ years with A1c

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be a helpful introduction for patients, giving them a better sense of whether personal

CGM may be right for them. We have also received feedback that because of the

comfort of Dexcom sensors relative to Medtronic sensors, the conversion fromprofessional to personal CGM use is generally higher for Dexcom.

Competitive Landscape: Dexcom the Clear Leader

Today there are essentially two players in the market for personal use

continuous glucose monitors: Medtronic and Dexcom. Dexcoms sensor

technology is well recognized as market-leading, and this competitive edge has only

been magnified by the company's late 2012 launch of G4 Platinum. From a clinical

perspective, the most commonly used metrics evaluating sensor accuracy are the

Clarke Error Grid (clinical accuracy) and MARD (numerical accuracy), which stands

for mean absolute relative difference between CGM readings and corresponding in-

time reference blood glucose measurements. On the clinical side, the Clarke Error

analysis assesses the impact of sensor errors on patient treatment decisions.

Dexcoms G4 Platinum compares well against the competition across numerical

(MARD) and clinical (Clarke Error) datapoints (see below under Clinical Data

Overview"for details) and is, according to our feedback, a more reliable,

comfortable and durable sensor relative to Medtronics offerings. G4 has a

seven-day wear claim, with many patients using the sensor for two weeks or longer

and still getting good performance, versus a three-day wear claim for Sof-

Sensor/MiniLink. Our provider feedback also suggests that G4s profile, which is

flatter to the surface of the skin, is a benefit and tolerates exercise well.

Medtronic

Medtronics MiniMed division has the largest installed base of insulin pump users

worldwide and is the pioneer in device-based therapy for Type 1 diabetics, includinginsulin pumps and continuous glucose monitors. MiniMed created the pump market

dating back to the 1980s and launched the first patient controlled CGM in 2005 on a

limited basis. MiniMed is still the 800-lb gorilla in the insulin pump market, but a

combination of (1) innovation from small players and (2) technology shortcomings

and regulatory delays have weakened Medtronic's position in both the insulin pump

and CGM markets over the last several years.

We expect Medtronic to be back with a new product cycle in the next 6-12

months. The company has the 530G pump system under review, including its new

Enlite sensor which has been available in Europe since 2011. The pump, which is

called Veo in Europe, includes a low glucose suspend feature and has been available

overseas since 2009. Medtronic is working through quality issues with the FDA, and

most recently indicated it is optimistic that the 530G system (Enlite plus pump withlow glucose suspend feature) will be approved in the US by the end of the current

fiscal year (April 2014).

We think Medtronic will ultimately help grow the CGM category with better

sensor technology. Currently, about 60% of Dexcoms patient base is on a pump and

about half of those are on a Medtronic pump. We would expect these patients to

continue using Dexcom once Enlite is approved based on (1) comfort with the G4

technology and sensor itself; and (2) better performance metrics for G4 Platinum

versus Enlite. Having said that, Dexcom has certainly benefited from Medtronics

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share losses in the pump market, diversifying the pump user base and giving the

company an entre on the CGM side with better technology. Enlite is smaller and

more accurate than Sof-Sensor (with Revel or Guardian), with better adhesives andan improved insertion process. Enlite is also indicated for six-day use versus three

days.

Feedback on Enlite in Europe has been generally favorable. Patient advocate

Kelly Close included a test drive of the sensor in 2001 in her diaTribepublication

which summarized the following advantages of Enlite versus MultiLink/Sof-Sensor:

Better stability on the body due to better adhesives; easy, painless insertion; higher

signal production and better resolution; more accurate on screen results; better results

at low and high glucose levels using the Veo algorithm. The disadvantages according

to the diaTribe test drive were: (1) about 10% more expensive than prior generation,

(2) not accurate on the first day, needs to be restarted on the second day and needs

two hours to start producing on-screen results. The user also found it was still better

to calibrate with finger stick when glucose levels were flat (i.e. not rising or falling).

Abbott

Abbotts Freestyle Navigator CGM system was FDA-approved in 2008 but was

never fully commercialized in the US. The Navigator was a good performance

sensor, as illustrated by early comparative studies with MARD scores in the low-

double-digit range and continuous glucose error-grid scores in the upper-90% range

for zones A+B but not very user-friendly. Abbott has communicated that it is

working on a next generation sensing product as a follow-on to Navigator, which the

company expects to be approved in Europe in the second half of 2014. The company

showed early data from its Navigator II project at the ATTD meeting in late February

with a 33% smaller transmitter and good accuracy. We expect an update on Abbotts

CGM program at the EASD meeting in Barcelona in late September, where ABT will

host a symposium.

Becton Dickinson

Becton Dickinson is another company that is involved in the broader diabetes

marketplace and is looking to bring a continuous glucose sensor to market over the

next several years. The company is using microneedle optical sensing technology,

feasibility data from which looks encouraging. Management has talked about the

accuracy and minimal warm-up time of its sensor as a potential differentiator, and the

company continues to work to make the system smaller.

Others

There are a handful of other public and private companies working on continuous

glucose sensing technology, including Roche, Bayer, and Echo Therapeutics,amongst others, none of which are out of the prototype phase. We could hear

another update on Roches program, which has turned in very good prototype

data (MARD 8.6%), at the EASD meeting in late September but are not

expecting new data on top of what we saw at ATTD in late February.

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Sensor Augmented Pumps

Only Medtronic offers a sensor augmented pump in the US today. What this

essentially does is allow the CGM to speak directly to the pump, reducing the deviceburden by eliminating a separate handheld for sensor readings. Physicians and nurse

educators we speak with say they see real demand for a combo product, but it's

important that the sensor work well. One doctor we spoke with recently said he

thinks many patients could take advantage of sensor-augmented pump therapy, but

went on to say "however, if you ask a patient whether they would rather have two

devices with a CGM that is accurate and user friendly and gives information they

trust, or one device that has a CGM that is not user friendly and is uncomfortable

with a lot of false alarms, they usually side with the better CGM device I see this

happen a lot in my practice.

Dexcom has two partnerships in place with JNJs Animas and privately held

Tandem Diabetes for development of a sensor augmented pump using the

companys G4 Platinum sensor. The Animas Vibe is currently available in selectmarkets in Europe and has been filed for FDA approval, which we expect in 2014.

Clinical Data Overview

From a clinical perspective, the most commonly used metrics evaluating sensor

accuracy are the Clarke Error Grid (clinical accuracy) and MARD (numerical

accuracy), which stands for mean absolute relative difference between CGM

readings and corresponding in-time reference blood glucose measurements. On the

clinical side, the Clarke Error analysis assesses the impact of sensor errors on patient

treatment decisions. Sensor efficacy over the longer term is often measured by the

ability to lower a patient's A1c levels and reduce hypoglycemic events.

Use of CGM devices has been shown clinically to improve glucose control datingback to the 2008New England Journal of Medicine publication of JDRFs CGM

Study Group data (n=322). The trial randomized patients already on intensive

therapy to either CGM therapy or a control group (finger sticks), and showed that

more frequent CGM usage is associated with a greater reduction in A1c levels for the

adult population (age 25+). This was true for both patients on an insulin pump and

patients on multiple daily injections, but its worth noting that the number of patients

in the trial using MDI was too low for this to be statistically meaningful.

Dexcoms G4 Platinum sensor ranks well both in terms of clinical and

numerical accuracy and ease of use, with the latter discussed in more detail

elsewhere in this report. On the data front, a comparison of the G4 Platinum with

Dexcoms prior generation Seven Plus was published in theDiabetes Technology &

Therapeuticsperiodical this year, showing for G4 Platinum a statistically significantimprovement in MARD on Days 4 and 7 (p

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we move out toward the seventh day of wear. Dexcom is also developing a new

version of G4 tailored to artificial pancreas programs with updated algorithms, where

early experiences have shown an MARD of 12%, also improving with dwelling time.

Dexcom has solid data in the pediatric age range (2-17), which it recently

submitted as part of its FDA request for a label expansion to include younger

patients. The study, which was presented at this year's ADA meeting in Chicago

(Laffel et al), included 176 pediatric patients from six US centers and was the largest

pediatric CGM study to date. The group turned in a G4 Platinum MARD of 15% in

aggregate, 14% on the abdomen and 16% on the buttocks. We note that in

comparative studies where G4 Platinum has been used in pediatrics, accuracy has

been even better for Dexcoms new sensor (including the Russell MGH comparison,

which was half children)

The CGM study that is getting the most attention comes from Dr. Steven

Russell at Mass General Hospital in Boston. Russell and team conducted acomparison of the Abbott Freestyle Navigator (not for sale in the US), Dexcoms G4

Platinum, and Medtronics Enlite with Veo algorithm (not for sale in the US) on 24

patients (12 adults, 12 children), with results presented at the American Diabetes

Association scientific sessions in June. In this study the patients wore all three

sensors as part of 48-hour closed loop experiments. The results were very compelling

for G4 Platinum, with a MARD of 10.8% and 85% of readings falling in Zone A of

the Clarke Error Grid. Navigator followed with a 12.3% MARD (84% of readings

Zone A) and then Enlite with a 17.9% MARD and 68% of readings in Zone A.

Table 2: Comparative CGM Analysis, MGH 2013

Sensor Company MARD Clarke A+B

G4 Platinum Dexcom 10.8% 99.7%

Navigator Abbott 12.3% 99.7%Enlite Medtronic 17.9% 97.1%

Source: ADA 2013, Steven Russell et all, Massachusetts General Hospital; CloseConcerns.com.

Comparative Analysis: The Lag Effect. There are several older comparative

analysis papers and studies available looking at metrics across different sensors;

however, with the pace of innovation having picked up, the endocrinology

community has pointed to a lag effect for many of these studies, as they do not

include the most up to date technology. For example, doctors Russell and Damiano

in Boston published their review of three competitive sensors inDiabetes Care

(December 2012), comparing Abbotts Navigator (not available for sale in the US),

Dexcoms older generation Seven Plus and Medtronics Guardian (with Sof-Sensor).

The MARD scores for the three sensors were 12%, 17% and 20%, respectively, but

the study did not include Dexcoms G4 sensor.

Medtonic is awaiting FDA approval for its new Enlite glucose sensor, with the

current Sof-Sensor turning in MARD levels in the 20% range (2009 Revel pump

with Sof-Sensor; 2012 Damiano/Russell study). The Enlite study was a multi-center,

randomized, prospective study designed to evaluate the performance of the Enlite

Sensor over the course of six days. The primary study endpoint was sensor accuracy

using minimum calibration requirements (every 12 hours after the second

calibration). When reported as labeled on a prospective basis (with calibration

2x/day) the current generation Enlite sensor turned in an MARD of approximately

The CGM study that is getting

the most attention comes fromDr. Steven Russell et al at MassGeneral Hospital in Boston,

showing superior accuracy for

the G4 Platinum sensor.

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17.2% (ATTD, 2013), which compares with the 13.6% presented at ADA in 2012

using a different data analysis method. The prospective data was similar to the Enlite

MARD reported earlier this year by Russell et al (17.9%), which was presented atADA 2103.

The Product Pipeline: Whats Next?

On the back of a successful G4 Platinum launch in late 2012, Dexcom has put

together a solid product pipeline that we think will help drive CGM penetration for

both Type 1 and 2 diabetics over the next several years and beyond. Dexcom has

developed a good working relationship with the FDA, which we think is also

important as the company paves the way with new technology for glucose sensing.

Table 3: Dexcom Product Pipeline

Product Approval DetailsG4 Platinum Oct-12 Improved accuracy and rel iabi li ty , smaller , better t ransmi tter , open archi tecture

G4 Pediatric YE 2013E Expands the call base o pediatric Endos; Peds are 20-25% of T1 diabetics

DexcomShare Ear ly 2014E Remote monitor ing system for careg ivers

Gen 5 Sensor 2013-2015E Mobile phone interface, new applicator, new transmitter, algori thm evolution

Animas Vibe Early 2014E Sensor augmented pump using G4 Platinum; currently available in Europe

Tandem pump late 2014E Sensor augmented pump using G4 Platinum

GlucoClear 2015E In-dwelling sensor collaborat ion with Edwards ; available in Europe

Gen 6 Sensor 2016+ Target label as replacement for finger stick testing


In the near term, the company is seeking approval for a label expansion to

include pediatrics, for patients as young as two years old. Dexcom filed for the

pediatric indication in March 2013 and in August indicated it is in labeling

discussions with the FDA. We view the pediatric label as an important next leg of

growth for Dexcom, meaningfully expanding the company's call base. We estimate

there are about 800-1,000 pediatric endocrinologists in the US and about 20-25% of

Type 1 diabetics are 2-18 years of age. The pediatric community provides an

extremely attractive patient base for the company's CGM First strategy, including:

(1) many newly diagnosed patients; and (2) a patient/parent group seeking tighter

disease management. Pediatrics have historically had lower compliance and, as such,

less effective outcomes with CGM, due to inaccuracy, discomfort, and/or the

adolescent patient's desire to be more discreet. We think G4 Platinum is a big

improvement on accuracy and comfort, which could meaningfully expand CGM

usage in this important category, particularly given accuracy in the hypoglycemia

range.

Dexcom has also filed for approval of its Dexcom Share system, which is a

remote monitoring system for caregivers and loved ones, including a docking station

for wireless transmission from the G4 Platinum sensor to a smart phone. The

caregiver can receive trend graphs and most importantly alert notifications if a

patient is going low in the middle of the night. Dexcom filed for this system in late

July 2013, and Share will be the first step in the companys move toward bringing

CGM technology to mobile phones.

The company will roll out its Gen 5 system in a series of updates over the next

two years. Gen 5 will not be a single platform update like Gen 4, but will include a

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variety of upgrades the first of which is the Dexcom Share system. Gen 5 will be an

open architecture system with an improved applicator and mobile phone interface.

There will be a new transmitter and algorithm evolution, but no change to the sensoritself or related membranes.

The Gen 6 system, which is likely a 2016+ event, is targeting a labeling

expansion to replace finger stick testing. Success here would be a big stride for

continuous sensing technology, likely to meaningfully expand CGM penetration for

both Type 1 and 2 diabetics. Recall that CGM today needs to be calibrated every 12

hours with finger stick testing and, as such, isnt a fully standalone technology.

Dexcom announced in August that is has received a $4M research funding grant

from the Helmsley Charitable Trust to help accelerate development of the G6

technology. The Helmsley Charitable Trust, in concert with the Juvenile Diabetes

Research Foundation (JDRF), supports medical research across a handful of disease

states, including Type 1 diabetes, and we note the importance of the Gen 6

technology for the variety of ongoing artificial pancreas studies.

Dexcom has two partnerships in place with JNJs Animas and privately held

Tandem Diabetes for development of a sensor augmented pump using the

companys G4 Platinum sensor. The Animas Vibe is currently available in select

markets in Europe and has been filed for FDA approval (filed 2Q13), which we

expect by early 2014. Dexcom indicated in August that Animas recently received a

round of questions on its PMA for the Vibe, which, given the pace of FDA (as well

as Animas), will likely push a US Vibe approval to 1H14. We see the Vibe approval

as another growth driver for Dexcom. Currently about 60% of Dexcom patients are

also on a pump, with about 1/3 of the pumpers on Animas. We estimate Animas has

an installed base of about 90K pumpers in the US. The company will look to switch

its pumper base over to Vibe over the next several years, allowing it to compete more

effectively against Medtronic's sensor-augmented pump offering, which in turnshould benefit Dexcom in the form of a recurring revenue stream. Dexcom is also

developing a sensor augmented pump with privately held Tandem Diabetes, which

has had good early success with the launch of its t:slim pump. The t:slim, which was

launched in the US in 2H12, is a durable pump that offers a sleek design, large

insulin reservoir and attractive touch screen user interface. We received positive

feedback on t:slim at the ADA meeting in June, and Dexcom expects the company to

file for a sensor-augmented pump with G4 prior to year end.

Reimbursement

Patient Reimbursement/Coverage

Reimbursement strides have been meaningful over the last several years for Type 1

diabetics, particularly for private pay, which accounts for the majority of the Type 1population. Today, most private plans routinely cover CGM for Type 1 patients,

which is a big improvement over the last five years. Having said that, the level of

coverage still varies, with patient copays ranging from 0% to 50%, according to our

discussions, which, while better than no coverage, can be a challenge for many

patients who are also paying for their test strips and possibly pump supplies. In our

US Endo survey (n=27, details below), 59% of physicians indicated that even with

reimbursement, out-of-pocket costs for CGM are still too much for many patients.

We see the reimbursement landscape continuing to improve, with Dexcom

announcing in August that Express Scripts added Dexcom CGM to its National

The Gen 6 system, which is

likely a 2016+ event, is targeting

a labeling expansion to replacefinger stick testing. Success

here would be a big stride for

continuous sensing technology,likely to meaningfully expand

CGM penetration for both Type 1

and 2 diabetics.

We view Dexcoms pump

partnerships as another leg of

growth for the company, whereDexcom sensors will effectively

be sold through the pump sales

forces of Animas (JNJ) andprivately held Tandem.

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Preferred Prescription Drug Formulary. While we expect this to be a gradual

transition, the move to pharmacy benefit payment should make CGM reimbursement

much easier over the next few years.

Medicare does not routinely cover CGM for Type 1 or 2 patients, which will be a

key initiative for CGM manufacturers and patient advocacy groups over the next few

years. Medicare reimbursement is becoming more meaningful as Type 1 patients are

living longer and with the increasing insulin dependence of the Type 2 population.

We think the generation of economic data showing the benefits of CGM to both the

patient and the system will be a meaningful step toward a Medicare reimbursement

code.

Type 2 reimbursement is improving: A meaningful catalyst

More recently, progress has been made on the Type 2 payment front, which we view

as a key step toward greater penetration into this large patient group. On its most

recent conference call in August, Dexcom announced that Humana (6.7 millioncovered lives) has updated its CGM coverage policy to include all insulin-using Type

2 diabetics. While our feedback suggests that insulin-using Type 2 diabetics today

can very often get coverage, this typically requires a good deal of additional

paperwork. The Humana decision is the first we are aware of by a large national

provider to cover this large group of patients. We estimate there are as many as 5

million Type 2 patients actively taking insulin in the US today, representing a

market opportunity that is about 2.5x the size of the Type 1 diabetic population.

Physician Reimbursement/Coverage

Physician reimbursement for time spent training and managing CGM patients is a

barrier at some practices. Our Endo/nurse feedback suggests that a CGM program

can be profitable for a practice once it is up and running and efficient, but not allEndo practices are so equipped, and we think help from the manufacturers will be an

important part of this progression going forward. Some of the more successful Endo

practices that we have spoken with (and those prescribing more CGM) have put in

place an efficient onboarding, training and follow-up process that allows for good

patient flow in the practice and better overall management. What was interesting to

us was in speaking with Endos and/or educators who tend to be the bigger prescribers

of CGM, many of them are Type 1 diabetics themselves, which really underscores

the utility of the technology.

Physicians can bill for the initial training sessions when onboarding a new patient to

CGM, for the patients quarterly visit, and for data download and interpretation,

which can even happen over the phone once the doc is comfortable with how to

interpret the data. Many busier Endo practices are using the Professional CGMModel, which means they will first start a patient on Professional CGM with

Medtronics iPro or Dexcoms Seven Plus (G4 not yet indicated). Professional

CGM is covered by both private payers and Medicare and gives: (1) the nurse/Endo a

good sense of who will be good candidates to put on personal CGM (plus its

profitable); and (2) the patient a "test drive" opportunity so they can see what CGM

would do for them. We received a good amount of anecdotal feedback from both

Endos and nurses around the efficacy of Professional CGM first both for the practice

and for the patient.

Type 2 reimbursement is

improving, with Humana recently

updating its CGM coveragepolicy to include insulin-using

Type 2 diabetics.

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What the Docs Are Saying about Dexcom

Propriety Survey

We conducted a survey of 27 US Endocrinologists and conducted separate in-

depth interviews of a handful of Endos and nurse educators to get a better sense

for how the prescribing base is viewing the role of CGM technology in the

treatment and management of Type 1 and 2 diabetics.

Our key takeaways are as follows:

(1) CGM is likely to be the next workhorse technology for the diabetes

market, particularly as manufacturers get closer to the claim for finger stick

replacement (Dexcoms Gen 6). The early experience with CGM was sour,

but newer sensors should overcome this with big leaps in precision and

reliability;

(2) Following a series of less accurate first generation products, the technology

is finally here with Dexcoms G4 Platinum sensor;

(3) Medtronics Enlite (awaiting FDA approval) will be an improvement versus

earlier generation sensors, but will still lag G4 Platinum in performance

(particularly in the low range), durability, and comfort;

(4) Reimbursement remains a challenge but has improved meaningfully for

both Type 1 and insulin-dependent Type 2 patients;

(5) Physicians from our survey and interviews are projecting healthy increases

in personal CGM usage at their practices over the next 12+ months; and

(6) DTC marketing could further accelerate the CGM adoption curve as CGM

awareness, particularly of new sensors, remains somewhat low at many

endocrinology practices. We heard from a few physicians many people

dont yet realize how much better (Dexcoms) G4 is.

Survey Details

Question 1: For what percentage of your Type 1 diabetics are you recommending:

(1) Professional CGM; and (2) Personal CGM?

Response: The Endocrinologists in our survey indicated that they recommend

professional CGM for 33% of their Type 1 patients and personal use CGM for 47%

of their patients.

Question 2: What percentage of your patient base are active CGM users amongst

both your Type 1 and Type 2 populations?

Response: The doctors in our survey indicated that 24% of their Type 1 patients are

active CGM users while 7% of their Type 2 patients use CGM. These are

encouraging numbers, in our view, and higher than the market as a whole, where we

estimate that only about 7% of Type 1 diabetics in the US use personal continuous

Physician feedback points to

sustainable growth in new CGM

patient additions over the next

12+ months.

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glucose monitoring on a regular basis. On the Type 2 side, we believe that well under

1% of patients are active CGM users in the United States.

Question 3: Over the last 12 months, has the number of patients on CGM at your

practice increased, decreased, or stayed the same?

Response: Of the 27 endocrinologists in our survey, 22 or 81% indicated that the

number of patients on CGM has increased by an average of 27%. None of the doctors

said their CGM patients had decreased, and five said the number of patients had

stayed the same, for a weighted average increase of 22% over the last 12 months.

Question 4: Over the next 12 months, how will the number of patients using

personal CGM devices change at your practice?

Response: Looking out 12 months, 23 of 27 Endos (85%) said they expect the

number of patients using CGM at their practice to increase, by an average of 27%.None of the doctors are projecting a decrease, and four said the number would stay

the same, for a weighted average projected increase of 23%.

Question 5: What percent of your personal CGM patients are also on an insulin

pump?

Response: The Endos indicated that 79% of their CGM users are also on an insulin

pump. This is an interesting statistic, in our view, and consistent with Dexcoms

estimation that about 60% of its sensor users are also on a pump (about half on

Medtronic MiniMed, 30% on Animas). The implication here is that CGM penetration

remains very low (about 2% by our estimates) amongst Type 1 diabetics who are not

today on an insulin pump, giving ample room for CGM manufacturers with those

patients currently on multiple daily injections alone (about 70% of Type 1 diabetics).Having said that, the non-pump users will also require more work in the form of

education and likely DTC advertising, because this group is likely to be less eager to

adopt new technology.

Question 6: Please indicate which CGM products you currently recommend for your

patients (check all that apply):

Response: Forty-one percent of the doctors indicated they currently prescribe G4

Platinum, while the remainder indicated they prescribe Medtronic sensors. While we

dont have great market data on the number of docs prescribing MDT versus

Dexcom, Dexcom has pointed to a broad prescriber base of approximately 6,000 in

1H13, double that of 2012.

Question 7: What are the most important factors driving your sensor

recommendation for CGM?

Response: The single most important factor cited was sensor accuracy and

reliability, with 74% of physicians citing this as a most important metric. Accuracy

was followed by comfort (67%), ease of use (63%), duration of the sensor (59%),

and profile of the sensor (41%). Other responses included good service from the

company and the ability to easily download data.

The physicians in our survey are

projecting a weighted averageincrease in patients on CGM of23% over the next 12 months.

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Figure 1: Factors Driving Sensor Recommendation for CGM

Source: J.P. Morgan survey data.

Question 8: What are the biggest challenges to putting a new patient on CGM

therapy?

Response: The biggest challenges cited to putting patients on CGM therapy were:

(1) reimbursement (both for Type 1 and Type 2) and (2) out-of-pocket costs for the

patient. Seventy-four percent of Endos said reimbursement for Type 2 patients is a

challenge, which comes as no surprise given that we are still in the early days of

Type 2 coverage, even for insulin-using diabetics. This was followed by 59% of the

docs saying that out-of-pocket costs were too much for many patients, and 52%

saying Type 1 reimbursement can still be a challenge. Depending on the plan, the

patient may be responsible for anywhere between 0% and 50% of the costs of CGM

therapy. Some physicians (37%) also indicated that patient compliance is an issue,

while 26% said their practice has inadequate staffing/resources to support CGM

programs. Finally, 11% indicated that CGM is not profitable for their practice, whileanother 11% cited complicated technology as a barrier to adoption.

Barriers to Market Adoption

The technology is here, in our view, but still 93-94% of Type 1 diabetics are not

using it. Several barriers to adoption remain for CGM technology, including:

(1) reimbursement is still a hurdle for some Type 1s (mainly Medicare) and most

Type 2s; (2) even after reimbursement, out of pocket costs are prohibitive for many

patients; (3) earlier generation devices that were not accurate and reliable have

clouded physician and patient perception on continuous monitoring devices; (4)

many physician practices dont have adequate resources to support a CGM program;

(5) CGM patient management is not well reimbursed; and (6) technology is

complicated and patient compliance can be an issue, particularly as diabetics often

want to be discrete and dont want to use devices to remind themselves or others of

their disease.

74%67%

59%

41%

63%

0%

10%

20%

30%

40%

50%

60%70%

80%

Accuracy/Reliability Comfor t Duration of Sensor Profile of sensor Ease of Use

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Earlier technologies did not work, creating market fatigue. From the

physicians perspective, many have had a bad first experience with earlier

generation technology (Dexcoms STS, the GlucoWatch) and/or the current Sof-Sensor from Medtronic, leaving providers somewhat weary of personal CGM

technology for their patients. In addition, many Endocrinology practices in the US

are still not there in terms of best practices and may not have adequate staffing to

transition their patient base to more CGM usage. The good news is that perception

is improving with technology. Endos we have spoken with who have used and

prescribed G4 Platinum are very enthusiastic about the technology, and we are

hearing some anecdotal feedback around the uptake of Dexcoms CGM First

approach, particularly leading with Professional CGM to get a patient started.

Reimbursement is still a challenge for Type 1 patients, according to our survey

work, though this has improved meaningfully. Most of the physicians and nurses

we spoke with indicated that with the exception of Medicare, Type 1 is relatively

routinely reimbursed. Type 2 patients are by no means routine but are getting betterand better coverage, particularly those who are dosing insulin at mealtimes (recall as

well that Humana recently updated its CGM coverage policy to include insulin using

T2 patients). Even after reimbursement, the incremental cost of CGM therapy can be

a hurdle for many patients. Coverage plans vary widely, reimbursing anywhere from

50-100% of the costs per our feedback. Dexcoms starter kit costs about $850, with

sensor ASPs of about $65-70. If we assume the average patient uses about 25 sensors

per year, and that the average copay is 20%, the annual out-of-pocket cost is just over

$500, which is a hurdle for many patients.

Financial Outlook

Revenue

We forecast 2013 sales of $143.5M (+44% YOY), including product revenue of

$140M (+51% YOY) which is $2M ahead of Street consensus and compares with the

companys $130-140M guidance range. Over the next several years, we forecast a

revenue CAGR for Dexcom of 34%, reaching $428M in sales in 2017E. We see solid

top-line growth as sustainable as the company: (1) expands its call point to pediatrics

(20-25% of Type 1 diabetics, YE13), including the Dexcom Share system;

(2) leverages its sensor augmented pump partnerships with Animas and Tandem

(2014+); (3) builds out its clinical data package, including cost effectiveness support

(2014+); and (4) further penetrates the Type 2 population.

The good news is perception is

improving with technology.

Endos we have spoken with who

have used and prescribed G4Platinum are very enthusiastic

about the technology, and weare hearing some anecdotal

feedback around the uptake of

Dexcoms CGM Firstapproach.

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Figure 2: Dexcom Revenue Trajectory, 2010-2017E

Source: Company Reports and J.P. Morgan Estimates

Dexcom is coming off of a very solid 2Q result. Our sales outlook is $4M ahead of

Street consensus estimate for 2013 and $6M ahead for 2014. Our 2015 forecast is

$17M above the Street at $254M.

Operating Margins

In 2013, we forecast an operating loss for Dexcom of $34.2M. On a cash basis

(excluding D&A and share based compensation), the net operating loss is projected

to be $2.2 million. We expect the company to generate operating income in 2014 of

$24.9M on a cash basis, with a loss of $15M on a GAAP basis. On a GAAP basis,

we forecast operating profitability in 2015, with margins of 7% growing to 24% by

2017E. Margin expansion is driven by a combination of gross margin expansion and

leverage of operating expenses including both SG&A and R&D. On the gross margin

front, Dexcom is targeting sensor margins of 70-75% on its sensors and just under

50% on hardware. This highlights what we view as one of Dexcoms key competitiveadvantages manufacturing efficiencies and know-how. We expect the company to

look to decrease sensor cost further in future generation models, particularly as the

company thinks about broader penetration in the Type 2 community. Our aggregate

gross margin forecast goes from 60% for 2013E to 70% in 2017E, as sensor margins

improve and sensors become a bigger piece of the overall business mix.

We forecast SG&A leveraging from 56% of sales in 2013E to 36% of sales in 2017E.

Dexcom went from 48 reps in mid-2012 to 68 reps today, and should be able to

leverage this new base going forward. We expect the company to continue to add

reps as it grows the business, but not likely at the same rate we've seen over the past

year or so. Recall that Dexcom should also benefit from sensor sales through its

sensor-augmented pump partnerships with Animas and Tandem as we move through

2014 and beyond.

Earnings

We forecast cash profitability for Dexcom in 2014 and GAAP earnings in 2015. For

2013, we project a loss per share of $0.48 on a GAAP basis and $0.03 on a cash

basis. Moving to 2014, we forecast a GAAP loss per share of $0.20 with cash

earnings of $0.32/share. Our GAAP EPS projections for 2015-2017E are $0.18,

$0.52, and $1.00, respectively.

$48.6$76.3

$99.9$143.5

$190.5

$254.0

$331.3

$427.7

$0.0

$50.0

$100.0

$150.0

$200.0

$250.0

$300.0

$350.0$400.0

$450.0

2010 2011 2012 2013E 2014E 2015E 2016E 2017E

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Cash Flow

Dexcom is cash flow positive today, and we forecast healthy cash flows through

2017E. The company has raised equity four times since its April 2005 IPO, with themost recent round in May 2011. Based on meaningfully improved cash flow, we do

not expect the company to come back to the equity markets going forward. On a free

cash flow basis, we forecast a loss in 2013 of $17M, turning positive in 2014

($2.7M) and ramping to $92M come 2017E.

Figure 3: Dexcom Free Cash Flow Projections ($ in Millions)

Source: J.P. Morgan Estimates.

Valuation

We value Dexcom primarily on an EV/Sales basis, supported by DCF analysis. We

use a representative sample of other small cap MedTech companies as the relevant

comp group. We are introducing a December 2014 price target of $32 for

Dexcom, which is based on 7.8x our 2016 sales estimate, discounted back over

one period at 11%, implying 16% upside potential from current levels. Our

target multiple represents a premium to the companys peer group, but is closer to in

line when adjusted for the companys top line growth rate at 30%+. Based on JPM

and Bloomberg estimates, the peer group currently trades at 5.4x 2014 sales

estimates and 4.5x 2015E. Dexcom today is at a clear premium to the group, trading

at 10.4x 2014E sales and 7.8x 2015E sales. Having said that, Dexcom is the only

company we are aware of in the space with a 30%+ revenue CAGR expected over

the next five years with a huge market opportunity and a clear path to profitability,

all of which we think warrant a premium multiple.

($16.5)

$2.7

$29.3

$56.1

$92.0

($40.0)

($20.0)

$0.0

$20.0

$40.0

$60.0

$80.0

$100.0

2013E 2014E 2015E 2016E 2017E

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Table 4: EV/Sales Price Target Methodology

Projected 2016 Revenues$3311-Year Forward Multiple 7.8x

Enterprise Value $2,582

Discount Periods (from Dec-2014) 1.0Discount Rate 11%Implied Enterprise Value (Dec-2014) $2,326

Projected Cash (YE14) $47Projected Debt (YE14) $7Implied Market Cap $2,365

Projected Shares Outstanding (YE14) 73.8

Implied Price per Share (Dec-2014) $32.00Upside from Current Price 16%

Source: J.P. Morgan Estimates

Physician, patient and industry feedback point to continued strength on a quarterly

basis. As such, we see the current multiple as sustainable over the next 12+ months

and see upside to numbers as (1) Dexcom expands its call base to pediatrics; (2) G4

Platinum awareness improves; and (3) the Type 2 opportunity unfolds.

Our Discounted Cash Flow Analysis Supports the Stock Higher

Our DCF analysis points to a share price of $35. Our model projects free cash flow

through 2024, where we assume from 2018-2024E revenue growth decelerates

toward 18%, with EBIT margins expanding from 23% in 2017E to 28% in 2024E.

These forecasts turn in free cash flow growth of 20% in 2024E, but we assume theperpetual rate of growth is lower at 3-5%. Using a discount rate of 11%, which is

about in line with the company's WACC, our DCF model implies a fair value for

DXCM of $35. This is higher than our $32 price target, but we are hesitant to call for

any meaningful multiple expansion on an EV/Sales basis (in light of the comp group)

from these levels and, as such, are using EV/Sales as our primary metric.

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Table 5: Dexcom Discounted Cash Flow Analysis

FY Ending Dec-13 Dec-14 Dec-15 Dec-16 Dec-17 Dec-18 Dec-19 Dec-20 Dec-21 Dec-22 Dec-23 Dec-24

Sales$142 $189 $252 $328 $424 $543 $690 $871 $1,080 $1,319 $1,584 $1,871Sales growth 32.8% 33.4% 30.5% 29.1% 28.1% 27.1% 26.1% 24.1% 22.1% 20.1%

EBIT (35) (16) 16 50 99 132 173 224 286 359 439 523EBIT margin -24.4% -24.4% -8.3% 6.4% 15.3% 23.4% 24.4% 25.1% 25.8% 26.5% 27.2% 27.7%Tax-affected EBIT (35) (35) (16) 10 33 64 87 116 152 196 248 307Free Cash Flow $9 $9 $2 $27 $50 $85 $107 $139 $179 $228 $286 $350growth -77% NM 87% 70% 26% 30% 29% 28% 25% 23% 20%

A + B = C

Discounted PV of Terminal Value at a Equivalent Terminal EBITDA

CashFlows

Perpetual Growth Rate of FirmValue

Multiple (Forward 12-Months)

Discount Rate (2013-2024) 3.0% 4.0% 5.0% 3.0% 4.0% 5.0% 3.0% 4.0% 5.0%

10.0% 714 1,952 2,300 2,786 2,666 3,014 3,500 11.6x 13.5x 16.2x10.5% 691 1,740 2,027 2,418 2,431 2,718 3,109 10.8x 12.5x 14.8x11.0% 669 1,558 1,797 2,117 2,226 2,466 2,786 10.2x 11.6x 13.6x11.5% 648 1,400 1,602 1,867 2,048 2,250 2,514 9.6x 10.9x 12.5x12.0% 627 1,264 1,435 1,656 1,891 2,063 2,283 9.1x 10.2x 11.7x

- D = E PV of Terminal Value as a

NetDebt

Total Equity Value Equi ty Value per Share Percentage of Firm Value

Discount Rate 3.0% 4.0% 5.0% 3.0% 4.0% 5.0% 3.0% 4.0% 5.0%

10.0% (39) 2,705 3,053 3,539 $38.16 $43.06 $49.92 73.2% 76.3% 79.6%10.5% (39) 2,470 2,757 3,149 $34.84 $38.89 $44.41 71.6% 74.6% 77.8%

11.0% (39) 2,266 2,506 2,825 $31.96 $35.34 $39.85 70.0% 72.9% 76.0%

11.5% (39) 2,087 2,289 2,554 $29.44 $32.29 $36.02 68.4% 71.2% 74.2%12.0% (39) 1,930 2,102 2,323 $27.22 $29.65 $32.76 66.8% 69.6% 72.5%


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Diabetes 101

A Debilitating, Deadly Disease

Diabetes is a widespread disease, marked by abnormally high blood sugar

levels. The statistical prevalence of the disease is staggering. The International

Diabetes Federation estimates there are 371 million people with diabetes worldwide.

In the United States alone, approximately 29 million people have diabetes. An

estimated 20 million people have been diagnosed according to the ADA, leaving

about 30% yet to be diagnosed. The annual economic cost of the disease is huge,

totaling approximately $245 billion in the US in 2012, according to ADA. These

costs included roughly $176 billion annually in direct medical costs and $69 billion

annually related to disability and mortality.

Diabetes is characterized by the inability to manufacture, or effectively utilize,

the hormone insulin. This hormone, produced in the beta cells of the pancreas,enables the body's cells to take in glucose (sugar) from the bloodstream, providing

the cells with energy. In diabetes, glucose accumulates in the blood, and cells are

deprived of energy acutely. Untreated diabetes can produce symptoms such as weight

loss, frequent urination, increased hunger and thirst, tiredness, vision disturbances

and in severe cases, coma. Diabetics can also develop long-term chronic

complications, such as diseases of the eyes (retinopathy), kidneys (nephropathy),

nerves (neuropathy), and the heart.

There are two basic forms of diabetes: Type 1 and Type 2. Type 1 diabetics are

unable to produce insulin and they must receive daily insulin therapy to survive. In

this form of the disease, the pancreatic beta cells are destroyed by immune reactions

and the pancreas cannot produce insulin. Type 1 diabetes usually manifests itself in

childhood or adolescence and was previously known as juvenile diabetes, but adults

can also develop this variation of the disease. Type 1 diabetics represent 5-10% of all

patients with the disease. According to our estimates, there are approximately 1.6

million Type 1 diabetics in the United States, and the incidence of the disease

appears to be increasing worldwide.

Type 2 diabetics are not entirely insulin deficient. This form of the disease is

caused by the insufficient production of insulin by pancreatic beta cells.

Alternatively, the pancreas may produce normal amounts of insulin, but the body's

cells may be resistant to the effects of the hormone. Both scenarios result in reduced

uptake of glucose by cells and increased levels of glucose in the blood

(hyperglycemia). Obesity increases insulin resistance, and obese patients are

therefore predisposed to diabetes. Since Type 2 patients are not entirely insulindeficient, some patients can be treated with oral medications to lower blood sugar

levels. More severe cases require insulin therapy as a supplement to, or instead of,

oral drug therapy. Type 2 diabetes is the most common form of the disease,

accounting for 90-95% of cases. This form of the disease usually manifests itself in

adulthood, but is on the rise among children and adolescents. The prevalence of Type

2 diabetes is on the rise in the United States owing to an aging population, increased

levels of obesity, and more sedentary lifestyles.

Other forms of diabetes include gestational diabetes and pre-diabetes. Pregnant

women who have never had diabetes before but have high blood glucose levels

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during pregnancy are said to have gestational diabetes. Seen in roughly 4% of all

pregnant women, there are about 135,000 cases of gestational diabetes in the United

States each year. When you have gestational diabetes, your pancreas works overtimeto produce insulin, but still fails to lower blood glucose levels, leading to

macrosomia or an overweight baby. Babies with excess insulin become children

who are at increased risk for obesity and adults who are at risk for Type 2 diabetes.

Also, there is a 2 in 3 chance that once a woman has had gestational diabetes, it will

return in future pregnancies. Furthermore, women with gestational diabetes usually

go on to develop Type 2 diabetes, albeit years later.

Diabetes Therapy: Controlling Glucose Levels Is Key

Treating diabetes is an enormous challenge. Diabetes is one of the most

frustrating and difficult to mange diseases and can be significantly debilitating. These

debilitating effects are a function of hyperglycemia and hypoglycemia (high and low

blood sugar levels). Remember that blood sugar levels tend to fluctuate through the

course of a day depending upon food intake (carbohydrate and fat content), exercise,

stress, illness, hormonal releases etc. As such, it is necessary to maintain these levels

within a somewhat normal range through frequent testing and the regular

administration of insulin via injections or pump therapy. Not only does this expose a

patient to the risk of over-correction, which can lead to rapid mood swings, but is

also a major time commitment. Prior to the emergence of intensive insulin

management, the conventional treatment for Type 1 diabetes included the

administration of 1-2 shots of insulin per day along with meals that had fixed

carbohydrate loads. For Type 2 diabetes, insulin therapy was often viewed as

treatment of last resort, as patients relied more on dietary management, exercise, and

oral drugs.

However, studies performed over the last decade or so show that the intensivecontrol of blood glucose levels can increase patients' life spans and reduce the

risk of complications. The goal of tight control is to maintain blood glucose levels

as close to normal as possible. Normal blood glucose levels are between 70-120

mg/dl before meals and less than 180 mg/dl after meals. The Diabetes Control and

Complications Trial (DCCT), a groundbreaking study, demonstrated that tight

control reduced the prevalence and seriousness of complications in Type 1 patients.

The study evaluated 1,441 patients with Type 1 diabetes for several years. Half of the

patients were treated with intensive management (tight control) of glucose levels,

using either an external insulin pump or at least three daily insulin injections, and

frequent blood glucose monitoring. The other half of the group received less rigid

standard treatment, with one or two daily insulin injections. The results demonstrated

a significant reduction in morbidity and long-term complications in the group with

tight control. Compared with the group receiving standard therapy, tightly controlledpatients demonstrated a 75% reduction in the onset of diabetic eye disease, a 50%

reduction in the onset of kidney disease, and a 66% reduction in the onset of nerve

disease. And in 1998, a second trial, the United Kingdom Prospective Diabetes study

(UKPDS), demonstrated that tight control also significantly reduces complications in

Type 2 diabetics.

Despite reducing the incidence of long-term complications, tight control can

have some negative consequences. First, the DCCT study demonstrated that tightly

controlled patients had a higher frequency of hypoglycemic (low blood sugar)

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episodes. Hypoglycemic patients can develop symptoms ranging from tiredness and

nervousness to disorientation. Tightly controlled patients must be cognizant of these

symptoms and they must be prepared to treat themselves. Second, intensivelymanaged patients appear to gain more weight compared with patients on standard

therapy. Finally, tight control costs more than less rigid, standard therapy. The

increased costs are due to more expensive supplies or more frequent use of supplies,

and increased visits to health care practitioners. Despite the challenges associated

with tight control, the positives of this type of treatment (increased well being,

decreased long-term complications, and greater lifestyle flexibility) generally

outweigh the negatives. As such, an increasing number of Type 1 diabetics are

resorting to intensive management. Furthermore, guidelines from the American

Diabetes Association suggest more aggressive treatment for Type 2 patients as

well, even as a first line therapy for some.

Intensive management requires frequent blood glucose measurements. The

traditional method of checking blood sugar levels requires the patient to prick theirfinger with a needle in order to obtain a drop of blood. The drop of blood is applied

to a special test strip and a glucose meter measures the amount of glucose on the

strip. This procedure must be performed several times per day, depending on the

volatility of a patient's blood glucose. Finger stick measurements can be painful and

inconvenient, thereby reducing patient compliance.

Continuous Glucose Monitoring

Continuous glucose monitoring (CGM) devices allow patients to monitor their

glucose levels over time, importantly looking at trends rather than single points in

time. Current generation devices must be calibrated with a finger stick every

12 hours. While early adoption of CGM was tempered by a lack of reimbursement as

well as technological shortcomings of first generation devices, we believe we areapproaching a tipping point for CGM therapy in both Type 1 and Type 2 patients.

Dexcom is today the clear technology leader, offering in G4 Platinum an accurate,

reliable, and comfortable sensor. Currently, Medtronic and Dexcom have approved

CGM devices on the US market. In April 2007, CMS announced its preliminary

decision to grant new billing codes for CGMs, which started the technology on a

gradual path to better reimbursement.

Continuous glucose monitors measure glucose levels in the interstitial fluid, and

provide glucose readings every three minutes on average. This gives patients a much

better idea of where their glucose levels are on a consistent basis (vs. multiple finger

sticks per day) allowing for better overall control with fewer finger sticks.

Continuous glucose monitors aim to increase patient compliance, reduce pain, and

improve patient lifestyle.

In addition to measuring glucose levels at specific points in time, it is also important

to gauge the effectiveness of a diabetic's long-term glucose control. This assessment

can be performed by evaluating blood levels of Hemoglobin-A1c (HbA1c). A sample

of blood, drawn from a patient's arm by a health care professional, is se

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