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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.

    12

    16

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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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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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    North America Equity Research13 September 2013

    Kimberly Gailun(1-617) [email protected]

    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

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

    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%

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

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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