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January 08, 2009

Insulet Corporation (PODD)
by Reggie Middleton

We performed some preliminary analysis on Insulet Corporation (PODD) with a focus on their latest quarterly results. With its stock price currently trading in the region of US$7-$8 per share, it fails in the very first parameter that we use for screening short candidates, and that is a company's share price must be at a level to provide X% return given Y investment. In other words, the share price is already too low. Since I do not consider it a candidate for my own prop trading program, I am releasing this cursory overview to the public.

The stock price has traded in the range of $3-$21 in the last 52 weeks and there could be further downside left from the current levels to make it an attractive short opportunity for the right type of speculator, but rationalization of their cost structure with most of the production being shifted to China and their preparation for an entry into Europe could well turn out to be positives and result in a rally in the near term. Following are some of our initial observation on the company's financials / fundamental strength:

Insulet posted strong revenue growth for the three months and nine months ended September 2008. Revenue for Q3 2008 rose 167% year-on-year to US$10.1 million mainly due to a 20% increase in the number of patients using OmniPod driven by the company's sales and marketing efforts. For the nine months ended September 2008 revenues increased 169% to US$24.2 million. Insulet has agreements with Abbott Diabetes Care Inc. and DexCom Inc. to integrate their continuous glucose monitoring technologies with its Personal Diabetes Manager (PDM). The company realized revenues of US$1.2 million in Q3 2008 and US$1.4 million for the three and nine months ended September 2008 in relation to the Abbott agreement. In June 2008, the company also signed an agreement with Ferring Pharmaceuticals to develop the OmniPod System for the delivery of drugs developed by Ferring. In fact, this is Insulet's first development agreement for a non-diabetes drug delivery application. Additionally the company has deferred revenue of US$2.3 million as of September 30, 2008.

In order to achieve profitability, Insulet aims to reduce production cost. In line with this strategy, the company outsourced the production of OmniPod to a subsidiary of Flextronics International Ltd in China in 2007. This move helped Insulet reduce per unit cost due to increased production and resultant higher absorption of overhead costs. Gross loss was US$87,000 in Q3 2008 as compared to US$3.8 million in Q3 2007. For the nine months ended September 2008, gross loss was US$5.8 million as compared to US$10 million for the corresponding period last year. Production is currently being undertaken on a partially automated manufacturing line at the Chinese facility. By completely automating the manufacturing process, the company aims to further expand production and improve gross margins in the coming quarters.

Since the commencement of commercial sales of the OmniPod System in the United States in October 2005, Insulet has expanded its sales and marketing efforts to increase market penetration of the OmniPod system throughout the US starting with the Eastern states. The OmniPod System is currently available in all 50 states. In Q3 2008, sales and marketing expenses increased by 146% y-o-y to US$10.2 million while that for the nine months ended September 2008 increased by 179% y-o-y to US$29.7 million due to additional hiring and trade shows. Additionally, general and administrative expenses increased by 86% y-o-y to US$6.3 million in Q3 2008 and by 91% y-o-y to 16.9 million for the nine months ended September 2008 as a result of expanding business. The significant increase in expenses led to an operating loss of US$19.8 million in Q3 2008 as compared to US$14.5 million in Q3 2007. The company expects operating expenses to continue to increase in the near term.

Insulet incurred interest expense of approximately US$1.1 million and US$1.3 million for the three and nine months ended September 30, 2008, respectively. This is in connection with the private placement of 5.375% Convertible Senior Notes worth US$85 million due on June 15, 2013. As a result, interest expense more than doubled to US$1.4 million in Q3 2008. This factor, in addition to the operating loss of US$19.8 million led to a net loss of US$20.8 million in Q3 2008 as compared to a net loss of 13.6 million in Q3 2007. For the nine months ended September 2008, net loss was US$64.5 million as compared to US$37.9 million for the corresponding period last year. Insulet is expected to continue incurring losses in the near term.

Insulet's cash balance as on September 30, 2008 stands at US$74.1 million. This includes US$81.5 million raised through the Convertible Notes issue. Approximately $23.2 million of the net proceeds of the issue were used to repay old debt while the remainder is intended to be used for general corporate purposes. As Insulet continues to expand its business it will need additional capital to increase market penetration amid stiff competition and increase manufacturing capacity. The company expects a capital expenditure of at least US$10 million in FY08 for the expansion and automation of the manufacturing capacity. As a result, the company may have to raise additional debt or issue shares - extremely difficult in the current market environment. While it has historically been successful in doing so (Insulet has raised US$327 million since its inception in 2000), the current market turmoil poses a challenge. The company recently declared a dividend distribution of one preferred stock purchase right for each outstanding equity share to existing shareholders. The rights will become exercisable if a person acquires 15% or more of Insulet's common stock.

Reggie Middleton
Reggie Middleton, LLC
Perpetual Interests, LLCTM
http://boombustblog.com/

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