DexCom, Inc. (DXCM - $9.40) HOLD. Feltl and Company Research Department 2100 LaSalle Plaza 800 LaSalle Avenue Minneapolis, MN

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1 DexCom, Inc. Company Description: DexCom is a real-time diagnostics medical device company focused on the continuous glucose monitoring (CGM) market for both diabetics and critical care patients. The company has several ongoing development agreements to provide its technology for use with insulin pumps and in the critical care market. Feltl and Company Research Department 2100 LaSalle Plaza 800 LaSalle Avenue Minneapolis, MN Ben Haynor, CFA bchaynor@feltl.com Healthcare- Real-time Diagnostics October 28, 2011 Q3 preview cautious on second half 2011, reducing to HOLD (DXCM - $9.40) HOLD Key Points DexCom reports earnings on Wednesday, November 2. Competition may be on its way sooner than expected. Insulin pump hacking controversy may have impacted diabetes device market during the quarter. SevenPlus device experience comments have dropped off dramatically from last quarter, which has tended to imply negative stock performance upon earnings release. Downgrading to HOLD, reducing valuation multiple to 5.3x 2012 sales and price target to $ We have become more cautious on Q3 2011, which DexCom will report on Wednesday, November 2, after the close. Several developments, while largely anecdotal (and perhaps tangential), have spurred our more cautious stance on the company s prospects in the second half of Competition may enter the market sooner than we had expected. Previously, we had anticipated that it would be mid-2013 before a new competitor entered the market. However, recent CE Mark approval of C8 Medisensors noninvasive CGM (continuous glucose monitor) system and Abbott Diabetes Care (ABT not rated) filing for a clinical study on the Navigator II CGM in mid-october have caused us to revisit our assumption. C8 Medisensors presented this week at the Diabetes Technology Meeting in California. We believe the coming increase in competition, threatening the current, effective duopoly in the CGM market warrants a more cautious stance and lower valuation multiple. The recent Medtronic (MDT not rated) insulin pump hacking controversy may hurt the market for diabetes devices of all stripes, including CGMs. At two recent digital security conferences, demonstrations were made on hacking the Medtronic Paradigm insulin pump. While we believe this is technically feasible, we believe the true risk is likely overblown. However, the media coverage of this vulnerability may have the potential to dissuade those in the insulin pump and CGM target market (Type 1 diabetics) from adopting devices that communicate wirelessly. Additionally, the risk that politicians and/or regulators may get involved is heightened and may force DexCom to spend additional money in complying with new regulations. The comment propensity level amongst DexCom users has declined sequentially, which has signaled poor share-price performance post-earnings release in the past. While it is unclear that this correlation means causation, the thought process is that growing comment levels imply acceleration in installed base growth and vice versa. We present this as an aside, not as reason for our decrease in rating and price target. We are lowering our rating to HOLD from BUY and our valuation multiple from 8x 2012 EV/sales to 5.3x 2012 EV/sales, reducing our price target to $10.70, estimates remain unchanged. Financial Summary Rev(mil) 2010A 2011E 2012E Mar $9.5A $14.2A $23.8E June $11.8A $21.4A $26.5E Sept $11.7A $18.6E $30.2E Dec $15.6A $22.3E $35.5E FY $48.6A $76.5E $115.9E P/Sales 13.0x 8.2x 5.4x EPS 2010A 2011E 2012E Mar ($0.40)A ($0.19)A ($0.08)E Jun ($0.20)A ($0.11)A ($0.06)E Sept ($0.23)A ($0.18)E ($0.03)E Dec ($0.16)A ($0.13)E $0.03E FY ($0.97)A ($0.61)E ($0.13)E P/E NM NM NM Price: $ Week Range: $ $9.13 Target: $10.70 Rating: HOLD Shares Outstanding: 67.3 mil Mkt. Capitalization: $629 mil Ave. Volume: 560,000 Instit. Ownership: 99% BV / Share: $1.81 Debt / Tot. Cap.: 0% Est. LT EPS Growth: 40% Please see important disclosures on pages 6 to 8.

2 rops Strong, Pricing Weak, Farm Profits Could Suffer INVESTMENT THESIS We are reducing our rating to HOLD with a 12-month price target of $10.70 (5.3x 2012 EV/sales). DexCom is a realtime diagnostics company focused on developing continuous glucose monitors (CGMs) for use by diabetics and in critical care settings. We believe DexCom will grow at a rate of over 40% Y/Y for the foreseeable future and successfully reach profitability by We believe DexCom has tremendous potential in a rapidly growing market. That being said, profitability is not imminent and we feel the market may view increased competition on the not too distant horizon negatively and not assign DexCom the multiples it has enjoyed in the past. Should the CGM industry reach a tipping point, positive developments on the Type 2 reimbursement front happen, or the share price become more attractively valued, we would be inclined to become more positive on the story. Competition Coming Sooner than Expected? Our view had previously been that Echo Therapeutics (ECTE STRONG BUY) would likely present the next source of competition to DexCom and Medtronic (MDT not rated) in the CGM space. However, a couple of recent developments have altered our view. First, a private company, C8 Medisensors, recently came out of stealth mode, presenting at European Association for the Study of Diabetes in Portugal in September and at the Diabetes Technology Meeting in Burlingame, California this week. Second, after a hiatus from the market, Abbott Diabetes Care, a division of Abbott Laboratories (ABT not rated), recently filed a clinical study for the FreeStyle Navigator II CGM system. The subsections below discuss in further detail potential competition. Abbott Diabetes Care Abbott filed a clinical study on October 15 th for home use of the Navigator II CGM system with NIH. The original Navigator has been on indefinite backorder and some speculated that Abbott would exit the CGM market, effectively leaving Medtronic and DexCom with a duopoly. The study s purpose is to gauge the Navigator II s performance in a home use environment over 15 days in Type 1 and Type 2 diabetics. The study will be conducted in two locations, and one of the locations is in the recruiting process already. C8 MediSensors C8 Medisensors recently emerged from stealth mode, showcasing its noninvasive CGM system at European Association for the Study of Diabetes in Portugal last month. Their CGM system utilizes Raman spectroscopy to measure glucose levels and has received CE Mark already. In our DexCom initiation, we went into great detail why we thought it would be unlikely that a spectroscopic approach, similar to how Masimo (MASI HOLD) measures other blood constituents, to measuring blood glucose would meet with failure. However, our discussion with C8 Medisensors management has changed our view. Very few previous attempts at spectroscopically measuring blood glucose attempted to use Raman spectroscopy and those that did faced a challenge in shrinking Raman spectrometers to wearable size. C8 Medisensors has apparently succeeded in shrinking their Raman spectrometer to wearable size (seen below), a technological feat in and of itself. The product will not require any disposable sensors, is projected to retail for $4,000, and may launch in the US in late Source: C8 Medisensors website. Feltl and Company Research Department DexCom, Inc. (DXCM) Page 2

3 rops Strong, Pricing Weak, Farm Profits Could Suffer Echo Therapeutics Echo Therapeutics has developed a noninvasive CGM based upon skin permeation technology originally licensed from MIT and similar electrochemistry to what both DexCom and Medtronic employ. Their coming CGM product, called the Symphony, recently completed a pilot study showing a 10.5% MARD on the continuous error grid. The company plans on conducting two more pilot studies, one on diabetics (currently ongoing) and one on critical care patients, prior to a pivotal study in early We estimate the company could reach the market by mid Insulin Pump Hacking Controversy Recently, a security researcher gave a presentation at the Black Hat Digital Securiy Conference in Las Vegas showing that it was technically feasible to hack an insulin pump (a Medtronic Paradigm) using the wireless protocol (connection) between the pump and control unit. Potentially, this could allow one to induce hypoglycemia in a pump wearer, which may cause death. Last week, security software developer, McAfee exposed a new vulnerability in Medtronic s Paradigm potentially allowing an attacker to gain control of one of Medtronic s insulin pumps from up to 300 feet away. Medtronic turned to Symantec, a McAfee competitor, to research the potential exploits. We believe that any device utilizing wireless communications can technically be hacked, but the practicality of doing so varies greatly. Based upon initial reports, it is likely that a setting may have to be changed on the insulin pump controller for this to work or the attacker needs to be in close proximity to the pump wearer as signals (or packets) are being sent for a relatively long period of time, similar to hacking a secure wireless Internet connection (WEP or WPA encryption), and/or having access to the pumps serial number. The potential perception issues that we see arising for DexCom out of this controversy are twofold. First, the news media has seized upon this story and proceeded, in our view, to exaggerate the true risk of having one s insulin pump hacked. As the patient populations of those who largely use diabetes devices are essentially the same, Type 1 diabetics, there is the possibility that the coverage of this story hurts both insulin pump manufacturers as well as CGM manufacturers, despite the fact that the level of risk a hacked CGM could result in is miniscule in comparison to what could happen with an insulin pump. Secondly, DexCom currently has a waiver from the FCC through March 2013 as the SEVEN PLUS does not comply with the requirement that device manufacturers transmit wirelessly within the Medical Implant Communication System (MICS) band (or side band at lower power). While the band on which a wireless transmission occurs has little or nothing to do with the security of the transmission, there remains the possibility that politicians and/or regulators wishing to grandstand on the issue may institute changes. To be clear, we view this controversy as overblown. However, others, including potential DexCom customers, may not and may make choices that decrease DexCom s sales at the margins or cause DexCom to spend additional funds on complying with new rules or regulations. DexCom Stock Performance Post-Earnings Release Since the beginning of 2010, DexCom s stock has not performed particularly well upon the release of earnings. Only twice has the company s stock reacted positively to an earnings release and it has declined more than 15% following the release on two occasions over the past six quarters. We have attempted to devise a method to signal when it may be likely that a negative reaction to earnings is likely to occur. In doing so, we looked at DexCom device experience comments to the FDA versus the estimated DexCom installed base, which we call comment propensity. If one looks at the sequential change in comment propensity versus the stock price reaction following earnings releases, shown in the bottom chart, it appears to correlate quite well. The idea being that growing comment propensity signals accelerating installed base growth, whereas slowing or reduced comment propensity signals slowing installed base growth. However, we would strongly caution that this is a short time series, correlation is not causation, and our downgrade is premised on other considerations. We present this as merely an intriguing data point. Feltl and Company Research Department DexCom, Inc. (DXCM) Page 3

4 rops Strong, Pricing Weak, Farm Profits Could Suffer DexCom Stock Perfomance Post-Earnings Release versus Q/Q Change in Comment Propensity 10% 100% Stock Performance 5% 0% -5% -10% -15% -20% 80% 60% 40% 20% 0% -20% -40% -60% -80% Q/Q Comment Propensity Change -25% Q1 Q2 Q3 Q4 Q1 Q2 Q3-100% Q/Q Comment Propensity Change DXCM Stock Performance Source: Feltl and Company estimates, Food and Drug Administration Feltl and Company Research Department DexCom, Inc. (DXCM) Page 4

5 DexCom, Inc. (DXCM) Ben Haynor, CFA Income Statement (millions, except EPS) 2009 Q1 Q2 Q3 Q Q1 Q2 Q3 Q Q1 Q2 Q3 Q Product revenue Y/Y growth 122.4% 153.1% 119.9% 133.2% 104.9% 122.7% 94.2% 67.9% 63.0% 57.1% 67.3% 69.4% 64.7% 63.5% 59.1% 63.5% 48.5% Development grant and other revenue Y/Y growth 573.8% 9.5% 3.9% -66.4% -46.8% -27.5% -62.8% 127.4% 12.6% -51.1% 9.7% 44.9% -76.0% 50.0% 50.0% -35.3% 0.0% Total revenue Product cost of sales Gross margin (products) -1.0% 24.0% 30.1% 35.2% 43.6% 35.0% 36.4% 45.0% 45.8% 50.7% 45.3% 65.7% 65.6% 65.6% 65.7% 65.7% 66.1% Development and other cost of sales Gross margin (development) 33.0% 66.0% 65.4% -35.8% 51.9% 51.7% 31.8% 80.8% 30.0% 30.0% 64.4% 33.3% 33.3% 33.3% 33.3% 33.3% 33.3% Total cost of sales Gross profit Gross margin 12.3% 36.2% 38.3% 29.8% 44.7% 37.9% 36.1% 55.4% 44.9% 49.8% 47.6% 63.7% 63.8% 64.0% 64.4% 64.0% 64.9% Operating expenses R&D % of sales 48.1% 49.6% 46.0% 52.8% 44.1% 47.8% 44.2% 32.8% 42.0% 34.9% 37.8% 31.6% 28.3% 24.8% 21.1% 25.9% 18.9% SG&A % of sales 118.5% 102.6% 87.9% 89.0% 63.8% 83.3% 75.6% 57.2% 67.1% 54.4% 62.2% 54.1% 50.8% 45.3% 37.7% 46.1% 34.7% Total operating expenses Operating Income (45.8) (11.1) (11.3) (13.1) (9.9) (45.3) (11.9) (7.4) (11.9) (8.8) (40.0) (5.2) (4.1) (1.9) 1.9 (9.2) 19.1 Operating margin % % -95.6% % -63.2% -93.1% -83.7% -34.5% -64.2% -39.6% -52.3% -22.0% -15.3% -6.2% 5.5% -8.0% 11.3% EBITDA (43.5) (10.6) (10.7) (12.4) (9.2) (42.9) (11.1) (6.5) (10.9) (7.7) (36.2) (4.1) (3.0) (0.8) 3.0 (4.8) 23.5 Total other income (7.7) (9.2) (0.4) (0.3) 0.1 (9.9) Net income (53.5) (20.3) (11.7) (13.4) (9.8) (55.2) (11.9) (7.4) (11.9) (8.8) (39.9) (5.2) (4.0) (1.8) 2.0 (9.1) 19.2 EPS $ (1.21) $ (0.40) $ (0.20) $ (0.23) $ (0.16) $ (0.97) $ (0.19) $ (0.11) $ (0.18) $ (0.13) $ (0.61) $ (0.08) $ (0.06) $ (0.03) $ 0.03 $ (0.13) $ 0.27 Shares outstanding Revenue Model Assumptions (thousands, except attrition rate and sensors) Starter kits sold Current users (end of period) Attrition Q/Q 7.0% 6.0% 5.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% 4.0% Average users Sensors purchased per average user per Q Feltl and Company Research Department DexCom, Inc. (DXCM) Page 5

6 Analyst Certification I, Ben Haynor, CFA, certify that the views expressed in this research report accurately reflect my personal views about the subject company and its securities. I also certify that I have not been, am not, and will not be receiving direct or indirect compensation related to the specific recommendations expressed in this report. Important Disclosures: The analyst or a member of his/her household does not hold a long or short position, options, warrants, rights or futures of this security in their personal account(s). As of the end of the month preceding the date of publication of this report, Feltl and Company did not beneficially own 1% or more of any class of common equity securities of the subject company. There is not any actual material conflict of interest that either the analyst or Feltl and Company is aware of. The analyst has not received any compensation for any investment banking business with this company in the past twelve months and does not expect to receive any in the next three months. Feltl and Company has not been engaged for investment banking services with the subject company during the past twelve months and does not anticipate receiving compensation for such services in the next three months. Feltl and Company has not served as a broker, either as agent or principal, buying back stock for the subject company s account as part of the company s authorized stock buy-back program in the last twelve months. No director, officer or employee of Feltl and Company serves as a director, officer or advisory board member to the subject company. Feltl and Company Rating System: Feltl and Company utilizes a four tier rating system for potential total returns over the next 12 months. Strong Buy: The stock is expected to have total return potential of at least 30%. Catalysts exist to generate higher valuations, and positions should be initiated at current levels. Buy: The stock is expected to have total return potential of at least 15%. Near term catalysts may not exist and the common stock needs further time to develop. Investors requiring time to build positions may consider current levels attractive. Hold: The stock is expected to have total return potential of less than 15%. Fundamental events are not present to make it either a Buy or a Sell. The stock is an acceptable longer-term holding. Sell: Expect a negative total return. Current positions may be used as a source of funds. 8/16/2011 Ratings Distribution for Feltl and Company Investment Banking Number of Percent Number of Percent of Rating Stocks of Total Stocks Rating category SB/Buy 40 67% 3 8% Hold 19 32% 0 0% Sell 1 2% 0 0% % 3 5% The above represents our ratings distribution on the stocks in the Feltl and Company research universe, together with the number in (and percentage of) each category for which Feltl and Company provided investment-banking services in the previous twelve months. Feltl and Company Research Department DexCom, Inc. (DXCM) Page 6

7 06/09/11 Hold Target: $ /04/11 Hold Target: $ /16/11 Buy Target: $ /28/11 Hold Target: $10.70 Date Nature of Report Rating Price Target 06/09/11 Hold $ /21/11 FDA releases draft guidelines for artificial pancreas Hold $16.25 system precursor 08/04/11 Frustrating CGM adoption rate continues; Q2 beat Hold $15.85 consensus on grant revenue 08/16/11 Still waiting on tipping point but risk-reward becoming Buy $15.35 favorable, upgrading to Buy 10/28/11 Q3 preview cautious on second half 2011, reducing to HOLD Hold $10.70 Feltl and Company does make a market in the subject security at the date of publication of this report. As a market maker, Feltl and Company could act as principal or agent with respect to the purchase or sale of those securities. Valuation and Price Target Methodology: We derive our valuation using an EV/sales methodology. We believe this is appropriate being that DexCom will not likely generate positive EBITDA or earnings until 2013 by our estimates. We have chosen 5.3x EV/sales as the multiple on which to DexCom based upon current high growth medical technology company multiples. Our $15.35 price target represents a 5.3x EV/sales multiple on our 2012 sales estimate of $115.9 million plus net cash of ~$110 million. Feltl and Company Research Department DexCom, Inc. (DXCM) Page 7

8 Risks to Achievement of Estimates and Price Target: DexCom s new products do not obtain FDA approval in a timely fashion. The FDA has significantly slowed down its rate of medical device approvals and all of DexCom s development agreement projects have slipped far beyond their initially intended timelines. While we believe management s current submission schedule is reasonable and that the company has far better guidance as to what the FDA will see as approvable, the risk remains that the approvals will continue to slip, causing investors to lose confidence in the company. The CGM industry is likely to become much more competitive. Currently, only DexCom and Medtronic (MDT not rated) have CGM systems that are being sold in the US. Numerous companies are attempting to develop CGM systems, and many have larger budgets and more experience commercializing technology. One company in particular, Echo Therapeutics (ECTE SB), is developing a noninvasive CGM system, which could redefine the market to the detriment of DexCom and Medtronic, who both have minimally invasive systems. Abbott patent litigation. DexCom is currently involved in a patent fight with Abbott (ABT not rated) which may result in DexCom being forced into a licensing agreement on unfavorable terms or see its products removed from the market. While we believe that the latter scenario is unlikely to occur, investors may adjust their valuations to account for this possibility as a final decision draws closer. Other Disclosures: The information contained in this report is based on sources considered to be reliable, but not guaranteed, to be accurate or complete. Any opinions or estimates expressed herein reflect a judgment made as of this date, and are subject to change without notice. This report has been prepared solely for informative purposes and is not a solicitation or an offer to buy or sell any security. The securities described may not be qualified for purchase in all jurisdictions. Because of individual requirements, advice regarding securities mentioned in this report should not be construed as suitable for all accounts. This report does not take into account the investment objectives, financial situation and needs of any particular client of Feltl and Company. Some securities mentioned herein relate to small speculative companies that may not be suitable for some accounts. Feltl and Company suggests that prior to acting on any of the recommendations herein, the recipient should consider whether such a recommendation is appropriate given their investment objectives and current financial circumstances. Past performance does not guarantee future results. Additional information is available upon request. Feltl and Company Research Department DexCom, Inc. (DXCM) Page 8

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