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Insulet Corporation (NASDAQ:PODD)

Q4 2012 Earnings Conference Call

February 27, 2013, 17:00 PM ET

Executives

Brian K. Roberts - CFO

Duane DeSisto - President and CEO

Analysts

Kimberly Gailun - JPMorgan

Danielle Antalfy - Leerink Swann

William Plovanic - Canaccord

Ben Andrew - William Blair & Company

Mimi Pham - ABR Healthco

Thomas Gunderson - Piper Jaffray

Jayson Bedford - Raymond James

Ben Haynor - Feltl & Company

Robert Goldman - CL King & Associates

Suraj Kalia - Northland Capital Markets

Debbie Wang – Morningstar

Operator

Good afternoon. My name is Stephanie, and I will be your conference operator today. At this time, I would like to welcome everyone to the Q4 2012 Insulet Corporation Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. (Operator Instructions).

Thank you. I would now like to turn the conference over to Brian Roberts. Please go ahead, sir.

Brian K. Roberts

Thank you. Good afternoon, everyone. Thank you for joining us for our fourth quarter and year-end 2012 conference call. I'm Brian Roberts, Chief Financial Officer of Insulet. Joining me on the call today is Duane DeSisto, our Chief Executive Officer.

Before we get started, I'd like to remind everyone that our discussion today may include forward-looking statements as defined under the securities laws. We intend these forward-looking statements to be covered by the Safe Harbor provisions for forward-looking statements contained in Section 27A of the Securities Act and Section 21E of the Securities Exchange Act and are making this statement for purposes of complying with those Safe Harbor provisions.

These forward-looking statements reflect our current views about our plans, intentions, expectations, strategies and prospects, which are based on the information currently available to us and on assumptions we have made. There are risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements. Information concerning the company's potential risks and uncertainties is highlighted in the company's press release issued earlier today and in the Risk Factors section of the company's SEC filings, including the company's Annual Report on Form 10-K for the year ended December 31, 2011 and the company's quarterly reports on Form 10-Q for the quarters ended March 31, June 30 and September 30, 2012. These risk factors apply to our oral and written comments.

We assume no obligation to update publicly any forward-looking statements whether as a result of new information, future events or otherwise. I'd also like to remind you that the guidance we're offering today represents the point in time estimate of our future performance. You'll find a link to the webcast of this call, as well as to today's press release at myomnipod.com in the Investor section.

Now, I'll turn the call over to Duane.

Duane DeSisto

Thanks, Brian. Good afternoon, everyone. 2012 was an extremely successful year across all fronts for Insulet with strong revenue growth and expanded gross margins driving us to operating cash profitability in the fourth quarter. The year culminated with our most exciting accomplishment, 510(k) clearance for the new OmniPod System.

We have pioneered a new market evidence by the 45,000 plus people who use the OmniPod to better control their diabetes. People continue to choose OmniPod in greater numbers for its ease-of-use, discretion and freedom from multiple daily injections or the freedom from nearly three feet of tubing required with a conventional insulin pump.

Revenue grew nearly 40% in 2012 to $211.4 million. Our core OmniPod business continued to perform exceptionally well with the third consecutive quarter of nearly 30% year-over-year revenue growth. This growth has propelled us to a double-digit share of the insulin pump market here in the U.S.

With over 70% of our new customers having never before used an insulin pump, we are expanding the market of those taking advantage of continuous insulin infusion therapy. However, with just 3% share of the overall type 1 market in the U.S., it is clear that we have an enormous opportunity in front of us as we continue to increase our sales reach.

To improve that reach, in 2012, we invested in sales and marketing in the U.S. We added approximately 20 new members to the commercial team in the first half of the year, including a new inside sales capability which launched in May. Almost immediately, we saw a return of these investments as growth accelerated in the second quarter and was sustained throughout the back half of the year.

I'm extremely proud of the efforts of our sales team. They were able to effectively communicate to both healthcare professionals and customers. There was no reason to wait until the new OmniPod was available to start therapy. While we know that some customers decided to wait, the team established new records for both referrals and initial shipments in the fourth quarter, and we entered 2013 with the referral backlog of potential new customers.

After an extensive review process with the Food and Drug Administration, we were pleased to receive a 510(k) clearance of our new OmniPod in December. The new OmniPod maintains all the same features and benefits of the original OmniPod, but does so in a package that's over a third smaller and a quarter lighter. We're confident that the new OmniPod will significantly address any size concerns of potential customers.

Since approval, we've been aggressively moving forward with the initial phase of our product launch to ensure a smooth introduction in the United States. At our national sales meeting in January, we focus primarily on training our commercial team. Our goal is to ensure a clear and consistent message to make sure that all healthcare providers and customers, both new and existing, are as excited as we are as we introduce the new product.

The field team has spent the last 45 days educating healthcare providers to make sure they've had a chance to see, touch and try the new product. Our customer support teams are prepared for the launch. They've been trained and have the resources to make the transition as seamless as possible to our customers. The result of these efforts is that we are now shipping the new OmniPod to new customers here in the United States.

For our existing customers, we will begin the transition from the original product to the new OmniPod in the next few weeks. To make this conversion as seamless as possible, we have taken several steps to make the change straightforward and easy. For example, we've created a 'What's New' information card that will be included in reorders, and we developed proprietary online training for customers to better understand the improvements in the new OmniPod.

Additionally, we have ramped up our 24 by 7 technical customer support team to assist customers who need additional help with the transition. With a start in March, we expect that the majority of our customers will be enjoying the benefits of the new OmniPod over the next few months.

As we commenced the transition of the customer base in the U.S., our international partners Ypsomed is nearing the completion of the conversion in Europe. Feedback in the new product has been excellent and has led to an overall increase in Ypsomed's growth rate. We expect growth in Europe to accelerate over the coming months and our international business to more than double in 2013.

On the operational side, we have also made significant strides towards a smooth changeover to the new OmniPod. Our operations team, our partner Flextronics and our many suppliers have worked closely together since approval to commence the manufacturing move from one product to the other. At this point, the supply chain has effectively transitioned to the new OmniPod.

At Flextronics, we're in the final production runs of the original product which will provide us enough supply to implement the transition plan of the customer base. Production of the new OmniPod continues to increase across two manufacturing lines as resources that were producing the original OmniPod switched to producing the new OmniPod.

With two manufacturing lines active, we have capacity to produce approximately 600,000 new OmniPod per month or about 20% excess capacity over current demand. While resources have been focused on the initial two lines as well as dealing with the shutdown for the Chinese New Year, we have made progress on the third manufacturing line as well. We anticipate that the third line will be qualified this summer, increasing our overall capacity to nearly 1 million pods per month.

While we are not at optimal production levels today, we expect to be at those quantities in the second quarter which will drive the cost per new OmniPod down under $12 allowed us to achieve 60% plus U.S. OmniPod margins by the end of the year. With the approval in the new OmniPod completed, we now turn our attention within our R&D team to what areas of development that will drive future growth.

First, we expect to file in the coming months a submission requesting 510(k) clearance for a PDM integrated with LifeScan Verio blood glucose meter. We are hopeful that this new PDM will be commercially available in 2013. Second, we continued to make progress towards leveraging the OmniPod technology for use with other pharmaceuticals outside of the diabetes space. The closest of these initiatives is an approved oncology drug that's in clinical trial now and could be on the market as early as 2014.

Third, we continue to look towards opportunities within the type 2 diabetes market to assist the growing population of insulin-dependent type 2 patients. Finally, in January, we signed an agreement with a new continuous glucose monitoring partner. The agreement calls for both parties to continue development work already underway towards the ultimate goal of an OmniPod integrated with a CGM sensor. The benefits of combining the OmniPod and the CGM sensor into the same system are numerous.

For example, a person no longer has to wear two things on the body giving the customer more freedom and eliminating CGM type holidays. Market data has always suggested that while people living with diabetes are willing to wear one device on the body, much few are willing to wear two devices. Additionally, both products share many similar components allowing the sensor to be added to the product at a significantly reduced cost as compared to stand-alone sensors.

As we've seen with the latest round of competitive bidding, the reimbursement environment is only going to become more challenging. By developing a more cost-effective all-in-one product, we are well positioned to address this changing reimbursement landscape. We believe a truly integrated OmniPod/CGM system has the potential to become standard care and are excited about its prospects.

Early returns on our progress have been very positive and we're confident that the sensor accuracy will be comparable to those currently on the market. Clearly, our pipeline is robust and will allow Insulet to remain an innovative leader in diabetes for years to come.

While the OmniPod business demonstrated strong growth throughout 2012, our Neighborhood business did lag behind our expectations. In the fourth quarter, Neighborhood Diabetes generated just under 13 million in revenue or about 4% year-over-year growth. When we acquired Neighborhood Diabetes in June of 2011, we did so to achieve three key strategic goals.

The first was to solidify and strengthen our reimbursement, billing and distribution infrastructure. With more than two-thirds of our patients receiving their OmniPods every quarter directly from Insulet, we needed to make sure that our services arm was capable of handling an ever-increasing number of customers. Second, we needed to add a national pharmacy capability as trends continue to push diabetes supplies to be adjudicated as pharmacy benefits. And third, we wanted to be able to drive customers of both entities with cross-selling opportunities.

As we reflect on our progress today, we are especially pleased with the results of our integrated infrastructure and pharmacy capability. In 2012, we completed the integration and the support functions and saw improvement in key metrics such as better conversion, lower days sales outstanding and a reduced cost per shipment. These improvements help drive the improved gross margin seen over the last couple of quarters.

On the top line, however, 2013 will be a challenging year for our Neighborhood Diabetes business. In late January, CMS announced results for the second round of competitive bidding for the distribution of certain diabetes products such as blood glucose test strips for Medicare customers. CMS has decreased the overall reimbursement rate for these products by an average of 72%, including a decrease in the reimbursement rate for blood glucose test strips for more than $33 per box of 50 strips to $10.41. The new rate is expected to become effective on July 1st.

At this new reimbursement rate, it is likely the Neighborhood Diabetes will see selling these products to Medicare patients after the effective date. The potential impact of competitive bidding on the business is expected to be 10 million to 15 million in revenue in 2013, with the majority of the impact in the second half of the year.

In summary, we had a great 2012 and we're very excited about 2013. The team has worked tremendously hard on making the new OmniPod a reality for our customers. The launch of the new OmniPod here in the U.S. will transform our business operationally and financially, as we bring an improved product to the market with a much better margin profile for the company.

We are confident the new OmniPod will also accelerate the top line of the business and we are seeing early signs of that in our forecast of new customer starts. In fact, as we look at first quarter which is historically a very challenging period for new patient starts, we are forecasting a year-over-year increase of nearly 30%.

For the full year 2013, we believe initial shipments will increase by over 40% as compared to 2012. We do expect some disruption in the first quarter in terms of reorders, as we have seen many patients delaying shipments to utilize any remaining supply they may have on hand. As a result, we do expect some percentage of our reordered customers to not reorder in Q1 but wait until the second quarter.

Taking into consideration our forecast for increased OmniPod initial shipments, the potential of a loss reorder for some percentage of our customers and the impact to competitive bidding, we are setting our initial revenue guidance at 240 million to 255 million for 2013. We expect that the OmniPod business will continue to growth for the full year at approximately 30% at the midpoint of the range with the top end achievable of growth accelerates the higher levels.

With that, I'll turn the call over to Brian to provide additional details about the fourth quarter, the full year 2012 and our expectations for 2013.

Brian K. Roberts

Thank you, Duane. First, let me summarize our fourth quarter results. Revenue increased overall by 23% to 57.8 million in the fourth quarter of 2012 compared to 47.2 million in the fourth quarter of 2011. Despite some patients choosing to wait for the launch of our new OmniPod, core business continued to perform exceptionally well with approximately 30% year-over-year growth for the third consecutive quarter coupled with record levels of initial shipments and referrals.

Gross profit for the quarter improved by over 25% to 25.3 million compared to gross profit of 20.1 million in the fourth quarter of last year. Gross margin was 44%, a slight decrease from the third quarter. This decrease was a result of higher international sales of the new OmniPod which given the current inefficiency of production, produced a decline.

Operating expenses for the fourth quarter were 31.4 million, less than a 3% increase from 30.6 million in the fourth quarter of 2011. Operating expenses declined 5% sequentially from 32.9 million in the third quarter of 2000, as we incurred higher costs related to our new OmniPod approval and commercial launch activities in Q3.

We reported an operating loss for the fourth quarter of 2012 of 6.1 million compared to an operating loss of 10.5 million for the fourth quarter of 2011 and 8.5 million for the third quarter of 2012.

Our fourth quarter 2012 operating loss includes over 6 million of non-cash operating expenses comprised primarily of depreciation, amortization and stock-based compensation. We achieved operating cash profitability back in September and maintained it throughout the fourth quarter.

Net interest expense was 4.1 million in the fourth quarter of 2012 compared to 3.8 million last year. Of the 4.1 million in interest expense, approximately 2.6 million was non-cash.

Finally, we reported a net loss for the fourth quarter of 2012 of 10.2 million or $0.21 per share compared to a net loss of 14.3 million or $0.30 per share for the fourth quarter of last year.

Now let me summarize our full year 2012 results. Revenue increased by 39% year-over-year to 211.4 million from 152.3 million in 2011. For the year, our core OmniPod business performed well growing nearly 30% and accounting for over 75% of our overall revenue.

Gross profit increased by nearly 40% to 92.3 million as compared to 66.7 million in 2011. Gross margin remained consistent at 44% each year, a significant achievement, given that our 2012 results included a full year of Neighborhood Diabetes as compared to a partial year in 2011.

Full year 2012 operating expenses were 128.3 million as compared to 109.2 million for 2011. The year-over-year change is primarily related to our acquisition of Neighborhood Diabetes in June of 2011 coupled with unplanned incremental costs related to the approval process for the new OmniPod this year.

For the full year, we reported an operating loss of 36 million compared to 42.5 million in 2011. For 2012, we reported a net loss of 51.9 million or $1.08 per share compared to a net loss of 45.8 million or $0.98 per share for the full year of '11.

As of December 31, 2012, cash and cash equivalents totaled 57.3 million. In early January 2013, we sold 4.7 million shares of our common stock at a price of $20.75. We received net proceeds after underwriting discounts and issuance costs of 92.8 million.

At the end of 2012, we had approximately 48.4 million common shares outstanding. However, after the sale of common stock, we currently have approximately 53.2 million shares outstanding.

Finally, let me turn towards providing some color for 2013. As we plan for 2013, we've taken several factors including the 510(k) approval of our new product, our launch strategy and customer transition plan as well as the potential impact of the competitive bidding program into consideration.

As Duane noted, the OmniPod business continues to perform exceptionally well and we are confident that we will see initial shipments accelerate with the launch of new product. In Q1, however, we have seen existing customers delay reorder shipments to utilize any remaining supply on hand resulting in some of the expected reorder disruption for the business in the first quarter.

Additionally, we know that historically the first quarter is always our most challenging time of the year due primarily to seasonality and deductible resets. As a result, we're projecting first quarter revenue in the range of 56 million to 59 million. For the full year, we expect revenue to be between 240 million and 255 million. This implies 30% year-over-year growth for the core OmniPod business at the midpoint in the range.

In regards to gross margins, as you've indicated in the past, we will provide our in-warranty customers with a new PDM at the time of transition at no additional costs. The payback to Insulet is effectively three to four months of savings from the new lower cost OmniPods.

Thus, with the conversion of the customer base expected over the next three to six months, we would expect gross margins to remain relatively flat with Q4 for both the first and second quarters of 2013. We would expect to see an uptick of approximately 3 percentage points in Q3 and further increase of an additional 3 to 4 percentage points in Q4. The full effect of the new pod will come to play in Q1 of 2014.

Operating expenses are likely to remain in the range of 32 million to 34 million per quarter throughout 2013 as we continue to invest in our sales and marketing function to support our growth and the launch of the new OmniPod. We do not expect significant increases in R&D or G&A with any uptick in G&A costs primarily a result of non-cash charges such as stock-based compensation.

We're confident that we'll be cash operating profitable for the full year and have set a goal to be operating profitable as defined as earnings before interest and taxes in the fourth quarter.

With that, let me turn the call back over to Duane.

Duane DeSisto

Thanks, Brian. In summary, 2012 was a year of very strong execution for Insulet and we expect 2013 will be even more exciting. The OmniPod launched in Europe to a strong early response and we have now commenced the launch in the U.S. We are on track with our transition plans for our 45,000 plus customers and our confident that the feedback in the U.S. will be just as positive.

We are always focused on innovation at Insulet in 2013. We will continue work towards expanding our product portfolio with the LifeScan PDM, new entries in the type 2 market and integrated CGM in OmniPod. We will do all this with our shareholders in mind. With the robust demand we expect for our new OmniPod, we expect to be able to continue delivering strong year-over-year top line growth while expanding our gross margins even further to become operating profitable by year-end.

At with that, operator, please open the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question comes from the line of Kim Gailun with JPMorgan.

Kimberly Gailun - JPMorgan

Hi, guys. Thanks for taking the question.

Duane DeSisto

Hi, Kimberly.

Kimberly Gailun - JPMorgan

Hi. So first question I guess is just on the new product launch and maybe just talk about the ability to get into new accounts with the new OmniPod, how those conversations are going? And why you think the new product is going to kind of get you (inaudible) that haven't been using your product before?

Duane DeSisto

I think, Kim, so the early returns -- and keep in mind they were early. But the early returns people are intrigued by this next step in our evolution. And I think from our standpoint, there is both patient excitement and like you said, many of these physicians -- one of the blocking things that was out there was our whole insulin on-board calculation and not to bore everybody with the kind of arcane way we did it, but we thought we had kind of a better mouse trap. It wasn't the way the market leader did it. So this product basically put it in line with the way the market leader did it, which was blocking us in several institutions that they don't want to be treating their patients in multiple ways to calculate this depending on the product. So we know for a fact there's a whole list of people that told us as soon as we fix that, come back in. And even in the original product, we just wanted to fix that. That would have been a whole new 510(k). So we coupled that in this. So we know there's places, we know why a lot of people were blocking. And like I said, there's a lot of interest and so it gives us the opportunity to go back into all these guys. But like I said, that one in and of itself is significant.

Kimberly Gailun - JPMorgan

Okay, great. And just a follow-up on the gross margin side. So it sounds like you guys are doing all the right things on the manufacturing side. But how do you get visibility into that second half gross margin ramp, because it sounds like you're still looking to kind of exit the year at about 60% plus gross margin level? Thanks.

Brian K. Roberts

No problem, Kim. It's Brian. So, we've certainly talked about partner Flextronics on a daily basis and Charlie has been leading the charge for us in making sure that we're hitting all the milestones that we need to hit around our overall pod costs, making sure the component costs is coming in as planned, and so far we're right on track. And so with all of those discussions with Flex, as we get to full capacity here, as we said in the prepared remarks, as the original pod ramped down its final runs of production and all of our resources can then be focused on generating the new pod, we're very confident that we're going to see the cost come in where we need it to be. So, I still feel extremely confident that we're going to end this year with a U.S. OmniPod margin in the low 60s which will translate on a consolidated basis. Our Q4 gross margin on a consolidated basis is probably somewhere around 50%, 51% and then you get the full effect of it probably a few more points in Q1 of '14 once all of the inefficiencies of the transition are now over.

Kimberly Gailun - JPMorgan

Okay, great. Thanks, guys.

Operator

Your next question comes from the line of Danielle Antalfy with Leerink Swann.

Danielle Antalfy - Leerink Swann

Hi. Good afternoon, guys. Thanks for taking the questions.

Duane DeSisto

Hi, Danielle.

Danielle Antalfy - Leerink Swann

Hi. Just wanted to, Duane, follow-up on your comment about patients sort of deferring for the new OmniPod. How do we think about the impact of those patients coming on line versus the reorder disruption that you expect to see in Q1, how do they sort of offset each other? If you could walk us through that, that would be helpful?

Brian K. Roberts

Yeah, sure. Danielle, it's Brian. As you guys know, in any given quarter, the majority of our revenue in a given quarter comes from our reorder base, right. As our patients come on board, they typically order every 90 days. And a lot of that is dictated by guidelines that come from the managed care plans of how we can bill. And so no surprise. Typical effect is your sales in the third month of a quarter tend to pick up a little bit, so you're always a little bit back ended. On average we see and hear from patients that they may have around a month's worth of supply maybe sitting around in the closet that they've accumulated over time for whatever those reasons may be. And some would like to be able to leverage and use that supply before going on to the next-gen product. And a lot of that couples with the fact it's Q1 and everybody's deductibles are reset. So there's more cash out of pocket in Q1 than as compared to Q2 or Q3. So what we're planning for just given the -- what we've been hearing from customers through the first two months is that some of our reorder customers who would ship in the month of March normally may not wind up shipping until the beginning part of April. The impact of that just becomes, depending on the managed care plan those reorders, you may have a group of patients who have three reorders in the course of 2013 versus four. And so that's what we've effectively baked into that Q1 number. And then our overall guidance is that phenomenon. Any disruption from the reorder base around this area we think is completely resolved as we get into the Q2. This is really almost just a March, April effect and it's just a timing issue of exactly when the quarter cuts off. Certainly new shipments and one of the things that we're pretty enthusiastic about is coming out of the gates with a strong new shipment number in the first quarter of the year. It means that those patients are going to have three reorders over the course of the year as compared to if they start in Q2, then they have two reorders, right? So, there's a compounding effect there by getting more people on board with the product earlier. It's certainly why we put a lot of effort to making sure that we were ready to go with the launch here and that all of our customers in the U.S. are now getting the new pod. So that will offset some of that effect. But really it's kind of just a timing phenomenon between March and April.

Danielle Antalfy - Leerink Swann

Okay, great. That's great color. And then on Neighborhood Diabetes, so obviously the business is turning out a little bit different than you guys had hoped and dreamed when you purchased it. Can you talk about how you're thinking about Neighborhood Diabetes going forward from a strategic perspective? What might happen to that business or does it still make sense within the total Insulet business from a potential sales synergies perspective?

Duane DeSisto

This is Duane. That's a great question, Danielle. Look, I think from our standpoint it wasn't lost on us or anyone else in the industry. The competitive bidding was going to come out. I think the entire industry in terms of the glucose monitoring business was stunned at $10.41, I think. You know why I would tell you flat out our proposal we thought that was still a profitable business for us in the $13 per 50 box range. At $10.41, it really isn't. I think the pluses that we saw and we described there, we're seeing the benefit of all that. So I think from our standpoint, we obviously have to modify the spend and take into account the business that will go away with this Medicare piece. There's subsets of people out there that are thinking that they can make a lot of money at $10.41, so there's some interesting customer names there. So there's a lot of activity swirling around. But I think our overall concept continues to be, and I think when you kind of fast forward whether it's two years from now or five years from now, patient-driven outcomes are going to be the real key to this whole thing and we still see Neighborhood playing a huge part and where we want to be, their High Touch service model. So we're still very excited about it. And in my mind, look, we didn't buy it for the Medicare strip business. I mean that came along for the ride and was nice and was an accretive business at the time. But at $10.41, you just scratch your head and say -- it's the only real Medicare business that we have. It's easier to get out from under that than it is to be involved and all that goes with being involved in the government at that price a very tough business model for all those guys. So, we're still excited. We still see -- nothing changed, I think, from our standpoint but obviously we have to just kind of readjust a little bit.

Danielle Antalfy - Leerink Swann

All right, that makes sense. Thanks, guys.

Operator

Your next question comes from Bill Plovanic with Canaccord.

William Plovanic - Canaccord

Great. Thanks. Good evening. Just a couple of questions here. First on the Q1 guide as Jan, February, you've talked about it but for me utilization rate it's going to drop down. It comes back in kind of April-ish. How do you know that that's not a competitive issue?

Duane DeSisto

Bill, this is Duane. Look, I think we're talking for the customers, right? What we have is when we've talked to people, we've explained to them the transition plan. I mean it's not like people are coming back to us saying, we don't want the product. They're trying to use this. What a lot of people are hoping is if they use the supplies, then the next reorder they get will be the new product. So there's a bunch of that going on. But I think one of the benefits that we have in this business, we actually talk to the customers. So, I think from our standpoint, the kind of insight guidance we're giving you is the feedback that we're receiving for our intake group. So really not -- I would tell you I don't -- we're not sitting here with initial starts going up and the other positive things. We don't see it as a competitive thing, but we are -- and like I said, the nice part about the good news and the bad news depending on the given day is we talk directly to the customer.

William Plovanic - Canaccord

Great. And then parlay that, 40% new patient growth doesn't sound like competitions really have an impact on you because I think the best growth you'll have had. Can you answer is that worldwide, just a little granularity?

Duane DeSisto

That 40% number is factored on the U.S.

William Plovanic - Canaccord

Okay. And then one more, if I may. As you look at CGM, you've talked about it. You signed a partnership we'll say with an unnamed company, a name would be helpful? One. Two, timeframe and cost to develop this? And that's all I had. Thanks.

Duane DeSisto

Sure, Bill. So just to make it clear, I mean the agreement we have with the company until we get to the point where we think we have a final version, a commercial version, we agreed not to give involved in disclosing that. If the company wants to disclose in some point in time, we said it is fine with us. But they asked us not to disclose it. And like I said, it's not material to anything we're doing at the moment. In terms of the cost, it really fits within the guidelines of R&D, because -- once again, just to reset everyone. We are not developing a sensor. We are taking a sensor that is developed by a company that's been in the blood glucose monitoring business and we are trying to integrate that into our products. So we have an existing product. So if you think about what's involved in terms of kind of a new R&D type stuff; it's a, they got to make sure the sensor is competitive with everything that's out there. And like I said, we tested on pigs, so far so good. Sometime next year we'd like to be doing it on people. And we'd like to be doing it on people not as a stand-alone sensor, but in our integrated format. So the big engineering hurdles/opportunities for us is how do we insert this within the framework of the product we have? And how close can it be to the insulin delivery? And the third one is -- and we've tested this a lot now, but we still have to go through in testing it in final is can the sensor withstand ETO sterilization. So from an engineering standpoint, those are the three big things that we have. So I would tell you it's not outside the scope of our ongoing engineering. I mean it's not some huge increase, because once again, we are not developing a continuous sensor.

Operator

Your next question comes from the line of Ben Andrew with William Blair & Company.

Ben Andrew - William Blair & Company

Hi. Good afternoon. Can you hear me?

Duane DeSisto

Hi, Ben.

Brian K. Roberts

Hi, Ben.

Ben Andrew - William Blair & Company

Hi, guys. So can you talk maybe about -- two or three topics? One is – and if you've covered this one, I apologize, but give some of the experience with both patient satisfaction and patient add rates as you've rolled off the Gen2, how is that going?

Duane DeSisto

We've seen an uptick. Ypsomed has worked over the course of the last, I call it, five months or so on transitioning their customer base from one to the next. I think our last shipments of the original OmniPod to them were probably back somewhere in the August-September timeframe. All of Q4 was the new pod. And the response has been really positive from that. We've seen it in a couple of ways. One is, their growth rate for the number of patients they've been adding every single month has started to accelerate and that's been happening in a period of time, so, for example, January and February within their business which aren't the strongest of months either. Second, we've also been able to get some early response back from them around their initial feedback, what we're hearing from customers. And one of the things that we've focused on is this idea of out-of-box failures from a quality perspective. One of the things that we know is that customers don't like the fact if the pod comes out of the box and for whatever reason we have a communication failure with a handout and it doesn't work. Historically, we've seen a 2% to 3% rate or so of those here in the United States. We made a lot of changes to the product including why we're giving people a new handout to be able to improve that overall communication protocol. And today, we're seeing that overall rate overseas now drop from that 2% to 3% kind of range to less than 1.5%. So, we think that's a significant improvement overall from where we are and it's a big -- but been a big positive for us and something they've commented back on.

Ben Andrew - William Blair & Company

Okay, good. And it sounds like the gross margin was trending consistent with what you'd expect, are the yields flowing in the same trajectory?

Duane DeSisto

Yeah, absolutely. Certainly as Charlie's been working through the process with our various suppliers, there's been a couple of components that the yields are a little bit lower on that you'd like. The good news is it's at the parts that are $0.10 a part versus to the point where you're getting more fully developed OmniPod. But I'd call that just kind of a normal course growing pains as these suppliers ramp up their production from tens of thousands per month to hundreds of thousands per month. And then obviously the next step will be as we get through the year to 1 million pods per month.

Ben Andrew - William Blair & Company

Okay. And then turning to the CGM product for a second, can you maybe give us a timeframe for when we could hear an update either public presentation of some data about the performance of the sensor? And have you been able to determine if you can use the same cannula or if you're going to need a fundamental redesign on the pod? Obviously R&D -- then I've got a follow-up for that.

Duane DeSisto

Ben, great question. So from our standpoint we want to fit it in the same form factor, but we're still going around that process to see if we can do it. But the last thing in the world we want to be doing is buying new tools and new base tools and doing all that. So right now we believe, but we still have to prove it, that we can use same form factor. I think in terms of -- I think for us, I think the first kind of real milestone other than the normal R&D and the pig data and the other stuff that we've done, we've kind of gotten (inaudible), we like to begin in next year to start getting it on people. And if we can get it on people, then I think you got -- if you start looking at the convention fees between the ADA, the ATTD, the AADE, hopefully at that point in time we'll have enough that we can start sharing that information with people. Like I said, right now we got some real promise. We'll see if we get where we want. I mean we're excited about it. We obviously wouldn't have signed it. We wouldn't have been putting the effort into it if we haven't seen enough to really kind of take the next step. But to me that's kind of -- that will be kind of a time period where I think we'd start having data in a meaningful format that it'd be worth sharing with clinicians and the general market.

Ben Andrew - William Blair & Company

And that's just the sensor itself, not embodied within the pod we'll be seeing…?

Duane DeSisto

No. That's another great question. We're trying to put it in -- we're not doing the sensor. What I'm talking about is we're trying to embody it in the pod and put it on people come the beginning of next year. And so we have a couple of variations that depending on where the insulin is going to be delivered in relationship with the sensor. We're going to try. We're trying a couple of different things here. We've done a lot of work understanding the impact of insulin delivery and the proximity to the sensor. So we think we understand. But as you know, until you go do it and start putting it on people, you really don't. But we think we understand, but we're going to find out what we don't know in doing this. But we are talking about -- when I talk about putting it on people, it's not a stand-alone sensor. I'm talking about in the embodiment that we believe will approximate what the product should look like.

Ben Andrew - William Blair & Company

And has that CGM sensor been used on actual patients as opposed to kind of -- human control testing as opposed to diabetics and patients that have got other comorbidities and all kinds of other stuff going on?

Duane DeSisto

It has been used -- the technology has been used on patients, but not in this particular format. We've been through the stats, we've been through blood, we've been through kind of pig testing, but we still got a ways to go. I don't want to paint any picture that we're -- this thing's around the corner. Like I said, I think our view is simple. I think if you look at the pressure being put on blood glucose monitoring and you look at where this is all going, you look at our internal studies on how many things people are willing to wear on the body, but we are focused on insulin-dependent patients. But I think it's pretty clear to us that the right format is to get it all in one person -- I mean get it on the insulin-dependent people and we think over time that will drive some interesting outcomes. We think that's the format. We think we have a cross-structure that we can accomplish that. But hang on. We will keep you informed as we go forward. But that's kind of how we're approaching it.

Ben Andrew - William Blair & Company

Okay. And just to be crystal clear, you're talking about the embodiment of the CGM within the pod that the CGM sensor itself has been used on diabetics and patients and all people with health and the different drugs on board and you're comfortable with the performance of the sensor?

Duane DeSisto

The technology has, the embodiment of this sensor has not.

Ben Andrew - William Blair & Company

Okay.

Duane DeSisto

They may have been used on a few patients, I don't know, but not in any meaningful way. But the technology itself has been tested on patients.

Ben Andrew - William Blair & Company

Okay. Thank you.

Operator

Your next question comes from the line of Mimi Pham with ABR Healthco.

Mimi Pham - ABR Healthco

Good evening. Did you give us the installed OmniPod base at the end of 2012?

Brian K. Roberts

Yeah, we mentioned that we're, at this point, slightly over 45,000 patients.

Mimi Pham - ABR Healthco

Okay. So I guess doing the math, would that be fair to use a ballpark number of 15,000 new patient add last year when talking about initial shipments increasing by 40%?

Brian K. Roberts

Yeah, I'll let you guys kind of go through that part. But I'll just leave it at we're over 45,000 patients and we've talked about that, our overall annualized attrition rate continues to be hovering in that kind of 8.5% to 9% kind of range. So, I'll leave it there.

Mimi Pham - ABR Healthco

Okay. And then in terms of just the delay in the CGM integration timeline, how important is CGM integration to your current customer base? Do you have any sense of that 45,000 what percent are using CGM?

Duane DeSisto

So we do an independent survey and I think that 20% of our installed base is using CGM. If you look back at the beginning of the year, about 20% of our installed base which uses CGM. So that's in our particular -- and that 45,000 number has been granted. We have independent companies do a survey. They ask lots of different questions, but CGM usage is one of it. So about 20% of that installed base is used in it. And we're obviously -- they're using the DexCom sensor because if people want CGM, that's where we direct them not to the market leader.

Mimi Pham - ABR Healthco

Got it. And then just last question, just to clarify, will you stop shipping first gen pods by year end?

Brian K. Roberts

Year-end 2013?

Mimi Pham - ABR Healthco

Yes.

Brian K. Roberts

Absolutely.

Mimi Pham - ABR Healthco

Okay. Thanks.

Brian K. Roberts

Hopefully sooner.

Mimi Pham - ABR Healthco

Okay. Thanks.

Operator

Your next question comes from the line of Tom Gunderson with Piper Jaffray.

Thomas Gunderson - Piper Jaffray

Hi. Good afternoon.

Duane DeSisto

Hi, Tom.

Thomas Gunderson - Piper Jaffray

So just to be clear, I didn't catch this at the beginning. You're going to start shipping to existing customers of Gen2 or next gen in the next several weeks. Are new customers getting this right away?

Brian K. Roberts

Yes. New customers, we've moved all of our new customer shipments to the new pod and we will start to transition our existing customer base here within the next couple of weeks, correct.

Thomas Gunderson - Piper Jaffray

Okay. Thanks. And then Duane, you said last quarter that you might start when you got approval or to getting approval, when you got approval that you might go out to some of the big centers that you could get a lot of bank for your buck. Did that in fact happen?

Duane DeSisto

Yes, it did. And Tom the kind of insulin on board calculation, like I said, is a bit of an arcane calculation, but obviously it's critical for diabetes patients. Some of the bigger centers were concerned about how our older product did this and not that there was anything wrong with it. It was just different, so that meant they had some of them were worried about confusing patients. The fact that we are now in line with kind of how the general market does it, we've already been back to those guys and a couple of them have already given us a couple of patients because they want to see it in a (inaudible). It's one thing to give them the demo, but they want to put a couple of patients on and they want to start seeing it. So we're pretty excited. Like I said, I think time will tell here but we're pretty excited about what the opportunity is.

Thomas Gunderson - Piper Jaffray

And then just sort of a larger concept on type 1, there's been reports now for the last couple of years that there's a new type of type 1, some are calling it late onset, adult onset the type 1. I would think that OmniPod would be well suited for that. Have you seen any differential uptick by those older, new type 1s?

Duane DeSisto

Tom, that's a great question. There's been a little bit, but the sweet spots for us still remains that 18 and under. What people gravitate to with this product and will gravitate even faster too with the smaller product is obviously this whole freedom not interfering in their lifestyle, basically having diabetes but in their mind they don't have diabetes for that period of time. But there has been an uptick. It's interesting. There's been a little bit of uptick while it's not meaningful yet in terms of our installed base, there has been an uptick in the type 2, insulin-dependent type 2 for the product. But we're seeing some of these numbers start to move a little bit. But it's still -- like I said, the sweet spot for the company is still kind of young, active, whatever you want to define that as, are the people that gravitate immediately to this product.

Thomas Gunderson - Piper Jaffray

Got it, thanks. And then one for you, Brian. I think in the script it said operating profitable by year-end was a goal. Could you talk a little bit about cash flow from operations since you've had a good run here in the last part of '12, what do you expect that to be maybe by quarter and '13?

Brian K. Roberts

I don't think I have the quarterly detail to probably go through. Overall, we were operating cash profitable over the last four months and again the definition that we use for everybody just to be clear is effectively EBITDA plus an add back for basically stock-comp expense. And so we've been able to achieve that now for the last four months. The trick now is as we continue to grow the overall top line, as we continue to expand the gross margin through the transition to the new product, is that we're able to then cover those non-cash expenses as well to get to overall operating profitability. Uses of cash in 2013, we will still use some cash mainly around capital expenditures and we'll have to cover the interest expense in our debt. But from an operational perspective, using the P&L as a guide I think we're going to be in really good shape and we'll be effectively operating cash profitable for the entire year. There could be a little bit of timing change from a working capital side as we build inventory, as we go through receivables and those things. So that piece is a little bit tricky to be able to nail for you right now.

Thomas Gunderson - Piper Jaffray

Got it. Thanks. That's good for me.

Operator

Your next question comes from the line of Jayson Bedford with Raymond James.

Jayson Bedford - Raymond James

Good evening. Thanks for taking the questions. Just a couple. I realize the benefits of the new device and you mentioned 8.5% to 9% attrition rate on Gen1. Just wondering internally, are you expecting a lower attrition rate with the new pod?

Duane DeSisto

I would tell you we're hoping for a lower attrition rate from the standpoint; one, if you take about half that attrition rate being economic in that people are impacted in their jobs or whatever, kind of take that off the table. The other big piece of that attrition rate was given that 70% of our customers have never been on an insulin pump before. And if you couple that with what Brian said -- one of the failures we struggled with on and off was the whole kind of out-of-box failure. If Europe is any indication, we are cautiously optimistic but we put that one in a good spot. And that's the one that gets people pretty irritated. The whole idea that they put it on and all of a sudden, they had a problem with this. So that we feel based on the European experience, so far we feel pretty good about. We specifically went after that one in design. And then the second piece, if you look at the second kind of cause, if you get out of that -- if you look in that kind of first 45 to 90 days where a bunch of these people would drop off. The second reason was some of the people put on, it was bigger than -- I know I tried it, but this is a little bigger than I thought. So we think the size will help impact that again. Let's put it this way. If size was an issue, there will probably not in any foreseeable future be a smaller insulin pump in this. So I think that will knock down the second one. So the hope is that we impact that number. Like I said, I think on the economics side, about half the number always has been related to people's jobs, their healthcare benefits. There is a school of thought internally that with kind of ObamaCare kicking in, maybe we get a benefit from that. But we'll see. I'm not -- I will readily admit I'm not smart enough to dial in the impact of what that all means. But there may be a positive in that. But right now, like I said, if you look at the two major things that we think we went after and hopefully knocked out here; size is obvious and then these out-of-box failures, we feel pretty good. If you put those two together, we think they'll do a positive impact.

Jayson Bedford - Raymond James

That's helpful. The financial structure of the CGM partnership, is this a royalty type arrangement, is there a catch outlay from you guys expected upon some sort of milestone?

Duane DeSisto

Yeah, I mean ultimately the plan would just be simply thinking of them as (inaudible). They'll effectively sell sensors to us at an agreed upon price and we'll work it into our bill of materials and then go forward. So no different than how we buy semiconductor chips from Freescale, any type of an approach.

Jayson Bedford - Raymond James

Okay. And then maybe Brian on the OpEx guidance, just curious as to the mix, it looks like it will stay fairly constant in '13 here. Wondering if you're able to take some of the cost out of the Neighborhood business given competitive bidding? And then maybe back drawing that with increased spend on the launch, is that a fair way to look at it?

Brian K. Roberts

Yeah, absolutely. I mean certainly as we continue just to figure out -- and obviously there's still some moving parts with the competitive bidding and will the July 1 date move and some of the other stuff, we're just watching it closely. Certainly there's an opportunity to be able to reallocate some resources from that area to other initiatives likely within the commercial team if it all comes to pass.

Jayson Bedford - Raymond James

Okay. And then last one for me if I may. You mentioned that you expect international sales to more than double in '13. What were international sales in '12? Thanks.

Brian K. Roberts

Yeah, we haven't disclosed specifically what that number is. I mean I have said to folks that it's somewhere in the mid-single digits, but we haven't got more specific than that.

Jayson Bedford - Raymond James

Thanks.

Operator

Your next question comes from the line of Ben Haynor with Feltl & Company.

Ben Haynor - Feltl & Company

Good afternoon, gentlemen. Thanks for taking the questions.

Duane DeSisto

Hi, Ben.

Brian K. Roberts

Hi, Ben.

Ben Haynor - Feltl & Company

Hi. On the gross margin guidance, you talked about the 2% to 3% out-of-the-box failures here in the U.S. and about a 0.5% in Europe. Does the gross margin guidance factor in any improvement in the out-of-box failure rate?

Brian K. Roberts

Yeah, we certainly -- again, as we've given you the gross margin expectations for the next four quarters at least which again roughly is flat for the first and second quarter of '13 from where we are today, probably up 300 dips improvement in Q3, another similar kind of an improvement, maybe a little bit more than that in Q4. We are taking into consideration where we're seeing a little bit so far and hopefully being able to just kind of dropdown, if you will, our implied warranty on COGS because -- certainly when people experience the out-of-box failures, we're able to -- we turn around and replace those. We haven't really factored does that impact customer support costs or any of those kinds of things at this point. It's just too early.

Ben Haynor - Feltl & Company

Okay, that's helpful. And then on the CGM side of things. Is the plan to insert like the cannula on the OmniPod? And then also is it a glucose oxidase type sensor? Is it something completely new and different?

Duane DeSisto

So the technology while different is based on the glucose oxidized sensor. And the idea is -- what we are working on is automatic insertion. So it will be, I can't say -- it will be on the same general concept as the [comp] product.

Ben Haynor - Feltl & Company

Okay, great. And then one more quick one. I didn't quite touch this. Did you say 10% to 15% impact versus 2012 revenue on Neighborhood or 10 million to 15 million?

Brian K. Roberts

Million dollars, yeah. So anticipate that it will be $10 million to $15 million of revenue impact in Neighborhood in 2013 with the majority of that in the back half of the year. But realistically, our expectation is that we'll start to see some attrition in the second quarter as we would expect some of the folks who were going to aggressively go after this business for a while will try and do a land grab.

Ben Haynor - Feltl & Company

Sure. So 35 million to 40 million type range?

Brian K. Roberts

No. You mean for the Neighborhood, this were the total?

Ben Haynor - Feltl & Company

Correct.

Brian K. Roberts

Yeah, okay. 10 million to 15 million decrease, right.

Ben Haynor - Feltl & Company

Okay. Thank you very much.

Operator

Your next question comes from the line of Robert Goldman with CL King.

Robert Goldman - CL King & Associates

Just two one-off things. With Neighborhood Diabetes in the quarter, was it about the same revenue in 2012 fourth quarter as compared to third? That's what I thought I was hearing but I just want to recheck that detail?

Brian K. Roberts

Yeah, that's pretty accurate. It was up slightly sequentially, a little under 13 million in Q4 but that's correct.

Robert Goldman - CL King & Associates

Okay. And also Brian, you mentioned some reference to 40% growth with U.S. OmniPod and I didn't catch exactly what metric you were referring to with that 40% growth?

Brian K. Roberts

Sure. So what Duane had said was that we're projecting -- I mean if you look at our new patient starts in 2013, we're forecasting that we should – we're forecasting a 40% uptick in that number of new patient starts from 2012.

Robert Goldman - CL King & Associates

Okay. And then on the international OmniPod, you mentioned that mid-single digits was what you've been suggesting the first quarter 2012 sales. Did you see any or what sort of progression did you see in the fourth quarter versus the third?

Brian K. Roberts

Certainly there was an uptick in the fourth quarter revenue versus the third as we move them completely to the new OmniPod. So, that was a quarter where -- I don't know what to call it, that they built inventory but they certainly added a little bit extra whereas beforehand they were pretty much hand-to-mouth.

Robert Goldman - CL King & Associates

Thank you. Okay. Thank you.

Operator

Your next question comes from Suraj Kalia with Northland Securities.

Suraj Kalia - Northland Capital Markets

Good afternoon, gentlemen.

Duane DeSisto

Hi, Suraj. How are you?

Suraj Kalia - Northland Capital Markets

Good, sir. Yourself?

Duane DeSisto

Good. Thanks.

Suraj Kalia - Northland Capital Markets

So, Duane, I know there has been a lot of discussion on the CGM part of the equation and hopefully forgive me, just two redundant or just beating down the same questions again. So I heard you say this technology may have been used on patients and I'm just curious in terms of the strategic thought process to the extent that you can share why go down the new technology given the challenges in terms of product launch and technology validation, so on and so forth. To whatever extent you can share, I'm very curious why -- it looks like you'll are going for the new player with probably some combination technology and I'm very curious why not go with some of the existing players?

Duane DeSisto

Suraj, great question. So there's two parts to it, right. First of all, these people do have experience in this. So when I say the technology, the sensor, the trick with all the existing sensor technology, any kind of oxidized sensor is they don't do well in heat and humidity. The way we sterilize our product involves heat and humidity. So the real trick for us if we're going to integrate it into the pod is was there sensor technology out there that can withstand heat and humidity and still function at a comparable level to the technologies out there. So that was the real trick for us. If we're going to put it in one pod, I think if you talk to any of the existing players, they would tell you that heat and humidity is not a good thing for any of their sensors. And we think we found one that has the servility cycle that can be ETO sterilized, that can be comparable to everything that's out there. It has a start-up time within an hour and can work in our products at a cost that we think we can make money at. So, I mean that's really the trick for us, right? Other than that, I would just tell a patient if that product doesn't exist, you would just the patient [go on]. We tell them to go with the DexCom sensors and that's the best one out there and they'll get it. I mean that's the way we go about it. But if we're going to put it all in one product that is a significant technological hurdle that the existing sensors -- I would tell you, I think if you talked to any of the players out there, they would tell you their product doesn't like and we think we have a product that we can do all that. All the animal testing we've done, all the testing in blood has all been through an ETO cycle. And like I said, while it's early and I want to emphasize it's early, the data looks very, very intriguing to us and the form factor can fit in our product. So those are the biggies.

Suraj Kalia - Northland Capital Markets

Duane, what percent of the Neighborhood Diabetes patient base has been converted to the OmniPod? And I guess how are you'll looking at it from a fiscal '13 perspective?

Brian K. Roberts

Hi, Suraj. It's Brian. So we purposely for a couple of different reasons have not aggressively gone after switching Neighborhood customers to the OmniPod at this point. And a lot of that was really predicated around we wanted to do it with the next gen product. Now Monday morning quarterbacking, we would have -- we thought we would have been kicking that initiative up nice months ago and instead we're effectively kind of kicking off that initiative now. So, as we talk about 2013 and new patient starts, certainly there's a group of folks within the Neighborhood business that we think we can get over to the OmniPod side that may up a piece of that number.

Suraj Kalia - Northland Capital Markets

Okay. And Brian, just to follow-up on that question. So if I strip out again in terms of units or new patient add-ons 40% growth, let the X% you remove, strip it out because of Neighborhood Diabetes and on a year-over-year basis when I strip out Neighborhood, would you say it would still be higher than what we have seen in 2012? I'm just trying to get a sense of the new OmniPod, what that is going to do to core patient growth stripping out Neighborhood Diabetes?

Brian K. Roberts

No, absolutely. I mean the Neighborhood's just a small piece of this overall, right? So – again, look at the last three quarters. We've seen overall 30% year-over-year growth in the core OmniPod business and again, [sans] and reorder disruption will need to just go here between the next couple of months and then that will be behind us. We're forecasting overall that our new shipment number here in Q1 can be as much as 30% higher than where we were last year and looking at even acceleration beyond that as you get into Q2 and beyond. So, it will absolutely be higher. There's no doubt, (inaudible) does not have enough patients…

Suraj Kalia - Northland Capital Markets

And finally, Brian, in terms of Neighborhood, should we assume that when the sales come down, let's say by 10 million or 13 million margins, everything at least anecdotally what we know about Neighborhood from a modeling perspective, we pretty much keep it in line or you anticipate some things to change on those lines so that the rated average gross margins from a modeling perspective, any help would be great?

Brian K. Roberts

On the numbers that I tried to give you guys were basically kind of consolidated gross margins for 2013. So to reiterate, I mean I think again we're looking at relatively flat gross margins in Q1 and Q2 of this year from where we are in Q4. We start to see the benefit of the new smaller pod coming through and effectively the PDMs, if you will, are paid off. We should see some uptick in the third quarter. My best guess at the moment is probably somewhere around 300 dips from where we are today. And then you'll see another uptick of a similar number probably a little higher as we get into the fourth quarter and that many more customers are now contributing with, if you will, a fully paid off in PDMs. So, the Neighborhood changes are reflected and factored into that thinking.

Suraj Kalia - Northland Capital Markets

Great. Thanks, guys.

Operator

Your last question comes from the line of Debbie Wang with Morningstar.

Debbie Wang - Morningstar

Thank you for taking my questions. In the past you have mentioned that supply chain issues keep you up at night. And then particular there's one component you were hoping to bring a second supplier on for. I'm just curious what's the situation now? Is it still giving you sleepless nights?

Duane DeSisto

So that will always give -- five years from now that will be giving me sleepless nights. But we have a second supplier. We're pretty happy with where we think we're at. And we continue to move through that. I would tell you any kind of issues we're facing at the moment is more just from the normal ramp out that we're going through as opposed to a particular supplier that I think in that particular case, we were concerned that they really had the capability to produce in that kind of volume. Now it's normal stuff. You go from a two-cavity tool to a 10-cavity tool. They're all 10 cavities working the way they should be and it's kind of normal ramp up stuff. But the thing that really scared us early on is, like I said, we had a supplier that helped us, was instrumental in the design. But when we started stepping on the gas, we came to the conclusion that we just didn't think they could handle the volume of business and we were way outside the comfort zone. So that's behind us.

Debbie Wang - Morningstar

Great. Thank you very much.

Operator

I would now like to turn it back over to management for closing remarks.

Duane DeSisto

Thanks everyone for joining us and we look forward to updating you throughout 2013. It should be an interesting year. Thanks.

Operator

Thank you. This concludes today's conference. You may now disconnect.

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