Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message| ()  

Executives

Terry Gregg - President and CEO

Steve Pacelli - COO

Jess Roper - VP and CFO

Analysts

Thom [Gunderson] - Piper Jaffray

Bill [Plovanic] - Canaccord Genuity

Matt - William Blair

Richard - Wedbush

Mimi [Pham Schoenholtz] - Weeden & Co.

Jonathan - SunTrust Robinson

John [Putnam] - Capstone Investments

Greg - [Inaudible]

Vivian - Federated Kauffman

Bill [Plovanic] - Cannacord Genuity

DexCom (DXCM) Q3 2010 Earnings Call November 4, 2010 4:30 PM ET

Operator

Welcome to the DexCom third quarter earnings conference call. [Operator Instructions.]I would now like to turn the call over to Terry Gregg. Mr. Gregg, you may begin.

Terry Gregg

Thank you and thank you for joining us today for our third quarter earnings conference call. Joining me today is Steve Pacelli, our chief operating officer, and Jess Roper, chief financial officer. I'm going to have Steve lead it off and give our Safe Harbors.

Steve Pacelli

Thanks Terry. Some of the statements that we will make in today's call may constitute forward-looking statements. These statements reflect management's expectations about future events, operating plans, and performance and speak only as of the date hereof. These forward-looking statements involve a number of risks and uncertainties. A list of factors that could cause actual results to be materially different from those expressed or implied by any of these forward-looking statements is detailed under risk factors and elsewhere in our annual repost on Form 10-K, our quarterly report on our Form 10-Q, and our other reports filed at SEC, we undertake no obligation to update publicly or revive these forward-looking statements for any reason. Thanks Terry.

Terry Gregg

Thanks Steve. Jess is going to start us off today with a financial review of the third quarter. Then I will follow up with a commercial update. Then we'll spend some time talking about the clinical and regulatory environment, including the Food and Drug Administration, our standalone technologies, and our partnerships, and then we can move to your questions. Jess?

Jess Roper

Great, thank you Terry. DexCom recorded product revenue of approximately $10.8 million for the third quarter of 2010, compared to $4.6 million for the same quarter in 2009, an increase of 133%. Sequentially, product revenue for Q3 increased 19% from the prior quarter. During Q3 we sold over 3,900 systems, and sequentially, sensor revenues were up 23% from the prior quarter.

Total revenue for the third quarter of 2010 was $11.7 million, compared to $7.3 million for the same quarter of 2009 and included a $0.9 million development grant and other revenue from our development and collaboration agreements with Edward Lifesciences and Animas Corporation.

Sequentially, development grant revenue declined from $2.7 million to $0.9 million as we re-forecasted the timeframe for recognition of the balance of our development grant revenue from the end of 2010 to the end of 2011.

Our decision to re-forecast the recognition of our development grant revenue was based on longer than expected development and regulatory review timelines under our development and collaboration agreements with Edwards and Animas. Terry will elaborate on this during his prepared remarks.

We will recognize the same aggregate amount of development grant revenue, but going forward, the amount recognized per quarter will drop from approximately $2.6 million to $0.9 million and will now be recognized over a longer period of time, through the end of 2011.

These quarterly amounts exclude any milestone based payments that we may also earn. The impact of our change in the recognition of our development grant revenue to our net loss in the third quarter was an increased loss of approximately? $1.7 million.

Cost of sales including both product and non-product totaled $8.2 million for the quarter. Product cost of sales totaled $7.0 million for Q3 of 2010, compared to $4.6 million for the same quarter of 2009. Sequentially, product cost of sales increased by $0.7 million from Q2 to Q3 of 2010 due to the increased number of starter kits and sensors sold during the quarter. The corresponding improved gross margin totaling $3.8 million, or 35% in Q3, compared to $2.7 million, or 30% in Q2 in the prior quarter, was mainly due to additional product revenue.

During the third quarter we increased inventory, primarily hardware components, by $2.3 million from the prior quarter in anticipation of Flextronics', our contract manufacturer, relocating our production line and in anticipation of increased sales volumes. Flextronics is in the process of relocating our production line from California to China.

We expect the new production line to be validated and subsequently improved by the FDA in Q1 of 2011 and for production to start immediately thereafter. We also expect to add some additional hardware inventory in Q4 of this year in anticipation of the move, and then to manage this inventory down beginning Q1 of 2011.

In addition, we expect to increase our sensor inventories in Q4 to account for a shutdown of our internal sensor manufacturing lines for approximately two weeks during Q1 of 2011 to perform upgrades and maintenance. This may lead to a small improvement in gross margins in Q4 due to an increase in manufacturing overhead absorption. Conversely, during Q1 of 2011 we anticipate a slight softening of our product margin as we manage our inventory levels down.

Development and other costs of sales totaled $1.2 million for the third quarter of 2010 compared to $1.8 million during the same quarter of 2009. The decline was primarily due to lower expenditures related to the development of our hospital-based system.

Sequentially, development and other cost of sales increased slightly quarter to quarter. Research and development expense totaled $6.2 million for Q3, compared to $3.5 million in Q3 of 2009. The increase in R&D costs was attributed to additional efforts associated with our next-generation ambulatory products. Sequentially, R&D costs increased by approximately $0.7 million from the prior quarter.

Selling, general, and administrative expense totaled $10.4 million in Q3 of 2010, compared to $8.9 million in Q3 of 2009. The increase was primarily due to additional selling, customer service, and information technology costs to support revenue growth.

Sequentially, SG&A remained flat over the prior quarter. Our net loss for the quarter totaled $13.4 million, compared to $13.5 million during the same quarter of 2009, and included $3.5 million of non-cash charges.

Sequentially, quarter to quarter, our net loss increased by $1.7 million, primarily due to recognizing a lower amount of development and grant revenue during the quarter as previously discussed. During the quarter, we converted out the remaining $4 million of our convertible debt, leaving a balance of zero at quarter end.

The loss per share was $0.23, and we ended the quarter with $32 million in cash, restricted cash, and marketable securities. I would like to now turn it back to our president and CEO, Terry Gregg.

Terry Gregg

Thanks Jess. The third quarter of 2010 represented yet another quarter of sequential growth for DexCom. We were extremely pleased with our performance as we again exceeded analysts' consensus estimates for starter kit sales and product revenue, and we achieved a positive product gross margin of 35% for the quarter.

Highlighting some key metrics from the third quarter, total product revenue grew approximately 19% sequentially from Q2 2010 to Q3 2010, and was up 133% compared to the third quarter of 2009. We sold approximately 3,900 starter kits, for the SEVEN PLUS in the third quarter, amounting to an 11% increase in starter kits compared to Q2 2010 and up 84% compared to the third quarter of 2009. And we posted an increase of approximately 23% in sensor revenues quarter to quarter as the stickiness among patients who go on the system continues to grow.

We are pleased to report that the demand for our SEVEN PLUS remained strong heading into the fourth quarter, and as we had discussed previously the fourth quarter is historically a strong quarter for product sales in the durable medical equipment business. Our pipeline of new patient referrals continues to expand and we expect the positive trends in sensor utilization we have witnessed thus far in 2010 to continue during the fourth quarter.

We'll also continue to work diligently to deliver our message of convenience, performance, and simplicity to patients and caregivers alike. We continue to drive home our message, supported of course by published clinical outcomes data that all sensors are not created equal.

With a substantially larger field presence, we expect our competition will continue to attempt to create confusion in the marketplace with regard to sensor performance. Nonetheless, with the best-performing commercial sensor, we will stay the course and we will continue to win the hearts, minds, and loyalty of patients and healthcare providers.

With only 26 direct field sales personnel, commercial reach is one of our greatest challenges, yet we continue to make excellent progress in gaining share. Heading into 2011, we expect to add a modest number of additional sales and clinical personnel to our field ranks, and we may explore one or more partnership arrangements involving the promotion of our standalone CGM systems in order to supplement our direct sales force without significant additional expense.

Shifting now to an update on clinical and regulatory affairs, in early October this year, we were subject to a follow-on site inspection by the Los Angeles district office of the Food and Drug Administration. As you'll recall, several months ago we received a warning letter from the agency.

We worked cooperatively with the FDA in response to the warning letter, and we are pleased to report that we concluded this follow-on site inspection with no 43 observations. Additionally, this week we received written notification from the FDA that we have resolved, to their satisfaction, all outstanding issues cited in the warning letter.

As you are all well aware, under the leadership of Dr. Margaret Hamburg, the FDA is undergoing sweeping changes to its review and approval policies and procedures, and has set forth as a priority an effort to improve the level of regulatory science the agency applies to all medical devices to better assess, evaluate, and review products. The FDA has embraced their renewed focus on patient safety and risk avoidance. Dr. Hamburg has emphasized publically that it is the agency's responsibility to promote and protect public health into the 21st century.

As a result, the medical device industry is in the midst of a sudden and dramatic shift in the requirements for product approvals. This has created an atmosphere of unpredictability and uncertainty surrounding the submissions process and in many instances it is not altogether clear what the agency will require or expect of new submissions, particularly for companies seeking clearance under the 510(k) regime.

We are living in an era of heightened scrutiny, where requests for additional information are becoming commonplace and consequently approval times are extended. As we mentioned during our last earnings call, we filed a PMA supplement relating to our fourth-generation ambulatory sensor during the second quarter, and we have now received a formal, written response from the FDA.

To call the response comprehensive would be an understatement. Although the Gen4 filing has been classified as a PMA supplement by the agency, we have been requested to provide substantial additional information. For example, we're being asked to repeat certain systems tests we conducted in support of our original PMA application back in 2004 and 2005. In many ways, this feels like a full PMA review rather than a PMA supplement.

Nonetheless, we are working collaboratively with the FDA as we formulate our response and I am extremely proud of our regulatory team and their continued ability to foster a cooperative relationship with the agency, even in this era of enhanced scrutiny and evolving regulation.

In fact, we believe we have identified an opportunity to accelerate review of our next-generation hardware platform as part of an amended Gen4 filing. Specifically, when we conducted the pivotal trial to support our Gen4 sensor filing, our next-generation hardware platform, which includes a smaller receiver form factor with a color screen and a modified transmitter with more robust transmission frequency, were still in the development stage.

Due primarily to the manufacturability and scalability benefits provided by the Gen4 sensor, we elected to move forward with the trial and subsequent filing of the Gen4 sensor paired with our legacy hardware platform. Now, as part of a comprehensive response to the FDA, we intend to include not only the additional information requested by the agency concerning the Gen4 sensor, we expect to include data to support approval of our next-generation hardware platform. This would enable us to launch a more robust fourth generation system.

To facilitate this, we expect to complete a small additional clinical trial with the Gen4 sensor paired with our next-generation receiver and transmitter, and file an amendment to our Gen4 PMA supplement during the first half of next year. Although we cannot predict the ultimate decision or timing for a decision by the FDA, we believe this amended Gen4 submission will be incorporated into the current Gen4 180-day review cycle, give or take a few months.

So while our timeline for launching the Gen4 system will be slightly delayed, through an open and transparent dialog with the agency, we believe we will be in a position to provide the additional information requested of us regarding the Gen4 sensor, and at the same time, accelerate review of our next-generation hardware platform, which would position us to launch yet another best-in-class CGM system during the second half of the year.

Shifting to our combination product, the regulatory uncertainty facing the insulin pump market is particularly daunting. Insulin pump companies today are faced with the likely prospect of having their pump products regulated under a new subset of class two devices where approval standards are in a state of flux and human clinical data requirements are unclear.

This changing landscape will certainly impact approval timelines in the United States for integrated systems with Animas and Insulet as I suspect it will for Medtronic and the numerous small privately funded pump companies seeking to bring new pump products to market.

As you know, we filed a PMA supplement seeking approval of an integrated insulin pump continuous glucose monitoring system with Insulet Corporation earlier this year. We've now received a formal written response from the agency regarding our submission, and much like the response to our Gen4 submission, the FDA has requested substantial additional information including additional human clinical trials data concerning the safety of insulin delivery by the system.

We are working with Insulet to formulate an appropriate response to the agency, but due to the time and expense associated with conducting an additional clinical trial, Insulet is evaluating whether it makes sense to move forward with the existing combination product that uses our SEVEN Plus, and the current OmniPod, or whether it would be more beneficial for potential patients to incorporate our current or future generation CGM technology into Insulet's next-generation OmniPod platform and conduct a more expansive trial as requested by FDA.

We are also exploring the opportunity to submit an IDE relating to the existing combination product for research purposes, which would allow us use of the system in various artificial pancreas studies in the near term. With respect to our integrated system with Animas Corporation, we are pleased to report that we have concluded development, and are nearing completion of final systems testing.

However, in light of the uncertain clinical and regulatory landscape I just mentioned, and based on our review of the additional information requested by FDA in response to our PMA supplement filing with our combination product with Insulet, we are seeking a pre-IDE meeting with the agency to determine the best clinical path to support approval of our combination product with Animas in the United States.

While this path will not enable us to file a PMA supplement for the Animas system this calendar year, we believe that working on a collaborative basis with FDA prior to conducting a human clinical study is the most prudent course of action from a timing perspective, and certainly the most cost-effective way to proceed.

In addition, we remain committed to filing for CE mark approval before the end of this year and expect to be in a position to launch the combination product in Europe during the first half of next year. We also mentioned during our last earnings call that we had submitted a 510(k) application for our first generation IV-based continuous glucose monitoring system, developed in collaboration with Edwards Lifesciences. We have now received a formal written response from the agency regarding this submission and no surprise, the FDA is asking for additional information.

We are currently working with Edwards to determine the most appropriate response regarding the Gen1 system. However, we have made considerable progress in the development of our second-generation system, and we have agreed with Edwards that should the agency require additional systems testing, or additional human clinical data to support the Gen1 510(k) filing, our most prudent course would be to focus on completing Gen2 development and filing for CE mark approval.

As Edwards CEO Mike Mussallem mentioned during the Edwards earning call last week, this may enable us to launch the second generation product in Europe before the end of next year. We expect to work with the agency to ensure that our Gen2 clinical protocols, systems testing, and ultimately our FDA filing for Gen2 meet the FDA's evolving requirements. If we shift from Gen1 and focus our efforts solely on Gen2, we would expect to work with Edwards to appropriately modify our contract to account for our milestone payments.

Now let's spend a few moments talking about advanced technology. Certainly driving the Gen4 system and our partnership products through the regulatory process to commercialization remains the primary focus of our clinical, regulatory, and R&D teams. However, we cannot lose sight of the value of innovation to the development and growth of the CGM category and it is critical for us to maintain our technology advantage over competition.

We continue to make progress on our fifth generation sensor system, which we are developing not only as an advanced ambulatory sensor, but also as a subcutaneous sensor for use in the hospital outside of critical care. We continue to believe maintaining good glycemic control as patients transition from the ICU to other areas of the hospital is important in reducing morbidity and mortality, thus positively impacting the economics of caring for these patients.

So in conclusion, DexCom is on track for a strong 2010 as the market-leading performance of our CGM technology continues to improve the lives of people with diabetes. Just last month, we were pleased to learn that the American Association of Clinical Endocrinologists, or AACE, published consensus guidelines for CGM. This is the first-ever full consensus statement on CGM by AACE, and is based on both the clinical experiences of AACE members, and published clinical data.

AACE recommends CGM for patients who are frequently hypoglycemic, who have A1C levels over their targets, who experience large variability in their glycemic levels, who need to lower their A1C levels without increasing hypoglycemic events and/or who are pregnant or are planning to become pregnant.

In the AACE press release it was noted that CGM technology will likely become a key component of comprehensive diabetes management, particularly with Type 1 diabetes patients, and that consistency of use is key as studies have shown that the more consistently CGM is used, the better the results for the patient. We are obviously pleased to see a consensus statement of this nature by the leading organization of endocrinologists in the United States.

Certainly the regulatory environment in which we are operating is challenging, so much so that on October 12, 2010, a group of congressional lawmakers sent a letter to Dr. Hamburg asking her to delay the implementation of certain changes that the agency is considering for the 501(k) program. Lawmakers have raised concerns that their implementation could prevent companies from using important evidence in product applications, delaying the introduction of innovative new therapies and potentially upset the delicate balance that exists between providing information to the public and protecting intellectual property.

I'm often asked about my greatest fears facing our industry. Honestly, it is a fear that the American medical device companies, long known as the leaders in medical innovation, will be forced to look to international markets to first launch new products where barriers to entry are less stringent. This could have a severe impact on the quality of care for patients in the U.S. and for our economy.

At the same time, I am reminded how fortunate we are to have a best-in-class FDA-approved commercial product in the SEVEN Plus that is making a difference in the lives of our patients each day, and that's the trajectory of our growth, both as a category and our company puts DexCom in a very enviable position despite the challenges of the current regulatory environment. We will continue to aggressively invest in our future, which we believe is very bright.

Thank you, and we will now entertain questions.

Question-and-Answer Session

Operator

[Operator Instructions.] Our first question comes from Thom, of Piper Jaffray. Please go ahead.

Thom [Gunderson] - Piper Jaffray

So that was a lot on the FDA. Let me see if I can dig in a little bit and just make sure that I caught it. If we look at Gen4, Terry, you did a good job of going through a lot of this but I'm not sure I caught it. If I take it to the bottom, are you going to do a sensor plus legacy hardware? Or are you just skipping over that and going to sensor plus the new hardware?

Terry Gregg

We've already done the legacy with the Gen4 and the pivotal trial, but because they asked for additional not only sensor information, we've elected now to do the next trial as a brand new system in terms of the Gen4, which hasn't changed. That will be added on to the clinical data that they already have, plus the new hardware, the new transmitter as well as global receiver.

Thom [Gunderson]

And that's what will be launched first?

Terry Gregg

Correct. That will be launched first.

Thom [Gunderson]

And then I know this is painful, but I just have to make sure I understand it, and that is on the Animas pump, which is approved, and your SEVEN Plus, which is approved, they're asking for more data?

Terry Gregg

Yes. I think if you look at this whole area with regards to 510(k), back a few months ago they - they being FDA - issued new pump proposed guidance. That said, in the creation between class 2a products and class 2b products, and pumps, insulin pumps, other pumps, LVPs, were also included in this proposed class 2. The class 2 now requires under the guidance proposal, and then I'll add the fact that they're actually using that in rejecting 510(k) applications from pump companies today, even though it's a guidance document, not officially sanctioned guidelines, that that requires clinical trial in the actual pumping of insulin. So we have to go through that, yes, with the Animas product.

Steve Pacelli

Thom, just to clarify actually, you're referring to the Insulet combination. Insulet, as you'll recall, is paired with the SEVEN Plus. The Animas product, when complete and filed, will be paired the Gen4 sensor.

Thom [Gunderson]

So still, I understand the rules as they've been put out there, but it seems like on the cusp for already approved might have gotten a buy, but they didn't, so you've got to join the crowd.

Terry Gregg

No, I think in this regulatory environment, no one's getting a buy.

Thom [Gunderson]

Yeah. That's what it feels like. As it applies to not only the development and launch of new products, but as you pointed out in the beginning it also applies to how we recognize the developmental revenues, can you give us a sense of what you're looking at for new timing for Gen4, Edwards, Animas, and Insulet in the U.S.?

Terry Gregg

Well, that's three different systems, four possibly, as we related to it. I think in the case of, let's start with Gen4, that's most near and dear to our hearts today. We will respond to the agency in the early part of next year. Can't give you an absolute date when we expect to have that filing. If, as I mentioned in my prepared remarks, we still fall under that 180-day review, the expectation would be late next year we could introduce a product in the U.S.

Again, I caution everyone. This is a moving target as it relates to the FDA and anything I'm saying here is trying to look through a crystal ball that is quite cloudy.

And I think then if you look at Animas as the next combination, since it is using Gen4, we can't get that combo product approved certainly until the Gen4 product is approved in the United States. But as I mentioned, we have already filed the Gen4 with the agency. We've filed it with our notified body. I think getting it into the international sector in the first half of next year is something that is very doable. Unfortunately, then it puts us in a position where the U.S. is a secondary market to the European sector for that combination product.

And the same is in the Edwards Lifesciences. [inaudible] prepared remarks say that if the agency is going to come back and force us to do more work on the Gen1, that was never intended to be a fully commercializable version. That was to gain awareness and understanding at the user level and to then come forth with a Gen2 product as a full commercializable product. That is still the intent, I think given what Mike said in the Edwards remarks and what I said earlier today, we would look to introduce that in the European sector late next year, towards the fourth quarter of next year.

The Insulet situation's a bit more difficult to describe, only from the standpoint that Insulet's got to make some decisions as to what they want to do going forward, either to move forward with the SEVEN Plus, or if they make the decision to go to Gen4 or even Gen5 for the future product as they look at their own economic situation and make that decision if they're going to combine that with their next generation system. I think those discussions are ongoing, no definitive answers have come of that. I'll just tell you my opinion is if I were driving the ship, I'd be launching with the SEVEN Plus, because I would certainly want to have some cannibalization going on of the existing pump combo by Medtronic. But I don't make that decision.

Operator

Our next question comes from Bill of Canaccord Genuity. Please go ahead.

Bill [Plovanic] - Canaccord Genuity

Wow. We'll start off the last question. Do you currently have an agreement with Insulet for the next generation, the Gen4, or that's the decision they have to make, whether they would option that in?

Steve Pacelli

No, not specifically. Our current contract does not provide for access to our future technologies, but certainly we're open to discussing that with them. Be it, as Terry mentioned, Gen4 or potentially even Gen5 depending on the development timelines there. I think the big question is whether we push forward hard and fast with the current developed product, which incorporates the Gen3 technology versus looking at something that would require some additional development time and expense and some additional clinical work. So that's really a decision for the Insulet team at this point.

Bill [Plovanic]

And then to gain clarity on the Edwards, you mentioned the EU second half of '11 with the Gen2. Could we hypothesize then that the U.S. would be a late-2011 or probably even a 2012 as you just gain experience with Gen2 in Europe?

Terry Gregg

We're still at this point in discussion with the agency with regards to Gen1, and once we have a definitive answer from them as to what they're really looking for, then that will be the basis for what we do with Gen2 in the U.S. But let's assume for discussion that they're going to ask us to do more systems testing and more additional clinical work on the Gen1. That doesn't make sense on a product that we only intended as an introduction just to gain experience with, so we would move much faster to Gen2. Therefore, under that scenario, Gen2 in the U.S would be a 2012 product, and my guess at this point, given what I know, following the Gen2, E.U. introduction. But again, I don't have good analytics on that yet, because we don't have all the information from the Food and Drug Administration yet.

Bill [Plovanic]

And then a tougher question I guess, if you decide to just skip Gen1 and go right to Gen2 do you get a milestone payment from Edwards?

Terry Gregg

I think I mentioned in the prepared remarks, yes there are, if you look back at the agreement, there's a $2.5 million Gen2 CE mark, and a $5 million Gen2 FDA approval and then a $2 million Gen2 Japan approval. So I think the question is on the Gen1 FDA approval of $2.5 million, plus some additional developmental dollars, that's what has to be reworked in the contract.

Bill [Plovanic]

And then, just on the nature of the additional data, obviously this all takes time, but is there anything in there that would be longer-term follow up than what you've normally done in any of your studies?

Terry Gregg

No. You know, in the world of glucose metering, there's a lot of debate that's going on with regard to the current ISO standard, and so, as you know, there was first the PQQ enzyme issue and then there was a recommendation that the ISO standard be tightened. That has not been officially done, and so the agency has yet to give us clear targets as to what their requirements are. Therein lies some of our problem. They don't know what they want yet, and so therefore it's kind of hard for us to plan accordingly, even to initiate additional bench top work or even additional clinical work. We don't know what the target is. And I don't think they yet know what the target is. So it's a little bit of a conundrum, and very frustrating for the industry to try to target something that is yet to be defined.

Bill [Plovanic]

And then what type of ASPs did you see on your starter kits?

Jess Roper

We had ASPs of about $800 this last quarter.

Bill [Plovanic]

Really, so it's going up?

Jess Roper

It's gone up a little bit, steadily quarter by quarter.

Bill [Plovanic]

Well, the good news is the base business continues to perform very well.

Operator

Our next question comes from Ben of William Blair. Please go ahead.

Matt - William Blair

Good afternoon, it's actually Matt in for Ben. Kind of following up on Bill's question a little bit, if we could talk about that base business. The performance in the quarter in what's typically a seasonally-soft quarter was very good. Can you talk about the patient flows in the quarter? Was it a function of reimbursement, that [inaudible] kind of improving a bit? Did you get better penetration in MDI patients? Can you just talk a little bit about the patient flows in the quarter?

Terry Gregg

It all boils down to more patients coming in, so that's the start of the cycle. Certainly our, I won't call it the backlog, but the folks that are in line as they come in to our - we call them opportunities. That flow has increased. Certainly both from pump patients as well as from MDI patients. I think we're still running, the last survey, around 60% pumps, 40% MDI patients. I think an increasing number of patients are using the product more consistently and that's - the term we use is stickiness from the standpoint that we're seeing more patients who use the product 24/7 rather than either not using the product 24/7 or even deciding not to use the product at all. And so I think that's all contributing to this growth.

I also think there's just greater awareness of CGM as a category, so we're beginning to get exposure beyond the traditional just endocrinology group treating Type 1 patients. We see referrals coming in from internal medicine, from family practice and general practitioners that are now much more aware of CGM as a category. Obviously, having the AACE group come out with a positive recommendation is huge because many of the folks who are non-endocrinology specialists but have large diabetes practices look to AACE for their recommendations of treatment therapies.

So I think it's just a whole combination of our product is performing extremely well. We're producing the best sensors in the history of this company in terms of accuracy, durability, and just the general robustness. Each quarter we intend to get better, just as we increase in volume and move to more of a manufacturing controlled environment, less variability. And at the same time you've got a growing awareness of CGM as an instrumental tool in reducing the amount of glycemic variability for those patients. So there's no one thing that is driving it. I think it's a combination.

Matt - William Blair

And then just flipping over to the production side of things, I caught a little bit of what Jess was saying, but the move to Flex, that's new news to me. Just walk us through that again a little bit in terms of I think you said you're going to ramp up during Q4 in anticipation of that move to manufacturing over there in Q4, then it will come online in Q1, you'll start to work down that inventory beginning next year. When do you think that you'll start to really see the benefits of Flex and then any sense of it longer term, even on the Gen3 product, where the cost per system can go in terms of manufacturing out of China?

Terry Gregg

When we look at the opportunities from a reduction in COGS. That's really at the sensor level, more so than at the hardware level. We do expect to see some reduction by moving to China, but when we talk about the great reductions, that's really Gen4 manufacturing when we talk about COGS. I think there is some 5%-10% upside moving to China on the hardware side, but again, that's why we were stressing to move into Gen4. That's why we ran the pivotal trial with legacy hardware from that standpoint because there were so many benefits on the manufacturing scalability of Gen4. So we're having to postpone that as a result of the agency delay. But the hardware is as I've stated.

Matt - William Blair

Okay, and one last one, and I apologize. It's a bit of a tough one. But just given the delay in integrated systems, margins, gross margins likely to be a bit soft in [inaudible] models, and then additional spending on SG&A for new reps and then some more R&D spending, how do you feel about your cash position? Do you think you'll need to come back to the market to raise more money? Or do you think you can get to profitability with the existing cash balances and other financing options?

Jess Roper

We exited the quarter at $32 million, and still another $17 million due us from the milestone payments. The million we should get from Animas this year and $4 million in the first half from Animas as we hit that milestone in the first part of next year for OUS. We're always looking at it from this standpoint. Obviously we're sensitive to our cash needs. We discuss it with the board routinely, and we keep an eye on the ball from that standpoint. But that's about the only way I can address it. I always remain [inaudible] myself, but we have to do what's in the best interest of the company.

Operator

Our next question comes from Richard of Wedbush. Please go ahead.

Richard - Wedbush

I think I'm all set on the FDA stuff, but I was wondering - you were talking about increased stickiness in the quarter. Can you comment at all on how long patients are now wearing the sensor, per week or per month?

Terry Gregg

They're supposed to wear it a week at a time, the indication for use. And that's all we promote and recommend. That said, obviously even by evidence of some of the questions that FDA is asking us on the Gen4, and their comments to us that DexCom we know the patients traditionally wear your sensor for a longer period of time than the recommended use. As a result of that, they've asked us to do some additional testing relative to indwelling time in patients of a longer nature.

So I would say, and I can only reflect on, that if you look at people like Close Concerns that have indicated some in their surveys over 75% of the patients on DexCom tend to wear it routinely and vigorously. And that's what we're continuing to see, those types of reorder patterns, which would indicate the patients when they go off or they cease wearing a sensor regardless of what the timeframe is that they immediately put a new sensor on and activate it. So we're beginning to see that continue to creep up, and I think that's positive. That's where we're seeing that stickiness.

Richard - Wedbush

And then just can you guys comment a little about Type 2 clinical trials going on? I believe there was a Walter Reed study that was scheduled to complete in September.

Terry Gregg

There's a meeting next week in Bethesda at the Diabetes Technology meeting. I don't know if Dr. [inaudible] is going to be presenting. We know that the last patient should be enrolled this month, so I wouldn't expect anything. At best we would get interim data next week, and I doubt it. I think given the nature - it's a hundred patient clinical trial for a year, type 2 patient, half on SMBG, half on CGM. My suspicion is that he's going to want not to disclose information. He probably wants to present it at ADA here in San Diego in June, and wants to not jeopardize having it in a major peer review journal. But that's the only status I know.

Richard - Wedbush

And then one last question. I was kind of poking around on your website. I noticed for a little while now it says you guys are making upgrades to the online store. Is there any sense of the timing, when the online store will be up and running?

Steve Pacelli

Yeah, it is a project that we're currently undertaking. It's a 2011 project for sure. It will be launched, and I can't give you an exact time in 2011. It will be launched first with respect to reorders and then sort of get rolled out incrementally for reorders first, and then for new patients to the therapy.

Operator

Our next question comes from Mimi of Weeden & Co. Please go ahead.

Mimi [Pham Schoenholtz] - Weeden & Co.

Regarding the FDA requirement for clinical trial data for the integrated OmniPod SEVEN Plus, you're using both devices the same way except for the screens, you know combined on the one PDN. Can you just help us understand what their concern is, and what they might get out of the clinical study?

Terry Gregg

Let's date back for a period of time. FDA's never had the opportunity because of the 510(k) mechanism, to push these companies in this direction. It's the pump companies, so we have to separate this. They want to see insulin being pumped. It has very little to do with DexCom. It has almost everything to do with the pump side of the equation and then the integration. We've done all the human factors work that we needed to do, showing that patients could use the different streams, they could toggle between them effectively. They understood all of those applications.

So now it's once these pump guidelines went into place and Dr. Hamburg has stated publically that the reason that they want to move pumps into this class 2B is because over the last few years there have been over 50,000 reported MDRs for pump problems, both in insulin pumps reported by insulin groups as well as people like Baxter, CareFusion, and Hospira, and their large-volume pumps in the hospital. So we have to, even though you have a 510(k) notified pump that's been on the market and you have a PMA approved CGM that's been on the market for a number of years, they now take this opportunity, they being the agency, to say aha, now they want you to do this, which they should have been doing all along.

I can't really - and remember I've spent nine years in the pump world - I can't really fault the agency from that standpoint, and I've long said it amazed me that the pumps were 510(k) products that carry around anywhere from 180 to 300 units of insulin, which is a potentially lethal amount of insulin. And so they were never quite required to do all the types of clinical evaluation that other more significant risk devices were subject to.

So I think it's just the agency flexing their muscle, saying now we have a right to know. Remember, Dr. Hamburg, publically, it is FDA's responsibility to promote and protect humans in a clinical setting into the 21st century. And they're exercising their muscle.

Mimi [Pham Schoenholtz]

And you used the word substantial. Did you guys get some sort of indication of patient trial size and follow up timelines?

Terry Gregg

No. If you're talking about the integrated product -

Mimi [Pham Schoenholtz]

For the integrated product, correct.

Terry Gregg

No, I think it's just that's part of the require - we've got to go back to them, Insulet and DexCom make a decision as to the path forward, go back to them, secure their prior approval of the clinical trial protocol, and then move forward from there. I can tell you I was at the [inaudible] two weeks ago, Dr. Hamburg spoke there, and made a recommendation to 1,700 attendees that whatever they're doing they want to be part of the protocol development process. So we can fight them or we can work in a collaborative fashion. We, DexCom, have elected to work with them in a collaborative fashion and present those in advance, those protocols.

Jess Roper

And I think that's reflected in our path forward with Animas. Rather than staying the course that we had charted in terms of the clinical trial that we were anticipating conducting before the end of this year, and filing with Animas, we took a step back and we're going to work collaboratively with the FDA to get that clinical protocol blessed before we jump into the trial with Animas. So we think we can out of the gate do it the right way the first time.

Mimi [Pham Schoenholtz]

Got it. Then can you give us any ballpark figures on how many new centers are prescribing, in those you've sold SEVEN Plus into, starter kits into the third quarter?

Terry Gregg

No, we don't publish that information.

Mimi [Pham Schoenholtz]

Would you characterize that there's enough under-penetrated areas out there to continue to expand the number of new centers prescribing?

Terry Gregg

Clearly.

Mimi [Pham Schoenholtz]

And then just is there any current backlog in the back office, or is that a totally done issue at this point?

Jess Roper

It's a non-issue. We monitor the opportunities. There are basically mathematical models that we use. We know when an opportunity comes in, how fast we, depending upon the insurance that that opportunity or that patient has, how fast we can get them through the system. Actually it's all home built. It's not something you can buy off the shelf. You have to build the software program. We've increased our sales numbers and throughput without increasing the back office folks, so it's been quite effective and efficient.

Mimi [Pham Schoenholtz]

And in another separate device sector, I guess they were talking about some pushback from insurers in late September and through October, about them adding some requirements for devices and putting more resources behind the pre-approval process. Did you see anything new over the last month or two on the payer side, where they're trying to make it harder at all?

Terry Gregg

No. Actually if anything we've seen a couple of the blues modify their criteria to make it easier. And we think that's going to continue to move in that direction and then on top of that you have AACE coming out last month with a very strong statement, so I don't see any of that. The data is irrefutable, no matter where you look. Anything associated with CGM shows two things: number one, you can reduce your A1C significantly without the increase in hypoglycemia, and the second, the more you use it, the better the results. The one thing we'd still like to see, obviously, is an economic analysis applied to that that shows the payer system, which we believe wholeheartedly that there will be a reduction in the payments for patients with diabetes in terms of the consequences of diabetes in terms of the morbidity clinical complications as a result of better glycemic control.

Mimi [Pham Schoenholtz]

And one last question. I think before you talked about your sales strategy. You were going to focus more time on the MDI patients while your partners focused on the top market. Now that that's pushed out are you going to add more marketing dollars and resources towards the top market over the next year?

Terry Gregg

No. I think our strategy stays the course. I think our pump partners have an incentive, appropriate incentive, that even without a combined system at this point for them, knowing that it is on the horizon, it's just the horizon got a little bit further out, that they are highly motivated to get their pumps. And so there's still today more of an informal effort, but we're still getting referrals from our pump partners, and I think that's still the strategy and course of direction we'll choose to take.

Operator

Our next question comes from Jonathan of SunTrust Robinson. Please go ahead.

Jonathan - SunTrust Robinson

Maybe first question, Jess, just when I look at R&D, it's stepped up a little bit here in the third quarter. Just curious with some of your commentary how we can look at that going forward. In other words, it's sort of flat now from here, because I'm guessing based on your commentary that total spending is now likely to occur over a longer period of time.

Steve Pacelli

I think that's right. There's some additional spend that we'll occur during the first part of next year as we look to enhance some of these clinical trials. We'll do an expanded Gen4 trial. We'll get to the trial with Animas, etc. So I would say that, and mindful that we need, and I hope Terry emphasized it sufficiently, we need to keep our eye on innovation and on the Gen5. So certainly the R&D dollars are not going to go down particularly in the first part of next year, but flat to slight uptick from where we are today I think is reasonable. And I think as you get out into the 2012, 2013 timeframe is where you start to see that come down.

Jonathan - SunTrust Robinson

And then Terry, sorry to circle back on this one, just a lot of moving parts with the FDA and I just want to make sure I've got it correctly. On the Gen4, now you're going to go ahead and file the new hardware platform with the Gen4. Does that add any complexity to a filing, where it's a lot of uncertainty with the FDA right now? In other words, you've gotten the question from Gen4, if you sort of stayed the course and you get that through, now that you're doing what looks like a combined filing could they come back to you. You've got to make some change on the hardware side and ultimately the whole thing gets kicked back in '11?

Terry Gregg

No, I think if you look at the hardware, typically these would be relatively small PMA supplemental filings. From the hardware standpoint you look at what are you doing, the stream's the same, it's really the form factor is smaller. You've gone to a color screen versus an LED that we use now. We tried to keep it as much the same in terms of the screens and what the patient would see in order to avoid that potential problem. We will do a human factors evaluation, which is required regardless. If we're combining it in a single filing if we had to do we would submit that anyhow. That's a standard requirement. The transmitter is for all purposes it's an improved transmitter. We get greater range. There's just some nice attributes to it. But again, from the FDA's standpoint it's no real change from what we're doing today. We're moving from, on the transmitter, from 402 MHz to 2.4 GHz, but it's a standard transmission that they see all the time. So as long as we're able to do the basic fundamental testing, we know what that is and satisfy that, I don't believe that that makes it any more complicated at all. It's really the Gen4 sensor has been the bulk of them asking for more information.

Jonathan - SunTrust Robinson

Understood. And maybe just one or two more. You mentioned building inventory in 4Q as Flextronic takes the production over to China. So first little one, just in terms of gross margins, so we think about it inflating 4Q in and around what - 100 bps to 200 bps - that then subsequently comes out as you work down the inventory in the first half of '11?

Steve Pacelli

Yes, that's correct. When we're talking about margin we're talking about building in this case sensors as well as hardware, so when we shut down the line in January for those first two weeks we'll build up some additional sensors. There's some overhead that we'll absorb in that. We'd expect kind of in the range of 1-3 margin points that we might have higher Q4 and then there would be a little softening in Q1 as we don't need to build as many sensors.

Jonathan - SunTrust Robinson

Okay. Great. And then last one, and [inaudible] sounds so conservative with the FDA but what is, from an inventory standpoint, you said you expect the FDA to sign off in China in 1Q '11. Where could you go from an inventory standpoint, God forbid that timeline were to slip three or six months?

Steve Pacelli

That's the whole purpose of building up this inventory. Without giving specifics, we have plenty of runway, and that's really been the exercise that we're undertaking here with some of the inventory. The hardware we started to build in the third quarter and will continue in the fourth.

Jess Roper

If you look we added about roughly $2.3 million in inventory. Most of that in Q3 was hardware-related. We'll add, don't have an exact number, another million or two, probably in Q4, between the mix of hardware and sensors.

Operator

Our next question comes from John of Capstone Investments. Please go ahead.

John [Putnam] - Capstone Investments

Terry, given the intensity of the discussion on the agency, do you have any feel as to where this process is? Are we just in the beginning? Have we reached the middle? I'm sure you haven't reached it yet.

Terry Gregg

[Laughter.] Well, I've been doing this for 40 years, and I will tell you this is the worst that I've ever seen it in 40 years of medical device experience, and I think most CEOs would echo my comment. I don't think we're at the end. I think it will be interesting to see with the election the way that it went yesterday, how much more pressure is brought to bear. We've already seen a dozen or so Congress people respond in a very negative way. While I was in DC a couple of weeks ago, I went to Congressman Bill Brady's office to meet with his chief of staff up on the hill to talk about us as an employer in San Diego and a growing entity, and there were lots of industry people up on Capitol Hill visiting their local Congress people to express the same kind of concerns and sentiment. So time will tell. We saw this before, not like this. We saw this during the Clinton administration with David Kessler. That was more of an enforcement-minded. This is more big government, we know what's best for you and you saw how the voters responded to that kind of philosophy yesterday. So it's a timing issue. But if we're stuck with this no matter what, my guess is 2-4 years.

John [Putnam]

Did they respond at all to the congressional letter? The one you mentioned in October?

Terry Gregg

I've not seen any public response. There was a meeting this week in Cleveland, I believe Dr. Hamburg spoke from that. We have an individual on our staff that was there. She did not comment on anything that Dr. Hamburg spoke of relative to that letter from the various Congress people.

John [Putnam]

Thanks. And another issue, I just wondered where you are on pediatric approval?

Terry Gregg

Well, it's interesting because we did, in fact, complete a pediatric trial with Gen4. The results were outstanding. We finished that trial before we got the letter from the agency asking for more information on Gen4 in the adult population. So we've got to go back there. I'm not quite sure what we do with this pediatric clinical trial information, if it will be sufficient or if they will require us to do another clinical trial. Don't know the answer.

Operator

Our next question comes from Greg of [inaudible]. Please go ahead.

Greg - [Inaudible]

Terry, at the beginning of the year you were talking about high deductibles and co-pays pushing back the purchasing decisions of many of your potential customers. Do you see that waning a little bit as we get into the last half of the year?

Terry Gregg

Well, yeah. We don't see any of that right now. All the flexible spending accounts and so forth, we're not seeing any of that. Obviously, we've got Q1 looming in front of us, and I would say again that typically in the durable medical equipment business Q1 is soft, and we expect that January even into February if it's a repeat of last year, January was very soft. Half of February was soft, and then we started roaring back in the second half of February, and March was an outstanding month. I'm predicting, and internally we're anticipating, that that's going to be a repeat of last year into the first quarter. But right now nothing that we're seeing, and just the opposite. We're showing a strong fourth quarter as we expected.

Greg - [Inaudible]

So that kind of fizzles out last part of February and by March you're back to normal.

Terry Gregg

That's what happened this year, so unless something changes in the healthcare environment that would alter that, it's pretty predictable.

Greg - [Inaudible]

And with regard to the ASPs on the starter kits, why are those creeping up?

Jess Roper

We've got opportunities to amend our contracts with some of the payers and then the new payers that we entered into were in a more favorable pricing than we were initially when we started this a couple of years ago.

Greg - [Inaudible]

And do you see that trend continuing?

Jess Roper

That's a good question. I don't know if I would count on just continued pricing forever, but we've had some good traction so far.

Steve Pacelli

Just for some color, I don't know if you've been following the company quite as long, but if you look back historically, back when we were a cash pay business, our [inaudible] were in the $400-$500 range. It crept up into the $600 range, so I think we've done an outstanding job, our contracting team has done an outstanding job, of moving that ASP to where it is today, creeping into that $800 range. I don't know how much room there is to go quite honestly. But as long as we can maintain that positive ASP we're pretty pleased with our pricing.

Greg - [Inaudible]

I was a little shocked when you said $800. I was tapping out at about $800 but that was in the middle of next year, but we can adjust that slightly. And with regard to the insulin pumps, Terry, this is more of a comment than a question. I think you're spot on with regard to 510(k)s for insulin pumps. I think they're using your old device, the old 508 insulin pump for the predicate devices, and that's a long time ago. So I think that continues. I wish you the best on that one.

Operator

Our next question comes from Vivian of Federated Kauffman. Please go ahead.

Vivian - Federated Kauffman

A couple of questions on the FDA timelines. Are you still thinking that the Animas in combo with the Gen4 could get filed before or after the Gen4 if approved?

Terry Gregg

No, it will be filed before the Gen4 is approved.

Vivian - Federated Kauffman

Okay. In other words they can process that in parallel.

Terry Gregg

It's in lock step with the Gen4. That's our [inaudible]. Once the Gen4 gets filed, the Animas Gen4 combination will be filed very quickly thereafter.

Vivian - Federated Kauffman

And the same would be true, then, for the insulin as well, whatever path they go down? They wouldn't need to wait for the Gen4?

Terry Gregg

No, they would not need to wait for the Gen4 to have a formal PMA approval.

Vivian - Federated Kauffman

Okay. And then do you get a sense from Animas that they would be willing to commit to a full launch in Europe before the U.S. approval?

Terry Gregg

Yes. I think they've just looked at the regulatory landscape for J&J, not just Animas, and that this is what we're going to have to live with and we need to get that product out in the market wherever they're allowed to first, so we've jointly said we would go out into the European market first.

Operator

Our final question comes from Bill of Cannacord Genuity. Please go ahead.

Bill [Plovanic] - Cannacord Genuity

Just a couple of points of clarity. One, ASP on the disposables, and then two, I know you don't normally do this, but you seem to be [inaudible] about Q4. I was wondering if just directionally, in terms of new patient addition you might give us some color, is that going to be up 10%, 20%, up 30%? That would be helpful. From Q3.

Terry Gregg

I'll let Jess answer the ASP on the sensor.

Jess Roper

Sensors is hovering right around 60, just a little north of $50 per sensor.

Terry Gregg

We've seen that stay pretty consistent over the last several quarters. Listen, I'm not going to give guidance percent-wise. We're four days into November, we've got October behind us. We're happy with what we're seeing, both from the patients we've already shipped, and with what's in the opportunity going forward. I've been out in the field recently. I'm happy with what I'm hearing out there from the prescribers and our sales force, so I would just say, again, each quarter I say we should do more than we did the last quarter. I'll say Q1's always the toughest, so that's soft, but certainly going into the fourth quarter we should see sequential growth from the third quarter, and I would probably get fired if we don't. So I am highly motivated.

Operator

That was our final question. Terry, did you have any closing remarks?

Terry Gregg

Just a couple. In summary, we have created a very special company, and we are being rewarded by the patients we serve and the healthcare providers we help. CGM continues to become more important in the therapy armamentarium to combat the complications of diabetes and excessive glycemic variability. DexCom is the continuous glucose sensor of choice by healthcare professionals. We are the technology leader, and we expect to maintain our leadership position in the future with our Gen4, Gen5, and future technologies. We are the sensor of choice in more than a dozen artificial pancreas projects around the world, and there is a reason that we are the sensor of choice. Thank you.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: DexCom CEO Discusses Q3 2010 Results - Earnings Call Transcript
This Transcript
All Transcripts