Welcome to the Dexcom 2011 year-end earnings release conference call. My name is Christine, and I will be your operator for today's conference. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note today's conference is being recorded. I will now turn the call over to Terrance H. Gregg, Chief Executive Officer. You may begin.
Thank you, operator. Thanks for joining us today for our conference call. I'm gonna first ask Steve Pacelli to review Safe Harbor statement.
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 the 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 the section Risk Factors and elsewhere in our annual report on Form 10-K, our quarterly reports on Form 10-Q, and our other reports filed with the SEC. We undertake no obligation to update publicly or revise these forward-looking statements for any reason. Terry.
Thanks, Steve. Joining me today are Kevin Sayer, our President, Steve Pacelli, who you just heard from, our Chief Operating Officer, and Jess Roper, our Chief Financial Officer. Before we review our fourth quarter and full year 2011 financial results and provide our customary operations update, I'd like to spend a few minutes discussing a very exciting transaction we announced just today. This afternoon, we announced that we have entered into a definitive agreement to acquire SweetSpot Diabetes Care, Inc., in an all-stock transaction with initial consideration of approximately $4.5 million and performance milestone-based earn-out consideration of up to another $4 million. SweetSpot is a healthcare-focused information technology company with an advanced platform for uploading and processing data from diabetes devices. The SweetSpot system specializes in turning raw output from patient devices into powerful information for healthcare providers, patients, and researchers.
SweetSpot and Dexcom share the mission of transforming diabetes care through the better use of data. We each offer advanced technologies to help patients control their diabetes, and we each believe that diabetes care must and will evolve with the help of connected monitoring devices and the more sophisticated use of data, providers, patients, and payers. Today, the SweetSpot platform comprised of a cleared SweetSpot Diabetes Data Management Service, a secure end-to-end solution for diabetes data management, automating the retrieval of data from numerous patient devices, managing, processing, and storing data in the cloud, and integrating into electronic medical records and other clinical systems for information delivery. The platform is vendor neutral, and today, data from most common blood glucose meters can be retrieved during a step-by-step session at a physical kiosk in-clinic or through a web-based application.
As currently configured, once patient data is retrieved, the service generates a plain English report and pushes it back to the clinic, either to a local printer or directly into the clinic's electronic health record system. Patients can also receive reports via a secure link. Reports contain visualizations of daily and weekly glucose levels, statistical summaries, and provide measures of glucose variability and testing frequency. The platform also has the capability to compare a patient's data with their cohort and can be customized by the clinic to best support physicians and their patients. As we work with SweetSpot to build out this platform, our intention is to use the platform to move and manage CGM data in the cloud, and we expect to add insulin data and other information considered necessary to better manage diabetes.
We will also add more data management tools specifically designed for the patient and additional reporting capabilities for wireless devices such as the iPad. While we believe we are firmly entrenched as the world's leading glucose sensor technology, from a competitive perspective, our two missing pieces remain insulin pump integration in the U.S. and a universal data management system. Our acquisition of SweetSpot, combined with our insulin pump partnerships, will fill these voids. Looking at future Dexcom product offerings, our ultimate objective is to move a patient's CGM data directly and seamlessly from the patient's phone or CGM receiver to our cloud-based platform. Not only will this cloud-based data provide patients and providers with much more useful information, it will greatly enhance Dexcom's ability to monitor our product performance and measure patient utilization patterns.
Data-driven healthcare services are evolving rapidly, and in addition to building out our data management platform, SweetSpot will continue to pursue its pre-acquisition business strategy, marketing the data management service directly to clinics and other customers, including leading academic research centers and integrated delivery networks such as the VA medical system. SweetSpot will operate largely independently from Dexcom in these activities, and its employees and facilities will remain headquartered in Portland, Oregon. Patient-based applications, however, will be provided to our patients directly through Dexcom. It is no secret that our healthcare system is witnessing a rapid expansion in the number of tools and services to support the gathering of health-related data, creating an unparalleled opportunity to inevitably and forever change the face of how healthcare is delivered. I've often stated that the majority of patients with diabetes are treated by internal medicine and primary care, not endocrinology.
We expect this trend to continue, and as the burden to manage a growing diabetes population falls increasingly on primary care and even on patients themselves, we need informative tools that are convenient and effective. We believe the future of healthcare is one in which the patient is presented not just raw data, but with simple, easy-to-use, timely, and actionable reports that not only interpret the data, but also provide motivational recommendations for positive health behavior change. We also believe that most of the tools and services available today are not taking full advantage of the vast amount of patient data that is being processed. This is where Dexcom, together with SweetSpot, will work to pioneer an integrated, interconnected data management solution. We expect the acquisition will close within the next several weeks. I would now like to turn the call over to Kevin Sayer.
Thank you, Terry. I'll start with the financial update. Dexcom finished the year strong, generating $20.9 million in product revenue for the fourth quarter of 2011, compared to $13.6 million for the same quarter in 2010, a 54% increase. Sequentially, product revenue for Q4 of 2011 increased 26% from the prior quarter. Year-over-year, product revenue was up approximately 64%, totaling $65.9 million for 2011, compared to $40.2 million in 2010. Total revenue for the fourth quarter was $22.4 million, compared to $15.6 million during the same quarter in 2010.
Our product gross profit totaled $10.2 million, generating a gross margin of 49% for Q4 2011, compared to gross profit of $5.9 million and a gross margin of 44% for the same quarter in the prior year. Sequentially, our product gross profit increased $2.8 million on increased sales of $4.3 million over the prior quarter, and our gross margin increased 4 margin points over Q3. Year-over-year, product gross profit increased $15.2 million on increased sales of $25.7 million. Gross profit more than doubled from last year, and our gross margin increased 9.4 margin points over 2010.
Research and development expense totaled $9.2 million for Q4 of 2011, compared to $6.9 million in Q4 of 2010, primarily a result of additional expenditures related to our future generation ambulatory products, primarily our G4 product. Sequentially, R&D expense increased 12%, which was primarily due to higher development, clinical, and regulatory costs, again relating to our future ambulatory products and primarily the G4 product. We expect to continue to incur significant R&D expenses as we complete our G4 trial in Q1 and complete our PMA filing. Right after our G4 filing, we will commence a pediatric trial to enhance our labeling for children, and these costs will hit during the Q2-Q3 timeframe.
We'll shift our efforts to our G5 platform to enable communication with a smartphone and the Roche and Tandem insulin pump products. After Q2, we expect things to stabilize a bit, but on an overall basis, it will be a year of much activity, and we expect R&D expenses for 2012 will increase some compared to fiscal 2011. Selling, general and administrative expense totaled $13.7 million in Q4 of 2011 compared to $10 million during the same quarter in 2010. This increase, which included $900,000 in additional share-based compensation, was primarily due to additional selling information technology costs and customer support costs to support revenue growth. We note, however, that year-over-year, SG&A grew only 23%, while product revenues grew 64%.
We're beginning to see some leverage in our SG&A infrastructure. Sequentially, SG&A expense increased 4%, with the increase primarily due to additional selling costs, information technology, and customer support costs to support our increased volumes. For full year 2012, we expect cash-based SG&A expenses to increase by less than 20% compared to the full year 2011 as we continue to expand our marketing and product awareness campaigns, our IT infrastructure, and support our revenue growth. Our net loss for the fourth quarter of 2011 totaled $12.3 million and included $5 million in non-cash expenses centered primarily in share-based compensation, and the loss per share for the quarter was $0.18. We ended the quarter with $83 million in cash, restricted cash, and marketable securities and had working capital of $90 million.
Our uses for cash during the fourth quarter can be characterized in three areas. First, our Q4 CapEx was over $3.5 million. As we are working rapidly to complete our clean room expansion and acquire the equipment necessary to ramp up manufacturing to support increased volumes for current and future generations of our technology. Second, we had a negative working capital swing of $4.4 million during Q4, with $3.5 million of this coming from receivables and the remainder coming from increases in inventory during the quarter. Finally, our cash operating loss was just over $7.3 million for the fourth quarter of 2011.
As we've discussed on numerous occasions, the fourth quarter is typically the strongest of the year for companies in the durable medical equipment business, as annual deductibles have generally been met, meaning patients can obtain the product for little or no out-of-pocket expense. Flexible spending account deadlines loom, so patients who participate in these employer-sponsored programs must utilize any excess funds they've saved prior to year-end. We attribute our strong performance during the fourth quarter both to typical Q4 seasonality as well as our stepped-up efforts to increase awareness and demand for our CGM products. Just as a point of reference, our Q4 product revenues exceeded our total revenues of 2009 by 16%. Obviously, our strong Q4 performance begs the question: what will our growth be in 2012?
As a reminder, at the JP Morgan Healthcare Conference in January, we issued guidance of estimated full year 2012 product revenue ranging from $85 million-$92 million, and we remain comfortable with that guidance. While we do not plan to provide quarterly guidance going forward, I remind investors that the first quarter is traditionally a seasonally slow quarter in the durable medical equipment business, as annual insurance deductibles reset and flexible spending accounts are largely unfunded. I also remind investors that in years past, approximately 40%-45% of our product revenues have been generated in the first half of the year, and 55%-60% have been generated in the second half. We do not view 2012 any differently.
Last year, Q1 accounted for approximately 20% of our annual revenue, and we would expect similar performance in the first quarter this year. I'll now provide you with the G4 update. Shifting to an update on our fourth-generation sensor system, I'm pleased to report that we have successfully completed the pivotal trial for our fourth generation system, and we are actively engaged in our data analysis. We expect to file a PMA with the FDA by the end of this quarter or early in the second quarter. I'm also pleased to report that we submitted our improved G4 configuration with our notified body to obtain CE mark approval and expect to launch a G4 standalone system outside the United States during the summer of 2012. Finally, partnership update.
Turning to our development partnerships in January, we announced that we entered into a development and commercialization agreement with Tandem Diabetes Care. Much like our agreement with Roche, under the terms of the Tandem agreement, Tandem will pay Dexcom a technology license fee of $3 million. Tandem will offset our development, clinical, and regulatory expenses, and upon commercialization of the combined system, Tandem will pay Dexcom $100 for each CGM-enabled handheld sold. To further our patient-centric model, we have adopted an open architecture strategy in order to provide our patients the ability to choose a pump system that best fits their needs. We believe the financial framework established under the Roche agreement and mirrored in our Tandem partnership is appropriate for both existing and potential future pump partners who wish to integrate our advanced CGM technologies into their product offerings.
Animas continues to commercialize the Vibe System in Europe and is expected to increase the number of available markets over the course of the year. With regards to the filing of a PMA supplement for U.S. approval of the Vibe, we continue to anticipate filing with the FDA approximately 100 days after we file our Gen 4 PMA. Finally, the development of our second generation in-hospital glucose monitoring system, conducted in collaboration with Edwards Lifesciences, continues to move forward. As Edwards mentioned in a Q4 earnings call, the commercial launch of Gen 2 in Europe is expected before year-end as we collectively work on several additional enhancements to that product. I would now like to turn the call back over to Terry for some concluding remarks.
Thanks, Kevin. Earlier this month, the fifth annual ATTD meeting was held in Spain. Just under 2,000 registrants from around the globe attended the important technology meeting. Prior to the official start of the meeting, there was a full day review of the current status of the artificial pancreas projects currently being conducted around the world and sponsored by a number of entities, including JDRF, the Helmsley Trust, the EU, and even the French government. Dexcom was clearly the sensor of choice in the overwhelming majority of programs, regardless of sponsorship. In fact, the few sites not using Dexcom sensors approached the company requesting access to our technology to include it in their ongoing efforts. Quite a tribute to our sensor technology.
Also, during the meeting, we presented accuracy data on our G4 technology and results from our clinical trial in support of our CE mark filing, achieving a mean absolute relative difference of 12.3% when compared to finger sticks. This is real-time prospective accuracy, and we believe this is the most accurate prospective data that has been presented on CGM to date. In addition, we discussed our G5 product platform that provides for open connectivity to a variety of devices, including smartphones, tablets, and PCs. Finally, we presented recent human clinical data from an ongoing trial, the Dexcom Edwards Intravenous Sensor in the critical care arena, achieving a MARD of approximately 5%. That is therapeutic accuracy. My final takeaway from the meeting was the presentation sponsored by the T1D Exchange.
The exchange is a data repository hosted at the Jaeb Center in Florida through a generous grant from the Helmsley Trust. 67 clinical centers around the U.S. participate in providing information from their diabetes patients to the exchange. To date, there are more than 20,000 patients from these centers that have responded to questions regarding their diabetes. Focusing on the more than 1,100 respondents that have utilized CGM, approximately 80% were pumpers and 20% used injection therapy. Of that group, 43% of the patients reported using Dexcom CGM, which is remarkable when you consider that our installed base is about 60% pump and 40% MDI. The authors also concluded that there was no difference in A1C when comparing injections and CGM versus pumps and CGM. With that, I will open up the call to Q&A.
Thank you. We will now begin the question and answer session. If you have a question, please press Star then one on your touchtone phone. If you wish to be removed from the queue, please press the pound sign or the hash key. If you are using a speakerphone, you may need to pick up the handset first before pressing the numbers. Once again, for any questions, please press Star then one on your touchtone phone. The first question comes from Tom Gunderson from Piper Jaffray. Please go ahead.
Hi. Good afternoon, guys.
Hey, Tom.
Let's start with the new news on SweetSpot. You did a good job of giving us a summary of the concept and technology. Can you give us a little bit better sense of the financial impact other than the acquisition costs? Maybe just a quick summary of what the business equation was and will be for SweetSpot. And secondly, is this gonna have any impact on OpEx in 2012?
Yeah. Tom, this is Steve. Let's start with the kind of OpEx and the expense and revenue side of the business. Today, I mean, revenue is very, very small. Particularly, we don't expect, you know, material revenue contribution in 2012, nor do we expect material additions to the OpEx line from this business. It's a very small business. It's a handful of employees, you know, highly skilled technical employees and some very early sales resources. We're gonna expect to add a few bodies over the course of the year to help with the technical build-out and probably build, you know, a few more bodies into that sales organization. Nothing, you know, it won't be material to the overall business in terms of an expense.
In terms of the business model, we talked a little bit about it in Terry's prepared remarks, but we're kind of looking at this kind of from almost as an acquisition of 2 distinct companies in one. The first side of the business that we focused most of our you know prepared remarks on have to do with building out the infrastructure that SweetSpot already has in place. The 510(k) cleared product that SweetSpot has today can aggregate basically any brand of commercial glucose meter up to their cloud-based system and then report that meter data back down to the clinic, and the patients can also see that reporting.
It provides them with, you know, really slick output in terms of, you know, very crisp, clean reports, and very clear, plain English messaging on kind of trends and key patterns and things to look for, in analyzing the finger stick data. Obviously that analysis and the analytics behind it will become much more robust when you start uploading, you know, the equivalent of 288 finger sticks a day versus what the patient, you know, is probably taking four to six to eight finger sticks today. We would also look as we build out that platform.
From a technical perspective, we'll build out the platform to include not just finger stick data, but the next step would be to incorporate obviously our CGM data, and then we would look to incorporate insulin pump data as well from the various insulin pump partners. From a clinic perspective, the clinic will have a you know kind of a single platform to aggregate basically all patient devices into a single cloud-based platform and then have access to that data again over initially you know directly into a printer in the clinic or directly into the EMR environment. Over time you know the clinician and even the patient will have access to it from a mobile device like an iPad or even potentially a smartphone. That's kind of one aspect of the business.
We have the other side of the business, which is the revenue generating opportunity. To be honest, the prospects for that business are somewhat unknown. It's a very new business. The concept of selling data services, be it into a clinic, you know, I think there's opportunities to work with payers in aggregating some of this data and providing that data to the payer community. We have a relationship where SweetSpot has a relationship today with the VA. It's an early stage, only in a single site at this point, but it's comprised of uploading data and actually remotely monitoring patients. We see some pretty interesting opportunities.
Don't really wanna comment much further on that because I think that business is really an evolving business, but I think it's really a separate and distinct part of the company that we're buying that I think we're pretty excited about.
And then after-
Well, I think you have three questions that kind of covers them.
Yeah, just one quick follow-up on that. It also on the website mentions R&D or research, sorry, applications. Would you see incorporating your clinical trial data
Both your direct and the ones that you're doing with other companies into this system in the near term?
Good catch, Tom. Yes.
Yeah. That's part of the platform as well, for sure.
Okay. That's it for me. Thanks, guys.
Thanks, Tom.
The next question comes from Ben Andrewes from William Blair. Please go ahead. Ben Andrewes from William Blair, please go ahead with your question.
Yep. Can you hear me?
We can.
Yeah, we can, Ben.
Okay, great. Just a couple follow-ups to Tom and then something else. Did you look at other businesses in this space, and what was the build versus buy timeframe? You know, it's a small acquisition, but you know, maybe just describe what you saw as you looked around the industry. Are these guys one of a kind, or have other people been trying to do this?
No, we you know did the appropriate diligence of what was available. These were not necessarily one of a kind. They were certainly the most advanced and comprehensive that we saw their current distribution format and their relationships. We talked about the VA. There are several others that we haven't talked about that they have existing relationships with, a very broad-based, important relationships that we either today have our own relationships with or certainly will allow us to enter into additional relationships as we look across a broad swath of what they can do. I think that the real key here, and then we keep need to iterate. The one thing that we have been missing, I think from a standpoint of our ability, we create software.
It's in a disk that you put into your computer, it's PC-based, and it's not web-enabled. One of the criticisms of Dexcom by the physician community has been the inability to pull that information down from a web. For us to build it on our own, which we went back to our own internal IT group, the infrastructure that would be required and the time was enormous. Much greater than what we're paying for and having it already integrated. In many ways, we took the advantage of this sophisticated system to buy it now and to build on it with our own IT infrastructure to incorporate it. That was the decision-making.
Okay, that's helpful. Thank you. I mean, probably not anytime soon or in the current, the scale, but is this a true platform where it could be used outside of diabetes, or they just haven't gone there at all, they've been so focused?
It is a true platform. As we look at data management, if you were to ask me what I thought the future would look like in three or four years from now, I will tell you that patients will wear multiple body-worn sensors in which they're registering glucose as well as blood pressure and other. I mean, even today, heart rate monitors are common using ANT+ technology, as an example, through Garmin or Nike endeavors. All of this is really the future of healthcare. Yes, this is a platform that can incorporate other vital sign measurements and also in the convergence of that information to either the patient themselves or to a caregiver.
Okay. Maybe switching gears a little bit, talk about patient adds, if you, if you're giving that number out, in the quarter. Talk to us about any trends you're seeing with retention and kind of utilization. I know the numbers looked solid in the quarter, but did you see a change in sensors per patient or, the length of time that each patient is using a sensor?
You know, Ben, this is Kevin. I'll take that. We've kind of scaled back on what we're going to disclose with respect to patient adds and kit sales for a couple of reasons. First of all, we've been giving our competitor a very clear map of everything that we do. Second of all, as we've disclosed kit sales, we've all interpreted that as a new patient add. As we look at the future, when Roche purchases a kit and puts it in a professional office, is that a kit? Is the Animas pump placed in Europe a kit? And then another transmitter, another kit? Things are getting blurry, so we've kind of backed off on that disclosure. I will give you a mix. Our sensor and hardware revenue, it's still about 30% hardware and 70% sensors.
As we look at utilization, we do know, and Terry can tell you firsthand from his field experiences, that patients are wearing our product for a very long time. We'd love it to be shorter, but they use it for a long time. We have seen, we believe in our more current patients in particular, increased utilization and stickiness as they use the product. Our sensor sales were very strong last quarter, and we're feeling very good about what we see right now. I'd say that's our trend there.
Okay, thank you.
The next question comes from Bill Plovanic from Canaccord Genuity. Please go ahead.
Great, thanks. Can you hear me okay?
Yeah, Bill.
Oh, fantastic. Just a couple of questions here. Just one, on ASPs in the quarter, if you could give us any trending data there and kind of where we sit on the sensors and the kits. Just in terms of one of Ben's questions, just any incremental change in attrition rates up or down in patients utilizing the product?
Yeah, I get back to last statement. We've never disclosed an attrition rate. What we are seeing is what we think is some pretty strong utilization right now. The mix between sensors and hardware remains 30-70. With respect to pricing, since so many of our sales now, Bill, are through managed care contracts, pricing is pretty well set. We don't see a lot of pricing moving quarter to quarter right now. Things have been relatively consistent with what we've had in the past.
Just as we, you know, try to kind of fine-tune our models, any update on the total number of patients that are currently utilizing your technology at the end of 2011?
Boy. No, I think, you know, we made the statement that we thought collectively the penetration in the Type one category in the U.S. exited the year at around 6%. You know how you factor that into a model and you saw where we just most recently in 1,100+ patients represented a 43%. If you look at Kelly Close's diaTribe analysis, it has us at about a 54% share. So somewhere in that range, that's about as far as we can go.
Okay. Last question, you gave us pretty good clarity on what R&D spending and SG&A will be going forward. You know, as we look at this, I mean, do you have a target as 2013, 2014, 2015 when you think you can get to be a cash flow positive or operating positive business?
Are you kidding me? I like my job.
It's gonna have to be quicker than 2014 and 2015, Bill. We're looking particularly as we get to the very last part of 2012 to start flipping towards cash flow positive and certainly during 2013. We're confident.
Great, thanks. I appreciate that. That's all I had.
Okay.
The next question comes from Raj Denhoy from Jefferies & Company. Please go ahead.
Hi, this is Amy in for Raj today.
Hey, Amy.
Just a question, I guess back on SweetSpot. I'd noticed that previously they did seem to have a direct subscription model for patients. Is that still an active business model or is that shifted solely just direct to clinics?
Yeah, today the 510(k) approved product is only for clinician use, although the patients do have the ability to access the data once they've uploaded it to the clinic. In the future, though, we would certainly expect to provide the platform to patients as well as clinicians.
Okay, great. Just kind of switching gears perhaps to the international market. I think wrapping up 3Q, you all noticed that was a little bit of a tougher market and this quarter Medtronic cited that as a very strong performer for them and noting CGM adoption. Could you all talk a little bit about your view of the international market?
Yeah, I'm happy to. Over the last three months, I've probably spent three to four weeks in the international market between Europe, Asia, India. I think there's great opportunity. We did finish out the fourth quarter in the international sector very strong. I was quite happy and I, you know, compared to my comments about the three previous quarters, Q1 through Q3 we were underperforming but came roaring back in Q4. I would say as we look out even now the prospects in the international market, although still as a % of our revenue will be, you know, single digit, maybe approaching double digit. Again, with a robust opportunity and, you know, we certainly applaud the good folks at Medtronic for paving the way, spending the money to build those markets.
Our goal is to come in and trump them with superior technology.
Great, thanks. Just regarding with Roche marketing to the professional physician group, has that started in earnest? Could you talk a little bit about any experiences thus far?
No, it's actually, you know, we were really engaged in the training exercise late last year. It's really not kicking off until just this month with the Roche national sales meeting. We don't really have much of an update at this point. Probably update you in the next couple quarters as we start to see some traction.
Great. Thanks so much.
Okay.
The next question comes from Sara Michelmore from Brean Murray. Please go ahead.
Yes, thanks for taking the question. I guess I'll hit you with some pipeline questions. First, just on this G4 trial, is there a venue where we may see the data from this latest trial? Then on the G5, I assume you're thinking right now this would be a supplemental PMA type of route. I'm just wondering in terms of the smartphone piece of the submission, how much clarity do you have in terms of what the FDA may or may not require? Thanks.
All right. Well this is Terry. I'll take both questions. The first one with regards to the first display or presentation of material clinical results, we're gearing towards ADA. That's the first part of June in Philadelphia. We believe that multiple investigators will want to present. Obviously, we're trying to get the analysis done, file the PMA, which would allow them to meet the timing requirements for late-breaking abstracts under the FDA or the ADA guidelines. Secondly, with regards to the G5, we are in active discussions and face-to-face meetings with the agency on the G5 technology. Don't have any definitive answers. You know, the learning curve of FDA in this convergence of healthcare information, mobile applications ported to a variety of devices is at its all-time high. We actually had Dr.
Dr. Shuren, head of CDRH in our offices in January, talking about this specific area, I think we all gain greater clarity as to their comfort level as to what we can and cannot do with a truly mobile device. Their primary concern remains, which is, you know, well known, has been to ensure that the protocol of receipt and transmission of sensor signal from a transmitter is always primary, no matter what you do. Regardless of the upgrade to your software or adding apps to your phone, we can make that primary, but there are some limitations, and we just need to ease them along that process for them to understand that no matter what an individual could do on their phone, that sensor signal cannot be corrupted in any way.
It's a matter of demonstrating all the testing that we're doing and others are doing as well.
Okay. That's helpful, Terry. Then just in terms of the G4 sensor, can we just get an update on your thoughts in terms of the cost position of that product? I suspect, but don't know that that's part and parcel with having that product out there with the lower cost position that's gonna enable you to deliver you know, cash flow breakeven or cash flow positive results in the near term. Thanks.
You know, Sara, we've consistently said we can pick up significant margin points when we go to our new manufacturing process. As we looked at internally, certainly a 70+ margin on sensors once we get there should be achievable based upon the volumes that we would expect to sell. The flip side of that argument is for a year, we're gonna be manufacturing 7+ sensors, then we're gonna integrate Gen 4 sensors. We'll have some blended manufacturing between the two. On a pure standalone basis with volumes where we think they're gonna be, you know, we should see a good margin improvement on the Gen 4 sensor.
Okay. Thanks so much.
The next question comes from John Putnam from Capstone Investments. Please go ahead.
Yeah, just to pursue that a little bit, Terry, do you think that the gross margin will improve sequentially on a quarterly basis through 2012 then?
This is Kevin. Again, based on volumes and timings of product launches, it should. I'll go back to cautioning and the quarter where we flip, and we have to manufacture both and support both, there will be a lot of startup costs involved. By and large, our model would indicate our margins improve every quarter as we increase our volumes.
Okay, thanks. You didn't mention your relationship with Insulet. Can you give us an update on that?
Yeah. I mean, not much to update other than, you know, Insulet's been focused on the OmniPod System and driving that through the FDA approval process. Obviously we've had our hands full with some things on the Gen 4 with the SweetSpot deal. I expect when, you know, now that both of us can come up for air as soon as Insulet sees their product approval, you know, we're kind of standing by ready to let them go forward with the Gen 4.
Okay, great. Thanks.
The next question comes from Caroline Corner from MLV & Co. Please go ahead.
Hi, guys. Thanks for taking my call. Most of my questions have been answered. Just a couple of quick ones. With regard to the former Abbott patients, since that product's been off the market now since last August, could you let us know how your sales efforts to those patients have been going and how successful you've been able to capture them, you think, as compared to Medtronic's efforts to that?
Yeah. By the time that Abbott actually exited the market, there were less than 300 patients that were still on the Navigator sensor. We did not go after them specifically. As I had mentioned previously, Abbott did give us a heads up that they were going to exit the business and that they would be referring their patients over to us versus referring them over to Medtronic. We don't have any record specifically of how many of those patients selected to use a Dexcom sensor technology.
Okay, thanks. My other question is just about the grant revenue line. It looks like that's been fairly strong lately. As we look forward, is there any component of that that is recurring that we should model in, or is it gonna be just on a quarter-by-quarter basis as they come in?
You know, there's three elements in the grant revenue line. The first one is when we receive these upfront payments for development contract. We amortize those over what we think is the life cycle of development agreement, and those are relatively straightforward. Those get amortized in. When we get a milestone payment based upon achieving some performance milestone, we take that revenue and immediately, similar to what we did with the Animas revenue in Q2 of this year when we received a CE mark on that combined system. Then, the last system on many of our partnership agreements, we have a component whereby we can bill them for development revenue in a current quarter as we incur costs on their behalf. Those are recognized quarterly and are relatively inconsistent depending upon the project that we're working on.
Okay.
You know, we'll amortize the rest of the deferred revenue that we have on our balance sheet over the course of the agreements as we set them up. If other things happen, it rolls in.
Okay. Thanks very much.
The next question comes from Ben Haynor from Feltl and Company. Please go ahead.
Good afternoon. Thanks for taking my questions.
Yeah.
Have you guys continued to see positive momentum on the reimbursement front? Are there any specific coverage policy review dates coming up that you might have your eye on?
Yeah. I mean, I guess the short answer is it gets better every day. And what I mean by that is, you know, we continue to see plans that may have been historically restrictive in terms of the documentation required to enable a patient to obtain coverage is lessening or being eliminated in its entirety. With respect to specific, you know, coverage policy dates, there's nothing that comes to mind. I mean, we're by and large, I would tell you north of 95%, maybe 97% of our patients receive reimbursement for the product at this point.
The one, you know, kind of hole if I were to identify a hole would be the Medicare side of the business, which, you know, we've been pretty transparent with the market on, in our plans there in the sense that we need to conduct a clinical trial specific to the Medicare population. As Terry mentioned or Kevin mentioned in the prepared remarks, you know, in order of priority, certainly we view a pediatric trial for the G4, for example, as much more important in the nearer term to our business than running a trial in the Medicare population.
It's something that we'll do at some point in time, and we probably look to have a, you know, some help from, you know, either an industry organization or potentially even Medtronic to try to do something together for a trial like that. But, you know, other than that, I think, reimbursement, you know, we're not out of the woods in terms of eliminating all restrictions with all payers, but I think it continues to get better.
Okay, great. On SweetSpot, do you guys believe that if you get patients using that, system or service, that could potentially increase the number of sensors that given patient may use over time?
Sure. I mean, that's only a small part of the strategy. Yeah, as you know, as patients have a better visualization of their data and, you know, there will be components to the Sweet Spot system that will roll out over time, providing, you know, not just data and analytics, but providing motivational support to the patient, really encouraging the patient, you know, encouraging the patient to maintain better glycemic control, things like that. Sure. We do expect that to lead to better sensor, better and more frequent sensor utilization.
Okay. That's all I had. Thank you.
Sure.
The next question comes from Richard Lau from Wedbush Securities. Please go ahead.
Hey, guys. My question is about the type 2 population, what your current thinking is on that market opportunity. I know you guys said recently that you think that patient group is kind of ready for CGM now, so just wanted an update there.
Yeah. This is Terry. I think it's clearly ready. You know, we had the Robert Vigersky paper in Diabetes Care. He's doing some follow-up work in a type 2 population that demonstrated sustainability of effect over time, even with periodic use. We believe. We've got at least two payers that have, in one case, it's still a letter of medical necessity, and they will approve. We are processing some of our patients on type 2 through insurance and getting that reimbursed, although it's very small, and I would classify those as one-off. The opportunity is, in my opinion, enormous, and particularly not only restricted to the U.S.
In fact, if you look at some emerging countries where you've got a Type 2 patient with a BMI of 22 and an increase in cardiovascular impact on that patient, they're very concerned about their glycemic control because they look at that, and the healthcare systems are beginning to look at that as well. Are there preventative ways in which to reduce that glycemic variability, and a reduction of the potential longer term complications associated with Type 2? I think the market is robust. It won't be in 2012. We'll continue to make inroads. Some of these studies that are being done today, some will be published later this year. You should see some at ADA, some at EASD, but I don't see anything transformational until no sooner than 2013 or possibly even later.
Okay. Is it safe to say you guys probably won't be putting significant marketing dollars behind until 2015?
No, not at this point. I mean, we do have some investigator-initiated trials, and we tend to support with product or in kind, but not that we are going out conducting, you know, $400,000 trials in the type 2 population.
Okay. Then one more question with regards to your Tandem Diabetes agreement. Can you give us a sense of the timing for a potential launch with integrated system there or what the development pathway is?
Yeah. Nothing specific. You know, we're just literally kicking off that program now, you know, between the development efforts on our side and the development efforts required by Tandem. I'd hesitate to give you any specifics at this point.
Okay. All right. Thanks, guys.
The next question comes from Jonathan Block from SunTrust. Please go ahead.
Hi, guys. This is Chris in for John. Thank you for taking the questions. First of all, I just wanted to just make sure that I got the timeline correct for the G4. I know you guys mentioned the PMA coming at the end of this quarter, potentially early second quarter. The 100 days after, have you guys in your conversations with the agency, had anything incremental that you think you could still get it in get an approval for G4 standalone by year-end? Has that slipped to a you know first quarter 2013 event, or are you confident that you know that happens on a standalone basis by year-end 2012? And secondly, just as a follow-up to Amy's on the international. I know previously we had talked about trials for reimbursement concerns international.
Any update that, we could have there would be great. Thanks a lot.
Sure. On the G4 approval would be too early to speculate as to what that review timeframe is. The agency, as you all know, has historically taken longer than the statutory requirements to review things. You counter that versus what we think will be excellent data that they will be reviewing. I don't know. I really would not wanna forecast any timing of it. Obviously, from a launch standpoint, the further out we get into the year 2012, the less motivated we would be to actually launch a product in the last two months of the year, as an example. We would most likely hold that launch until early 2013. With regards to the international sector, you know, I just got back from Spain, had multiple meetings with investigators.
We will do some small trials for reimbursement. There already exists a number of data analyses with regards to the benefit versus economic outlay that have been filed in dossiers. Some of these countries are already reviewing them from that standpoint. Others, even though it's the European community, they're not as harmonized as one would hope for. We will run small 20-patient trials with a key opinion leader in order to generate that type of data. That will actually happen in 2012.
Great. Thank you.
The next question comes from Gregory Chwierut from First Analysis. Please go ahead.
Yeah, just a couple of quick questions. With regards to Edwards, what is the story with the milestone payments? I know, I think there was about $12 million remaining. Has that been renegotiated? You know, just a couple, you know, a little color on that. And also, is there any type of milestone payment when you file a PMA with Animas? Thanks.
I can take both of those, Greg. With Edwards Lifesciences, I would describe it as we're in active discussions with Edwards Lifesciences, but nothing definitive yet. That's sort of a still kinda stay tuned, and we'll update you as soon as we have something more definitive. Now Animas, if you recall that the $5 million payment from Animas was based on the CE mark approval.
Right.
That was due to the exclusive nature of the Animas pump outside of the U.S. In the U.S., they're not exclusive, so there's no additional payment there.
You know, looking at the royalty payments this coming year, it's a lot, you know, there's not a lot of one-timers coming, but a lot of amortizations coming.
That's an accurate characterization.
That's a fair statement.
Yeah.
Okay, great. Thanks, guys.
Okay, thanks.
The next question comes from Gregory Simpson from Wunderlich Securities. Please go ahead.
Okay, thanks. Good afternoon, guys, and congratulations. A lot of good news here. Most of my questions have obviously been answered, but Terry, if I could maybe throw something a little more anecdotal at you. Can you maybe characterize your relationship with the FDA at this point? Seems like it's improved dramatically. What I'm specifically trying to get at, obviously the process for the G4 has been kind of excruciating, but it seems you guys are gonna come pretty rapid fire with the five and the six. So can you maybe just throw some comments at us with respect to the relationship with the FDA today?
Yeah, I would say the relationship with the FDA is at the highest level of collaborative state that it has been in the past few years. I think to give the FDA all the credit that they richly deserve, they have listened. We have been, you know, very open and transparent with G4, G5, G6. Other face-to-face meetings. They've been highly receptive to receiving us and making time for us in D.C. to have those face-to-face meetings. As I mentioned, Dr. Shuren was here, and we spent a good hour and a half reviewing today's projects, artificial pancreas, future projects with him, and I think there is a real desire for them to try in their best way to accelerate the review process in an efficient, effective way.
I will also say, though, that they have a responsibility that was enabled by the device amendments way back when that they need to protect the citizens of the United States from adulterated, abusive products, and they take that charter very seriously. I do think that this world of regulatory science deserved improvement, and that's what Dr. Hamburg and Dr. Shuren and the people that we deal with have done. It is demanding, and it is frustrating for us as well. In the end, I think that the public is better served by having better products, and it forces all of us in industry to actually go the extra mile to produce better, more robust products to better serve our patients. I'm happy with the FDA at this point in time.
I think they're, again, they work in a very collaborative way if you make the effort. You've really got to go out and make the effort on behalf of industry. You know, the rhetoric that you keep hearing, I think is in many ways, they can also be an easy excuse. I think some companies choose to use them in that way. Dexcom does not. We view them as a partner in trying to get better products into our patients' hands as soon as possible.
Okay, thanks very much and congratulations.
Thanks.
Thanks, Greg.
At this time, there are no additional questions. Please go ahead with any final remarks.
Thank you, operator. Well, 2011 was an important year for Dexcom as we expanded our presence in the diabetes and CGM marketplace. We have long believed that CGM will be the standard of care in glucose monitoring. Although it is not today, we continue to make progress towards that goal, and the diabetes community, both patients and healthcare providers, share our vision. Clearly, it is now apparent that CGM is more than just a continuous glucose monitoring device. As we saw with Dr. Robert Vigersky's Diabetes Care article on CGM in a type 2 population, it is also a behavior modification tool. This year, we will explore its application in prediabetes as the financial impact of unprecedented growth of diabetes on a global basis, unfortunately continues unabated. Dexcom is addressing these challenges and opportunities through strategic partnerships and relationships.
We are extremely excited about 2012 as we expand our global reach and CGM takes its rightful place in the entire spectrum of diabetes. Thank you.
Thank you for participating in the Dexcom 2011 year-end earnings release conference call. This concludes the conference for today. You may all disconnect at this time.