Welcome to the Dexcom Third Quarter Earnings 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 Terry Gregg, Dexcom's Chief Executive Officer. You may begin.
Thank you, operator, and thank you for joining us for the Third Quarter 2011 Earnings Call. I will ask Steve Pacelli to review our safe harbor statement to kick it off.
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 as 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, of course, our Chief Operating Officer, and Jess Roper, our Chief Financial Officer. Consistent with our Second Quarter Earnings Call, Kevin will provide you with our third quarter financial results and a brief operational update, and I will conclude with a more macro update and some thoughts on our strategy for the balance of the year. This will be followed by a question-and-answer period. Before I turn the call over to Kevin, I would like to update investors on a very exciting relationship that we just announced this afternoon. We have entered into a definitive research and development agreement with Roche Diabetes Care relating to the development of an integrated diabetes management system.
Our goal is to integrate our next-generation smart CGM technology into an advanced Accu-Chek insulin infusion system that will provide patients with the option of utilizing a single handheld to control either a traditional durable insulin pump or a disposable patch pump and will also include integrated built-in blood glucose meter and bolus calculation capabilities. Under the terms of the agreement, Roche will pay Dexcom a technology license fee of $3 million. Roche will offset our development, clinical, and regulatory expenses, and upon commercialization of the combined system, Roche will pay Dexcom $100 for each CGM-enabled handheld sold. From a timing perspective, we expect to complete development, clinical, and regulatory work and file a PMA supplement with the FDA before the end of 2013.
Separately, during the third quarter, we entered into an exclusive distribution agreement under which Roche Diabetes Care will promote our 7+ system for real-time professional use in the United States. This agreement allows Roche Diabetes Care to sell the Dexcom 7+ system directly to healthcare providers who will use it with their patients to promote a better understanding of individual glucose patterns and trends. This information will support healthcare providers to make better-informed, individualized therapy adjustments, which can lead to optimized diabetes management. Over the past several months of deal discussions and due diligence, it became increasingly clear to us that our technical teams operate extremely well together, and we expect this effort to jumpstart a new level of cooperation now that our formal agreement is in place. I would now like to turn the call over to Kevin Sayer.
Thanks, Terry. I'll start with the financial update. Dexcom generated $16.7 million in product revenue for the third quarter of 2011, compared to $10.8 million for the same quarter in 2010, a 55% increase. Recognizing this is slightly short of analyst expectations of approximately $18 million in product revenue, we note that our international business continues to underperform our expectations. In the third quarter, domestic starter kit and sensor sales volumes were not as strong as we'd hoped, as many potential patients are reluctant to use their discretionary spending dollars on a product that is still not viewed as a must-have by their healthcare providers. During the third quarter, we shipped approximately 5,200 systems, representing a 33% increase compared to the same quarter in 2010.
Sequentially, product revenue for the third quarter of 2011 increased 10% from the prior quarter, as both starter kit and sensor revenues were up approximately 10%. Total revenue for the third quarter of 2011 was $18.3 million, compared to $11.7 million during the same quarter in 2010. Our product gross profit totaled $7.4 million, generating a gross margin of 45% for Q3 of 2011 compared to gross profit of $3.8 million and a gross margin of 35% for the same quarter in the prior year. Sequentially, our product gross profit increased $0.6 million or $600,000 on increased sales of $1.5 million over the prior quarter, while our gross margin remained flat.
Our product gross margin was approximately 2-3 percentage points lower than expected due to several lost manufacturing days as a result of the September 8 power outage that affected Southern California and Arizona. Which cause an absorption of our fixed overhead costs required us to scrap certain work-in-process inventory. We are currently implementing systems, processes, and procedures to mitigate losses of this nature in the future. Research and development expense totaled $8.2 million for the third quarter of 2011, compared to $6.2 million in the third quarter of 2010, primarily a result of additional expenses related to our future generation ambulatory products. Sequentially, research and development expense increased 17%, which was primarily due to higher development, clinical, and regulatory costs relating to our future ambulatory products.
Selling, general and administrative expense totaled $13.2 million in the third quarter of 2011, compared to $10.4 million during the same quarter in 2010. The increase, which included $0.7 million or $700,000 in additional share-based compensation, was primarily due to additional selling, marketing, and information technology costs necessary to support revenue growth. Sequentially, selling, general and administrative expense increased 8%, with the increase primarily due to seasonal marketing and trade show costs. Our net loss for the third quarter of 2011 totaled $13.3 million and included $5.0 million in non-cash expenses, centered primarily in share-based compensation. The loss per share for the quarter was $0.20, slightly higher than analyst consensus estimates of $0.16, due primarily to the following.
First of all, we had reduced gross profit related to lower than expected product revenue and the cost of goods issue related to the power outage, which accounted for approximately $0.02. Greater R&D expenses accounted for another $0.01. Finally, greater sales SG&A costs accounted for another $0.01. We ended the quarter with $98 million in cash, restricted cash and marketable securities, and had working capital of $100 million. Finally, a brief comment on our Q4 outlook. While we are pleased with our Q4 2011 performance through the month of October, both in terms of starter kit and sensor sales, we have elected at this time to revise our guidance for estimated fiscal 2011 product revenue to a range of $62.5 million-$67.5 million.
Terry will add some color on our Q3 performance and our expectations for Q4 during his prepared remarks. Shifting to an update on our fourth generation sensor system. As most of you know, Gen 4 in its original embodiment was designed with a focus on increased scalability and improved manufacturability and less on improved sensor performance. During the Q&A session of our last earnings call, Terry mentioned that it was unclear whether Gen 4 would be classified as a PMA supplement or a new PMA by the FDA. His comment was predicated on the fact that to date we have filed 43 supplements to our original PMA for the STS three-day system, coupled with the fact that the FDA will often require a new PMA if a design change is so significant that a new generation of the device will be developed.
Remember, Gen 4 embodies a new receiver form factor, a new transmission frequency in the transmitter, certain sensor material changes, and a number of manufacturing process changes. We've had continued dialogue with the FDA regarding the nature of the Gen 4 filing, and we were recently informed by the FDA that based on the information we have provided, our Gen 4 submission will be classified as a new PMA. In anticipation of this, as we started down the path of our Gen 4 pivotal trial, we decided to pause to evaluate the current state of our technology to ensure we were testing and ultimately seeking approval of the best possible system configuration.
Based upon this evaluation, it became obvious to us that we should include a few key modifications to the Gen 4 system that we developed during the course of our advanced technology development activities over the past year, modifications we believe will give us substantially improved accuracy and reliability over the full seven-day sensor session. We believe these improvements will further entrench Dexcom as the gold standard in terms of sensor performance in the CGM category. From a timing perspective, we expect to conclude the pivotal trial with our improved Gen 4 configuration, prepare the appropriate submission, and file the Gen 4 PMA in the first part of 2012.
We also intend to submit our improved Gen 4 configuration with our notified body to obtain CE mark approvals and expect to launch a Gen 4 standalone system outside the United States during the summer of 2012. Turning to our development partnerships. Animas continues to commercialize the Vibe system in Europe, and it is expected that the Vibe will be available in up to five markets by the end 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. Similarly, we believe the FDA will allow us to file a PMA supplement for U.S. approval of the insulin integrated system, subject of course to completion of development, clinical, and regulatory work on that product.
Finally, the development of our second generation in-hospital glucose monitoring system conducted in collaboration with Edwards Lifesciences continue to move forward. As Edwards announced on their Q3 earnings call, recent design enhancements, a more extensive regulatory review in Europe. Consistent with Edwards' guidance, we now anticipate obtaining CE mark and beginning a U.S. IDE study in the second half of 2012. I would now like to turn the call back over to Terry.
Thanks, Kevin. I would first like to add some additional color to our G4 regulatory path. As Kevin mentioned, we have filed 43 supplements to original PMA for the STS three-day sensor dating back to early 2006. Obviously, we had achieved a great deal of success iterating product improvements through the PMA supplement process, and we certainly tried to continue that trend with the G4. The fact of the matter is the G4 system embodies new hardware, new sensor materials, and new manufacturing processes, all subject to the PMA. We know that FDA very thoughtfully considered our request to treat G4 as a supplement, but we always anticipated that someday we would need to file a new PMA to accommodate the substantial number of changes we have made to the system over the years.
I remind investors that while the volume of information required to be submitted by us for a full PMA filing is more extensive than for a PMA supplement, the statutory review cycle for a PMA versus a PMA supplement is identical at 180 days. While the burden on our regulatory department is greater, we are cautiously optimistic that a full PMA will not materially add to the review timeframe for Gen 4. As evidenced by the Gen 4 data presented in a poster session at ADA back in June, upon approval, we expect to be in a position to commercialize the Gen 4 system with much greater accuracy, durability, and on-time performance, and with less physiological interference than any other system on the market. Shifting to some thoughts on our commercial activities.
Uncertainty regarding the global economy continues to weigh heavily on everyone's mind, and I believe pressure on discretionary spending, coupled with increasing overall healthcare expense, has impacted both starter kit and recurring sensor sales. For example, I read in a recent Wall Street Journal article citing a poll conducted by the Kaiser Family Foundation and the Health Research & Educational Trust that health insurance premiums paid by employers continued to rise sharply, with the average annual cost of family coverage passing the $15,000 mark for the first time. More concerning was the fact that this increase in premiums came despite a continued trend toward high-deductible plans, which require workers to bear significant out-of-pocket costs, and that 31% of employees are enrolled in a plan with a general annual deductible of at least $1,000 for a single person.
Yet in spite of that, we sold 5,200 starter kits in the quarter, which is a record number for us, and we remain confident of sequential growth in starter kits during this fourth quarter. As Kevin mentioned, growth in our international markets continues to be slow. We are still faced with a general lack of reimbursement for CGM outside the United States, and it is becoming more clear that obtaining reimbursement will require us to conduct clinical trials in the various countries. We expect to look to markets such as China, India, and the Middle East as expansion opportunities in cash pay markets. I just returned from a 10-day tour of diabetes clinics across India, and I believe there is substantial interest in CGM, although I think it will take time to develop this market as well.
When Kevin joined us as president in June, I committed to focusing my efforts more externally, particularly in the sales and marketing arenas. What have I learned since then? Well, I've learned that now more than ever, there's a critical need for our technology. I've learned that while reimbursement is substantially better than it was even just a year ago, it's not perfect, and many patients are still required to battle their insurance companies to obtain coverage. I've learned that while we do a good job with our patients and our healthcare providers, we need better tools. Improved physician and patient training will be a focus for us going forward. I've been reminded on the need for us to go deeper into our target accounts. We need more scripts out of our core group of endocrinologists. Finally, some thoughts on the future of our technology.
At the eleventh annual Diabetes Technology Meeting held in San Francisco last week, the most notable subject matter discussed was the development of an artificial pancreas. Over the course of several days, we heard presentations from some of the diabetes industry's most highly regarded researchers, including doctors Roman Hovorka, Howard Zisser, Boris Kovatchev, and Lutz Heinemann. We were pleased to learn that FDA has approved Medtronic's IDE to conduct an in-home clinical study of the Veo insulin pump with a low glucose suspend system. Of course, we were pleased to see that we continue to be the sensor of choice in the vast majority of artificial pancreas projects ongoing around the globe. We were also presented with data from a host of would-be competitors to Dexcom, including a non-invasive CGM and an implantable CGM.
I remind our investors the need to focus on four key things when looking at competitive technology. The first consideration is technical performance. Does their technology perform through the full range of requirements? Those requirements being 40-400 mg per dL, and do they show required data points at each of the three major zones required by the FDA? Below 80 mg per dL or hypoglycemia, the mid-range of 81-150 mg per dL, and greater than 150 mg per dL to at least 250 mg per dL, or the hyperglycemic range. This traditionally is only accomplished by moving patients up and down with insulin data to support performance of this nature. Second are the human factors consideration.
With one potential competitor, you have to wear an elastic bandage around your torso to hold the heavy, bulky device in place. Take a moment and think about the patient experience in the summer as a problematic example of why this is not doable. They also have movement artifact issues according to their own people, as presented at the Diabetes Technology Meeting. In the case of another, you have to denude the skin with a microabrasion device every day or every couple of days. They say they can get to 48 hours. We've only seen data at 12 hours. Even in the case of Medtronic Enlite sensor, to achieve increased durability and accuracy, the patient has to increase the frequency of calibration measurements to 3 to 4 a day in order to compensate for the increased drift of the sensor signal.
The third, and possibly the most important part, is the PMA process itself. It has become clear that certain sell-side analysts are not well-informed in the PMA requirements, and they report it as a CGM or a 510(k) filing rather than a PMA. The degree of difficulty is tremendously different. Just setting up an approvable quality system is very costly. Every component part and the manufacturer of that component part have to be certified and audited by the company and the FDA. Every part has to undergo extensive testing, validation, and verification before they can be used on the manufacturing line. The entire manufacturing facility has to be audited by the FDA and approved before a PMA will even be considered. You have to have engineering change order process that is validated.
You have to have a CAPA system, a Corrective Action and Preventative Action system in place, and validated with extensive amounts of data demonstrating its effectiveness. We're talking about millions of dollars of investment to set up and maintain. In fact, we estimate that Dexcom spends between $10-$15 million per year just to maintain our quality system as required by the Food and Drug Administration. Finally, it gets back to the data. These would-be competitors, excluding Medtronic, of course, are trying to compare their limited data sets to our seven-plus data and then make claims. We have learned over the years that trials with a small number of subjects, meaning fewer than 20, can provide inconclusive or misleading results. In many cases, these companies provide retrospective data and try to compare it to our prospective data. Simply not an apples-to-apples comparison.
We have Gen 4 approved in the EU, and we know that the MARD improves versus our Seven Plus by 2-3 points over the full range of 40-400, and particularly in the less than 80 milligrams per deciliter range hypoglycemia. This is prospective accuracy. We have Gen 6 human feasibility data showing a single-digit MARD with less frequency of calibration and greater durability. Again, this is prospective accuracy. Even Gen 4 shows no degradation of sensor performance beyond 7 days, but we will have to conduct yet another clinical trial to achieve that claim. It is my belief that these early-stage companies will not catch up to the advancement of our technology. Never mind the challenges of scaling manufacturing to build millions of sensors per year. With that, I'll get off my soapbox and open it up to question and answer.
Thank you. We will now begin the question-and-answer session. If you have a question, please press star then one on your touch tone 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 touch tone phone. The first question comes from Thom Gunderson from Piper Jaffray. Please go ahead.
Hi, everybody. Can you, Terry, maybe you can talk a little bit about the Roche deal. There's just a couple parts I missed. Number one is, has your sales force in the U.S. been spending any time calling on the professional, the doctors, in what Roche is gonna be taking over?
No, we have not. In fact, we have specifically instructed our sales force not to go down that pathway, Tom, and the reason was that building the ambulatory category was extremely important to us and getting that mind share and taking the sensor outside of the realm of only integrated with a pump was a key component to driving to the MDI market, which is much larger than the pump market in the U.S. As a result of that, no, the easy answer is no. This is a new opportunity. As you know, the seven plus has two capabilities, both blinded and unblinded, depending upon how the physician wants to use it.
We obviously, even with the professional use, recommend in its unblinded state because there's more valuable information from that, and it is real time with all the alarm systems that are available to keep patients safe even during diagnostic use.
The distribution for the combined Roche product will be U.S. only?
Well, I mean, if you think about going back to the original agreement with Animas, that agreement 2013. As we mentioned in the call, the intent is to file this with this combined system with Roche in either the durable or the patch pump towards the second part of 2013. Rolling into 2014 with this approval, we would expect this to be a global distribution.
Got it. Thanks for the clarification. On the Q4 guidance, Kevin or Terry, can you give us a little bit more color? I understand sort of the seasonality that we see in the summer. Others have had a slow time, but is there what are you seeing? You said sensors and kits look good in October. What are you seeing that gives you some pause that you wanna bring in Q4 a little bit?
Well, this is Kevin. Our initial guidance range was $67.5-$72.5, and the fact is we could not see getting to $72.5. As we looked at an even getting to $67.5 is a very substantial quarter for us. We brought it down a little bit and thought that would be a more conservative, more prudent approach at this point in time, Tom. Now, again, as we said earlier, our October numbers to date are good and we're doing well, but we just felt it more prudent to bring things down a little bit right now.
Yeah, Tom, I would add to this. If we had the upper end of each of the Q1, 2, and 3 number, then the Q4 number would be, and total year number would be a lot more achievable. We again just, you know, eyeballing one-third of the quarter with the end of October, we're very pleased with what we saw. That said, the makeup to get up to that $67.5-$72.5 is challenging, even if we didn't have the economic headwinds, but we do expect a substantial increase over the Q3 number.
Okay, last question and I'll get back in queue. The Vibe in Europe, if memory serves well, that has Gen 4. I think you may have said something about that, but could you repeat it or clarify?
Yeah, that's correct, Tom, that the Vibe does incorporate the Gen 4 sensor. What we said is that we would expect to launch the Gen 4 as a standalone system in the middle of, you know, obtain CE mark in the early to middle part of 2012 and launch it as a standalone Gen 4. Today, the Gen 4 is not commercially available as a standalone in Europe.
Right. I was just trying to figure out, I don't know what the PMA product is called, G4 point 1 or something, but this G4 continues on until there's another one available?
That is correct.
Okay.
The Animas Vibe, the Animas Vibe version of Gen 4 will continue on. Ultimately, they will marry up and be the same sensor when we launch the standalone.
Got it. Thank you.
The next question comes from Ben Andrew from William Blair & Company. Please go ahead.
Good afternoon. Maybe a little bit of commentary on the gross margin impact in the quarter and what happened on the manufacturing side. I know there was a power outage. How much product did you have to scrap and what will it take for you to get to a point where you can kind of avoid that in the future, if possible?
Well, let's go through a couple steps. We said it impacted our margins 2 or 3, between 2 and 3 points. We had to scrap quite a bit of production certainly for that day and a little bit that was queued up for the next day. The factory was shut down literally for several days while we revalidated all the equipment and all the manufacturing lines because we had lost our power. What we're doing to mitigate is a couple things. One of the first things that we have in process right now is setting up a distribution center on the East Coast, so we can have our finished goods inventory spread between the two.
There was a lot of chaos around here as we moved our finished goods inventories into air-conditioned controlled spaces at that time. We don't wanna have to go through that effort again. The second thing we have to do, Ben, is develop some more emergency power sources. While we actually had a very good position with the local power company to get some portable generators in here, and we have one big generator system now, we're gonna need more. We are looking at the best configuration to ensure that this doesn't happen again. Those are the things that we're doing.
Is that a, I mean, more than a few $ million sort of expenditure that we would notice in the CapEx, Kevin?
No, it's not a few.
Okay.
It's not a few. It probably wouldn't exceed $1 million.
It's less than one.
Okay.
Yeah, it'd be less than one.
Terry, in terms of the R&D budget as you go into 2012 with the increase in the PMA or the change to the full PMA, is there anything related to, or anything material related to that? Or is the clinical trial going to change, do you think? You know, are you still comfortable that you're on the right path there? 'Cause it doesn't sound like the timing on Gen 4 changed a whole lot.
No, it didn't. I think when we look at the clinical trial, the criteria that we received for the approval of the IDE remains the same. We'll initiate the clinical trial yet this year is the goal, and then complete it, analyze it, and submit it to the agency as Steve or Kevin mentioned in the first part of 2012. I don't expect any additional data requirements than we already know about. This is from that standpoint, then it's more taking the information of all the changes that we made. I'll just point out, so as we mentioned about advanced technology, we have Gen 5 in humans, we've got Gen 6 in humans.
Over the last year, these projects were in place long ago. The difference is they have matured. The results of that, what we decided that when back when we filed the original Gen 4, we filed it as a PMA supplement. During the course of discussion with the agency, we continued to believe that it would be a supplement. But we continued also at the same time for the Gen 5 and Gen 6 developmental all the way going into humans. We did not want to interrupt, and if there was any chance from our standpoint of maintaining a Gen 4 PMA supplement, that was a pathway that we wanted to. We would iterate with the improvements in Gen 5 and Gen 6.
At the same time, being prudent, we initiated a contingency plan to say, "Look, if we go down this pathway and they turn us into a PMA, are we ready to look at some of these improvements that we've developed in Gen 5 and Gen 6 and convert those over into the Gen 4?" It may delay us a month or two, but the difference of the output in terms of the clinical experience by the patient, as an example, would more than offset the slight delay that we would have. That came to be in the last couple of weeks, basically.
Can you describe in maybe a little more detail some of the components you're adding, if that's not proprietary at this point?
It is proprietary, and I really don't want to go down that pathway. Obviously, you know, this is being recorded and people have access to this. I would just say that, you know, our long-term goal has always been to get to factory calibration and increase durability beyond the seven days. Everything we did with Gen 5 and Gen 6 was with that mindset. That said, Gen 4 is still being looked at as seven days without any new claims with regards to reduced calibration in this original filing. That is not to say we will not explore other claims with Gen 4. It will require additional clinical trials, but we now believe that this platform is sufficient in the technology to allow us to pursue those other claims.
That'd be subsequent clinical data after either the filing or the approval.
That is correct. We don't want to do anything that would cause the agency at this point to delay the review.
Right.
Obviously, they have seen the data to date from a standpoint of the original Gen 4 pivotal trial that we filed, and we mentioned as a poster session at ADA. They have seen the improvements in what we've already filed with them. Those were, as I mentioned, 2-3 improvement points in MARD over the full range of 40-400, better hypoglycemia detection, more robustness, less interference from biological interaction. There's a lot that the agency's already seen. What we're doing with the additional is really getting a platform that will allow us to expand and to keep it. Since we're filing as a PMA, we believe that subsequent filings off of this PMA will then once again restart from PMA supplement filing as we go forward.
Okay. Two real brief questions, if I might, just to finish up. First, you know, if you think about the revenue impact from Roche, this is just to the professional market. It's more of a seeding effort, isn't it, in terms of driving patient demand and interest and getting clinicians to buy in as opposed to, you know, a material revenue generator? Second, are you sort of stuck with this, you know, economic sensitivity or are there things you can do in the marketplace, whether it's price or marketing or whatever, to try to accelerate demand over the next call it 18 months? Thanks.
Well, I think it is part of the awareness. My field visits to date have been enlightening from a standpoint that, as Kevin mentioned in his comments, you know, we haven't moved it to a must-have yet, and we're geared to do that. I think the greater exposure with the Roche carrying the product, they've got, you know, a lot more sales reps and feet on the street than we do, will get a greater exposure to the product as CGM as a category. We need to be able to develop that because remember, we're at this point in the United States, we're the only company with a standalone product. That everything that Medtronic does is to sell pumps, and, you know, they do a very good job at it, but they really don't look at the category of the MDI patient.
This will allow us to expand that awareness and grow. I think there are other activities related to that that will assist us in growing that adoption. We're still, regardless of the economic headwinds, we're still pushing and growing. Let's be sure we keep this in perspective that as a company, regardless of what we end up with the final year number, that growth will be significantly greater than the $40 million that we did last year. We're still gonna be in that 60 kinda % growth range. I think that in this market from an economic standpoint, there aren't many companies that can make that claim. Am I satisfied? Absolutely not.
I think it's frustrating that when I call on these accounts that they still take the position of, you know, "Oh, I don't think about it for my MDI patients," or that it's, you know, it's too expensive. I think those are barriers that we still have to overcome. I mean, it's a value proposition. You've got to demonstrate that the value is worth the effort, and I'm not sure that we have done that adequately out in the field. That's part of that effort. Certainly, having more people promoting the product can only be a good thing.
Well, is it another $5 million of clinical work to demonstrate that or marketing dollars that could move the needle or that's just not useful at this point?
I think it's more marketing dollars than R&D dollars because if you look at the sensor today, I mean, the Seven Plus is exquisite. It's the most accurate sensor, longest durability on the market. You know, I would say, and these guys are gonna jump on me, but you know, from a standpoint, if Medtronic was truly serious about an artificial pancreas project, and I think they are, they would be better served by using our sensor and their technology than their sensor or even the Enlite. We know that. They know that, and investigators have told them that. I don't think that from a technology standpoint, we do more R&D from a sensor performance standpoint. I do think from the marketing standpoint, we do.
I will tell you that, you know, November is National Diabetes Month, and so we are initiating a major public awareness campaign starting next week. You'll see flyers on it talking about the incidence of hypoglycemia on a national campaign level. We'll have people out, including myself, engaged with beyond the professional population to talk about this awareness of, you know, I'm sick and tired of getting letters and interviewing patients or loved ones of patients who have succumbed to hypoglycemia. It's ridiculous when technology is available today. That is an awareness campaign that we are spending some dollars on starting this month.
The next question comes from Bill Plovanic from Canaccord Genuity. Please go ahead.
Great. Thank you. Good evening. Can you hear me okay?
Yep, absolutely, Bill.
Fantastic. Just clarity. The new Gen 4, as we call it, you know, you start the trial by year-end, you complete it sometime in the first half, you submit sometime in the first half, and we expect approval by the end of 2012, early 2013. Is that timing correct?
Yes.
Okay. I, you know, missed the first couple minutes of the call. I didn't understand the Roche deal and kinda the drivers behind it and kinda who owns what and how long that exclusivity lasts for. If you could just bear with me and maybe explain that'd be helpful for me. Thank you.
Yeah. Bill, this is Steve. There's two components. The first component is the research and development portion of the deal, which is really very similar to the agreements we have with Animas and Insulet. What we're doing is we're actually incorporating our next generation. Not Gen 4, it would actually be our Gen 5, what we've talked about publicly about our smart technology, utilizing the Gen 5 system to communicate with a Roche handheld device that will be capable. It will be a future Roche handheld device that they're classifying as a diabetes manager. This handheld device will contain an SMBG, a finger stick reader. It'll contain some bolus calculators. It'll be able to control either their durable pump or a future patch pump that they've talked about publicly. That's kind of one element of the deal.
That's exclusive?
It is not exclusive. No. I'll get to the exclusive. That is a non-exclusive deal, and it's initially targeted only at the U.S. because as Terry mentioned, we have an exclusive arrangement with Animas that currently goes through the end of 2013 outside of the U.S. It's a non-exclusive deal, and we have not entered into a commercial relationship with Roche. The agreement today contemplates that we would enter into a commercial arrangement down the road, but one aspect of the commercial deal that has been finalized is that for every handheld, CGM-enabled handheld that Roche sells, we will get a $100 royalty. Does that make sense?
Okay. Yeah.
Switching to the other deal. Another separate agreement was this distribution agreement that allows Roche. It is an exclusive distribution in the U.S. only to sell the Seven Plus system to healthcare providers to use with patients in their clinic. They don't have the right to sell it. It's not a full-blown distribution deal where they would actually be selling Seven Plus product to patients. Do you follow? It's only to healthcare providers.
Basically for the professional market only.
For the professional, you know, call it diagnostic market, you know. Yeah. It's for that sort of diagnostic use of CGM.
Was there any upfront or ongoing fee associated with it, or how's the-
Not in that one. There was in the pump deal. What we've always said, you know, take this opportunity to sort of characterize it as such. We've always said that kind of going forward with our Gen 5 technology and any future technologies that we were gonna establish a framework that was really a template that all future partners will have to live by. This is basically what we've done with Roche. We've established a framework for Roche, for any, you know, any would-be, you know, durable or patch pump companies who come along. To incorporate our technology in the future, you're gonna need to pay us an upfront license fee, which is a $3 million upfront license fee.
You'll have to reimburse us for our development, clinical, and regulatory expenses, and you'll have to pay us a royalty on every device. That's sort of the standard. If there are other companies who wish to come and incorporate our technology, we would entertain the ability to do so on an open architecture basis. Those are gonna be the terms under which, you know, all future companies have to play by.
Okay. That's helpful. Thank you for that. Just on Q4, on the starter, given the guidance you gave, I'm sorry, I don't have a model in front of me, I'm on the road, but I was wondering what are you looking at in terms of starter kits? What are your assumptions in Q4, low-end, high-end?
You know what? We've never given guidance down to that detail. They'll certainly be more than what we achieved in the third quarter. I guess I would leave it at that. Their baseline of $5,200 this quarter, we certainly would hope to do better than that.
Okay. I actually think that was all my questions. Thank you very much.
You bet.
The next question comes from Raj Denhoy from Jefferies & Company. Please go ahead.
Hi, this is Amy in for Raj today. How are you all?
Good.
We're great.
Good. I guess just kind of starting off looking at with new patient adds this quarter. It seems like we're at least not read too much into a trend with two quarters in a row, but we're coming in at, you know, in the low 30s% for year-on-year growth. Is this kind of where we start thinking about where we're tracking from a growth rate moving forward? Is that a good way to be thinking about this, given the economy?
I wouldn't necessarily think about it like that. You know, this is a cyclical business. Fourth quarter always being the strongest, first quarter always being the weakest. I don't think you can level load it across the year and say that last quarter we were X, and therefore it's representative of the successive quarter.
I guess I'm kind of looking year-on-year because typically it does pick up quite a bit in Q4. I guess just trying to look at it and get our numbers to jive with new guidance that it's, you know, perhaps we're kind of hitting a new level of growth right now that's a little bit lower than what we've been running at for some time.
Yeah. No, I think that's a fair statement.
Okay. Just, I guess, just to confirm, to make sure I have my timelines down for, I guess, Gen 4, since it does sound like, I guess things will slip a bit. I think we were hoping for some time mid-2012, hopefully having a chance to get through FDA. Start clinical trial then in Q1, is that correct? Can you just kind of walk me through? I just want to make sure I have-
Actually, what I said was we would initiate the clinical trial yet this year.
Okay.
We would finish it and file in the early part of 2012. I didn't define early by quarter.
Okay.
You know, the goal obviously is to get it in as soon as possible in early 2012. Our expectation is if, you know, again, statutorily it's a 180-day review. I don't wanna try to crystal ball it to say that it's gonna be 180 days. Although at the same time, you know, certainly the engagement with the agency has been active and frequent. I know that we certainly don't expect an extended review.
Okay. Okay, that makes sense. Just to tag on to the questions with Roche. That was helpful kind of clarification of targeting just the healthcare provider market. I guess this is really looking more for this is building the market, versus looking for incremental distribution to. Would you-
Yeah, I think that's right. I think it's both, but I think you're absolutely right that gaining more, you know, using the Roche field force, which as Terry mentioned, was substantially larger than ours, obviously. Using a substantially larger field organization to help gain better understanding of the value of the technology with the healthcare provider community, which ultimately should lead to additional ambulatory kit sales. The goal of this partnership specifically is to drive awareness, drive utilization among the healthcare provider community.
Okay. Any kits, any sales though, that are driven by Roche, I guess, would then still flow through your internal sales force from a starter kit?
That's correct.
Revenue. Okay.
That is correct.
It wouldn't be selling to Roche at any level.
That is correct.
Okay, great. Thank you very much.
The next question comes from John Putnam from Capstone Investments. Please go ahead.
Yeah, thanks and good afternoon. Two questions really. One, can you kind of go through the math of recognition of either the licensing agreement or the development costs for Roche?
Uh.
Will this all hit in one quarter or is it spread out?
Actually, Jess, you want to take care of that for us?
Sure. You know, we're in the very early stages. We have had conversations with our independent external accountants, you know, trying to figure out what the revenue recognition on this will be. You can look at it really in a couple different buckets. You've got what Steve was talking about, the upfront $3 million payments, and they're broken out into different ways. We also have $1 million-plus in development dollars, and we also have the $100 royalty per unit sold. It's likely that we would combine the development dollars and some portion of the $3 million and spread that over the development period and recognize it ratably. On any milestone payments, we'd recognize that as received or as earned, I should say. On the $100 per unit-
We would recognize that as units are sold. That's very similar to our Edwards arrangements, for example.
Okay. Development grant revenue in the fourth quarter will be greater than in the third quarter, I'm assuming?
Just, I wouldn't say that. As we've guided previously, we are recognizing approximately $600,000 per quarter through mid-2012. We have received some additional development dollars from Edwards the last couple of quarters. Those additional amounts are not, I mean, they fluctuate, and we haven't given any real guidance on that. Relative to Roche, there would be some incremental development dollars that we would expect in the quarter. Just, it's too early to give the dollar amount at this point.
Okay. My other question is: How do the changes in the PMA affect your development with Insulet for a combined product?
It doesn't, other than the, you know, we have that kinda 100-day waiting period. Assuming Insulet is. You know, the Vibe is already commercial, so the Vibe is basically sitting, waiting to file with the FDA. It'll be 100 days after our filing. We're still in the development process with Insulet, assuming the development, clinical, and regulatory work is completed. Anytime after that 100-day window, we believe we would be able to file that one as well.
Okay, great. Thanks very much.
The next question comes from Jonathan Block from SunTrust Robinson Humphrey. Please go ahead.
Thanks, and good afternoon, guys. Terry, maybe just a quick question for you. You know, in your commentary, you had some interesting chatter about what you were seeing in international markets. Maybe if you can just elaborate a bit there. What are you seeing? I think you alluded to the need for more robust clinical data in order for reimbursement. Is that broad-based? Is that specific to certain markets but not others? Any color would be great.
Sure. As you look through the market, be it individual countries within the European Union, I think their local reimbursement folks have asked for local clinical trials to be done to demonstrate the efficacy of the product. We also have to include financial analyses as part of those trials. The same thing when I was in India last week, it was very clear to me in talking to the largest hospitals and clinics there that that's gonna be the expectation to get going down the regulatory process and reimbursement process. These are observational studies. They're not the type of studies that we normally engage in terms of a PMA process, but they do wanna see it in citizens of that particular country. We've heard that Sweden, France, Germany, throughout the EU.
We're talking about relatively small studies being conducted by key opinion leaders within those countries and then filing that dossier with the local authorities.
Okay. Like you said, these are small studies. It's not nearly as robust as the PMA adventure here in the U.S. Is it still fair to think of, you know, these studies being initiated in early 2012 in a reimbursement landscape that takes effect, when? Sometime early 2013, late 2012. Is there a timetable that you can assign to that?
I would assign sometime in 2013. I wouldn't even try to get to the specificity of a quarter within that. Now, the trials are relatively short because the number of patients are relatively small. You're looking at it versus SMBG as a criteria. You don't have to have the traditional laboratory measurement using YSI or some other laboratory blood glucose meter. Collect the data, analyze it, and then submit it. I think the small wrinkle to it is the financial analysis. Now we have, interestingly enough, we do have several studies that we have done, particularly analyzed and presented by an investigator in Sweden. We're well along the pathway of how to do that, but it would require additional trials that we haven't done yet.
We would initiate those sometime in 2012 with the expectation of filing those dossiers in 2012.
Okay, great. Then maybe just a quick one on SG&A. You know, where you guys exited the September quarter on an absolute basis from SG&A, should we think of that as a pretty good number and any incremental would sort of show up more in the agreement with Roche? Or are you gonna still need some additional build to go directly to the patients since Roche is just more on the healthcare professional side?
The Roche agreement shouldn't affect our SG&A costs at all as we look going forward. Our SG&A, you know, we built a pretty large increase to the sales force, both internal and external, into those numbers in Q3. If there's an increase in Q4, it'll be volume related to the fact that we're doing a lot more business. Then we'll look at expenses after that for next year.
Okay, maybe last one or two quick ones. I know you don't give exact detail, but Steve, maybe just overall, you know, utilization, attrition, ASPs on the handheld. Not a whole lot of movement. Maybe the continuum build a little bit on the ASP side on the handheld.
Yeah, no, the ASPs have remained basically the same. You know, a little north of $800 on the kits and, you know, mid-$60s on a sensor basis. You know, still
Closing any specifics at that point.
Fair enough. Last one, and then I'll just jump back in queue. Jess, on the milestones from Edwards, I mean, the development grant revenue came in ahead of where we were. Is that from Edwards? Has there been a renegotiated contract there? Any update?
No, there has not been a renegotiated contract. Those are development dollars that Edwards has agreed to pay us on a one-off basis for Q1, Q2, and Q3.
Perfect. Thanks, guys.
The next question comes from Richard Lau from Wedbush Morgan. Please go ahead.
Hey, guys. Thanks. Most of my questions have been answered, but is there any color you can give us in terms of patient feedback on the Vibe product out in Europe so far?
Very limited from that standpoint, that we know. I mean, they've basically presented it from a market introduction standpoint, they being Animas. All we're getting is positive feedback, but nothing more than almost anecdotal at this point as they look to expand, as Kevin mentioned, through the remainder of the year, a total of 5 countries. It really hasn't been a what we would consider to be a full commercial launch at this point.
Okay, thank you.
The next question comes from Ben Haynor from Feltl and Company. Please go ahead.
Good afternoon, guys. Thanks for taking my questions. Just curious, with Abbott discontinuing the U.S. sales of the FreeStyle Navigator, CGM sensors, do you expect to see a benefit from that? Do you have any anticipation on what the magnitude might be there?
No, we don't expect to see much of a benefit. Certainly, we were contacted by Abbott at the time that they were discontinuing to alert us to the fact that they would, in those cases, send patients our way. But it's just, I mean, at the end, we estimated there were about 300 patients still on the Navigator system in the U.S., so it did not have a material impact on us.
Okay. I know you've talked quite a bit about moving CGM up the list in terms of diabetes treatment options. Have you seen any movement, as far as notable payer coverage decisions to make it more broadly available, reduce paperwork involved, et cetera?
I think the last one we commented on, we've seen some movement. Actually, Steve would have the details on that.
Yeah, earlier this year we haven't seen anything since our last earnings call is what I should answer specifically. We did earlier this year see the Anthem organization liberalize its coverage policy, basically remove most of the documentation requirements. We saw some movement on the Aetna policy as well, more specifically to documentation for under the age of 25, or removing documentation requirements for patients under the age of 25. You know, anecdotally, we continue to hear, you know, positives from the field that it's becoming easier. As Terry mentioned in the prepared remarks, it's not perfect yet. That was one of the things.
I think one of the more eye-opening things, I think that we heard back, you know, as Terry's been out in the field a bit more, you know, that we sit here at the headquarters and listen only to the positive stories that come in from the field in terms of, you know, positive momentum on the reimbursement front. I think, you know, Terry's eyes should be clear, but your eyes have been opened a little bit as to it isn't as maybe as perfect as we thought. We still got some work to do.
Yeah, I think if you look and it goes, unfortunately state by state, you go up to Washington State as an example, and we've spent a lot of time up in the Seattle area most recently, and it's a very much a challenge up there. You know, as those states try to figure out ways and the carriers in the states, they are still demanding, and the demand then comes upon the physician population to provide the documentation. They're being pressured from an economic standpoint of their own practices. It's a domino effect, and we keep again, it gets back to my earlier comment then from a value proposition.
One of the things that we have to continue to push is this value that it is worth the effort, doctor, for you to write the letter of medical necessity for us to fight for that patient, because this is the benefit to make it from this nice to have to a must have. Really one of the avenues and that has been most effective recently is identifying those patients that have succumbed to hypoglycemia in their practice. I mean, I hate to ask them, but I'm not hesitant to say, how many patients have you lost in the last year to hypoglycemia, and how many of those patients would have been saved or survived their event as a result of having CGM? That's where it's got to be.
If there's some degree of shock value that is unfortunately working, but if that's what it takes to get that awareness, and that's what we're willing to do.
Okay, sure. Just this one quick one. What was D&A, depreciation and amortization during the quarter?
We had share-based compensation of $3.7 million and depreciation of about $1 million.
All right, great. Thanks for taking my questions, guys.
The last question is a follow-up from Bill Plovanic from Canaccord Genuity. Please go ahead.
Great. Thank you. Can you hear me?
Yeah.
Yes, we can, Bill.
Yeah. Thanks, guys. I wanted to jump back on. I know you haven't addressed this, but, you know, as models come down for 2011, I think there's going to be people looking at 2012. I was just wondering if there's any kind of way you'd like to bracket 2012 at this point in time for us as we start thinking about that.
No, you know, again, as is our plan right now, we'll finish the year, probably and have the discussion in January as to what our expectation is on a top-line basis, as we have done over the past couple of years. Outside of that, I do expect that Q1 is gonna be challenging. We saw Q1 this year be a lot more challenging than Q1 in 2010, and I have no reason that Q1 2012 is not going to be more challenging than 2011. Again, you know, it's just we've got to continue to push the value proposition of CGM as a standard of care.
All right, great. Thanks a lot.
That was the last question for today. Please go ahead with any additional comments.
Thank you. You know, when I joined Dexcom from the board to become CEO in 2007, nobody said it was gonna be easy. Over the last 4 years, we have built a technology leading company. Just last month, as an example, we were recognized by Deloitte in their Fast 500 companies as number 57 out of 500 fastest growing technology, telecommunications, life sciences, and clean technologies with a five-year growth rate of over 2,000%. Dexcom is driving CGM to be the standard of care in diabetes. We are addressing the insulin-using market regardless of the method of delivery of the drug. We're addressing now in clinical work, non-insulin, but other diabetes drugs either taken by injection or by oral.
Again, from a standpoint of CGM as a tool in which to demonstrate reduction of glycemic variability, which continues to be extremely important in both our pharma work as well as the day-to-day living of patients. In spite of the economic headwinds, we continue to grow. It is not without its challenges, but the difference we make in people's lives make every effort worth it. Too often today, life and death is what happens between finger sticks. Thank you.
Thank you for participating in today's conference. This concludes the conference for today. You may all disconnect at this time.