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| DXCM > SEC Filings for DXCM > Form 10-Q on 30-Jul-2007 | All Recent SEC Filings |
30-Jul-2007
Quarterly Report
CAUTIONARY NOTE REGARDING FORWARD-LOOKING STATEMENTS
This document, including the following Management's Discussion and Analysis of Financial Condition and Results of Operations, contains forward-looking statements that are based upon current expectations. These forward-looking statements fall within the meaning of the federal securities laws that relate to future events or our future financial performance. In some cases, you can identify forward-looking statements by terminology such as "may," "will," "expect," "plan," "anticipate," "believe," "estimate," "intend," "potential" or "continue" or the negative of these terms or other comparable terminology. Forward-looking statements involve risks and uncertainties. Our actual results and the timing of events could differ materially from those anticipated in our forward-looking statements as a result of many factors, including product performance, a lack of acceptance in the marketplace by physicians and patients, the inability to manufacture products in commercial quantities at an acceptable cost, possible delays in the company's research and development programs, the inability of patients to receive reimbursements from third-party payors, inadequate financial and other resources and the other risks those set forth below under "Risk Factors" and elsewhere in this report. We assume no obligation to update any of the forward-looking statements after the date of this report or to conform these forward-looking statements to actual results.
Overview
We are a medical device company focused on the design, development and commercialization of continuous glucose monitoring systems for people with diabetes. On March 24, 2006, we received approval from the U.S. Food and Drug Administration, or FDA, for our Short-Term Continuous Glucose Monitoring System, or STS®, and we have commercialized this product throughout the United States. Our approval allows for the use of our STS by adults with diabetes to detect trends and track glucose patterns, to aid in the detection of hypoglycemia and hyperglycemia and to facilitate acute and long-term therapy adjustments. On May 31, 2007 we received approval from the FDA for our second generation continuous glucose monitoring system, the SEVENTM, designed for up to seven days of continuous use, and we expect to begin commercializing this product in the second half of 2007. This approval allows for the use of the SEVEN by adults with diabetes to detect trends and track glucose patterns, to aid in the detection of hypoglycemia and hyperglycemia and to facilitate acute and long-term therapy adjustments. Our products are indicated for use as an adjunctive devices to complement, not replace, information obtained from standard home blood glucose monitoring devices. Our products must be prescribed by a physician and includes a disposable sensor, a transmitter and a small cell phone-sized receiver. The sensor is inserted by the patient and is intended to be used continuously for up to three days, in the case of the STS, or up to seven days in the case of the SEVEN, after which it is removed and may be replaced by a new sensor. Our transmitter and receiver are reusable. Since inception, we have devoted substantially all of our resources to start-up activities, raising capital and research and development, including product design, testing, manufacturing and clinical trials. More recently, we have devoted considerable resources for the commercialization of our products as well as the continued clinical development of our technology platform.
To support our national product launch, we have built a direct sales organization to call on endocrinologists, physicians and diabetes educators who can educate and influence patient adoption of continuous glucose monitoring. To complement our direct sales efforts, we also employ clinical specialists who educate and provide clinical support in the field. We believe our direct, highly-specialized and focused sales organization is sufficient for us to support our sales efforts and have no immediate plans to increase the size of the sales organization.
We are leveraging our technology platform to enhance the capabilities for our current products and develop additional continuous glucose monitoring products. We are continuing clinical development to seek "replacement" claim labeling from the FDA, which would allow patients to use our STS as the sole basis for making therapeutic adjustments, to obtain a pediatric indication for our STS, and are developing a product for the in-hospital monitoring market. Our clinical trials may be delayed due to scheduling issues with patients and investigators, institutional review boards, sensor performance and manufacturing supply constraints, among other factors. Support of these clinical trials requires significant resources in research and development, manufacturing, quality assurance, and clinical and regulatory personnel. Even if our development and clinical trial efforts are successful, the FDA may not approve our products, and if approved, we may not achieve acceptance in the marketplace by physicians and patients.
We manufacture our products at our facility in San Diego, California. This facility was inspected for medical device manufacturing by the FDA in August 2005. We manufacture our products with components supplied by outside vendors and with parts manufactured by us internally. Key components that we manufacture internally include our wire-based sensor for our disposable sensors. The remaining components and assemblies are purchased from outside vendors. We then assemble, test, package and ship the finished product, which includes a transmitter, a receiver and a disposable sensor. We are expanding our manufacturing capacity in our current facility in San Diego, California and have leased an additional 66,400 square foot manufacturing facility in San Diego, California to enable us to produce greater quantities of our devices. Our capacity expansion could be constrained by the lack of material availability, equipment design, production and validation, regulatory approval of our new facility, personnel staffing and other factors.
Revenues are generated from sales of our durable transmitter and receiver and from the recurring sales of disposable sensors. The disposable sensor is inserted by the patient and intended to be used continuously for up to three days, in the case of the STS, or up to seven days in the case of the SEVEN, after which it may be replaced with a new disposable sensor. Our transmitter and receiver are reusable. In the event we establish an installed base of patients using our continuous glucose monitoring systems, we expect to generate an increasing portion of our revenues through recurring sales of our disposable sensors. We generally recognize revenue on our products upon shipment and our sales terms provide for customer payment at the time of order.
For the three months ended June 30, 2007, we generated $863,000 of revenue. We have incurred net losses in each year since our inception in May 1999. Through June 30, 2007, we had an accumulated deficit of $152.6 million. We expect our losses to continue as we expand our clinical trial activities and continue commercialization activities. We have financed our operations primarily through offerings of equity and debt securities. In April 2005, we completed our initial public offering in which we sold 4,700,000 shares of common stock for net proceeds of $50.5 million. In March 2006, we entered into a loan and security agreement that provides for a loan of up to $5.0 million to finance various equipment expenses. As of June 30, 2007, we had $3.1 million in borrowings under this agreement. In May 2006 we completed a follow-on offering of 2,117,375 shares of our common stock at $24.00 per share for gross proceeds of $50.8 million. After deduction of underwriting discounts and expenses of the offering we received net proceeds of $47.0 million. In March 2007, we issued $60.0 million in convertible senior notes. After deducting offering costs of $2.6 million and the purchase of $11.0 million in call spread options to reduce potential dilution resulting from conversion of the notes, we netted approximately $46.4 million.
Financial Operations
Revenue
From inception through June 30, 2007, we generated $4.0 million in revenue from the sale of our continuous glucose monitoring systems after launching our system on March 28, 2006. We expect that revenues we generate from the sales of our systems will fluctuate from quarter to quarter.
Cost of Sales
Cost of sales includes direct labor and material costs related to each product sold or produced including assembly and test labor and scrap, as well as factory overhead supporting our manufacturing operations. This includes facilities, material procurement and control, manufacturing engineering, quality control, supervision and management. These costs are primarily salary, fringe benefits, stock based compensation, facility expense, supplies and purchased services. The majority of our costs are currently fixed due to the relatively low production volumes compared to our potential capacity. From our inception until December 31, 2005, all of our manufacturing costs were included in research and development expense due to our development stage. From January 1, 2006 and forward these costs are included in cost of sales.
Research and Development
Our research and development expenses primarily consist of engineering and research expenses related to our continuous glucose monitoring technology, clinical trials, regulatory expenses, materials and products for clinical trials. Up until December 31, 2005 our manufacturing costs were included in research and development expense. Research and development expenses are primarily related to employee compensation, including salary, fringe benefits, recruitment, stock based compensation, relocation and temporary employee expenses. We also incur significant expenses to operate our clinical trials including trial design, clinical site reimbursement, data management clinical trail product, and associated travel expenses. Our research and development expenses also include fees for design services, contractors and development materials. We expect our research and development expenses to increase as we continue to support the development and clinical trials of additional products.
Selling, General and Administrative
Our selling, general and administrative expenses primarily consist of salary, fringe benefits and stock based compensation for our executive, financial, sales, marketing and administrative functions. Other significant expenses include trade show expenses, sales samples, insurance, professional fees for our outside legal counsel and independent auditors, litigation expenses and expenses for board meetings. We expect our selling, general and administrative expenses to continue to increase to support the commercialization of our products.
Results of Operations
Quarter Ended June 30, 2007 Compared to June 30, 2006
Revenue, Cost of Sales and Gross Margin
Revenues increased $384,000 to $863,000 for the second quarter of 2007 compared to $479,000 for the second quarter of 2006. Cost of sales increased $815,000 to $2.9 million for the second quarter of 2007 compared to $2.1 million for the second quarter in 2006. The increase in cost of goods sold was primarily related to a credit of $1.1 million in the 2006 period for materials purchased and expensed in 2005 while we were still in the development stage. A decrease in direct product costs and net direct labor was partially offset by higher fixed overhead spending. Gross margin loss of $2.0 million for the second quarter of 2007
increased $431,000 compared to the same quarter in 2006, primarily due to the effect of the materials credit in the 2006 quarter, partially offset by higher revenue and better labor utilization.
Research and Development. Research and development expense decreased $1.3 million to $4.0 million for the second quarter of 2007, compared to $5.4 million for the second quarter of 2006. Changes in research and development expense include $0.5 million in lower clinical and regulatory costs and $1.0 million in lower development expenses partially offset by higher quality assurance costs. Major elements of declining research and development costs include $463,000 in lower clinical trial expenses, $263,000 in lower tooling and fixturing costs, and $163,000 in lower facility costs.
Selling, General and Administrative. Selling, general and administrative expense increased $538,000 to $5.5 million for the second quarter of 2007, compared to $4.9 million for the second quarter of 2006. The increase was primarily due to $419,000 in higher general and administrative expenses and $118,000 in higher sales and marketing expense. Major elements in the increased expense include $853,000 in higher compensation expense, primarily due to $400,000 in separation payments to our former CEO, offset by $129,000 in lower legal expense. Additional share-based compensation expense of $269,000 relating to our former CEO for extended vesting and post-employment exercise period was more than offset by the declining expense of vesting grants for other employees.
Interest Income and Expense, Net. Net interest income and interest expense decreased $532,000 to $204,000 for the second quarter of 2007, compared to $736,000 for the second quarter of 2006. The decrease was due to a $915,000 increase in interest expense, primarily related to our $60 million in convertible notes, partially offset by $383,000 in higher interest income.
Six Months Ended June 30, 2007 Compared to June 30, 2006
Revenue, Cost of Sales and Gross Margin
Revenues increased $1.4 million to $1.9 million for the six months ending June 30, 2007 compared to $494,000 for the six months ending June 30, 2006. Cost of sales increased $1.8 million to $6.0 million for the six months ending June 30, 2007 compared to $4.2 million for the same period in 2006. The increase in cost of goods sold was primarily related to a credit of $1.1 million in the 2006 period for materials purchased and expensed in 2005 while we were still in the development stage, as well as $842,000 in higher fixed overhead spending in the 2007 period. Gross margin loss increased $415,000 to $4.1 million for the six months ending June 30, 2007 compared to $3.7 million for the same period in 2006. $1.4 million in higher revenues were more than offset by higher direct product costs and higher fixed overhead spending, as well as the effect of the $1.1 million credit in the 2006 period.
Research and Development. Research and development expense decreased $2.8 million to $8.1 million for the six months ending June 30, 2007, compared to $10.9 million for the six months ending June 30, 2006. Changes in research and development expense include $1.2 million in lower clinical and regulatory costs and $1.6 million in lower development expenses partially offset by higher quality assurance costs. Major elements of declining research and development costs include $1.0 million in lower clinical trial expenses, $720,000 in lower tooling and fixturing costs and $393,000 in lower stock based compensation.
Selling, General and Administrative. Selling, general and administrative expense increased $2.1 million to $10.8 million for the six months ending June 30, 2007, compared to $8.8 million for the six months ending June 30, 2006. The increase was primarily due to $2.1 million in higher sales and marketing expense. Major elements in the increased expense include $2.6 million in higher compensation expense, including $400,000 in separation payments to our former CEO, offset by $674,000 in lower legal expense. Additional share-based compensation expense of $269,000 relating to our former CEO extended vesting and post-employment exercise period was more than offset by the declining expense of vesting grants.
Interest Income and Expense, Net. Net interest income and interest expense decreased $488,000 to $731,000 for the six months ending June 30, 2007, compared to $1.2 million for the six months ending June 30, 2006. The decrease was due to a $1.2 million increase in interest expense, primarily related to our $60 million in convertible notes, partially offset by $692,000 in higher interest income.
Liquidity and Capital Resources
We are in the early commercialization stage and have incurred losses since our inception in May 1999. As of June 30, 2007, we had an accumulated deficit of $152.6 million and had working capital of $80.1 million, which included $84.2 million in cash, cash equivalents and short-term marketable securities. We have funded our operations primarily from the sale of equity and debt securities and our bank line, raising aggregate net proceeds of $167.1 million from equity sales and $46.4 million from debt sales through June 30, 2007. In April 2005, we completed our initial public offering in which we sold 4,700,000 shares of common stock for net proceeds of $50.5 million. On March 20, 2006, we entered into a loan and security agreement that provides for a loan of up to $5.0 million to finance various equipment purchases. As of March 31, 2007 we had drawn $3.4 million under our bank equipment loan and on April 1, 2007 the loan converted into a 30 month amortized term loan. At June 30, 2007, we had $3.1 million outstanding on our term loan. On May 2, 2006 we completed the sale of 2,117,375 shares of common stock at $24 per share for net proceeds of $47.0 million. On March 9, 2007 we completed a $60 million offering of our 4.75% Convertible Senior Notes due 2027. After payment of related expenses including the purchase of a related call option hedge we received net proceeds of $46.4 million.
Net Cash Used in Operating Activities. Net cash used in operating activities decreased $9.0 million to $16.0 million for the six months ending June 30, 2007, compared to $25.0 million net cash used for the same period in 2006. The decrease in cash used in operations was primarily due to $3.4 million less cash invested in inventories and $4.9 less cash used to pay down payables and accrued liabilities compared to the same period in 2006.
Net Cash Used in Investing Activities. Net cash used in investing activities decreased $14.6 million to $23.1 million for the six months ending June 30, 2007, compared to $37.6 million used for the same period of 2006. The decrease was primarily due to $13.1 million in lower net purchases and sales of short-term marketable securities as well as $1.5 million in lower purchases of property and equipment. For the six months ending June 30, 2007, we invested $718,000 in manufacturing and computer equipment and facilities to support manufacturing improvements.
Net Cash Provided by Financing Activities. Net cash provided by financing activities decreased $2.5 million to $46.8 million for the six months ending June 30, 2007, compared to $49.4 million for the same period of 2006. The decrease was primarily due to $1.4 million in change in our capital equipment bank line.
Operating Capital and Capital Expenditure Requirements
We anticipate that we will continue to incur net losses for the foreseeable future as we incur expenses to commercialize our approved products, develop additional continuous glucose monitoring products, expand our sales, marketing, manufacturing and corporate infrastructure.
We believe that our cash, cash equivalents and short-term marketable securities balances, and the interest we earn on these balances, will be sufficient to meet our anticipated cash requirements with respect to the scale-up of our commercialization, clinical trials, research and development activities PMA applications and to meet our other anticipated cash needs for at least the next twelve months. If our available cash, cash equivalents and short-term marketable securities and the funds available under our loan and security agreement are insufficient to satisfy our liquidity requirements, or if we develop additional products, we may seek to sell additional equity or debt securities or obtain an additional credit
facility. The sale of additional equity and debt securities may result in additional dilution to our stockholders. If we raise additional funds through the issuance of debt securities or preferred stock, these securities could have rights senior to those of our common stock and could contain covenants that would restrict our operations. We may require additional capital beyond our currently forecasted amounts. Any such required additional capital may not be available on reasonable terms, if at all. If we are unable to obtain additional financing, we may be required to reduce the scope of, delay or eliminate some or all of our planned research, development and commercialization activities, which could harm our business.
Because of the numerous risks and uncertainties associated with the development of continuous glucose monitoring technologies, we are unable to estimate the exact amounts of capital outlays and operating expenditures associated with our current and anticipated clinical trials. Our future funding requirements will depend on many factors, including, but not limited to:
† the revenue generated by sales of our STS and other future products;
† the expenses we incur in manufacturing, developing, selling and marketing our products;
† the quality levels of our products and services;
† the third party reimbursement of our products for our customers;
† our ability to efficiently scale our manufacturing operations to meet demand for our current and any future products;
† the costs and timing of additional regulatory approvals;
† the costs of filing, prosecuting, defending and enforcing any patent claims and other intellectual property rights, including, but not limited to, defending the patent infringement lawsuit filed against us by Abbott;
† the rate of progress and cost of our clinical trials and other development activities;
† the success of our research and development efforts;
† the emergence of competing or complementary technological developments;
† the terms and timing of any collaborative, licensing and other arrangements that we may establish; and
† the acquisition of businesses, products and technologies, although we currently have no commitments or agreements relating to any of these types of transactions.
Contractual Obligations
In March 2007, we issued $60 million aggregate principal amount of Convertible Senior Notes due 2027 in a private offering. The notes are convertible into shares of common stock based on an initial conversion rate of 128.2051 shares of common stock per $1,000 principal amount of notes, which is equivalent to an initial conversion price of approximately $7.80 per share. Interest on the notes is due semiannually on March 15 and September 15 of each year at a rate of 4.75% per year. The notes will be redeemable by us beginning March 20, 2010 at a price equal to 100% of the principal amount to be redeemed plus accrued and unpaid interest. Holders of the notes may require us to repurchase the notes for cash equal to 100% of the principal amount to be repurchased plus accrued and unpaid interest upon the occurrence of certain designated events, including a change of control. In addition, we will have the right to automatically convert the notes if the closing price of its common stock exceeds 150% of the conversion price or $11.70 per share, for at least 20 trading days during any 30-day period. If such an automatic conversion occurs before March 15, 2010, we are required to pay additional interest in cash or,
at our option, in shares of our common stock. The holders of the notes may require us to repurchase the notes for cash on March 15, 2012, March 15, 2017 and March 15, 2022 at a repurchase price equal to 100% of the principal amount, plus accrued and unpaid interest.
We are party to various purchase arrangements related to components used in production and research and development activities. As of June 30, 2007, we had purchase commitments with certain vendors totaling approximately $448,000 due within one year. There are no purchase commitments due beyond one year.
Critical Accounting Policies and Estimates
The discussion and analysis of our financial condition and results of operations are based on our financial statements, which we have prepared in accordance with generally accepted accounting principles. The preparation of these financial statements requires us to make estimates and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the financial statements as well as the reported revenue and expenses during the reporting periods. On an ongoing basis, we evaluate our estimates and judgments. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.
Our significant accounting policies are described in Note 1 to our financial statements included in our annual report on Form 10-K. Other than the adoption of FASB Interpretation No. 48 Accounting for Uncertainty in Income Taxes as discussed below, there were no significant changes in critical accounting policies or estimates from those at December 31, 2006.
Revenue Recognition
We sell durable systems and disposable units through a direct sales force in the United States. Both products are individually priced and can be purchased separately or together. The initial durable system is comprised of a transmitter, a receiver, a power cord, a finger-stick meter interface cable and a carrying case. STS 3-day durable system "starter kits" include the durable system and two disposable sensors, each labeled to be worn for three days. Customers are not required to purchase additional three-day disposable sensors at the time of their initial purchase and the initial price for the system is not dependent upon disposable purchase minimums. The SEVEN 7-day durable system includes a transmitter, a receiver, a power cord, a finger-stick meter interface cable, data management software and a USB cable. 7-Day disposable sensors are sold separately in packages of four. The initial SEVEN durable system price is not dependent upon the purchase of any amount of disposable SEVEN sensors.
Revenue on product sales is recognized upon shipment, which is when title and the risk of loss have been transferred to the customer and there are no other post shipment obligations. Our products are generally paid for at the time of shipment using a customer's credit card and do not include customer acceptance provisions. After approval of our second generation continuous glucose monitoring system, the SEVEN, on May 31, 2007, we started taking orders for an "Upgrade Kit" to upgrade existing customers for $150. For systems sold during June 2007 that included an upgrade right, a portion of the sales price is allocated to the undelivered upgrade and deferred based on vendor specific objective evidence of the fair value. This deferred revenue will be recognized when the upgrade has been delivered to the customer. Deferred revenue for the period ended June 30, 2007 totaled approximately $25,000 for 167 units shipped with this right in June 2007. We do not currently offer rebates or price . . .
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