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DXCM > SEC Filings for DXCM > Form 10-K on 21-Feb-2013All Recent SEC Filings

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Form 10-K for DEXCOM INC


21-Feb-2013

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 our research and development programs, the inability of patients to receive reimbursements from third-party payors, inadequate financial and other resources, global economic conditions, and the other risks 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 ambulatory use by people with diabetes and for use by healthcare providers in the hospital for the treatment of patients with and without diabetes. The majority of our product revenue comes from sales of our SEVEN PLUS ambulatory continuous glucose monitoring system, which we began commercializing in the first quarter of 2009, and our G4 PLATINUM ambulatory continuous glucose monitoring system, which we began commercializing in the fourth quarter of 2012. We also have received CE Mark approval for the GlucoClear in-hospital system, and in partnership with Edwards, we initiated a very limited launch of the first generation GlucoClear system in Europe in 2009 and Edwards plans to initiate another limited launch in Europe of the second generation GlucoClear during 2013.

From inception to 2006, we devoted substantially all of our resources to start-up activities, raising capital and research and development, including product design, testing, manufacturing and clinical trials. Since 2006, we have devoted considerable resources to the commercialization of our ambulatory continuous glucose monitoring systems, including the SEVEN PLUS and G4 PLATINUM, as well as the continued research and clinical development of our technology platform.

From inception through December 31, 2012, we generated $271.1 million of product and development grant and other (non-product) revenue, and we have incurred net losses in each year since our inception in May 1999. From inception through December 31, 2012, we had an accumulated deficit of $445.6 million. We expect our losses to continue as we proceed with our commercialization and research and development activities. We have financed our operations primarily through offerings of equity securities and convertible debt. 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 Agreement, which was subsequently amended in January 2008, and no amounts remain outstanding. In May 2006, we completed a follow-on public offering of 2,117,375 shares of our common stock for net proceeds of $47.0 million. In March 2007, we issued an aggregate principal amount of $60.0 million of 4.75% convertible senior notes due in 2027, all of which convertible senior notes have converted into shares of our common stock. In February 2009, we completed a follow-on public offering of 15,994,000 shares of our common stock for net proceeds of approximately $45.6 million. In January 2010, we completed a follow-on public offering of 4,025,000 shares of our common stock for net proceeds of approximately $33.0 million. In November 2010, we completed a follow-on public offering of 3,277,500 shares of our common stock for net proceeds of approximately $33.0 million. In May 2011, we completed a follow-on


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public offering of 4,700,000 shares of our common stock for net proceeds of approximately $71.2 million. In November 2012, we entered into a loan and security agreement that provides for up to $35.0 million.

Financial Operations

Revenue

From inception through December 31, 2012, we generated $232.0 million in product revenue. We expect that revenues we generate from the sales of our products will fluctuate from quarter to quarter. Between 2008 and 2012, we entered into joint development and collaboration agreements with Animas, Edwards, Roche and Tandem under which we recognized development grant and other revenue received pursuant to that agreement ratably over the term of the development period. We recognize development milestones associated with each agreement as revenue upon achievement of each milestone if the milestone is considered substantive. Between 2008 and December 31, 2012, we recognized $39.1 million in development grant and other revenue, which includes milestones and services.

Cost of Sales

Product cost of sales includes direct labor and materials costs related to each product sold or produced, including assembly, test labor and scrap, as well as factory overhead supporting our manufacturing operations. Factory overhead includes facilities, material procurement and control, manufacturing engineering, quality assurance, supervision and management. These costs are primarily salary, fringe benefits, share-based compensation, facility expense, supplies and purchased services. The majority of our costs are currently fixed due to our relatively low production volumes compared to our potential capacity. All of our manufacturing costs are included in product cost of sales. Development and other cost of sales consists primarily of salaries, fringe, facilities, and supplies directly attributable to our development contracts.

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, quality assurance programs, materials and products for clinical trials. Research and development expenses are primarily related to employee compensation, including salary, fringe benefits, share-based compensation, and temporary employee expenses. We also incur significant expenses to operate our clinical trials including clinical site reimbursement, clinical trial product and associated travel expenses. Our research and development expenses also include fees for design services, contractors and development materials.

Selling, General and Administrative

Our selling, general and administrative expenses primarily consist of salary, fringe benefits and share-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 consulting expenses.

Results of Operations

Fiscal year ended December 31, 2012 Compared to December 31, 2011

Revenue, Cost of Sales and Gross Profit

Product revenues increased $27.1 million to $93.0 million for the twelve months ended December 31, 2012 compared to $65.9 million for the twelve months ended December 31, 2011 based primarily on increased sales volume of our durable systems and disposable sensors, due in part to the launch of the G4 PLATINUM system in the fourth quarter of 2012. Product cost of sales increased $11.7 million to $48.3 million for the twelve months


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ended December 31, 2012 compared to $36.6 million for the twelve months ended December 31, 2011. The product gross profit of $44.7 million for the twelve months ended December 31, 2012 increased $15.4 million compared to $29.3 million for the same period in 2011, primarily due to increased revenue.

Development grant and other revenues decreased $3.5 million to $6.9 million for the twelve months ended December 31, 2012 compared to $10.4 million for the twelve months ended December 31, 2011. Development and other cost of sales increased $1.2 million to $5.0 million for the twelve months ended December 31, 2012 compared to $3.8 million for the twelve months ended December 31, 2011. The decrease in development grant and other revenues during the twelve months ended December 31, 2012 was due to the $4.0 million milestone payment received from Animas for CE Mark approval in June 2011 and by extended revenue recognition timelines related to longer than expected development and regulatory review timelines under our collaboration arrangements with Edwards. The increase in costs associated with development was primarily due to additional development obligations during the year with respect to our collaboration arrangements.

Research and Development. Research and development expense increased $8.7 million to $39.5 million for the twelve months ended December 31, 2012, compared to $30.8 million for the twelve months ended December 31, 2011. The increase in research and development expense was primarily due to increased development efforts for our future generation ambulatory products and by decreased activity with respect to our development and collaboration agreements. Major elements of increased research and development costs include $3.3 million in additional salaries, bonus, and payroll related costs, $1.8 million in additional share-based compensation and $1.7 million in additional consulting costs.

Selling, General and Administrative. Selling, general and administrative expense increased $12.9 million to $62.8 million for the twelve months ended December 31, 2012, compared to $49.9 million for the twelve months ended December 31, 2011. The increase was primarily due to higher selling, marketing, and information technology costs to support revenue growth and the continued commercialization of our products. Major elements of increased selling, general, and administrative expenses include $3.7 million in higher salaries, bonus, and payroll related costs, $2.7 million in higher share-based compensation, and $1.8 million in higher commissions.

Interest and Other Income. Interest and other income was $0.1 million for each of the twelve months ended December 31, 2012 and 2011.

Interest Expense. Interest expense increased to $0.2 million for the twelve months ended December 31, 2012, compared to $11,000 for the twelve months ended December 31, 2011. The increase in interest expense was primarily due to the loan and security agreement entered into in November 2012.

Income Tax Benefit. Income tax benefit was $1.3 million for the twelve months ended December 31, 2012, compared to none for the twelve months ended December 31, 2011. The increase in income tax benefit was primarily due to the acquisition of SweetSpot and the release of the valuation allowance against some of our deferred tax assets.

Fiscal year ended December 31, 2011 Compared to December 31, 2010

Revenue, Cost of Sales and Gross Profit

Product revenues increased $25.7 million to $65.9 million for the twelve months ended December 31, 2011 compared to $40.2 million for the twelve months ended December 31, 2010 based primarily on increased sales volume of our durable systems and disposable sensors, and higher average per unit selling prices. Product cost of sales increased $10.5 million to $36.6 million for the twelve months ended December 31, 2011 compared to $26.1 million for the twelve months ended December 31, 2010. The increased product cost of sales associated with additional product sales was offset primarily by increased manufacturing absorption for the twelve months


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ended December 31, 2011 as compared to the same period in 2010. The product gross profit of $29.3 million for the twelve months ended December 31, 2011 increased $15.2 million compared to $14.1 million for the same period in 2010, primarily due to increased revenue and improved manufacturing absorption.

Development grant and other revenues increased $2.0 million to $10.4 million for the twelve months ended December 31, 2011 compared to $8.4 million for the twelve months ended December 31, 2010. Development and other cost of sales decreased $0.3 million to $3.8 million for the twelve months ended December 31, 2011 compared to $4.1 million for the twelve months ended December 31, 2010. The increase in development grant and other revenues during the twelve months ended December 31, 2011 was due to additional services performed and the $4.0 million milestone payment received from Animas for CE Mark approval, and was partially offset by extended development and regulatory review timelines under our collaboration arrangements with Edwards and Animas. The decrease in costs associated with development was primarily due to fewer development obligations during the year with respect to our collaboration arrangements.

Research and Development. Research and development expense increased $7.6 million to $30.8 million for the twelve months ended December 31, 2011, compared to $23.2 million for the twelve months ended December 31, 2010. The increase in research and development expense was primarily due to increased development efforts for our future generation ambulatory products and by decreased activity with respect to our development and collaboration agreements. Major elements of increased research and development costs include $2.1 million in additional consulting costs, $1.8 million in additional salaries, bonus, and payroll related costs, and $1.7 million in additional share-based compensation.

Selling, General and Administrative. Selling, general and administrative expense increased $9.4 million to $49.9 million for the twelve months ended December 31, 2011, compared to $40.5 million for the twelve months ended December 31, 2010. The increase was primarily due to higher selling, customer operations, and information technology costs to support revenue growth and the continued commercialization of our products. Major elements of increased selling, general, and administrative expenses include $4.6 million in higher salaries, bonus, and payroll related costs, $1.5 million in higher share-based compensation, and $1.0 million in higher facility costs.

Interest and Other Income. Interest and other income was $0.1 million for each of the twelve months ended December 31, 2011 and 2010.

Interest Expense. Interest expense decreased $1.5 million to $11,000 for the twelve months ended December 31, 2011, compared to $1.5 million for the twelve months ended December 31, 2010. The decrease in interest expense was primarily due to the conversion of all of the outstanding convertible notes in 2010.

Loss on Debt Extinguishment upon Conversion of Convertible Debt

For the twelve months ended December 31, 2010, we completed exchanges with prior holders of our issued and outstanding Notes, under which we issued an aggregate of approximately 7.9 million shares of our common stock, par value $0.001 per share, in exchange for $60.0 million in aggregate principal amount of the Notes previously held by the exchanging holders. We incurred a loss on the extinguishment of the Notes in the amount of $8.5 million for the twelve months ended December 31, 2010, which includes the difference between the carrying value and the fair value of the Notes on the conversion date, other consideration given to note holders to induce early conversion and transaction costs incurred with third parties, other than the investors, to settle the conversion of the Notes.

Liquidity and Capital Resources

We are in the early commercialization stage and have incurred losses since our inception in May 1999. As of December 31, 2012, we had an accumulated deficit of $445.6 million and had working capital of $58.1


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million. Our cash, cash equivalents and short-term marketable securities totaled $48.7 million, excluding $1.0 million in restricted cash. We have funded our operations primarily from the sale of equity and debt securities and our bank loans. In January 2010, we completed a follow-on public offering of 4,025,000 shares of our common stock for net proceeds of approximately $33.0 million. In November 2010, we completed a follow-on public offering of 3,277,500 shares of our common stock for net proceeds of approximately $33.0 million. In May 2011, we completed a follow-on public offering of 4,700,000 shares of our common stock for net proceeds of approximately $71.2 million. In November 2012, we entered into a loan and security agreement that provides for up to $35.0 million.

Net Cash Used in Operating Activities. Net cash used in operating activities increased $3.0 million to $33.1 million for the twelve months ended December 31, 2012, compared to $30.1 million for the same period in 2011. The increase in cash used in operating activities was primarily due to $9.8 million in higher net loss, offset by $8.4 million in higher non-cash charges primarily comprised of share-based compensation and depreciation and amortization. Higher non-cash charges were offset by a one-time non-cash tax benefit of $1.3 million. Also included in net loss were $3.0 million of non-cash charges for excess and obsolete inventory and accelerated depreciation on manufacturing equipment related to the approval and launch of our next generation G4 PLATINUM system.

Net Cash Provided by Investing Activities. Net cash provided by investing activities was $28.4 million for the twelve months ended December 31, 2012, compared to $46.4 million used in investing activities for the same period of 2011. The increase in cash provided by investing activities was primarily due to $36.3 million decrease in cash used to purchase available-for-sale marketable securities and by $40.0 million increase in proceeds from the maturity of available-for-sale marketable securities for the twelve months ended December 31, 2012 as compared to the same period in 2011. For the twelve months ended December 31, 2012, we invested $9.5 million in equipment to support manufacturing improvements compared to $8.0 million during the same period in 2011.

Net Cash Provided by Financing Activities. Net cash provided by financing activities decreased $64.0 million to $10.2 million for the twelve months ended December 31, 2012, compared to $74.2 million for the same period of 2011. The decrease was primarily due to the approximately $3.6 million in net proceeds generated by the sale of common stock for the twelve months ending December 31, 2012 compared to approximately $74.7 million in the same period of 2011, offset by net proceeds of $6.6 million from the loan and security agreement entered into during the twelve months ending December 31, 2012 compared to none in the same period of 2011.

Operating Capital and Capital Expenditure Requirements

We anticipate that we will continue to incur net losses as we incur expenses to continue to expand the commercialization of our approved products, develop additional continuous glucose monitoring products, and expand our marketing, manufacturing and corporate infrastructure.

We believe that our cash, cash equivalents, short-term marketable securities balances, and projected cash contributions from existing partnership arrangements will be sufficient to meet our anticipated cash requirements with respect to the continued scale-up of our commercialization activities, research and development activities, including clinical trials, the expansion of our marketing, manufacturing and corporate infrastructure, and to meet our other anticipated cash needs through at least December 31, 2013. If our available cash, cash equivalents and short-term marketable securities 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. Additionally, there can be no assurance that we will be successful in obtaining additional cash contributions from future partnership arrangements. Our ability to transition to attaining


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profitable operations is dependent upon achieving a level of revenues adequate to support our cost structure. If events or circumstances occur such that we do not meet our operating plan as expected, or if we are unable to obtain additional financing, we may be required to reduce planned increases in compensation related expenses or other operating expenses related to research, development, and commercialization activities, which could have an adverse impact on our ability to achieve our intended business objectives.

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 approved products 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, timing and risks of delays 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.

On March 6, 2012, we consummated our acquisition of SweetSpot. Through our acquisition of SweetSpot, we have a software platform that enables our customers to aggregate and analyze data from diabetes devices and to share it with their healthcare providers. In November 2011, SweetSpot received 510(k) clearance from the FDA to market to clinics a data management service, which helps healthcare providers and patients see, understand and use blood glucose meter data to diagnose and manage diabetes. SweetSpot's data transfer service is registered with the FDA as a MDDS and allows researchers to control the transfer of data from patient diabetes devices to research tools and databases according to their own research workflows. SweetSpot's software provides an advanced cloud-based platform for uploading, processing and delivering health data and transforms raw output from patient medical devices into useful information for healthcare providers, patients and researchers. The acquisition could increase our cost structure or divert management's attention more than anticipated.

Contractual Obligations

In November 2012, we entered into a loan and security agreement (the "Loan Agreement") that provides for (i) a $15 million revolving line of credit and
(ii) a total term loan up to $20 million, in both cases, to be used for general corporate purposes. The borrowings under the Loan Agreement are collateralized by a first priority security interest in substantially all of our assets with a negative pledge on our intellectual property. The revolving line of credit is an interest-only financing that bears an interest rate equal to the prime rate plus 0.5% and requires repayment of principal at the maturity date of November 2015. Per the Loan Agreement, $7 million


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was advanced under the term loan at the funding date, excluding issuance costs and fees withheld, and up to $13 million in additional funds will be available upon our request from June 1, 2013 to September 30, 2013. The term loan bears a fixed interest rate equal to the three-year treasury rate at the time of advance plus 6.94% and requires payment of interest only for the first year and amortized payments of interest and principal thereafter through the maturity date of November 2016.

In April 2006, we entered into an office lease agreement for facilities located in San Diego, California. In connection with the lease, we entered into a $0.7 million letter of credit to secure future payments under the lease and paid a security deposit in the amount of $0.1 million in April 2006. In August 2010, we entered into a First Amendment to Office Lease (the "Lease Amendment") with respect to facilities in the buildings at 6340 Sequence Drive and 6310 Sequence Drive, each in San Diego, California (the "Buildings"). Under the Lease Amendment, we have leased approximately 128,815 square feet of space in the Buildings. The lease term for the Buildings extends through November 2016 and we have an option to renew the lease upon the expiration of the initial term for an additional five years. In September 2008, our subsidiary in Sweden entered into a three year lease for a small shared office space, which was renewed for a three-year term and has a quarterly adjustment clause for rent to increase or decrease in proportion to changes in consumer prices. In July 2012, our subsidiary SweetSpot entered into a five year lease for a small office space in a multi-tenant commercial building. Excluding real estate taxes and operating costs, we are required to make total future monthly payments for all of our real estate obligations for the period from January 2013 through August 2016 totaling $10.6 million.

We are party to various purchase arrangements related to components used in production and research and development activities. As of December 31, 2012, we had purchase commitments with certain vendors totaling approximately $12.6 million due within one year. There are no material purchase commitments due beyond one year.

The following table summarizes our outstanding contractual obligations as of December 31, 2012 and the effect those obligations are expected to have on our liquidity and cash flows in future periods (in millions):

. . .

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