UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

FORM 10-Q

 

For the Quarterly Period Ended September 30, 2015

OR

For the Transition Period from              to                 

Commission File Number 001-36189

 

Tandem Diabetes Care, Inc.

(Exact name of registrant as specified in its charter)

 

 

(858) 366-6900

Registrant’s telephone number, including area code

Securities registered pursuant to Section 12(b) of the Act:

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No   x

As of October 26, 2015, there were 30,074,979 shares of the registrant’s Common Stock outstanding.

 

 

 

 

 

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TABLE OF CONTENTS

 

 

 

 

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PART I. FINANCIAL INFORMATION

 

 

TANDEM DIABETES CARE, INC.

CONDENSED BALANCE SHEETS

(In thousands, except par values)

 

 

See accompanying notes to unaudited condensed financial statements.

 

 

 

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TANDEM DIABETES CARE, INC.

CONDENSED STATEMENTS OF OPERATIONS and comprehensive loss

(Unaudited)

(In thousands, except per share data)

 

 

See accompanying notes to unaudited condensed financial statements.

 

 

 

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TANDEM DIABETES CARE, INC.

CONDENSED STATEMENTS OF CASH FLOWS

(Unaudited)

(In thousands)

 

See accompanying notes to unaudited condensed financial statements.

 

 

 

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TANDEM DIABETES CARE, INC.

 

NOTES TO UNAUDITED CONDENSED FINANCIAL STATEMENTS

 

1. Organization and Basis of Presentation

 

The Company

 

Tandem Diabetes Care, Inc. is a medical device company focused on the design, development and commercialization of products for people with insulin-dependent diabetes. Unless the context requires otherwise, the terms the “Company” or “Tandem” refer to Tandem Diabetes Care, Inc.

 

The Company designed and commercialized its flagship product, the t:slim Insulin Delivery System, or t:slim, based on its proprietary technology platform and consumer-focused approach. The U.S. Food and Drug Administration (FDA) cleared t:slim in November 2011 and the Company commenced commercial sales of t:slim in the United States in August 2012. In January 2015, the Company received clearance from the FDA to commercialize its second product, the t:flex Insulin Delivery System, or t:flex, for people with greater insulin needs. The Company commenced commercial sales of t:flex in the United States during the second quarter of 2015. In September 2015, the Company received clearance from the FDA to commercialize its third product, the t:slim G4™ Insulin Delivery System, or t:slim G4. The t:slim G4 combines features of the t:slim Insulin Pump and Dexcom G4^® PLATINUM Continuous Glucose Monitoring (CGM) System into a single device. The Company commenced commercial sales of t:slim G4 in the United States during the third quarter of 2015.

 

Basis of Presentation

 

The Company has prepared the accompanying unaudited condensed financial statements in accordance with accounting principles generally accepted in the United States of America (U.S. GAAP) for interim financial information and pursuant to the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and disclosures required by U.S. GAAP for complete financial statements. In the opinion of management, all adjustments which are of a normal and recurring nature, considered necessary for a fair presentation of the financial information contained herein, have been included.

 

Interim financial results are not necessarily indicative of results anticipated for the full year or any other period(s). These unaudited condensed financial statements should be read in conjunction with the Company’s audited financial statements and footnotes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2014, from which the balance sheet information herein was derived but excludes disclosures required by GAAP for complete financial statements.

 

Voluntary Recall

 

On January 10, 2014, the Company announced a voluntary recall of select lots of cartridges used with t:slim that may have been at risk of leaking. The cause of the recall was identified during the Company’s internal product testing. The recall was expanded on January 20, 2014 to include additional lots of affected cartridges used with t:slim. The Company incurred approximately $1.7 million in direct costs associated with the recall. The Company recorded a cost of sales charge of approximately $1.3 million in the fourth quarter of 2013 and recorded a cost of sales charge for the remainder in the first quarter of 2014 for affected cartridges shipped in 2014. The total cost of the recall consisted of approximately $0.7 million associated with the return and replacement of affected cartridges in the field and approximately $1.0 million for the write-off of affected cartridges within the Company’s internal inventory. As of December 31, 2014, the FDA determined that the recall was terminated.

 

2. Summary of Significant Accounting Policies

 

There have been no significant changes in our significant accounting policies during the nine months ended September 30, 2015, as compared with those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Use of Estimates

 

The preparation of the financial statements in conformity with U.S. GAAP requires management to make informed estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities in the Company’s financial statements and accompanying notes as of the date of the financial statements. Actual results could materially differ from those estimates and assumptions.

 

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Restricted Cash

 

Restricted cash as of September 30, 2015 and December 31, 2014 composed of a $2.0 million minimum cash balance requirement in connection with the Capital Royalty Term Loan Agreement (see Note 7 “Loan Agreements”).

 

Accounts Receivable

 

The Company grants credit to various customers in the normal course of business. The Company maintains an allowance for doubtful accounts for potential credit losses. Provisions are made, generally, for receivables greater than 120 days past due and based upon a specific review of other outstanding invoices. Uncollectible accounts are written off against the allowance after appropriate collection efforts have been exhausted and when it is deemed that a balance is uncollectible.

 

Fair Value of Financial Instruments

 

The carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued expense, and employee-related liabilities are reasonable estimates of their fair values because of the short-term nature of these assets and liabilities. Short-term investments and foreign exchange forward contracts that are not designated as hedges are carried at fair value. Based on the borrowing rates currently available for loans with similar terms, the Company believes that the fair value of its long-term debt approximates its carrying value.

 

Revenue Recognition

 

Revenue is generated from sales, in the United States, of the t:slim insulin pump, t:flex insulin pump and t:slim G4 insulin pump (each, a “Tandem Pump”), disposable cartridges and infusion sets to individual customers and third-party distributors that resell the product to insulin-dependent diabetes customers. The Company is paid directly by customers who use the products, distributors and third-party insurance payors.

 

Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred and title passed, the price is fixed or determinable, and collectability is reasonably assured. These criteria are applied as follows:

 

 

 

 

 

Revenue Recognition for Arrangements with Multiple Deliverables

 

The Company considers the deliverables in its product offering as separate units of accounting and recognizes deliverables as revenue upon delivery only if (i) the deliverable has standalone value and (ii) if the arrangement includes a general right of return relative to the delivered item(s), delivery or performance of the undelivered item(s) is probable and substantially controlled by the Company. The Company allocates consideration to the separate units of accounting, unless the undelivered elements were deemed perfunctory and inconsequential. The Company uses the relative selling price method, in which allocation of consideration is based on vendor-specific objective evidence (VSOE) if available, third-party evidence (TPE), or if VSOE and TPE are not available, management’s best estimate of a standalone selling price (ESP) for the undelivered elements.

 

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The Company offers a cloud-based data management application, t:connect, which is made available to customers upon purchase of a Tandem Pump. This service is deemed an undelivered element at the time of the Tandem Pump sale. Because the Company has neither VSOE nor TPE for this deliverable, the allocation of revenue is based on the Company’s ESP. The Company establishes its ESP based on the estimated cost to provide such services, including consideration for a reasonable profit margin, which is then corroborated by comparable market data. The Company allocates fair value based on management’s ESP to this element at the time of sale and recognizes the revenue over the four-year hosting period. At September 30, 2015 and December 31, 2014, $0.9 million and $0.7 million was recorded as deferred revenue for the t:connect hosting service, respectively. All other undelivered elements at the time of sale are deemed inconsequential or perfunctory.

 

Product Returns

 

The Company offers a 30-day right of return to its customers from the date of shipment of a Tandem Pump, provided a physician’s confirmation of the medical reason for the return is received. Estimated allowances for sales returns are based on historical returned quantities as compared to pump shipments in those same periods of return. The return rate is then applied to the sales of the current period to establish a reserve at the end of the period. The return rates used in the reserve are adjusted for known or expected changes in the marketplace when appropriate. The allowance for product returns is recorded as a reduction of revenue and accounts receivable in the period that the related sale is recorded. The amounts recorded on the Company’s balance sheet for product return allowance were $0.2 million and $0.3 million at September 30, 2015 and December 31, 2014, respectively. Actual product returns have not differed materially from estimated amounts reserved in the accompanying financial statements.

 

In connection with the t:slim G4 commercial launch, the Company offered an exchange program (“exchange program”) for eligible customers. The exchange program offered customers who received a t:slim or t:flex pump on or after August 1, 2015, an opportunity to elect to exchange their pump for a t:slim G4. The exchange program ended in October 2015. The Company accrued for the right of return and estimated cost of exchanges by reducing revenues in the same period that the related sale was recorded and establishing a deferred revenue account that is included in “Other current liabilities” in the Company's balance sheet. The amount accrued for the right of return related to the exchange program was $700,000. The related revenues will be recognized upon fulfillment of the exchanges.

 

Warranty Reserve

 

The Company generally provides a four-year warranty on a Tandem Pump to end user customers and may replace any pumps that do not function in accordance with the product specifications. Any pump returned to the Company may be eligible for refurbishment and redeployed. Additionally, the Company offers a six-month warranty on disposable cartridges and infusion sets. Estimated warranty costs are recorded at the time of shipment. Warranty costs are estimated based on the current expected replacement product cost and actual experience. The Company evaluates the reserve quarterly and makes adjustments when appropriate. At September 30, 2015 and December 31, 2014, the warranty reserve was $3.0 million and $2.0 million, respectively. Actual warranty costs have not differed materially from estimated amounts reserved in the accompanying financial statements.

 

The following table provides a reconciliation of the change in product warranty liabilities through September 30, 2015 (in thousands):

 

 

Stock-Based Compensation

 

Stock-based compensation cost is measured at the grant date, based on the estimated fair value of the award, and the portion that is ultimately expected to vest is recognized as compensation expense over the employee’s requisite service period on a straight-line basis. The Company estimates the fair value of stock options and shares issued to employees under the Employee Stock Purchase Plan (ESPP) using a Black-Scholes option-pricing model on the date of grant. The Black-Scholes option-pricing model requires the use of subjective assumptions including volatility, expected term, and risk-free rate. For awards that vest based on service conditions, the Company recognizes expense using the straight-line method less estimated forfeitures.

 

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The Company records the expense for stock option grants to non-employees based on the estimated fair value of the stock options using the Black-Scholes option-pricing model. The fair value of non-employee awards is remeasured at each reporting period as the underlying awards vest, unless the instruments are fully vested, immediately exercisable and nonforfeitable on the date of grant.

 

Net Loss Per Share

 

Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares that were outstanding for the period, without consideration for common stock equivalents. Diluted net loss per share is calculated by dividing the net loss by the sum of the weighted-average number of dilutive common share equivalents outstanding for the period determined using the treasury stock method. Dilutive common share equivalents are comprised of warrants, potential awards granted pursuant to the ESPP, and options outstanding under the Company’s other equity incentive plans. For all periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position.

 

Potentially dilutive securities not included in the calculation of diluted net loss per share (because inclusion would be anti-dilutive) are as follows (in common stock equivalent shares):

 

 

Recent Accounting Pronouncements

 

In July 2015, the Financial Accounting Standards Board (“FASB”) issued guidance on simplifying the measurement of inventory. The guidance changes the measurement principle for inventory from the lower of cost or market, to the lower of cost and net realizable value. The guidance defines net realizable value as estimated selling prices in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The new guidance must be applied on a prospective basis and is effective for fiscal years beginning after December 15, 2015, and interim periods within those years, with early adoption permitted. The Company does not believe the implementation of this standard will have a material impact on its financial statements.

 

In April 2015, FASB issued guidance on the balance sheet presentation requirements for debt issuance costs. The guidance will require that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of that debt liability, consistent with debt discounts. The guidance is effective for financial statements issued for fiscal years beginning after December 15, 2015, and interim periods within those fiscal years. Early adoption is permitted for financial statements that have not been previously issued. A company should apply the new guidance on a retrospective basis, wherein the balance sheet of each individual period presented should be adjusted to reflect the period-specific effects of applying the new guidance. Upon transition, a company is required to comply with the applicable disclosures for a change in an accounting principle. The guidance only affects the presentation of debt issuance costs in the balance sheet and has no impact on results of operations. We will apply ASU 2015-03 on January 1, 2016 and will reclassify debt issuance costs from other long-term assets to notes payable. Debt issuance costs included in other long-term assets in the accompanying financial statements were $0.4 million and $0.5 million at September 30, 2015 and December 31, 2014, respectively.

 

In May 2014, FASB and the International Accounting Standards Board issued a comprehensive new revenue recognition standard that will supersede existing revenue guidance under U.S. GAAP and International Financial Reporting Standards. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. This may include identifying performance obligations in the contract, estimating the amount of variable consideration to include in the transaction price and allocating the transaction price to each separate performance obligation. On July 9, 2015, the FASB approved a one-year deferral of the effective date of the standard to December 15, 2017 and early application is permitted, but not before the original effective date of December 15, 2016. The Company is in the process of assessing the future impact of the adoption of the standard on its financial statements.

 

 

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3. Short-Term Investments

 

The Company invests its excess cash in investment securities, principally debt instruments of financial institutions and corporations with strong credit ratings. The following represents a summary of the estimated fair value of short-term investments at September 30, 2015 and December 31, 2014 (in thousands):

 

 

 

 

  

4. Inventory

 

Inventories, stated at the lower of cost or market, consisted of the following (in thousands):

 

 

 

5. Fair Value Measurements

 

Authoritative guidance on fair value measurements defines fair value, establishes a consistent framework for measuring fair value, and expands disclosures for each major asset and liability category measured at fair value on either a recurring or a nonrecurring basis. Fair value is an exit price, representing the amount that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. As such, fair value is a market-based measurement that should be determined based on assumptions that market participants would use in pricing an asset or liability. As a basis for considering such assumptions, the authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:

 

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The following table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2015 and December 31, 2014, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (in thousands):  

 

 

 

 

 

 

 

 

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The Company’s Level 2 financial instruments are valued using market prices on less active markets with observable valuation inputs such as interest rates and yield curves. The Company obtains the fair value of Level 2 financial instruments from quoted market prices, calculated prices or quotes from third-party pricing services. The Company validates these prices through independent valuation testing and review of portfolio valuations provided by the Company’s investment managers. There were no transfers between Level 1 and Level 2 securities during the three and nine months ended September 30, 2015.

 

6. Loan Agreements

 

At September 30, 2015 and December 31, 2014, the Company had $30.0 million of aggregate borrowings outstanding under the Amended and Restated Term Loan Agreement with Capital Royalty Partners (the “Amended and Restated Term Loan Agreement”). Under the agreement, interest is payable, at the Company’s option, (i) in cash at a rate of 11.5% per annum or (ii) at a rate of 9.5% of the 11.5% per annum in cash and 2.0% of the 11.5% per annum to be added to the principal of the loan and subject to accruing interest. The Company has elected to pay interest in cash at a rate of 11.5% per annum. Interest-only payments are due quarterly on March 31, June 30, September 30 and December 31 of each year of the interest-only payment period, which ends on March 31, 2018.

 

At December 31, 2014, the Company was also a party to a new Term Loan Agreement with Capital Royalty Partners (the “New Tranche Term Loan Agreement”), under which the Company could have borrowed up to an additional $30.0 million on or before March 31, 2015 at the same interest rate and on the same key terms as the Amended and Restated Term Loan Agreement.

 

In February 2015, the Company amended its Amended and Restated Term Loan Agreement, as well as its New Tranche Term Loan Agreement. Pursuant to this amendment, the interest-only payment period was extended to December 31, 2019 from March 31, 2018, at the same interest rate and on the same key terms as the existing agreements. The principal balance is due in full at the end of the term of the amended and restated term loan, which is March 31, 2020. The present value of the future cash flows under the modified terms did not exceed the present value of the future cash flows under the previous terms by more than 10%. The Company treated this amendment as a modification. The remaining debt discount costs are be amortized over the remaining term of the Amended and Restated Term Loan Agreement using the effective interest method.

 

The Company did not elect to borrow any amounts under the New Tranche Term Loan Agreement on or before March 31, 2015, and the Company’s ability to borrow any amounts under that agreement has now lapsed.

 

The Capital Royalty loan is collateralized by all assets of the Company. The Amended and Restated Term Loan Agreement also imposes various affirmative and negative covenants on the Company. The principal financial covenants require that the Company attain minimum annual revenues of $50.0 million in 2015, $65.0 million in 2016, $80.0 million in 2017 and $95.0 million each year thereafter until the end of the term of the loan. At September 30, 2015, the Company was in compliance with all of the covenants in the Amended and Restated Term Loan Agreement.

 

 

7. Stockholders’ Equity

 

Public Offering

 

In the first quarter of 2015, the Company completed a public offering of 6,037,500 shares of its common stock at a public offering price of $11.50 per share. Net cash proceeds from the public offering were approximately $64.9 million, after deducting underwriting discounts, commissions and offering expenses payable by the Company.

 

Shares Reserved for Future Issuance

 

The following shares of the Company’s common stock are reserved for future issuance at September 30, 2015:

 

 

The Company issued 213,981 shares of its common stock upon the exercise of stock options and warrants during the nine months ended September 30, 2015, and issued 477,741 shares of its common stock upon the exercise of stock options and warrants during the year ended December 31, 2014.

 

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In October 2013, the Company adopted the ESPP, which enables eligible employees to purchase shares of the Company’s common stock using their after tax payroll deductions, subject to certain conditions. Generally, the ESPP consists of a two-year offering period with four six-month purchase periods which begin in May and November of each year. There were 164,569 shares of the Company’s common stock purchased under the ESPP during the nine months ended September 30, 2015, and 251,390 shares of the Company’s common stock purchased under the ESPP during the year ended December 31, 2014.

 

Stock-Based Compensation

 

The assumptions used in the Black-Scholes option-pricing model are as follows:

 

 

 

The following table summarizes the allocation of stock-based compensation expense (in thousands):

 

 

The total stock-based compensation capitalized as part of the cost of inventory was $0.2 million at September 30, 2015 and December 31, 2014.

 

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8. Collaborations

 

DexCom Development and Commercialization Agreement

 

In February 2012, the Company entered into a Development and Commercialization Agreement (the “DexCom Agreement”) with DexCom, Inc. (“DexCom”) for the purpose of collaborating on the development and commercialization of an integrated system which incorporates the t:slim Insulin Delivery System with DexCom’s proprietary G4 PLATINUM continuous glucose monitoring system. Under the DexCom Agreement, the Company paid DexCom $1.0 million at the commencement of the collaboration in 2012, $1.0 million in 2014 upon the achievement of the t:slim G4 pre-market approval, or PMA, submission to the FDA and an additional $1.0 million in September 2015 upon approval of the PMA submission by the FDA. All payments were recorded as research and development costs in their respective years. Additionally, the Company agreed to reimburse DexCom up to $1.0 million of its research and development costs and is solely responsible for its own research and development costs. As of September 30, 2015, the Company has reimbursed DexCom $0.2 million of its research and development costs. The research and development costs recognized for the three and nine months ended September 30, 2015, and 2014 were not significant. The Company does not expect any further research and development costs to be incurred in connection with the DexCom Agreement.

 

Under the DexCom Agreement, upon commercialization of the t:slim G4 integrated system, and as compensation for the non-exclusive license rights, the Company agreed to pay DexCom a royalty of $100 for each integrated system sold.

 

In September 2015, the Company entered into an amendment to the DexCom Agreement (the “Amendment”). Pursuant to the Amendment, in lieu of the $100 royalty payment, the Company will commit $100 for each t:slim G4 integrated system sold for incremental marketing activities associated with the t:slim G4 integrated system that are in addition to a level of ordinary course marketing activities or marketing activities to support other Company and DexCom jointly funded development projects. The liability associated with the Amendment was not material at September 30, 2015.

 

JDRF Collaboration

 

In January 2013, the Company entered into a Research, Development and Commercialization Agreement with the Juvenile Diabetes Research Foundation (JDRF Agreement) to develop the t:dual Infusion System, a first-of-its-kind, dual-chamber infusion pump for the management of diabetes. According to the terms of the JDRF Agreement, JDRF will provide research funding of up to $3.0 million based on the achievement of research and development milestones, not to exceed research costs incurred by the Company. Under the terms of the agreement, the Company has agreed to pay JDRF a royalty calculated as a percentage of each t:dual Infusion System the Company sells until JDRF has received royalty payments equal to three times the amount of funding that the Company receives from JDRF under the agreement. Thereafter, no royalty payments will be due under the agreement. Either party may terminate the agreement without cause at any time upon 90 days’ prior notice, provided that if the Company terminates the agreement without cause prior to 2017, then it may be required to pay JDRF two times the amount that it has received from JDRF prior to such termination, and if the Company terminates the agreement without cause after that date it may be required to pay JDRF three times the amount that it has received from JDRF prior to such termination. Any intellectual property developed by either party in the performance of the agreement will be owned or exclusively licensed by the Company.

 

Payments that the Company receives to fund the collaboration efforts under the terms of the JDRF Agreement are recorded as restricted cash and current and long-term liabilities. The liabilities are recognized as an offset of research and development expenses straight-line over the remaining months until anticipated completion of the final milestone, only to the extent that the restricted cash is utilized to fund such development activities. The estimated completion date is re-evaluated each reporting period based on development progress through that date.

 

As of September 30, 2015, milestone achievement payments received by the Company totaled $0.7 million, and research and development costs were offset cumulatively by $0.5 million. The research and development costs were offset by $0 and $74,000 for the three and nine months ended September 30, 2015, respectively, and $46,000 and $0.1 million for the three and nine months ended September 30, 2014, respectively. The Company did not have any restricted cash balances related to the JDRF Agreement at September 30, 2015 or December 31, 2014.

 

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The Company and JDRF have been in ongoing discussions over a period of several months surrounding the Company’s assessment of technical, scientific and regulatory challenges associated with developing and commercializing the t:dual Infusion System in a manner consistent with the existing JDRF Agreement.  In October 2015, JDRF notified the Company that it believes an interruption has occurred under the agreement, and has requested a payment in the amount of $1.3 million, which is equivalent to two times the amount that it has received from JDRF to date, or that the Company resume development of t:dual Infusion System notwithstanding the Company’s assessment of technical, scientific and regulatory challenges.  The notification from JDRF also initiated the dispute resolution procedures under the agreement. The Company intends to continue good faith discussions with JDRF in an effort to resolve the dispute.  However, due to the ongoing nature of the matter, it is not currently possible to predict whether the agreement will ultimately be amended or terminated or, to the extent it is terminated, the extent to which the Company would incur any liability to JDRF. As of September 30, 2015, and in light of the Company’s assessment of technical, scientific and regulatory challenges and the status of the Company’s ongoing discussions with JDRF, further amortization of the liabilities will cease until a resolution is reached. As of September 30, 2015, the Company has not accrued a liability related to potential losses as a result of notification from JDRF.

 

 

9. Commitments and Contingencies

 

From time to time, the Company may be subject to legal proceedings, regulatory encounters or other matters arising in the ordinary course of business, including actions with respect to intellectual property, employment, product liability, and contractual matters. The Company assesses the probability and range of possible loss based on the developments in these matters on a regular basis. A liability is recorded in the financial statements if the Company believes it is probable that a loss has been incurred and the amount of the loss can be reasonably estimated. Because of the uncertainties related to the occurrence, amount, and range of loss on any pending actions, the Company is currently unable to predict their ultimate outcomes, and, with respect to any pending litigation or claim where no liability has been accrued, to make a meaningful estimate of the reasonably possible loss or range of loss that could result from an unfavorable outcome. At each of September 30, 2015 and December 31, 2014, there were no material matters for which the negative outcome was considered probable or estimable.

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You should read the following discussion and analysis together with our financial statements and related notes in Part I, Item 1 of this Quarterly Report on Form 10-Q.

 

This Quarterly Report contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report, other than statements of historical fact, are forward-looking statements. You can identify forward-looking statements by the use of words such as “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to such statements.

 

Our forward-looking statements are based on our management’s current assumptions and expectations about future events and trends, which affect or may affect our business, strategy, operations or financial performance. Although we believe that these forward-looking statements are based upon reasonable assumptions, they are subject to numerous known and unknown risks and uncertainties and are made in light of information currently available to us. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below in the section entitled “Risk Factors” in Part II, Item 1A, and elsewhere in this Quarterly Report. You should read this Quarterly Report with the understanding that our actual future results may be materially different and worse from what we expect.

 

Forward-looking statements speak only as of the date they were made, and, except to the extent required by law or the rules of the NASDAQ Stock Market, we undertake no obligation to update or review any forward-looking statement because of new information, future events or other factors. Readers are cautioned not to place undue reliance on forward-looking statements.

 

Overview

 

We are a medical device company with an innovative approach to the design, development and commercialization of products for people with insulin-dependent diabetes. The foundation of our product portfolio is our proprietary technology platform and unique consumer-focused approach, which allows us to focus on both consumer and clinical needs to develop and commercialize products that address different segments of the insulin-dependent diabetes market. We began commercial sales of our flagship product, the t:slim Insulin Delivery System, or t:slim, in August 2012. In January 2015, we received clearance from the FDA to commercialize our second product, the t:flex Insulin Delivery System, or t:flex, for people with greater insulin needs. We began commercial sales of t:flex in the United States during the second quarter of 2015. In September 2015, we received approval from the FDA and began commercial sales of our third product, the t:slim G4 Insulin Delivery System, or t:slim G4, the first and only touch-screen pump with continuous glucose monitoring (CGM) integration. The t:slim G4 Pump can operate as a stand-alone insulin pump without CGM, or be paired with a DexCom G4 PLATINUM sensor. We are responsible for the manufacturing and sale of the pump and cartridges. DexCom will separately make and sell the associated sensor and transmitters to customers as they do today.

 

Our technology platform features our patented Micro-Delivery Technology, a miniaturized pumping mechanism which draws insulin from a flexible bag within the pump’s cartridge rather than relying on a syringe and plunger mechanism. It also features an easy-to-navigate embedded software architecture, a vivid color touchscreen and a micro-USB connection that supports both a rechargeable battery and t:connect, our data management application. Our innovative approach to product design and development is also consumer-focused and based on our extensive market research, as we believe the user is the primary decision maker when purchasing an insulin pump. We also apply the science of human factors to our design and development process, which seeks to optimize our devices to the intended users, allowing users to successfully operate our devices in their intended environment. Leveraging our technology platform and consumer-focused approach, we develop products to address unmet needs of people in different segments of the large and growing insulin-dependent diabetes market.

 

Since inception, we have derived nearly all of our revenue from the sale of insulin pumps and associated supplies in the United States. We consider the number of units shipped per quarter to be an important metric for managing our business. We have shipped over 28,000 insulin pumps since commercialization. Pump shipments are broken down by product, and by quarter as follows:

 

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For the three months ended September 30, 2015 and 2014, our sales were $15.7 million and $13.5 million, respectively. For the three months ended September 30, 2015 and 2014, our net loss was $19.6 million and $19.9 million, respectively. For the nine months ended September 30, 2015 and 2014, our sales were $43.7 million and $31.8 million, respectively. For the nine months ended September 30, 2015 and 2014, our net loss was $60.3 million and $61.1 million, respectively.

 

We believe that the timing of the regulatory approval and commercial launch of the t:slim G4 pump negatively impacted our aggregate pump shipments during the three months ended September 30, 2015. We believe that, in the period leading up to the FDA approval of the t:slim G4, there was an increasing number of customers anticipating its approval and availability. Potential customers may have delayed their purchasing decisions until they could include the t:slim G4 in their decision-making process. Since the announcement of the FDA approval of the t:slim G4 Pump, there has been a high level of customer interest in the product. However, potential customers, as well as customers who originally placed an order for a t:slim or t:flex Pump but had not yet received their pump at the time of the FDA approval of the t:slim G4, are taking additional time to consider the t:slim G4 Pump in their purchasing decision, as well as to satisfy any additional insurance verification and approval requirements.  

 

In connection with the t:slim G4 commercial launch, we offered a limited product exchange program (“exchange program”) for eligible customers. The exchange program offered customers who received a t:slim or t:flex Pump on or after August 1, 2015, a limited period in which to elect to exchange their pump for a t:slim G4. The ability to elect an exchange ended in the early part of October 2015. We expect that 178 t:slim or t:flex pumps will be exchanged for t:slim G4 Pumps under the exchange program. We accrued for estimated exchanges and associated costs by reducing sales and deferring cost of sales in the third quarter of 2015. The deferred sales and the cost of sales under the exchange program will be recognized upon delivery of the t:slim G4 Pump to the customer, which is expected during the fourth quarter of 2015.

 

A substantial portion of the purchase price of an insulin pump is typically paid for by third-party payors, including private insurance companies, preferred provider organizations and other managed care providers. Access to adequate coverage and reimbursement for our current and future products by third-party payors is essential to the acceptance of our products by customers. Future sales of our current and future products will be limited unless our customers can rely on third-party payors to pay for all or part of the associated purchase cost. In circumstances in which we do not have contracts established with third-party payors, to the extent possible, we utilize our network of national and regional distributors to service our customers.

 

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We believe we can achieve profitability because our proprietary technology platform will allow us to maximize efficiencies in the development, production and sale of our products. By leveraging our technology platform, we believe we can develop and bring to market products more rapidly, while significantly reducing our design and development costs. We also expect to continue to increase production volume and to reduce the per-unit production overhead cost for our pump products and their associated disposable cartridges over time. Further, due to shared product design features, our production system is adaptable to new products and we intend to leverage our shared manufacturing infrastructure to reduce our product costs and drive operational efficiencies. By expanding our product offerings to address people in different segments of the large and growing insulin-dependent diabetes market, we believe we can increase the productivity of our sales force, thereby improving our operating margin.

 

From inception through September 30, 2015, we have primarily financed our operations through sales of equity securities, and, to a lesser extent, debt financings. We expect to continue to incur net losses for the next several years, and may require additional capital through equity and debt financings in order to fund our operations at a level of revenue adequate to support our cost structure.

 

In the first quarter of 2015, we completed a public offering of 6,037,500 shares of our common stock at a public offering price of $11.50 per share. Net cash proceeds from the public offering were approximately $64.9 million, after deducting underwriting discounts, commissions and offering expenses payable by us.

 

We have experienced considerable revenue growth since the commercial launch of t:slim in the third quarter of 2012, while incurring operating losses since our inception. Our operating results may fluctuate on a quarterly or annual basis in the future, in particular in the periods surrounding anticipated and actual regulatory approvals of new products and during the initial stages of commercialization of new products, and our growth or operating results may not be consistent with predictions made by securities analysts. We may not be able to achieve profitability in the future. For additional information about the risks and uncertainties associated with our business, see the section entitled “Risk Factors” in Part II, Item 1A of this Quarterly Report on Form 10-Q.

 

Voluntary Recall

 

On January 10, 2014, we announced a voluntary recall of select lots of cartridges used with the t:slim that may have been at risk of leaking. The cause of the recall was identified during our internal product testing. The recall was expanded on January 20, 2014 to include additional lots of affected cartridges used with the t:slim. We incurred approximately $1.7 million in direct costs associated with the recall. This included a cost of sales charge of approximately $0.4 million in the first nine months of 2014 for affected cartridges shipped in the first quarter of 2014. The total cost of the recall consisted of approximately $0.7 million associated with the return and replacement of affected cartridges in the field and approximately $1.0 million for the write-off of affected cartridges within our internal inventory. As of December 31, 2014, the FDA determined that the recall is terminated.

 

Components of Results of Operations

 

Sales

 

We commenced commercial sales of t:slim Insulin Delivery System in the United States in the third quarter of 2012. We launched our second insulin pump product, the t:flex Insulin Delivery System, in the second quarter of 2015, and launched our third insulin pump product, the t:slim G4 Insulin Delivery System, in September 2015. Each Insulin Delivery System is comprised of the insulin pump and pump-related supplies that include disposable cartridges and infusion sets. We also offer accessories including protective cases, belt clips, and power adapters. Sales of accessories since commercial launch have not been material.

 

We primarily sell our products through national and regional distributors on a non-exclusive basis. These distributors are generally providers of medical equipment and supplies to individuals with diabetes. Our primary end customers are people with insulin-dependent diabetes. Similar to other durable medical equipment, the primary payor is generally a third-party insurance carrier and the customer is usually responsible for any medical insurance plan copay or coinsurance requirements.

 

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We anticipate that our sales will increase as we expand our sales and marketing infrastructure, increase awareness of our products, introduce new products into the market, and broaden third-party reimbursement for our products. Our quarterly sales may also fluctuate substantially in the periods surrounding anticipated and actual regulatory approvals of new products. For instance, customers may defer a purchasing decision if they believe that a new product may be launched in the future. Additionally, upon the announcements of the FDA approval and commercial launch of a new product, potential new customers may delay their purchasing decision to take additional time to consider the new product in their purchase decision. We believe that we experienced purchasing decision delays for these reasons during the three-month period ended September 30, 2015, as we announced the regulatory approval and commercial launch of the t:slim G4 during that quarter. However, we are not able to quantify the extent of these delays. We also expect that our sales will fluctuate on a quarterly basis in the future due to a variety of factors, including the impact of the buying patterns of our distributors and other customers, as well as the impact of seasonality. We believe that our sales are subject to seasonal fluctuation due to the impact of annual deductible and coinsurance requirements associated with most medical insurance plans utilized by our individual customers and the individual customers of our distributors. Our sales may also be negatively impacted by the summer vacation period. In addition, we have experienced and, subject to the factors described above that could impact quarterly fluctuations, expect to continue to experience sequential growth of sales in each quarter from the first quarter to the fourth quarter, but we also expect sequential sales from the fourth quarter to the first quarter to be relatively flat or down. Our overall 2014 sales were weighted heavily towards the second half of the year. Due to the timing of the regulatory approval and commercial launch of the t:slim G4, we expect our sales in 2015 to be weighted even more heavily towards the three-month period ended December 31, 2015.

 

Cost of Sales

 

We manufacture our pumps and disposable cartridges at our manufacturing facility in San Diego, California. Infusion sets and pump accessories are manufactured by third-party suppliers. Cost of sales includes raw materials, labor costs, manufacturing overhead expenses, product training costs and reserves for expected warranty costs, scrap and inventory obsolescence. Due to our relatively low production volumes compared to our potential production capacity, manufacturing overhead expenses are currently a significant portion of our per-unit costs. These manufacturing overhead expenses include expenses relating to quality assurance, manufacturing engineering, material procurement, inventory control, facilities, equipment, information technology and operations supervision and management. We anticipate that our cost of sales will increase as our products gain broader market acceptance

 

We expect our overall gross margin, which for any given period is calculated as sales less cost of sales divided by sales, to improve over the long term, as our sales increase and we have more opportunities to spread our overhead costs over larger production volumes. We will also be able to leverage manufacturing efficiencies among our 3 pump products that utilize the same core manufacturing infrastructure. However we do expect our overall gross margin to fluctuate in future quarterly periods as a result of numerous factors besides those associated with production volumes, such as the changing mix of products sold with different gross margins, the changing percentage of products sold to distributors versus directly to individual customers, varying levels of reimbursement among third-party payors, the timing and success of new product launches, warranty and training costs, and changes in our manufacturing processes, costs or output. Manufacturing efficiencies or inefficiencies will also impact our gross margins, which we may experience as we attempt to manufacture our products on a larger scale, launch new products, change our manufacturing processes, change our manufacturing capacity or output, implement additional automated manufacturing equipment and expand our manufacturing facilities.

 

Selling, General and Administrative

 

Our selling, general and administrative, or SG&A, expenses primarily consist of salary, cash-based incentive compensation, fringe benefits and stock-based compensation for our executive, financial, marketing, sales, business development, regulatory affairs and administrative functions. Other significant SG&A expenses include those incurred for product demonstration samples, commercialization activities associated with new product launches, trade shows, outside legal counsel fees, independent auditor fees, outside consultant fees, insurance premiums, facilities costs and information technology costs. We expect our SG&A expenses to increase as our business expands, including expansion of the number of sales territories in which we operate.

 

Research and Development

 

Our research and development, or R&D, activities primarily consist of engineering and research programs associated with our products under development, as well as R&D activities associated with our core technologies and processes. R&D expenses are primarily related to employee compensation, including salary, fringe benefits, stock-based compensation and temporary employee expenses. We also incur R&D expenses for supplies, license fees, development prototypes, outside design and testing services and milestone payments under our development and commercialization agreements. We expect our R&D expenses to increase as we initiate and advance our development projects.

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Other Income and Expense

 

Our other income and expense primarily consists of interest expense and amortization of debt discount and debt issuance costs associated with the Amended and Restated Term Loan Agreement. At each of September 30, 2015 and December 31, 2014, there was $30.0 million of outstanding principal under the agreement, which accrues interest at a rate of 11.5% per annum (see the section below entitled “Indebtedness”).

 

Results of Operations

 

 

Comparison of the Three Months Ended September 30, 2015 and 2014

 

Sales. Sales for the three months ended September 30, 2015 were $15.7 million, representing an increase of 16% compared to $13.5 million for the same period in 2014. Sales in the third quarter of 2015 excluded $700,000 that was deferred in conjunction with the exchange program.

 

For the three months ended September 30, 2015, sales for t:slim pumps, t:flex pumps and t:slim G4 pumps were $8.7 million, $2.2 million and $1.9 million, respectively. For the three months ended September 30, 2015 and 2014, sales of insulin pumps accounted for 81% and 86% of sales, respectively, while sales of pump-related supplies primarily accounted for the remainder of our sales during those periods. Sales of accessories were not material in either of the reported periods.

 

The increase in sales during the three months ended September 30, 2015 compared to the same period in 2014 was primarily attributable to a 17% increase in pump shipments from 2,935 in the third quarter of 2014 to 3,431 in the third quarter of 2015. This includes pump shipments of 555 t:flex pumps and 486 t:slim G4 pumps during the third quarter of 2015 compared to none in 2014.  Sale of t:flex pumps and t:slim G4 pumps began May 2015 and September 2015, respectively. The increase in sales in the third quarter of 2015 was offset by $700,000, reflecting the amount of revenue that was deferred in conjunction with the exchange program.

 

Sales to distributors accounted for 77% and 76% of our total sales for the three months ended September 30, 2015 and 2014, respectively. The mix of sales to distributors versus direct customers is principally determined by whether or not we have a contractual arrangement with the underlying third-party insurance payor.

 

Cost of Sales and Gross Profit. Our cost of sales for the three months ended September 30, 2015 was $10.2 million, representing an increase of 12% compared to $9.1 million for the same period in 2014. Cost of sales in the third quarter of 2015 excluded $230,000 deferred cost of sales in conjunction with the exchange program. Gross profit for the three months ended September 30, 2015 was $5.5 million and gross margin was 35%, compared to gross profit of $4.4 million and gross margin of 33% for the same period in 2014.

 

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The increase in our gross margin for the three months ended September 30, 2015 from the comparable period in 2014 was primarily due to a decrease in per-unit material and manufacturing overhead costs of our products, which was driven by increased production volumes and manufacturing efficiencies. We continue to increase our manufacturing operations and costs as we address increasing production volume requirements. Our manufacturing overhead costs have been, and will continue to be, a significant component of the costs of our products. As a result our manufacturing overhead costs have impacted, and may continue to impact, our gross margins as we attempt to manufacture our products on a larger scale, change our manufacturing processes, change our manufacturing capacity or output, implement additional automated manufacturing equipment and expand our manufacturing facilities.

 

Although gross margin for pumps and cartridges both improved during the period of three month ended September 30, 2015 as compared to the same period in 2014, this increase was partially offset by a reduction in the percentage of sales represented by our insulin pumps. Our gross margin on the insulin pumps was higher than our gross margin on pump-related supplies for the quarters ended September 30, 2015 and 2014, and is expected to remain higher in the future. Other factors impacting our gross margins included the changing percentage of products sold to distributors versus directly to individual customers, varying levels of reimbursement among third party payors on our direct business, new product launch scale-up, warranty and training costs, and other changes in our manufacturing processes, costs and output.

 

Selling, General and Administrative Expenses. SG&A expenses increased 1% to $19.1 million for the three months ended September 30, 2015 from $18.9 million for the same period in 2014. The increase in SG&A expenses for the three months ended September 30, 2015 was primarily the result of increased activities associated with the t:slim G4 launch, such as sales force training and demonstration units and samples, which increased expense by $0.4 million. Additional expenses associate with t:slim G4 launch may occur next quarter as we complete the product launching activities. This increase in expenses was offset by a decrease of $0.2 million in employee-related expenses. The decrease in such employee-related expenses was primarily related to decrease in stock based compensation expense of $0.6 million, offset by an increase of $0.4 million in other employee-related expenses, such as salaries, bonuses and sales commissions.

 

Research and Development Expenses. R&D expenses increased 13% to $5.1 million for the three months ended September 30, 2015 from $4.5 million for the same period in 2014, principally associated with increase in employee-related expenses. Included in the R&D expenses are $1.0 million milestone payments made to DexCom, under the DexCom Agreement, in each of the three months ended September 30, 2015 and 2014.

 

Other Income and Expense. Other expense for the three months ended September 30, 2015 and 2014 was $1.0 million and $0.9 million, respectively. Other expense for both periods was primarily comprised of interest expense associated with the term loan agreement with Capital Royalty Partners. Interest currently accrues at a rate of 11.5% of the outstanding principal balance of $30.0 million. Other income for both periods presented was not material.

 

Comparison of the Nine Months Ended September 30, 2015 and 2014

 

Sales. Sales for the nine months ended September 30, 2015 were $43.7 million, representing an increase of 37% compared to sales of $31.8 million for the same period in 2014. Sales in the third quarter of 2015 excluded $700,000 that was deferred in conjunction with the exchange program.

 

For the nine months ended September 30, 2015, sales for t:slim, t:flex, and t:slim G4 pumps were $30.3 million, $3.6 million and $1.9 million, respectively. For the nine months ended September 30, 2015 and 2014, sales from our insulin pumps accounted for 82% and 86% of sales, respectively, while sales of pump-related supplies primarily accounted for the remainder of our sales during those periods. Sales of accessories were not material in either of the reported periods.

 

The increase in sales during the nine months ended September 30, 2015 compared to the same period in 2014 was primarily attributable to a 34% increase in pump shipments from 6,893 in the first nine months of 2014 to 9,249 in the same period of 2015. During the first nine months of 2014, we expanded from 36 to 60 sales territories. At September 30, 2015, we operated with 60 sales territories. During the expansion of the sales territories in 2014 and for several months following, we believe our sales representatives experienced some disruption in their individual productivity as territories were realigned and responsibilities adjusted.

 

Sales to distributors accounted for 77% and 72% of our total sales for the nine months ended September 30, 2015 and 2014, respectively. The mix of sales to distributors versus direct customers is principally determined by whether or not we have a contractual arrangement with the underlying third-party insurance payor. The increase in the percentage of our sales to distributors is primarily attributable to certain arrangements between insurance payors and our distributors that became effective during the third quarter of 2014. As a result of these arrangements, a portion of our business that previously involved an opportunity to make a direct sale to the customer transitioned to an opportunity to make a sale through a distributor. The new arrangement afforded certain members easier access to our products as an in-network benefit and provided access to our products to a large portion of members who were previously unable to obtain coverage for our products.

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Cost of Sales and Gross Profit. Our cost of sales for the nine months ended September 30, 2015 was $30.6 million, representing an increase of 32% compared to $23.1 million for the same period in 2014. Gross profit for the nine months ended September 30, 2015 was $13.1 million and gross margin was 30% compared to gross profit of $8.7 million and gross margin of 27% for the same period in 2014. Cost of sales for the nine months ended September 30, 2015 excluded $230,000 deferred cost of sales in conjunction with the exchange program. Included in cost of sales for the nine months ended September 30, 2014 was $0.4 million associated with our voluntary product recall of selected lots of cartridges initiated in January 2014, which resulted in a reduction of the gross margin for that period of one percentage point.

 

The increase in our gross margin for the nine months ended September 30, 2015 compared to the comparable period in 2014, was primarily due to an improvement in per-unit manufacturing overhead costs, driven by increased production volumes and manufacturing efficiencies. This increase was partially offset by the percentage of products sold to distributors versus directly to individual customers, the varying levels of reimbursement among a changing mix of third-party payors and an increase in sales of pump-related supplies, which generally have lower gross margins than our insulin pumps.

 

Selling, General and Administrative Expenses. SG&A expenses increased 6% to $58.1 million for the nine months ended September 30, 2015 from $55.0 million for the same period in 2014. Employee-related expenses for our sales, general and administrative functions comprise the majority of the SG&A expenses. Such employee-related expenses increased $3.8 million for the period ended September 30, 2015 as compared to the same period in 2014, including an increase of $1.9 million in sales commissions. The increase in SG&A expenses was offset by a decrease of $0.7 million primarily associated with travel expenses, supplies, and outside services as compared to the same period in 2014.

 

Research and Development Expenses. R&D expenses increased 8% to $12.8 million for the nine months ended September 30, 2015 from $11.9 million for the same period in 2014, principally as a result of increased headcount within our R&D organization. Included in the R&D expenses are $1.0 million milestone payments made to DexCom, under the DexCom Agreement, in each of the nine months ended September 30, 2015 and 2014.

 

Other Income and Expense. Other expense for the nine months ended September 30, 2015 and 2014 was $2.8 million and $3.0 million, respectively. This was primarily comprised of interest expense associated with the term loan agreement with Capital Royalty Partners. The decrease in expense is due to a reduction in the interest rate from 14% to 11.5% effective April 2014. Other income for both periods presented was not material.

 

Liquidity and Capital Resources

 

At September 30, 2015, we had $83.8 million in cash, cash equivalents and short-term investments, which included $2.0 million of restricted cash. We believe that our current cash and cash equivalents balances, together with cash generated from operations and proceeds from the exercise of options and warrants will be sufficient to satisfy our liquidity requirements for at least the next twelve months. We expect that our future liquidity and capital resource needs will be impacted by numerous factors, including market acceptance and sales of our products, and our financial and operating performance. We have utilized, and may continue to utilize, debt arrangements with debt providers and financial institutions to finance our operations. Factors such as interest rates and available cash will impact our decision to continue to utilize debt arrangements as a source of cash.

 

Historically, our primary sources of cash have included private placements and public offerings of equity securities, debt arrangements, and cash generated from operations. Our historical cash outflows have primarily been associated with cash used for operating activities such as the purchase of inventory, expansion of our sales and marketing infrastructure, increase in our R&D activities and other working capital needs, as well as cash used for investing activities, such as the acquisition of intellectual property, expenditures related to equipment and improvements used to increase our manufacturing capacity and improve our manufacturing efficiency and overall facility expansion.

 

The following table shows a summary of our cash flows for the nine months ended September 30, 2015 and 2014:

 

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Operating activities. Net cash used in operating activities was $48.5 million for the nine months ended September 30, 2015, compared to $47.8 million for the same period in 2014. The change in net cash used in operating activities was primarily due to an increase in inventory to meet higher production volumes, including those associated with new products, offset by other changes in working capital including those resulting from the timing of payments of certain liabilities.

 

Investing activities. Net cash used in investing activities was $6.4 million for the nine months ended September 30, 2015, which was primarily related to the purchase of $67.5 million of short-term investments and $4.1 million of long-term assets, offset by proceeds from sales and maturities of short-term investments of $65.2 million. Net cash used in investing activities was $43.0 million for the nine months ended September 30, 2014, which was primarily related to the net purchase of $61.9 million in short-term investments and $3.7 million in purchases of property and equipment, offset by proceeds from sales and maturities of short-term investments of $22.7 million.

 

Financing activities. Net cash provided by financing activities was $67.0 million for the nine months ended September 30, 2015, which was primarily the result of the net proceeds from a public offering of our common stock in the amount of $64.9 million and $2.1 million in proceeds from the issuance of common stock through our ESPP, as well as the exercise of outstanding stock options and warrants. Net cash provided by financing activities was $2.0 million for the nine months ended September 30, 2014, which was primarily related to net proceeds from the exercise of outstanding stock options and warrants, as well as purchases of common stock by employees pursuant to the ESPP. 

 

Our liquidity position and capital requirements are subject to fluctuation based on a number of factors. For example, our cash inflows and outflows may be impacted by the following:

 

 

 

 

Our primary short-term capital needs, which are subject to change, include expenditures related to:

 

 

 

 

 

 

 

 

 

Although we believe the foregoing items reflect our most likely uses of cash in the short term, we cannot predict with certainty all of our particular short-term cash uses or the timing or amount of cash used. If cash generated from operations is insufficient to satisfy our working capital and capital expenditure requirements, we may be required to sell additional equity or debt securities or obtain additional credit facilities. Additional capital, if needed, may not be available on satisfactory terms, if at all. Furthermore, any additional equity financing may be dilutive to stockholders, and debt financing, if available, may include restrictive covenants and commit us to significant additional debt service obligations.

 

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Indebtedness

 

Capital Royalty Partners Term Loans

 

At September 30, 2015, we had $30.0 million aggregate borrowings outstanding under a term loan agreement with Capital Royalty Partners. Under the agreement, interest is payable, at our option, (i) in cash at a rate of 11.5% per annum or (ii) at a rate of 9.5% of the 11.5% per annum in cash and 2.0% of the 11.5% per annum to be added to the principal of the loan and subject to accruing interest. We have elected to pay interest in cash at a rate of 11.5% per annum. Interest-only payments are due quarterly on March 31, June 30, September 30 and December 31 of each year of the interest-only payment period, which ends on December 31, 2019. The principal balance is due in full at the end of the term of the loan which is March 31, 2020.

          

The loan is collateralized by all of our assets. The term loan agreement also imposes various affirmative and negative covenants on us. The principal financial covenants require that we attain minimum annual revenues of $50.0 million in 2015, $65.0 million in 2016, $80.0 million in 2017 and $95.0 million each year thereafter until the end of the term of the loan. At September 30, 2015, we were in compliance with all of the covenants in the Amended and Restated Term Loan Agreement.

 

Critical Accounting Policies

 

Our discussion and analysis of our financial condition and results of operations are based on our financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our financial statements. We evaluate our estimates and judgments on an ongoing basis. 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 our financial condition and results of operations that are not readily apparent from other sources. Actual results may differ from these estimates. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies Involving Management Estimates and Assumptions”, included in our Annual Report on Form 10-K for the year ended December 31, 2014.

 

Off-Balance Sheet Arrangements

 

We do not have any off-balance sheet arrangements.

 

 

 

We invest our excess cash primarily in commercial paper, government-sponsored enterprise securities and U.S. government treasury securities. Some of the financial instruments in which we invest have market risk associated with them, in that a change in prevailing interest rates may cause the principal amount of the instrument to fluctuate. Other financial instruments in which we invest potentially subject us to credit risk, in that the value of the instrument may fluctuate based on the issuer’s ability to pay.

 

The primary objectives of our investment activities are to maintain liquidity and preserve principal while maximizing the income we receive from our financial instruments without significantly increasing risk. We have established guidelines regarding approved investments and maturities of investments, which are primarily designed to maintain liquidity and preserve principal.

 

Because of the short-term maturities of our financial instruments, we do not believe that an increase or decrease in market interest rates would have any significant impact on the realized value of our investment portfolio. If a 10% change in interest rates were to have occurred on September 30, 2015, this change would not have had a material effect on the fair value of our investment portfolio as of that date.

 

The interest rate under our Amended and Restated Term Loan Agreement is fixed and not subject to changes in market interest rates.

 

Our operations are located in the United States, and nearly all of our sales since inception have been made in U.S. dollars. Accordingly, we have assessed that we do not have any material exposure to foreign currency rate fluctuations. From time to time, we may have foreign exchange risk associated with currency exposure related to existing assets and liabilities, committed transactions and forecasted future cash flows. In certain circumstances, we may seek to manage our foreign exchange risk by using derivative instruments such as foreign exchange forward contracts to hedge our risks. In general, we may hedge material foreign exchange exposures up to twelve months in advance. However, we may choose not to hedge some exposures for a variety of reasons including prohibitive economic costs.

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Since commercialization of our products, inflation has not had a material impact on our financial position.

 

 

Evaluation of Disclosure Controls and Procedures

 

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in the periodic and current reports that we file with the SEC is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow for timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable and not absolute assurance of achieving the desired control objectives. In reaching a reasonable level of assurance, management necessarily is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. In addition, the design of any system of controls is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance a particular design will succeed in achieving its stated goals under all potential future conditions. Furthermore, over time, controls may become inadequate because of changes in conditions, or the degree of compliance with policies or procedures may deteriorate. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

 

As of September 30, 2015, we carried out an evaluation, under the supervision and with the participation of our management, including our principal executive officer and principal financial officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act. Based on this evaluation, our principal executive officer and principal financial officer concluded that our disclosure controls and procedures were effective at the reasonable assurance level as of September 30, 2015.

 

Changes in Internal Control over Financial Reporting

 

There were no changes in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) during the quarter ended September 30, 2015, that have materially affected, or are reasonably likely to materially affect, the Company’s internal control over financial reporting.

 

 

 

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PART II. OTHER INFORMATION

 

 

From time to time we may be involved in various disputes and litigation matters that arise in the ordinary course of business. We are currently not a party to any material legal proceedings.

 

Item 1A. Risk Factors

 

The following sets forth certain risk factors associated with our business. The risk factors set forth below marked with an asterisk (*) next to the title contain changes to the description of the risk factors associated with our business previously disclosed in Part I, Item 1A of our Annual Report on Form 10-K for the year ended December 31, 2014.

 

If any of the following risks occur, our business, financial condition, results of operations or prospects could be materially and adversely affected. In these circumstances, the market price of our common stock could decline and you might lose all or part of your investment. Additional risks and uncertainties of which we are currently unaware may also become important factors that affect us.

 

Risks Relating to Our Business and our Industry

 

We have incurred significant operating losses since inception and cannot assure you that we will achieve profitability.*

 

Since our inception in January 2006 we have incurred a significant net loss. As of September 30, 2015, we had an accumulated deficit of $309.0 million. To date, we have financed our operations primarily through public and private sales of our equity securities, debt financing with Capital Royalty Partners and certain of its affiliates, and sales of our products. We have devoted substantially all of our resources to the research and development of our products, the commercial launch of our products, the development of a sales and marketing team and the assembly of a management team to manage our business.

 

We began commercial sales of our flagship t:slim insulin pump in the third quarter of 2012. We began commercial sales of our t:flex insulin pump in the second quarter of 2015 and our t:slim G4 insulin pump in the third quarter of 2015. Since the first quarter of 2013, we have been able to manufacture and sell our insulin pump products at a cost and in volumes sufficient to allow us to achieve a positive gross margin. For the years ended December 31, 2014 and 2013, our gross profit was $15.2 million and $6.2 million, respectively. For the nine months ended September 30, 2015 and 2014, our gross profit was $13.1 million and $8.7 million, respectively. However, although we have achieved a positive gross margin, we still operate at a substantial net loss and expect that we will continue to do so for the next several years.

 

To implement our business strategy we need to, among other things, grow our sales and marketing infrastructure to increase sales of our products, fund ongoing research and development activities, expand our manufacturing capabilities, and obtain regulatory clearance or approval to commercialize our products currently under development. We expect our expenses to increase significantly as we pursue these objectives. The extent of our future operating losses and the timing of profitability are highly uncertain, especially given that we expect to further expand the size of our sales, clinical and marketing infrastructure and that we only recently began sales of two new commercial products, which makes forecasting our sales more difficult. Any additional operating losses will have an adverse effect on our stockholders’ equity, and we cannot assure you that we will ever be able to achieve or sustain profitability.

 

We currently rely on sales of insulin pumps to generate a significant portion of our revenue, and any factors that negatively impact sales of our insulin pump products may adversely affect our business, financial condition and operating results.*

 

We generate a significant majority of our commercial revenue from the sale of our insulin pump products, which include our t:slim, t:flex and t:slim G4 products.

 

Sales of our insulin pumps may be negatively impacted by many factors, including:

 

 

 

 

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In addition, sales of our t:slim G4 insulin pump in particular are subject to the continuation of our Development and Collaboration Agreement with DexCom, Inc, which is subject to termination by DexCom, with or without cause, on relatively short notice.

 

Because we currently rely on sales of our insulin pump products to generate a significant majority of our revenue, any factors that negatively impact sales of these products, or result in sales of these products increasing at a lower rate than expected, could adversely affect our business, financial condition and operating results and negatively impact our ability to successfully launch future products currently under development.

 

The failure of our products to achieve and maintain market acceptance could result in us achieving sales below our expectations, which would cause our business, financial condition and operating results to be materially and adversely affected. *

 

Our current business strategy is highly dependent on our insulin pump products, which include t:slim, t:flex and t:slim G4 achieving and maintaining market acceptance. We began commercial sales of t:flex in the second quarter of 2015 and of t:slim G4 in the third quarter of 2015. In order for us to sell our products to people with insulin-dependent diabetes, we must convince them, their caregivers and healthcare providers that it is an attractive alternative to competitive products for the treatment of diabetes, including traditional insulin pump products and MDI therapies, as well as alternative insulin treatment methodologies. Market acceptance and adoption of our products depends on educating people with diabetes, as well as their caregivers and healthcare providers, as to the distinct features, ease-of-use, positive lifestyle impact, and other perceived benefits of our products as compared to competitive products. If we are not successful in convincing existing and potential customers of the benefits of our products, or if we are not able to achieve the support of caregivers and healthcare providers for our insulin pump products, our sales may decline or we may fail to increase our sales in line with our forecasts.

 

Achieving and maintaining market acceptance of our products could be negatively impacted by many factors, including:

 

 

 

 

 

 

 

In addition, t:slim, t:flex and t:slim G4 may be perceived by people with insulin-dependent diabetes, their caregivers or healthcare providers to be more complicated, less reliable or less effective than traditional insulin therapies, including MDI, and people may be unwilling to change their current treatment regimens. These negative perceptions may be heightened following our January 2014 recall of cartridges used with t:slim.

 

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Moreover, we believe that healthcare providers tend to be slow to change their medical treatment practices because of perceived liability risks arising from the use of new products and the uncertainty of third-party reimbursement. Accordingly, healthcare providers may not recommend our products until there is sufficient evidence to convince them to alter the treatment methods they typically recommend, such as receiving recommendations from prominent healthcare providers or other key opinion leaders in the diabetes treatment community that our products are effective in providing insulin therapy. Additionally, payors may have more stringent requirements for reimbursement.

 

Further, even if we are able to convince people with insulin-dependent diabetes, their caregivers or healthcare providers that our products compare favorably to the products and treatment alternatives offered by our competitors, the rapid evolution of technology and treatment options within our industry may cause consumers to delay the purchase of our products in anticipation of advancements, or the perception that advancements could occur, in our products or the products offered by our competitors. For example, we believe that during the third quarter of 2015 there were consumers interested in purchasing one of our insulin pump products may have delayed the purchase decision in anticipation of the release of the t:slim G4. It is also possible that consumers interested in purchasing any of our future products currently in development may delay the purchase of one of our current products, particularly in light of our current practice of generally not offering product upgrades to existing customers.

 

If t:slim, t:flex and t:slim G4 do not achieve and maintain widespread market acceptance, we may fail to achieve sales at or above our projected amounts. If our sales do not meet our projections, we may fail to meet our strategic objectives, and our business, financial condition and operating results could be materially and adversely affected.

 

Failure to secure or retain adequate coverage or reimbursement for our current products and our potential future products by third-party payors could adversely affect our business, financial condition and operating results.*

 

We expect to derive nearly all of our revenue during 2015 from sales of t:slim, t:flex and t:slim G4 insulin pumps and associated supplies, and expect to continue to do so until we are able to commercialize our other products that are currently under development. A substantial portion of the purchase price of an insulin pump is typically paid for by third-party payors, including private insurance companies, preferred provider organizations and other managed care providers. Future sales of our current and future products will be limited unless our customers can rely on third-party payors to pay for all or part of the associated purchase cost. Because we only recently initiated commercial sales of t:flex and t:slim G4, there remains some uncertainty regarding the coverage that third-party payors will offer for our new products, particularly for individuals with type 2 diabetes where coverage requirements may necessitate additional laboratory tests or other information to support a determination of medical necessity. Access to adequate coverage and reimbursement for our current and future products by third-party payors is essential to the acceptance of our products by customers.

 

Many third-party payors use coverage decisions and payment amounts determined by the Centers for Medicare and Medicaid Services, or CMS, which administers the U.S. Medicare program, as guidelines in setting their coverage and reimbursement policies. Medicare has recently begun to review its reimbursement practices for diabetes-related products. Medicare implemented a competitive bidding process for blood glucose strip reimbursement, which resulted in a significant reduction in the reimbursement rate for those products. More recently, Medicare has also initiated a competitive bidding process for insulin pumps in limited geographies. As a result, there is uncertainty as to the future Medicare reimbursement rate for our products. In addition, those third-party payors that do not follow the CMS guidelines may adopt different coverage and reimbursement policies for our current and future products. It is possible that some third-party payors will not offer any coverage for our current or future products.

 

We currently have contracts establishing reimbursement for our insulin pump products with approximately 100 national and regional third-party payors in the United States. We are also currently in the process of approaching these and other third-party payors to discuss reimbursement for t:flex and t:slim G4. While we anticipate adding coverage for t:flex and t:slim G4 under our current agreements and entering into additional contracts with third-party payors to provide reimbursement for t:slim, t:flex and t:slim G4, we cannot guarantee that we will succeed in doing so or that the reimbursement contracts that we are able to negotiate will enable us to sell our products on a profitable basis. In addition, contracts with third-party payors generally can be modified or terminated by the third-party payor without cause and with little or no notice to us. Moreover, compliance with the administrative procedures or requirements of third-party payors may result in delays in processing approvals by those third-party payors for customers to obtain coverage for our products. Failure to secure or retain adequate coverage or reimbursement for our current and future products by third-party payors, or delays in processing approvals by those payors, could result in the loss of sales, which could have a material adverse effect on our business, financial condition and operating results.

 

Further, the healthcare industry in the United States is increasingly focused on cost containment as government and private insurers seek to control healthcare costs by imposing lower payment rates and negotiating reduced contract rates with third-party payors. If third-party payors deny coverage or reduce their current levels of payment, or if our production costs increase faster than increases in reimbursement levels, we may be unable to sell our products on a profitable basis.

 

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We operate in a very competitive industry and if we fail to compete successfully against our existing or potential competitors, many of whom have greater resources than us, our sales and operating results may be negatively affected. *

 

The medical device industry is intensely competitive, subject to rapid change and highly sensitive to the introduction of new products or technologies, or other activities of industry participants. We expect our products will compete directly with a number of traditional insulin pumps as well as other methods for the treatment of diabetes. In particular, we expect that the competitive landscape for t:flex and t:slim G4 will be similar to that of t:slim.

 

Many of our existing and potential competitors are major medical device companies that are either publicly traded companies or divisions or subsidiaries of publicly traded companies. For instance, Medtronic MiniMed, a division of Medtronic, Inc., has been the market leader for many years and has the majority share of the traditional insulin pump market in the United States. Other significant insulin pump suppliers in the United States include Animas Corporation, a division of Johnson & Johnson, Roche Diagnostics, a division of F. Hoffman-La Roche Ltd., and Insulet Corporation. There are also newer companies entering the field.

 

Many of these more established competitors enjoy several competitive advantages over us, including:

 

 

 

 

 

 

 

 

 

In some instances, our competitors also offer products that include features that we do not currently offer. For instance, Medtronic currently offers a traditional insulin pump that is integrated with a CGM system with a threshold suspend feature, and Insulet offers an insulin pump with a tubeless delivery system that does not utilize an infusion set. For these and other reasons, we may not be able to compete successfully against our current or potential future competitors. As a result, we may fail to meet our strategic objectives and forecasted budget, and our business, financial condition and operating results could be materially and adversely affected.

 

Competitive products or other technological breakthroughs for the monitoring, treatment or prevention of diabetes or technological developments may render our products obsolete or less desirable. *

 

Our ability to achieve our strategic objectives will depend, among other things, on our ability to develop and commercialize products for the treatment of diabetes that offer distinct features, are easy-to-use, receive adequate coverage and reimbursement from third-party payors, and are more appealing than available alternatives. Our primary competitors, as well as a number of other companies, medical researchers and pharmaceutical companies are pursuing new delivery devices, delivery technologies, sensing technologies, procedures, drugs and other therapies for the monitoring, treatment and prevention of diabetes. Any technological breakthroughs in diabetes monitoring, treatment or prevention could reduce the potential market for our products or render our products obsolete altogether, which would significantly reduce our sales or cause our sales to grow at a slower rate than we currently expect. In addition, even the perception that technological or treatment advancements could occur in the future could cause consumers to delay the purchase of our products.

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Because the insulin-dependent diabetes market is large and growing, we anticipate that companies will continue to dedicate significant resources to developing competitive products. The frequent introduction by competitors of products that are or claim to be superior to our products may create market confusion that may make it difficult to differentiate the benefits of our products over competitive products. In addition, the entry of multiple new products has led some of our competitors to employ pricing strategies, including the use of discounts, rebates, low cost product upgrades or other financial incentives that could adversely affect sales of our products. If a competitor develops a product that competes with or is perceived to be superior to our own products, or if competitors continue to utilize strategies that place downward pressure on pricing within our industry, our sales may decline, our operating margins could be reduced and we may fail to meet our projections, which would materially and adversely affect our business, financial condition and operating results.

 

Moreover, we have designed our products to resemble modern consumer electronic devices to address certain embarrassment and functionality concerns consumers have raised with respect to traditional pumps. The consumer electronics industry is itself highly competitive, and characterized by continual new product introductions, rapid developments in technology, and subjective and changing consumer preferences. If, in the future, consumers cease to view our products as contemporary or convenient as compared to then-existing consumer electronics technology, our products may become less desirable.

 

If we are unable to expand our sales, marketing and clinical infrastructure effectively and on a timely basis, we may fail to increase our sales to meet our forecasts. *

 

Because we began commercialization of t:slim in the third quarter of 2012, of t:flex in the second quarter of 2015 and of t:slim G4 in the third quarter of 2015, we have only limited experience marketing and selling our products as well as training new customers on their use. Moreover, we have no experience training new customers on the use of continuous glucose monitoring, which we will begin to perform in connection with the commercialization of the t:slim G4. In addition, the vast majority of our existing customers are individuals with type 1 diabetes, and we have only limited experience in marketing and selling our products to customers with type 2 diabetes. As a result, we may face unexpected challenges as we begin marketing and selling t:flex. We expect to derive nearly all of our revenue from the sale of t:slim, t:flex, t:slim G4 and pump-related supplies unless and until we receive regulatory clearance or approval for other products currently in development. As a result, our financial condition and operating results are and will continue to be highly dependent on the ability of our sales representatives to adequately promote, market and sell our current generation of insulin pumps, and the ability of our diabetes educators to train new customers on the use of our products. If our sales and marketing representatives or diabetes educators fail to achieve their objectives, our sales could decrease or may not increase at levels that are in line with our forecasts.

 

A key element of our business strategy is the continued expansion of our sales, marketing and clinical infrastructure to drive adoption of our products, which includes our team of diabetes educators that trains new customers on the use of our products. We have rapidly increased the number of sales, marketing and clinical personnel employed by us since the initial commercial launch of t:slim in 2012. However, we have faced considerable challenges in growing and managing our sales, marketing and clinical force over the past 12-18 months, including with respect to recruiting, training and assimilation of new territories and accounts. We expect to continue to face significant challenges as we manage and grow our sales, marketing and clinical infrastructure and work to motivate and retain the individuals who make up those networks. In particular, we intend to further expand our sales and marketing infrastructure over the next year, and newly hired sales representatives require training and take time to achieve full productivity. Moreover, the overall expansion of our sales force disrupts the productivity of our existing sales representatives. Unexpected turnover, especially during a period of anticipated expansion, would have a negative impact on our ability to achieve our sales projections. Further, if a sales, marketing or clinical representative were to depart and be retained by one of our competitors, we may fail to prevent him or her from helping competitors solicit business from our existing customers, which could adversely affect our sales. Similarly, if we are not able to recruit and retain a network of diabetes educators, we may not be able to successfully train new customers on the use of our products, which could delay new sales and harm our reputation.

 

We expect that the management and future expansion of our sales, marketing and clinical personnel will continue to place significant burdens on our management team. If we are unable to retain and expand our sales, marketing and clinical capabilities in line with our strategic plans, we may not be able to effectively commercialize our existing or planned products, or enhance the strength of our brand, either of which could result in the failure of our sales to increase in line with our projections or could even cause sales to decline.

 

Our sales and marketing efforts are dependent on independent distributors who are free to market products that compete with our own. If we are unable to maintain or expand our network of independent distributors, our sales may be negatively affected.*

 

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For the year ended December 31, 2014, sales to approximately 36 independent distributors represented approximately 75% of our sales, and for the nine months ended September 30, 2015 sales to independent distributors represented an even greater percentage of our overall sales. While our goal is to reduce the percentage of our sales to independent distributors over time as we enter into contracts with additional third-party payors, we believe that a meaningful percentage of our sales will continue to be to independent distributors for the foreseeable future and it is possible that the percentage of our sales to independent distributors could even increase in the near term. For example, our dependence upon independent distributors could increase if third-party payors decide to contract with independent distributors directly in lieu of contracting with us to supply our products to their members on a direct basis. Our dependence upon independent distributors could also increase if customers prefer to purchase all of their diabetes supplies through a single source, instead of purchasing pump-related products through us and other diabetes supplies through other suppliers. None of our independent distributors has been required to sell our products exclusively and each of them may freely sell the products of our competitors. Our distributor agreements generally have one-year initial terms with automatic one-year renewal terms, and are terminable in connection with a party’s material breach.

 

Some of our independent distributors account for a significant portion of our sales volume. For the year ended December 31, 2014, our three largest independent distributors comprised approximately 38% of our sales. If any of our key independent distributors were to cease to distribute our products, our sales could be adversely affected. In such a situation, we may need to seek alternative independent distributors or increase our reliance on our other independent distributors or our direct sales representatives, which may not prevent our sales from being adversely affected. Additionally, to the extent that we enter into additional arrangements with independent distributors to perform sales, marketing, or distribution services, the terms of the arrangements could cause our product margins to be lower than if we directly marketed and sold our products.

 

Our ability to maintain and grow our revenue depends in part on retaining a high percentage of our customer base.

 

A key to maintaining and growing our revenue is the retention of a high percentage of our customers due to the potentially significant revenue generated from ongoing purchases of disposable insulin cartridges. In addition, our pumps are designed and tested to remain effective for four years and a satisfied customer may consider purchasing another product from us when the time comes to replace the pump. We have developed retention programs aimed at customers, their caregivers and healthcare providers, which include training specific to our products, ongoing support by sales and clinical employees and 24/7 technical support and customer service. If demand for our products fluctuates as a result of the introduction of competitive products, changes in reimbursement policies, manufacturing problems, perceived safety or reliability issues with our or competitors’ products, the failure to secure regulatory clearance or approvals, or for other reasons, our ability to attract and retain customers could be harmed. The failure to retain a high percentage of our customers would negatively impact our revenue growth and may have a material adverse effect on our business, financial condition and operating results.

 

If important assumptions about the potential market for our products are inaccurate, or if we have failed to understand what people with insulin-dependent diabetes are seeking in an insulin pump, our business and operating results may be adversely affected.

 

Our business strategy was developed based on a number of important assumptions about the diabetes industry in general, and the insulin-dependent diabetes market in particular, any one or more of which may prove to be inaccurate. For example, we believe that the benefits of insulin pump therapy as compared to other common insulin treatment alternatives will continue to drive growth in the market for insulin pump therapy. In addition, we believe the incidence of diabetes in the United States and worldwide is increasing rapidly. However, each of these trends is uncertain and limited sources exist to obtain reliable market data. The actual incidence of diabetes, and the actual demand for our products or competitive products, could differ materially from our projections if our assumptions are incorrect. In addition, our strategy of focusing exclusively on the insulin-dependent diabetes market may limit our ability to increase sales or achieve profitability.

 

Another key element of our business strategy is utilizing market research to understand what people with diabetes are seeking to improve their diabetes therapy management. This strategy underlies our entire product design, marketing and customer support approach and is the basis on which we developed our current products and are pursuing the development of new products. However, our market research is based on interviews, focus groups and online surveys involving people with insulin-dependent diabetes, their caregivers and healthcare providers that represent only a small percentage of the overall insulin-dependent diabetes market. As a result, the responses we received may not be reflective of the broader market and may not provide us accurate insight into the desires of people with insulin-dependent diabetes. In addition, understanding the meaning and significance of the responses received during our market research necessarily requires that analysis be conducted and conclusions be drawn. We may not be able perform an analysis that yields meaningful results, or the conclusions we draw from the analysis could be misleading. Moreover, even if our market research has allowed us to better understand the features consumers are seeking in an insulin pump to improve management of their diabetes therapy, there can be no assurance that consumers will actually purchase our products or that our competitors will not develop products with similar features.

 

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We have a limited operating history and may face difficulties encountered by companies early in their commercialization in competitive and rapidly evolving markets.*

 

We commenced operations in 2006, began commercializing t:slim in the third quarter of 2012 and significantly expanded our operations during 2014. We commenced commercial sales of t:flex in the second quarter of 2015 and of t:slim G4 in the third quarter of 2015. Accordingly, we have a limited operating history upon which to evaluate our business and forecast our future sales and operating results, especially with respect to the impact of t:flex and t:slim G4 on our mix of product sales and our overall growth rate. In assessing our business prospects, you should consider the various risks and difficulties frequently encountered by companies early in their commercialization in competitive and rapidly evolving markets, particularly companies that develop and sell medical devices. These risks include our ability to:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Due to our limited operating history, we may not have the institutional knowledge or experience to be able to effectively address these and other risks that may face our business. In addition, we may not be able to develop insights into trends that could emerge and negatively affect our business and may fail to respond effectively to those trends. As a result of these or other risks, we may not be able to execute key components of our business strategy, and our business, financial condition and operating results may suffer.

 

Manufacturing risks may adversely affect our ability to manufacture products and could negatively impact our sales and operating margins.*

 

Our business strategy depends on our ability to manufacture our current and proposed products in sufficient quantities and on a timely basis so as to meet consumer demand, while adhering to product quality standards, complying with regulatory requirements and managing manufacturing costs. We are subject to numerous risks relating to our manufacturing capabilities, including:

 

 

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These risks are likely to be exacerbated by our limited experience with our current products and manufacturing processes. As demand for our products increases, and as the number of our commercial products expands, we will have to invest additional resources to purchase components, hire and train employees, and enhance our manufacturing processes and quality systems. Over the past year we have implemented several new pieces of equipment that are intended to improve our manufacturing capacity and efficiency and we expect to implement additional equipment and procedures over the next 12 months. However, it is possible that we may not derive the anticipated improvements from these investments. If we fail to increase our production capacity efficiently while also maintaining quality requirements, our sales may not increase in line with our forecasts and our operating margins could fluctuate or decline. In addition, although we expect some of our products in development to share product features and components with our current products, manufacturing of these products may require the modification of our production lines, the hiring of specialized employees, the identification of new suppliers for specific components, the implementation of additional equipment and procedures, or the development of new manufacturing technologies. It may not be possible for us to manufacture these products at a cost or in quantities sufficient to make these products commercially viable.

 

We depend on a limited number of third-party suppliers for certain components, and the loss of any of these suppliers, or their inability to provide us with an adequate supply of materials, could harm our business.*

 

We rely on third-party suppliers to supply components of our current products and of our potential future products, including our disposable cartridges. For example, we rely on plastic injection molding companies to provide plastic molded components, electronic manufacturing suppliers to provide electronic assemblies, and machining companies to provide machined mechanical components. We also purchase all of our infusion sets and pump accessories from third-party suppliers. For our business strategy to be successful, our suppliers must be able to provide us with components in sufficient quantities, in compliance with regulatory requirements and quality control standards, in accordance with agreed upon specifications, at acceptable costs and on a timely basis. Increases in our product sales, whether forecasted or unanticipated, could strain the ability of our suppliers to deliver an increasingly large supply of components in a manner that meets these various requirements.

 

We do not have long-term supply agreements with most of our suppliers and, in many cases, we make our purchases on a purchase order basis. Under most of our supply agreements, we have no obligation to buy any given quantity of products, and our suppliers have no obligation to manufacture for us or sell to us any given quantity of products. As a result, our ability to purchase adequate quantities of our products may be limited. Additionally, our suppliers may encounter problems that limit their ability to manufacture products for us, including financial difficulties or damage to their manufacturing equipment or facilities. If we fail to obtain sufficient quantities of high quality components to meet demand on a timely basis, we could lose customer orders, our reputation may be harmed and our business could suffer.

 

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We generally use a small number of suppliers for our products. Depending on a limited number of suppliers exposes us to risks, including limited control over pricing, availability, quality and delivery schedules. Moreover, due to the recent commercialization of our products and the limited amount of our sales to date, we do not have long-standing relationships with our manufacturers and may not be able to convince suppliers to continue to make components available to us unless there is demand for such components from their other customers. As a result, there is a risk that certain components could be discontinued and no longer available to us. We have in the past been, and we may in the future be, required to make significant “last time” purchases of component inventory that is being discontinued by the manufacturer to ensure supply continuity. If any one or more of our suppliers cease to provide us with sufficient quantities of components in a timely manner or on terms acceptable to us, we would have to seek alternative sources of supply. Because of factors such as the proprietary nature of our products, our quality control standards and regulatory requirements, we cannot quickly engage additional or replacement suppliers for some of our critical components. Failure of any of our suppliers to deliver products at the level our business requires would limit our ability to meet our sales commitments, which could harm our reputation and could have a material adverse effect on our business.

 

We may also have difficulty obtaining similar components from other suppliers that are acceptable to the FDA, or other regulatory agencies, and the failure of our suppliers to comply with strictly enforced regulatory requirements could expose us to regulatory action including warning letters, product recalls, termination of distribution, product seizures or civil penalties. It could also require us to cease using the components, seek alternative components or technologies and modify our products to incorporate alternative components or technologies, which could result in a requirement to seek additional regulatory approvals. Any disruption of this nature or increased expenses could disrupt our ability to manufacture our products on a timely basis or in sufficient quantities, or at all, which could harm our commercialization efforts and adversely affect our operating results.

 

We operate primarily at a single location comprised of five buildings, and any disruption at this location could adversely affect our business and operating results.*

 

Our principal offices are presently located in five buildings in San Diego, California. Substantially all of our operations are conducted at this location, including our manufacturing processes, research and development activities, customer and technical support, and management and administrative functions. In addition, substantially all of our inventory of component supplies and finished goods is held at this location. We take precautions to safeguard our facilities, including acquiring insurance, employing back-up generators, adopting health and safety protocols and utilizing off-site storage of computer data. However, vandalism, terrorism or a natural or other disaster, such as an earthquake, fire or flood, could damage or destroy our manufacturing equipment or our inventory of component supplies or finished goods, cause substantial delays in our operations, result in the loss of key information, and cause us to incur additional expenses. Our insurance may not cover our losses in any particular case. In addition, regardless of the level of insurance coverage, damage to our facilities may have a material adverse effect on our business, financial condition and operating results.

 

If we do not enhance our product offerings through our research and development efforts, we may fail to effectively compete or become profitable.

 

In order to increase our sales and market share in the insulin-dependent diabetes market, we must enhance and broaden our product offerings in response to the evolving demands of people with insulin-dependent diabetes and healthcare providers, as well as competitive pressures and technologies. We may not be successful in developing, obtaining regulatory approval for, or marketing our proposed products when anticipated, or at all. In addition, notwithstanding our market research efforts, our future products may not be accepted by consumers, their caregivers, healthcare providers or third-party payors who reimburse consumers for our products. The success of any proposed product offerings will depend on numerous factors, including our ability to:

 

 

 

 

 

 

 

 

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If we fail to generate demand by developing products that incorporate features requested by consumers, their caregivers or healthcare providers, or if we do not obtain regulatory clearance or approval for proposed products in time to meet market demand, we may fail to generate sales sufficient to achieve or maintain profitability. We have in the past experienced, and we may in the future experience, delays in various phases of product development and commercial launch, including during research and development, manufacturing, limited release testing, marketing and customer education efforts. Any delays in our anticipated regulatory submissions or approvals, or subsequent product launches, may significantly impede our ability to successfully compete in our markets. In particular, such delays could cause customers to delay or forego purchases of our products, or to purchase our competitors’ products. Even if we are able to successfully develop proposed products when anticipated, these products may not produce sales in excess of the costs of development, and they may be quickly rendered obsolete by changing consumer preferences or the introduction by our competitors of products embodying new technologies or features.

 

The safety and efficacy of our products is not supported by long-term clinical data, which could limit sales, and our products could cause unforeseen negative effects.*

 

t:slim, which we currently market in the United States, received pre-market clearance under Section 510(k) of the U.S. Federal Food, Drug, and Cosmetic Act, or FDCA. t:flex, which we began marketing and selling in the United States during the second quarter of 2015, also received 501(k) clearance. The 510(k) clearance process is shorter and typically requires the submission of less supporting documentation than other FDA approval processes and does not always require long-term clinical studies. t:slim G4, which we began marketing and selling in the United States during the third quarter of 2015, received FDA approval under a PMA. However, there are no published studies to evaluate the safety or effectiveness of the t:slim G4.

 

As a result, we currently lack the breadth of published long-term clinical data supporting the safety and efficacy of our products and the benefits they offer that might have been generated in connection with other approval processes. For these reasons, people with insulin-dependent diabetes and healthcare providers may be slower to adopt or recommend our products, we may not have comparative data that our competitors have or are generating, third-party payors may not be willing to provide coverage or reimbursement for our products and we may be subject to greater regulatory and product liability risks. These and other factors could slow the adoption of our products and result in our sales being lower than anticipated. In addition, future studies or clinical experience may indicate that treatment with our products is not superior to treatment with competitive products. Such results could slow the adoption of our products and significantly reduce our sales, which could prevent us from achieving our forecasted sales targets or achieving or sustaining profitability.

 

Moreover, we monitor any incoming customer complaints on an ongoing basis, particularly following the launch of any new products or any changes to our existing products. Changes to our existing products may include changes to hardware or software, or changes to manufacturing methods or procedures. If the results of clinical studies or other experience, such as our monitoring and investigation of customer complaints, indicate that our products cause or create an unacceptable risk of unexpected or serious complications or other unforeseen negative effects, we could be subject to mandatory product recalls, suspension or withdrawal of FDA clearance or approval, significant legal liability or harm to our business reputation.

 

Any alleged illness or injury associated with any of our products or product recall may negatively impact our financial results and business prospects depending on the scope, degree of publicity, reaction of our customers, healthcare professionals, and collaborators, competitive reaction, and consumer attitudes overall. Even if such an allegation or product liability claim lacks merit, cannot be substantiated, is unsuccessful or is not fully pursued, the negative publicity surrounding any assertion that our products caused illness, injury or death could adversely affect our reputation with customers, healthcare professionals, and existing and potential collaborators, and could adversely affect our operating results and cause a decline in our stock price.

 

We may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships with third parties that may not result in the development of commercially viable products or the generation of significant future revenues.*

 

In the ordinary course of our business, we may enter into collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships to develop proposed products and to pursue new markets, or we may amend or modify similar agreements that we already have in place. Proposing, negotiating and implementing collaborations, in-licensing arrangements, joint ventures, strategic alliances or partnerships may be a lengthy and complex process. Other companies, including those with substantially greater financial, marketing, sales, technology or other business resources, may compete with us for these opportunities or arrangements. We may not identify, secure, or complete any such transactions or arrangements in a timely manner, on a cost-effective basis, on acceptable terms or at all. We have limited institutional knowledge and experience with respect to these business development activities, and we may also not realize the anticipated benefits of any such transaction or arrangement. In particular, these collaborations may not result in the development of products that achieve commercial success or result in significant revenues and could be terminated prior to developing any products.

 

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Additionally, we may not be in a position to exercise sole decision making authority regarding the transaction or arrangement, which could create the potential risk of creating impasses on decisions, and our collaborators may have economic or business interests or goals that are, or that may become, inconsistent with our business interests or goals. It is possible that conflicts may arise with our collaborators, such as conflicts concerning the achievement of performance milestones, or the interpretation of significant terms under any agreement, such as those related to financial obligations, termination rights or the ownership or control of intellectual property developed during the collaboration. If any conflicts arise with our current or future collaborators, they may act in their self-interest, which may be adverse to our best interest, and they may breach their obligations to us. In addition, we have limited control over the amount and timing of resources that our current collaborators or any future collaborators devote to our collaborators’ or our future products. Disputes between our collaborators and us may result in litigation or arbitration which would increase our expenses and divert the attention of our management. Further, these transactions and arrangements are contractual in nature and may be terminated or dissolved under the terms of the applicable agreements and, in such event, we may not continue to have rights to the products relating to such transaction or arrangement or may need to purchase such rights at a premium.

 

For example, we have entered into a development and commercialization agreement with DexCom, which provides us a non-exclusive license to integrate the DexCom G4 PLATINUM Continuous Glucose Monitor with t:slim G4, during the term of the agreement. This agreement currently runs until January 4, 2017, with automatic one-year renewals. The license granted covers the United States and other territories may be added from time to time. Under certain circumstances, the agreement may be terminated by either party without cause or on short notice. Termination of this agreement could require us to redesign t:slim G4 and attempt to integrate an alternative CGM system into our insulin pump systems, which would require significant development and regulatory activities that could result in an interruption in the availability of the product to our customers.

 

If there are significant disruptions in our information technology systems, our business, financial condition and operating results could be adversely affected.*

 

The efficient operation of our business depends on our information technology systems. We rely on our information technology systems to effectively manage sales and marketing data, accounting and financial functions, inventory management, product development tasks, research and development data, customer service and technical support functions. Our information technology systems, including those that support t:connect, our cloud-based data management system, are vulnerable to damage or interruption from earthquakes, fires, floods and other natural disasters, terrorist attacks, attacks by computer viruses or hackers, power losses, and computer system or data network failures. In addition, our currently marketed insulin pumps, and our products currently in development contain software which could be subject to computer virus or hacker attacks or other failures. We are currently in the process of developing a system that is designed to enable customers to remotely update the software on their t:slim and t:flex pumps. Any such system could also be subject to similar risks.

 

The failure of our or our service providers’ information technology systems or our pumps’ software to perform as we anticipate or our failure to effectively implement new information technology systems could disrupt our entire operation or adversely affect our software products and could result in decreased sales, increased overhead costs, and product shortages, all of which could have a material adverse effect on our reputation, business, financial condition and operating results.

 

If we fail to properly manage our anticipated growth, our business could suffer.*

 

Our rapid growth has placed, and we expect that it will continue to place, a significant strain on our management team and on our financial resources. For example, between December 31, 2013 and December 31, 2014 our employee base increased more than 30% and we expect to continue to experience growth of our employee base during 2015 and 2016. Failure to manage our growth effectively could cause us to misallocate management or financial resources, and result in losses or weaknesses in our infrastructure, which could materially adversely affect our business. Additionally, our anticipated growth will increase the demands placed on our suppliers, resulting in an increased need for us to manage our suppliers and monitor for quality assurance. Any failure by us to manage our growth effectively could have an adverse effect on our ability to achieve our business objectives.

 

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We depend on the knowledge and skills of our senior management and other key employees, and if we are unable to retain and motivate them or recruit additional qualified personnel, our business may suffer.

 

We have benefited substantially from the leadership and performance of our senior management, as well as certain key employees. For example, our chief executive officer, as well as other key members of management, have experience successfully scaling an early stage medical device company to achieve profitability. Our success will depend on our ability to retain our current management and key employees, and to attract and retain qualified personnel in the future. Competition for senior management and key employees in our industry is intense and we cannot guarantee that we will be able to retain our personnel or attract new, qualified personnel. The loss of the services of certain members of our senior management or key employees could prevent or delay the implementation and completion of our strategic objectives, or divert management’s attention to seeking qualified replacements. Each member of senior management as well as our key employees may terminate employment without notice and without cause or good reason. The members of our senior management are not subject to non-competition agreements. Accordingly, the adverse effect resulting from the loss of certain members of senior management could be compounded by our inability to prevent them from competing with us.

 

If we are found to have violated laws protecting the confidentiality of patient health information, we could be subject to civil or criminal penalties, which could increase our liabilities and harm our reputation or our business.

 

There are a number of federal and state laws protecting the confidentiality of certain patient health information, including patient records, and restricting the use and disclosure of that protected information. In particular, the U.S. Department of Health and Human Services, or HHS, promulgated patient privacy rules under the HIPAA. These privacy rules protect medical records and other personal health information by limiting their use and disclosure, giving individuals the right to access, amend and seek accounting of their own health information and limiting most use and disclosures of health information to the minimum amount reasonably necessary to accomplish the intended purpose. If we, or any of our service providers, are found to be in violation of the promulgated patient privacy rules under HIPAA, we could be subject to civil or criminal penalties, which could increase our liabilities, harm our reputation and have a material adverse effect on our business, financial condition and operating results.

 

We may seek to grow our business through acquisitions of complementary products or technologies, and the failure to manage acquisitions, or the failure to integrate them with our existing business, could have a material adverse effect on our business, financial condition and operating results.

 

From time to time, we may consider opportunities to acquire other products or technologies that may enhance our product platform or technology, expand the breadth of our markets or customer base, or advance our business strategies. Potential acquisitions involve numerous risks, including:

 

 

 

 

 

 

 

We have no current commitments with respect to any acquisition. We do not know if we will be able to identify acquisitions we deem suitable, whether we will be able to successfully complete any such acquisitions on favorable terms or at all, or whether we will be able to successfully integrate any acquired products or technologies. Our potential inability to integrate any acquired products or technologies effectively may adversely affect our business, operating results and financial condition.

 

Risks Related to our Financial Results and Need for Financing

 

Our future capital needs are uncertain and we may need to raise additional funds in the future, and these funds may not be available on acceptable terms or at all.*

 

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At September 30, 2015, we had $83.8 million in cash, cash equivalents and short-term investments, which included $2.0 million of restricted cash. We believe that our cash on hand, cash generated from operations, and cash proceeds from the exercise of warrants and options will be sufficient to satisfy our liquidity requirements for at least the next twelve months. However, the continued growth of our business, including the expansion of our sales and marketing infrastructure, research and development activities, and manufacturing capabilities, will continue to increase our expenses. In addition, the amount of our future product sales is difficult to predict and actual sales may not be in line with our forecasts. As a result, we may seek additional funds in the future. Our future capital requirements will depend on many factors, including:

 

 

 

 

 

 

 

 

 

 

As a result of these and other factors, we do not know the extent to which we may be required to raise additional capital. We may in the future seek additional capital from public or private offerings of our capital stock, borrowings under credit lines or other sources. In particular, we have an effective shelf registration statement on file with the SEC, under which we may offer to sell equity securities. If we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, we may incur significant financing costs, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaborations, licensing, joint ventures, strategic alliances, partnership arrangements or other similar arrangements, it may be necessary to relinquish valuable rights to our potential future products or proprietary technologies, or grant licenses on terms that are not favorable to us.

 

If we are unable to raise additional capital, we may not be able to expand our sales and marketing infrastructure, enhance our current products or develop new products, take advantage of future opportunities, or respond to competitive pressures, changes in supplier relationships, or unanticipated changes in customer demand. Any of these events could adversely affect our ability to achieve our strategic objectives, which could have a material adverse effect on our business, financial condition and operating results.

 

Our operating results may fluctuate significantly from quarter to quarter.*

 

There has been and may continue to be meaningful variability in our operating results from quarter to quarter, as well as within each quarter, especially around the time of anticipated new product introductions. Our operating results, and the variability of these operating results, will be affected by numerous factors, including:

 

 

 

 

 

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Due to the timing of the regulatory approval and commercial launch of the t:slim G4, we expect that our quarterly financial results during the second half of 2015 are subject to even greater fluctuation and uncertainty than in prior years, as customers may have delayed purchasing decisions in anticipation of the launch, and may need to satisfy additional insurance verification and approval requirements prior to completing their purchase.

 

As a result of our very recent product launches, and due to the complexities of the industry in which we operate, it will continue to be difficult for us to forecast demand for our products with any degree of certainty, which means it will be difficult for us to forecast our sales. In addition, we will continue to increase our operating expenses as we expand our business. Accordingly, we may experience substantial variability in our operating results from quarter to quarter, including anticipated or unanticipated quarterly losses. If our quarterly or annual operating results fall below the expectation of investors or securities analysts, the price of our common stock could decline substantially. Further, any quarterly or annual fluctuations in our operating results may, in turn, cause the price of our common stock to fluctuate substantially. We believe that quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

 

We may not be able to generate sufficient cash to service our indebtedness, which currently consists of our credit facility with Capital Royalty Partners.*

 

As of September 30, 2015, we owed an aggregate principal amount of $30.0 million to Capital Royalty Partners and their related affiliates pursuant to term loan agreements. We currently do not have the ability to borrow additional amounts under our agreements with Capital Royalty Partners. Our ability to make scheduled payments or to refinance our debt obligations depends on numerous factors, including the amount of our cash reserves at the time a scheduled payment becomes due and our actual and projected financial and operating performance. The amount of our cash reserves and our financial and operating performance are subject to certain financial and business factors, as well as prevailing economic and competitive conditions, some of which may be beyond our control. We cannot assure you that we will maintain a level of cash reserves or cash flows from operating activities sufficient to permit us to pay the principal, premium, if any, or interest on our existing or future indebtedness. If our cash balances or cash flows from operations are insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets or operations, seek additional capital, or restructure or refinance our indebtedness. We cannot assure you that we would be able to take any of these actions, or that these actions would permit us to meet our scheduled debt service obligations. In addition, in the event of our breach of the term loan agreements with Capital Royalty Partners we may be required to repay any outstanding amounts earlier than anticipated.

 

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Our term loan agreement with Capital Royalty Partners contains restrictive and financial covenants that may limit our operating flexibility.*

 

Our loan agreement with Capital Royalty Partners contains certain restrictive covenants that limit our ability to incur additional indebtedness and liens, merge with other companies or consummate certain changes of control, acquire other companies, engage in new lines of business, make certain investments, pay dividends, transfer or dispose of assets, amend certain material agreements or enter into various specified transactions. We therefore may not be able to engage in any of the foregoing transactions unless we obtain the consent of the lenders or terminate the applicable loan agreement. Our term loan agreement also contains certain financial covenants, including minimum revenue and cash balance requirements, and financial reporting requirements. There is no guarantee that we will be able to generate sufficient cash flow or sales to meet the financial covenants or pay the principal and interest under our agreement. Further, there is no guarantee that future working capital, borrowings or equity financing will be available to repay or refinance the amounts outstanding under a given agreement.

 

Risks Related to our Intellectual Property and Potential Litigation

 

Our ability to protect our intellectual property and proprietary technology is uncertain.*

 

We rely primarily on patent, trademark and trade secret laws, as well as confidentiality and non-disclosure agreements, to protect our proprietary technologies. As of September 30, 2015, our patent portfolio consisted of approximately 37 issued U.S. patents and 45 pending U.S. patent applications. Of these, our issued U.S. patents expire between approximately 2021 and 2031. We are also seeking patent protection for our proprietary technology in other countries throughout the world. In addition, we also have seven pending U.S. trademark applications, as well as 19 trademark registrations, including seven U.S. trademark registrations and 12 foreign trademark registrations.

 

We have applied for patent protection relating to certain existing and proposed products and processes. Currently, eight of our issued U.S. patents as well as various pending U.S. and foreign patent applications relate to the structure and operation of our pumping mechanism and are therefore particularly important to the functionality of our products. If we fail to file a patent application timely in any jurisdiction, we may be precluded from doing so at a later date. Further, we cannot assure you that any of our patent applications will be approved in a timely manner or at all. The rights granted to us under our patents, and the rights we are seeking to have granted in our pending patent applications, may not be meaningful or provide us with any commercial advantage. In addition, those rights could be opposed, contested or circumvented by our competitors, or be declared invalid or unenforceable in judicial or administrative proceedings. The failure of our patents to adequately protect our technology might make it easier for our competitors to offer the same or similar products or technologies. Even if we are successful in receiving patent protection for certain products and processes, our competitors may be able to design around our patents or develop products that provide outcomes which are comparable to ours without infringing on our intellectual property rights. Due to differences between foreign and U.S. patent laws, our patented intellectual property rights may not receive the same degree of protection in foreign countries as they would in the United States. Even if patents are granted outside the United States, effective enforcement in those countries may not be available.

 

We rely on our trademarks and trade names to distinguish our products from the products of our competitors, and have registered or applied to register many of these trademarks. We cannot assure you that our trademark applications will be approved in a timely manner or at all. Third parties also may oppose our trademark applications, or otherwise challenge our use of the trademarks. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition, and could require us to devote additional resources to marketing new brands. Further, we cannot assure you that competitors will not infringe upon our trademarks, or that we will have adequate resources to enforce our trademarks.

 

We have entered into confidentiality agreements and intellectual property assignment agreements with our officers, employees, temporary employees and consultants regarding our intellectual property and proprietary technology. In the event of unauthorized use or disclosure or other breaches of those agreements, we may not be provided with meaningful protection for our trade secrets or other proprietary information.

 

If a competitor infringes upon one of our patents, trademarks or other intellectual property rights, enforcing those patents, trademarks and other rights may be difficult and time consuming. Patent law relating to the scope of claims in the industry in which we operate is subject to rapid change and constant evolution and, consequently, patent positions in our industry can be uncertain. Even if successful, litigation to defend our patents and trademarks against challenges or to enforce our intellectual property rights could be expensive and time consuming and could divert management’s attention from managing our business. Moreover, we may not have sufficient resources or desire to defend our patents or trademarks against challenges or to enforce our intellectual property rights. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially valuable. The occurrence of any of these events may have a material adverse effect on our business, financial condition and operating results.

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The medical device industry is characterized by patent litigation, and from time to time we may be subject to litigation that could be costly, result in the diversion of management’s time and efforts, or require us to pay damages.

 

Our success will depend in part on not infringing the patents or violating the other proprietary rights of third parties. Significant litigation regarding patent rights exists in our industry. Our competitors in both the United States and abroad, many of which have substantially greater resources and have made substantial investments in competing technologies, may have applied for or obtained or may in the future apply for and obtain, patents that will prevent, limit or otherwise interfere with our ability to make and sell our products. The large number of patents, the rapid rate of new patent issuances, and the complexities of the technology involved increase the risk of patent litigation.

 

From time to time we receive communications from third parties alleging our infringement of their intellectual property rights. Any intellectual property dispute or litigation could force us to do one or more of the following:

 

 

 

 

 

 

Any litigation or claim against us, even those without merit, may cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. Further, as the number of participants in the diabetes market increases, the possibility of intellectual property infringement claims against us increases.

 

We may be subject to damages resulting from claims that we, or our employees, have wrongfully used or disclosed alleged trade secrets of our competitors or are in breach of non-competition or non-solicitation agreements with our competitors.

 

Many of our employees were previously employed at other medical device companies, including those that are our direct competitors or could potentially be our direct competitors. In some cases, those employees joined our company recently. We may be subject to claims that we, or our employees, have inadvertently or otherwise used or disclosed trade secrets or other proprietary information of these former employers or competitors. In addition, we have been and may in the future be subject to allegations that we caused an employee to breach the terms of his or her non-competition or non-solicitation agreement. Litigation may be necessary to defend against these claims. Even if we successfully defend against these claims, litigation could cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business and harm our reputation. If our defense to those claims fails, in addition to paying monetary damages, we may lose valuable intellectual property rights or personnel. We cannot guarantee that this type of litigation will not continue, and any future litigation or the threat thereof may adversely affect our ability to hire additional direct sales representatives. A loss of key personnel or their work product could hamper or prevent our ability to commercialize proposed products, which could have an adverse effect on our business, financial condition and operating results.

 

We may incur product liability losses, and insurance coverage may be inadequate or unavailable to cover these losses.

 

Our business exposes us to potential product liability claims that are inherent in the design, manufacture, testing and sale of medical devices. We could become the subject of product liability lawsuits alleging that component failures, manufacturing flaws, design defects or inadequate disclosure of product-related risks or product-related information resulted in an unsafe condition, injury or death to customers. The risk of one or more product liability claims or lawsuits may be even greater following our January 2014 voluntary recall of cartridges used with the t:slim pump. In addition, the misuse of our products or the failure of customers to adhere to operating guidelines could cause significant harm to customers, including death, which could result in product liability claims. Product liability lawsuits and claims, safety alerts or product recalls, with or without merit, could cause us to incur substantial costs, and could place a significant strain on our financial resources, divert the attention of management from our core business, harm our reputation and adversely affect our ability to attract and retain customers, any of which could have a material adverse effect on our business, financial condition and operating results.

 

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Although we maintain third-party product liability insurance coverage, it is possible that claims against us may exceed the coverage limits of our insurance policies. Even if any product liability loss is covered by an insurance policy, these policies typically have substantial deductibles for which we are responsible. Product liability claims in excess of applicable insurance coverage could have a material adverse effect on our business, financial condition and operating results. In addition, any product liability claim brought against us, with or without merit, could result in an increase of our product liability insurance premiums. Insurance coverage varies in cost and can be difficult to obtain, and we cannot guarantee that we will be able to obtain insurance coverage in the future on terms acceptable to us or at all. Our inability to obtain sufficient insurance coverage to protect again potential product liability claims could prevent or limit our commercialization of current products or products currently under development.

 

Risks Related to our Legal and Regulatory Environment

 

Our products and operations are subject to extensive governmental regulation, and failure to comply with applicable requirements could cause our business to suffer.

 

The medical device industry is regulated extensively by governmental authorities, principally the FDA and corresponding state regulatory agencies. The regulations are very complex and are subject to rapid change and varying interpretations. Regulatory restrictions or changes could limit our ability to carry on or expand our operations or result in higher than anticipated costs or lower than anticipated sales. The FDA and other U.S. governmental agencies regulate numerous elements of our business, including:

 

 

 

 

 

 

 

 

 

 

 

Before we can market or sell a new regulated product or a significant modification to an existing product in the United States, we must obtain either clearance under Section 510(k) of the FDCA or approval of a PMA application from the FDA, unless an exemption from pre-market review applies. In the 510(k) clearance process, the FDA must determine that a proposed device is “substantially equivalent” to a device legally on the market, known as a “predicate” device, with respect to intended use, technology and safety and effectiveness, in order to clear the proposed device for marketing. Clinical data is sometimes required to support substantial equivalence. The PMA pathway requires an applicant to demonstrate the safety and effectiveness of the device based on extensive data. The PMA process is typically required for devices that are deemed to pose the greatest risk, such as life-sustaining, life-supporting or implantable devices. We received approval of our PMA for the t:slim G4 pump in September 2015. Products that are approved through a PMA application generally need FDA approval before they can be modified. Similarly, some modifications made to products cleared through a 510(k) may require a new 510(k). The process of obtaining regulatory clearances or approvals to market a medical device can be costly and time-consuming, and we may not be able to obtain these clearances or approvals on a timely basis, or at all for our proposed products.

 

We initially received pre-market clearance for t:slim under Section 510(k) of the FDCA in November 2011. We obtained 510(k) clearance for t:connect and t:flex in February 2013 and January 2015, respectively. From time to time, we make modifications to these products that may require a new 510(k). We received 510(k) clearance for modifications to t:slim and its associated cartridge during 2014 and expect to pursue 510(k) clearance for additional modifications to t:slim and t:flex in the future. If the FDA requires us to go through a more rigorous examination for future products or modifications to existing products than we had expected, our product introductions or modifications could be delayed or canceled, which could cause our sales to decline or to not increase in line with our forecasts. In addition, the FDA may determine that future products will require the more costly, lengthy and uncertain PMA process.

 

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The FDA can delay, limit or deny clearance or approval of a device for many reasons, including:

 

 

 

 

In addition, the FDA may change its clearance and approval policies, adopt additional regulations or revise existing regulations, or take other actions which may prevent or delay approval or clearance of our products under development or impact our ability to modify our currently cleared or approved products on a timely basis.

 

Any delay in, or failure to receive or maintain, clearance or approval for our products under development could prevent us from generating revenue from these products or achieving profitability. Additionally, the FDA and other regulatory authorities have broad enforcement powers. Regulatory enforcement or inquiries, or other increased scrutiny on us, could dissuade some customers from using our products and adversely affect our reputation and the perceived safety and efficacy of our products.

 

Failure to comply with applicable regulations could jeopardize our ability to sell our products and result in enforcement actions such as fines, civil penalties, injunctions, warning letters, recalls of products, delays in the introduction of products into the market, refusal of the FDA or other regulators to grant future clearances or approvals, and the suspension or withdrawal of existing approvals by the FDA or other regulators. Any of these sanctions could result in higher than anticipated costs or lower than anticipated sales and have a material adverse effect on our reputation, business, financial condition and operating results.

 

Further, we may evaluate international expansion opportunities in the future. If we expand our operations outside of the United States, we will become subject to various additional regulatory and legal requirements under the applicable laws and regulations of the international markets we enter. These additional regulatory requirements may involve significant costs and expenditures and, if we are not able comply any such requirements, our international expansion and business could be significantly harmed.

 

Modifications to our products may require new 510(k) clearances or pre-market approvals, or may require us to cease marketing or recall the modified products until clearances are obtained.

 

Any modification to a 510(k)-cleared device that could significantly affect its safety or effectiveness, or that would constitute a major change in its intended use, design, or manufacture, requires a new 510(k) clearance or, possibly, a PMA. The FDA requires every manufacturer to make this determination in the first instance, but the FDA may review any manufacturer’s decision. The FDA may not agree with our decisions regarding whether new clearances or approvals are necessary for changes that we have made to our products. If the FDA disagrees with our determination and requires us to submit new 510(k) notifications or PMAs for modifications to our previously cleared or approved products for which we previously concluded that new clearances or approvals were not necessary, we may be required to cease marketing or to recall the modified product until we obtain clearance or approval, and we may be subject to significant regulatory fines or penalties.

 

Further, the FDA’s ongoing review of the 510(k) program may make it more difficult for us to modify our previously cleared products, either by imposing stricter requirements on when a new 510(k) for a modification to a previously cleared product must be submitted, or by applying more onerous review criteria to such submissions.

 

If we or our third-party suppliers fail to comply with the FDA’s good manufacturing practice regulations, this could impair our ability to market our products in a cost-effective and timely manner.

 

We and our third-party suppliers are required to comply with the FDA’s Quality System Regulation, or QSR, which covers the methods and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our products. The FDA audits compliance with the QSR through periodic announced and unannounced inspections of manufacturing and other facilities. The FDA may impose inspections or audits at any time. If we or our suppliers have significant non-compliance issues or if any corrective action plan that we or our suppliers propose in response to observed deficiencies is not sufficient, the FDA could take enforcement action against us. Any of the foregoing actions could have a material adverse effect on our reputation, business, financial condition and operating results.

 

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A recall of our products, or the discovery of serious safety issues with our products, could have a significant negative impact on us.

 

The FDA has the authority to require the recall of commercialized products in the event of material deficiencies or defects in design or manufacture or in the event that a product poses an unacceptable risk to health. Manufacturers may, under their own initiative, recall a product if any material deficiency in a device is found. A government-mandated or voluntary recall by us, one of our distributors or any of our other third-party suppliers could occur as a result of an unacceptable risk to health, component failures, manufacturing errors, design or labeling defects or other deficiencies and issues. Recalls of any products that we distribute would divert managerial and financial resources and have an adverse effect on our reputation, financial condition and operating results, which could impair our ability to produce our products in a cost-effective and timely manner.

 

Further, under the FDA’s medical device reporting, or MDR, regulations, we are required to report to the FDA any incident in which our product may have caused or contributed to a death or serious injury or in which our product malfunctioned and, if the malfunction were to recur, would likely cause or contribute to death or serious injury. Repeated product malfunctions may result in a voluntary or involuntary product recall, which could divert managerial and financial resources, impair our ability to manufacture our products in a cost-effective and timely manner and have an adverse effect on our reputation, financial condition and operating results.

 

In January 2014, we implemented a voluntary recall of select lots of cartridges used with t:slim that may be at risk of leaking. A cartridge leak could potentially result in the delivery of too much or too little insulin, which could lead to unexpected high or low blood glucose levels. Too much insulin can result in severe low blood sugar, or hypoglycemia, and too little insulin can lead to severe high blood sugar, or hyperglycemia, both of which can lead to serious injury or death. We notified the FDA of the recall and also notified our customers and any of our independent distributors that may have received affected cartridges. We have also filed multiple MDRs with the FDA following the recall and we may file additional MDRs in the future as we collect additional information.

 

Any adverse event involving any products that we distribute could result in future voluntary corrective actions, such as recalls or customer notifications, or regulatory agency action, which could include inspection, mandatory recall or other enforcement action. Any corrective action, whether voluntary or involuntary, will require the dedication of our time and capital, distract management from operating our business and may harm our reputation and financial results.

 

Our failure to comply with U.S. federal and state fraud and abuse laws, including anti-kickback laws and other U.S. federal and state anti-referral laws, could have a material, adverse impact on our business.

 

There are numerous U.S. federal and state laws pertaining to healthcare fraud and abuse, including anti-kickback laws and physician self-referral laws. Our relationships with healthcare providers and other third parties are subject to scrutiny under these laws. Violations of these laws are punishable by criminal and civil sanctions, including, in some instances, imprisonment and exclusion from participation in federal and state healthcare programs, including the Medicare, Medicaid and Veterans Administration health programs.

 

Healthcare fraud and abuse regulations are complex, and even minor irregularities can potentially give rise to claims that a statute or prohibition has been violated. The laws that may affect our ability to operate include:

 

 

 

 

 

 

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Further, the Patient Protection and Affordable Care Act, as amended by the Healthcare and Education Affordability Reconciliation Act, or, collectively, the PPACA, among other things, amends the intent requirement of the federal anti-kickback and criminal healthcare fraud statutes. A person or entity can now be found guilty under the PPACA without actual knowledge of the statute or specific intent to violate it. In addition, the PPACA provides that the government may assert that a claim including items or services resulting from a violation of the federal anti-kickback statute constitutes a false or fraudulent claim for purposes of the false claims statutes. Possible sanctions for violation of these anti-kickback laws include monetary fines, civil and criminal penalties, exclusion from Medicare and Medicaid programs and forfeiture of amounts collected in violation of those prohibitions. Any violations of these laws, or any action against us for violation of these laws, even if we successfully defend against it, could result in a material adverse effect on our reputation, business, financial condition and operating results.

 

To enforce compliance with the federal laws, the U.S. Department of Justice, or DOJ, has recently increased its scrutiny of interactions between healthcare companies and healthcare providers, which has led to a number of investigations, prosecutions, convictions and settlements in the healthcare industry. Dealing with investigations can be time- and resource-consuming and can divert management’s attention from our core business. Additionally, if a healthcare company settles an investigation with the DOJ or other law enforcement agencies, we may be forced to agree to additional onerous compliance and reporting requirements as part of a consent decree or corporate integrity agreement. Any such investigation or settlement could increase our costs or otherwise have an adverse effect on our business.

 

The scope and enforcement of these laws is uncertain and subject to rapid change in the current environment of healthcare reform, especially in light of the lack of applicable precedent and regulations. Federal or state regulatory authorities might challenge our current or future activities under these laws. Any of these challenges could have a material adverse effect on our reputation, business, financial condition and operating results. Any state or federal regulatory review of us, regardless of the outcome, would be costly and time-consuming. Additionally, we cannot predict the impact of any changes in these laws, whether or not retroactive.

 

We may be liable if we engage in the off-label promotion of our products.

 

Our promotional materials and training methods must comply with FDA and other applicable laws and regulations, including the prohibition of the promotion of the off-label use of our products. Healthcare providers may use our products off-label, as the FDA does not restrict or regulate a physician’s choice of treatment within the practice of medicine. However, if the FDA determines that our promotional materials or training constitutes promotion of an off-label use, it could request that we modify our training or promotional materials or subject us to regulatory or enforcement actions, including the issuance of an untitled letter, a warning letter, injunction, seizure, civil fine and criminal penalties. It is also possible that other federal, state or foreign enforcement authorities might take action if they consider our promotional or training materials to constitute promotion of an unapproved use, which could result in significant fines or penalties. Although our policy is to refrain from statements that could be considered off-label promotion of our products, the FDA or another regulatory agency could disagree and conclude that we have engaged in off-label promotion. In addition, the off-label use of our products may increase the risk of product liability claims. Product liability claims are expensive to defend and could result in substantial damage awards against us and harm our reputation.

 

Legislative or regulatory healthcare reforms may make it more difficult and costly for us to obtain regulatory clearance or approval of our products.

 

Recent political, economic and regulatory influences are subjecting the healthcare industry to fundamental changes. The sales of our products depend in part on the availability of coverage and reimbursement from third-party payors such as government health administration authorities, private health insurers, health maintenance organizations and other healthcare-related organizations. Both the Federal and state governments in the United States continue to propose and pass new legislation and regulations designed to contain or reduce the cost of healthcare. This legislation and regulation may result in decreased reimbursement for medical devices, which may further exacerbate industry-wide pressure to reduce the prices charged for medical devices. This could harm our ability to market our products and generate sales.

 

In addition, FDA regulations and guidance are often revised or reinterpreted by the FDA in ways that may significantly affect our business and our products. Any new regulations or revisions or reinterpretations of existing regulations may impose additional costs or lengthen review times of our products. Delays in receipt of or failure to receive regulatory clearances or approvals for our proposed products would have a material adverse effect on our business, financial condition and operating results.

 

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Federal and state governments in the United States have enacted legislation to overhaul the nation’s healthcare system. While the goal of healthcare reform is to expand coverage to more individuals, it also involves increased government price controls, additional regulatory mandates and other measures designed to constrain medical costs. The PPACA substantially changes the way healthcare is financed by both governmental and private insurers, encourages improvements in the quality of healthcare items and services and significantly impacts the medical device industries. Among other things, the PPACA:

 

 

 

 

In addition, other legislative changes have been proposed and adopted since the PPACA was enacted. Most recently, on August 2, 2011, the President signed into law the Budget Control Act of 2011, which, among other things, creates the Joint Select Committee on Deficit Reduction to recommend to Congress proposals in spending reductions. The Joint Select Committee did not achieve a targeted deficit reduction of at least $1.2 trillion for the years 2013 through 2021, triggering the legislation’s automatic reduction to several government programs. This includes aggregate reductions to Medicare payments to providers of up to 2% per fiscal year which commenced in 2013. The uncertainties regarding the ultimate features of the PPACA and other healthcare reform initiatives and their enactment and implementation may have an adverse effect on our customers’ purchasing decisions regarding our products. In the coming years, additional changes could be made to governmental healthcare programs that could significantly impact the success of our products. Cost control initiatives could decrease the price that we receive for our products. At this time, we cannot predict which, if any, additional healthcare reform proposals will be adopted, when they may be adopted or what impact they, or the PPACA, may have on our business and operations, and any of these impacts may be adverse on our operating results and financial condition.

 

Our financial performance may be adversely affected by medical device tax provisions in the healthcare reform laws.

 

The PPACA imposes, among other things, an annual excise tax of 2.3% on any entity that manufactures or imports medical devices offered for sale in the United States beginning in 2013. Under these provisions, the Congressional Research Service predicts that the total cost to the medical device industry may be up to $20 billion over the next decade. We do not believe that our current products are currently subject to this tax based on the retail exemption under applicable Treasury Regulations. However, the availability of this exemption is subject to interpretation by the IRS, and the IRS may disagree with our analysis. In addition, future products that we manufacture, produce or import may be subject to this tax. The financial impact this tax may have on our business is unclear and there can be no assurance that our business will not be materially adversely affected by it.

 

Risks Related to our Common Stock

 

Because of their significant stock ownership, certain of our executive officers, directors and principal stockholders will be able to exert control over us and our significant corporate decisions.*

 

Based on an aggregate of 30,070,795 shares of our common stock outstanding as of September 30, 2015, our executive officers and directors, and their affiliates owned, in the aggregate, approximately 40% of the voting power of our outstanding common stock. These persons, acting together, will have the ability to significantly influence the outcome of all matters submitted to our stockholders for approval, including the election and removal of directors and any merger, consolidation, or sale of all or substantially all of our assets.

 

The interests of the aforementioned stockholders might not coincide with the interests of the other holders of our capital stock. This concentration of ownership may reduce the value of our common stock by, among other things:

 

 

 

 

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Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change of control, even if an acquisition would be beneficial to our stockholders, which could reduce our stock price and prevent our stockholders from replacing or removing our current management.

 

Our amended and restated certificate of incorporation and bylaws contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions:

 

 

 

 

 

 

 

 

 

 

We are subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our amended and restated certificate of incorporation, bylaws and Delaware law could make it more difficult for stockholders or potential acquirers to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including a merger, tender offer or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

 

Our board of directors is authorized to issue and designate shares of our preferred stock in additional series without stockholder approval.

 

Our amended and restated certificate of incorporation authorizes our board of directors, without the approval of our stockholders, to issue 5,000,000 shares of our preferred stock, subject to limitations prescribed by applicable law, rules and regulations and the provisions of our amended and restated certificate of incorporation, as shares of preferred stock in series, and to establish from time to time the number of shares to be included in each such series, and to fix the designation, powers, preferences and rights of the shares of each such series and the qualifications, limitations or restrictions thereof. The powers, preferences and rights of these additional series of preferred stock may be senior to or on parity with our common stock, and the issuance of such shares in the future may reduce the value of our common stock.

 

Our ability to use our net operating loss carryforwards and certain other tax attributes may be limited.

 

As of December 31, 2014, we have federal net operating loss, or NOL, carryforwards of approximately $177.2 million. In general, if there is an “ownership change” with respect to our company, as defined under Section 382 of the Internal Revenue Code of 1986, as amended, which we refer to as the Code, the utilization of our NOL carryforwards may be subject to substantial limitations imposed by the Code, and similar state provisions. In general, an ownership change occurs whenever there is a shift in ownership of our company by more than 50% by one or more 5% stockholders over a specified time period. We updated our Section 382/383 analysis, from January 1, 2012 through December 31, 2013, regarding the limitation of the net operating losses and research and development credits. Based upon the analysis, we determined that no ownership changes occurred during that period. However, previous analysis determined that ownership changes have occurred in years prior to 2012, but will not have a material impact on the future utilization of such carryforwards. We may also experience ownership changes in the future as a result of subsequent shifts in our stock ownership. Accordingly, if we earn net taxable income, our ability to use net operating loss carryforwards to offset U.S. federal taxable income may become subject to limitations, which could potentially result in increases in our future tax liabilities.

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We do not intend to pay cash dividends.

 

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. In addition, pursuant to the term loan agreements with Capital Royalty Partners, we are precluded from paying any cash dividends. Accordingly, you may have to sell some or all of your shares of our common stock in order to generate cash flow from your investment. You may not receive a gain on your investment when you sell shares and you may lose the entire amount of the investment.

 

The requirements of being a public company will increase our costs and may strain our resources and divert management’s attention.

 

As a public company, we are subject to the reporting requirements of the Securities Exchange Act of 1934, as amended, the Dodd-Frank Wall Street Reform and Consumer Protection Act, or the Dodd-Frank Act, the listing requirements of The NASDAQ Stock Market and other applicable securities rules and regulations. Compliance with these rules and regulations has increased our legal and financial compliance costs, make some activities more difficult, time-consuming or costly, and increase demand on our systems and resources.

 

The Sarbanes-Oxley Act of 2002, or the Sarbanes-Oxley Act, requires, among other things, that we maintain effective disclosure controls and procedures and internal control over financial reporting. Recent legislation permits “emerging growth companies” to implement many of these requirements over a longer period and up to five years from the end of our last fiscal year. We intend to take advantage of this new legislation but cannot guarantee that we will not be required to implement these requirements sooner than budgeted or planned and thereby incur unexpected expenses.

 

In order to maintain and, if required, improve our disclosure controls and procedures and internal control over financial reporting to meet this standard, significant resources and management oversight may be required. As a result, management’s attention may be diverted from other business concerns, which could harm our business and operating results. Although we have hired additional employees to help us comply with these requirements, in the future we may need to hire more employees or utilize external consultants in order to further support our efforts, which will increase our expenses.

 

New regulations related to "conflict minerals" may cause us to incur additional expenses and could limit the supply and increase the cost of certain metals used in manufacturing our products.

 

On August 22, 2012, the SEC adopted a new rule requiring disclosures by public companies of specified minerals, known as conflict minerals, that are necessary to the functionality or production of products manufactured or contracted to be manufactured. The rule requires companies to perform due diligence, disclose and annually report to the SEC whether or not such minerals originate from the Democratic Republic of Congo or an adjoining country. The rule could affect sourcing at competitive prices and availability in sufficient quantities of certain minerals used in the manufacture of our products, including tantalum, tin, gold and tungsten. The number of suppliers who provide conflict-free minerals may be limited. In addition, there may be material costs associated with complying with the disclosure requirements, such as costs related to determining the source of certain minerals used in our products, as well as costs of possible changes to products, processes, or sources of supply as a consequence of such verification activities. Within our supply chain, we may not be able to sufficiently verify the origins of the relevant minerals used in our products through the due diligence procedures that we implement, which may harm our reputation. We are currently investigating the use of conflict materials, if any, within our supply chain.

 

We are an “emerging growth company” and we do not know whether the reduced disclosure requirements and relief from certain other significant obligations that are applicable to emerging growth companies will make our common stock less attractive to investors.

 

We are an “emerging growth company,” as defined in the Jumpstart our Business Startups Act of 2012, or the JOBS Act, and we intend to take advantage of certain exemptions from various reporting requirements that apply to other public companies that are not “emerging growth companies.” These exemptions include the following:

 

 

 

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We intend to take advantage of these exemptions but cannot guarantee that we will not be required to implement these requirements sooner than budgeted or planned and thereby incur unexpected expenses. We cannot predict if investors will find our common stock less attractive because we will rely on these exemptions. If some investors find our common stock less attractive as a result, there may be a less active trading market for our common stock, which could result in a reduction in the price of our common stock.

 

Pursuant to the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting for so long as we are an “emerging growth company.”

 

Under existing SEC rules and regulations, we will be required to disclose changes made in our internal control over financial reporting on a quarterly basis and management will be required to assess the effectiveness of our controls annually. However, under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404 of the Sarbanes-Oxley Act of 2002 until we are no longer an “emerging growth company.” We could be an “emerging growth company” for up to five years from our November 2013 initial public offering.

 

If we fail to maintain an effective system of internal control over financial reporting, we may not be able to accurately report our financial results or prevent fraud. As a result, stockholders could lose confidence in our financial and other public reporting, which would harm our business and the trading price of our common stock.

 

Effective internal controls over financial reporting are necessary for us to provide reliable financial reports and, together with adequate disclosure controls and procedures, are designed to prevent fraud. Any failure to implement required new or improved controls, or difficulties encountered in their implementation could cause us to fail to meet our reporting obligations. In addition, any testing by us conducted in connection with Section 404(a) of the Sarbanes-Oxley Act, or the subsequent testing by our independent registered public accounting firm conducted in connection with Section 404(b) of the Sarbanes-Oxley Act after we no longer qualify as an “emerging growth company,” may reveal deficiencies in our internal controls over financial reporting that are deemed to be material weaknesses or that may require prospective or retroactive changes to our consolidated financial statements or identify other areas for further attention or improvement. Inferior internal controls could also cause investors to lose confidence in our reported financial information, which could have a negative effect on the trading price of our common stock.

 

We are required to disclose changes made in our internal control procedures on a quarterly basis and our management is required to assess the effectiveness of these controls annually. However, for as long as we are an “emerging growth company” under the JOBS Act, our independent registered public accounting firm will not be required to attest to the effectiveness of our internal control over financial reporting pursuant to Section 404. We could be an “emerging growth company” for up to five years from our November 2013 initial public offering. An independent assessment of the effectiveness of our internal controls could detect problems that our management’s assessment might not. Undetected material weaknesses in our internal controls could lead to financial statement restatements and require us to incur the expense of remediation.

 

The price of our common stock might fluctuate significantly.

 

Prior to our initial public offering in November 2013, there was no public market for our common stock. The trading price of our common stock is likely to be volatile for the foreseeable future. Our stock price could be subject to wide fluctuations in response to a variety of factors, including the following:

 

 

 

 

 

 

 

 

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These and other factors might cause the market price of our common stock to fluctuate substantially, which may negatively affect the liquidity of our common stock. In addition, in recent years, the stock market has experienced significant price and volume fluctuations. This volatility has had a significant impact on the market price of securities issued by many companies across many industries. The changes frequently appear to occur without regard to the operating performance of the affected companies. Accordingly, the price of our common stock could fluctuate based upon factors that have little or nothing to do with our company, and these fluctuations could materially reduce our share price.

 

Securities class action litigation has often been instituted against companies following periods of volatility in the overall market and in the market price of a company’s securities. This litigation, if instituted against us, could result in substantial costs, divert our management’s attention and resources, and harm our business, operating results and financial condition.

 

Future sales, or the perception of future sales, of shares of our common stock could materially reduce the market price of our common stock.*

 

Sales of our common stock, or the perception in the market that the holders of a large number of our shares intend to sell such shares, could reduce the market price of our common stock which would impair our ability to raise future capital through the sale of additional equity securities. We had outstanding 30,070,795 shares of common stock as of September 30, 2015, of which approximately 12,111,350 shares are restricted securities that may be sold only in accordance with the resale restrictions under Rule 144 of the Securities Act. In addition, as of September 30, 2015, we had outstanding options to purchase 5,613,183 shares of common stock and warrants to purchase 990,031 shares of common stock that, if exercised, will result in these additional shares becoming available for sale. As of September 30, 2015, there are also an aggregate of 2,789,077 shares of our common stock reserved for future grant or issuance under our 2013 Equity Incentive Plan and Employee Stock Purchase Plan.

 

Certain holders of shares of common stock have the right, subject to various conditions and limitations, to include their shares in registration statements relating to our securities. In addition, these holders are entitled to piggyback registration rights with respect to the registration under the Securities Act of shares of our common stock. Shares of common stock sold under these registration statements can be freely sold in the public market. In the event registration rights are exercised and a large number of shares of common stock are sold in the public market, those sales could reduce the trading price of our common stock.

 

In the future, we also may issue our securities if we need to raise additional capital. The number of new shares of our common stock issued in connection with raising additional capital could constitute a material portion of the then-outstanding shares of our common stock.

 

 

None.

 

 

None.

 

 

Not applicable.

 

 

None.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

 

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