Quarterly Report (10-q)

Date : 11/04/2019 @ 9:20PM
Source : Edgar (US Regulatory)
Stock : Tandem Diabetes Care Inc (TNDM)
Quote : 60.445  1.735 (2.96%) @ 12:59AM
After Hours
Last Trade
Last $ 60.45 ▲ 0.01 (0.01%)

Quarterly Report (10-q)

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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________________________________________________________________________________________
FORM 10-Q
_____________________________________________________________________________________________
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended September 30, 2019
OR
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Transition Period from              to                 
Commission File Number 001-36189
_____________________________________________________________________________________________
Tandem Diabetes Care, Inc.
(Exact name of registrant as specified in its charter)
_____________________________________________________________________________________________
Delaware
 
20-4327508
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
11075 Roselle Street
 
92121
San Diego
California
 
(Zip Code)
(Address of principal executive offices)
 
 
(858) 366-6900
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
Title of Each Class
Symbol
Name of Exchange on Which Registered
Common Stock, par value $0.001 per share
TNDM
NASDAQ Global Market
_____________________________________________________________________________________________
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  ☒    No  ☐
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted 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 such files).    Yes  ☒    No  ☐
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
x
 
Accelerated filer
Non-accelerated filer
 
Smaller reporting company
 
 
 
Emerging growth company
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) 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  
As of October 30, 2019, there were 59,092,861 shares of the registrant’s Common Stock outstanding.
 



TABLE OF CONTENTS
1
1
 
1
 
2
 
3
 
5
 
6
19
33
34
 
 
 
35
35
35
66
66
66
66
67



PART I. FINANCIAL INFORMATION
Item 1. Financial Statements
TANDEM DIABETES CARE, INC.
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
 
September 30,
 
December 31,
 
2019
 
2018
 
(Unaudited)
 
(Note 1)
Assets
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
46,060

 
$
41,826

Short-term investments
110,887

 
87,201

Accounts receivable, net
45,325

 
35,193

Inventories, net
40,732

 
19,896

Prepaid and other current assets
3,594

 
3,769

Total current assets
246,598

 
187,885

Property and equipment, net
28,072

 
17,151

Operating lease right-of-use assets
16,577

 

Patents, net
885

 
1,130

Other long-term assets
515

 
128

Total assets
$
292,647

 
$
206,294

Liabilities and Stockholders’ Equity
 
 
 
Current liabilities:
 
 
 
Accounts payable
$
16,314

 
$
6,824

Accrued expenses
7,978

 
3,930

Employee-related liabilities
28,207

 
24,030

Deferred revenue
8,187

 
4,600

Common stock warrants
23,283

 
17,926

Operating lease liabilities
5,951

 

Other current liabilities
10,346

 
8,978

Total current liabilities
100,266

 
66,288

Deferred rent - long-term

 
3,799

Operating lease liabilities - long-term
15,258

 

Other long-term liabilities
10,129

 
4,932

Total liabilities
125,653

 
75,019

Commitments and contingencies (Note 9)


 


Stockholders’ equity:
 
 
 
Common stock, $0.001 par value; 200,000 shares authorized, 59,029 and 57,554 shares issued and outstanding at September 30, 2019 (unaudited) and December 31, 2018, respectively.
59

 
57

Additional paid-in capital
794,324

 
731,306

Accumulated other comprehensive income (loss)
91

 
(13
)
Accumulated deficit
(627,480
)
 
(600,075
)
Total stockholders’ equity
166,994

 
131,275

Total liabilities and stockholders’ equity
$
292,647

 
$
206,294

See accompanying notes to unaudited condensed consolidated financial statements.

1


TANDEM DIABETES CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(Unaudited)
(In thousands, except per share data)
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2019
 
2018
 
2019
 
2018
Sales
$
94,657

 
$
46,264

 
$
253,907

 
$
107,667

Cost of sales
43,974

 
24,468

 
119,967

 
59,381

Gross profit
50,683

 
21,796

 
133,940

 
48,286

Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
44,649

 
29,506

 
120,173

 
73,048

Research and development
12,038

 
7,999

 
32,632

 
20,430

Total operating expenses
56,687

 
37,505

 
152,805

 
93,478

Operating loss
(6,004
)
 
(15,709
)
 
(18,865
)
 
(45,192
)
Other income (expense), net:
 
 
 
 
 
 
 
Interest and other income
914

 
443

 
2,457

 
833

Interest and other expense
(60
)
 
(1,401
)
 
(76
)
 
(7,585
)
Loss on extinguishment of debt

 
(5,313
)
 

 
(5,313
)
Change in fair value of stock warrants
2,321

 
(12,265
)
 
(10,849
)
 
(69,042
)
Total other income (expense), net
3,175

 
(18,536
)
 
(8,468
)
 
(81,107
)
Loss before income taxes
(2,829
)
 
(34,245
)
 
(27,333
)
 
(126,299
)
Income tax expense
72

 

 
72

 

Net loss
$
(2,901
)
 
$
(34,245
)
 
$
(27,405
)
 
$
(126,299
)
Other comprehensive loss:
 
 
 
 
 
 
 
Unrealized gain (loss) on short-term investments
$
(60
)
 
$
(19
)
 
$
91

 
$
(13
)
Foreign currency translation gain (loss)
(11
)
 

 
13

 

Comprehensive loss
$
(2,972
)
 
$
(34,264
)
 
$
(27,301
)
 
$
(126,312
)
 
 
 
 
 
 
 
 
Net loss per share, basic
$
(0.05
)
 
$
(0.62
)
 
$
(0.47
)
 
$
(2.81
)
Net loss per share, diluted
$
(0.09
)
 
$
(0.62
)
 
$
(0.47
)
 
$
(2.81
)
 
 
 
 
 
 
 
 
Weighted average shares used to compute basic net loss per share
58,801

 
55,615

 
58,268

 
44,993

Weighted average shares used to compute diluted net loss per share
59,196

 
55,615

 
58,268

 
44,993

See accompanying notes to unaudited condensed consolidated financial statements.

2


TANDEM DIABETES CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(Unaudited)
(In thousands)

Three Months Ended September 30, 2019
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
Balance at June 30, 2019
58,589

 
$
58

 
$
769,704

 
$
162

 
$
(624,579
)
 
$
145,345

Exercise of stock options
440

 
1

 
7,033

 

 

 
7,034

Fair value of common stock warrants at time of exercise

 

 
13

 

 

 
13

Stock-based compensation

 

 
17,574

 

 

 
17,574

Foreign currency translation

 

 

 
(11
)
 

 
(11
)
Unrealized loss on short-term investments

 

 

 
(60
)
 

 
(60
)
Net loss

 

 

 

 
(2,901
)
 
(2,901
)
Balance at September 30, 2019
59,029

 
$
59

 
$
794,324

 
$
91

 
$
(627,480
)
 
$
166,994



Nine Months Ended September 30, 2019
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
Balance at December 31, 2018
57,554

 
$
57

 
$
731,306

 
$
(13
)
 
$
(600,075
)
 
$
131,275

Exercise of stock options
1,214

 
2

 
14,510

 

 

 
14,512

Exercise of common stock warrants
93

 

 
326

 

 

 
326

Issuance of common stock for Employee Stock Purchase Plan
168

 

 
2,951

 

 

 
2,951

Fair value of common stock warrants at time of exercise

 

 
5,492

 

 

 
5,492

Stock-based compensation

 

 
39,739

 

 

 
39,739

Foreign currency translation

 

 

 
13

 

 
13

Unrealized gain on short-term investments

 

 

 
91

 

 
91

Net loss

 

 

 

 
(27,405
)
 
(27,405
)
Balance at September 30, 2019
59,029

 
$
59

 
$
794,324

 
$
91

 
$
(627,480
)
 
$
166,994

See accompanying notes to unaudited condensed consolidated financial statements.


3


Three Months Ended September 30, 2018
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated
Deficit
 
Total
Stockholders’
Equity
 
Shares
 
Amount
Balance at June 30, 2018
53,186

 
$
53

 
$
595,463

 
$
6

 
$
(569,518
)
 
$
26,004

Issuance of common stock in public offering, net of underwriter’s discount and offering costs
4,035

 
4

 
108,916

 


 


 
108,920

Exercise of stock options
31

 

 
467

 


 


 
467

Exercise of common stock warrants
112

 

 
393

 


 


 
393

Fair value of common stock warrants at time of exercise

 

 
3,913

 


 


 
3,913

Stock-based compensation

 

 
9,996

 


 


 
9,996

Unrealized loss on short-term investments

 

 


 
(19
)
 


 
(19
)
Net loss

 

 


 


 
(34,245
)
 
(34,245
)
Balance at September 30, 2018
57,364

 
$
57

 
$
719,148

 
$
(13
)
 
$
(603,763
)
 
$
115,429


Nine Months Ended September 30, 2018
 
Common Stock
 
Additional
Paid-in
Capital
 
Accumulated
Other
Comprehensive
Income (Loss)
 
Accumulated
Deficit
 
Total
Stockholders’
Equity (Deficit)
 
Shares
 
Amount
Balance at December 31, 2017
10,119

 
$
10

 
$
448,455

 
$

 
$
(477,614
)
 
$
(29,149
)
Adjustment to retained earnings from adoption of ASC 606

 

 

 

 
150

 
150

Issuance of common stock in public offering, net of underwriter’s discount and offering costs
38,535

 
39

 
172,890

 

 

 
172,929

Exercise of stock options
32

 

 
470

 

 

 
470

Exercise of common stock warrants
8,598

 
8

 
29,552

 

 

 
29,560

Fair value of common stock warrants at time of exercise

 

 
53,831

 

 

 
53,831

Stock-based compensation
80

 

 
13,950

 

 

 
13,950

Unrealized loss on short-term investments

 

 

 
(13
)
 

 
(13
)
Net loss

 

 

 

 
(126,299
)
 
(126,299
)
Balance at September 30, 2018
57,364

 
$
57

 
$
719,148

 
$
(13
)
 
$
(603,763
)
 
$
115,429

See accompanying notes to unaudited condensed consolidated financial statements.

4


TANDEM DIABETES CARE, INC.
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2019
 
2018
Operating activities
 
 
 
Net loss
$
(27,405
)
 
$
(126,299
)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities:
 
 
 
Depreciation and amortization expense
4,430

 
4,353

Interest expense related to amortization of debt discount and debt issuance costs

 
1,721

Provision for allowance for doubtful accounts
1,468

 
1,017

Provision for inventories reserve
1,508

 
397

Change in fair value of common stock warrants
10,849

 
69,042

Amortization of premium (discount) on short-term investments
(302
)
 
783

Stock-based compensation expense
39,386

 
13,427

Loss on extinguishment of debt

 
5,313

Other
42

 
155

Changes in operating assets and liabilities:
 
 
 
Accounts receivable, net
(11,588
)
 
(1,913
)
Inventories, net
(21,990
)
 
2,752

Prepaid and other current assets
(17
)
 
(823
)
Other long-term assets
(387
)
 
(39
)
Accounts payable
7,131

 
1,083

Accrued expenses
4,045

 
1,098

Employee-related liabilities
4,173

 
2,741

Deferred revenue
3,587

 
1,178

Other current liabilities
2,335

 
1,100

Deferred rent

 
(571
)
Other long-term liabilities
5,198

 
1,033

Net cash provided by (used in) operating activities
22,463

 
(22,452
)
Investing activities
 
 
 
Purchases of short-term investments
(126,307
)
 
(100,550
)
Proceeds from maturities of short-term investments
96,495

 
18,500

Proceeds from sales of short-term investments
6,550

 

Purchases of property and equipment
(12,792
)
 
(2,098
)
Net cash used in investing activities
(36,054
)
 
(84,148
)
Financing activities
 
 
 
Principal payments on notes payable

 
(87,711
)
Proceeds from public offering, net of offering costs

 
172,929

Proceeds from exercise of common stock warrants
327

 
29,536

Proceeds from issuance of common stock under Company stock plans
17,462

 
473

Net cash provided by financing activities
17,789

 
115,227

Effect of foreign exchange rate changes on cash
36

 

Net increase in cash and cash equivalents and restricted cash
4,234

 
8,627

Cash and cash equivalents and restricted cash at beginning of period
41,826

 
23,700

Cash and cash equivalents at end of period
$
46,060

 
$
32,327

Supplemental disclosures of cash flow information
 
 
 
Interest paid
$

 
$
5,841

Supplemental schedule of non-cash investing and financing activities
 
 
 
Right-of-use assets obtained in exchange for operating lease obligations
$
11,445

 
$

Property and equipment included in accounts payable
$
2,484

 
$
57

See accompanying notes to unaudited condensed consolidated financial statements.

5


TANDEM DIABETES CARE, INC.
NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
The Company
Tandem Diabetes Care, Inc. is a medical device company with an innovative approach to the design, development and commercialization of products for people with insulin-dependent diabetes. The Company is incorporated in the state of Delaware. Unless the context requires otherwise, the terms the “Company” or “Tandem” refer to Tandem Diabetes Care, Inc., together with its wholly-owned subsidiary in Canada.
The Company manufactures, sells and supports insulin pump products that are designed to address the evolving needs and preferences of differentiated segments of the insulin-dependent diabetes market. The Company’s manufacturing, sales and support activities principally focus on the t:slim X2 Insulin Delivery System (t:slim X2), the Company’s flagship pump platform which is capable of remote feature updates and is designed to display continuous glucose monitoring (CGM) sensor information directly on the pump home screen. The Company’s insulin pump products are compatible with the Tandem Device Updater, a Mac and PC-compatible tool for the remote update of the Company's insulin pump software. The Company’s insulin pump products are generally considered durable medical equipment and have an expected lifespan of at least four years. In addition to insulin pumps, the Company sells disposable products that are used together with the pumps and are replaced every few days, including cartridges for storing and delivering insulin, and infusion sets that connect the insulin pump to a user’s body.
The Company began commercial sales of its first product, t:slim, in August 2012 and subsequently commercialized t:flex in May 2015, t:slim G4 in September 2015 and t:slim X2 in October 2016. The t:slim X2 hardware platform now represents 100% of new pump shipments, but the Company continues to provide ongoing service and support to existing t:slim, t:slim G4 and t:flex customers. In August 2017, the Company received approval from the United States Food and Drug Administration (FDA) for the integration of t:slim X2 with the Dexcom G5 Mobile CGM system. In June 2018, the Company received FDA approval for t:slim X2 with Basal-IQ technology, the Company’s first-generation Automated Insulin Delivery (AID) algorithm, and the first insulin pump designated as compatible with integrated CGM (known as iCGM) devices. The Company commenced commercial sales of t:slim X2 with Basal-IQ technology integrated with the Dexcom G6 CGM in August 2018.
During the third quarter of 2018, the Company commenced sales of the t:slim X2 with G5 integration through distribution partners in select European countries, in addition to Australia, New Zealand and South Africa. Direct sales efforts in Canada began in the fourth quarter of 2018. During the second quarter of 2019, the Company began selling the t:slim X2 with Basal-IQ technology in select geographies outside of the United States.
As of September 30, 2019, the Company had $156.9 million in cash, cash equivalents and short-term investments. The Company has incurred operating losses since its inception and had an accumulated deficit of $627.5 million as of September 30, 2019, which included a net loss of $27.4 million for the nine months ended September 30, 2019. Management believes that the cash, cash equivalents and short-term investments on hand will be sufficient to satisfy the Company’s liquidity requirements for at least the next 12 months from the date of this filing.
The Company’s ability to execute on its business strategy, meet its future liquidity requirements, and achieve and maintain profitable operations, is dependent on a number of factors, including its ability to continue to gain market acceptance of its products and achieve a level of revenues adequate to support its cost structure, achieve renewal pump sales objectives, develop and launch new products, expand the commercialization of products into new international markets, maximize manufacturing efficiencies, satisfy increasing production requirements, leverage the investments made in its sales, clinical, marketing and customer support organizations, and operate its business and manufacture and sell products without infringing on third party intellectual property rights.

6


The Company has funded its operations primarily through private and public offerings of equity securities, and through debt financing which has since been fully repaid. The Company may in the future seek additional capital from public or private offerings of equity or debt securities, or it may elect to borrow capital under new credit arrangements or from other sources. If the Company issues equity or debt securities to raise additional funds, its existing stockholders may experience dilution, it may incur significant financing or debt service costs, and the new equity or debt securities may have rights, preferences and privileges senior to those of its existing stockholders. There can be no assurance that equity or debt financing will be available on acceptable terms, or at all.
Basis of Presentation
The Company has prepared the accompanying unaudited condensed consolidated 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 consolidated financial statements should be read in conjunction with the Company’s audited consolidated financial statements and accompanying notes included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2018 (Annual Report), from which the balance sheet information herein was derived.
The condensed consolidated financial statements include the accounts of Tandem Diabetes Care, Inc. and its wholly owned subsidiary in Canada. All significant intercompany balances and transactions have been eliminated in consolidation.
2. Summary of Significant Accounting Policies
There have been no material changes to the Company's significant accounting policies during the nine months ended September 30, 2019, as compared to those disclosed in the Annual Report other than adoption of the new lease accounting standard effective January 1, 2019 (See Note 6, “Leases”).
Use of Estimates
The preparation of the consolidated financial statements in conformity with U.S. GAAP 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 the Company’s consolidated financial statements and accompanying notes as of the date of the consolidated financial statements. Some of those judgments can be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or conditions.
Segment Reporting
Operating segments are identified as components of an enterprise about which discrete financial information is available for evaluation by the chief operating decision-maker (CODM) in making decisions regarding resource allocation and assessing performance. The Company’s current product offering consists primarily of insulin pumps, disposable cartridges and infusion sets for the storage and delivery of insulin. The Company views its operations and manages its business as one segment as key operating decisions and resource allocations are made by the CODM using consolidated financial data.
Accounts Receivable
The Company grants credit to various customers in the ordinary course of business and is paid directly by customers who use the products, distributors and third-party insurance payors. The Company maintains an allowance for doubtful accounts for potential credit losses. Provisions are made based on historical experience, assessment of specific risk, review of outstanding invoices, and various assumptions and estimates that are believed to be reasonable under the circumstances. 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.

7


Fair Value of Financial Instruments
The Company believes the carrying amounts of cash and cash equivalents, accounts receivable, accounts payable, accrued expenses, 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 are carried at fair value. The Company believes the fair value of its operating lease liabilities at September 30, 2019 approximated their carrying value, based on the borrowing rates that were available for loans with similar terms as of that date. The estimated fair value of certain of the Company’s common stock warrants was determined using a Black-Scholes pricing model as of September 30, 2019 and December 31, 2018 (see Note 5, “Fair Value Measurements”).
Revenue Recognition
Revenue is generated primarily from sales of insulin pumps, disposable cartridges and infusion sets to individual customers and third-party distributors that resell the products to insulin-dependent diabetes customers.
In January 2018, the Company adopted the Revenue from Contracts with Customers Standard which superseded existing revenue guidance under U.S. GAAP and International Financial Reporting Standards. Pursuant to the Revenue from Contracts with Customers Standard’s core principle, subsequent to January 1, 2018, the Company recognizes 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. The Company elected to implement this new standard utilizing the modified retrospective method. Under this approach, the Company applied the new standard to all new contracts initiated on or after the effective date, and for contracts which had remaining obligations as of the effective date the Company recorded an adjustment to the opening balance of accumulated deficit. The accounting for the significant majority of the Company’s revenues was not impacted by the new guidance. On January 1, 2018, the Company recorded a net reduction to accumulated deficit in the amount of $149,000, to reflect the impact of the accounting change. Prior to the implementation of this new standard, revenue was recognized when persuasive evidence of an arrangement existed, delivery had occurred and title passed, the price was fixed or determinable, and collectability was reasonably assured.
The Company considers the individual deliverables in its product offering as separate performance obligations. The transaction price is determined based on the consideration expected to be received, based either on the stated value in contractual arrangements or the estimated cash to be collected in non-contracted arrangements. The Company allocates the consideration to the individual performance obligations and recognizes the consideration based on when the performance obligation is satisfied, considering whether or not this occurs at a point in time or over time. Generally, insulin pumps, cartridges, infusion sets and accessories are deemed performance obligations that are satisfied at a point in time when the customer obtains control of the promised good, which is upon delivery, while access to the complementary products, such as the t:connect cloud-based data management application and the Tandem Device Updater, are considered performance obligations satisfied over the typical four-year warranty period of the insulin pumps. There is no standalone value for these complementary products. Therefore, the Company determines their value by applying the expected cost plus a margin approach and then allocates the residual to the insulin pumps. At September 30, 2019 and December 31, 2018, $7.6 million and $3.8 million, respectively, were recorded as deferred revenue for these performance obligations that are satisfied over time.
Additionally, the Company offers a 30-day right of return to its customers from the date of shipment of any of its insulin pumps, 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 sales returns is recorded as a reduction of revenue and an increase in deferred revenue in the period in which the related sale is recorded. The amount recorded on the Company’s balance sheets for allowance for sales returns was $0.2 million and $0.3 million at September 30, 2019 and December 31, 2018, respectively. Actual product returns have not differed materially from estimated amounts reserved in the accompanying condensed consolidated financial statements.

8


Warranty Reserve
The Company generally provides a four-year warranty on its insulin pumps to end user customers and may replace any pumps that do not function in accordance with the product specifications. Insulin pumps returned to the Company may be refurbished 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 product replacement cost and expected replacement rates based on historical experience. The Company evaluates the reserve quarterly and makes adjustments when appropriate. Changes to the actual replacement rates or the expected product replacement cost could have a material impact on the Company’s estimated warranty reserve. 
As of September 30, 2019 and December 31, 2018, the warranty reserve was $16.1 million and $9.1 million, respectively. The following table provides a reconciliation of the change in product warranty liabilities from December 31, 2018 through September 30, 2019 (in thousands):
Balance at December 31, 2018
$
9,138

Provision for warranties issued during the period
13,790

Settlements made during the period
(7,443
)
Increases in warranty estimates
607

Balance at September 30, 2019
$
16,092

 
 
Current portion
$
5,963

Non-current portion
10,129

Total
$
16,092


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 requisite service period on a straight-line basis. The Company estimates the fair value of stock options issued under the Company’s Amended and Restated 2013 Stock Incentive Plan (2013 Plan), and the fair value of the employees’ purchase rights under the Company’s 2013 Employee Stock Purchase Plan (ESPP), using the Black-Scholes option-pricing model on the date of grant. The Black-Scholes option-pricing model requires the use of assumptions about a number of variables, including stock price volatility, expected term, dividend yield and risk-free interest rate. For awards that vest based on the achievement of service conditions, the Company recognizes expense using the straight-line method less estimated forfeitures based on historical experience.
Net Loss Per Share
Basic net loss per share is calculated by dividing the net loss by the weighted average number of shares of common stock that were outstanding for the period, without consideration of common stock equivalents. Diluted net loss per share is calculated in accordance with the treasury stock method and reflects the potential dilution that would occur if outstanding securities or other contracts to issue common stock were exercised or converted to common stock. Dilutive common stock equivalents are comprised of warrants, potential awards granted pursuant to the ESPP, and stock options outstanding under the Company’s equity incentive plans. For warrants that are recorded as a liability in the accompanying balance sheets, the calculation of diluted net loss per share requires that, to the extent the average market price of the underlying shares for the reporting period exceeds the exercise price of the warrants and the presumed exercise of the warrants is dilutive to loss per share for the period, an adjustment be made to net loss used in the calculation to remove the change in fair value of the warrants from the numerator for the period. Likewise, an adjustment to the denominator is required to reflect the related dilutive shares, if any, under the treasury stock method. For all periods presented other than the three months ended September 30, 2019, 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. For the three months ended September 30, 2019, the net loss used in the calculation of diluted net loss per share was increased by $2.3 million to remove the decrease in fair value of common stock warrants based on the dilutive effect of assumed exercise, and the denominator was increased by 394,433 shares calculated under the treasury stock method.

9


Potentially dilutive securities not included in the calculation of diluted net loss per share (because inclusion would be anti-dilutive) are as follows (in thousands, in common stock equivalent shares):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Warrants to purchase common stock
293

 
710

 
710

 
710

Options to purchase common stock
6,234

 
5,155

 
5,868

 
3,031

Awards granted under the ESPP
134

 
61

 
45

 
24

 
6,661

 
5,926

 
6,623

 
3,765


Recent Accounting Pronouncements
In June 2016, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2016-13, Financial Instruments – Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments, which modifies the measurement and recognition of credit losses for most financial assets and certain other instruments. The new standard requires the use of forward-looking expected credit loss models based on historical experience, current conditions, and reasonable and supportable forecasts that affect the collectability of the reported amount, which may result in earlier recognition of credit losses under the new standard. The new standard also requires that credit losses related to available-for-sale debt securities be recorded as an allowance through net income (loss) rather than reducing the carrying amount under the current, other-than-temporary-impairment model. The standard is effective for public business entities for annual periods beginning after December 15, 2019, and interim periods within those years. The Company plans to implement the new standard in the first quarter of 2020, and is in the process of reviewing its credit loss models to assess the impact of the adoption of the standard on its consolidated financial statements.
In August 2018, the FASB issued ASU No. 2018-13, Fair Value Measurement: Disclosure Framework – Changes to the Disclosure Requirements for Fair Value Measurement, which adds and modifies certain disclosure requirements for fair value measurements. Under the new guidance, entities will no longer be required to disclose the amount of and reasons for transfers between Level 1 and Level 2 of the fair value hierarchy, or valuation processes for Level 3 fair value measurements. However, public companies will be required to disclose the range and weighted average of significant unobservable inputs used to develop Level 3 fair value measurements, and related changes in unrealized gains and losses included in other comprehensive income. The updated guidance is effective for annual periods beginning after December 15, 2019, and interim periods within those periods, with early adoption permitted. The Company is in the process of assessing the impact of the adoption of the updated guidance on its consolidated financial statements, as well as whether to early adopt the new standard.
In August 2018, the FASB issued ASU No. 2018-15, Customer's Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract, which changes the accounting for implementation costs incurred in a cloud computing arrangement that is a service contract. The updated guidance aligns the requirements for capitalizing implementation costs incurred in a hosting arrangement with the requirements for capitalizing implementation costs incurred to develop or obtain internal-use software. The implementation costs should be presented as a prepaid asset on the balance sheets and expensed over the term of the hosting arrangement. The updated guidance is effective for annual periods beginning after December 15, 2019, and interim periods within those periods, with early adoption permitted. The Company is in the process of assessing the impact of the adoption of the updated guidance on its consolidated financial statements.

10


3. Short-Term Investments
The Company invests in marketable securities, principally debt instruments of the U.S. Government, and financial institutions and corporations with strong credit ratings. The following represents a summary of the estimated fair value of short-term investments as of September 30, 2019 and December 31, 2018 (in thousands):
At September 30, 2019
Maturity
(in years)
 
Amortized
Cost
 
Gross Unrealized
Gain
 
Gross Unrealized
Loss
 
Estimated
Fair Value
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Commercial paper
Less than 1
 
$
24,997

 
$
10

 
$
(3
)
 
$
25,004

U.S. Government-sponsored enterprise
Less than 2
 
21,830

 
9

 
(4
)
 
21,835

U.S. Treasury securities
Less than 1
 
12,710

 
18

 

 
12,728

Corporate debt securities
Less than 2
 
51,242

 
83

 
(5
)
 
51,320

Total
 
 
$
110,779

 
$
120

 
$
(12
)
 
$
110,887

At December 31, 2018
Maturity
(in years)
 
Amortized
Cost
 
Unrealized
Gain
 
Unrealized
Loss
 
Estimated
Fair Value
Available-for-sale securities:
 
 
 
 
 
 
 
 
 
Commercial paper
Less than 1
 
$
53,559

 
$

 
$
(22
)
 
$
53,537

U.S. Treasury securities
Less than 1
 
17,937

 

 
(2
)
 
17,935

Corporate debt securities
Less than 1
 
15,718

 
12

 
(1
)
 
15,729

Total
 
 
$
87,214

 
$
12

 
$
(25
)
 
$
87,201


The Company has classified all marketable securities, regardless of maturity, as short-term investments based upon the Company's ability and intent to use any and all of those marketable securities to satisfy the Company's current liquidity requirements.

The Company periodically reviews the portfolio of available-for-sale debt securities to determine if any investment is other-than-temporarily impaired due to changes in credit risk or other potential valuation concerns. The Company believes that the short-term investments held at September 30, 2019 were not other-than-temporarily impaired. Unrealized losses on available-for-sale debt securities at that date were not significant and were due to changes in interest rates, including credit spreads, and not due to increased credit risks associated with specific securities. The Company does not intend to sell the available-for-sale debt securities that are in an unrealized loss position, and it is not more likely than not that the Company will be required to sell these debt securities before recovery of their amortized cost bases, which may be at maturity.
4. Inventories
Inventories consisted of the following as of September 30, 2019 and December 31, 2018 (in thousands):
 
September 30,
2019
 
December 31,
2018
Raw materials
$
12,488

 
$
6,622

Work-in-process
11,051

 
2,710

Finished goods
17,192

 
10,564

Total
$
40,732

 
$
19,896



11


5. Fair Value Measurements
Authoritative guidance on fair value measurements defines fair value and provides a consistent framework for both measuring fair value as well as for disclosures of each major asset and liability category measured at fair value on either a recurring or a nonrecurring basis. Fair value is intended to reflect an assumed 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 provides a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
Level 1:
Observable inputs such as unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities.
Level 2:
Inputs, other than quoted prices in active markets, that are observable either directly or indirectly for substantially the full term of the asset or liability.
Level 3:
Unobservable inputs in which there is little or no market data and that are significant to the fair value of the assets or liabilities, which require the reporting entity to develop its own valuation techniques that require input assumptions.
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, 2019 and December 31, 2018, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (in thousands):  
 
 
 
Fair Value Measurements at
September 30, 2019
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents(1)
$
37,987

 
$
37,987

 
$

 
$

Commercial paper
25,004

 

 
25,004

 

U.S. Government-sponsored enterprise
21,835

 

 
21,835

 

U.S. Treasury securities
12,728

 
12,728

 

 

Corporate debt securities
51,320

 

 
51,320

 

Total assets
$
148,874

 
$
50,715

 
$
98,159

 
$

 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
Common stock warrants
$
23,283

 
$

 
$

 
$
23,283

Total liabilities
$
23,283

 
$

 
$

 
$
23,283

 
 
 
Fair Value Measurements at
December 31, 2018
 
 
(Level 1)
 
(Level 2)
 
(Level 3)
Assets
 
 
 
 
 
 
 
Cash equivalents(1)
$
37,373

 
$
37,373

 
$

 
$

Commercial paper
53,537

 

 
53,537

 

U.S. Treasury securities
17,935

 
17,935

 

 

Corporate debt securities
15,729

 

 
15,729

 

Total assets
$
124,574

 
$
55,308

 
$
69,266

 
$

Liabilities
 
 
 
 
 
 
 
Common stock warrants
$
17,926

 
$

 
$

 
$
17,926

Total liabilities
$
17,926

 
$

 
$

 
$
17,926


12


(1)
Generally, cash equivalents include money market funds and investments with a maturity of three months or less from the date of purchase.
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 assets during the nine months ended September 30, 2019 and 2018.
The Company’s Level 3 liabilities at September 30, 2019 and December 31, 2018 include the Series A warrants issued by the Company in connection with the public offering of common stock in October 2017. The Series A warrants have a term of five years and initially provided holders the right to purchase 4,630,000 shares of the Company’s common stock at an exercise price of $3.50 per share. The Series A warrants were initially valued in the aggregate amount of $5.2 million on the date of issuance utilizing a Black-Scholes pricing model.
The Company reassesses the fair value of the outstanding Series A warrants at each reporting date utilizing a Black-Scholes pricing model. Variables used in the pricing model include the market price of the Company’s common stock and estimates of stock price volatility, dividend yield, expected warrant term and risk-free interest rate. The Company develops its estimates based on publicly available historical data. The assumptions used to estimate the fair values of the outstanding Series A warrants at September 30, 2019 and December 31, 2018 are presented below:
 
September 30, 2019
 
December 31, 2018
Risk-free interest rate
1.6
%
 
3.0
%
Expected dividend yield
0.0
%
 
0.0
%
Expected volatility
83.3
%
 
78.3
%
Expected term (in years)
3.0

 
3.8


The following table presents a summary of changes in the fair value of the Company’s Level 3 financial liabilities for the nine months ended September 30, 2019 and 2018:
 
Nine Months Ended September 30,
 
2019
 
2018
Balance at beginning of period
$
17,926

 
$
5,432

Increase in fair value included in change in fair value of common stock warrants
10,849

 
69,042

Decrease in fair value from warrants exercised during the period
(5,492
)
 
(53,831
)
Balance at end of period
$
23,283

 
$
20,643


During the nine months ended September 30, 2019, the Company issued 93,470 shares of common stock upon the exercise of Series A warrants. During the nine months ended September 30, 2018, the Company issued 8,598,076 shares of common stock upon the exercise of certain warrants issued in October 2017, and 13,450 warrants expired unexercised. As of September 30, 2019, there were Series A warrants outstanding to purchase 417,315 shares of the Company's common stock (see Note 8, “Stockholders’ Equity”).

13


6. Leases
In February 2016, the FASB issued ASU No. 2016-02, Leases. The new standard and its related amendments (collectively referred to as ASC 842) requires lessees to recognize right-of-use assets and corresponding lease liabilities for all leases with lease terms of greater than 12 months. It also changed the definition of a lease and expanded the disclosure requirements of lease arrangements. In July 2018, the FASB added a transition option for implementation of the standard that allowed companies to continue to use the legacy guidance in ASC 840, Leases, including its disclosure requirements, in the comparative periods presented in the year of adoption. The new standard must be adopted using the modified retrospective approach and was effective for the Company starting in the first quarter of fiscal 2019. The Company elected the transition option and certain practical expedients, and recognized a cumulative-effect transition adjustment for the recognition of right-of-use leased assets and corresponding operating lease liabilities of $12.4 million on the consolidated balance sheets upon adoption of the standard as of January 1, 2019. The Company did not restate prior periods. Deferred rent of $1.0 million and $3.8 million as of January 1, 2019 was reclassified from other current liabilities and deferred rent long-term, respectively, to a reduction of the right-of-use leased assets in connection with the adoption of the standard.
The Company's leases consist primarily of operating leases for general office space, laboratory, manufacturing, and warehouse facilities, and equipment. Leases with an initial term of 12 months or less are not recorded on the balance sheets. The Company recognizes lease expense for these leases on a straight-line basis over the lease term. Because the Company's leases do not provide an implicit interest rate, the Company uses its incremental borrowing rate based on the information available at the lease commencement date in determining the present value of future lease payments. The Company used the incremental borrowing rate on January 1, 2019 for operating leases that commenced prior to that date. For lease agreements entered into or reassessed after the adoption of ASC 842, the Company combines lease and non-lease components.
Certain leases include an option to renew, with renewal terms that can extend the lease term for additional periods. The exercise of lease renewal options is at the Company's sole discretion. The depreciable life of assets and leasehold improvements are limited by the expected lease term, unless there is a transfer of title or purchase option that is reasonably certain to be exercised.
In January 2019, the Company entered into a lease agreement for approximately 25,332 square feet of additional general administrative office space (Initial Premises) located at 10935 Vista Sorrento Parkway, San Diego, California (Vista Sorrento Parkway Lease). The lease term for the Initial Premises commenced in March 2019 and expires in September 2022. In May 2019, the Company entered into a First Amendment to the Vista Sorrento Parkway Lease (First Amendment) to expand the leased premises by adding approximately 33,681 square feet of additional general administrative office space (Expansion Space), and to extend the lease term for the Initial Premises through December 2022. The lease term for the Expansion Space commenced in May 2019 and expires in December 2022. The Company has a one-time option to extend the term of the Vista Sorrento Parkway Lease, covering both the Initial Premises and the Expansion Space, for a period of four years. The Company recognized right-of-use leased assets and corresponding operating lease liabilities of $3.1 million on the consolidated balance sheets in the first quarter of 2019 related to the Initial Premises, and $4.5 million in the second quarter of 2019 related to the First Amendment to the Vista Sorrento Parkway Lease.
In March 2019, the Company entered into a lease agreement for approximately 40,490 square feet of space located at 6495 Marindustry Place, San Diego, California to house additional operations functions, including warehousing and shipping (Marindustry Place Lease). The lease term commenced in May 2019 and expires in April 2026. The Company has a one-time option to extend the term of the Marindustry Place Lease for a period of no less than three years and no more than five years. The Company recognized right-of-use leased assets and corresponding operating lease liabilities of $3.4 million on the consolidated balance sheets in the second quarter of 2019 related to the Marindustry Place Lease.

14


Future minimum lease payments under non-cancellable operating leases as of September 30, 2019 were as follows (in thousands):
Years Ending December 31,
 
 
2019 (remaining)
 
$
867

2020
 
6,831

2021
 
7,100

2022
 
5,880

2023
 
1,991

Thereafter
 
1,577

Total future minimum lease payments
 
24,246

Less: amount representing interest
 
(3,037
)
Present value of future minimum lease payments
 
21,209

Less: current portion of operating lease liabilities
 
(5,951
)
Operating lease liabilities - long-term
 
$
15,258


7. Term Loan Agreement
In August 2018, the Company fully repaid the term loan made by Capital Royalty Partners II, L.P. and its affiliated funds (CRG) pursuant to the Amended and Restated Term Loan Agreement (Term Loan Agreement). The balance of the outstanding debt during 2018 up until the time of repayment was $82.7 million. The repayment included approximately $1.1 million in accrued interest and approximately $5.0 million in associated financing fees that became due. As a result of the repayment, the Company did not have any borrowings outstanding under the Term Loan Agreement as of September 30, 2019 or December 31, 2018.
Under the Term Loan Agreement, interest was 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 (PIK Loan) to be added to the principal of the loan and subject to accruing interest.
The Company entered into a series of amendments to the Term Loan Agreement between 2016 and 2018, which included the addition of a financing fee payable at the maturity of the Company’s loans, the issuance of 193,788 ten-year warrants to CRG to purchase shares of the Company’s common stock at an exercise price of $23.50 per share and certain other minimum financing covenants. The financing fee was applicable to the entire aggregate principal amount of borrowings outstanding, including total PIK Loans issued. As of September 30, 2019, the warrants to purchase 193,788 shares of the Company's common stock at an exercise price of $23.50 per share remained outstanding.
8. Stockholders’ Equity
Public Offerings
In the first quarter of 2018, the Company completed a public offering of 34,500,000 shares of common stock at a public offering price of $2.00 per share. The gross proceeds to the Company from the offering were approximately $69.0 million, before deducting underwriting discounts and commissions and other offering expenses payable by the Company.

In the third quarter of 2018, the Company completed a public offering of 4,035,085 shares of common stock at a public offering price of $28.50 per share. The gross proceeds to the Company from the offering were $115.0 million, before deducting underwriting discounts and commissions and other offering expenses payable by the Company.

15



Shares Reserved for Future Issuance

The following shares of the Company’s common stock were reserved for future issuance as of September 30, 2019 (in thousands):

Shares underlying outstanding warrants
710

Shares underlying outstanding stock options
7,358

Shares authorized for future equity award grants
3,165

Shares authorized for issuance pursuant to awards granted under the ESPP
1,852

 
13,085



As of September 30, 2019, there were Series A warrants outstanding to purchase 417,315 shares of the Company's common stock at an exercise price of $3.50 per share, which were issued in connection with the October 2017 Financing, and which expire in October 2022. Also outstanding as of September 30, 2019, were warrants to purchase 193,788 shares of the Company's common stock at an exercise price of $23.50 per share, which were issued in March 2017, and which expire in March 2027 (see Note 7, “Term Loan Agreement”), and warrants to purchase 98,965 shares of the Company's common stock at an exercise price of $73.73 per share, which were issued between August 2011 and August 2012, and which expire between August 2021 and August 2022. The Company issued 200 and 93,470 shares of its common stock upon the exercise of warrants during the three and nine months ended September 30, 2019, respectively. The Company issued 8,603,321 shares of its common stock upon the exercise of warrants during the year ended December 31, 2018.
In both June 2019 and 2018, the Company received approval from its stockholders to increase the number of shares of its common stock reserved for issuance under the 2013 Plan by 5,000,000 and 5,500,000 shares, respectively. The Company issued 439,646 and 1,213,428 shares of its common stock upon the exercise of stock options during the three and nine months ended September 30, 2019, respectively. The Company issued 136,042 shares of its common stock upon the exercise of stock options during the year ended December 31, 2018.
The ESPP enables eligible employees to purchase shares of the Company's common stock using their after-tax payroll deductions, subject to certain conditions. Historically, offerings under the ESPP consisted of a two-year offering period with four six-month purchase periods which begin in May and November of each year. The Company previously suspended the ESPP in May 2017 due to a lack of available shares. In June 2018, the Company received approval from its stockholders to increase the number of shares of its common stock reserved for issuance under the ESPP by 2,000,000 shares. A new offering commenced under the ESPP on June 15, 2018, and the first purchase date was November 15, 2018. There were 168,165 shares of common stock purchased under the ESPP in the nine months ended September 30, 2019. There were 80,581 shares of common stock purchased under the ESPP during the year ended December 31, 2018.
Stock-Based Compensation
In June 2019, the Company granted options to purchase 1,644,715 shares of common stock under the 2013 Plan, which were originally awarded between February 2019 and June 2019, subject to and conditioned upon the approval by its stockholders of an increase in the number of shares of common stock reserved for issuance under the 2013 Plan. In total, the Company granted options to purchase 2,916,906 shares of common stock under the 2013 Plan during the nine months ended September 30, 2019. These options have an exercise price equal to the closing price of the Company's common stock on the applicable award date, and generally vest as to 25% of the underlying shares on the first anniversary of the award, with the balance of the options vesting monthly over the following three years.
In June 2018, the Company granted options to purchase 811,800 shares of common stock under the 2013 Plan, which were originally awarded on December 1, 2017, subject to and conditioned upon the approval by its stockholders of an increase in the number of shares of common stock authorized under the 2013 Plan. These options have an exercise price equal to the closing price of the Company's common stock on the applicable award date, and generally vest as to 50% of the underlying shares on the first anniversary of the award, with the balance of the options vesting monthly over the following year.

16


The Company also granted options to purchase 3,661,220 shares of common stock under the 2013 Plan during the nine months ended September 30, 2018. These options have an exercise price equal to the closing price of the Company's common stock on the applicable award date, and generally vest as to 25% of the underlying shares on the first anniversary of the award, with the balance of the options vesting monthly over the following three years, except with respect to options to purchase 3,389,300 shares of common stock granted in June 2018, which vest as to 50% of the underlying shares on the first anniversary of the award, with the balance of the options vesting monthly over the following year.
The assumptions used in the Black-Scholes option-pricing model are as follows:
 
Stock Options
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
2019
 
2018
 
2019
 
2018
Weighted average grant date fair value (per share)
$
38.74

 
$
21.77

 
$
39.08

 
$
12.35

Risk-free interest rate
1.7
%
 
2.8
%
 
2.1
%
 
2.8
%
Expected dividend yield
0.0
%
 
0.0
%
 
0.0
%
 
0.0
%
Expected volatility
71.8
%
 
70.5
%
 
71.8
%
 
71.4
%
Expected term (in years)
6.1

 
6.1

 
6.0

 
5.7

 
ESPP
Nine Months Ended
September 30,
2019
 
2018
Weighted average grant date fair value (per share)
$
33.49

 
$
9.62

Risk-free interest rate
2.3
%
 
2.4
%
Expected dividend yield
0.0
%
 
0.0
%
Expected volatility
75.9
%
 
77.0
%
Expected term (in years)
1.3

 
1.3


The Company records stock-based compensation expense associated with the ESPP using the Black-Scholes option-pricing model. Valuations are performed on the grant date at the beginning of the purchase period, which generally occurs in May and November of each year.
The following table summarizes the allocation of stock-based compensation expense included in the consolidated statement of operations (in thousands):
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
 
2019
 
2018
 
2019
 
2018
Cost of sales
$
1,751

 
$
784

 
$
4,178

 
$
1,129

Selling, general & administrative
13,110

 
6,821

 
29,060

 
9,833

Research and development
2,369

 
1,932

 
6,148

 
2,465

Total
$
17,230

 
$
9,537

 
$
39,386

 
$
13,427


The total stock-based compensation expense capitalized as part of the cost of the Company’s inventories was $0.8 million and $0.4 million as of September 30, 2019 and December 31, 2018, respectively.

17


9. Commitments and Contingencies
From time to time, the Company may be subject to legal proceedings or regulatory matters arising in the ordinary course of business, including actions with respect to intellectual property, employment, regulatory, product liability and contractual matters. In connection with these proceedings or matters, the Company regularly assesses the probability and amount (or range) of possible issues based on the developments in these proceedings or matters. A liability is recorded in the consolidated financial statements if it is determined that it is probable that a loss has been incurred, and that the amount (or range) of the loss can be reasonably estimated. Because of the uncertainties related to any pending proceedings or matters, the Company is currently unable to predict their ultimate outcome and, with respect to any legal proceeding or regulatory matter where no liability has been accrued, to make a reasonable estimate of the possible loss (or range of loss) that could result from an adverse outcome. As of September 30, 2019 and December 31, 2018, there were no legal proceedings, regulatory matters, or other disputes or claims for which a material loss was considered probable or for which the amount (or range) of loss was reasonably estimable. However, regardless of the outcome, legal proceedings, regulatory matters, and other disputes and claims can have an adverse impact on the Company because of legal costs, diversion of management time and resources, and other factors.

18


Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
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 for the quarter ended September 30, 2019 (Quarterly Report).
This Quarterly Report contains forward-looking statements within the meaning of the federal securities laws, which statements are subject to considerable risks and uncertainties. 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. In particular, forward-looking statements contained in this Quarterly Report may relate to, among other things, our future or assumed financial condition, results of operations, liquidity, business forecasts and plans, research and product development plans, manufacturing plans, strategic plans and objectives, capital needs, financing plans and objectives, product launches, distribution plans, clinical trials, regulatory approvals and competitive environment. We caution you that the foregoing list may not include all of the forward-looking statements made in this Quarterly Report.
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 financial condition and 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, as well as the other public filings we make with the Securities and Exchange Commission. You should read this Quarterly Report with the understanding that our actual future financial condition and results may be materially different from and worse than what we expect.
Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements.
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 Global Market, we undertake no obligation to update or review any forward-looking statement because of new information, future events or other factors.
We qualify all of our forward-looking statements by these cautionary 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. We believe our competitive advantage is rooted in our consumer-focused approach, and the incorporation of modern and innovative technology into our product offerings. Our manufacturing, sales and support activities principally focus on our flagship pump platform, the t:slim X2 Insulin Delivery System (t:slim X2), and our complementary product offerings. The simple-to-use t:slim X2 is based on our proprietary technology platform and is the smallest durable insulin pump available. It is the only pump currently available in the United States that is capable of remote feature updates, which positions us well to address the evolving needs and preferences of differentiated segments of the insulin-dependent diabetes market. By delivering innovative hardware and software solutions, as well as best-in-class customer support, we aim to improve and simplify the lives of people with diabetes and those of their healthcare providers.
We have commercially launched six insulin pumps in the United States since inception, all of which have been developed using our proprietary technology platform. Three of our insulin pumps have featured continuous glucose monitoring (CGM) technology, and one features an automated insulin delivery (AID) algorithm. In addition, the United States Food and Drug Administration (FDA) has classified two categories for the interoperability of devices for AID. In June 2018, the t:slim X2 was the first insulin pump designated as compatible with integrated continuous glucose monitoring (known as iCGM) devices, and in February 2019, the t:slim X2 was the first in a new device category called Alternate Controller Enabled Infusion Pumps (ACE pumps).

19


In the four-year period ended September 30, 2019, we shipped approximately 129,000 insulin pumps, which is representative of our estimated global installed customer base on the typical four-year reimbursement cycle. Approximately 107,000 of these pumps were shipped to customers in the United States and approximately 22,000 were shipped to international markets.
During the third quarter of 2018, we began selling our t:slim X2 with G5 integration through distribution partners in select European countries, in addition to Australia, New Zealand, and South Africa. Direct sales efforts in Canada began in the fourth quarter of 2018. During the second quarter of 2019, we began selling our t:slim X2 with Basal-IQ technology in select geographies outside of the United States.
We have discontinued sales of our original t:slim, t:slim G4 and t:flex pumps, and our t:slim X2 hardware platform now represents 100% of new pump shipments. However, we continue to provide pump supplies, and ongoing service and support to customers using our earlier products.
Our insulin pump products are generally considered durable medical equipment and have an expected lifespan of at least four years. In addition to insulin pumps, we sell disposable products that are used together with our pumps and are replaced every few days, including cartridges for storing and delivering insulin, and infusion sets that connect the insulin pump to a user’s body.
Our insulin pumps are compatible with the Tandem Device Updater, a revolutionary tool that allows pump users to update their pumps’ software quickly and easily from a personal computer. The Tandem Device Updater launched in the United States in the first quarter of 2017 and outside of the United States in the third quarter of 2019. This unique offering provides our in-warranty customers potential access to new and enhanced features and functionality faster than the industry has been able to in the past. The first use of our Tandem Device Updater was to provide t:slim pumps with enhanced features, including an expedited fill cycle. We set a new standard of care in our industry by offering existing in-warranty t:slim X2 customers in the United States two significant software updates: (i) integration with the Dexcom G5 Mobile CGM system in August 2017 and (ii) an upgrade to our new Basal-IQ technology and integration with Dexcom’s G6 CGM system in August 2018. We are preparing to offer these customers a third significant software update, Control-IQ technology, subject to FDA approval. Outside of the United States, we plan to begin offering Control-IQ technology to in-warranty t:slim X2 customers in the second half of 2020, subject to required regulatory and reimbursement approvals. Our Tandem Device Updater positions us to bring future innovations, including our next generation AID algorithms, to t:slim X2 customers independent of the typical four-year insurance pump reimbursement cycle.
For the nine months ended September 30, 2019 and 2018, our consolidated sales were $253.9 million and $107.7 million, respectively. For the nine months ended September 30, 2019 and 2018, our net loss was $27.4 million and $126.3 million, respectively. Worldwide pump sales accounted for 69% and 64% of our total sales, respectively, for the nine months ended September 30, 2019 and 2018, while pump-related supplies and accessories accounted for the remainder in each year. Our accumulated deficit as of September 30, 2019 and December 31, 2018 was $627.5 million and $600.1 million, respectively. These amounts included $197.7 million and $147.4 million of non-cash stock-based compensation charges and non-cash changes in the fair value of common stock warrants as of September 30, 2019 and December 31, 2018, respectively.
In the United States, we have rapidly increased sales since the commercial launch of our first product by expanding our sales, clinical and marketing organization, by developing, commercializing and marketing multiple differentiated products that utilize our proprietary technology platform and consumer-focused approach, and by providing strong customer support. Our sales have further increased following our scaled product launches in geographies outside of the United States. We believe that by demonstrating our product benefits and the shortcomings of existing insulin therapies, more people will choose our insulin pumps for their therapy needs, allowing us to further penetrate and expand the market both domestically and outside of the United States. In addition, we believe publications, such as the results from the study using Control-IQ technology that was published in the New England Journal of Medicine in October 2019, will be valuable in demonstrating the clinical outcome benefits derived from our system to healthcare providers and payors. We also believe we are positioned well to address consumers’ needs and preferences with our current products and products under development and by offering customers access to our future innovations through the Tandem Device Updater, as they are approved by the local regulating bodies. At the same time, by innovating and offering new product features and benefits using our t:slim X2 platform, we are able to leverage a shared global manufacturing and supply chain infrastructure. In the United States, we are able to leverage a single sales, marketing, and clinical organization, as well as our domestic customer support services. In Canada, we have a separate sales organization and our customer support infrastructure benefits from close collaboration with our United States organization. In other international geographies, we have contracted with experienced distribution partners to commercialize and support our t:slim X2 platform.

20


Products Under Development
Our products under development support our strategy of focusing on both consumer and clinical needs, and include a new AID system, a connected (mobile) health offerings and a next-generation hardware platform which we call the t:sport Insulin Delivery System. We intend to leverage our consumer-focused approach and proprietary technology platform to continue to develop products that have the features and functionality that will allow us to meet the needs of people in differentiated segments of the insulin-dependent diabetes market, including the following:
t:slim X2 with Control-IQ technology – Our second-generation AID system integrates our t:slim X2 with the technology that we licensed from TypeZero Technologies, LLC (TypeZero) and Dexcom’s G6 CGM sensor. Our product is intended to both increase and decrease basal insulin based on a user’s predicted blood glucose levels from a compatible iCGM sensor, as well as deliver automated correction boluses. In conjunction with Dexcom and TypeZero, which was acquired by Dexcom in August 2018, we have integrated our technologies into the U.S. portion of the Clinical Acceptance of the Artificial Pancreas (DCLP3) portion of the International Diabetes Closed Loop (IDCL) trial. The 6-month study was completed in April 2019. In June 2019, positive results from this study were announced with significant time-in-range improvements. Subsequently, we filed a regulatory submission with the FDA for our t:slim X2 insulin pump with Control-IQ technology. Subject to FDA approval, our goal is to commence commercial sales of our t:slim X2 with Control-IQ technology in the United States in the fourth quarter of 2019. We are also awaiting the results of two studies using the t:slim X2 with Control-IQ technology in pediatric populations, which we intend to use to support a future regulatory submission for a lower age indication.
Connected (Mobile) Health Offerings – We are currently developing a mobile application that is being designed to utilize the capability of the Bluetooth radio integrated with the t:slim X2 to wirelessly upload pump data to t:connect, receive notification of pump alerts and alarms, integrate other health-related information from third party sources, and support future pump-control capabilities for our products under development.
We are preparing to launch the first generation of this mobile application in the United States in conjunction with our Control-IQ technology, which will allow for the wireless upload of data to t:connect. The t:connect application is intended to reduce patient burden and increase healthcare provider office efficiency by reducing the manual steps historically required for data extraction.
Over time, we also intend to offer additional features and enhancements to the mobile application.
t:sport Insulin Delivery System – Approximately half the size of our t:slim X2 pump, the t:sport pump is being designed for people who seek even greater discretion and flexibility with the use of their insulin pump. We anticipate that t:sport will feature a 200-unit cartridge, an on-pump bolus button, a rechargeable battery, an AID algorithm, and a Bluetooth radio. t:sport is being designed for use with leading U-100 insulins, and we are evaluating the use of insulin concentrates to provide to people with greater insulin needs. t:sport is expected to utilize a pumping mechanism that differs from our current Micro-Delivery technology. We anticipate that t:sport will be our first insulin pump to support full pump-control from our mobile application, subject to FDA review and approval. A separate controller may be offered in addition to or in advance of full mobile control availability.
Pump Shipments
From inception through June 2018, we derived nearly all of our sales from the shipment of insulin pumps and associated supplies to customers in the United States. Starting in the third quarter of 2018, we commenced sales of our t:slim X2 insulin pump in select international geographies. We consider the number of insulin pump units shipped per quarter domestically and internationally to be an important metric for managing our business.
In the four-year period ended September 30, 2019, we shipped approximately 129,000 insulin pumps, of which approximately 107,000 were shipped to customers in the United States and approximately 22,000 were shipped to international markets. In the third quarter of 2019, we shipped 17,839 insulin pumps worldwide compared to 8,434 insulin

21


pumps shipped in the third quarter of 2018. For the nine months ended September 30, 2019, we shipped 53,829 insulin pumps worldwide compared to 18,325 in the nine months ended September 30, 2018.
Pump shipments to customers in the United States by fiscal quarter were as follows:
 
Pump Units Shipped for Each of the Three Months Ended in Respective Years(1) - U.S.
 
March 31
 
June 30
 
September 30
 
December 31
 
Total
2012

 
9


204

 
844

 
1,057

2013
852

 
1,363

 
1,851

 
2,406

 
6,472

2014
1,723

 
2,235

 
2,935

 
3,929

 
10,822

2015
2,487

 
3,331

 
3,431

 
6,234

 
15,483

2016(2)
4,042

 
4,582

 
3,896

 
4,418

 
16,938

2017(2)
2,816

 
3,427

 
3,868

 
6,950

 
17,061

2018
4,444

 
5,447

 
7,379

 
12,935

 
30,205

2019
9,669

 
12,799

 
13,814

 
N/A
 
36,282

Pump shipments to international customers by fiscal quarter were as follows:
 
Pump Units Shipped for Each of the Three Months Ended in Respective Years(1) - International
 
March 31
 
June 30
 
September 30
 
December 31
 
Total
2018
N/A
 
N/A
 
1,055

 
3,233

 
4,288

2019
5,063

 
8,459

 
4,025

 
N/A

 
17,547

(1)
The pump units shipped do not reflect returns or exchanges of pump products that occur in the ordinary course of business.
(2)
2016 and 2017 U.S. shipments do not include approximately 3,300 pump trade-ins fulfilled under the Technology Upgrade Program related to our commercial launch of t:slim X2.
Trends Impacting Financial Results
Overall, we have experienced considerable sales growth since the commercial launch of our first product in the third quarter of 2012, while incurring operating losses since our inception. Our operating results have historically fluctuated on a quarterly or annual basis, particularly in periods surrounding anticipated regulatory approvals, the commercial launch of new products by us and our competitors, and the commercial launch of our products in geographies outside of the United States. We expect these periodic fluctuations in our operating results to continue.
We believe that our financial condition and operating results, as well as the decision-making process of our current and potential customers, has been and will continue to be impacted by a number of general trends, including the following:
market acceptance of our products and competitive products by people with insulin-dependent diabetes, their caregivers and healthcare providers;
the introduction of new products, treatment techniques or technologies for the treatment of diabetes, including the timing of the commercialization of new products by us and our competitors;
seasonality in the United States associated with annual insurance deductibles and coinsurance requirements associated with the medical insurance plans utilized by our customers and the customers of our distributors;
timing of holidays and summer vacations, which may vary by geography;
the buying patterns of our distributors and other customers, both domestically and internationally;
changes in the competitive landscape, including as a result of companies entering or exiting the diabetes therapy market;

22


access to adequate coverage and reimbursement for our current and future products by third-party payors, and reimbursement decisions by third-party payors;
the magnitude and timing of any changes to our facilities, manufacturing operations and other infrastructure;
anticipated and actual regulatory approvals of our products and competitive products; and
product recalls impacting, or the suspension or withdrawal of regulatory clearance or approval relating to, our products or the products of our competitors.
In addition to these general trends, we believe the following specific factors have materially impacted, and could continue to materially impact our business going forward:
continued increase in demand following the commercial launch of t:slim X2 and the demonstrated success of our Tandem Device Updater;
anticipated new product launches;
increased opportunity to achieve customer renewals as customers become eligible for insurance reimbursement to purchase a new insulin pump at the end of the typical four-year reimbursement cycle;
opportunity to attract customers of Animas Corporation (Animas) following the announcement by Johnson & Johnson that it discontinued the operations of Animas and discontinued availability of Animas pump supplies on September 30, 2019;
designation by UnitedHealthcare of one of our competitors as its preferred, in-network durable medical equipment provider of insulin pumps for most customers age seven and above;
ability to enter into and maintain agreements with CGM partners for CGM integration;
expansion and new product launches in select international geographies; and
ability to effectively scale our operations to support rapid growth, including expanding our facilities, increasing manufacturing capacity through third party manufacturers, and hiring and retaining employees in the customer service and support functions.

In addition to working to achieve our sales growth expectations, we intend to continue to leverage our infrastructure investments to realize additional manufacturing, sales, marketing and administration cost efficiencies with the goal of improving our operating margins and ultimately achieving sustained profitability. We achieved profitability for the first time in the fourth quarter of 2018, although we may be unable to achieve profitability from period to period. We believe we can ultimately achieve sustained profitability by driving incremental sales growth in U.S. and international markets, meeting our pump renewal sales objectives, increasing gross profits from additional sales of infusion sets, maximizing manufacturing efficiencies on increased production volumes, and leveraging the investments made in our sales, clinical, marketing and customer support organizations.

Recent Developments

Collaboration with Abbott

In October 2019, we and Abbott Laboratories (Abbott) announced that we intend to develop and commercialize integrated diabetes solutions that combine Abbott's glucose sensing technology with Tandem's innovative insulin delivery systems to provide additional treatment options for people with insulin-dependence to manage their diabetes. These development and commercialization plans are contingent on the negotiation of a definitive agreement, and while the parties are currently exploring a business relationship, there can be no assurance that an agreement will be reached or that any agreement will be on the terms that are currently being discussed.


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International Diabetes Closed Loop trial using the t:slim X2 insulin pump with Control-IQ advanced hybrid closed-loop technology

In October 2019, the New England Journal of Medicine published results from the Protocol 3 study (DCLP3) of the National Institutes of Health (NIH)-funded International Diabetes Closed Loop (iDCL) trial using the t:slim X2 insulin pump with Control-IQ advanced hybrid closed-loop technology. The DCLP3 study was the first-ever large-scale, six-month closed-loop study that included a dedicated control group. The study concluded that over the six-month period, use of Control-IQ technology led to a higher percentage of time spent in range (70-180 mg/dL), less hyper- and hypoglycemia and better glycated hemoglobin (HbA1c) levels than use of a sensor augmented pump. No severe hypoglycemic events were reported, and 100% of participants completed the study. We believe publications such as this will be valuable in demonstrating the clinical outcome benefits derived from our system to people with insulin-dependent diabetes, healthcare providers and payors.

Components of Results of Operations
Sales
We offer products for people with insulin-dependent diabetes. We commenced commercial sales of our original t:slim insulin pump platform in the United States in the third quarter of 2012 and continued to launch various iterations of that platform during the following years. In October 2016, we began shipping our flagship pump platform, the t:slim X2 insulin pump. The t:slim X2 hardware platform, which includes remote software update capabilities, now represents 100% of our new pump shipments. Accordingly, in the third quarter of 2018 we discontinued new sales of all prior platform versions. Our products also include disposable cartridges and infusion sets. In addition, we offer accessories including protective cases, belt clips, and power adapters, although sales of these products are not significant.
We primarily sell our products through national and regional distributors in the United States 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. We believe our existing sales, clinical, and marketing infrastructure will allow us to continue to increase sales by allowing us to promote our products to a greater number of potential customers, caregivers and healthcare providers.
In the third quarter of 2018, we began selling our t:slim X2 with G5 through distribution partners in select European countries, Canada, Australia, New Zealand, and South Africa. During the second quarter of 2019, we began selling our t:slim X2 with Basal-IQ technology in select geographies outside of the United States. In Canada, we market with a direct sales force and, similar to the United States, use a distributor partner for certain billing and fulfillment activities. In other international markets, we expect that most of our commercial sales will initially be to independent distributors who will perform all sales, customer support and training in their respective markets. Historically, we have experienced consistent levels of reimbursement for our products in the United States, but we expect the average sales price will vary in international markets based on a number of factors, such as the geographical mix, nature of the reimbursement environment, government regulations and the extent to which we rely on distributor relationships to provide sales, clinical and marketing support.
In general, in the United States we have experienced, and expect to continue to experience, pump shipments being weighted heavily towards the second half of the year, with the highest percentage of pump shipments expected in the fourth quarter of the year due to the nature of the reimbursement environment. Consistent with our historical seasonality, we also expect domestic pump shipments from the fourth quarter to the following first quarter to decrease significantly. Internationally, we do not expect this same impact from seasonality. We also believe the opportunity to transition former Animas customers during 2019 has, and will continue to, impact our quarterly sales trends worldwide.
In addition, our quarterly sales have fluctuated, and may continue to fluctuate, substantially in the periods surrounding anticipated and actual regulatory approvals and commercial launches of new products by us or our competitors. We believe customers may defer purchasing decisions if they believe a new product may be launched in the future. Additionally, upon the announcement of FDA approval or commercial launch of a new product, either by us or one of our competitors, potential new customers may reconsider their purchasing decisions or take additional time to consider the anticipated or new approval or product launch in making their purchasing decisions. For instance, we believe certain customers paused in their decision-making during the third quarter of 2019 in anticipation of the commercial availability of the t:slim X2 with Control-IQ technology. However, we are not able to quantify the extent of the impact of these or similar events on future purchasing decisions.

24


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, freight, reserves for expected warranty costs, scrap and excess and obsolete inventories. 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 continue to increase as our product sales increase.
We expect our overall gross margin percentage, 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 our overhead costs are spread over larger production volumes. We expect we will be able to leverage our manufacturing cost structure across our products that utilize the same proprietary technology platform and manufacturing infrastructure, and will be able to further reduce per unit costs with increased automation, process improvements and raw materials cost reductions. Pumps have, and are expected to continue to have, a higher gross margin than our pump-related supplies. Therefore, the percentage of pump sales relative to total sales will have a significant impact on gross margin. We also expect our warranty cost per unit to decrease as we release additional product features and functionality utilizing the Tandem Device Updater. However, our overall gross margin may fluctuate in future quarterly periods as a result of numerous factors aside from those associated with production volumes and product mix. In addition, as demand for our products increases, we have begun, and may continue, to make additional investments in manufacturing capacity or increase our reliance on third parties for manufacturing-related services, which could have a negative impact on gross margin.
Other factors impacting our overall gross margin may include the changing percentage of products sold to distributors versus directly to individual customers, varying levels of reimbursement among third-party payors in domestic and international markets, the timing and success of new regulatory approvals and product launches, the impact of the valuation and amortization of employee stock option grants on non-cash stock-based compensation expense allocated to cost of sales, warranty and training costs, licensing and royalty costs, cost associated with excess and obsolete inventories, and changes in our manufacturing processes, capacity, costs or output.
Selling, General and Administrative
Our selling, general and administrative (SG&A) expenses primarily consist of salary, cash-based incentive compensation, fringe benefits and non-cash stock-based compensation for our executive, financial, legal, marketing, sales, clinical, customer support, technical services, insurance verification, regulatory affairs and other administrative functions. We began expanding our U.S. field sales and clinical organization during the third quarter of 2019 to support an expected increase in demand. We expect to have approximately 90 territories by early 2020. Our existing territories are maintained by sales representatives and field clinical specialists, and supported by managed care liaisons, additional sales management and other customer support personnel. Our operations in Canada are supported by a direct sales force of approximately 10 field representatives. Other significant SG&A expenses include those incurred for product demonstration samples, commercialization activities associated with new product launches, travel, trade shows, outside legal fees, independent auditor fees, outside consultant fees, insurance premiums, facilities costs and information technology costs. Overall, we expect our SG&A expenses, including the cost of our customer support infrastructure, to increase as our customer base grows in the United States and international markets. We will continue to evaluate, and may further increase, the number of our field sales and clinical personnel in order to optimize the coverage of our existing territories. Additionally, we realized a notable increase in non-cash stock-based compensation expense allocated to SG&A beginning in the third quarter of 2018, and again in the second quarter of 2019, due to the valuation of certain employee stock option grants and the impact on the valuation of the significant increase in our stock price over the previous year. We expect higher non-cash stock-based compensation expense will be sustained in future quarters. Our SG&A expenses may also increase due to anticipated costs associated with additional compliance and regulatory reporting requirements.

25


Research and Development
Our research and development (R&D) activities primarily consist of engineering and research programs associated with our products under development, as well as activities associated with our core technologies and processes. R&D expenses are primarily related to employee compensation, including salary, fringe benefits, non-cash stock-based compensation and temporary employee expenses. We also incur R&D expenses for supplies, development prototypes, outside design and testing services, depreciation, allocated facilities and information services, clinical trial costs, payments under our licensing, development and commercialization agreements and other indirect costs. We expect our R&D expenses to increase as we advance our products under development and develop new products and technologies, as well as continue to reflect a notable increase in non-cash stock-based compensation expense due to the valuation of certain employee stock option grants and the impact on the valuation of the significant increase in our stock price over the previous year.
Other Income and Expense

Other income and expense primarily consists of changes in the fair value of certain warrants issued in our public offering of common stock in October 2017. In 2018, it also included interest expense and amortization of debt discount and debt issuance costs associated with our Amended and Restated Term Loan Agreement (Term Loan Agreement) with Capital Royalty Partners II, L.P. and its affiliated funds (CRG) and a $5.3 million loss on extinguishment of debt associated with the full repayment of amounts due under the Term Loan Agreement in August 2018. Prior to the repayment, there was $82.7 million of outstanding principal under the Term Loan Agreement, which accrued interest at a rate of 11.5% per annum. As a result of the full repayment, we did not incur any interest expense or costs associated with the Term Loan Agreement subsequent to the third quarter of 2018. Other income also includes interest earned on our cash equivalents and short-term investments. We expect other income and expense to fluctuate from period to period primarily due to the revaluation of the outstanding Series A warrants, which expire in the fourth quarter of 2022.

Results of Operations
 
Three Months Ended
September 30,
 
Nine Months Ended
September 30,
(in thousands, except percentages)
2019
 
2018
 
2019
 
2018
Sales:
 
 
 
 
 
 
 
Domestic
$
78,842

 
$
43,720

 
$
203,867

 
$
105,123

International
15,815

 
2,544

 
50,040

 
2,544

Total sales
94,657

 
46,264

 
253,907

 
107,667

Cost of sales
43,974

 
24,468

 
119,967

 
59,381

Gross profit
50,683

 
21,796

 
133,940

 
48,286

Gross margin
54
%
 
47
%
 
53
%
 
45
%
Operating expenses:
 
 
 
 
 
 
 
Selling, general and administrative
44,649

 
29,506

 
120,173

 
73,048

Research and development
12,038

 
7,999

 
32,632

 
20,430

Total operating expenses
56,687

 
37,505

 
152,805

 
93,478

Operating loss
(6,004
)
 
(15,709
)
 
(18,865
)
 
(45,192
)
Other income (expense), net:
 
 
 
 
 
 
 
Interest and other income
914

 
443

 
2,457

 
833

Interest and other expense
(60
)
 
(1,401
)
 
(76
)
 
(7,585
)
Loss on extinguishment of debt

 
(5,313
)
 

 
(5,313
)
Change in fair value of stock warrants
2,321

 
(12,265
)
 
(10,849
)
 
(69,042
)
Total other income (expense), net
3,175

 
(18,536
)
 
(8,468
)
 
(81,107
)
Loss before income taxes
(2,829
)
 
(34,245
)
 
(27,333
)
 
(126,299
)
Income tax expense
72

 

 
72

 

Net loss
$
(2,901
)
 
$
(34,245
)
 
$
(27,405
)
 
$
(126,299
)

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Comparison of the Three Months Ended September 30, 2019 and 2018
Sales. For the three months ended September 30, 2019, sales were $94.7 million, which included $15.8 million of international sales. Sales were $46.3 million for the same period in 2018, which included $2.5 million of international sales (which commenced in that period).
The total sales increase of $48.4 million was primarily driven by a 112% increase in worldwide pump shipments to 17,839 in the third quarter of 2019 compared to 8,434 in the third quarter of 2018. Worldwide pump shipments were positively impacted by strong demand for our products following the August 2018 domestic launch of t:slim X2 with Basal-IQ technology, and the commencement of commercial sales in select international geographies beginning in the third quarter of 2018. Additionally, sales from pump-related supplies increased 105% primarily due to an overall increase in our installed base of customers reordering supplies.

Domestic sales by product were as follows (in thousands):
 
Three Months Ended
September 30,
 
2019
 
2018
Pump
$
52,914

 
$
28,704

Infusion sets
17,646

 
10,309

Cartridges
8,149

 
4,594

Other
133

 
113

Total Domestic Sales
$
78,842

 
$
43,720


International sales by product were as follows (in thousands):
 
Three Months Ended
September 30,
 
2019
 
2018
Pump
$
10,310

 
$
2,217

Infusion sets
3,444

 
67

Cartridges
2,018

 
228

Other
43

 
32

Total International Sales
$
15,815

 
$
2,544

Sales to distributors accounted for 72% and 76% of our total domestic sales for the three months ended September 30, 2019 and 2018, respectively. Our percentage of sales to distributors versus individual customers is principally determined by the mix of customers ordering our products within the period and whether or not we have a contractual arrangement with their underlying third-party insurance payor. Sales to international distributors accounted for the vast majority of our total international sales.
Cost of Sales and Gross Profit. Our cost of sales for the three months ended September 30, 2019 was $44.0 million resulting in gross profit of $50.7 million, compared to $24.5 million in cost of sales for the same period in 2018 resulting in gross profit of $21.8 million. The gross margin for the three months ended September 30, 2019 was 54% compared to 47% in the same period in 2018.
The increase in our gross profit for the three months ended September 30, 2019 was primarily the result of a 112% increase in pump shipments. Gross profit and gross margin also increased as a result of per unit manufacturing cost improvements from higher production volumes and continued overall manufacturing efficiencies gained from our new manufacturing facility which became fully operational at the beginning of 2018. Non-cash stock-based compensation expense allocated to cost of sales was $1.8 million for the three months ended September 30, 2019, compared to $0.8 million in the same period in 2018. On an aggregate basis, other non-manufacturing costs, which primarily consist of warranty, freight and training costs, also reflected improvement on a per unit basis.

27


Selling, General and Administrative Expenses. SG&A expenses increased 51% to $44.6 million for the three months ended September 30, 2019 from $29.5 million for the same period in 2018. Employee-related expenses for our SG&A functions comprise the majority of SG&A expenses. The increase compared to 2018 was primarily the result of a $12.4 million increase in salaries, incentive compensation and other employee benefits due to an increase in personnel to support higher sales and our growing installed customer base, which included an increase of $6.3 million in non-cash stock-based compensation. Non-cash stock-based compensation expense allocated to SG&A was $13.1 million for the three months ended September 30, 2019, compared to $6.8 million in the same period in 2018. The increase in non-cash stock-based compensation expense was primarily due to the valuation of certain 2019 employee stock option grants and the impact on the valuation of the significant increase in our stock price.
Research and Development Expenses. R&D expenses increased 50% to $12.0 million for the three months ended September 30, 2019 from $8.0 million for the same period in 2018. The increase in R&D expenses was primarily the result of an increase of $1.8 million in salaries, incentive compensation and other employee benefits due to an increase in personnel to support our product development efforts, as well as an increase of $1.3 million in clinical trials, outside services and consulting services attributable to R&D. Non-cash stock-based compensation expense allocated to R&D was $2.4 million for the three months ended September 30, 2019, compared to $1.9 million in the same period in 2018.
Other Income and Expense. Total other income for the three months ended September 30, 2019 was $3.2 million compared to total other expense of $18.5 million in the same period in 2018. Other income for the three months ended September 30, 2019 primarily consisted of a $2.3 million revaluation gain from the change in the fair value of the Series A warrants, and $0.9 million in interest income. Other expense for the three months ended September 30, 2018 primarily consisted of a $12.3 million revaluation loss from the change in the fair value of certain warrants due to the significant appreciation of our stock price, as well as a $5.3 million loss on extinguishment of debt associated with the full repayment of our Term Loan Agreement in August 2018. Interest and other income primarily consisted of interest earned on our cash equivalents and short-term investments, for which our average invested balances were significantly higher during the third quarter of 2019 compared to the third quarter of 2018.

Comparison of the Nine Months Ended September 30, 2019 and 2018
Sales. For the nine months ended September 30, 2019, sales were $253.9 million, which included $50.0 million of international sales. For the nine months ended September 30, 2018, sales were $107.7 million, which included $2.5 million of international sales (which commenced in the third quarter of 2018).
The total sales increase of $146.2 million was primarily driven by a 194% increase in worldwide pump shipments to 53,829 in the first nine months of 2019, compared to 18,325 in the first nine months of 2018. Worldwide pump shipments were positively impacted by strong demand for our products following the August 2018 domestic launch of t:slim X2 with Basal-IQ technology, and the commencement of commercial sales of t:slim X2 with G5 integration in select international geographies in the third quarter of 2018, as well as the fulfillment of international pump demand from backlog that existed at the end of 2018 due to supply constraints. Additionally, sales from pump-related supplies increased 105% primarily due to an overall increase in our installed base of customers reordering supplies.

Domestic sales by product were as follows (in thousands):
 
Nine Months Ended
September 30,
 
2019
 
2018
Pump
$
138,624

 
$
67,029

Infusion sets
44,335

 
25,957

Cartridges
20,530

 
11,820

Other
378

 
317

Total Domestic Sales
$
203,867

 
$
105,123


28



International sales by product were as follows (in thousands):
 
Nine Months Ended
September 30,
 
2019