Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
You should read the following discussion and analysis together with “Selected Financial Data” in Part II, Item 6 and our consolidated financial statements and related notes in Part II, Item 8. The following discussion contains forward-looking statements, which statements are subject to considerable risks and uncertainties. Our actual results could differ materially from those expressed or implied in any forward-looking statements as a result of various factors, including those set forth under the caption “Risk Factors” in Part I, Item 1A.
Certain statements contained in this Annual Report are “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Exchange Act, and are subject to the “safe harbor” created by these sections. Future filings with the SEC, future press releases and future oral or written statements made by us or with our approval, which are not statements of historical fact, may also contain forward-looking statements. Because such statements include risks and uncertainties, many of which are beyond our control, actual results may differ materially from those expressed or implied by such forward-looking statements. Some of the factors that could cause actual results to differ materially from those expressed or implied by such forward-looking statements can be found under the caption “Risk Factors” in Part I, Item 1A, and elsewhere in this Annual Report. The forward-looking statements speak only as of the date on which they are made, and we undertake no obligation to update such statements to reflect events that occur or circumstances that exist after the date on which they are made.
Overview
We are a medical device company with a positively different approach to the design, development and commercialization of products for people with insulin-dependent diabetes. Diabetes management can vary greatly person-to-person, creating multiple market segments based on clinical needs and personal preferences. We aim to improve and simplify the lives of all people living with insulin-dependent diabetes and those of their healthcare providers, by delivering innovative hardware and software solutions, as well as best-in-class customer support. Our goal is to lead in insulin therapy management by building a robust ecosystem and portfolio of data-driven products and services around our flagship insulin pumps. 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.
Since our initial commercial launch, we have been able to rapidly innovate and bring more products to market than our competitors. We have commercially launched seven insulin pump configurations in the United States since 2012 and three insulin pump configurations outside the United States since 2018. Today, our software-updatable t:slim X2 hardware platform represents 100% of our new pump shipments.
Our simple-to-use t:slim X2 is based on our proprietary technology platform and is the smallest durable insulin pump available. We have commercially offered our pump technology integrated with three generations of Dexcom’s continuous glucose monitoring (CGM) sensors. The t:slim X2 is the only pump on which remote software updates have been commercially available in the United States. This experience, which offers and supports different software updates, provides us with a unique competitive advantage. Two of our updates provided our users access to our AID algorithms, Basal-IQ technology and Control-IQ technology. Basal-IQ technology launched in August 2018 and is a predictive low glucose suspend feature that is designed to temporarily suspend insulin delivery to help reduce the frequency and duration of hypoglycemic events. Control-IQ technology launched in January 2020 and is an advanced hybrid-closed loop feature, designed to help increase a user's time in targeted glycemic range. It is the first and only system cleared by the FDA to deliver automatic correction boluses in addition to adjusting insulin to help prevent high and low blood sugar. Outside the United States we began selling efforts with t:slim X2 with Dexcom G5 integration in the third quarter of 2018, offering no-cost software updates for Basal-IQ technology in the third quarter of 2019 and for Control-IQ technology beginning in the third quarter of 2020. We intend to complete our scaled launch of Control-IQ technology outside the United States in the first half of 2021, subject to securing necessary regulatory clearances or approvals. We continue to offer both AID algorithms on the market to support the varying needs of people living with diabetes.
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, as well as a variety of accessories designed for enhanced usability. We also offer t:connect, a web-based data management application that provides users, their caregivers and their healthcare providers with a fast, easy and visual way to display diabetes therapy management data from our pumps, integrated CGMs and supported blood glucose meters.
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In the four-year period ended December 31, 2020, we shipped more than 215,000 insulin pumps, which is representative of our estimated global installed customer base, assuming the typical four-year reimbursement cycle. More than 170,000 of these pumps were shipped to customers in the United States, and nearly 45,000 were shipped to international markets.
For the years ended December 31, 2020, 2019 and 2018, our consolidated sales were $498.8 million, $362.3 million, and $183.9 million, respectively. For the years ended December 31, 2020, 2019 and 2018, our net loss was $34.4 million, $24.8 million, and $122.6 million, respectively. Worldwide pump sales accounted for 63%, 68%, and 67% of our total sales, respectively, for the years ended December 31, 2020, 2019 and 2018, while pump-related supplies and accessories accounted for the remainder in each year. Our accumulated deficit as of December 31, 2020 and 2019 was $659.2 million and $624.8 million, respectively. These amounts included $292.1 million and $216.6 million of non-cash stock-based compensation charges and non-cash changes in the fair value of common stock warrants as of December 31, 2020 and 2019, respectively.
In support of our digital health strategy, we continue to offer and improve t:connect and the Tandem Device Updater, and also develop and launch other complementary offerings. In the first quarter of 2020, we began a limited launch in the United States of our first-generation t:connect mobile application, followed by general availability in July 2020. This mobile app wirelessly uploads pump data to our t:connect diabetes management application, receives notification of pump alerts and alarms, and provides a discrete, secondary display of glucose and insulin data. The availability of this mobile app is intended to reduce patient burden and increase healthcare provider office efficiency by reducing the manual and more time-consuming steps historically required for data extraction. In addition, in the second quarter of 2020, we acquired Sugarmate, the developer of a popular app designed to help people visualize diabetes therapy data in innovative ways that also connects with many other popular, consumer-friendly devices. We intend to support the Sugarmate app in addition to our t:connect mobile app to provide a wide variety of features intended to benefit a broad community of people with diabetes.
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 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 worldwide. In addition, we believe publications, such as the results from studies using Control-IQ technology that were published in the New England Journal of Medicine in October 2019 and August 2020, and post-market real-world data 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 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.
COVID-19 Global Pandemic Impact and Considerations
We are deemed an essential healthcare business under applicable governmental orders based on the critical nature of the products we offer and the communities we serve. We experienced a modest impact from the COVID-19 global pandemic during the first quarter of 2020, which became more pronounced beginning in the second quarter and continuing through the end of the year. We originally anticipated that our sales outside the United States would experience a greater proportional impact due to differences in the sales process in domestic versus international markets. Initially, the impact on our business was relatively consistent worldwide but we have since seen varying degrees of impact in international markets based on local conditions. We anticipate that our sales and operating results will continue to be adversely impacted and subject to unpredictable variability for the duration of the pandemic. For example, we have experienced delays in certain programs of up to three or six months from when they were originally planned, such as human factors studies associated with our product development efforts. In addition, regulatory timelines may be difficult to predict as the FDA has stated that its review process may take longer than normal due to the impact of the COVID-19 global pandemic. The full extent of the impact of the COVID-19 global pandemic on our future business and operations is difficult to estimate and will depend on a number of factors including the scope and duration of the COVID-19 global pandemic and the relative impact of COVID-19 on the business operations of our contract manufacturers, suppliers and competitors.
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We have taken steps to prioritize the health and safety of our employees and customers during the COVID-19 global pandemic, while working to maintain a continuous supply of products, training and customer support. To that end, we have increased the frequency of our communications to employees, suppliers, customers, and healthcare providers. Since March 2020, we have restricted non-essential employee travel, banned visitors from all of our facilities, and transitioned those employees able to perform their job function outside of our facilities to a remote work environment. For our field-based sales and clinical employees, we initially discontinued all in-person activities and began utilizing technology to remotely engage healthcare providers and customers. We continue to work closely with our healthcare providers and customers, remaining flexible in our method of interaction. To help ensure the safety and health of our employees in manufacturing and warehousing positions involved in production and fulfillment operations, we have implemented preventative measures to comply with social distancing requirements and require temperature checks of our employees before each shift.
In response to developments surrounding the COVID-19 global pandemic, we initiated discussions with our key suppliers in early 2020 regarding their abilities to fulfill existing orders, and we have continued to regularly assess their capacity. During the first six months of 2020, we experienced certain challenges managing our inventory, primarily due to the impacts of the COVID-19 global pandemic. For example, in the first quarter of 2020, we observed customers purchasing cartridges and infusion sets at a higher rate than anticipated. In addition, during the second quarter of 2020, our infusion set manufacturer experienced certain inventory constraints which resulted in us asking some customers to accept substitutions of similar products to prevent delays in order fulfillment. At this time, we believe many of our suppliers are deemed essential businesses under applicable governmental orders, and we have not experienced, and do not anticipate experiencing, disruption in our ability to manufacture insulin pumps and cartridges due to component procurement limitations. Additionally, our third-party cartridge manufacturer completed validation and commenced commercial-scale manufacturing near the end of the first quarter to supplement our existing cartridge manufacturing capacity, which we believe will assist us in meeting product demand in future periods. Our finished goods and raw material inventory, as well as available manufacturing capacity, position us well to respond to unforeseen disruptions in the near term.
Commercially, we have been communicating with our customers and healthcare providers through social media, direct email outreach and our website, in addition to regular communications sent by our sales and clinical employees. We are also leveraging our technology platforms, such as our t:connect diabetes management application, to support healthcare providers, as many of them are increasingly utilizing telehealth capabilities in their practices. By the end of the first quarter of 2020, we expanded our remote new pump training offering to all customers who purchased a t:slim X2 insulin pump, and in the third quarter, we resumed offering in-person trainings under specific conditions.
We are prudently managing our use of cash and completed a convertible debt financing in May 2020 to further strengthen our balance sheet. We believe that our total cash and investments on hand are sufficient to sustain our existing operations for at least the next 12 months from the date of this filing. In the meantime, we are focused on making necessary investments in the organization as originally planned to continue to progress against our long-term sales and profitability initiatives, including recruitment of key employees, advancement of our R&D pipeline, and implementation of technology solutions. We will continue to evaluate our business operations and strategy based on new information as it becomes available and will make changes that we consider necessary in light of this information.
Products Under Development
Our products under development support our strategy of focusing on both consumer and clinical needs, and include a connected (mobile) health offering, a next-generation hardware platform, which we refer to as the t:sport Insulin Delivery System (t:sport), AID system enhancements, and additional CGM integrations with our current and future products. 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:
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•Connected (Mobile) Health Offerings – In July of 2020, we began offering the first version of our t:connect mobile application that wirelessly uploads pump data to our cloud-based t:connect diabetes management application, receives notification of pump alerts and alarms, and provides a discrete, secondary display of glucose and insulin data. Future updates of our mobile application are planned to include mobile bolus delivery, additional pump control features, integrate other health-related information from third-party sources and support future capabilities for our products under development. We plan to transition our mobile health offerings to a single, global digital platform, which is intended to provide all users, including pump users, caregivers and healthcare providers, with a simplified and tailored user experience. The platform is being designed to enhance the user experience, streamline the pump and supplies purchasing process, and provide internal efficiencies. In the future, data from our centralized system may be used for new product development, continuous product improvement, and for the generation of health economic outcomes data, and may ultimately support other advanced technology and patient monitoring services.
•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. 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 full mobile control availability.
•AID Enhancements – We intend to further enhance our automated insulin delivery system and are considering alternative strategies to deliver new features and benefits to our customers on a regular basis. In addition to algorithm enhancements intended to improve clinical outcomes, we are also developing new features for greater personalization and refinements to the overall system usability.
•Additional CGM Integration – In June 2020 we announced an agreement with Abbott to develop and commercialize integrated diabetes solutions that combine Abbott’s CGM technology with our insulin delivery systems to provide more options for people to manage their diabetes. Following the completion of our integrated product development work, and after obtaining required regulatory clearances or approvals, we intend to focus our initial commercial activities on integrated products in the U.S. and Canada, with additional geographies considered in the future.
For additional information, see the section of this Annual Report under the caption “Business” in Part I, Item 1.
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 December 31, 2020, we shipped more than 215,000 insulin pumps, which is representative of our estimated global installed customer base, assuming the typical four-year reimbursement cycle. Approximately 170,000 of these pumps were shipped to customers in the United States, and nearly 45,000 were shipped to international markets. In the year ended December 31, 2020, we shipped 90,771 insulin pumps worldwide, compared to 73,431 insulin pumps shipped in 2019.
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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 - U.S.
March 31 June 30 September 30 December 31 Total
Pump shipments to international customers by fiscal quarter were as follows:
March 31 June 30 September 30 December 31 Total
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, the commercial launch of our products in geographies outside of the United States and due to general seasonality in 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;
•incidence of disease or illness, including the COVID-19 global pandemic, that may impact customer purchasing patterns or disrupt our supply chain;
•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;
•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, and factors impacting our ability to access our facilities;
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•the impact of any privacy breaches, which may subject us to legal and regulatory proceedings and substantial fines, penalties and expenses, as well as significant reputational harm;
•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:
•the disruptions caused by the COVID-19 global pandemic on suppliers, third-party manufacturers, healthcare providers, distributors and our existing or potential customers;
•continued increase, in demand following the commercial launch of t:slim X2 with Control-IQ technology, 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 transition former customers of Animas Corporation (Animas) to our t:slim X2 insulin pump in 2018 and 2019 following the announcement by Johnson & Johnson that it had discontinued the operations of Animas and discontinued the availability of Animas pump supplies in September 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 from July 2016 through June 2020;
•ability to enter into and maintain agreements with CGM partners for CGM integration;
•expansion and new product launches in select international geographies, including initial orders to stock inventories; and
•ability to effectively scale our operations to support rapid growth, including expanding our facilities, advancing our research and development efforts, increasing manufacturing capacity through third-party manufacturers, and hiring and retaining employees in customer service and support functions.
In addition to working to achieve our sales growth expectations, in the long-term 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, and again in both the fourth quarters of 2019 and 2020. Though we may be unable to achieve profitability consistently 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, maximizing manufacturing efficiencies on increased production volumes, and leveraging the investments made in our sales, clinical, marketing and customer support organizations.
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 insulin pump platform with advanced software algorithms and remote software update capabilities, now represents 100% of our new pump shipments and is used by nearly all of our in-warranty customers. Our products also include disposable cartridges and infusion sets, as well as our complementary t:connect, Tandem Device Updater and mobile application products. We also offer additional accessories including protective cases, belt clips, and power adapters, although sales of these products are not significant.
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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, although the COVID-19 global pandemic has had, and may continue to have, an adverse impact on our sales.
In the third quarter of 2018, we began the launch of our t:slim X2 hardware platform through distribution partners outside the United States, including in select European countries, Australia, New Zealand, and South Africa. The software version on the t:slim X2 hardware platform has progressed from Dexcom G5 CGM integration at initial launch, followed by Basal-IQ technology scaling across various international markets beginning in the second quarter of 2019, and more recently our Control-IQ technology beginning in the third quarter of 2020. Our launch of Control-IQ technology in international markets will continue to scale across all geographies through the first half of 2021, contingent upon regulatory and reimbursement approvals.
In the first quarter of 2020, we expanded into additional international markets, including initial orders to support product launches in France and Germany occurring in the second and third quarters of 2020, respectively. Our independent international distributor partners perform all sales, customer support and training in their respective markets. In Canada, we market with a direct sales force and, similar to the United States, use distribution partners for certain billing and fulfillment activities. 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 pump shipments being weighted heavily towards the second half of the year, with the highest percentage of pump shipments expected in the fourth quarter due to the nature of the reimbursement environment. Consistent with these historical seasonality trends, our domestic pump shipments have typically decreased significantly from the fourth quarter to the following first quarter. Internationally, we do not expect this same impact from seasonality associated with reimbursement, although the quarterly sales trends may be impacted by a number of factors, including summer vacations and product launches into new geographies. While the opportunity to transition former Animas customers positively impacted our 2019 quarterly sales trends worldwide, we did not see a material benefit in 2020.
During 2020, the COVID-19 global pandemic had a major impact on businesses around the world. While we experienced only a modest negative impact from the pandemic during the first quarter of 2020, which became more pronounced in the second quarter and remained through the end of the year, and we anticipate that our sales and operating results will continue to be adversely impacted for the duration of the pandemic. Starting in March 2020, we ceased nearly all in-person sales, marketing and training activities and adopted numerous other changes to our daily business operations. These changes primarily remain in effect as of the date of this report and it remains uncertain when we may be able to resume our normal operations. Accordingly, we anticipate that our sales may not follow historical trends and will be adversely impacted in the coming months as customers delay their purchasing decisions or physicians pause their prescriptions of new products. Our sales outside the United States have been negatively impacted due to similar disruptions. Initially, the impact was relatively consistent worldwide but we have since seen varying degrees of impact in international markets based on local conditions. The full extent of the impact of the COVID-19 global pandemic on our business and operations will depend on a number of factors, including the scope and duration of the pandemic, varying government responses to the pandemic and potential delays to product development timelines.
Separate from any impacts of the COVID-19 global pandemic, our quarterly sales have historically 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 such FDA approval or product launch before making their purchasing decisions. For instance, we believe certain customers paused their decision-making during the second half of 2019 in anticipation of the commercial availability of the t:slim X2 with Control-IQ technology. However, it is difficult to quantify the extent of the impact of these or similar events on future purchasing decisions.
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Cost of Sales
Historically, we have manufactured our pumps and disposable cartridges at our manufacturing facility in San Diego, California. Near the end of the first quarter of 2020, our third-party cartridge manufacturer completed validation and commenced commercial-scale manufacturing to supplement our existing cartridge manufacturing capacity. We expect to increase production capacity and volumes at our third-party cartridge manufacturer over the next 24 months. 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, royalties, freight, reserves for expected warranty costs, costs of supporting our digital health platforms, scrap and charges for 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.
Over the long term, 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, 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 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. We also expect our warranty cost per unit to decrease as we release additional product features and functionality utilizing the Tandem Device Updater. Pumps have, and are expected to continue to have, a higher gross margin percentage than our pump-related supplies. Therefore, the percentage of pump sales relative to total sales will have a significant impact on our overall gross margin percentage. In the event that customers delay their pump purchasing decisions or physicians pause in prescribing new pumps, whether as a result of the COVID-19 global pandemic, or for other reasons, it is possible that we may experience a higher percentage of pump-related supply sales than anticipated, which in turn could adversely impact our overall gross margin percentage. However, our overall gross margin percentage may fluctuate in future quarterly periods as a result of numerous factors aside from those associated with production volumes and product mix. For instance, as a result of the COVID-19 global pandemic we have implemented operational changes that may introduce unpredictable variability to our cost of sales, such as supplemental staffing, incremental expenses to protect the health, safety and welfare of our employees working on-site and to enable other employees to work remotely. In addition, as demand for our products increases, we may continue to make additional investments in manufacturing capacity or increase our reliance on third parties for manufacturing-related services, either of which could have a negative impact on our gross margins. Specifically, in 2020 we invested in additional manufacturing equipment to double our existing capacity in order to meet anticipated long-term demand for our cartridges, which may initially place downward pressure on the gross margin percentage associated with our pump-related supplies.
Other factors impacting our overall gross margin percentage 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 awards on non-cash stock-based compensation expense allocated to cost of sales, changes in warranty estimates, training costs, licensing and royalty costs, increased costs to support our digital health platforms, cost associated with excess and obsolete inventories, and changes in our manufacturing processes, capacity, costs or output.
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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, which also includes our clinical, customer support, technical services, and insurance verification. We began expanding our U.S. field sales and clinical organization during the third quarter of 2019 to support an expected increase in demand for our products. We had approximately 90 sales territories in the United States as of December 31, 2020 and are expanding modestly to approximately 95 in 2021. Our existing territories are generally maintained by sales representatives and field clinical specialists, and supported by managed care liaisons, additional sales management and other customer support personnel, which have also been rapidly expanding to support our growing installed base. Our operations in Canada are comprised of approximately ten sales territories. 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 2018 and 2019 employee stock option grants and the impact on the valuation of the significant increase in our stock price over the previous year. We recognized higher non-cash stock-based compensation expense through the first half of 2020, and experienced a reduction in expense beginning in the third quarter of 2020 as certain 2018 employee stock option grants became fully amortized. We anticipate that we will continue to see improvement in non-cash stock-based compensation as a percent of sales in future years. Our SG&A expenses may be affected by our response to the COVID-19 global pandemic, including reduced spending in areas such as non-essential employee travel, which may be offset by increased spending to support measures designed to prioritize the retention, health, safety and welfare of our employees. In the longer term, SG&A expenses may also increase due to anticipated costs associated with additional compliance and regulatory reporting requirements.
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, cash-based incentive compensation, 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, but will continue to see a reduction in non-cash stock-based compensation as a percent of sales in the longer term. Similar to our SG&A expenses, our future R&D spending may be impacted by the COVID-19 global pandemic. For instance, we may experience lower spending associated with delays in the advancement of particular programs, which may be offset by increased spending to support the retention, health, safety and welfare of our employees or to enable development activities under alternative conditions.
Other Income and Expense
Other income and expense primarily consists of changes in the fair value of certain warrants issued in connection with our public offering of common stock in October 2017 (Series A Warrants), interest expense which includes the amortization of debt discount and debt issuance costs related to our Convertible Senior Notes issued in May 2020 (our Notes), and interest earned on our cash equivalents and short-term investments. We expect interest expense in future years to be higher than 2020 as our Notes were not outstanding for the entire twelve month period ended December 31, 2020. We expect total other income and expense, net 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.
Income Tax Expense (Benefit)
Because we are in a net loss position with respect to federal income taxes, income tax expense is expected to primarily consist of state and foreign income tax expense as a result of current taxable income in those jurisdictions. Income tax expense (benefit) may fluctuate in future quarters due to adjustments related to non-recurring transactions and changes in certain tax assessments.
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Results of Operations
Year Ended December 31,
Sales:
Operating expenses:
Other income (expense), net:
Loss on extinguishment of debt — — (5,313)
Comparison of Years Ended December 31, 2020 and 2019
Sales. For the year ended December 31, 2020, sales were $498.8 million, which included $83.2 million of international sales.For the year ended December 31, 2019, sales were $362.3 million, which included $60.2 million of international sales.
The increase in worldwide sales of $136.5 million in 2020, as compared to 2019, was primarily driven by a $69.4 million increase in pump-related supplies sales due to 52% growth in our estimated worldwide installed base of customers, and a $67.1 million increase in pump sales driven by a 24% increase in worldwide pump shipments to 90,771 in 2020, compared to 73,431 in 2019 which benefited from the effect of certain non-recurring international market dynamics.
Domestic sales by product were as follows (in thousands):
Year Ended December 31,
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Domestic pump sales were $269.9 million for the year ended December 31, 2020, compared to $205.5 million in the year ended December 31, 2019, as pump shipments increased 32% compared to the same period in the prior year due to continued strong demand for our products following the January 2020 domestic launch of our t:slim X2 insulin pump with Control-IQ technology. Domestic pump shipments were 70,825 in the year ended December 31, 2020 compared to 53,735 in 2019. Sales of pump-related supplies increased primarily due to a 46% increase in our estimated domestic installed base of customers. Sales to distributors accounted for 70% and 73% of our total domestic sales for the years ended December 31, 2020 and 2019, 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.
International sales by product were as follows (in thousands):
Year Ended December 31,
International pump sales were $44.9 million for the year ended December 31, 2020, compared to $42.1 million in the year ended December 31, 2019. The first half of 2019 was positively impacted by the transition of former Animas customers to our products and the fulfillment of certain international pump demand from backlog that existed at the end of 2018 due to supply constraints in prior periods. Sales of pump-related supplies benefited from an 83% increase in our estimated international installed base of customers. The ordering patterns of our international distributors for pumps and supplies is highly variable from period to period. This variability was compounded by the varying levels of impact of the global pandemic across the international markets in which we operate. Sales to distributors accounted for 94% and 92% of our total international sales for the years ended December 31, 2020 and 2019, respectively.
Cost of Sales and Gross Profit. Our cost of sales for the year ended December 31, 2020was$238.3 million, resulting in gross profit of$260.5 million, compared to cost of sales of$168.1million for the year ended December 31,2019, resulting ingross profit of$194.2million. The gross margin for 2020 was 52%, compared to 54% in 2019.
The increase in our gross profit for the year ended December 31, 2020, was primarily the result of the $136.5 million increase in total sales. Gross profit and gross margin in 2020 were negatively impacted by royalty costs, for which there was no comparable expense in 2019. During the year ended December 31, 2020, we recognized $6.7 million of product royalty costs, or approximately one percent of sales, associated with sales of pumps with Control-IQ technology launched in the first quarter of 2020, and free software updates downloaded by existing customers in the United States, as well as in certain international markets where we launched Control-IQ beginning in the third quarter of 2020. Excluding the impact of royalty, gross margins for both pumps and supplies saw improvement compared to the prior year, but were still slightly pressured by the product mix. Gross margin was also pressured to a lesser extent by other factors that are more temporary in nature or anticipated to be leveraged through growth in future quarters, including costs associated with COVID-19 risk mitigation, managing pump production to achieve desired stocking levels, the expansion of cartridge manufacturing capacity and increased spending to support our digital health product offerings. Other factors that have and may continue to have an impact on the gross margin percentage are changes in product and geographical mix and the level of non-cash stock-based compensation allocated to cost of sales. Pump sales, which have the highest gross margin, were 63% of total worldwide sales for the year ended December 31, 2020, versus 68% in 2019. Non-cash stock-based compensation expense allocated to cost of sales was $8.2 million for the year ended December 31, 2020, compared to $6.4 million in the same period of 2019, representing 2% of sales in both periods.
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Selling, General and Administrative Expenses. SG&A expenses increased 24% to $204.9 million for the year ended December 31, 2020, from $165.7 million for the same period in 2019. Employee-related expenses for our SG&A functions comprise the majority of the SG&A expenses. The increase compared to 2019 was primarily the result of a$32.8 million increase in salaries, incentive compensation and other employee benefits due to an increase in personnel to support additional sales territories, higher sales and other services in support of our growing installed customer base, offset by a $1.3 million decrease in non-cash stock-based compensation expense. Non-cash stock-based compensation expense allocated to SG&A was $41.6 million in 2020, compared to $42.9 million in 2019. The increase in non-cash stock-based compensation expense associated with increased headcount in 2020 was more than offset by a decrease in non-cash stock-based compensation expense from the valuation of certain 2018 employee stock option grants which are now fully amortized. We also experienced increased costs for equipment and supplies, and outside consulting and services of $11.2 million, offset by a $2.9 million decrease in travel costs.
Research and Development Expenses. R&D expenses increased 41% to $63.6 million for the year ended December 31, 2020, from $45.2 million for the same period in 2019. The increase in R&D expenses wasprimarily the result of an increase of $9.9 million in salaries, incentive compensation and other employee benefitsdue to an increase in personnel to support ourproduct development efforts, as well as an increase of $8.5 million in outside consulting and services, equipment and supplies attributable to R&D.Non-cash stock-based compensation expense allocated to R&D was $8.7 million in 2020, compared to $8.8 million in 2019.
Other Income (Expense). Total other expense, net for the year ended December 31, 2020 was $28.3 million, compared to $7.9 million in 2019. Other expense for 2020 primarily consisted of a $17.1 million revaluation loss from the change in the fair value of certain warrants due to the appreciation of our stock price during 2020, and $12.8 million of interest expense which includes the amortization of debt discount and debt issuance costs related to our Notes issued in the second quarter of 2020. Other expense for 2019 consisted primarily of an $11.1 million revaluation loss from the change in the fair value of certain warrants due to the appreciation in our stock price during 2019. Interest income and other, for the years ended December 31, 2020 and 2019 primarily consisted of interest earned on our cash equivalents and short-term investments, and decreased in 2020 primarily due to the lower interest rate environment as compared to 2019.
Income Tax Expense (Benefit). We recognized an income tax benefit of $1.9 million on a pre-tax loss of $36.3 million for the year ended December 31, 2020, compared to income tax expense of $0.1 million on a pre-tax loss of $24.6 million for the same period in 2019. The income tax benefit for the year ended December 31, 2020 was primarily due to benefit associated with the release of valuation allowance related to the acquisition of certain intangible assets, partially offset by state and foreign income tax expense as a result of current taxable income in those jurisdictions. Income tax expense for the year ended December 31, 2019 was primarily attributable to state and foreign income tax expense as a result of current taxable income in those jurisdictions.
Comparison of Years Ended December 31, 2019 and 2018
Sales. For the year ended December 31, 2019, sales were $362.3 million, which included $60.2 million of international sales. For the year ended December 31, 2018, sales were $183.9 million, which included $9.7 million of international sales which commenced in the third quarter of 2018.
The increase in worldwide sales of $178.4 million in 2019, as compared to 2018, was primarily driven by a $123.6 million increase in pump sales driven by a 113% increase in worldwide pump shipments to 73,431 in 2019, compared to 34,493 in 2018. In addition, worldwide sales in 2019 and 2018 were positively impacted by the transition of former Animas customers to our products. Sales of pump-related supplies increased $54.8 million, or 91%, primarily due to an overall increase in our installed base of customers reordering supplies.
Domestic sales by product were as follows (in thousands):
Year Ended December 31,
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Domestic pump sales were $205.5 million for the year ended December 31, 2019, compared to $115.7 million in the year ended December 31, 2018, as pump shipments increased 78% compared to the same period in the prior year due to continued strong demand for our products following the August 2018 domestic launch of t:slim X2 with Basal-IQ technology. Domestic pump shipments were 53,735 in the year ended December 31, 2019 compared to 30,205 in 2018. Sales of pump-related supplies increased primarily due to a 48% increase in our estimated domestic installed base of customers. Sales to distributors accounted for 73% and 78% of our total domestic sales for the years ended December 31, 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.
International sales by product were as follows (in thousands):
Year Ended December 31,
International pump sales were $42.1 million for the year ended December 31, 2019, compared to $8.2 million in the year ended December 31, 2018. Our first full year of international sales was 2019, as we commenced commercial sales of t:slim X2 with G5 integration in select international geographies beginning in the third quarter of 2018. The first half of 2019 was also positively impacted by the transition of former Animas customers to our products, and the fulfillment of certain international pump demand from backlog that existed at the end of 2018 due to supply constraints in prior periods. Sales of pump-related supplies benefited from the growing international installed base of customers. Sales to distributors accounted for 92% and 100% of our total international sales for the years ended December 31, 2019 and 2018, respectively.
Cost of Sales and Gross Profit. Our cost of sales for the year ended December 31, 2019 was $168.1 million, resulting in gross profit of $194.2 million, compared to cost of sales of $94.0 million for the year ended December 31, 2018, resulting in gross profit of $89.8 million. The gross margin for 2019 was 54%, compared to 49% in 2018.
The improvement in both gross profit and gross margin was primarily the result of the $123.7 million increase in insulin pump sales which have a higher gross margin than pump-related supplies. Gross margin and gross profit 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. 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. Non-cash stock-based compensation expense allocated to cost of sales increased to $6.4 million in 2019 compared to $2.6 million in 2018, due primarily to the valuation of certain 2018 and 2019 employee stock option grants and the impact on the valuation of the significant increase in our stock price.
Selling, General and Administrative Expenses. SG&A expenses increased 58% to $165.7 million in 2019 from $105.2 million in 2018. Employee-related expenses for our SG&A functions comprise the majority of the SG&A expenses. These expenses increased $49.6 million during 2019, compared to 2018, which included an increase of $23.6 million in salaries, incentive compensation and other employee benefits due to an increase in personnel to support our growing installed customer base, and a $26.0 million increase in non-cash stock-based compensation expense. Non-cash stock-based compensation expense allocated to SG&A increased to $42.9 million in 2019, compared to $16.8 million in 2018, due primarily to the valuation of certain 2018 and 2019 employee stock options grants and the impact on the valuation of the significant increase in our stock price. We also experienced increased costs for equipment and supplies, outside consulting and services, and travel of $10.9 million.
Research and Development Expenses. R&D expenses increased 55% to $45.2 million in 2019 from $29.2 million in 2018. The increase in R&D expenses was primarily the result of an increase of $4.8 million in salaries, incentive compensation and other employee benefits due to an increase in personnel to support our product development efforts, and a $4.5 million increase in non-cash stock-based compensation expense, as well as a $5.8 million increase in costs for outside consulting and services, clinical trials, and supplies. Non-cash stock-based compensation expense allocated to R&D increased to $8.8 million in 2019, compared to $4.3 million in 2018, due primarily to the valuation of certain 2018 and 2019 employee stock option grants and the impact on the valuation of the significant increase in our stock price.
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Other Income (Expense). Total other expense, net for the year ended December 31, 2019 was $7.9 million, compared to $77.9 million for the same period in 2018. Other expense in 2019 primarily consisted of an $11.1 million revaluation loss from the change in the fair value of certain warrants due to the appreciation in our stock price during 2019. Other expense in 2018 consisted primarily of a $66.5 million revaluation loss from the change in the fair value of certain warrants due to the significant appreciation in our stock price during 2018, and $7.6 million of interest expense associated with the term loan agreement with Capital Royalty Partners and its affiliated funds (the Term Loan Agreement), which was originally executed in in 2012, and was amended multiple times between 2016 and 2018. Additionally, we recorded a $5.3 million loss on extinguishment of debt associated with the full repayment of our Term Loan Agreement in August 2018. Interest income and other, net primarily consisted of interest earned on our cash equivalents and short-term investments, and increased in 2019 as our average invested balances were significantly higher as compared to 2018.
Liquidity and Capital Resources
At December 31, 2020, we had $484.9 million in cash and cash equivalents and short-term investments. We believe that our cash and cash equivalents and short-term investments balance will be sufficient to satisfy our liquidity requirements for at least the next 12 months from the date of this filing.
Historically, our principal sources of cash have included cash collected from product sales, private and public offerings of equity securities, exercises of employee stock awards, and debt financing. Since the beginning of 2018, we completed the following financing activities:
•In May 2020, we raised $278.7 million in net proceeds from the issuance of the Notes, and used $34.1 million of the net proceeds to purchase capped call options in connection with the transaction (see Note 6, “Debt”).
•From January 2019 through December 31, 2020, we issued 3,758,420 shares of common stock upon the exercise of stock options, and 631,581 shares of common stock were purchased under our 2013 Employee Stock Purchase Plan, which generated aggregate proceeds of $90.7 million.
•In February 2018, we completed a registered public offering of 34,500,000 shares of common stock at a public offering price of $2.00 per share. The gross proceeds from the offering were approximately $69.0 million, before deducting underwriting discounts and commissions and other offering expenses.
•In August 2018, we completed a registered public offering of 4,035,085 shares of common stock at a public offering price of $28.50 per share. The gross proceeds from the offering were $115.0 million, before deducting underwriting discounts and commissions and other offering expenses. From January 2019 through December 2020, we received proceeds of $1.2 million from the exercise of 356,085 outstanding warrants which were originally issued in a registered public offering of common stock in October 2017. As of December 31, 2020, there were warrants to purchase 154,700 shares outstanding relating to the October 2017 offering.
•From January 2019 through December 2020, we received proceeds of $2.0 million from the exercise of 32,911 outstanding warrants which were originally issued between August 2011 and August 2012. As of December 31, 2020, there were warrants to purchase 30,861 warrants outstanding relating to these issuances.
Our historical cash outflows have primarily been associated with cash used for operating activities such as the development and commercialization of our products, the expansion and support of our sales, marketing, clinical and customer support organizations, the expansion of our R&D activities, the expansion of our commercial activities to select international geographies, the acquisition of intellectual property, expenditures related to increases in our manufacturing capacity and improvements to our manufacturing efficiency, overall expansion of our facilities and operations, and other working capital needs. Additionally, we have used cash to pay the interest expense associated with our convertible senior notes and our Term Loan Agreement. The outstanding balance associated with the Term Loan Agreement was fully repaid in August 2018, and we have ceased incurring interest expense and other costs associated with the Term Loan Agreement subsequent to the third quarter of 2018.
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We expect our sales performance and the resulting operating income or loss, as well as the status of each of our new product development programs, will significantly impact our cash flow from operations, liquidity position and cash management decisions.
The following table shows a summary of our cash flows for the years ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
Net cash provided by (used in):
Effect of foreign exchange rate changes on cash 387 191 —
Operating activities. Net cash provided by operating activities was $24.7 million and $41.9 million for the years ended December 31, 2020 and 2019, respectively, compared to net cash used of $8.3 million for the same period in 2018.
The decrease in net cash provided by operating activities for 2020 compared to 2019 was driven by net changes in working capital, partially offset by a reduction in net loss when adjusted for non-cash expenses, particularly stock-based compensation expense, the change in the fair value of common stock warrants and non-cash interest expense. Working capital changes in 2020 primarily consisted of increases in accounts receivable and inventories, offset by increases in employee-related liabilities, deferred revenue, and other current and long-term liabilities, all of which are related to the growth in our business. Accounts receivable increased to $82.2 million at December 31, 2020 from $46.6 million at December 31, 2019, as a result of higher sales in the fourth quarter of 2020 as compared to the fourth quarter of 2019. Inventories increased to $63.7 million at December 31, 2020 from $49.1 million at December 31, 2019, primarily to support the growth in our business.
The improvement to net cash provided by operating activities for 2019 compared to 2018 was primarily driven by higher sales and gross margins in 2019, which resulted in a significant reduction in net loss when adjusted for non-cash expenses, particularly stock-based compensation expense and the change in the fair value of common stock warrants, offset by net changes in working capital. Working capital changes in 2019 primarily consisted of increases in accounts receivable and inventories, offset by increases in accounts payable, accrued expenses, employee-related liabilities, deferred revenue, and other long-term liabilities related to warranty reserves for 2019 pump sales. Accounts receivable increased to $46.6 million at December 31, 2019 from $35.2 million at December 31, 2018, as a result of higher sales in the fourth quarter of 2019 as compared to the fourth quarter of 2018. Inventories increased to $49.1 million at December 31, 2019 from $19.9 million at December 31, 2018, primarily to support the growth in our business.
Investing activities. Net cash used by investing activities was $296.1 million for the year ended December 31, 2020,which was primarily related to purchases of short-term investments of $497.1 million using the net proceeds from the issuance of our convertible notes in May of 2020, and $27.4 million in purchases of property and equipment, offset by $233.3 million in proceeds from maturities and sales of short-term investments.Net cash used by investing activities was $57.0 million for the year ended December 31, 2019, which was primarily related to purchases of short-term investments of $164.6 million and $19.5 million in purchases of property and equipment, offset by $127.2 million in proceeds from maturities of short-term investments. Net cash used by investing activities was $90.7 million for the year ended December 31, 2018, which was primarily related to purchases of short-term investments of $123.6 million using the net proceeds from our public offering of common stock in August of 2018, and $3.0 million in purchases of property and equipment, offset by $35.8 million in proceeds from maturities of short-term investments.
Financing activities. Net cash provided by financing activities was$314.4million for the year ended December 31, 2020, which primarily consisted of $278.7 million in proceeds from the issuance of the Convertible Senior Notes which was partially offset by $34.1 million in payments for the purchase of the related Capped Call Options (see Note 6, “Debt”), and $66.9 million in proceeds from the issuance of common stock under our stock plans. Net cash provided by financing activities was $24.2 million for the year ended December 31, 2019, which was primarilythe result of proceeds of $23.9million from the issuance of common stock under our stock plans. Net cash provided by financing activities was $117.2 million for the year ended December 31, 2018, which was primarilythe result of net proceeds of approximately $172.9 million from the public offerings of our common stock in February 2018 and August 2018, as well as proceeds of $29.6million from the exercise of common stock warrantsthat wereissued in the public offering of common stock in October 2017, offset by the $87.7 millionrepayment of our term loanand associated financing fees.
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Our liquidity position and capital requirements are subject to fluctuation based on a number of factors. In particular, our cash inflows and outflows are principally impacted by the following:
•our ability to generate sales, the timing of those sales, the mix of products sold and the collection of receivables from period to period;
•the timing of any additional financings, and the net proceeds raised from such financings;
•the timing and amount of the exercise of outstanding warrants, and proceeds from the issuance of equity awards pursuant to employee stock plans;
•fluctuations in gross margins and operating margins;
•fluctuations in working capital, including changes in accounts receivable, inventories, accounts payable, employee-related liabilities, and operating lease liabilities; and
•the impacts and disruptions caused by the COVID-19 global pandemic.
Our primary short-term capital needs are expected to include expenditures related to:
•support of our commercialization efforts related to our current and future products;
•expansion of our customer support resources for our growing installed customer base;
•research and product development efforts, including clinical trial costs;
•acquisitions, leasing or licensing of equipment, technology, intellectual property and other assets;
•additional facilities leases and related tenant improvements, and manufacturing equipment to support business growth and increase manufacturing capacity; and
•payments under licensing, development and commercialization agreements.
Although we believe the foregoing items reflect our most likely uses of cash in the short-term, we cannot predict with certainty all of our particular cash uses or the timing or amount of cash used. In addition, from time to time we may consider opportunities to acquire or license other products or technologies that may enhance our product platform or technology, expand the breadth of our markets or customer base, or advance our business strategies. Any such transaction may require short-term expenditures that may impact our capital needs. If for any reason our cash and cash equivalents balances, or cash generated from operations is insufficient to satisfy our working capital requirements, we may in the future be required to seek additional capital from public or private offerings of our equity or debt securities, or we may elect to borrow capital under new credit arrangements or from other sources. We may also seek to raise additional capital from such offerings or borrowings on an opportunistic basis when we believe there are suitable opportunities for doing so. If we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, we 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 our existing stockholders. There can be no assurance that financing will be available on acceptable terms, or at all. Our ability to raise additional financing may be negatively impacted by a number of factors, including our recent and projected financial results, recent changes in and volatility of our stock price, perceptions about the dilutive impact of financing transactions, the competitive environment in our industry, uncertainties regarding the regulatory environment in which we operate and conditions impacting the capital markets more generally, including economic weakness, inflation, political instability, war and terrorism, natural disasters, incidence of illness or disease, or other events beyond our control.
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Indebtedness
In May 2020, the Company entered into a purchase agreement with certain counterparties for the sale of an aggregate of $287.5 million principal amount of 1.50% Convertible Senior Notes due 2025 in a private offering to qualified institutional buyers (the Notes). The Notes were issued pursuant to an Indenture, dated May 15, 2020, between the Company and U.S. Bank National Association, as trustee. The net proceeds from the issuance of the Notes were $244.6 million, net of debt issuance costs and cash used to purchase the capped call transactions (see Note 6, “Debt”). The Notes are the Company’s senior unsecured obligations. Interest is payable in cash semi-annually in arrears beginning on November 1, 2020 at a rate of 1.50% per year. The Notes mature on May 1, 2025 unless repurchased, redeemed, or converted in accordance with their terms prior to the maturity date.
Repayment of Term Loan Agreement
In August 2018, we fully repaid our term loan with CRG pursuant to the Term Loan Agreement. The balance of the outstanding debt at the time of repayment was $82.7 million. The total repayment amount of $88.8 million included approximately $1.1 million in accrued interest, and approximately $5.0 million in associated financing fees that became due. Therefore, we did not have any borrowings outstanding under the Term Loan Agreement as of December 31, 2019 and December 31, 2018. At the time of repayment, the remaining $5.3 million debt discount balance associated with the financing fees and certain debt issuance costs was accelerated and recognized as a loss on extinguishment of debt during the third quarter of 2018.
Contractual Obligations & Commitments
The following table summarizes the payments due by fiscal period for our outstanding contractual obligations at December 31, 2020:
Payments Due by Period
(in thousands) Total Less than 1 year 1-3 years 3-5 years More than5 years
(1)Operating lease obligations of $25.3 million were included in operating lease liabilities current and long-term in the consolidated balance sheet at December 31, 2020 (see Note 5, "Leases").
(2)Includes purchase orders that are cancellable under the standard terms of our purchase order agreements. In certain cases, cancellation of outstanding purchase commitments may require payment of costs incurred through the date of cancellation.
(3)Amounts represent contractual payments of interest and principal.
Critical Accounting Policies Involving Management Estimates and Assumptions
Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of these consolidated financial statements requires management to make estimates and judgments that affect the reported amounts of assets, liabilities, revenues and expenses and the disclosure of contingent assets and liabilities in our consolidated financial statements. We evaluate our estimates and judgments on an ongoing basis. We base our estimates on historical experience and on various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about our financial condition and results of operations that are not readily apparent from other sources. Actual results may differ materially from these estimates.
While our significant accounting policies are more fully described in Note 2 to our consolidated financial statements included in this Annual Report, we believe that the following accounting policies are the most critical to the judgments and estimates used in the preparation of our consolidated financial statements.
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Revenue Recognition
Our revenue is generated primarily from sales of our insulin pumps, disposable cartridges and infusion sets to individual customers and third-party distributors that resell the product to insulin-dependent diabetes customers. We are paid directly by customers who use the products, distributors and third-party insurance payors. We recognize revenue when control of our products is transferred to our customers in an amount that reflects the consideration we expect to receive from our customers in exchange for those products. This process involves identifying the contract with a customer, determining the performance obligations in the contract, determining the contract price, allocating the contract price to the distinct performance obligations in the contract, and recognizing revenue when the performance obligations have been satisfied. Revenue recognition for contracts with multiple performance obligations is based on the separate satisfaction of each distinct performance obligation within the contract. A performance obligation is considered distinct from other obligations in a contract when it provides a benefit to the customer either on its own or together with other resources that are readily available to the customer and is separately identified in the contract. We consider a performance obligation satisfied once we have transferred control of a product to the customer, meaning the customer has the ability to use and obtain the benefit of the product. Complementary products, such as the t:connect cloud-based data management application and the Tandem Device Updater, are considered performance obligations satisfied over time, as access and support for these products is provided throughout the typical four-year warranty period of the insulin pumps. Accordingly, revenue related to the complementary products is deferred and recognized ratably over a four-year period. There is no standalone value for these complementary products. Therefore, we determine their value by applying the expected cost plus a margin approach and then allocate the residual to the insulin pumps.
Warranty Reserve
We generally provide a four-year warranty on our 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 us may be refurbished and redeployed. Additionally, we offer a six-month warranty on disposable cartridges and infusion sets. Estimated warranty costs are recorded at the time of shipment. We evaluate the reserve quarterly. Warranty costs are primarily estimated based on the current expected product replacement cost and expected replacement rates utilizing historical experience. Recently released versions of our pump may not incur warranty costs in a manner similar to previously released pumps, on which we initially base our warranty estimate of newer pumps. We may make further adjustments to the warranty reserve when deemed appropriate, giving additional consideration to length of time the pump version has been in the field and future expectations of performance based on new features and capabilities that may become available through Tandem Device Updater. Changes to the actual replacement rates or the expected product replacement cost could have a material impact on our estimated warranty reserve.
Income Taxes
Significant judgment is required in determining our provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against net deferred tax assets. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not the future realization of all or some of the deferred tax assets will not be achieved. The evaluation of the need for a valuation allowance is performed on a jurisdiction-by-jurisdiction basis, and includes a review of all available positive and negative evidence. Factors reviewed include projections of pre-tax book income for the foreseeable future, determination of cumulative pre-tax book income after permanent differences, earnings history, and reliability of forecasting. We will continue to assess the need for a valuation allowance on our deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the statement of operations for the period that the adjustment is determined to be required.
Utilization of our net operating loss and research credit carryforwards may be subject to a substantial annual limitation due to ownership change limitations provided by Section 382 of the Internal Revenue Code of 1986, as amended, and similar state provisions. The annual limitations may result in the expiration of net operating loss carryforwards before utilization. We have completed analyses through December 31, 2020 to determine whether our net operating losses and credits are likely to be limited by Section 382. Based on the 2018 study completed in 2019, we determined that an ownership change, as defined under Section 382, occurred in 2018 and the resulting limitation significantly reduced our ability to utilize our net operating loss and credit carryovers before they expire. As a result, in 2019 we reduced our deferred tax assets for the net operating loss and research credit carryforwards that were projected to expire unused with a corresponding offset to the valuation allowance recorded against such assets. Additionally, future ownership changes under Section 382 may also limit our ability to fully utilize any remaining tax benefits.
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The Company’s income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. We recognize liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While we believe we have appropriate support for the positions taken on our tax returns, we regularly assess the potential outcomes of examinations by tax authorities in determining the adequacy of our provision for income taxes. We continually assess the likelihood and amount of potential revisions and adjust the income tax provision, income taxes payable and deferred taxes in the period in which the facts that give rise to a revision become known.
Convertible Senior Notes
In accounting for the issuance of the convertible senior notes, we separated the notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of similar debt instruments that do not have associated convertible features. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the respective notes. The equity component is not remeasured as long as it continues to meet the condition for equity classification. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the notes.
We allocated the issuance costs incurred to the liability and equity components of the notes based on their relative fair values. Issuance costs attributable to the liability component were recorded as a reduction to the liability portion of the notes and are being amortized to interest expense over the term of the notes. Issuance costs attributable to the equity component, representing the conversion option, were netted with the equity component in stockholders' equity.
Off-Balance Sheet Arrangements
As of December 31, 2020, we did not have any off-balance sheet arrangements.
Item 7A. Quantitative and Qualitative Disclosures about Market Risk.
We invest our excess cash primarily in commercial paper, corporate debt securities, U.S. Government-sponsored enterprise securities and U.S. Treasury securities. Some of the financial instruments in which we invest subject us to market risk, in that a change in prevailing interest rates may cause the principal amount of the instrument to fluctuate. Other financial instruments in which we invest subject us to credit risk, in that the value of the instrument may fluctuate based on the issuer’s ability to pay.
The primary objectives of our investment activities are to maintain liquidity and preserve principal while maximizing the income we receive from our financial instruments without significantly increasing risk. We have established guidelines regarding approved investments and maturities of investments, which are primarily designed to maintain liquidity and preserve principal.
Because of the short-term maturities of our financial instruments, we do not believe that an increase or decrease in market interest rates would have any significant impact on the realized value of our investment portfolio. If a 10% change in interest rates were to have occurred on December 31, 2020, this change would not have had a material effect on the fair value of our investment portfolio as of that date.
Our operations are primarily located in the United States, and nearly all of our sales since inception have been made in U.S. dollars. With the exception of a portion of our sales in Canada, our sales outside of the United States are currently made to independent distributors under agreements denominated in U.S. dollars. Accordingly, we believe we do not currently have any material exposure to foreign currency rate fluctuations. As our business in markets outside of the United States increases, we may be exposed to foreign currency exchange risk. We believe this is currently limited to our operations in Canada, where fluctuations in the rate of exchange between the U.S. dollar and the Canadian dollar could adversely affect our financial results. In addition, from time to time, we may have foreign currency exchange risk related to existing assets and liabilities, committed transactions and forecasted future cash flows. In certain circumstances, we may seek to manage such foreign currency exchange risk by using derivative instruments such as foreign currency exchange forward contracts to hedge our risk. In general, we may hedge foreign currency exchange exposures up to 12 months in advance. However, we may choose not to hedge some exposures for a variety of reasons, including prohibitive economic costs.
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Item 8. Consolidated Financial Statements and Supplementary Data
Our consolidated financial statements as of December 31, 2020 and 2019 and for each of the three years in the period ended December 31, 2020, and the Report of the Independent Registered Public Accounting Firm are included in this report as listed in the index.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Registered Public Accounting Firm 84
Consolidated Balance Sheets as of December 31, 2020 and 2019 87
Notes to Consolidated Financial Statements 91
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Report of Independent Registered Public Accounting Firm
To the Stockholders and the Board of Directors of Tandem Diabetes Care, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheets of Tandem Diabetes Care, Inc. (the “Company”) as of December 31, 2020 and 2019, the related consolidated statements of operations and comprehensive loss, stockholders’ equity (deficit), and cash flows, for each of the three years in the period ended December 31, 2020 and the related notes (collectively referred to as the “consolidated financial statements”). In our opinion, the consolidated financial statements present fairly, in all material respects, the financial position of the Company at December 31, 2020 and 2019, and the results of its operations and its cash flows for each of the three years in the period ended December 31, 2020, in conformity with U.S. generally accepted accounting principles.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States) (PCAOB), the Company’s internal control over financial reporting as of December 31, 2020, based on criteria established in Internal Control-Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (2013 framework), and our report dated February 24, 2021 expressed an unqualified opinion thereon.
Basis for Opinion
These financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on the Company’s financial statements based on our audits. We are a public accounting firm registered with the PCAOB and are required to be independent with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities and Exchange Commission and the PCAOB.
We conducted our audits in accordance with the standards of the PCAOB. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement, whether due to error or fraud. Our audits included performing procedures to assess the risks of material misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audits also included evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation of the financial statements. We believe that our audits provide a reasonable basis for our opinion.
Critical Audit Matters
The critical audit matters communicated below are matters arising from the current period audit of the financial statements that were communicated or required to be communicated to the audit committee and that: (1) relates to accounts or disclosures that are material to the financial statements and (2) involved our especially challenging, subjective or complex judgments. The communication of the critical audit matters does not alter in any way our opinion on the consolidated financial statements, taken as a whole, and we are not, by communicating the critical audit matters below, providing a separate opinion on the critical audit matters or on the accounts or disclosures to which they relate.
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Warranty reserve – Estimation of Product Replacement Reserve
85
Valuation of Convertible Notes
/s/ Ernst & Young LLP
We have served as the Company's auditor since 2009.
San Diego, California
February 24, 2021
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TANDEM DIABETES CARE, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands except par value)
December 31,
Assets
Current assets:
Prepaid and other current assets 6,383 4,025
Liabilities and Stockholders’ Equity
Current liabilities:
Convertible senior notes, net - long-term 202,984 —
Operating lease liabilities - long-term 15,914 14,063
Commitments and contingencies (Note 10) — —
Stockholders’ equity:
Accumulated other comprehensive income 220 122
Total liabilities and stockholders’ equity $ 716,415 $ 326,110
The accompanying notes are an integral part of the consolidated financial statements.
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TANDEM DIABETES CARE, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(In thousands, except per share data)
Year Ended December 31,
Operating expenses:
Other income (expense), net:
Loss on extinguishment of debt — — (5,313)
Other comprehensive income (loss):
Unrealized gain (loss) on short-term investments $ (20) $ 77 $ (13)
Foreign currency translation gain 118 58 —
Net loss per share - basic and diluted $ (0.56) $ (0.42) $ (2.55)
The accompanying notes are an integral part of the consolidated financial statements.
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TANDEM DIABETES CARE, INC.
CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY (DEFICIT)
(In thousands)
Common Stock
Issuance of common stock for Employee Stock Purchase Plan 81 — 1,364 — — 1,364
Fair value of common stock warrants at time of exercise — — 54,000 — — 54,000
Unrealized loss on short-term investments — — — (13) — (13)
Adjustment to retained earnings from adoption of ASC 606 — — — — 149 149
Issuance of common stock for Employee Stock Purchase Plan 327 1 6,205 — — 6,206
Exercise of common stock warrants 93 — 327 — — 327
Fair value of common stock warrants at time of exercise — — 5,492 — — 5,492
Stock-based compensation expense — — 58,622 — — 58,622
Unrealized gain on short-term investments, net of deferred tax — — — 77 — 77
Foreign currency translation adjustments — — — 58 — 58
Issuance of common stock under equity incentive plans 2,341 2 57,748 — — 57,750
Issuance of common stock for Employee Stock Purchase Plan 303 1 9,115 — — 9,116
Fair value of common stock warrants at time of exercise — — 26,335 — — 26,335
Stock-based compensation expense — — 57,725 — — 57,725
Unrealized loss on short-term investments — — — (20) — (20)
Foreign currency translation adjustments — — — 118 — 118
The accompanying notes are an integral part of the consolidated financial statements.
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TANDEM DIABETES CARE, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
Year Ended December 31,
Operating Activities
Amortization of debt discount and debt issuance costs 10,096 — 1,721
Provision (recovery) for inventory obsolescence (57) 2,353 607
Amortization of premium (discount) on short-term investments (1,296) (565) 539
Benefit for deferred income taxes (2,126) (25) —
Loss on extinguishment of debt — — 5,313
Changes in operating assets and liabilities:
Net cash provided by (used in) operating activities 24,669 41,906 (8,319)
Investing Activities
Proceeds from sales of short-term investments 52,392 12,250 —
Acquisition of intangible assets (4,886) — —
Financing Activities
Purchase of capped call options related to convertible senior notes (34,069) — —
Principal payments on notes payable — — (87,711)
Proceeds from public offerings, net of offering costs — — 172,929
Proceeds from exercise of common stock warrants 2,950 327 29,575
Effect of foreign exchange rate changes on cash 387 191 —
Supplemental disclosures of cash flow information
Supplemental schedule of non-cash investing and financing activities
Property and equipment included in accounts payable $ 1,082 $ 2,134 $ 125
The accompanying notes are an integral part of the consolidated financial statements
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TANDEM DIABETES CARE, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1. Organization and Basis of Presentation
The Company
Tandem Diabetes Care, Inc. is a medical device company with a positively different 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 subsidiaries in the U.S. and 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 other complementary digital health offerings, such as the t:connect cloud-based data management application (t:connect) and 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, as well as other accessories for enhanced usability.
Basis of Presentation and Principles of Consolidation
The Company has prepared the accompanying consolidated financial statements in accordance with accounting principles generally accepted in the United States of America, or U.S. GAAP. The statements include the accounts of Tandem Diabetes Care, Inc. and its wholly-owned subsidiaries in the U.S. and Canada. All significant intercompany balances and transactions have been eliminated in consolidation.
The functional currency of the Company's foreign subsidiary is the local currency. The Company translates the financial statements of its foreign subsidiary into U.S. dollars using period-end exchange rates for assets and liabilities and average exchange rates for each period for revenue, costs and expenses. Translation related adjustments are included in comprehensive loss and in accumulated other comprehensive income (loss) in the stockholders' equity section of the Company's consolidated balance sheets. Foreign exchange gains or losses resulting from balances denominated in a currency other than the functional currency are recognized in interest income and other, net in the Company's consolidated statements of operations.
Reclassifications
Prior year amounts related to the presentation of other income (expense), net on the Company’s consolidated statements of operations and comprehensive loss, have been reclassified to conform to the current year presentation. Starting with the third quarter of 2020, the first full quarter in which the Company’s convertible senior notes were outstanding, the Company began to present non-operating expenses unrelated to the convertible senior notes with interest income and other, net. In prior periods, other non-operating expenses were combined with interest expense and reported as interest and other expense.
2. Summary of Significant Accounting Policies
There have been no material changes to the Company’s significant accounting policies during the year ended December 31, 2020, as compared to those disclosed in this Annual Report with the exception of policies put in place with regards to its convertible senior notes issued in May 2020.
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.
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Cash Equivalents
The Company considers all highly liquid investments with a maturity of three months or less from the date of purchase and that can be liquidated without prior notice or penalty to be cash equivalents.
Short-Term Investments
The Company’s short-term investments are classified as available-for-sale securities. Such securities are carried at fair value as determined by prices for identical or similar securities at the balance sheet date. The Company’s short-term investments consist of Level 1 and Level 2 financial instruments in the fair value hierarchy. The net unrealized gains or losses on available-for-sale securities are reported as a component of other comprehensive gain (loss) within the statements of operations and accumulated other comprehensive gain (loss) as a separate component of stockholders’ equity on the consolidated balance sheets. The Company determines realized gains or losses on the sale of available-for-sale securities using the specific identification method and includes net realized gains and losses as a component of other income or expense within the consolidated statements of operations. The Company periodically reviews available-for-sale securities for other than temporary declines in fair value below the cost basis whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. To date, the Company has not identified any other than temporary declines in fair value of its short-term investments.
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 its current estimate of expected credit losses. Provisions for expected credit losses are estimated based on historical experience, assessment of specific risk, review of outstanding invoices, forecasts about the future, and various assumptions and estimates that are believed to be reasonable under the circumstances, which included the Company’s estimates of credit risks as a result of the novel coronavirus pandemic (COVID-19 global pandemic). 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.
Concentration of Credit Risk
Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash, cash equivalents, short-term investments and accounts receivable. The Company maintains deposit accounts in federally insured financial institutions in excess of federally insured limits. The Company also maintains investments in money market funds that are not federally insured. Additionally, the Company has established guidelines regarding investment instruments and their maturities, which are designed to maintain preservation of principal and liquidity.
The following table summarizes customers who accounted for 10% or more of accounts receivable, net:
December 31,
Customer A 12.7 % N/A
Customer B 12.3 % N/A
Customer C N/A 20.4 %
Customer D N/A 10.1 %
The following table summarizes customers who accounted for 10% or more of total sales for the periods presented:
Year Ended December 31,
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Fair Value of Financial Instruments
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 determined the fair value of its convertible senior notes at December 31, 2020 to be $333.5 million, based on Level 2 quoted market prices as of that date (see Note 6, “Debt”). The estimated fair value of certain of the Company’s common stock warrants was determined using the Black-Scholes pricing model as of December 31, 2020 and 2019 (see Note 4, "Fair Value Measurements").
Valuation of Inventories
Inventories are valued at the lower of cost or net realizable value, determined by the first-in, first-out method. Inventory is recorded using standard cost, including material, labor and overhead costs. The Company periodically reviews inventories for potential impairment and adjusts inventory for potentially excess or obsolete goods to state inventories at their net realizable value. Factors influencing these adjustments include quantities on hand and firm purchase commitments, expectations of future use, judgments based on quality control testing data and assessments of the likelihood of scrapping or obsoleting certain inventories based on future demand for its products and market conditions.
Long-Lived Assets
Property and Equipment
Property and equipment, which primarily consist of office furniture and equipment, manufacturing equipment, scientific equipment, computer equipment, and leasehold improvements, are stated at cost, less accumulated depreciation. Property and equipment are depreciated over the estimated useful lives of the assets, generally three to seven years, using the straight-line method. Leasehold improvements are amortized over the lesser of the estimated useful lives of the assets or the remaining lease term. Maintenance and repair costs are expensed as incurred.
Operating Lease Right-of-Use Assets and Liabilities
In February 2016, the Financial Accounting Standards Board (FASB) issued ASU No. 2016-02, Leases. The new standard and its related amendments (collectively referred to as ASC 842) require lessees to recognize right-of-use assets and corresponding lease liabilities for all leases with lease terms of greater than 12 months. The new standard was effective for the Company starting in the first quarter of 2019. The Company adopted the new standard using the modified retrospective approach and recognized right-of-use leased assets and corresponding operating lease liabilities of $12.4 million on the consolidated balance sheet 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.
Lease right-of-use assets represent the Company’s right to use an underlying asset for the lease term and lease liabilities represent its obligation to make lease payments arising from the lease. Operating lease right-of-use assets and liabilities are recognized when the Company takes possession of the leased property (the Commencement Date) based on the present value of lease payments over the lease term. For lease agreements entered into or reassessed after the adoption of ASC 842, the Company combines lease and non-lease components. Rent expense on noncancelable leases containing known future scheduled rent increases is recorded on a straight-line basis over the term of the respective leases beginning on the Commencement Date. The difference between rent expense and rent paid is accounted for as a component of operating lease right-of-use assets on the Company’s consolidated balance sheet. Landlord improvement allowances and other similar lease incentives are recorded as a reduction of the right-of-use leased assets, and are amortized on a straight-line basis as a reduction to operating lease costs.
Intangible Assets Subject to Amortization
On June 24, 2020, the Company acquired Sugarmate, Inc. (Sugarmate), the developer of a popular mobile app for people with diabetes who use insulin, which is designed to help people with diabetes visualize diabetes therapy data in innovative ways. The Sugarmate acquisition was accounted for as an acquisition of assets in accordance with ASU No. 2017-01, Business Combinations (Topic 805) Clarifying the Definition of a Business. Substantially all of the fair value was concentrated in a single identifiable asset, a technology-based intangible asset. The purchased intangible is being amortized on a straight-line basis over an estimated useful life of five years. The Company’s results of operations for the year ended December 31, 2020 included the operating results of Sugarmate since the date of acquisition, the amounts of which were not material.
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Finite-lived intangible assets are recorded at cost, net of accumulated amortization and, if applicable, impairment charges. Amortization of finite-lived intangible assets is provided over their estimated useful lives on a straight-line basis. We review our finite-lived intangible assets for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. The Company has not recognized any impairment losses through December 31, 2020.
Research and Development Costs
All research and development costs are charged to expense as incurred. Such costs include personnel-related costs, including stock-based compensation, supplies, license fees, development prototypes, outside design and testing services, depreciation, allocated facilities and information services, clinical trial costs, milestone payments under the Company’s development and commercialization agreements and other indirect costs.
Income Taxes
The Company uses the asset and liability method of accounting for income taxes. Deferred income tax assets or liabilities are recognized based on the temporary differences between financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the years in which the differences are expected to reverse. Tax law and rate changes are reflected in income in the period such changes are enacted. A valuation allowance is recorded when it is more likely than not that some of the deferred tax assets will not be realized. The Company includes interest and penalties related to income taxes, including unrecognized tax benefits, within income tax expense.
The Company’s income tax returns are based on calculations and assumptions that are subject to examination by the Internal Revenue Service and other tax authorities. In addition, the calculation of the Company’s tax liabilities involves dealing with uncertainties in the application of complex tax regulations. The Company recognizes liabilities for uncertain tax positions based on a two-step process. The first step is to evaluate the tax position for recognition by determining if the weight of available evidence indicates that it is more likely than not that the position will be sustained on audit, including resolution of related appeals or litigation processes, if any. The second step is to measure the tax benefit as the largest amount that is more than 50% likely of being realized upon settlement. While the Company believes it has appropriate support for the positions taken on its tax returns, the Company regularly assesses the potential outcomes of examinations by tax authorities in determining the adequacy of its provision for income taxes. The Company continually assesses the likelihood and amount of potential revisions and adjusts the income tax provision, income taxes payable and deferred taxes in the period in which the facts that give rise to a revision become known.
Significant judgment is required in determining the Company’s provision for income taxes, deferred tax assets and liabilities and the valuation allowance recorded against net deferred tax assets. Deferred tax assets and liabilities are determined using the enacted tax rates in effect for the years in which those tax assets are expected to be realized. A valuation allowance is established when it is more likely than not the future realization of all or some of the deferred tax assets will not be achieved. The evaluation of the need for a valuation allowance is performed on a jurisdiction-by-jurisdiction basis, and includes a review of all available positive and negative evidence. Factors reviewed include projections of pre-tax book income for the foreseeable future, determination of cumulative pre-tax book income after permanent differences, earnings history, and reliability of forecasting. The Company will continue to assess the need for a valuation allowance on its deferred tax assets by evaluating both positive and negative evidence that may exist. Any adjustment to the net deferred tax asset valuation allowance would be recorded in the statement of operations for the period that the adjustment is determined to be required.
The Company is required to file federal and state income tax returns in the United States and various other state jurisdictions and, starting with 2018, a corporation income tax return in Canada. The preparation of these income tax returns requires the Company to interpret the applicable tax laws and regulations in effect in such jurisdictions, which could affect the amount of tax paid by the Company. An amount is accrued for the estimate of additional tax liability, including interest and penalties, for any uncertain tax positions taken or expected to be taken in an income tax return. The Company reviews and updates the accrual for uncertain tax positions as more definitive information becomes available. For further information, see Note 8, "Income Taxes."
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Convertible Senior Notes
In accounting for the issuance of the convertible senior notes, the Company separated the notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of similar debt instruments that do not have associated convertible features. The carrying amount of the equity component representing the conversion option was determined by deducting the fair value of the liability component from the par value of the respective notes. The equity component is not remeasured as long as it continues to meet the condition for equity classification. The excess of the principal amount of the liability component over its carrying amount (“debt discount”) is amortized to interest expense over the term of the notes.
The Company allocated the issuance costs incurred to the liability and equity components of the notes based on their relative fair values. Issuance costs attributable to the liability component were recorded as a reduction to the liability portion of the notes and are being amortized to interest expense over the term of the notes. Issuance costs attributable to the equity component, representing the conversion option, were netted with the equity component in stockholders' equity.
Revenue Recognition
Revenue is generated primarily from sales of insulin pumps, disposable cartridges and infusion sets to individual customers with third-party insurance coverage and through a network of distributors that resell the products to insulin-dependent diabetes customers. 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.
Revenue Recognition for Arrangements with Multiple Performance Obligations
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 for our distributor arrangements and upon receipt for sales directly to individual customers. Complementary products, such as t:connect and the Tandem Device Updater, are considered performance obligations that are satisfied over time, as access and support for these products is provided throughout the typical four-year warranty period of the insulin pumps. Accordingly, revenue related to the complementary products is deferred and recognized ratably over a four-year period. Where there is no standalone value for the complementary product, the Company determines their value by applying the expected cost plus a margin approach and then allocates the residual to the insulin pumps. Deferred revenue related to these performance obligations that are satisfied over time was included in the following consolidated balance sheet accounts in the amounts shown as of December 31, 2020 and 2019 (in thousands):
Sales Returns
The Company offers a 30-day right of return to customers in the U.S. and Canada from the date of shipment 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, adjusted for known or expected changes in the marketplace when appropriate. The amount recorded in deferred revenue on the Company’s consolidated balance sheets for allowances for sales returns was $0.6 million and $0.4 million at December 31, 2020 and 2019, respectively. Actual product returns have not differed materially from estimated amounts recorded in the accompanying consolidated financial statements.
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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. The Company evaluates the reserve quarterly. Warranty costs are primarily estimated based on the current expected product replacement cost and expected replacement rates utilizing historical experience. Recently released versions of the pump may not incur warranty costs in a manner similar to previously released pumps, on which the Company initially bases its warranty estimate of newer pumps. The Company may make further adjustments to the warranty reserve when deemed appropriate, giving additional consideration to length of time the pump version has been in the field and future expectations of performance based on new features and capabilities that may become available through Tandem Device Updater.
The following table provides a reconciliation of the changes in product warranty liabilities for the years ended December 31, 2020, 2019 and 2018:
Year Ended December 31,
(Decrease) increase in warranty estimates (2,048) (582) 1,678
As of December 31, 2020 and December 31, 2019, total product warranty reserves of $22.1 million and $16.7 million, respectively, were included in the following consolidated balance sheet accounts:
December 31,
Other current liabilities $ 8,409 $ 4,707
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. The fair value of restricted stock unit (RSU) awards issued under the Company’s 2013 Plan that vest solely based on service is estimated based on the fair market value of the underlying stock on the date of grant.
Common Stock Warrant Liabilities
The Company accounts for certain stock warrants as a liability in the consolidated financial statements when they contain a provision within the warrant contracts that could require cash settlement in the event the Company did not have an active registration statement. The fair value of these common stock warrants is remeasured at each financial reporting period with any changes in fair value being recognized as a component of other income (expense) in the accompanying statements of operations and comprehensive loss.
Shipping and Handling Expenses
Shipping and handling expenses associated with product delivery are included within cost of sales in the Company’s statements of operations. Amounts billed to a customer for shipping and handling are reported as revenues.
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Comprehensive Loss
All components of comprehensive loss, including net loss, are reported in the consolidated financial statements in the period in which they are recognized. Comprehensive loss is defined as the change in equity during a period from transactions and other events and circumstances from non-owner sources, including unrealized gains and losses on marketable securities and foreign currency translation adjustments.
Net Loss Per Share
Basic net loss per share is calculated by dividing the net loss by the weighted average number of common shares that were outstanding for the period, without consideration for common stock equivalents. Diluted loss per share reflects the potential dilution that would occur if securities exercisable for or convertible into common stock were exercised for or converted into common stock. Dilutive common share equivalents are comprised of warrants, stock options outstanding under the Company’s equity incentive plans, unvested RSUs, and potential awards granted pursuant to the ESPP, each calculated using the treasury stock method; and shares issuable upon conversion of the senior convertible notes using the if-converted method. For warrants that are recorded as a liability in the accompanying condensed consolidated balance sheets, the calculation of diluted 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 is 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 the annual periods presented, there is no difference in the number of shares used to calculate basic and diluted shares outstanding due to the Company’s net loss position (see Note 12, "Selected Quarterly Financial Data (Unaudited)" for quarterly details).
Potentially dilutive securities outstanding and 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):
Year Ended December 31,
Unvested restricted stock units 78 N/A N/A
Awards granted under the ESPP 3 5 4
Convertible senior notes (if-converted) 1,605 N/A N/A
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 prior, other-than-temporary-impairment model. The new standard must be adopted using the modified retrospective approach and was effective for the Company starting in the first quarter of 2020. The Company determined there was no cumulative-effect transition adjustment to the opening balance of accumulated deficit for recognition of additional credit losses upon adoption of this standard as of January 1, 2020 based on its outstanding accounts receivable, the composition and credit quality of its short-term investments, and current economic conditions as of that date.
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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 was effective for the Company starting in the first quarter of 2020. As a result, the Company modified certain fair value measurement disclosures primarily related to its Level 3 liabilities (see Note 4, “Fair Value Measurements”).
In December 2019, the FASB issued ASU No. 2019-12, Simplifying the Accounting for Income Taxes, which is intended to simplify various aspects of the income tax accounting guidance, including requirements such as tax basis step-up in goodwill obtained in a transaction that is not a business combination, ownership changes in investments, and interim-period accounting for enacted changes in tax law. ASU 2019-12 is effective for public business entities for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years, and early adoption is permitted. The Company early adopted the new guidance in the second quarter of 2020. As a result, the Company recognized, on a prospective basis, $13,000 of income tax expense in the second quarter of 2020 upon the reversal of tax benefits recorded in the first quarter of 2020 related to unrealized gains on short-term investments.
In June 2020, the FASB issued ASU No. 2020-06, Accounting for Convertible Instruments and Contracts in
an Entity’s Own Equity, which is intended to simplify the accounting for convertible instruments. This new guidance eliminates certain models that require separate accounting for embedded conversion features, and eliminates certain of the conditions for equity classification for contracts in an entity’s own equity. Accordingly, a convertible debt instrument will be accounted for as a single liability measured at its amortized cost, as long as no other features require bifurcation and recognition as derivatives. The new guidance can be adopted through either a modified retrospective method of transition or a fully retrospective method of transition. ASU 2020-06 is effective for public business entities for fiscal years beginning after December 15, 2021, including interim periods within those fiscal years. Early adoption is permitted for fiscal years beginning after December 15, 2020, including interim periods within those fiscal years. The Company is in the process of determining the impact of the adoption of the standard on its consolidated financial statements as well as whether to early adopt the new standard.
3. Financial Statement Information
Short-Term Investments
The Company invests in marketable securities, principally debt instruments of the U.S. Government, financial institutions and corporations with strong credit ratings. The following represents a summary of the estimated fair value of short-term investments at December 31, 2020 and 2019 (in thousands):
Available-for-sale securities:
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Available-for-sale securities:
U.S. Government-sponsored enterprise Less than 2 33,073 26 — 33,099
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 of those marketable securities to satisfy the Company’s 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. 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, from perceived increased credit risks as a result of the COVID-19 global pandemic. 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. Based on the credit quality of the available-for-sale debt securities that are in an unrealized loss position, and the Company’s estimates of future cash flows to be collected from those securities, the Company believes the unrealized losses are not credit losses. Accordingly, the Company has not recognized any impairment losses related to its available-for-sale debt securities at December 31, 2020.
Accounts Receivable
Accounts receivable consisted of the following (in thousands):
December 31,
Less: allowance for credit losses (3,857) (3,304)
Allowance for Credit Losses
The following table provides a reconciliation of the changes in the estimated allowance for expected accounts receivable credit losses (formerly the allowance for doubtful accounts) for the years ended December 31, 2020, 2019 and 2018 (in thousands):
Year Ended December 31,
Write-offs and adjustments, net of recoveries (2,463) (855) (646)
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Inventories
Inventories consisted of the following at (in thousands):
December 31,
Property and Equipment
Property and equipment consisted of the following at (in thousands):
December 31,
Office furniture and equipment 9,876 6,367
Manufacturing and scientific equipment 44,026 33,422
Less: accumulated depreciation and amortization (38,933) (29,865)
Total property and equipment, net $ 50,022 $ 32,923
Depreciation and amortization expense related to property and equipment was $9.2 million, $5.7 million, and $5.5 million for the years ended December 31, 2020, 2019, and 2018, respectively.
Intangible Assets Subject to Amortization
Intangible assets subject to amortization consist of technology-based intangibles related to the Company’s acquisition of Sugarmate, as well as patents purchased or licensed that are related to the Company’s commercialized products. Intangible assets at December 31, 2020 and 2019, which were included in other long-term assets on the consolidated balance sheets, were as follows (in thousands):
December 31,
Intangible assets, gross amount $ 12,502 $ 3,247
Intangible assets, net $ 8,805 $ 777
Weighted average remaining amortization period (in months) 52 30
Amortization expense related to intangible assets subject to amortization amounted to $1.2 million, $0.3 million and $0.3 million for the years ended December 31, 2020, 2019, and 2018, respectively. The amortization expense is recorded in cost of sales and selling, general and administrative expense in the consolidated statement of operations. The estimated aggregate amortization expense for each of the five succeeding years is $2.2 million for 2021, $2.0 million for 2022, $1.9 million for each of 2023 and 2024, and $0.9 million for 2025.
4. Fair Value Measurements
Authoritative guidance on fair value measurements defines fair value, and provides a consistent framework for measuring fair value and 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
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liability. As a basis for considering such assumptions, the authoritative guidance establishes a three-tier fair value hierarchy, which prioritizes the inputs used in measuring fair value as follows:
The following table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of December 31, 2020 and 2019, and indicates the fair value hierarchy of the valuation techniques utilized by the Company to determine such fair value (in thousands):
Fair Value Measurements atDecember 31, 2020
Assets
U.S. Government-sponsored enterprise 52,350 — 52,350 —
Liabilities
Fair Value Measurements atDecember 31, 2019
Assets
U.S. Government-sponsored enterprise 33,099 — 33,099 —
Liabilities
(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.
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The Company's Level 3 liabilities at December 31, 2020 and 2019 included the remaining Series A warrants issued by the Company in connection with the public offering of common stock in October 2017. The Series A warrants, which expire in October 2022, 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.
During the years ended December 31, 2020 and 2019, the Company issued 262,615 shares and 93,470 shares of common stock, respectively, upon the exercise of Series A warrants. As of December 31, 2020 and 2019, there were Series A warrants outstanding to purchase 154,700 shares and 417,315 shares, respectively, of the Company’s common stock (see Note 7, “Stockholders’ Equity”).
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 closing market price of the Company’s common stock at the balance sheet date, 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. A significant increase (decrease) in any of these inputs in isolation, particularly the market price of the Company’s common stock, would have resulted in a significantly higher (lower) fair value measurement. The assumptions used to estimate the fair values of the outstanding Series A warrants at December 31, 2020 and 2019 are presented below:
Series A Warrants
Risk-free interest rate 0.1 % 1.6 %
Expected dividend yield 0.0% 0.0%
Expected volatility 55.3 % 77.2 %
Expected term (in years) 1.8 2.8
The following table presents a summary of changes in fair value of the Company’s total Level 3 financial liabilities for the years ended December 31, 2020 and 2019:
Of the loss recognized from the change in fair value of common stock warrants for the years ended December 31, 2020 and 2019, $5.5 million and $8.9 million, respectively, was attributable to warrants outstanding as of December 31, 2020 and 2019.
5. Leases
The Company's leases consist of operating leases for general office space, laboratory, manufacturing and warehouse facilities, and equipment. These noncancellable operating leases have initial lease terms from one year to seven years. Leases with an initial term of 12 months or less are expensed as incurred and are not recorded as right-of-use assets on the consolidated balance sheets. 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.
The Company recognizes lease expense for operating 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.
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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 on Vista Sorrento Parkway, in San Diego, California (Vista Sorrento 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 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 January 2023. The lease term for the Expansion Space commenced in May 2019 and expires in January 2023. The Company has a one-time option to extend the term of the Vista Sorrento 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 sheet in the first quarter of 2019 related to the Initial Premises, and $4.7 million related to the First Amendment.
In March 2019, the Company entered into a lease agreement for approximately 40,490 square feet of space located on 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 sheet on the Commencement Date in the second quarter of 2019.
In November 2019, the Company entered into a lease agreement for approximately 94,562 square feet of additional general office space located on Shoreline Drive, in Boise, Idaho (Shoreline Lease). The lease term commenced on July 1, 2020, and expires in June 2027. The Company has a one-time option to extend the term of the Shoreline Lease for a period of three years. The Company recognized right-of-use leased assets and corresponding operating lease liabilities of approximately $6.5 million on the consolidated balance sheet on the Commencement Date in the first quarter of 2020.
In January 2020, the Company entered into a sub-lease agreement for approximately 30,703 square feet of general office space located on High Bluff Drive, in San Diego, California. The lease term began in April 2020 and expires in March 2022. The Company recognized right-of-use leased assets and corresponding operating lease liabilities of approximately $2.3 million on the consolidated balance sheet on the Commencement Date in the first quarter of 2020.
In September 2020, the Company amended certain leases covering approximately 77,000 square feet of general office and laboratory space located on Roselle Street in San Diego, California (Roselle Street Leases). The lease amendments extended the term of each lease for an additional period of one year, and included a rent increase during the additional lease term. The Roselle Street Leases, which would have expired in May 2022, are now scheduled to expire in May 2023. The Company recognized additional right-of-use leased assets and corresponding operating lease liabilities of $2.2 million on the consolidated balance sheet in the third quarter of 2020 related to the amendment of the Roselle Street Leases.
The Company’s lease cost recorded in the consolidated statements of operations was as follows (in thousands):
Year Ended December 31,
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Maturities of operating lease liabilities at December 31, 2020 were as follows (in thousands):
Year Ending December 31,
Total undiscounted lease payments 28,373
Less: amount representing interest (3,038)
Present value of operating lease liabilities 25,335
Less: current portion of operating lease liabilities (9,421)
Operating lease liabilities - long-term $ 15,914
The weighted-average remaining lease term and weighted-average discount rate for operating leases were as follows:
Weighted-average remaining lease term (in years) 3.7 3.6
Cash paid for amounts included in the measurement of lease liabilities, representing operating cash flows from operating leases, was $8.2 million and $4.4 million for the years ended December 31, 2020 and 2019, respectively.
6. Debt
Convertible Senior Notes
In May 2020, the Company entered into a purchase agreement with certain counterparties for the sale of an aggregate of $287.5 million principal amount of 1.50% Convertible Senior Notes due 2025 in a private offering to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The Notes were issued pursuant to an Indenture, dated May 15, 2020, between the Company and U.S. Bank National Association, as trustee (Indenture). The net proceeds from the issuance of the Notes were $244.6 million, net of debt issuance costs and cash used to purchase the capped call transactions (Capped Call Transactions) discussed below.
The Notes are the Company’s senior unsecured obligations. Interest is payable in cash semi-annually in arrears beginning on November 1, 2020 at a rate of 1.50% per year. The Notes mature on May 1, 2025 unless repurchased, redeemed, or converted in accordance with their terms prior to the maturity date.
The Notes are convertible into cash, shares of the Company’s common stock, or a combination of cash and shares of the Company’s common stock, at the Company’s election, at an initial conversion rate of 8.8836 shares of common stock per $1,000 principal amount of the Notes, which is equivalent to an initial conversion price of approximately $112.57 (Conversion Price) per share of the Company’s common stock. The conversion rate is subject to customary adjustments for certain events as described in the Indenture.
The Company may not redeem the Notes prior to May 6, 2023. The Company has the option to redeem for cash all or any portion of the Notes on or after May 6, 2023 if the last reported sale price of the Company’s common stock has been at least 130% of the Conversion Price then in effect for at least 20 trading days (whether or not consecutive), including the trading day immediately preceding the date on which the Company provides notice of redemption, during any 30 consecutive trading day period, at a redemption price equal to 100% of the principal amount of the Notes to be redeemed, plus accrued and unpaid interest. No sinking fund is provided for the Notes.
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Holders of the Notes may convert all or a portion of their Notes at their option prior to November 1, 2024, in multiples of $1,000 principal amounts, only under the following circumstances:
•if the last reported sale price of the Company’s common stock for at least 20 trading days (whether or not consecutive) during the period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the applicable conversion price of the Notes on each such trading day;
•during the five business day period after any five consecutive trading day period in which the trading price per $1,000 principal amount of the Notes for each day of that five consecutive trading day period was less than 98% of the product of the last reported sale price of the Company’s common stock and the applicable conversion rate of the Notes on such trading day;
•if the Company calls any or all of the Notes for redemption, at any time prior to the close of business on the scheduled trading day immediately preceding the redemption date; or
•on the occurrence of specified corporate events.
On or after November 1, 2024, until the close of business on the second scheduled trading day immediately preceding the maturity date, holders may convert their Notes at any time, regardless of the foregoing circumstances.
Holders of the Notes who convert in connection with a make-whole fundamental change, as defined in the Indenture, or in connection with a redemption are entitled to an increase in the conversion rate. Additionally, in the event of a fundamental change, as defined in the Indenture, holders of the Notes may require us to repurchase all or a portion of the Notes at a price equal to 100% of the principal amount of the Notes, plus any accrued and unpaid interest.
In accounting for the issuance of the Notes, the Company separated the Notes into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of similar debt instruments, which do not have an associated convertible feature. The amount of the equity component representing the conversion option for the Notes was $88.5 million and was recorded as a debt discount, which is amortized to interest expense at an effective interest rate of 9.9%. The Company allocated $2.7 million of debt issuance costs to the equity component and the remaining debt issuance costs of $6.1 million were allocated to the liability component, which are amortized to interest expense under the effective interest rate method. The equity component of the Notes will not be remeasured as long as it continues to meet the conditions for equity classification. It is the Company’s intent and policy to settle conversions through combination settlement, which essentially involves payment in cash equal to the principal portion and delivery of shares of common stock for the excess of the conversion value over the principal portion.
The liability and equity components of the Notes consisted of the following (in thousands):
Liability:
Unamortized debt discount and debt issuance costs (84,516)
Carrying amount of the equity component $ 85,803
As of December 31, 2020, the debt discount and debt issuance costs associated with the Notes will be amortized over the remaining period of approximately 4.3 years using the effective interest method.
The following table details interest expense recognized related to the Notes for the year ended December 31, 2020 (in thousands):
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Year Ended
Contractual interest expense $ 2,707
Amortization of debt issuance costs 652
Amortization of debt discount 9,446
Total interest expense $ 12,805
The Notes will have a dilutive effect to the extent the average market price per share of common stock for a given reporting period exceeds the conversion price of $112.57. As of December 31, 2020, the “if-converted value” did not exceed the principal amount of the Notes.
Capped Call Transactions
In connection with the issuance of the Notes, the Company entered into Capped Call Transactions with certain counterparties at a net cost of $34.1 million. The Capped Call Transactions are intended to reduce potential dilution to holders of the Company’s common stock beyond the conversion price of $112.57, up to a conversion price of $173.18 on any conversion of the Notes, or to offset any cash payments the Company is required to make in excess of the principal amount of such converted Notes, as the case may be, with such reduction or offset subject to a cap. The cap price of the Capped Call Transactions is initially $173.18 per share of the Company’s common stock, representing a premium of 100% above the last reported sale price of $86.59 per share of the Company’s common stock on May 12, 2020, and is subject to certain adjustments under the terms of the Capped Call Transactions. Conditions that cause adjustments to the initial strike price of the Capped Call Transactions mirror conditions that result in corresponding adjustments for the Notes.
For accounting purposes, the Capped Calls are separate transactions, and not part of the terms of the Notes. As these transactions meet certain criteria under the applicable accounting guidance, the Capped Calls are recorded in stockholders' equity and are not accounted for as derivatives. The cost of the Capped Call Transactions was recorded as a reduction of the Company’s additional paid-in capital in the Company’s consolidated balance sheet and will not be remeasured.
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, and was included in Notes payable long-term in the consolidated balance sheet, offset by the debt discount associated with financing fees and certain debt issuance costs. At the time of repayment, the remaining unamortized debt discount of $5.3 million was accelerated and recognized as a loss on extinguishment of debt in the consolidated statement of operations for the year ended December 31, 2018. The total repayment amount of $88.8 million included approximately $1.1 million in accrued interest, and approximately $5.0 million in associated financing fees that became due.
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.
7. Stockholders’ Equity (Deficit)
Public Offerings
In the first quarter of 2018, the Company completed a registered public offering of 34,500,000 shares of common stock at a public offering price of $2.00 per share. The gross proceeds from the offering were approximately $69.0 million, before deducting underwriting discounts and commissions and other offering expenses.
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.
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Shares Reserved for Future Issuance