TANDEM DIABETES CARE INC 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. You should read the following discussion and analysis together with our financial statements and related notes in Part I, Item 1 of this Quarterly Report on Form 10-Q for the quarter ended March 31, 2022 (Quarterly Report). This Quarterly Report contains forward-looking statements within the meaning of the federal securities laws, which statements are subject to considerable risks and uncertainties. These forward-looking statements are intended to qualify for the safe harbor from liability established by the Private Securities Litigation Reform Act of 1995. All statements included or incorporated by reference in this Quarterly Report, other than statements of historical fact, are forward-looking statements. You can identify forward-looking statements by the use of words such as “may,” “will,” “could,” “anticipate,” “expect,” “intend,” “believe,” “continue” or the negative of such terms, or other comparable terminology. Forward-looking statements also include the assumptions underlying or relating to such statements. In particular, forward-looking statements contained in this Quarterly Report may relate to, among other things, our future or assumed financial condition, results of operations, liquidity, trends impacting our financial results, business forecasts and plans, research and product development plans, manufacturing plans, strategic plans and objectives, capital needs and financing plans, product launches, geographic expansion, distribution plans, production capacity, clinical trials, regulatory approvals, competitive position and the impact of changes in the competitive environment, the impact of the COVID-19 global pandemic on our business, supply chain, and the businesses of our contract manufacturers and suppliers, integration of acquisitions and partner technologies, and the application of accounting guidance. We caution you that the foregoing list may not include all of the forward-looking statements made in this Quarterly Report. Our forward-looking statements are based on our management’s current assumptions and expectations about future events and trends, which affect or may affect our business, strategy, operations or financial performance. Although we believe that these forward-looking statements are based upon reasonable assumptions, they are subject to numerous known and unknown risks and uncertainties and are made in light of information currently available to us. Our actual financial condition and results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth below in the section entitled “Risk Factors” in Part II, Item 1A, and elsewhere in this Quarterly Report, as well as the other public filings we make with the Securities and Exchange Commission. You should read this Quarterly Report with the understanding that our actual future financial condition and results may be materially different from and worse than what we expect. Moreover, we operate in an evolving environment. New risk factors and uncertainties emerge from time to time and it is not possible for our management to predict all risk factors and uncertainties, nor can we assess the impact of all factors on our business or the extent to which any factor, or combination of factors, may cause actual results to differ materially from those contained in any forward-looking statements. Forward-looking statements speak only as of the date they were made and, except to the extent required by law or the rules of the Nasdaq Global Market, we undertake no obligation to update or review any forward-looking statement because of new information, future events or other factors. We qualify all of our forward-looking statements by these cautionary statements. Overview We are a medical device company focused on the design, development and commercialization of technology solutions for people living with diabetes. Diabetes management can vary greatly from person-to-person, creating multiple market segments based on clinical needs and personal preferences. Our goal is to lead in insulin therapy management across multiple of these market segments by providing a portfolio of delivery devices, software, and data insight solutions to people living with diabetes, as well as their caregivers and healthcare providers. Since our initial commercial launch, we have rapidly innovated and brought 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 Insulin Delivery System (t:slim X2) hardware platform represents 100% of our new pump shipments. In the four-year period ended March 31, 2022, we shipped more than 350,000 insulin pumps, which is representative of our estimated global installed customer base, assuming the typical four-year reimbursement cycle. More than 250,000 of these pumps were shipped to customers in the United States and nearly 100,000 were shipped to more than 20 countries in which we operate outside the United States. 24 Our manufacturing, sales and support activities principally focus on our flagship pump platform, the t:slim X2 and our complementary product offerings. Our simple-to-use t:slim X2 is based on our proprietary technology platform and is the smallest durable insulin pump available in the United States. We have commercially offered two different automated insulin dosing (AID) algorithms on t:slim X2, including our Control-IQ technology, which is an advanced hybrid-closed loop feature, designed to help increase a user's time in their targeted glycemic range. It was the first system cleared by the U.S. Food and Drug Administration (FDA) to deliver automatic correction boluses in addition to adjusting insulin to help prevent high and low blood sugar based on continuous glucose monitoring (CGM) readings. More than 200,000 t:slim X2 users have our Control-IQ technology, which launched in the United States in the first quarter of 2020, and is now available in all of the countries in which we operate. Our Control-IQ technology uses information from Dexcom Inc.’s (Dexcom) G6 sensor, which is the third generation of Dexcom CGM that we have integrated and commercially launched with our pump technology. The t:slim X2 is unique in that it is the only pump on which remote software updates have been made commercially available in the United States. Now available in the countries we serve worldwide, our Tandem Device Updater (TDU), is a revolutionary tool that has allowed more than 130,000 people to update their t:slim X2 software from a personal computer. This offering is a competitive advantage as it allows us to bring new features, such as our AID technology and CGM integration, to our customers faster than the industry has been able to do historically. In February 2022, the FDA provided clearance for our t:slim X2 pump users to bolus insulin from a compatible smartphone. This is the first-ever FDA-cleared smartphone app capable of initiating insulin delivery on both iOS and Android operating systems. We intend to offer in-warranty t:slim X2 users in the United States with the pump software update to use this new feature at no cost through TDU. 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. Additionally, we sell accessories such as belt clips and cases for use with pumps which are designed to enhance usability. In the United States, we also offer t:connect, our data management web 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. For the three months ended March 31, 2022 and 2021, our consolidated sales were $175.9 million, and $141.0 million, respectively. For the three months ended March 31, 2022 and 2021, our net loss was $14.7 million, and $5.0 million, respectively. Pump sales accounted for 54% and 58%, of our total worldwide sales, for the three months ended March 31, 2022 and 2021, respectively, while pump-related supplies and accessories accounted for the remainder in each year. COVID-19 Global Pandemic Impact and Considerations Our business has been impacted in a variety of ways since the onset of the COVID-19 global pandemic in early 2020, and will likely continue to be impacted for the remainder of 2022. Specific factors that have influenced our financial results and the way in which we operate include fluctuations in shelter-in-place restrictions, supply chain constraints, labor shortages, the timing and extent of vaccine availability and surges in infection and hospitalization rates as new COVID variants have emerged. Throughout this time, we have responded to each of these unique challenges, while prioritizing the health and safety of our employees and customers and working diligently to maintain a continuous supply of products, training and customer support. Most notably, our sales results reflected a high degree of variability across the quarters during this time, unlike historical seasonal trends. We experienced a modest impact early in 2020, which became more pronounced and continued in varying degrees as the pandemic progressed. Initially, the impact on our business was relatively consistent worldwide but we have since seen variations in individual markets based on local conditions and anticipate ongoing fluctuations may continue. Our inventory levels have also fluctuated as we respond to supply chain constraints, due to availability of components from the various suppliers we use to build our products. While we have adequate raw material inventory for a substantial portion of our pump and cartridge components, we are below our targeted stocking levels for others. In early 2020, we initiated regular discussions with our key suppliers regarding their abilities to fulfill existing orders and assess their ongoing capacity. Over the course of the pandemic, we have increased the frequency of those communications. We continue to monitor factors that could negatively impact our supply chain, such as global shortages of semiconductors, copper and paper, as well as custom components for our insulin pumps and cartridges where we rely on a limited number of qualified suppliers. We anticipate experiencing continued challenges managing supply chain constraints, including the potential for limitations on availability of components as well as increased purchase costs. 25 Generally, our entire operation has been impacted as we navigate the generalized labor shortages impacting global markets. The labor challenges affect our ability to recruit and hire key talent at the same pace as in years past, but we remain active in our recruiting efforts and competitive in our offerings. In particular, these labor challenges combined with regulatory delays have impacted our product development and launch timelines. The FDA has generally stated that its review process may take longer than normal due to prioritization of COVID-related products and services. We have experienced lengthy delays in the review of submissions with the FDA, making regulatory timelines difficult to predict. We have adapted well in our commercial operations and customer-facing functions to the challenges presented by the pandemic. Our sales organization balances remote and in-person interactions based on the needs and requirements of the customers with whom they interact. For example, prior to the onset of the pandemic, nearly all trainings for customers purchasing our pump platform were in-person. We quickly pivoted to nearly all trainings being provided on remote platforms. Since that time, we have achieved a balance that includes options for the individual based on their unique needs. We continue to see variability across the markets in which we operate and anticipate these fluctuations between in-person and remote interactions will continue. Our facilities have been closed for non-essential purposes throughout most of the pandemic, while our manufacturing operations were deemed essential due to the critical nature of our product and the communities that we serve. To help ensure the safety and health of those employees working in our facilities, we have implemented various preventative measures throughout the pandemic. In the first quarter of 2022, we began implementing a return-to-office strategy for the rest of the organization that incorporates a hybrid approach to meet the needs of our employees, as well as optimize usage of our facilities. Overall, we anticipate that our sales and operating results will continue to be impacted and subject to unpredictable variability. The full extent of the impact of the 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. Products Under Development Our products under development support our strategy of developing insulin delivery systems as part of a therapy management portfolio that is designed to improve patient experience and outcomes. Our product development efforts fall into three pillars of innovation: delivery devices, device software including algorithms, and data and insights. Delivery Devices We are developing a family of delivery device solutions to meet the varying needs of people living with type 1 and type 2 diabetes by providing choice within our own portfolio. Preferences in the size, shape, and mode of operation that comprise an insulin pump’s hardware often impact a person’s pump purchasing decision and overall user experience. Mobi Formerly referred to under its development name, t:sport, the Tandem Mobi is approximately half the size of our t:slim X2 pump, and is being designed for people who seek even greater discretion and flexibility with the use of their insulin pump. Its features include a 200-unit cartridge, an on-pump bolus button, inductive charging, an AID algorithm, and is waterproof. We anticipate that Mobi will be our first insulin pump to support full pump-control from our mobile application. t:slim X3 Advancing our flagship t:slim platform, the t:slim X3 is being designed to provide a modernized user interface and even greater usability for our planned feature updates. It is also being designed to include enhanced technology, such as greater processing power and capacity to support our advanced algorithms, as well as increased battery life, improved durability, and wireless software update capabilities. 26 Mobi: Tubeless This offering is being developed to provide an alternative tubeless infusion site option for Mobi pump users. A goal of this design is to allow for people living with diabetes to customize the way they wear their pump with each cartridge change to best suit their personal preferences and lifestyle Patch Our patch pump design is in its early stages and is being developed for people living with diabetes who want a disposable tubeless solution. Device Software Our device software is used to control our pumps either directly through the pump’s interface or through our mobile application. It also includes our AID technology and the software used to support remote pump updatability. Control-IQ Advancements We are driving innovation in our algorithms, emphasizing automation, personalization and simplification, all intended to continue to improve therapeutic outcomes and provide a positive patient experience characterized by simplicity and ease of use. Additionally, we have initiated clinical studies to expand the indications of our Control-IQ technology to include people with type 1 diabetes ages 2 to 5 years old, as well as people living with type 2 diabetes. We are also researching the use of different insulins with our Control-IQ technology. Mobile Control We are working to expand our mobile control capability. In the future, our t:connect mobile app is planned to include additional pump control features, such as full operation of our Mobi pump. Integration Building a robust ecosystem and portfolio around our flagship insulin pumps requires product development efforts to integrate, add and enhance complementary system components. Dexcom CGM : In November 2020, we entered into an agreement with Dexcom to extend our current collaboration to include integration with their future G7 CGM technology. Following integrated product development work, and required regulatory clearances or approvals, this will be the fourth generation of Dexcom CGM that we intend to integrate with our devices. Abbott CGM : In June 2020, we announced an agreement with Abbott Laboratories (Abbott), to develop and commercialize integrated diabetes solutions that combine Abbott’s CGM technology with our insulin delivery systems. 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. Data and Insights Our goal is to innovate across our digital health platforms by using the vast amount of data that we collect, in combination with technology such as artificial intelligence or machine learning, to provide information and insights to people living with diabetes, their caregivers and healthcare providers and insurance payors. Key areas of development include making these insights easy to understand, provided in a flexible format with mobile or web apps, and available real time. In addition, we are working to integrate health-related information from third-party sources and use our data to support current and future products under development. Tandem Source Expanding the capabilities of our t:connect data management application available for customers in the United States, Tandem Source is our second-generation web-based data management application that is being designed to become our single, global platform. This application enhances clinical data visualization, provides added interface customization for users to personalize how they engage with their data and for healthcare providers to better manage their care. In the second quarter of 2021, we began limited testing of an initial version of Tandem Source in the United Kingdom. 27 Settings Automation Our automation research and development activities center around opportunities for enhanced user and healthcare provider experience, and improved clinical outcomes. In support of this effort, we are working to automate our pump settings adjustments to further enhance ease of use and expand adoption of our insulin pump products. Pump Shipments From inception in 2012 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 geographies outside the United States and now offer our technology solutions in more than 20 countries worldwide. We consider the number of insulin pump units shipped to be an important metric for managing our business. Insulin pumps in the markets we serve worldwide are generally subject to a four-year reimbursement cycle, imposed by the third-party insurance carrier, government plan or healthcare system that serves as the primary payor. In the past four years, we have shipped more than 350,000 insulin pumps worldwide, which is representative of our estimated global in-warranty installed customer base. At the end of the typical four-year reimbursement cycle, customers may be eligible for the purchase of a new insulin pump, subject to the rules and requirements of their primary insurance payor. While warranties generally expire four years from the original pump shipment date, our typical renewal cycle, or time from original pump purchase to a subsequent pump purchase by the same customer, averages five years. The majority of our insulin pump sales through the current period have been generated by new customers, but the opportunity for existing customers to purchase a renewal insulin pump increases each period as additional customer warranties expire. With programs dedicated to customer retention efforts, we expect such renewal purchases to represent a more significant portion of our shipments in the long-term. More than 250,000 of pumps were shipped to customers in the United States in the past four years, which aligns with the standard four-year warranty period. Pump shipments to customers in the United States by fiscal quarter for the last five years, which aligns more closely with our typical renewal cycle, were as follows: United States Pump Unit Shipments for Each of the Three Months Ended in Respective Years March 31 June 30 September 30 December 31 Total 2017 2,816 3,427 3,868 6,950 17,061 2018 4,444 5,447 7,379 12,935 30,205 2019 9,669 12,799 13,814 17,453 53,735 2020 13,158 14,735 18,380 24,552 70,825 2021 16,644 20,665 20,296 25,712 83,317 2022 18,658 N/A N/A N/A 18,658 Since commencing sales outside the United States in the third quarter of 2018, we have shipped nearly 100,000 pumps to customers in more than 20 countries, and have yet to complete a full four-year reimbursement cycle. Pump shipments to customers outside the United States by fiscal quarter were as follows: Outside the United States Pump Unit Shipments for Each of the Three Months Ended in Respective Years March 31 June 30 September 30 December 31 Total 2018 N/A N/A 1,055 3,233 4,288 2019 5,063 8,459 4,025 2,149 19,696 2020 4,220 3,952 3,641 8,133 19,946 2021 8,708 13,152 11,262 11,873 44,995 2022 9,437 N/A N/A N/A 9,437 28 Trends Impacting Financial Results Overall, we have experienced considerable sales growth each year since the commercial launch of our first product in the third quarter of 2012, only recognizing an operating profit on a full year basis for the first time in 2021. 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, or create uncertainty or delay with respect to regulatory approvals; • timing of holidays and summer vacations, which may vary by geography and may be further influenced by the lifting or relaxation of COVID-19 related restrictions and broader availability of vaccines; • the buying patterns of our distributors and other customers; • 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; • the impact of any potential claims, investigations, information requests, or legal, regulatory or administrative proceedings with respect to potential or asserted violations of law, including: sales and marketing practices, anti-corruption and the Foreign Corrupt Practices Act, antitrust, securities, employment, product liability, environmental, data privacy breaches and patent infringement, which may subject us to fines, penalties, expenses, or 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 in additional geographies, and the ability to access new pump software using our Tandem Device Updater; • anticipated new product launches; 29 • 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; • ability to enter into, maintain agreements, and accomplish continued success in current and future product integrations with CGM partners; • expansion and new product launches in select geographies outside the United States, 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 administrative cost efficiencies with the goal of improving our operating margins and ultimately achieving sustained profitability. While we have achieved profitability in each fourth quarter since 2018, we were profitable for the first time on a full-year basis in 2021. We believe we can ultimately achieve sustained profitability by driving incremental sales growth in markets worldwide, 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 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 insulin cartridges and infusion sets, as well as our complementary t:connect, TDU 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. In the United States, we primarily sell our products through national and regional distributors on a non-exclusive basis. These distributors are generally providers of medical equipment and supplies to individuals with diabetes. Our primary end customers are people with insulin-dependent diabetes. Similar to other durable medical equipment, the primary payor is generally a third-party insurance carrier and the customer is usually responsible for any medical insurance plan copay or coinsurance requirements. We believe we can continue to increase sales by promoting 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. Our products are now sold in more than 20 countries, including in Canada, France and Germany. Our independent distributor partners outside the United States and Canada 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 a distributor partner 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 markets outside the United States 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 pump shipments in the United States have typically decreased significantly from the fourth quarter to the following first quarter. Outside the United States, we do not expect this same impact from seasonality associated with reimbursement, although the quarterly sales trends may be impacted by a number of other factors, including summer vacations, the timing of product launches into new geographies and variability in the ordering patterns of our distributor partners. 30 Since early 2020, the COVID-19 global pandemic had a major impact on businesses around the world, as well as our own quarterly trends. Initially, the impact on our business was relatively consistent worldwide but we have since seen varying degrees of impact in individual markets based on local conditions. For example, during 2021, we saw a gradual increase in the amount of in-person sales and training activities in the United States as vaccination availability expanded and social-distancing requirements were relaxed. During the second half of 2021, we saw reduced availability of customers and healthcare providers relating to people taking time off to vacation, which adversely impacted our sales of new pumps to customers during the period. We anticipate that our sales may not follow historical trends and may be subject to unpredictable variability in the coming months based on varying levels of impact of the global pandemic across the markets in which we operate. 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 example, 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, and similar occurrences may occur in future periods. However, it is difficult to quantify the extent of the impact of these or similar events on future purchasing decisions. Cost of Sales Historically, we have manufactured our pumps and disposable insulin cartridges at our manufacturing facility in San Diego, California. In early 2020, our third-party cartridge manufacturer completed validation and commenced commercial-scale manufacturing to supplement our existing cartridge manufacturing capacity. By the end of 2021, the majority of our t:slim cartridge manufacturing capacity transitioned to our partner in order to create capacity for t:sport cartridge manufacturing in the future. 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. 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 could 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, 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 implemented temporary operational changes that introduced 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. We are also experiencing higher costs as we manage global supply challenges and anticipate that this will continue for the remainder of 2022. 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, we have and will continue to evaluate investing in additional manufacturing equipment to substantially increase 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. 31 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 individual markets worldwide, 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, cost to support our digital health platforms, cost associated with excess and obsolete inventories, and changes in our manufacturing processes, capacity, costs or output. Selling, General and Administrative Our selling, general and administrative (SG&A) expenses primarily consist of salary, cash-based incentive compensation, fringe benefits and non-cash stock-based compensation for our sales, marketing and administrative functions, which also includes our clinical, customer support, technical services, insurance verification and regulatory affairs personnel. We had approximately 110 sales territories in the United States in the first quarter of 2022, up from 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 typically 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. While we experienced reduced spending in areas such as travel and trade shows in 2021 due to the COVID-19 global pandemic, we may experience additional costs as our employees return to work at our offices and as we adapt to alternative hybrid work models, or as needed to respond to general labor shortages and heightened competition for employees with specialized skills. Overall, we expect our SG&A expenses, including the cost of our customer support infrastructure, to continue to increase as our customer base grows worldwide. In addition, 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. 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 hardware, software and digital health 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, develop new products and technologies and support more clinical trials. 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 interest expense which includes the amortization of debt issuance costs related to our 1.50% Convertible Senior Notes due 2025, changes in the fair value of certain warrants issued in connection with our public offering of common stock in October 2017, and interest earned on our cash equivalents and short-term investments. We expect interest expense in future quarters to be comparable with the amount expensed in 2021, through the date of conversion or redemption of the Notes. We expect the revaluation of the outstanding Series A warrants will not have a significant impact on our other income and expense through their expiration in the fourth quarter of 2022. Income Tax Expense (Benefit) Because the Company maintains a full valuation allowance against its net deferred tax assets, income tax expense is expected to primarily consist of current state and foreign cash tax expense as a result of taxable income anticipated or incurred 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. 32 Results of Operations Three Months Ended March 31, (in thousands, except percentages) 2022 2021 Sales: United States $ 131,283 $ 103,339 Outside the United States 44,624 37,698 Total sales 175,907 141,037 Cost of sales 84,814 67,750 Gross profit 91,093 73,287 Gross margin 52 % 52 % Operating expenses: Selling, general and administrative 73,271 58,563 Research and development 33,160 17,961 Total operating expenses 106,431 76,524 Operating loss (15,338) (3,237) Other income (expense), net: Interest income and other, net 381 272 Interest expense (1,516) (1,506) Change in fair value of common stock warrants 34 (690) Total other expense, net (1,101) (1,924) Loss before income taxes (16,439) (5,161) Income tax benefit (1,724) (117) Net loss $ (14,715) $ (5,044) Comparison of the Three Months Ended March 31, 2022 and 2021 Sales . For the three months ended March 31, 2022, sales were $175.9 million, which included $44.6 million of sales outside the United States. Sales were $141.0 million for the same period in 2021, which included $37.7 million of international sales. The increase in worldwide sales of $34.9 million in the first quarter of 2022, compared to the first quarter of 2021, was driven by an 11% increase in worldwide pump shipments to 28,095 in the first quarter of 2022, compared to 25,352 in the first quarter of 2021, and a 35% increase in pump-related supply sales. Sales of pump-related supplies increased primarily due to 47% growth in our estimated worldwide installed base of customers. Sales by product in the United States were as follows (in thousands): Three Months Ended March 31, 2022 2021 Pump $ 73,497 $ 62,912 Infusion sets 39,741 27,392 Cartridges 17,677 12,765 Other 368 270 Total Sales in the United States $ 131,283 $ 103,339 33 Pump sales in the United States were $73.5 million for the first quarter of 2022, compared to $62.9 million in the first quarter of 2021. Pump shipments in the United States were 18,658 in the first quarter of 2022, compared to 16,644 in the first quarter of 2021. The increase in pump shipments was primarily due to continued strong demand for our t:slim X2 insulin pump with Control-IQ technology despite the challenging COVID-19 environment which has impacted the availability of both customers and healthcare providers. Sales of pump-related supplies increased primarily due to a 36% increase year over year in our estimated installed base of customers in the United States. Sales to distributors accounted for 65% and 68% of our total sales in the United States for the three months ended March 31, 2022 and 2021, respectively. Our percentage of sales to distributors versus individual customers is principally determined by the mix of customers ordering our products within the period and whether or not we have a contractual arrangement with their underlying third-party insurance payor. Sales by product outside the United States were as follows (in thousands): Three Months Ended March 31, 2022 2021 Pump $ 22,332 $ 18,908 Infusion sets 14,999 12,734 Cartridges 7,177 5,949 Other 116 107 Total Sales Outside the United States $ 44,624 $ 37,698 Pump sales outside the United States were $22.3 million for the first quarter of 2022, compared to $18.9 million in the first quarter of 2021. Pump shipments increased 8% compared to the same period in the prior year due to strong demand for our products as we continue to expand the launch of Control-IQ technology outside the United States, which began in the first quarter of 2020. Sales of pump-related supplies benefited from an 87% increase in our estimated installed base of customers outside the United States. The ordering patterns of our distributors outside the United States for pumps and supplies is highly variable from period to period as they continue to gain familiarity with the markets in which they operate and the acceptance of our products in those markets. This variability was compounded during the period by the differing levels of impact from the global pandemic with regard to both access to physicians and customers, as well as shipping logistics. Sales to distributors accounted for 96% of our total sales outside the United States for both of the three month periods ended March 31, 2022 and 2021. Cost of Sales and Gross Profit . Our cost of sales for the three months ended March 31, 2022 was $84.8 million , resulting in gross profit of $91.1 million, compared to cost of sales of $67.8 million and gross profit of $73.3 million for the same period in 2021. The gross margin for the three months ended March 31, 2022 and 2021 was 52%. The increase in our gross profit for the three months ended March 31, 2022 was primarily the result of the $34.9 million increase in total sales. Gross margin benefited from an increase in average selling prices as well as improvement in per unit manufacturing costs across all products from manufacturing efficiencies, leverage of fixed overhead and increased volumes from our third-party cartridge manufacturer. On an aggregate basis, non-manufacturing costs, which primarily consist of warranty, training, royalty and freight, were negatively impacted by increased supply chain costs due to the global pandemic. We anticipate continued pressure from increased supply chain and material costs through the end of this year as we continue to navigate the challenges of the global pandemic. Other factors that have and may continue to impact 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 54% of total worldwide sales in the first quarter of 2022 versus 58% in the first quarter of 2021. Selling, General and Administrative Expenses. SG&A expenses increased 25% to $73.3 million for the three months ended March 31, 2022, from $58.6 million for the same period in 2021. Employee-related expenses for our SG&A functions comprise the majority of SG&A expenses. The increase compared to 2021 was primarily the result of a $12.8 million increase in salaries, incentive compensation, non-cash stock-based 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. Non-cash stock-based compensation expense allocated to SG&A was $11.9 million for the three months ended March 31, 2022, compared to $9.4 million in the same period in 2021. We also experienced a $1.8 million increase in other non-employee discretionary spending, including outside services, and supplies costs. 34 Research and Development Expenses . R&D expenses increased 85% to $33.2 million for the three months ended March 31, 2022 from $18.0 million for the same period in 2021. The increase in R&D expenses was primarily the result of an increase of $8.9 million in salaries, incentive compensation, non-cash stock-based compensation, and other employee benefits due to an increase in personnel to support our product development efforts. Non-cash stock-based compensation expense allocated to R&D was $4.4 million for the three months ended March 31, 2022 , compared to $2.1 million in the same period in 2021. We also experienced a $6.3 million increase in other non-employee discretionary spending, including clinical trial expenses, outside consulting and services, information technology and equipment costs attributable to R&D. Other Income (Expense), Net . Total other expense, net for the three months ended March 31, 2022 was $1.1 million compared to $1.9 million in the same period in 2021. Total other expense, net for both periods primarily consisted of $1.5 million of interest expense which included the amortization of debt issuance costs related to our Notes, partially offset by interest earned on our cash equivalents and short-term investments. Total other expense, net for the three months ended March 31, 2021 also included a $0.7 million loss on revaluation from the change in fair value of certain warrants. Liquidity and Capital Resources At March 31, 2022, we had $635.4 million in cash and cash equivalents and short-term investments. We believe that our cash and cash equivalents, short-term investments, and future cash flows from operations will be sufficient to fund our ongoing core business activities. 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. 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 geographies outside the United States, the acquisition of intellectual property and equity investments, 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. The following table shows a summary of our cash flows for the three months ended March 31, 2022 and 2021 (in thousands): Three Months Ended March 31, 2022 2021 Net cash provided by (used in): Operating activities $ 13,800 $ 28,685 Investing activities 5,197 (6,094) Financing activities 3,500 3,573 Effect of foreign exchange rate changes on cash 3 14 Net increase in cash and cash equivalents $ 22,500 $ 26,178 Operating Activities . Net cash provided by operating activities was $13.8 million for the three months ended March 31, 2022, compared to $28.7 million in the same period in 2021. The reduction in net cash provided by operating activities for 2022 compared to 2021 was primarily a result of a $9.7 million increase in net loss as well as working capital changes. Working capital changes during the first three months of 2022, primarily consisted of decreases in accounts receivable and employee-related liabilities, and increases in inventories and accounts payable and accrued expenses. Accounts receivable decreased to $94.1 million at March 31, 2022, from $110.7 million at December 31, 2021, as a result of lower sales in the first quarter of 2022 as compared to the fourth quarter of 2021. Inventories increased to $80.0 million at March 31, 2022 from $68.6 million at December 31, 2021. Investing Activities . Net cash provided by investing activities was $5.2 million for the three months ended March 31, 2022, which was primarily related to $118.6 million in proceeds from maturities and sales of short-term investments, offset by $110.7 million of purchases of short-term investments, and $2.6 million in purchases of property and equipment. Net cash used by investing activities was $6.1 million for the three months ended March 31, 2021, which was primarily related to $154.3 million of purchases of short-term investments, and $3.5 million in purchases of property and equipment, offset by $151.7 million in proceeds from maturities and sales of short-term investments. 35 Financing Activities. Net cash provided by financing activities was $3.5 million for the three months ended March 31, 2022, which primarily consisted of proceeds from the issuance of common stock under our stock plans. Net cash provided by financing activities was $3.6 million for the three months ended March 31, 2021, which consisted of $3.1 million in proceeds from the issuance of common stock under our stock plans, and $0.4 million in proceeds from the exercise of common stock warrants. 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; • investments for the development, improvement and acquisition of manufacturing, testing and packaging equipment to support business growth and increase 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. 36 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 proceeds from the issuance of the Notes were $244.6 million, net of debt issuance costs and cash used to pay the cost of the Capped Call Transactions (see Note 7, “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. Cash payments due by calendar year for our Convertible Senior Notes at March 31, 2022 are as follows (in thousands): Total Remaining in 2022 2023 2024 2025 Contractual interest $ 14,357 $ 4,313 $ 4,313 $ 4,313 $ 1,418 Principal amount of convertible senior notes (1) 287,500 — — — 287,500 Total $ 301,857 $ 4,313 $ 4,313 $ 4,313 $ 288,918 (1) The Convertible Senior Notes may be settled in cash, shares of our common stock, or a combination of cash and shares of our common stock, at our election. Critical Accounting Policies 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 of America (U.S. GAAP). 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 and accompanying notes as of the date of the 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 from these estimates. There have been no material changes to our critical accounting policies and estimates from the information provided in Part II, Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations – Critical Accounting Policies Involving Management Estimates and Assumptions,” included in our Annual Report on Form 10-K for the year ended December 31, 2021. Off-Balance Sheet Arrangements As of March 31, 2022, we are a party to certain standby letter of credit arrangements in support of our operating lease obligations. For a description of the arrangements we consider significant, see Note 12 “Commitments and Contingencies” to the condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report. 37