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 September 30, 2023 (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, 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 in the section entitled “Risk Factors” in Part I, Item 1A, of our Annual Report on Form 10-K for the year ended December 31, 2022 (Annual Report), in the section entitled “Risk Factors” in Part II, Item 1A, of our Quarterly Report on Form 10-Q for the quarter ended June 30, 2023, and below in the section entitled “Risk Factors” in this Quarterly Report, as well as in 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. We consider our primary addressable market to be people who live with type 1 diabetes. Through our product development efforts, we are seeking to expand our addressable market to include people living with type 2 diabetes who require intensive insulin therapy. 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 robust ecosystem and 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. Today, the t:slim X2 Insulin Delivery System is our flagship technology solution. In the four-year period ended September 30, 2023, we shipped approximately 444,000 t:slim X2 insulin pumps, which is representative of our in-warranty global installed customer base assuming the typical four-year reimbursement cycle. Approximately 308,000 of these pumps were shipped to customers in the United States and approximately 136,000 were shipped to customers outside the United States. Our products are currently available in approximately 25 countries outside the United States. The vast majority of our customers worldwide are people living with type 1 diabetes. 24 In addition, in July 2023, the FDA provided clearance for the Tandem Mobi insulin pump, which is the world’s smallest durable automated insulin delivery (AID) system. At approximately half the size of our t:slim X2 pump, Tandem Mobi is designed for people who seek even greater discretion and flexibility, and includes features such as expanded pump-control from our iOS mobile application, inductive charging, and an on-pump button that can be used for bolusing and other actions. A limited release of Tandem Mobi in the United States began in the fourth quarter of 2023 with full commercial availability expected to begin in early 2024. Our manufacturing, sales and support activities are scaling in anticipation of offering people living with diabetes a choice between the t:slim X2 and Tandem Mobi insulin pumps based on their individual needs and preferences. The majority of our customers use their t:slim X2 with continuous glucose monitoring (CGM) integration. This allows their insulin pump to receive CGM sensor readings, which can then be used in our AID algorithms, including our Control-IQ technology. Control-IQ is an advanced hybrid-closed loop feature designed to help increase a user’s time in their targeted glycemic range. Multiple studies have demonstrated that use of Control-IQ technology provides people across all demographics with improved clinical outcomes that are both immediate and sustained. 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. The t:slim X2 was the first pump on which remote software updates were made commercially available in the United States and Tandem Mobi will offer the same capability. Now available for t:slim X2 in the countries we serve worldwide, our Tandem Device Updater (TDU) has allowed hundreds of thousands of people to update their pump software from a personal computer. This offering is a competitive advantage that allows us to bring our customers clinical and lifestyle enhancements, such as new developments in our AID technology, CGM integrations and mobile app features. In the third quarter of 2022, we launched a new pump software update through TDU to allow all t:slim X2 pump users in the United States to bolus insulin using our smartphone app that is available on compatible iOS and Android devices. 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. In the United States, we also offer a 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. Our first-generation data management application, t:connect, was commercially introduced in the United States in 2013. In the second quarter of 2023, we began a scaled global launch of our second-generation data management application, Tandem Source. 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 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. 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. 25 Mobi: Tubeless This offering is being developed to provide an alternative tubeless infusion site option for Tandem Mobi pump users. It will allow a Tandem Mobi pump to be worn completely on the user’s body with no tubing. A goal of this design is to allow people living with diabetes to customize the way they wear their pump with each cartridge change, switching between tubed and tubeless wear configurations, to best suit their personal preferences and lifestyle . Sigi This ergonomic, rechargeable Sigi Patch Pump is being designed to reduce the burden of managing diabetes through its use of pre-filled insulin cartridges and compatibility with AID technology. Extended Wear Infusion Sets Infusion sets provide additional choice and flexibility to people living with diabetes. Our goals for infusion set innovations focus on solutions that extend wear time and enhance user experience, while reducing occlusions, body burden and waste. In support of this effort, we are currently developing a unique extended wear infusion set technology. 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 continuing to drive innovation in our algorithms, emphasizing automation, personalization and simplification to continue to improve therapeutic outcomes and provide a positive patient experience. We recently began a pivotal study to support expanding indications to include people living with type 2 diabetes. We are also researching the use of different insulins with our Control-IQ technology. 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 : We have agreements with Dexcom, Inc. (Dexcom) to extend our current collaboration to include integration with their G7 CGM technology. This will be the fourth generation of Dexcom CGM that we integrate with our devices. Integration of the t:slim X2 with Dexcom’s G7 is in the release process, which we plan to scale for full availability in the United States, followed by a rolling launch in international markets. Abbott CGM : We have an agreement with Abbott Laboratories (Abbott) to develop and commercialize integrated diabetes solutions that combine Abbott’s FreeStyle Libre CGM technology with our insulin delivery systems. This will be the first-generation of the Abbott Freestyle Libre CGM integrated with our t:slim X2. We intend to launch in the United States, and expand to additional geographies after obtaining regulatory clearances or approvals, where required. 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. Our key objectives include making these insights easy to understand, making the data available in real time, and providing the information in a flexible format through mobile or web apps. In addition, we are working to integrate health-related information from third-party sources and to use our data to support current and future products under development. 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. 26 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 began selling our t:slim X2 insulin pump in select geographies outside the United States and our technology solutions are now available in approximately 25 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 four-year period ended September 30, 2023, we shipped approximately 444,000 insulin pumps worldwide, which is representative of our global in-warranty installed customer base. Our ending estimated worldwide installed base increased approximately 11% year over year. At the end of the typical four-year reimbursement cycle, customers may be eligible to purchase 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, those customers that renew typically take up to one year from date of warranty expiration to purchase a subsequent pump. While the majority of our insulin pump sales from initial commercialization through the current period have been generated by sales to new customers, the opportunity to make subsequent sales of renewal insulin pumps to existing customers increases each period as an escalating number of customer warranties expire. With programs dedicated to customer retention efforts, we expect such renewal purchases to represent an increasing portion of our pump shipments over time. Approximately 308,000 pumps were shipped to customers in the United States in the four-year period ended September 30, 2023, which is representative of our U.S. installed customer base. Pump shipments to customers in the United States by fiscal quarter for the current year and each of the previous 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 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 20,818 20,394 23,684 83,554 2023 17,003 18,964 16,842 N/A 52,809 27 Since beginning sales outside the United States in the third quarter of 2018, we shipped approximately 136,000 pumps and our products are now available in approximately 25 countries. The ordering patterns of, and levels of inventory carried by, our distributors outside the United States for pumps and supplies have historically been highly variable from period to period due to a number of factors, including summer vacations, the timing of product launches into new geographies and variability due to supply chain logistics, particularly during the global pandemic. This also influences the timing in which renewal eligibility begins for existing customers, which may not initially be consistent with trends in the U.S. market. We recently began completing a full four-year reimbursement cycle in an increasing number of our markets outside of the United States. Pump shipments to customers outside the United States by fiscal quarter for the current year and each of the previous five years, 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 11,296 12,113 11,939 44,785 2023 6,052 10,530 7,989 N/A 24,571 Trends and Uncertainties Impacting Financial Results Our financial condition and operating results have historically fluctuated on a quarterly or annual basis. We expect these periodic fluctuations will continue to be impacted by a number of trends and uncertainties, including the following: Regulatory Approvals and Actions • Sales of new products are subject to local government regulations. The requirements and timelines to receive regulatory clearance can vary substantially from country to country and delays may impact our ability to expand our worldwide customer base and bring products to market in a competitive timeframe. These delays, or failure to receive regulatory approval could adversely impact our revenue and results of operations. • Any adverse event involving any products that we distribute could result in future corrective actions, such as recalls or customer notifications, or regulatory agency action, which could include inspection, mandatory recall or other enforcement action. Any action by regulatory bodies against us, and any regulatory challenges we encounter could have a negative impact on our product sales and harm our reputation. Product - Launches and Reimbursement • We expect our business to be impacted by the introduction of new diabetes devices and treatments by us or our competitors. The success of our products is variable and we believe it correlates to market acceptance, anticipated product launches and commercial availability. We anticipate that our Tandem Choice program, and its related financial and accounting impact, may continue to materially impact our business until the conclusion of the program. • We have historically experienced higher net sales in our third and fourth quarters compared to the first half of the year. We believe our recently announced FDA clearance of Tandem Mobi and its anticipated launch has impacted and may impact the future timing of purchasing decisions by our current and prospective customers as the full commercial launch date approaches, resulting in delays that are unlike historical seasonal patterns or purchasing behaviors. Regulatory approval and/or upcoming launches of other new Tandem or competitor products could also adversely impact timing of purchasing decisions. • Our revenue and results of operations may be impacted by the failure to secure or retain adequate coverage or reimbursement for our current and future products from third-party payors. 28 Foreign Markets • We have expanded our business and launched new products in select geographies outside the United States. The ordering patterns of our distributors outside the United States is highly variable from period to period. We commenced operations of a European distribution center beginning in the third quarter of 2022, which led to downward adjustments of inventory levels at our distributors in late 2022 and in the first half of 2023. Seasonality • Seasonality in the United States is associated with annual insurance deductibles and coinsurance requirements of the medical insurance plans used by our customers and the customers of our distributors. In the United States, we typically experience a higher volume of pump shipments in the third and fourth quarters due to the nature of the reimbursement environment. Other factors that may impact sales across the year include the timing of winter, summer and other seasonal holidays, particularly in our markets outside the United States, as well as the anticipated launch of new products. Macroeconomic Factors • Global economic and market uncertainty, such as recessionary concerns, inflation, changes in discretionary spending and increased interest rates have impacted our customers’ purchasing decisions and the buying patterns of our distributors. • High inflation and the effects of other macroeconomic factors and concerns have continued to disrupt our relationships with suppliers, third-party manufacturers, healthcare providers, distributors and our existing or potential customers. We are experiencing higher costs as we navigate these global macroeconomic challenges. Components of Results of Operations Sales We offer products for people with insulin-dependent diabetes in approximately 25 countries. The t:slim X2 insulin pump is our flagship pump platform. Our other products include disposable insulin cartridges and infusion sets, as well as our complementary t:connect, TDU and mobile application products. Our primary customers are the end users of our products, non-exclusive distribution partners whose level of service varies based on geography, the healthcare professionals who prescribe our products and the healthcare systems or payors who provide insurance coverage and access to our products. Our sales may fluctuate from period to period, particularly due to seasonality in the United States associated with the timing of insurance deductible resets, which generally reflect in a significant decline in pump shipments from any fourth quarter to the following first quarter. Therefore, the lowest percentage of sales is typically reported in the first quarter of each calendar year and the highest percentage is typically reported in the fourth quarter. See also “Trends and Uncertainties Impacting Financial Results—Product Launches and Reimbursement,” above. In September 2022, we began offering the Tandem Choice program to eligible t:slim X2 customers to provide a pathway to ownership of our newest hardware platform, Tandem Mobi, for a fee when available. Tandem Choice expires on December 31, 2024. The accounting treatment for Tandem Choice is complex (see Note 2, “Summary of Significant Accounting Policies”). Initially, the program requires the deferral of some portion of sales for shipments of eligible pumps, which began in the third quarter of 2022. No election is made by the customer at the time of the initial sale, nor does the right offered to the customer impact the economics associated with how or when the initial pump sale is reimbursed. If a customer elects to participate in Tandem Choice at a future date beginning with the launch of our next generation hardware platform, Tandem Mobi, we will recognize the existing deferral, incremental fees received and the associated costs of providing the new hardware, Tandem Mobi, at the time of fulfillment. Any remaining deferrals will be recognized at program expiration. At this time, we are not able to estimate the financial impact for the duration of Tandem Choice. 29 Cost of Sales 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. When taking into consideration the differences in reimbursement levels and cost structure, pumps have, and are expected to continue to have, a higher gross profit and 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. 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 have approximately 110 sales territories in the United States, which are generally maintained by sales representatives and field clinical specialists, and supported by managed care liaisons, additional sales management and other customer support personnel. Other significant SG&A expenses typically include those incurred for 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. 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 and non-cash stock-based compensation. 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. Acquired In-process Research and Development (IPR&D) Expenses Acquired IPR&D reflects costs of external research and development projects acquired directly in a transaction other than a business combination, that do not have an alternative future use. Other Income and Expense Other income and expense primarily consists of interest earned on our cash equivalents and short-term investments, foreign currency transaction gains and losses, and interest expense which includes the amortization of debt issuance costs related to our 1.50% Convertible Senior Notes due May 2025 (Notes) and our line of credit facility. On or about October 24, 2023, we were notified that additional interest beyond the 1.50% per annum has been accruing on the Notes since May 2021, pursuant to the terms of the indenture. This additional interest continues to accrue at a rate of 0.50% per annum on the outstanding principal amount of the Notes, and as of November 1, 2023 amounts to approximately $3.2 million in the aggregate. The overdue unpaid interest itself accrues interest at a rate of 2.50% per annum. We are coordinating with the trustee for the Notes to pay all overdue amounts as soon as reasonably practicable in the fourth quarter of 2023. See “Risk Factors—An event of default has occurred under the indenture governing our 1.50% Convertible Senior Notes due 2025.” 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 federal, state and foreign cash tax expense as a result of taxable income anticipated or incurred in those jurisdictions. 30 Results of Operations Three Months Ended September 30, Nine Months Ended September 30, (in thousands, except percentages) 2023 2022 2023 2022 Sales: United States $ 130,222 $ 146,035 $ 403,964 $ 422,985 Outside the United States 55,400 58,512 146,958 157,731 Total sales 185,622 204,547 550,922 580,716 Cost of sales 95,869 100,122 276,527 283,252 Gross profit 89,753 104,425 274,395 297,464 Gross margin 48 % 51 % 50 % 51 % Operating expenses: Selling, general and administrative 79,328 84,104 266,752 237,989 Research and development 41,970 36,798 127,063 103,529 Acquired in-process research and development — 31,016 78,750 31,016 Total operating expenses 121,298 151,918 472,565 372,534 Operating loss (31,545) (47,493) (198,170) (75,070) Other income (expense), net: Interest income and other, net 5,656 1,720 17,305 2,961 Interest expense (4,840) (1,576) (8,079) (4,629) Total other income (expense), net 816 144 9,226 (1,668) Loss before income taxes (30,729) (47,349) (188,944) (76,738) Income tax expense 2,232 1,621 3,665 2,003 Net loss $ (32,961) $ (48,970) $ (192,609) $ (78,741) Comparison of the Three Months Ended September 30, 2023 and 2022 Sales For the three months ended September 30, 2023, sales were $185.6 million, which included $55.4 million of sales outside the United States. For the three months ended September 30, 2023, we deferred $8.2 million of pump sales as the result of Tandem Choice, which launched in the United States in September of 2022. Sales were $204.5 million for the same period in 2022, which included $58.5 million of sales outside the United States. Sales by product in the United States were as follows (in thousands): Three Months Ended September 30, 2023 2022 % Change Pump $ 66,365 $ 81,295 (18)% Supplies and other 72,093 65,339 10% Deferral for Tandem Choice program (8,236) (599) (1,275)% Total Sales in the United States $ 130,222 $ 146,035 (11)% 31 Pump sales in the United States were $66.4 million for the third quarter of 2023, compared to $81.3 million in the third quarter of 2022 as pump shipments decreased 17% compared to the same period in 2022. We continued to face challenging marketplace dynamics and economic conditions similar to recent quarters, with inflation and the threat of recession impacting pump purchasing decisions. Additionally, we believe the anticipation for the full release of the Dexcom G7 sensor integration with t:slim X2 and the recent FDA clearance of Tandem Mobi have begun to impact the timing of purchasing decisions for those who prefer those offerings, resulting in some customers delaying current purchases until full commercial availability of each product in future periods. Sales of pump-related supplies increased 10% primarily due to a 10% year-over-year increase in our ending estimated installed base of customers in the United States. Sales to distributors accounted for 64% and 66% of our total sales in the United States for the three months ended September 30, 2023 and 2022, respectively. Sales in the United States for the three months ended September 30, 2023 and 2022 were reduced by a deferral of $8.2 million and $0.6 million, respectively, as the result of our Tandem Choice program which launched in September of 2022. The increase in the revenue deferral for Tandem Choice in 2023 as compared to 2022, was primarily a result of a reduction in the Tandem Choice program price which became effective in the third quarter of 2023, resulting in an increase to our estimate of the future customer participation rate and, therefore, a higher deferral per pump sold, coupled with the Tandem Choice program being in effect for the entire third quarter of 2023. Sales by product outside the United States were as follows (in thousands): Three Months Ended September 30, 2023 2022 % Change Pump $ 21,672 $ 27,385 (21)% Supplies and other 33,728 31,127 8% Total Sales Outside the United States $ 55,400 $ 58,512 (5)% Pump sales outside the United States were $21.7 million for the third quarter of 2023, compared to $27.4 million in the third quarter of 2022. Pump shipments decreased 34% compared to the same period in the prior year. The decrease in pump sales was offset by an increase in average selling prices due primarily to geographical mix. Sales of pump-related supplies increased 8% primarily due to a 13% year-over-year increase in our ending estimated installed base of customers outside the United States. The year-over-year changes in pump and supply shipments were not necessarily indicative of actual customer demand, as they were heavily influenced by variability in historical ordering patterns of our distributors prior to commencement of operations at our centralized European distribution center in late 2022. Sales to distributors accounted for 95% and 96% of our total sales outside the United States for the three-month periods ended September 30, 2023 and 2022, respectively. Cost of Sales and Gross Profit Our cost of sales for the three months ended September 30, 2023 was $95.9 million , resulting in gross profit of $89.8 million, compared to cost of sales of $100.1 million and gross profit of $104.4 million for the same period in 2022. The gross margin for the three months ended September 30, 2023 and 2022 was 48% and 51%, respectively. Gross profit for the three months ended September 30, 2023 was reduced by $8.2 million from the impact of Tandem Choice, resulting in a gross margin reduction of more than two percentage points. The impact on gross margin from our Tandem Choice program will fluctuate through the expiration of the program based on the timing of availability of a new hardware platform, Tandem Mobi, and the number of eligible customers who ultimately elect to participate. Excluding the impact of Tandem Choice, gross margin was consistent with the prior year. Gross margin benefited from progress in underlying fundamentals, including an increase in average selling prices and manufacturing efficiencies, as well as leverage of fixed overhead. Gross margin further benefited from reduction in the impact of certain high-cost raw materials acquired in the prior year. More specifically, the higher cost of raw materials acquired in the prior year stemmed from supply chain challenges during the COVID-19 global pandemic, where certain pump materials were sourced from alternative suppliers to reduce the risk of component shortages. The impact in the quarter of these high-cost raw materials was reduced to less than one percent of sales. These benefits were offset by the impact of product and geographical mix. Pump sales, which have the highest gross margin, were 43% of total worldwide sales, excluding the impact of Tandem Choice, in the third quarter of 2023, compared to 53% in the third quarter of 2022. 32 Operating Expenses Our operating expenses for the three months ended September 30, 2023 were $121.3 million, compared to $151.9 million for the three months ended September 30, 2022. The $30.6 million decrease was primarily driven by $31.0 million of acquired in-process research and development expenses incurred in 2022 in connection with our acquisition of Capillary Biomedical (see Note 12, “Acquisitions”). Selling, General and Administrative Expenses. SG&A expenses decreased 6% to $79.3 million for the three months ended September 30, 2023, from $84.1 million for the same period in 2022. The decrease of $4.8 million was largely driven by lower employee-related expenses of $2.3 million, as well as reduced costs pertaining to certain facilities expense savings from our facilities consolidation initiatives. Research and Development Expenses . R&D expenses increased 14% to $42.0 million for the three months ended September 30, 2023, from $36.8 million for the same period in 2022. The increase in R&D expenses was primarily the result of a $3.2 million increase in salaries and related benefits due to our acquisitions and an increase in personnel to support our product development efforts. We also experienced a $2.0 million increase in other non-employee discretionary spending, including supplies, outside services and equipment costs. Acquired In-Process Research and Development Expenses. Acquired IPR&D expenses of $31.0 million for the three months ended September 30, 2022 represented the value of assets acquired, and acquisition related expenses, in connection with our acquisition of Capillary Biomedical. Other Income (Expense), Net Total other income (expense), net for the three months ended September 30, 2023 was $0.8 million income, compared to $0.1 million expense in the same period in 2022. Other income, net for the three months ended September 30, 2023 primarily consisted of $5.9 million of interest income earned on our cash equivalents and short-term investments, partially offset by $4.8 million of interest expense which included $3.1 million of additional interest as discussed above and the amortization of debt issuance costs related to our Convertible Senior Notes. Other expense, net for the three months ended September 30, 2022 primarily consisted of $1.7 million of interest income earned on our cash equivalents and short-term investments, partially offset by $1.6 million of interest expense which included the amortization of debt issuance costs related to our Notes. Income Tax Expense We recognized income tax expense of $2.2 million on a pre-tax loss of $30.7 million for the three months ended September 30, 2023, compared to income tax expense of $1.6 million on a pre-tax loss of $47.3 million for the three months ended September 30, 2022. Income tax expense for the three months ended September 30, 2023 and 2022 was primarily attributable to federal, state and foreign income tax expense as a result of current taxable income in certain jurisdictions. Comparison of the Nine Months Ended September 30, 2023 and 2022 Sales For the nine months ended September 30, 2023, sales were $550.9 million, which included $147.0 million of sales outside the United States. For the nine months ended September 30, 2023, we deferred $12.6 million of pump sales as a result of Tandem Choice, which launched in the United States in September of 2022. For the nine months ended September 30, 2022, sales were $580.7 million, which included $157.7 million of sales outside the United States. Sales by product in the United States were as follows (in thousands): Nine Months Ended September 30, 2023 2022 % Change Pump $ 207,180 $ 236,448 (12)% Supplies and other 209,352 187,136 12% Deferral for Tandem Choice program (12,568) (599) (1,998)% Total Sales in the United States $ 403,964 $ 422,985 (4)% 33 Pump sales in the United States were $207.2 million for the first nine months of 2023, compared to $236.4 million in the first nine months of 2022, as pump shipments decreased 12% compared to the same period in the prior year. We continued to face challenging marketplace dynamics and economic conditions, with inflation and the threat of recession impacting pump purchasing decisions. Additionally, we believe the anticipation for the full release of the Dexcom G7 sensor integration with t:slim X2 and the FDA clearance of Tandem Mobi in the third quarter of 2023 have begun to impact the timing of purchasing decisions for those who prefer those offerings, resulting in some customers delaying current purchases until full commercial availability of those products in future periods. Sales of pump-related supplies increased primarily due to a 10% year-over-year increase in our ending estimated installed base of customers in the United States. Sales to distributors accounted for 64% and 65% of our total sales in the United States for the nine months ended September 30, 2023 and 2022, respectively. Sales in the United States for the nine months ended September 30, 2023 and 2022 were reduced by a deferral of $12.6 million and $0.6 million, respectively, as the result of our Tandem Choice program which launched in September of 2022. The increase in the revenue deferral for Tandem Choice in 2023 as compared to 2022, was primarily a result of a reduction in the Tandem Choice program price which became effective in the third quarter of 2023, resulting in an increase to our estimate of the future customer participation rate and, therefore, a higher deferral per pump sold, coupled with the Tandem Choice program being in effect for the full nine months of 2023. Sales by product outside the United States were as follows (in thousands): Nine Months Ended September 30, 2023 2022 % Change Pump $ 67,235 $ 75,515 (11)% Supplies and other 79,723 82,216 (3)% Total Sales Outside the United States $ 146,958 $ 157,731 (7)% Pump sales outside the United States were $67.2 million for the first nine months of 2023, compared to $75.5 million in the first nine months of 2022. We commenced operations of a centralized European distribution center in late 2022, which resulted in a material disruption to distributor ordering patterns in the first half of 2023 as affected distributors reduced their pump and supply inventory levels to adjust for the reduced transit time. As a result, pump shipments decreased 25% compared to the same period in the prior year and supply orders declined as well. The decrease in pump sales was offset by an increase in average selling prices due primarily to geographical mix. The year-over-year changes in pump and supply shipments were not necessarily indicative of actual customer demand, as they were heavily influenced by variability in historical ordering patterns of our distributors prior to commencement of operations at our centralized European distribution center in late 2022. Sales to distributors accounted for 94% of our total sales outside the United States for the nine-month period ended September 30, 2023, and 96% for the same period in 2022. Cost of Sales and Gross Profit Our cost of sales for the nine months ended September 30, 2023 was $276.5 million resulting in gross profit of $274.4 million, compared to cost of sales of $283.3 million and gross profit of $297.5 million for the same period in 2022. The gross margin for the nine months ended September 30, 2023 was 50% compared to 51% in the same period in 2022. Gross profit for the nine months ended September 30, 2023 was reduced by $12.6 million from the impact of Tandem Choice, resulting in a gross margin reduction of approximately one percentage point, as well as the decrease in sales in the first half of 2023 associated with the European distribution center transition. The impact on gross margin from our Tandem Choice program will fluctuate through the expiration of the program based on the timing of availability of Tandem Mobi and the number of eligible customers who ultimately elect to participate. Excluding the impact of Tandem Choice, gross margin for the nine months ended September 30, 2023 was consistent with the same period in 2022. Gross margin benefited from progress in underlying fundamentals, including an increase in average selling prices and manufacturing efficiencies, as well as leverage of fixed overhead. Gross margin further benefited from the lower impact of certain high-cost raw materials acquired during the pandemic. These benefits were offset by the impact of product mix and geographical mix. 34 Operating Expenses Our operating expenses for the nine months ended September 30, 2023 were $472.6 million, compared to $372.5 million for the nine months ended September 30, 2022. A significant portion of the increase was driven by certain unique or non-recurring transactions. In 2023, we incurred $78.8 million of acquired in-process research and development expenses in connection with our recent acquisition of AMF Medical, compared to $31.0 million of acquired IPR&D expenses in connection with our acquisition of Capillary Biomedical in 2022 (see Note 12, “Acquisitions”). As a part of continued operating efficiency measures, in 2023 we also incurred a non-recurring operating lease impairment charge in SG&A of $14.1 million as a result of a facilities consolidation (see Note 6, “Leases”), and employee severance costs of $2.7 million. Additionally, incremental personnel and discretionary spending attributable to our recent acquisitions in both SG&A and R&D was $15.2 million. Selling, General and Administrative Expenses. SG&A expenses increased 12% to $266.8 million for the nine months ended September 30, 2023, from $238.0 million for the same period in 2022. Excluding the impact of the $14.1 million lease impairment charge and $2.1 million in severance costs, the increase of $12.6 million was largely driven by $9.8 million in employee-related expenses. This was primarily the result of higher salaries and related benefits to provide continued support services for our growing installed customer base. Research and Development Expenses . R&D expenses increased 23% to $127.1 million for the nine months ended September 30, 2023, from $103.5 million for the same period in 2022. The increase in R&D expenses was primarily the result of a $17.4 million increase in salaries and related benefits from our acquisitions and an increase in personnel to support our product development efforts. We also experienced a $6.2 million increase in other non-employee discretionary spending, including equipment, supplies and clinical trials costs. Acquired In-Process Research and Development Expenses. Acquired IPR&D expenses of $78.8 million for the nine months ended September 30, 2023 represented the value of assets acquired, and acquisition related expenses, in connection with our acquisition of AMF Medical. Acquired IPR&D expenses of $31.0 million for the nine months ended September 30, 2022 represented the value of IPR&D assets acquired, and acquisition related expenses, in connection with our acquisition of Capillary Biomedical. Other Income (Expense), Net Total other income (expense), net for the nine months ended September 30, 2023 was $9.2 million income, compared to $1.7 million expense in the same period in 2022. Other income, net for the nine months ended September 30, 2023 primarily consisted of $15.2 million of interest income earned on our cash equivalents and short-term investments, and $2.0 million in foreign currency transaction gains, partially offset by $8.1 million of interest expense which included $3.1 million of additional interest as discussed above and the amortization of debt issuance costs related to our Notes. Other expense, net for the nine months ended September 30, 2022 primarily consisted of $4.6 million of interest expense which included the amortization of debt issuance costs related to our Notes, partially offset by $2.9 million of interest income earned on our cash equivalents and short-term investments. Income Tax Expense We recognized income tax expense of $3.7 million on a pre-tax loss of $188.9 million for the nine months ended September 30, 2023, compared to income tax expense of $2.0 million on a pre-tax loss of $76.7 million for the nine months ended September 30, 2022. Income tax expense for the nine months ended September 30, 2023 and 2022 was primarily attributable to federal, state and foreign income tax expense as a result of current taxable income in certain jurisdictions. Liquidity and Capital Resources At September 30, 2023, we had $498.2 million in cash and cash equivalents and short-term investments. In addition, we have a Revolving Line of Credit (Line of Credit), which expires in May 2025 (see Note 7, “Debt”), under which we may borrow up to $50.0 million, less the amount of our standby letter of credit, provided we are currently not entitled to borrow any amounts under the Line of Credit as a result of our inadvertent failure to timely pay additional interest under the Notes. See above under “Other Income and Expense”. We believe that our cash and cash equivalents, short-term investments, borrowing availability under the Line of Credit, and future cash flows from operations will be sufficient to fund our ongoing core business activities for at least the next twelve months. 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. 35 Our historical cash outflows have primarily been associated with cash used for operating activities such as research and development activities, sales, marketing and commercialization of our products worldwide, expansion of clinical and customer support organizations, the acquisition of intellectual property, equity investments and acquired assets, capital expenditures and debt service costs. The following table shows a summary of our cash flows for the nine months ended September 30, 2023 and 2022 (in thousands): Nine Months Ended September 30, 2023 2022 Net cash provided by (used in): Operating activities $ (24,594) $ 44,644 Investing activities (69,156) (2,609) Financing activities 1,496 10,777 Effect of foreign exchange rate changes on cash (652) (207) Net increase (decrease) in cash and cash equivalents $ (92,906) $ 52,605 Operating Activities . Net cash used in operating activities was $24.6 million for the nine months ended September 30, 2023, compared to $44.6 million cash provided by operating activities in the same period in 2022. The reduction in net cash provided by operating activities for 2023 compared to 2022 was primarily a result of the increase in net loss, which included $78.8 million of acquired in-process research and development expenses and a $14.1 million operating lease impairment charge in 2023, as well as working capital changes. Working capital changes during the first nine months of 2023 primarily consisted of increases in inventories and prepaids and other current assets, partially offset by a decrease in accounts receivable and an increase in deferred revenue. Accounts receivable decreased to $100.3 million at September 30, 2023, from $114.7 million at December 31, 2022. Inventories increased to $143.5 million at September 30, 2023, from $111.1 million at December 31, 2022 primarily due to a return to target stocking levels post-pandemic as supply chain constraints subsided, as well as the scaling up of inventory to meet anticipated demand for Tandem Mobi. Investing Activities . Net cash used in investing activities was $69.2 million for the nine months ended September 30, 2023, which primarily consisted of $391.0 million of purchases of short-term investments, $69.5 million for the acquisition of AMF Medical, including transaction costs (see Note 12, “Acquisitions”), and $21.6 million in purchases of property and equipment of which $8.7 million was associated with improvements to the new Headquarters lease facility which is now complete (see Note 6, “Leases”), offset by $415.5 million in proceeds from maturities and redemptions of short-term investments. Net cash used in investing activities was $2.6 million for the nine months ended September 30, 2022, which primarily consisted of $362.5 million of purchases of short-term investments, $28.5 million in purchases of property and equipment, and $25.7 million paid for the acquisition of Capillary Biomedical, including transaction costs (see Note 12, “Acquisitions”), offset by $422.9 million in proceeds from maturities and redemptions of short-term investments. Financing Activities. Net cash provided by financing activities was $1.5 million for the nine months ended September 30, 2023, which primarily consisted of proceeds from the issuance of common stock under our stock plans, net of payments for related tax withholdings. Net cash provided by financing activities was $10.8 million for the nine months ended September 30, 2022, which primarily consisted of proceeds from the issuance of common stock under our stock plans, net of payments for related tax withholdings. 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; • contractual debt obligations, including periodic interest payments; • the timing of any additional financings, and the net proceeds raised from such financings; • the timing and amount of proceeds from the issuance of equity awards pursuant to employee stock plans; • fluctuations in gross margins and operating margins; and 36 • fluctuations in working capital, including changes in accounts receivable, inventories, accounts payable, employee-related liabilities, and operating lease liabilities. Both our primary short-term and long-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, including contingent earnout payments that become payable upon the achievement of certain milestones; • 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; • payments under licensing, development and commercialization agreements; and • integration costs related to acquisitions of businesses, products and technologies. Critical Accounting Policies Our discussion and analysis of our financial condition and results of operations are based on our condensed consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these condensed 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 condensed consolidated financial statements and accompanying notes as of the date of the 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. Some of those judgments can be subjective and complex, and therefore, actual results could differ materially from those estimates under different assumptions or conditions. 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, 2022. 37