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PODD > SEC Filings for PODD > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for INSULET CORP

Form 10-K for INSULET CORP


28-Feb-2014

Annual Report


ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

The following discussion and analysis should be read in conjunction with the consolidated financial statements and accompanying notes and the other financial information appearing elsewhere in this Annual Report on Form 10-K. This discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results could differ materially from those anticipated in these forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Annual Report on Form 10-K, particularly under the heading "Risk Factors." Overview
We are primarily engaged in the development, manufacturing and sale of our proprietary OmniPod Insulin Management System (the "OmniPod System"), an innovative, discreet and easy-to-use insulin infusion system for people with insulin-dependent diabetes. The OmniPod System is the only commercially-available insulin infusion system of its kind. The OmniPod System features a unique disposable tubeless OmniPod which is worn on the body for approximately three days at a time and the handheld, wireless Personal Diabetes Manager ("PDM"). Conventional insulin pumps require people with insulin-dependent diabetes to learn to use, manage and wear a number of cumbersome components, including up to 42 inches of tubing. In contrast, the OmniPod System features two discreet, easy-to-use devices that eliminate the need for a bulky pump, tubing and separate blood glucose meter, provides for virtually pain-free automated cannula insertion, communicates wirelessly and integrates a blood glucose meter. We believe that the OmniPod System's unique proprietary design offers significant lifestyle benefits to people with insulin-dependent diabetes.
In June 2011, we acquired Neighborhood Holdings, Inc. and its wholly-owned subsidiaries (collectively, "Neighborhood Diabetes") in order to support our sales of the OmniPod System, expand our full suite diabetes management product offerings and obtain access to a larger number of insulin dependent patients. Through Neighborhood Diabetes, we are able to provide customers with blood glucose testing supplies, traditional insulin pumps, pump supplies and pharmaceuticals and have the ability to process claims as either durable medical equipment or through pharmacy benefits.
We began commercial sale of the OmniPod System in the United States in October 2005. We sell the OmniPod System and other diabetes management supplies in the United States through direct sales to customers or through our distribution partners. The OmniPod System is currently available in multiple countries in Europe through our exclusive distribution partner Ypsomed Distribution AG ("Ypsomed") and in Canada through our exclusive distribution partner GlaxoSmithKline Inc. ("GSK"). In August 2011, we received CE Mark approval, and in December 2012 we received 510(k) clearance from the FDA for our new OmniPod System. The new OmniPod System is more than one-third smaller and one-quarter lighter than the original version, while maintaining the same features and operating capabilities. Ypsomed began selling the new OmniPod System in certain European countries in 2012. We began selling the new OmniPod System to new customers in the U.S. during the first quarter of 2013 and began converting the existing customer base during the second quarter of 2013. We completed the transition of our U.S. customer base to the new OmniPod System as of December 31, 2013.
We sell our proprietary OmniPod System as well as blood glucose testing supplies, traditional insulin pumps, pump supplies, pharmaceuticals and other products for the management and treatment of diabetes to people with diabetes. Through our infrastructure in the reimbursement, billing and collection areas, we are able to provide for adjudication of claims as either durable medical equipment or through pharmacy benefits. Claims are adjudicated under private insurers, Medicaid or Medicare. As we expand our sales and marketing focus, increase our manufacturing capacity and expand to additional international markets, we will need to maintain and expand available reimbursement for our product offerings.


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Our sales and marketing effort is focused on generating demand and acceptance of the OmniPod System among key diabetes practitioners, academic medical centers, clinics, people with insulin-dependent diabetes, third-party payors, government agencies, and third-party distributors. Our marketing strategy is to build awareness for the benefits of the OmniPod System through a wide range of education programs, social networking, patient demonstration programs, support materials, media advertisements and events at the national, regional and local levels. We are using third-party distributors to improve our access to managed care and government reimbursement programs, expand our commercial presence and provide access to additional potential patients. Our total revenue was $247.1 million, $211.4 million and $152.3 million for the years ended December 31, 2013, 2012 and 2011, respectively.
We currently produce the OmniPod System on partially automated manufacturing lines at a facility in China operated by a subsidiary of Flextronics International Ltd. ("Flextronics"). We purchase complete OmniPods pursuant to our agreement with Flextronics. Under the agreement, Flextronics has agreed to supply us, as a non-exclusive supplier, with OmniPods at agreed upon prices per unit pursuant to a rolling forecast that we provide. The current term of the agreement expires in December 2017 and is automatically renewed for one-year terms subsequently. It may be terminated upon prior written notice given no less than a specified number of days prior to the date of termination. The specified number of days is intended to provide the parties with sufficient time to make alternative arrangements in the event of termination.
To achieve profitability, we continue to seek to increase manufacturing volume and reduce the per-unit production cost for the OmniPod. By increasing production volumes of the OmniPod, we have been able to reduce our per-unit raw material costs and improve absorption of manufacturing overhead costs. Our new OmniPod was designed to further lower the cost of the product through component sourcing, volume discounts and efficient manufacturing. The cost reductions are important as we strive to achieve profitability. We believe our current manufacturing capacity is sufficient to meet our expected 2014 demand for OmniPods.
We purchase certain other diabetes management supplies from manufacturers at contracted rates and supply these products to our customers. Based on market penetration, payor plans and other factors, certain manufacturers provide rebates based on product sold. We record these rebates as a reduction to cost of goods sold as they are earned.
Since our inception in 2000, we have incurred losses every quarter. In the years ended December 31, 2013, 2012 and 2011, we incurred net losses of $45.0 million, $51.9 million and $45.8 million, respectively. As of December 31, 2013, we had an accumulated deficit of $526.5 million. We have financed our operations through private placements of debt and equity securities, public offerings of our common stock, issuances of convertible debt and borrowings under certain other debt agreements. As of December 31, 2013, we had $143.8 million of convertible debt outstanding which matures in June 2016. Since our inception, we have received net proceeds of $709.5 million from the issuance of redeemable convertible preferred stock, common stock and debt.
Our long-term financial objective is to achieve and sustain profitable growth. Our efforts in the beginning of 2014 will be focused primarily on the expansion of our customer base in the United States and internationally. Achieving these objectives is expected to require additional investments in certain personnel and initiatives. We believe that we will continue to incur net losses in the near term in order to achieve these objectives. However, we believe that the accomplishment of our near term objectives will have a positive impact on our financial condition in the future.
At December 31, 2013, we had cash and cash equivalents totaling $149.7 million. We believe that our cash and cash equivalents, together with the cash expected to be generated from product sales, will be sufficient to meet our projected operating and debt service requirements for the next twelve months. Financial Operations Overview
Revenue. We derive most of our revenue from the sale of the OmniPod System and other diabetes related products including blood glucose testing supplies, traditional insulin pumps, pump supplies and other pharmaceuticals to customers and third-party distributors who resell the product to customers. The OmniPod System is comprised of two devices: the OmniPod, a disposable insulin infusion device that the patient wears for up to three days and then replaces; and the PDM, a handheld device much like a personal digital assistant that wirelessly programs the OmniPod with insulin delivery instructions, assists the patient with diabetes management and incorporates a blood glucose meter.


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In June 2011, we entered into a development agreement with a U.S. based pharmaceutical company (the "Development Agreement"). Under the Development Agreement, we are required to perform design, development, regulatory, and other services to support the pharmaceutical company as it works to obtain regulatory approval to use our drug delivery technology as a delivery method for its pharmaceutical. Over the term of the Development Agreement, we have invoiced amounts as we meet certain defined deliverable milestones. Revenue on the Development Agreement is recognized using a proportional performance methodology based on costs incurred and total payments under the agreement. The impact of changes in the expected total effort or contract payments are recognized as a change in estimate using the cumulative catch-up method.
As of December 31, 2013 and 2012 we had deferred revenue of $0.9 million and $5.4 million, respectively. These amounts primarily include product-related revenue and unrecognized amounts related to the Development Agreement. For the year ending December 31, 2014, we expect our revenue to continue to increase as we gain new customers in the United States and continue expansion in Europe, Canada, and certain other international markets. Increased revenue will be dependent upon the success of our sales efforts, our ability to produce our new OmniPods in sufficient volumes as our patient base grows and other risks and uncertainties.
Cost of revenue. Cost of revenue consists primarily of raw material, labor, warranty and overhead costs such as freight and depreciation related to the OmniPod System, the cost of products we acquire from third party suppliers, and costs incurred related to the Development Agreement. Cost of revenue will continue to increase in line with an increase in revenue.
Research and development. Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical functions, and the costs of market studies and product development projects. We expense all research and development costs as incurred. For the year ending December 31, 2014, we expect overall research and development spending to increase from our 2013 spend as we increase our development efforts on our on-going projects such as continued improvements to the manufacturing process of the OmniPod System, the integration of our OmniPod System with the LifeScan OneTouch blood glucose monitoring technology, the incorporation of continuous sensing technology into the OmniPod, the development of a new PDM, the development of a Type 2 pump with Eli Lilly and Company ("Lilly") and the ability to use our technology as a delivery platform for other pharmaceuticals. General and administrative. General and administrative expenses consist primarily of salaries and other related costs for personnel serving the executive, finance, information technology and human resource functions, as well as legal fees, accounting fees, insurance costs, bad debt expenses, shipping, handling and facilities-related costs. For the year ending December 31, 2014, we expect general and administrative expenses to decrease as compared to 2013. We incurred significant one-time costs related to the transition to the new OmniPod System and the resolution of our outstanding litigation with Medtronic Minimed Inc. in the year ended December 31, 2013.
Sales and marketing. Sales and marketing expenses consist primarily of personnel costs within our sales, marketing, reimbursement support, customer support and training functions, sales commissions paid to our sales representatives and costs associated with participation in medical conferences, physician symposia and promotional activities, including distribution of units used in our demonstration kit programs. We expect sales and marketing expenses to increase in the year ending December 31, 2014 as compared to 2013 as we expand our commercial team to enhance awareness and drive increased adoption of the new OmniPod System.


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Results of Operations for the Fiscal Years Ended December 31, 2013, 2012 and 2011
The following table presents certain statement of operations information for the years ended December 31, 2013, 2012 and 2011:

                                   Year Ended December 31,                Year Ended December 31,
                                2013          2012       % Change      2012          2011       % Change
                                                    (Dollar amounts in thousands)
Revenue                      $ 247,084     $ 211,369       17%      $ 211,369     $ 152,255       39%
Cost of revenue                134,683       119,033       13%        119,033        85,543       39%
Gross profit                   112,401        92,336       22%         92,336        66,712       38%
Operating expenses:
Research and development        21,765        24,359       11%         24,359        21,863       11%
General and administrative      64,077        51,240       25%         51,240        44,083       16%
Sales and marketing             55,694        52,708        6%         52,708        43,233       22%
Total operating expenses       141,536       128,307       10%        128,307       109,179       18%
Operating loss                 (29,135 )     (35,971 )     19%        (35,971 )     (42,467 )     15%
Other expense, net             (15,739 )     (15,684 )      -%        (15,684 )     (14,576 )      8%
Income tax benefit (expense)      (100 )        (212 )     53%           (212 )      11,212       102%
Net loss                     $ (44,974 )   $ (51,867 )     13%      $ (51,867 )   $ (45,831 )     13%

Comparison of the Years Ended December 31, 2013 and December 31, 2012 Revenue
Our total revenue was $247.1 million for the year ended December 31, 2013, as compared to $211.4 million for the year ended December 31, 2012. The increase in revenue is mainly due to the continued adoption of the OmniPod System by patients in the United States and internationally. This increase was offset by a reduction in revenue related to certain mail-order diabetic testing supplies such as blood glucose testing strips and lancets to Medicare beneficiaries that we no longer are eligible to service under the Medicare Durable Medical Equipment, Prosthetics, Orthotics, and Supplies ("DMEPOS") Competitive Bidding Program, which took effect on July 1, 2013. Cost of Revenue
Cost of revenue was $134.7 million for the year ended December 31, 2013, as compared to $119.0 million for the year ended December 31, 2012. The increase is due to higher sales volumes in the United States and internationally. These increases were partially offset by lower per-unit costs of the OmniPod System resulting from cost savings on raw materials, volume discounts from our suppliers and increased absorption of manufacturing overhead driven by increased production volumes.
Research and Development
Research and development expense decreased $2.6 million, or 11%, to $21.8 million for the year ended December 31, 2013, as compared to $24.4 million for the year ended December 31, 2012. This decrease was primarily a result of a $3.9 million reduction in third party costs associated with the development and regulatory approval of the new OmniPod System and a $1.6 million decrease in supplies and consumables used in development efforts on our ongoing projects. These decreases were offset by a $3.0 million increase in employee related expenses. The new OmniPod received 510(k) clearance from the FDA in December 2012.


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General and Administrative
General and administrative expense increased $12.8 million, or 25%, to $64.1 million for the year ended December 31, 2013, as compared to $51.2 million for the year ended December 31, 2012. This increase was primarily the result of an increase of $9.6 million in legal expense mainly related to the Medtronic patent litigation settlement and related legal fees, additional expense of $2.5 million related to the write-off of equipment no longer expected to be used in our manufacturing process, an increase of $1.3 million in bad debt expense, an increase of $1.2 million in employee related expenses including stock-based compensation, and an increase of $1.1 million of shipping expenses as volumes of patient shipments increased. These increases were partially offset by a decrease of $1.2 million in administrative and consulting fees, a decrease of $1.1 million in amortization expense related to the customer relationship asset acquired in the June 2011 acquisition of Neighborhood Diabetes, and a decrease of $0.5 million related to sales and use tax compliance. Sales and Marketing
Sales and marketing expense increased $3.0 million, or 6%, to $55.7 million for the year ended December 31, 2013, as compared to $52.7 million for the year ended December 31, 2012. This increase was primarily a result of a $0.8 million net increase in costs associated with the launch of the new OmniPod System and other advertising expenses and a $2.2 million increase in costs related to customer support functions and strategic planning initiatives. Other Expense, Net
Other expense, net was $15.7 million for both the years ended December 31, 2013 and 2012. In the year ended December 31, 2013, other expense, net primarily consisted of non-cash interest expense on the 5.375% Notes and the 3.75% Notes based on their effective interest rates and the $0.3 million inducement charge recorded for the extinguishment of debt related to the exchange of 620,122 shares of common stock for $13 million in principal amount of the 5.375% Notes (as defined below). This expense was offset by $1.4 million of other income representing the fair value of the call feature related to $59.5 million of modified 3.75% Notes. In the year ended December 31, 2012, other expense, net primarily consisted of non-cash interest expense on the 5.375% Notes and the 3.75% Notes based on their effective interest rates. Income Tax Benefit (Expense)
Income tax expense was $0.1 million for the year ended December 31, 2013 as compared to $0.2 million for the year ended December 31, 2012. Income tax expense is comprised of a current and deferred portion. The current portion primarily related to federal, state, and foreign taxes and the deferred portion primarily related to federal and state tax amounts.
Comparison of the Years Ended December 31, 2012 and December 31, 2011 Revenue
Our total revenue was $211.4 million for the year ended December 31, 2012, as compared to $152.3 million for the year ended December 31, 2011. The increase in revenue is mainly due to additional revenues generated by our Neighborhood Diabetes business which was acquired in June 2011 as well as continued adoption of the OmniPod System by patients in the United States and internationally. Cost of Revenue
Cost of revenue was $119.0 million for the year ended December 31, 2012, as compared to $85.5 million for the year ended December 31, 2011. The increase is due to higher sales volume in the United States and internationally and higher costs related to our Neighborhood Diabetes business. These increases were partially offset by lower per-unit costs on the OmniPod System resulting from cost savings on raw materials, volume discounts from our suppliers and increased absorption of manufacturing overhead driven by production volumes. Research and Development
Research and development expense increased $2.5 million, or 11%, to $24.4 million for the year ended December 31, 2012, as compared to $21.9 million for the year ended December 31, 2011. This increase was primarily related to an additional $1.9 million of employee related expenses including stock-based compensation and $1.5 million of consulting and other services in connection with development and regulatory approval of the new OmniPod System. These increases were offset in part by a $0.8 million reduction in products used for research and development projects.


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General and Administrative
General and administrative expense increased $7.1 million, or 16%, to $51.2 million for the year ended December 31, 2012, as compared to $44.1 million for the year ended December 31, 2011. The increase was largely due to an additional $2.3 million of employee related expenses including stock-based compensation, a $2.1 million increase in amortization expense on the customer relationship and tradename assets related to the June 2011 acquisition of Neighborhood Diabetes, a $2.6 million increase in administrative and consulting services, a $1.6 million increase in product shipping expenses due to higher shipment volumes and a $1.3 million increase related to sales and use tax compliance. These increases were offset in part by $3.2 million of transaction costs related to the acquisition of Neighborhood Diabetes in June 2011. Sales and Marketing
Sales and marketing expense increased $9.5 million, or 22%, to $52.7 million for the year ended December 31, 2012, as compared to $43.2 million for the year ended December 31, 2011. This increase was largely due to an increase of $8.8 million in employee related expenses including stock-based compensation as a result of the on-going expansion of our sales force and the acquisition of Neighborhood Diabetes, a $1.0 million increase for convention fees, and a $0.5 million increase in additional outside services costs primarily for customer support functions.
Other Expense, Net
Other expense, net mainly consists of interest income and expense. Net interest expense was $15.7 million for the year ended December 31, 2012, compared to $14.6 million for the same period in 2011. The increase in net interest expense for the year ended December 31, 2012, is primarily the result of additional interest expense due to the issuance of $143.8 million in principal amount of the 3.75% Notes (as defined below) in June 2011, offset in part by the repurchase of $70 million in principal amount of the 5.375% Notes (as defined below) in June 2011.
Income Tax Benefit (Expense)
Income tax expense was $0.2 million for the year ended December 31, 2012 as compared to an income tax benefit of $11.2 million in the year ended December 31, 2011. Income tax expense is comprised of a current and deferred portion. The current portion in 2012 and 2011 was primarily related to state, local, and foreign taxes and the deferred portion in 2012 primarily related to U.S. Federal and State tax amounts. Income tax benefit in 2011 was generated as a result of the deferred tax liabilities acquired with the Neighborhood Diabetes acquisition. These deferred tax liabilities were used to offset our preexisting deferred tax assets reducing the amount of the valuation allowance required in that period.
Liquidity and Capital Resources
We commenced operations in 2000 and to date we have financed our operations primarily through private placements of common and preferred stock, secured indebtedness, public offerings of our common stock and issuances of convertible debt. In June 2011, we acquired all of the outstanding shares of Neighborhood Diabetes. The aggregate purchase price of approximately $62.4 million included approximately $37.9 million in cash paid at closing.
For the quarter ending March 31, 2014, the 3.75% Notes are convertible at the option of the holder since the last reported sales price per share of our common stock was equal to or greater than 130% of the conversion price for at least 20 of the 30 trading days ended on December 31, 2013. Based on the terms of the 3.75% Notes we have the ability to convert using cash, shares of our common stock or a combination of cash and shares of our common stock for the principal amount.
As of December 31, 2013, we had $149.7 million in cash and cash equivalents. We believe that our current cash and cash equivalents, together with the cash expected to be generated from sales, will be sufficient to meet our projected operating and debt service requirements for at least the next twelve months. Equity
In June 2011, in connection with the acquisition of Neighborhood Diabetes, we issued 1,197,631 shares of our common stock with a value of $20.40 per share on the issuance date, as partial consideration for the acquisition.
In January 2013, in a public offering, we issued and sold 4,715,000 shares of our common stock at a price of $20.75 per share. In connection with the offering, we received total gross proceeds of $97.8 million, or approximately $92.8 million in net proceeds after deducting underwriting discounts and offering expenses.
In May 2013, we entered into an Exchange Agreement with a holder of our 5.375% Notes. Under the Exchange Agreement, we issued 620,122 shares of our common stock to the holder in exchange for the extinguishment of $13 million in principal amount of the 5.375% Notes.


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In June 2013, in connection with the repayment of the remaining $2 million in principal amount of the 5.375% Notes, we issued 26,523 shares of our common stock to the holders representing the conversion value in excess of the principal amount in accordance with the terms of the 5.375% Notes. Debt
At December 31, 2013 and 2012, we had convertible debt and related deferred financing costs on our balance sheet as follows (in thousands):

                                                           As of December 31,
                                                           2013          2012
Principal amount of the 5.375% Convertible Senior Notes $       -     $  15,000
Principal amount of the 3.75% Convertible Senior Notes    143,750       143,750
Unamortized discount                                      (30,099 )     (40,591 )
Total debt                                                113,651       118,159
Current portion of long-term debt                               -        14,429
Long-term debt                                          $ 113,651     $ 103,730
Deferred financing costs                                $   1,414     $   2,004

Interest expense related to the 5.375% Senior Notes (as defined below) and the 3.75% Senior Notes (as defined below) was included in interest expense on the consolidated statements of operations as follows (in thousands):

                                         Year Ended December 31,
. . .
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