As filed with the Securities and Exchange Commission on April 25, 2007

Registration Statement No. 333-140694

 

UNITED STATES SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

 

Amendment No. 2

to

Form S-1

REGISTRATION STATEMENT

UNDER

THE SECURITIES ACT OF 1933

 

 

 

 

 

 

 

 

9 Oak Park Drive

Bedford, Massachusetts 01730

(781) 457-5000

(Address, including zip code, and telephone number, including area code, of registrant’s principal executive offices)

 

 

 

 

Duane DeSisto

President and Chief Executive Officer

Insulet Corporation

9 Oak Park Drive

Bedford, Massachusetts 01730

(781) 457-5000

(Name, address, including zip code, and telephone number, including area code, of agent for service)

 

 

 

 

 

 

 

 

Approximate date of commencement of proposed sale to public:   As soon as practicable after this Registration Statement becomes effective.

 

If any of the securities being registered on this Form are to be offered on a delayed or continuous basis pursuant to Rule 415 under the Securities Act of 1933, check the following box.   o

 

If this Form is used to register additional securities for an offering pursuant to Rule 462(b) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(c) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

If this Form is a post-effective amendment filed pursuant to Rule 462(d) under the Securities Act, check the following box and list the Securities Act registration statement number of the earlier effective registration statement for the same offering.   o

 

 

 

 

 

 

 

TABLE OF CONTENTS

 

 

You should rely only on the information contained in this prospectus. We have not authorized anyone to provide you with information different from that contained in this prospectus. We are offering to sell, and seeking offers to buy, shares of our common stock only in jurisdictions where offers and sales are permitted. The information contained in this prospectus is accurate only as of the date of this prospectus, regardless of the time of delivery of this prospectus or of any sale of our common stock.

 

No action is being taken in any jurisdiction outside the United States to permit a public offering of the common stock or possession or distribution of this prospectus in that jurisdiction. Persons who come into possession of this prospectus in jurisdictions outside the United States are required to inform themselves about and to observe any restrictions as to this offering and the distribution of this prospectus applicable to those jurisdictions.

 

OMNIPOD and the OMNIPOD design are registered trademarks of ours, and INSULET and POD are trademarks of ours. Other products, services and company names mentioned in this prospectus are the service marks/trademarks of their respective owners, including, but not limited to, FREESTYLE, which is a registered trademark of Abbott Diabetes Care, Inc., and NAVIGATOR, which is a registered trademark of Abbott Laboratories.

 

Our estimates of market share and market size in this prospectus were based on, in certain cases, public disclosure, industry and trade publications and reports prepared by third parties, which we believe to be reliable, but have not independently verified.

 

PROSPECTUS SUMMARY

	•	The OmniPod , measuring 1.6 x 2.4 x 0.7 inches and weighing 1.2 ounces, is a small, lightweight, self-adhesive, disposable insulin infusion device that the patient wears directly on the skin beneath clothing for up to three days and then replaces. During wear, the OmniPod delivers precise, personalized doses of insulin through a small, flexible tube, called a cannula, inserted beneath the skin once at the beginning of wear via an automated, hands-free insertion process. The OmniPod is watertight and does not need to be removed for showering, swimming or exercise, thereby eliminating the interruptions of therapy associated with the disconnecting of conventional insulin pumps.
	•	The Personal Diabetes Manager , or PDM, measuring 2.6 x 4.3 x 1.0 inches, is a wireless, menu-driven, hand-held device, similar in size and appearance to a personal digital assistant. The patient uses the PDM to program the OmniPod with personalized insulin delivery instructions and to check blood glucose levels using FreeStyle test strips. The PDM facilitates diabetes management by seamlessly integrating blood glucose results into suggested bolus calculations, incorporating a food reference library, and storing and displaying carbohydrate, insulin delivery and blood glucose records in one device. The PDM also features a large display, large font and a backlight to enhance readability for people with various levels of vision acuity in any setting. When the PDM is not in use, it can be stored conveniently in a purse, pocket, backpack or briefcase.

	•	discreet, two-part design;
	•	no tubing;
	•	virtually pain-free automated cannula insertion;
	•	easy to train, learn and use; and
	•	low up-front cost and pay-as-you-go pricing structure.

	•	promoting awareness of the OmniPod System among thought leaders, key academic centers, diabetes clinics and top insulin-prescribing healthcare professionals;
	•	promoting awareness and trial experience of the OmniPod System among people with insulin-dependent diabetes;
	•	expanding third-party payor coverage for the OmniPod System;
	•	enhancing our automated manufacturing capabilities to increase capacity and reduce per unit production costs;
	•	continuing research and development efforts to enhance the features of the OmniPod System and reduce per unit production costs; and
	•	maintaining a customer-focused approach.

Risk Factors

 

Our business is subject to numerous risks as discussed more fully in the section entitled “Risk Factors” immediately following this prospectus summary. Principal risks of our business include:

 

	•	We have incurred significant operating losses since inception, our independent registered public accounting firm has issued an opinion expressing substantial doubt about our ability to continue as a going concern, and we are currently selling the OmniPod System at a loss and cannot assure you that we will achieve profitability.
	•	We currently rely entirely on sales of our sole product, the OmniPod System, to generate revenues. The failure of the OmniPod System to achieve and maintain significant market acceptance or any factors that negatively impact sales of this product will adversely affect our business, financial condition and results of operations.
	•	Our ability to achieve profitability from a current net loss level will depend on our ability to reduce the per unit cost of manufacturing the OmniPod through the successful implementation of our automated manufacturing strategy or otherwise.
	•	Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply problems and price fluctuations.
	•	Failure to secure or retain adequate coverage or reimbursement for the OmniPod System by third-party payors could adversely affect our business, financial condition and results of operations.
	•	We face competition from numerous competitors, most of whom have far greater resources than we have, which may make it more difficult for us to achieve significant market penetration and which may allow them to develop additional products for the treatment of diabetes that compete with the OmniPod System.
	•	The patent rights on which we rely to protect the intellectual property underlying the OmniPod System may not be adequate, which could enable third parties to use our technology and would harm our continued ability to compete in the market.
	•	Claims that our current or future products infringe or misappropriate the proprietary rights of others could adversely affect our ability to sell those products and cause us to incur additional costs.

 

Our Corporate Information

 

Insulet Corporation is a Delaware corporation formed in 2000. Our principal offices are located at 9 Oak Park Drive, Bedford, Massachusetts 01730, and our telephone number is (781) 457-5000. Our website address is http://www.MyOmniPod.com. We do not incorporate the information on, or accessible through, our website into this prospectus, and you should not consider it part of this prospectus.

The Offering

 

Common stock offered:		6,700,000 shares

 

Common stock to be outstanding immediately following the offering:		24,633,237 shares

 

Use of proceeds:		We expect to receive net proceeds from this offering of approximately $90,565,000. We intend to use the proceeds for general corporate purposes, which may include the completion and improvement of our existing automated line and the construction of a second automated line to increase our manufacturing capacity, the expansion of our sales and marketing activities and the funding of research and development. See the section entitled “Use of Proceeds.”

 

Dividend policy:		We do not anticipate paying any cash dividends on our common stock.
Proposed Nasdaq Global Market symbol:		“PODD”

	•	2,566,978 shares of our common stock issuable upon the exercise of outstanding stock options as of April 15, 2007, at a weighted average exercise price per share of $4.10;

	•	219,981 shares of our common stock issuable upon the exercise of warrants outstanding as of April 15, 2007, at a weighted average exercise price per share of $7.73;

	•	309,299 shares of our common stock reserved for future issuance under our 2000 Stock Option and Incentive Plan as of April 15, 2007, of which options to purchase 118,963 shares will be granted effective upon the closing of this offering at an exercise price equal to the initial public offering price;

	•	535,000 shares of our common stock reserved for future issuance under our 2007 Stock Option and Incentive Plan as of April 15, 2007 (subject to an annual increase through January 1, 2012 equal to 3% of the number of shares of our common stock outstanding as of each preceding December 31, up to a maximum of 725,000 additional shares per year); and

	•	380,000 shares of our common stock reserved for future issuance under our 2007 Employee Stock Purchase Plan as of April 15, 2007.

	•	a 1-for-2.6267 reverse stock split of our common stock to be effected immediately prior to the effectiveness of this offering;

	•	the filing of our Seventh Amended and Restated Certificate of Incorporation and the adoption of our Amended and Restated By-Laws immediately prior to the effectiveness of this offering;

	•	conversion of all of our outstanding preferred stock into 17,447,791 shares of our common stock upon the closing of this offering;

	•	automatic conversion of the existing warrants to purchase 330,579 shares of Series D preferred stock and 247,252 shares of Series E preferred stock into warrants to purchase 125,853 and 94,128 shares of our common stock, respectively, upon the closing of this offering; and

	•	the filing of our Eighth Amended and Restated Certificate of Incorporation upon the closing of this offering.

		Year Ended December 31,
		2004				2005				2006
		(In thousands, except share and per share data)
Consolidated Statements of Operations Data:
Revenue		$	—			$	50			$	3,663
Cost of revenue			—				1,530				15,660
Gross loss			—				(1,480	)			(11,997	)
Operating expenses:
Research and development			9,026				10,764				8,094
General and administrative			3,950				5,490				8,389
Sales and marketing			1,177				3,771				6,165
Total operating expenses			14,153				20,025				22,648
Operating loss			(14,153	)			(21,505	)			(34,645	)
Other income (expense), net			332				(131	)			(1,305	)
Net loss			(13,821	)			(21,636	)			(35,950	)
Accretion of redeemable convertible preferred stock			(64	)			—				(222	)
Net loss attributable to common stockholders		$	(13,885	)		$	(21,636	)		$	(36,172	)
Net loss per share basic and diluted(1)		$	(47.86	)		$	(70.95	)		$	(99.72	)
Weighted-average number of shares used in calculating net loss per share			290,140				304,962				362,750
Pro forma net loss per share basic and diluted(1)(2)										$	(2.07	)
Pro forma weighted-average number of shares used in calculating net loss per share(2)											17,464,800

(1)	See note 3 to our consolidated financial statements included in this prospectus for an explanation of the method used to calculate basic and diluted net loss per common share and pro forma basic and diluted net loss per common share.

(2)	Pro forma numbers assume all preferred stock is converted 1-for-2.6267 into common stock in connection with this offering.

		As of December 31,
										2006
		2005				2006				As Adjusted(1)
		(In thousands)
Consolidated Balance Sheet Data:
Cash and cash equivalents		$	7,660			$	33,231			$	123,796
Working capital		$	5,168			$	785			$	91,350
Total assets		$	16,792			$	57,140			$	147,705
Current debt		$	1,479			$	29,222			$	29,222
Long-term debt, net of current portion		$	8,302			$	—			$	—
Other long-term liabilities		$	315			$	316			$	316
Redeemable convertible preferred stock		$	69,500			$	119,509			$	—
Total stockholders’ (deficit) equity		$	(66,091	)		$	(101,765	)		$	108,309

(1)		On an as adjusted basis to give effect to the automatic conversion of all outstanding shares of redeemable convertible preferred stock into common stock upon the closing of this offering, and to reflect the sale of shares of our common stock in this offering at an

		assumed initial public offering price of $15.00 per share, after deducting the underwriting discounts and estimated offering expenses payable by us. Each $1.00 increase (decrease) in the assumed initial public offering price of $15.00 per share, the mid-point of the range reflected on the cover page of this prospectus, would increase (decrease) each of cash and cash equivalents, working capital, total assets and total stockholders’ equity by approximately $6,231,000, assuming that the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same, and after deducting estimated underwriting discounts and estimated offering expenses payable by us. We may also increase or decrease the number of shares we are offering. Each increase (decrease) of 0.5 million shares in the number of shares offered by us based on the assumed initial public offering price of $15.00 per share, would increase (decrease) the net proceeds to us from this offering by approximately $6,975,000. The information discussed above is illustrative only and will adjust based on the actual initial public offering price and other terms of this offering determined at pricing.

 

You should carefully consider the risk factors set forth below as well as the other information contained in this prospectus before investing in our common stock. Any of the following risks could materially and adversely affect our business, financial condition or results of operations. In such a case, you may lose all or part of your investment. The risks described below are not the only risks facing us. Additional risks and uncertainties not currently known to us or those we currently view to be immaterial may also materially adversely affect our business, financial condition or results of operations.

 

Risks Relating to Our Business

 

We have incurred significant operating losses since inception, our independent registered public accounting firm has issued an opinion expressing substantial doubt about our ability to continue as going concern and we are currently selling the OmniPod System at a loss and cannot assure you that we will achieve profitability.

 

Since our inception in 2000, we have incurred losses every quarter. We began commercial sales of the OmniPod System in October 2005 and we are currently not able to manufacture and sell the OmniPod System at a cost and in volumes sufficient to allow us to achieve profitability. For the years ended December 31, 2005 and 2006, our gross losses from the manufacture and sale of the OmniPod System were $1.5 million and $12.0 million, respectively. The extent of our future operating losses and the timing of profitability are highly uncertain, and we may never achieve or sustain profitability. We have incurred a significant net loss since our inception, including a net loss of $36.0 million for the year ended December 31, 2006. As of December 31, 2006, we had an accumulated deficit of $102.0 million.

 

We currently rely entirely on sales of our sole product, the OmniPod System, to generate revenues. The failure of the OmniPod System to achieve and maintain significant market acceptance or any factors that negatively impact sales of this product will adversely affect our business, financial condition and results of operations.

 

Our sole product is the OmniPod System, which we introduced to the market in October 2005. We expect to derive substantially all of our revenue from the sale of this product. Accordingly, our ability to generate revenues is entirely reliant on our ability to market and sell the devices that comprise the OmniPod System. Our sales of the OmniPod System may be negatively impacted by many factors, including:

 

 

If any of these events occurs, our ability to generate revenues could be significantly reduced.

 

Our ability to achieve profitability from a current net loss level will depend on our ability to reduce the per unit cost of manufacturing the OmniPod through the successful implementation of our automated manufacturing strategy or otherwise.

 

Currently, the sale price of the OmniPod System is not sufficient to cover our direct manufacturing costs. We are in the process of completing the construction, testing and installation of automated manufacturing equipment to be used in the assembly of the OmniPod in order to increase our manufacturing volume. Increased volumes will allow for volume purchase discounts to reduce our raw material costs and improve absorption of manufacturing overhead costs. During 2008, we expect to complete the planned automation of our existing manufacturing line, which is designed exclusively for the manufacture of the OmniPod, and begin construction of a second manufacturing line. Pending construction and installation of the remaining automated manufacturing equipment that we plan to use, we are manually performing these steps in the manufacturing process, which limits our ability to increase our manufacturing capacity and decrease our per unit cost of goods sold, thereby causing us to incur negative gross margins. We are also exploring alternative site manufacturing capabilities in Asia. We cannot assure you that we will successfully complete the planned automation of our existing manufacturing line or subsequent lines in the future or otherwise reduce the per unit cost of manufacturing the OmniPod. Failure to do so would limit our production capacity and our ability to reduce raw material and manufacturing overhead costs. If we are unable to reduce raw material and manufacturing overhead costs through volume purchase discounts and increased production capacity, our ability to achieve profitability will be severely constrained.

 

Our manufacturing operations are dependent upon third-party suppliers, making us vulnerable to supply problems and price fluctuations.

 

We rely on a number of suppliers who manufacture the components of the OmniPods and PDMs. For example, we rely on Phillips Plastic Corporation to manufacture and supply a number of injection molded components of the OmniPod and Freescale Semiconductor, Inc. to manufacture and supply the application specific integrated circuit that is incorporated into the OmniPod. Each of these suppliers is a sole-source supplier. In addition, we have entered into a contract manufacturing agreement with a subsidiary of Flextronics International Ltd. in China for the supply of a sub-assembly of some of the OmniPod’s components. We do not have long-term supply agreements with the suppliers of most of our components, and, in most cases, we purchase these components on a purchase order basis. In some other cases, where we do have agreements in place, our agreements with our suppliers can be terminated by either party upon short notice. Our suppliers may encounter problems during manufacturing due to a variety of reasons, including failure to follow specific protocols and procedures, failure to comply with applicable regulations, equipment malfunction and environmental factors, any of which could delay or impede their ability to meet our demand. Our reliance on these third-party suppliers also subjects us to other risks that could harm our business, including:

 

 

We may not be able to quickly establish additional or replacement suppliers, particularly for our sole-source components, in part because of the FDA approval process and because of the custom nature of various parts we require. Any interruption or delay in the supply of components, or our inability to obtain components from alternate sources at acceptable prices in a timely manner, could impair our ability to meet the demand of our customers and cause them to cancel orders or switch to competing products.

 

Failure to secure or retain adequate coverage or reimbursement for the OmniPod System by third-party payors could adversely affect our business, financial condition and results of operations.

 

We expect that sales of the OmniPod System will be limited unless a substantial portion of the sales price of the OmniPod System is paid for by third-party payors, including private insurance companies, health maintenance organizations, preferred provider organizations and other managed care providers. As of March 31, 2007, we had entered into contracts establishing reimbursement for the OmniPod System with national and regional third-party payors covering an estimated 92 million lives. These contracts provide reimbursement in each of the 26 states in which we currently sell the OmniPod System. While we anticipate entering into additional contracts with other third-party payors doing business in these states, we cannot assure you that we will be successful in doing so. In addition, these contracts can generally be terminated by the third-party payor without cause. Also, healthcare market initiatives in the United States may lead third-party payors to decline or reduce reimbursement for the OmniPod System. Moreover, compliance with administrative procedures or requirements of third-party payors may result in delays in processing approvals by those payors for patients to obtain coverage for the use of the OmniPod System. We are an approved Medicare provider and current Medicare coverage for CSII therapy does exist. However, existing Medicare coverage for CSII therapy is based on the pricing structure developed for conventional insulin pumps. Currently, we are in the process of seeking appropriate coding verification for Medicare reimbursement of the OmniPod System. As a result, we have decided to focus our initial efforts in establishing reimbursement for the OmniPod System by negotiating contracts with private insurers. Failure to secure or retain adequate coverage or reimbursement for the OmniPod System by third-party payors could have a material adverse effect on our business, financial condition and results of operations.

 

We face competition from numerous competitors, most of whom have far greater resources than we have, which may make it more difficult for us to achieve significant market penetration and which may allow them to develop additional products for the treatment of diabetes that compete with the OmniPod System.

 

The medical device industry is intensely competitive, subject to rapid change and significantly affected by new product introductions and other market activities of industry participants. The OmniPod System competes with a number of existing insulin delivery devices as well as other methods for the treatment of diabetes. Medtronic MiniMed, a division of Medtronic, Inc., has been the market leader for many years and has the majority share of the conventional insulin pump market in the United States. Other significant suppliers in the United States are Animas Corporation, a division of Johnson & Johnson, and Deltec, a division of Smiths Medical MD, Inc. In October 2006, following the lifting of an FDA ban on the import of Disetronic insulin pumps, Roche Disetronic, a division of Roche Diagnostics, announced its re-entry into the conventional insulin pump market in the United States.

 

All of these competitors are large, well-capitalized companies with significantly more market share and resources than we have. As a consequence, they are able to spend more aggressively on product development, marketing, sales and other product initiatives than we can. Many of these competitors have:

 

 

 

We also compete with multiple daily injection, or MDI, therapy, which is substantially less expensive than CSII therapy. MDI therapy has been made more effective by the introduction of long-acting insulin analogs by both sanofi-aventis and Novo Nordisk AS. While we believe that CSII therapy, in general, and the OmniPod System, in particular, have significant competitive and clinical advantages over traditional MDI therapy, improvements in the effectiveness of MDI therapy may result in fewer people with insulin-dependent diabetes converting from MDI therapy to CSII therapy than we expect and may result in negative price pressure.

 

Our current competitors or other companies may at any time develop additional products for the treatment of diabetes. For example, there is an inhaled insulin product that was recently introduced by Pfizer Inc., and other diabetes-focused pharmaceutical companies, including Abbott Laboratories, Eli Lilly and Company, MannKind Corporation, Novo Nordisk AS and Takeda Pharmaceuticals Company Limited, are developing similar products. All of these competitors are large, well-capitalized companies with significantly greater product development resources than we have. If an existing or future competitor develops a product that competes with or is superior to the OmniPod System, our revenues may decline. In addition, some of our competitors may compete by changing their pricing model or by lowering the price of their insulin delivery systems or ancillary supplies. If these competitors’ products were to gain acceptance by healthcare professionals, people with insulin-dependent diabetes or third-party payors, a downward pressure on prices could result. If prices were to fall, we may not improve our gross margins or sales growth sufficiently to achieve profitability.

 

Technological breakthroughs in diabetes monitoring, treatment or prevention could render the OmniPod System obsolete.

 

The diabetes treatment market is subject to rapid technological change and product innovation. The OmniPod System is based on our proprietary technology, but a number of companies, medical researchers and existing pharmaceutical companies are pursuing new delivery devices, delivery technologies, sensing technologies, procedures, drugs and other therapeutics for the monitoring, treatment and/or prevention of insulin-dependent diabetes. For example, FDA approval of a commercially viable “closed-loop” system that combines continuous “real-time” glucose sensing or monitoring and automatic continuous subcutaneous insulin infusion in a manner that delivers appropriate amounts of insulin on a timely basis without patient direction could have a material adverse effect on our revenues and future profitability. We have an agreement with Abbott Diabetes Care, Inc., a global healthcare company that develops continuous glucose monitoring technology, to develop a product that will integrate the receiver portion of Abbott’s continuous glucose monitor, the FreeStyle Navigator, with the OmniPod System PDM. The FreeStyle Navigator is currently pending FDA approval and is not available on the market. Medtronic, Inc. has developed an FDA-approved product combining continuous glucose sensing and CSII therapy and if we fail to do so, we may be at a significant competitive disadvantage, which could negatively impact our business. In addition, the National Institutes of Health and other supporters of diabetes research are continually seeking ways to prevent, cure or improve the treatment of diabetes. Any technological breakthroughs in diabetes monitoring, treatment or prevention could render the OmniPod System obsolete, which may have a material adverse effect on our business, financial condition and results of operations.

 

If our existing license agreement with Abbott Diabetes Care, Inc. is terminated or we fail to enter into new license agreements allowing us to incorporate a blood glucose meter into the OmniPod System, our business may be materially adversely impacted.

 

Our rights to incorporate the FreeStyle blood glucose meter into the OmniPod System are governed by a development and license agreement with Abbott Diabetes Care, Inc., as the successor to TheraSense, Inc. This agreement provides us with a non-exclusive, fully paid, non-transferable and non-sublicensable license in the United States under patents and other relevant technical information relating to the FreeStyle blood glucose

meter during the term of the agreement. The term of the agreement is for seven years, with automatic renewals for subsequent three-year periods unless either party provides written notice of termination at least 90 days prior to the scheduled expiration of the then-current term. The current term is scheduled to expire in January 2009. The agreement may also be terminated by Abbott if it discontinues its FreeStyle blood glucose meter or test strips or by either party if the other party is acquired by a competitor of the first party or materially breaches its obligations under the agreement. Termination of this agreement could require us to either remove the blood glucose meter from PDMs to be sold in the future, which would impair the functionality of the OmniPod System, or attempt to incorporate an alternative blood glucose meter into the PDM, which would require us to acquire rights to or develop an alternative blood glucose meter, incorporate it into the OmniPod System and obtain regulatory approval for the new OmniPod System. Any of these outcomes could have a material adverse effect on our business, financial condition and results of operations.

 

Additionally, in the future, we may need additional licenses to intellectual property owned by third parties in order to commercialize new products. If we cannot obtain these additional licenses, we may not be able to develop or commercialize these future products. Our rights to use technologies licensed to us by third parties are not entirely within our control, and we may not be able to continue selling the OmniPod System or sell future products without these technologies.

 

The patent rights on which we rely to protect the intellectual property underlying the OmniPod System may not be adequate, which could enable third parties to use our technology and would harm our continued ability to compete in the market.

 

Our success will depend in part on our continued ability to develop or acquire commercially-valuable patent rights and to protect these rights adequately. Our patent position is generally uncertain and involves complex legal and factual questions. The risks and uncertainties that we face with respect to our patents and other related rights include the following:

 

 

We also may not be able to protect our patent rights effectively in some foreign countries. For a variety of reasons, we may decide not to file for patent protection. Our patent rights underlying the OmniPod System may not be adequate, and our competitors or customers may design around our proprietary technologies or independently develop similar or alternative technologies or products that are equal or superior to ours without infringing on any of our patent rights. In addition, the patents licensed or issued to us may not provide a competitive advantage. The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.

 

Other rights and measures we have taken to protect our intellectual property may not be adequate, which would harm our ability to compete in the market.

 

In addition to patents, we rely on a combination of trade secrets, copyright and trademark laws, confidentiality, non-disclosure and assignment of invention agreements and other contractual provisions and technical measures to protect our intellectual property rights. While we currently require employees, consultants and other third parties to enter into confidentiality, non-disclosure or assignment of invention agreements, or a combination thereof where appropriate, any of the following could still occur:

 

 

 

If, for any of the above reasons, our intellectual property is disclosed or misappropriated, it would harm our ability to protect our rights and have a material adverse effect on our business, financial condition and results of operations.

 

We may need to initiate lawsuits to protect or enforce our patents and other intellectual property rights, which could be expensive and, if we lose, could cause us to lose some of our intellectual property rights, which would harm our ability to compete in the market.

 

We rely on patents to protect a portion of our intellectual property and our competitive position. Patent law relating to the scope of claims in the technology fields in which we operate is still evolving and, consequently, patent positions in the medical device industry are generally uncertain. In order to protect or enforce our patent rights, we may initiate patent litigation against third parties, such as infringement suits or interference proceedings. Litigation may be necessary to:

 

 

Any lawsuits that we initiate could be expensive, take significant time and divert management’s attention from other business concerns. Litigation also puts our patents at risk of being invalidated or interpreted narrowly and our patent applications at risk of not issuing. Additionally, we may provoke third parties to assert claims against us. We may not prevail in any lawsuits that we initiate and the damages or other remedies awarded, if any, may not be commercially valuable. The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.

 

Claims that our current or future products infringe or misappropriate the proprietary rights of others could adversely affect our ability to sell those products and cause us to incur additional costs.

 

Substantial litigation over intellectual property rights exists in the medical device industry. We expect that we could be increasingly subject to third-party infringement claims as our revenues increase, the number of competitors grows and the functionality of products and technology in different industry segments overlaps. Third parties may currently have, or may eventually be issued, patents on which our current or future products or technologies may infringe. For example, we are aware of certain patents and patent applications owned by our competitors that cover different aspects of insulin infusion and the related devices. Any of these third parties might make a claim of infringement against us. In particular, Medtronic, Inc., in a letter dated March 13, 2007, invited us to discuss our “taking a license to certain Medtronic patents.” The patents referenced by this letter relate to technology that is material to our business. While we believe that the OmniPod System does not infringe these patents, we would consider resolving the matter on reasonable terms. If we are unable to reach agreement with Medtronic, Inc. on this matter, they may sue us for infringement. We believe we would have meritorious defenses to any such suit. Any litigation, regardless of its outcome, would likely result in the expenditure of significant financial resources and the diversion of management’s time and resources. In addition, litigation in which we are accused of infringement may cause negative publicity, adversely impact prospective customers, cause product shipment delays, prohibit us from manufacturing, marketing or selling our current or future products, require us to develop non-infringing technology, make substantial payments to third parties or enter into royalty or license agreements, which may not be available on acceptable terms or at all. If a successful claim of infringement were made against us and we could not develop non-infringing technology or license the infringed or similar technology on a timely and cost-effective basis, our revenues may decrease substantially and we could be exposed to significant liability. A court could enter orders that temporarily, preliminarily or permanently enjoin us or our customers from making, using, selling, offering to sell or importing our current or future products, or could enter an order mandating that we undertake certain remedial activities. Claims that we have misappropriated the confidential information or

trade secrets of third parties can have a similar negative impact on our reputation, business, financial condition or results of operations.

 

We are subject to extensive regulation by the U.S. Food and Drug Administration, which could restrict the sales and marketing of the OmniPod System and could cause us to incur significant costs.

 

We sell medical devices that are subject to extensive regulation by the FDA. These regulations relate to manufacturing, labeling, sale, promotion, distribution and shipping. Before a new medical device, or a new use of or claim for an existing product, can be marketed in the United States, it must first receive either 510(k) clearance or pre-market approval from the FDA, unless an exemption applies. We may be required to obtain a new 510(k) clearance or pre-market approval for significant post-market modifications to the OmniPod System. Each of these processes can be expensive and lengthy, and entail significant user fees, unless exempt. The FDA’s process for obtaining 510(k) clearance usually takes three to twelve months, but it can last longer. The process for obtaining pre-market approval is much more costly and uncertain and it generally takes from one to three years, or longer, from the time the application is filed with the FDA.

 

Medical devices may be marketed only for the indications for which they are approved or cleared. We have obtained 510(k) clearance for the current clinical applications for which we market our OmniPod System, which includes the use of U-100, which is a common form of insulin. However, our clearances can be revoked if safety or effectiveness problems develop. Further, we may not be able to obtain additional 510(k) clearances or pre-market approvals for new products or for modifications to, or additional indications for, the OmniPod System in a timely fashion or at all. Delays in obtaining future clearances would adversely affect our ability to introduce new or enhanced products in a timely manner which in turn would harm our revenue and future profitability. We have made modifications to our devices in the past and may make additional modifications in the future that we believe do not or will not require additional clearances or approvals. If the FDA disagrees, and requires new clearances or approvals for the modifications, we may be required to recall and to stop marketing the modified devices. We also are subject to numerous post-marketing regulatory requirements, which include quality system regulations related to the manufacturing of our devices, labeling regulations and medical device reporting regulations, which require us to report to the FDA if our devices cause or contribute to a death or serious injury, or malfunction in a way that would likely cause or contribute to a death or serious injury. In addition, these regulatory requirements may change in the future in a way that adversely affects us. If we fail to comply with present or future regulatory requirements that are applicable to us, we may be subject to enforcement action by the FDA, which may include any of the following sanctions:

 

 

The occurrence of any of these events may have a material adverse effect on our business, financial condition and results of operations.

 

If we or our component suppliers fail to comply with the FDA’s quality system regulations, the manufacturing and distribution of our devices could be interrupted, and our product sales and operating results could suffer.

 

We and our component suppliers are required to comply with the FDA’s quality system regulations, which is a complex regulatory framework that covers the procedures and documentation of the design, testing, production, control, quality assurance, labeling, packaging, sterilization, storage and shipping of our devices. The FDA enforces its quality system regulations through periodic unannounced inspections. We cannot assure you that our facilities or our component suppliers’ facilities would pass any future quality system inspection. If our or any of our component suppliers’ facilities fails a quality system inspection, the manufacturing or distribution of our devices could be interrupted and our operations disrupted. Failure to take adequate and timely corrective action in response to an adverse quality system inspection could force a suspension or shutdown of our packaging and labeling operations or the manufacturing operations of our contract manufacturers, or a recall of our devices. If any of these events occurs, we may not be able to provide our customers with the quantity of OmniPods they require on a timely basis, our reputation could be harmed and we could lose customers, any or all of which may have a material adverse effect on our business, financial condition and results of operations.

 

Our current or future products are subject to recalls even after receiving FDA clearance or approval, which would harm our reputation, business and financial results.

 

The FDA and similar governmental bodies in other countries have the authority to require the recall of our current or future products if we or our contract manufacturers fail to comply with relevant regulations pertaining to manufacturing practices, labeling, advertising or promotional activities, or if new information is obtained concerning the safety or efficacy of these products. A government-mandated recall could occur if the FDA finds that there is a reasonable probability that the device would cause serious, adverse health consequences or death. A voluntary recall by us could occur as a result of manufacturing defects, labeling deficiencies, packaging defects or other failures to comply with applicable regulations. Any recall would divert management attention and financial resources and harm our reputation with customers. A recall involving the OmniPod System would be particularly harmful to our business, financial condition and results of operations because it is currently our only product.

 

We are subject to federal and state laws prohibiting “kickbacks” and false or fraudulent claims, which, if violated, could subject us to substantial penalties. Additionally, any challenge to or investigation into our practices under these laws could cause adverse publicity and be costly to respond to, and thus could harm our business.

 

A federal law commonly known as the Medicare/Medicaid anti-kickback law, and several similar state laws, prohibit payments that are intended to induce physicians or others either to refer patients or to acquire or arrange for or recommend the acquisition of healthcare products or services. These laws constrain our sales, marketing and other promotional activities by limiting the kinds of financial arrangements, including sales programs, we may have with hospitals, physicians or other potential purchasers of medical devices. Other federal and state laws generally prohibit individuals or entities from knowingly presenting, or causing to be presented, claims for payment from Medicare, Medicaid or other third-party payors that are false or fraudulent, or for items or services that were not provided as claimed. Because we may provide some coding and billing information to purchasers of the OmniPod System, and because we cannot assure that the government will regard any billing errors that may be made as inadvertent, these laws are potentially applicable to us. In addition, these laws are potentially applicable to us because we provide reimbursement to healthcare professionals for training patients on the use of the OmniPod System. Anti-kickback and false claims laws prescribe civil and criminal penalties for noncompliance, which can be substantial. Even an unsuccessful challenge or investigation into our practices could cause adverse publicity, and be costly to respond to, and thus could have a material adverse effect on our business, financial condition and results of operations.

 

If we are found to have violated laws protecting the confidentiality of patient health information, we could be subject to civil or criminal penalties, which could increase our liabilities and harm our reputation or our business.

 

There are a number of federal and state laws protecting the confidentiality of certain patient health information, including patient records, and restricting the use and disclosure of that protected information. In particular, the U.S. Department of Health and Human Services promulgated patient privacy rules under the Health Insurance Portability and Accountability Act of 1996, or HIPAA. These privacy rules protect medical records and other personal health information by limiting their use and disclosure, giving individuals the right to access, amend and seek accounting of their own health information and limiting most use and disclosures of health information to the minimum amount reasonably necessary to accomplish the intended purpose. If we are found to be in violation of the privacy rules under HIPAA, we could be subject to civil or criminal penalties, which could increase our liabilities, harm our reputation and have a material adverse effect on our business, financial condition and results of operations.

 

Product liability suits, whether or not meritorious, could be brought against us due to an alleged defective product or for the misuse of our devices. These suits could result in expensive and time-consuming litigation, payment of substantial damages, and an increase in our insurance rates.

 

If our current or future products are defectively designed or manufactured, contain defective components or are misused, or if someone claims any of the foregoing, whether or not meritorious, we may become subject to substantial and costly litigation. Misusing our devices or failing to adhere to the operating guidelines of the OmniPod System could cause significant harm to patients, including death. In addition, if our operating guidelines are found to be inadequate, we may be subject to liability. Product liability claims could divert management’s attention from our core business, be expensive to defend and result in sizable damage awards against us. While we believe that we are reasonably insured against these risks, we may not have sufficient insurance coverage for all future claims. Any product liability claims brought against us, with or without merit, could increase our product liability insurance rates or prevent us from securing continuing coverage, could harm our reputation in the industry and could reduce revenues. Product liability claims in excess of our insurance coverage would be paid out of cash reserves harming our financial condition and adversely affecting our results of operations.

 

Our ability to grow our revenues depends in part on our retaining a high percentage of our customer base.

 

A key to driving our revenue growth is the retention of a high percentage of our customers. We have developed retention programs aimed at both the healthcare professionals and the patients, which include appeals assistance, patient training, 24/7 customer support and an automatic re-order program for patients. Since we began shipping the OmniPod System in October 2005, we have had a very high customer retention rate; however, we cannot assure you that we will maintain this retention rate in the future. The failure to retain a high percentage of our customers would negatively impact our revenue growth and may have a material adverse effect on our business, financial condition and results of operations.

 

We intend to sponsor market studies seeking to demonstrate certain aspects of the efficacy of the OmniPod System, which may fail to produce favorable results.

 

To help improve, market and sell the OmniPod System, we intend to sponsor market studies to assess various aspects of its functionality and its relative efficacy. The data obtained from the studies may be unfavorable to the OmniPod System or may be inadequate to support satisfactory conclusions. In addition, in the future we may sponsor clinical trials to assess certain aspects of the efficacy of the OmniPod System. If future clinical trials fail to support the efficacy of our current or future products, our sales may be adversely affected and we may lose an opportunity to secure clinical preference from prescribing clinicians, which may have a material adverse effect on our business, financial condition and results of operations.

 

If future clinical studies or other articles are published, or diabetes associations or other organizations announce positions that are unfavorable to the OmniPod System, our sales efforts and revenues may be negatively affected.

 

Future clinical studies or other articles regarding our existing products or any competing products may be published that either support a claim, or are perceived to support a claim, that a competitor’s product is clinically more effective or easier to use than the OmniPod System or that the OmniPod System is not as effective or easy to use as we claim. Additionally, diabetes associations or other organizations that may be viewed as authoritative could endorse products or methods that compete with the OmniPod System or otherwise announce positions that are unfavorable to the OmniPod System. Any of these events may negatively affect our sales efforts and result in decreased revenues.

 

If we expand, or attempt to expand, into foreign markets, we will be affected by new business risks that may adversely impact our business, financial condition and results of operations.

 

If we expand, or attempt to expand, into foreign markets, we will be subject to new business risks, including:

 

 

If we are successful in introducing our current or future products into foreign markets, we will be affected by these additional business risks, which may adversely impact our business, financial condition and results of operations. In addition, expansion into foreign markets imposes additional burdens on our executive and administrative personnel, research and sales departments and general managerial resources. Our efforts to introduce our current or future products into foreign markets may not be successful, in which case we may have expended significant resources without realizing the expected benefit. Ultimately, the investment required for expansion into foreign markets could exceed the results of operations generated from this expansion.

 

All of our operations are currently conducted at a single location and any disruption at our facility could increase our expenses.

 

All of our operations are currently conducted at a single location in Bedford, Massachusetts. We take precautions to safeguard our facility, including insurance, health and safety protocols and off-site storage of computer data. However, a natural or other disaster, such as a fire or flood, could cause substantial delays in our operations, damage or destroy our manufacturing equipment or inventory, and cause us to incur additional expenses. The insurance we maintain against fires, floods and other natural disasters may not be adequate to cover our losses in any particular case. With or without insurance, damage to our manufacturing facility or our

other property, or to any of our suppliers, due to fire, flood or other natural disaster or casualty event may have a material adverse effect on our business, financial condition and results of operations.

 

Our success will depend on our ability to attract and retain our personnel.

 

We have benefited substantially from the leadership and performance of our senior management, especially Duane DeSisto, our President and Chief Executive Officer, and Carsten Boess, our Chief Financial Officer. Our success will depend on our ability to retain our current management and to attract and retain qualified personnel in the future, including clinicians, engineers and other highly skilled personnel. Competition for senior management personnel, as well as clinicians and engineers, is intense and there can be no assurances that we will be able to retain our personnel. The loss of the services of Mr. DeSisto, Mr. Boess, certain other members of our senior management, clinicians or engineers could prevent or delay the implementation and completion of our objectives, or divert management’s attention to seeking a qualified replacement.

 

Additionally, the sale and after-sale support of the OmniPod System is logistically complex, requiring us to maintain an extensive infrastructure of field sales personnel, diabetes educators, customer support, insurance specialists, and billing and collections personnel. We face considerable challenges in recruiting, training, managing, motivating and retaining these teams, including managing geographically dispersed efforts. If we fail to maintain and grow an adequate pool of trained and motivated personnel, our reputation could suffer and our financial position could be adversely affected.

 

If we do not effectively manage our growth, our business resources may become strained, we may not be able to deliver the OmniPod System in a timely manner and our results of operations may be adversely affected.

 

To date, we have focused our sales and marketing efforts in the Eastern United States. As we expand our sales into the balance of the United States and internationally, we will need to obtain coverage contracts with additional third-party payors in those areas. Failure to obtain such contracts would limit our ability to successfully penetrate those areas. In addition, the geographic expansion of our business will require additional manufacturing capacity to supply those markets as well as additional sales and marketing resources.

 

Subsequent to this offering, we expect to significantly increase our manufacturing capacity, our personnel and the scope of our sales and marketing efforts on a phased basis into the rest of the United States and internationally. This growth, as well as any other growth that we may experience in the future, will provide challenges to our organization and may strain our management and operations. In order to manage future growth, we will be required to improve existing, and implement new, management systems, sales and marketing efforts and distribution channels. We may also need to partner with additional third-party suppliers to manufacture certain components of the OmniPod System and complete the planned automation of our existing line as well as subsequent lines in the future. A transition to new suppliers may result in additional costs or delays. We may misjudge the amount of time or resources that will be required to effectively manage any anticipated or unanticipated growth in our business or we may not be able to manufacture sufficient inventory or attract, hire and retain sufficient personnel to meet our needs. If we cannot scale our business appropriately, maintain control over expenses or otherwise adapt to anticipated and unanticipated growth, our business resources may become strained, we may not be able to deliver the OmniPod System in a timely manner and our results of operations may be adversely affected.

 

Our future capital needs are uncertain and we may need to raise additional funds in the future, and these funds may not be available on acceptable terms or at all.

 

We believe that our current cash and cash equivalents, including the proceeds from this offering, together with our short-term investments and the cash to be generated from expected product sales, will be sufficient to meet our projected operating requirements for at least the next 12 months. However, we may seek additional funds from public and private stock offerings, borrowings under credit lines or other sources. Our capital requirements will depend on many factors, including:

 

 

As a result of these factors, we may need to raise additional funds, and these funds may not be available on favorable terms, or at all. Furthermore, if we issue equity or debt securities to raise additional funds, our existing stockholders may experience dilution, and the new equity or debt securities may have rights, preferences and privileges senior to those of our existing stockholders. In addition, if we raise additional funds through collaboration, licensing or other similar arrangements, it may be necessary to relinquish valuable rights to our potential future products or proprietary technologies, or grant licenses on terms that are not favorable to us. If we cannot raise funds on acceptable terms, we may not be able to enhance the OmniPod System or develop new products, execute our business plan, take advantage of future opportunities or respond to competitive pressures or unanticipated customer requirements. If any of these events occur, it could adversely affect our business, financial condition and results of operations.

 

We may experience significant fluctuations in our quarterly results of operations.

 

The fluctuations in our quarterly results of operations have resulted, and will continue to result, from numerous factors, including:

 

 

These factors, some of which are not within our control, may cause the price of our stock to fluctuate substantially. In particular, if our quarterly results of operations fail to meet or exceed the expectations of securities analysts or investors, our stock price could drop suddenly and significantly. We believe the quarterly comparisons of our financial results are not necessarily meaningful and should not be relied upon as an indication of our future performance.

 

If we choose to acquire or invest in new businesses, products or technologies, instead of developing them ourselves, these acquisitions or investments could disrupt our business and could result in the use of significant amounts of equity, cash or a combination of both.

 

From time to time we may seek to acquire or invest in new businesses, products or technologies, instead of developing them ourselves. Acquisitions and investments involve numerous risks, including:

 

 

In addition, any future acquisitions or investments may result in one or more of the following:

 

 

Any of these factors could materially harm our stock price, business, financial condition and results of operations.

 

Our credit and security agreement contains restrictions and covenants that may limit our operating flexibility and which, if violated, could result in the acceleration of the amounts due under this agreement.

 

On December 27, 2006, we entered into a credit and security agreement with a group of lenders led by Merrill Lynch Capital pursuant to which we borrowed $30.0 million in a term loan. This term loan is secured by all of our assets other than our intellectual property. The credit and security agreement imposes certain limitations on us, including limitations on our ability to do the following, subject to certain exceptions:

 

 

 

Additionally, under the agreement, we must complete construction of a second manufacturing line for the OmniPods by March 31, 2009, which deadline may be extended to June 30, 2009 in specified circumstances.

 

Complying with these restrictions and covenants may make it more difficult for us to successfully execute our business strategy and compete against companies who are not subject to similar restrictions and covenants. Additionally, if we violate any of these restrictions or covenants, our lenders under this agreement may accelerate all of our outstanding indebtedness and other amounts due under the credit and security agreement and, if we do not pay these amounts, proceed against the collateral securing these obligations.

 

We will incur increased costs as a result of recently enacted and proposed changes in laws and regulations relating to corporate governance matters.

 

The laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules adopted thereunder by the Securities and Exchange Commission, or SEC, will result in increased costs to us as we become a publicly-traded company. As a public company, we will be required to comply with many of these rules and regulations, and may be required to comply with additional rules and regulations in the future. For example, we are evaluating our internal controls systems in order to allow us to report on, and our independent registered public accounting firm to attest to, our internal controls, as required by Section 404 of the Sarbanes-Oxley Act. While we anticipate being able to fully implement the requirements relating to internal controls and all other aspects of Section 404 in a timely fashion, we cannot be certain as to the timing of completion of our evaluation, testing and remediation actions or the impact of the same on our operations. In addition, these efforts will divert management’s time and attention away from our business in order to ensure compliance with these regulatory requirements. This diversion of management’s time and attention may have a material adverse effect on our business, financial condition and results of operations. These new rules and regulations may also make it more difficult and expensive for us to obtain director and officer liability insurance, and we may be required to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage.

 

If we are unable to successfully maintain effective internal control over financial reporting and disclosure controls and procedures, investors may lose confidence in our reported financial information and our stock price and our business may be adversely impacted.

 

As a public company, after an initial transition period, we will be required to maintain internal control over financial reporting and our management will be required to evaluate the effectiveness of our internal control over financial reporting as of the end of each fiscal year. Additionally, we will be required to disclose in our annual reports on Form 10-K our management’s assessment of the effectiveness of our internal control over financial reporting and a registered public accounting firm’s attestation report on this assessment. As a public company, we will also be required to maintain disclosure controls and procedures, which encompass most of our internal control over financial reporting. Our principal executive officer and principal financial officer will be required to evaluate our disclosure controls and procedures as of the end of each quarter and

disclose in our annual reports on Form 10-K and our quarterly reports on Form 10-Q their conclusions regarding the effectiveness of these controls and procedures. If we are not successful in establishing effective internal control over financial reporting or disclosure controls and procedures, there could be inaccuracies or omissions in the information we are required to file with the Securities and Exchange Commission, including our consolidated financial information. Additionally, even if there are no inaccuracies or omissions, we will be required to publicly disclose the conclusion of our management that our internal control over financial reporting or disclosure controls and procedures are not effective. These events could cause investors to lose confidence in our reported financial information, adversely impact our stock price, result in increased costs to remediate any deficiencies, attract regulatory scrutiny or lawsuits that could be costly to resolve and distract management’s attention, limit our ability to access the capital markets or cause our stock to be delisted from the Nasdaq Global Market or any other securities exchange on which it is then listed.

 

Risks Relating to this Offering

 

Our common stock has not been publicly traded and we expect that the price of our common stock will fluctuate substantially.

 

Prior to this offering, there has been no public market for shares of our common stock. An active public trading market may not develop following completion of this offering or, if developed, may not be sustained. The price of the shares of our common stock sold in this offering will be determined by negotiation between the underwriters and us. This price will not necessarily reflect the market price of our common stock following this offering. The market price of our common stock following this offering will be affected by a number of factors, including:

 

 

Future sales of shares of our common stock in the public market, or the perception that such sales may occur, may depress our stock price and make it difficult for you to recover the full value of your investment in our shares.

 

If our existing stockholders sell substantial amounts of our common stock in the public market following this offering, or if there is a perception that these sales may occur, the market price of our common stock could decline. Upon closing of this offering, we will have outstanding 24,633,237 shares of our common stock. Of these shares, only 145,657 shares held by former employees of ours who did not enter into lock-up agreements and the shares of our common stock sold in this offering, plus any of the shares purchased pursuant to the exercise of the underwriters’ overallotment option, will be freely tradable, without restriction, in the public market. We have obtained lock-up agreements from our current stockholders representing over

99% of our outstanding common stock (adjusted for the conversion of all of our outstanding preferred stock into common stock upon the closing of this offering) preventing, with limited exceptions, those stockholders from selling their stock for a period of 180 days from the date of this prospectus, subject to certain extensions described under the section entitled “Underwriting,” unless waived prior to the expiration of the applicable period.

 

At various times after the lock-up agreements pertaining to this offering expire, approximately 17,787,580 additional shares will be eligible for sale in the public market at various times, subject to volume limitations under Rule 144 of the Securities Act of 1933, as amended. Holders of substantially all of such shares of our common stock have the right to require us to register such shares for sale under the Securities Act in certain circumstances and also have the right to include those shares in a registration initiated by us. If we are required to include the shares of our common stock of these stockholders pursuant to these registration rights in a registration initiated by us, sales made by such stockholders may adversely affect the price of our common stock and our ability to raise needed capital. In addition, if these stockholders exercise their demand registration rights and cause a large number of shares to be registered and sold in the public market or demand that we register their shares on a shelf registration statement, such sales or shelf registration may have an adverse effect on the market price of our common stock.

 

Following this offering, we also intend to file one or more registration statements with the SEC covering, as of April 15, 2007: 2,685,941 shares of our common stock issuable upon the exercise of outstanding stock options granted under our 2000 Stock Option and Incentive Plan (which includes 118,963 shares to be granted upon the closing of this offering); 4,160,000 shares of our common stock available for future issuance under our 2007 Stock Option and Incentive Plan (which includes 3,625,000 shares, representing the maximum aggregate increases of 725,000 shares per year through 2012 provided for by this Plan); and 380,000 shares of our common stock available for future issuance under our 2007 Employee Stock Purchase Plan. Upon effectiveness of such registration statements, any shares subsequently issued under such plans will be eligible for sale in the public market, except to the extent that they are restricted by the lock-up agreements referred to above and subject to compliance with Rule 144 in the case of our affiliates. Sales of a large number of shares of our common stock issued under these plans in the public market may have an adverse effect on the market price of our common stock. For more information regarding the sale of shares subsequently issued under such plans and the permissible sale of our common stock by existing stockholders after the closing of this offering, see the section entitled “Shares Eligible for Future Sale.”

 

You will incur immediate and substantial dilution as a result of this offering.

 

The initial public offering price is substantially higher than the book value per share of our common stock. As a result, purchasers in this offering will experience immediate and substantial dilution of $10.60 per share in the tangible book value of our common stock from the initial public offering price assuming an initial public offering price of $15.00 per share (the midpoint of the range on the front cover of this prospectus). In addition, to the extent that currently outstanding options to purchase common stock are exercised, there will be further dilution. For more information, see the section entitled “Dilution.”

 

We have broad discretion in the use of the net proceeds we receive from this offering and may not use them effectively.

 

We cannot specify with certainty the particular uses of the net proceeds we will receive from this offering. Our management will have broad discretion in the application of the net proceeds, including for any of the purposes described in “Use of Proceeds.” Accordingly, you will have to rely upon the judgment of our management with respect to the use of the net proceeds, with only limited information concerning management’s specific intentions. Our management may spend a portion or all of the net proceeds we receive from this offering in ways that our stockholders may not desire or that may not yield a favorable return. The failure by our management to apply these funds effectively could harm our business. Pending their use, we may invest the net proceeds we receive from this offering in a manner that does not produce income or that loses value.

 

Anti-takeover provisions in our organizational documents and Delaware law may discourage or prevent a change of control, even if an acquisition would be beneficial to our stockholders, which could affect our stock price adversely and prevent attempts by our stockholders to replace or remove our current management.

 

Our restated certificate of incorporation and restated bylaws to be in effect upon the closing of this offering contain provisions that could delay or prevent a change of control of our company or changes in our board of directors that our stockholders might consider favorable. Some of these provisions:

 

 

In addition, we are subject to the provisions of Section 203 of the Delaware General Corporation Law, which may prohibit certain business combinations with stockholders owning 15% or more of our outstanding voting stock. These and other provisions in our restated certificate of incorporation, restated bylaws and Delaware law could make it more difficult for stockholders or potential acquirors to obtain control of our board of directors or initiate actions that are opposed by our then-current board of directors, including a merger, tender offer or proxy contest involving our company. Any delay or prevention of a change of control transaction or changes in our board of directors could cause the market price of our common stock to decline.

 

We do not intend to pay cash dividends.

 

We have never declared or paid cash dividends on our capital stock. We currently intend to retain all available funds and any future earnings for use in the operation and expansion of our business and do not anticipate paying any cash dividends in the foreseeable future. In addition, the terms of our existing debt facility prohibits us from paying any dividends. As a result, capital appreciation, if any, of our common stock will be your sole source of potential gain for the foreseeable future.

 

The statements contained in this prospectus, including under the section entitled “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and other sections of this prospectus that are not purely historical, are forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934, including, without limitation, statements regarding our or our management’s expectations, hopes, beliefs, intentions or strategies regarding the future. Forward-looking statements in this prospectus may include, for example, statements about:

 

 

The forward-looking statements contained in this prospectus are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to, those factors described in the section entitled “Risk Factors.” Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise, except as may be required under applicable securities laws.

USE OF PROCEEDS

 

We estimate that the net proceeds from the sale of 6,700,000 shares of our common stock that we are offering will be approximately $90,565,000, based on an assumed initial public offering price of $15.00 per share (the midpoint of the range on the front cover of this prospectus) and after deducting the estimated underwriting discount and estimated offering expenses payable by us. If the underwriters’ overallotment option is exercised in full, we estimate that we will receive net proceeds of approximately $104,584,750. Each $1.00 increase (decrease) in the assumed initial public offering price per share would increase (decrease) the net proceeds to us from this offering by $6,231,000, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discount and estimated offering expense payable by us. Each increase (decrease) of 0.5 million shares in the number of shares offered by us, based on the assumed initial public offering price of $15.00 per share, would increase (decrease) the net proceeds to us from this offering by approximately $6,975,000.

 

We intend to use the proceeds from this offering for general corporate purposes, which may include:

 

 

As of the date of this prospectus, we cannot estimate the amount of net proceeds which will be used for any of the purposes described above. The amounts and timing of our actual expenditures will depend on numerous factors, including the implementation of our manufacturing strategy, the status of our product development efforts, our sales and marketing activities, the amount of cash generated or used by our operations and competition. Accordingly, our management will have broad discretion in the application of the net proceeds and investors will be relying on the judgment of our management regarding the application of the net proceeds of this offering.

 

Until we use the net proceeds of this offering for the above purposes, we intend to invest the funds in short-term, investment-grade, interest-bearing securities. We cannot predict whether these investments will yield a favorable return.

DIVIDEND POLICY

 

We have never declared or paid any cash dividends on our common stock. For the foreseeable future, we intend to retain any earnings in our business, and we do not anticipate paying any cash dividends. Whether or not to declare any dividends will be at the discretion of our board of directors, considering then-existing conditions, including the terms of our credit arrangements as well as our financial condition and results of operations, capital requirements, business prospects and other factors that our board of directors considers relevant.

 

The following table presents our total capitalization as of December 31, 2006:

 

 

 

You should read this table together with our consolidated financial statements and related notes appearing at the end of this prospectus and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section of this prospectus.

 

 

 

 

The number of shares of our common stock to be outstanding after this offering is based on 457,076 shares of our common stock outstanding as of December 31, 2006, on an actual basis, and excludes:

 

 

 

 

 

If you invest in our common stock, your interest will be diluted immediately to the extent of the difference between the public offering price per share you will pay in this offering and the pro forma net tangible book value per share of our common stock immediately after this offering.

 

Our pro forma net tangible book value as of December 31, 2006 was approximately $17.7 million, or $0.99 per share. Pro forma net tangible book value per share represents the amount of our total tangible assets minus total liabilities, divided by the total number of shares of common stock outstanding as of December 31, 2006, after giving effect to the conversion of all of our outstanding preferred stock into 17,447,791 shares of our common stock.

 

After giving effect to the sale of the 6,700,000 shares of our common stock we are offering at an assumed initial public offering price of $15.00 per share, and after deducting the estimated underwriting discount and our estimated offering expenses, our pro forma as adjusted net tangible book value as of December 31, 2006 would have been approximately $108.3 million, or $4.40 per share. This represents an immediate increase in pro forma net tangible book value of $3.41 per share and an immediate dilution of $10.60 per share to new investors. The following table illustrates this calculation on a per share basis:

 

 

If the underwriters exercise their overallotment option in full, pro forma as adjusted net tangible book value will increase to $4.78 per share, representing an increase to existing holders of $3.79 per share, and an immediate dilution of $10.22 per share to new investors.

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) our pro forma as adjusted net tangible book value by $6,231,000, the pro forma as adjusted net tangible book value per share after this offering by $0.25 per share and the dilution per share to new investors in this offering by $0.75 per share, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting the estimated underwriting discounts and estimated offering expenses payable by us.

 

The following table summarizes, on a pro forma as adjusted basis as of December 31, 2006, after giving effect to this offering at an assumed initial public offering price of $15.00 per share and the pro forma adjustments referred to above, the total number of shares of our common stock purchased from us and the total consideration and average price per share paid by existing stockholders and by new investors:

 

 

If the underwriters exercise their overallotment option in full, the following will occur:

 

 

 

The tables and calculations above are based on 457,076 shares of our common stock outstanding as of December 31, 2006, on an actual basis, and excludes:

 

 

 

 

 

If all of our options and warrants outstanding as of December 31, 2006, had been exercised as of that date, the pro forma as adjusted net tangible book value per share after this offering would be $4.32 per share, total dilution to new investors would be $10.68 per share and the total number of shares of our common stock on a pro forma as adjusted basis purchased from us and the total consideration and average price per share paid by existing stockholders and by new investors would be:

 

 

Each $1.00 increase (decrease) in the assumed initial public offering price of $15.00 per share, the midpoint of the range set forth on the cover of this prospectus, would increase (decrease) total consideration paid by new investors, total consideration paid by all stockholders and the average price per share paid by all stockholders by $6,700,000, $6,700,000 and $0.27, respectively, assuming the number of shares offered by us, as set forth on the cover page of this prospectus, remains the same and after deducting estimated underwriting discounts and estimated offering expenses payable by us.

 

The selected consolidated financial data for the years ended December 31, 2002, 2003, 2004, 2005 and 2006 have been derived from our historical financial statements audited by Ernst & Young LLP, an independent registered public accounting firm. Historical results are not necessarily indicative of the results to be expected in the future. The following selected consolidated financial data should be read in conjunction with “Capitalization,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and our consolidated financial statements and the accompanying notes to those consolidated financial statements included in this prospectus.

 

 

 

 

 

 

 

You should read the following discussion of our financial condition and results of operations in conjunction with our selected financial data, our financial statements and the accompanying notes to those financial statements included in this prospectus. This discussion contains forward-looking statements that involve risks and uncertainties. As a result of many factors, such as those set forth under the section entitled “Risk Factors” and elsewhere in this prospectus, our actual results may differ materially from those anticipated in these forward-looking statements.

 

Overview

 

We are a medical device company that develops, manufactures and markets an innovative, discreet and easy-to-use insulin infusion system for people with insulin-dependent diabetes. Our proprietary OmniPod Insulin Management System, which consists of our OmniPod disposable insulin infusion device and our handheld, wireless Personal Diabetes Manager, is the only commercially-available insulin infusion system of its kind. 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 only two discreet, easy-to-use devices that eliminate the need for a bulky pump, tubing and separate blood glucose meter, provide for virtually pain-free automated cannula insertion, communicate wirelessly and integrate a blood glucose meter. We believe that the OmniPod System’s unique proprietary design offers significant lifestyle benefits to people with insulin-dependent diabetes.

 

We believe that the advantages of the OmniPod System over conventional insulin pumps create an attractive market opportunity for the OmniPod System, when combined with:

 

 

Since inception, we have devoted substantially all of our efforts to designing and developing the OmniPod System, raising capital and recruiting personnel. As a result, we were considered a development stage company pursuant to Statement of Financial Accounting Standards (“SFAS”) No. 7, Accounting and Reporting by Development Stage Enterprises , through December 31, 2005. The year 2006 is the first year during which we were an operating company and were no longer in the development stage. In October 2005, we shipped our first commercial OmniPod System. Since October 2005, in order to align the demand for the OmniPod System with our capacity to manufacture the OmniPod, we have engaged in limited marketing efforts focused in the Eastern United States and with some key diabetes practitioners, academic centers and clinics elsewhere in the United States. Our total revenues were $3.7 million for the year ended December 31, 2006. As of March 31, 2007, we have approximately 1,750 patients using the OmniPod System in the United States.

 

At present, the expansion of our business is constrained by our current capacity to manufacture the OmniPod insulin infusion device, and our primary near-term goal is to expand our manufacturing volume for OmniPods. Currently, the sale price of the OmniPod System is not sufficient to cover our direct manufacturing costs. We are in the process of completing the construction, testing and installation of automated manufacturing equipment to be used in the assembly of the OmniPod in order to increase our manufacturing volume. Increased volumes will allow for volume purchase discounts to reduce our raw material costs and improve absorption of manufacturing overhead costs.

 

During 2008, we expect to complete the planned automation of our existing manufacturing line, which is designed exclusively for the manufacture of the OmniPod, and begin construction of a second manufacturing line. Pending construction and installation of the remaining automated manufacturing equipment that we plan

to use, we are manually performing these steps in the manufacturing process, which limits our ability to increase our manufacturing capacity and decrease our per unit cost of goods sold, thereby causing us to incur negative gross margins. We are exploring alternative site manufacturing capabilities both domestically and abroad. No assurances can be given that we will successfully complete the planned automation of our existing manufacturing line or subsequent lines in the future or otherwise reduce the per unit cost of manufacturing the OmniPod. Failure to do so would limit our production capacity and not allow us to achieve per unit cost improvements, which could severely constrain our ability to achieve profitability.

 

Additionally, as a medical device company, reimbursement from third-party payors is an important element of our success. If patients are not adequately reimbursed for the costs of using the OmniPod System, it will be much more difficult for us to penetrate the market. As of March 31, 2007, we had entered into contracts establishing reimbursement for the OmniPod System with national and regional third-party payors covering an estimated 92 million lives, and we believe that substantially all of the units sold have been reimbursed by third-party payors, subject to applicable deductible and co-payment amounts. As we expand our sales and marketing focus and increase our manufacturing capacity, we will need to maintain and expand available reimbursement for the OmniPod System.

 

Since our inception in 2000, we have incurred losses every quarter. In the year ended December 31, 2006, we incurred a net loss of $36.0 million compared to a net loss of $21.6 million for the same period in 2005. As of December 31, 2006, we had an accumulated deficit of $102.0 million. We have financed our operations through the private placement of equity securities and secured indebtedness. As of December 31, 2006, we had $30.0 million of secured debt outstanding, and, since inception, we have received net proceeds of $119.5 million from the issuance of redeemable convertible preferred stock.

 

Our long-term financial objective is to achieve and sustain profitable growth. Our efforts in 2007 will be focused primarily on expanding our manufacturing capacity, reducing our per unit production costs and expanding our sales and marketing efforts for the OmniPod System. The expansion of our manufacturing capacity will allow us to increase production volumes which will help us to achieve lower material costs due to volume purchase discounts and improve the absorption of manufacturing overhead costs. Achieving these objectives is expected to require additional investments in manufacturing and additional hiring of sales and administrative personnel with the goal of increasing our market penetration. We believe that we will continue to incur net losses in the near term in order to achieve these objectives, although we believe that the accomplishment of these combined efforts will have a positive impact on our financial condition in the future.

 

Financial Operations Overview

 

Revenues.   Revenues are recognized in accordance with Securities and Exchange Staff Accounting Bulletin No. 104, or SAB 104 and Statement of Financial Accounting Standards No. 48, Revenue Recognition when the Right of Return Exists , or SFAS 48. We derive all of our revenues from the sale of the OmniPod System directly to patients. 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 Personal Diabetes Manager, or 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. Revenues are derived from the sale to new customers of OmniPods and Starter Kits, which include the PDM, two OmniPods, the OmniPod System User Guide and our Interactive Training CD, and from the follow-on sales of OmniPods to existing customers. Customers generally order a three-month supply of OmniPods. Our first commercial shipment was in October 2005, and we recognized no revenue before this time. During the years ended December 31, 2005 and 2006, all of our revenues were derived from sales within the United States. During that period, we deferred recognition of revenue from the OmniPods and Starter Kit shipped as part of a customer’s initial shipment for thirty days during which time the items could be returned and completely refunded (we changed prospectively to a forty-five day right of return effective for shipments subsequent to December 1, 2006).

 

In 2007, we expect our revenues to increase, but we expect that this increase will continue to be limited by our OmniPod manufacturing capacity. We expect our OmniPod manufacturing capacity to grow as we continue

the process of automating our OmniPod manufacturing process, but we do not expect the most significant increase in manufacturing capacity to occur until substantially all of the OmniPod manufacturing process is automated. Currently, our manufacturing capacity is approximately 30,000 OmniPods per month, and we expect our manufacturing capacity to increase five to seven fold over this level upon the completion of the planned automation of our current manufacturing line during 2008. However, we are still in the process of designing and testing the custom equipment that we will need in order to automate our OmniPod manufacturing process, and we cannot be assured that our efforts will be successful or that the expected increases will be realized. Additionally, increased revenues will be dependent upon the success of our sales efforts and subject to many risk and uncertainties, some of which are detailed in the section of this prospectus titled “Risk Factors.”

 

Cost of revenues.   Cost of revenues consists primarily of raw material, labor, warranty and overhead costs related to the OmniPod System. Cost of revenues also includes depreciation, distribution, and freight and packaging costs. Currently, the sale price of the OmniPod System is not sufficient to cover the direct manufacturing costs. Accordingly, inventory has been adjusted down to reflect the values at the lower of cost or market. In 2007, we expect the cost of revenues to decrease as a percentage of revenues due to expected reductions in per unit raw materials costs associated with volume purchase discounts and increases in our OmniPod manufacturing capacity as our OmniPod manufacturing process becomes more automated. The increase in our OmniPod manufacturing capacity is expected to reduce the per unit cost of manufacturing the OmniPods by allowing us to spread our fixed and semi-fixed overhead costs over a greater number of units. However, if sales volumes do not increase or we are not successful in our efforts to fully automate the OmniPod manufacturing process, then the average cost of revenues per OmniPod may not decrease and we may continue to realize negative gross margins.

 

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. In 2007, we expect overall research and development spending to increase to support our current research and development efforts, which are focused primarily on increased functionality, design for ease of use and reduction of production cost, as well as developing a new OmniPod System that incorporates continuous glucose monitoring technology.

 

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. In 2007, we expect sales and marketing expenses to more than double compared to 2006 as we hire additional sales and marketing personnel, incur additional sales commission expense related to sales growth and expand our sales and marketing efforts, which will include the implementation of broader direct-to-consumer marketing programs and the roll-out of our Patient Demonstration Kit Program.

 

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 and facilities-related costs. We expect general and administrative expenses to increase as we increase personnel and become subject to reporting requirements as a publicly-held company.

 

Stock based compensation expense.   Prior to January 1, 2006, we accounted for our stock option plan under the recognition and measurement provisions of APB Opinion No. 25, Accounting for Stock Issued to Employees , and related Interpretations, as permitted by the Financial Accounting Standards Board Statement No. 123, Accounting for Stock-Based Compensation , or SFAS 123. Effective January 1, 2006, we adopted the fair value recognition provisions of SFAS Statement No. 123 (revised 2004), Share-Based Payment , or SFAS 123R, using the prospective method and therefore we have not restated our financial results for prior periods.

 

 

 

 

Comparison of the Years Ended December 31, 2006 and December 31, 2005

 

Revenues

 

Our total revenues were $3.7 million for the year ended December 31, 2006 as compared to $50,000 for the year ended December 31, 2005. We did not begin commercial shipment of the OmniPod System until October 2005; therefore, we only had three months of sales in 2005. As we continue our sales and marketing efforts into 2007, we expect our revenues to increase, but this increase will continue to be limited by our OmniPod manufacturing capacity.

 

Cost of Revenues

 

Cost of revenues for the year ended December 31, 2006 was $15.7 million as compared to $1.5 million for the year ended December 31, 2005. The increase is due to the increased sales volume. Cost of revenues include inventory write down and indirect costs. Since the OmniPods are sold at a price below direct manufacturing costs, inventory was adjusted down $1.5 million as of December 31, 2006 to reflect values at the lower of cost or market. Stock based compensation expense for the year ended December 31, 2006 allocated to cost of revenues was $22,000.

 

Research and Development

 

Research and development expense decreased $2.7 million, or 24.8%, to $8.1 million for the year ended December 31, 2006 from $10.8 million for the year ended December 31, 2005. The decrease in research and development expense was attributable to a reduction of $990,000 in employee related expenses, $835,000 in consulting expenses, which was attributable to the reduced need for design services in 2006, $689,000 in temporary employees, $294,000 in tools and services and an increase of $88,000 for stock based compensation expense.

 

General and Administrative

 

General and administrative expenses increased $2.9 million, or 52.8%, to $8.4 million for the year ended December 31, 2006 from $5.5 million for the year ended December 31, 2005. The increase in expenses was primarily due to an increase of $1.3 million in employee compensation and benefit costs, $521,000 in

consulting expenses, $170,000 in stock based compensation expense and $149,000 in bad debt expense, as well as an expense of $771,000 related to the disposal of equipment.

 

Sales and Marketing

 

Sales and marketing expenses increased $2.4 million, or 63.5%, to $6.2 million for the year ended December 31, 2006 from $3.8 million for the same period in 2005. The increase in expenses was primarily due to an increase of $1.1 million in employee compensation and benefit costs resulting from the hiring of fifteen additional employees in our sales and marketing department, $677,000 in demonstration kit units, $480,000 in marketing consultants, $466,000 in travel, printing and tradeshow expenses used to support our selling efforts and $27,000 of stock based compensation expense, offset by a reduction in market research expenses of $360,000.

 

Other Income (Expense)

 

Interest income was $1.4 million and $505,000 during the years ended December 31, 2006 and 2005, respectively. This represents an increase of $873,000. Interest income was earned from investments in cash and cash equivalents. Interest income increased primarily due to higher combined average cash and cash equivalents resulting from the issuance of Series E preferred stock in February 2006. Interest expense was $1.8 million and $636,000 during the years ended December 31, 2006 and 2005, respectively. This represents an increase of $1.2 million. The increase in interest expense was primarily attributable to the interest expense on the $10.0 million loan from Lighthouse Capital Partners V, L.P. that we borrowed in June 2005 including the amortization of the discount associated with the warrant issued in connection with the term loan. In addition, we recorded $845,000 of other expense for the year ended December 31, 2006 to reflect any increases in the estimated fair value of the warrants, which resulted from our adoption of Financial Accounting Standards Board Staff Position 150-5.

 

In December 2006, we repaid the remaining balance of the term loan from Lighthouse Capital Partners in full with a portion of the proceeds from a $30.0 million term loan from a group of lenders led by Merrill Lynch Capital. As a result of the new term loan, we expect interest expense to increase in 2007. See “— Liquidity and Capital Resources.”

 

 

Comparison of Years Ended December 31, 2005 and December 31, 2004

 

Revenues

 

Our total revenues were $50,000 in 2005. Since we did not commence commercial sales of the OmniPod System until October 2005, we had no revenues in the year ended December 31, 2004.

 

Cost of Revenues

 

Cost of revenues for the year ended December 31, 2005 were $1.5 million, attributable to the commercial sales of the OmniPod System. Since we did not commence commercial sales of the OmniPod System until October 2005, we did not have any cost of revenues for the year ended December 31, 2004. Cost of revenues include inventory writedown and indirect costs.

 

Research and Development

 

Research and development expenses increased $1.7 million, or 19.2%, to $10.8 million for the year ended December 31, 2005 from $9.0 million for the year ended December 31, 2004. The increase in expenses was primarily due to an increase in expenses of $1.3 million in employee compensation and benefit costs resulting from the hiring of additional employees in our research and development department and an increase in cost of temporary employees of $853,000, partially offset by a decrease of $524,000 in outside consulting costs.

 

General and Administrative

 

General and administrative expenses increased $1.5 million, or 39.0%, to $5.5 million for the year ended December 31, 2005 from $3.9 million for the year ended December 31, 2004. The increase in expenses was primarily due to an increase of $884,000 in depreciation, an increase of $490,000 in rent expense for our new

facility and an increase of $186,000 in employee compensation and benefit costs resulting from the hiring of additional employees.

 

Sales and Marketing

 

Sales and marketing expenses increased $2.6 million, or 220.3%, to $3.8 million for the year ended December 31, 2005 from $1.2 million for the year ended December 31, 2004. The increase in expenses was primarily due to an increase of $1.2 million in employee compensation and benefit costs resulting from the hiring of additional employees in our sales and marketing department, $645,000 increase in travel and trade show expenses, $365,000 increase in demonstration kit units and $337,000 increase in expenses relating to marketing studies used to support our selling efforts.

 

Other Income (Expense)

 

Interest income was $505,000 and $333,000 for the years ended December 31, 2005 and December 31, 2004, respectively, representing an increase of $172,000. Interest income increased primarily due to higher combined balance of average cash and cash equivalents from the issuance of Series D preferred stock. Interest expense was $636,000 for the year ended December 31, 2005 and $1,000 for the year ended December 31, 2004. The increase in interest expense was primarily attributable to the interest associated with the $10.0 million loan from Lighthouse Capital Partners that we borrowed in June 2005, including the amortization of the debt discount of $32,000 for the year ended December 31, 2005.

 

Cash used in investing activities was primarily for the purchase of fixed assets for use in the development and manufacturing of the OmniPod System. Cash provided by financing activities was primarily generated from the issuance of preferred stock in February 2006 and February 2004 and the issuance of $30.0 million of long-term debt provided by a group of lenders led by Merrill Lynch Capital in December 2006.

 

In February 2006, we sold 13,738,661 shares of Series E preferred stock for net proceeds of $49.8 million. In February 2004, we sold 14,669,421 shares of Series D preferred stock for net proceeds of $35.4 million. All of these shares will convert into shares of common stock on a 1-for-2.6267 basis upon the closing of this offering.

 

On June 2, 2005, we entered into a term loan and security agreement with Lighthouse Capital Partners V, L.P. pursuant to which we borrowed $10.0 million. This term loan was secured by all of our assets other than our intellectual property. Our borrowings under the term loan bore interest at a rate of 8% per annum. Interest was payable on a monthly basis during the term of the loan and, beginning on June 1, 2006, we were required to repay the principal in 42 equal monthly installments until the loan matured in December 2009. Upon the prepayment or final maturity of the term loan, we were required to pay the lender an additional amount equal to $1.0 million of the original loan amount. In connection with the term loan, we issued a warrant to the lender to purchase up to 330,579 shares of Series D preferred stock at a purchase price of $2.42 per share. The warrant automatically converts into a warrant to purchase common stock on a 1-for-2.6267 basis at a purchase price of $6.36 per share upon the closing of this offering. We recorded the $251,240 value of the warrant as a discount to this term loan. The cost of the warrant is being amortized to interest expense over the 54 month life of this term loan. The fair value of the warrant was calculated using the Black-Scholes option pricing model with the following assumptions: seven year expected life risk-free, interest rate of 3.89% and no dividend yield. At December 31, 2005, there were 330,579 shares of common stock reserved for the exercise of the warrant. Accordingly, the discount on the long-term debt is being accreted over the repayment term of 42 months.

 

On December 27, 2006, we entered into a credit and security agreement with a group of lenders led by Merrill Lynch Capital pursuant to which we borrowed $30.0 million in a term loan. We used $9.5 million of the proceeds from this term loan to repay all remaining amounts owed under the loan with Lighthouse Capital Partners V, L.P. that we had entered into in June 2005. This term loan is secured by all of our assets other than our intellectual property. Our borrowings under the term loan bear interest at a floating rate equal to the LIBOR rate plus 6% per annum. Interest is payable on a monthly basis during the term of the loan and, beginning on October 1, 2007, we will be required to repay the principal in 33 equal monthly installments of $909,091. In addition, we are subject to loan origination fees amounting to $900,000 for the costs incurred by the lenders in making the funds available. We have capitalized these costs as deferred financing costs. The deferred financing cost will be amortized to interest expense over the entire 42-month life of this term loan. This term loan also is subject to acceleration upon the occurrence of any fact, event or circumstance that has resulted or could reasonably be expected to result in a material adverse effect. Consequently, such debt has been classified as a current liability at December 31, 2006 in accordance with the provisions set forth by FASB Technical Bulletin No. 79-3 Subjective Acceleration Clauses in Long-Term Debt Agreements. In connection with the term loan, we issued seven-year warrants expiring in December 2013 to the lenders to purchase up to 247,252 shares of Series E preferred stock at a purchase price of $3.64 per share. The warrants automatically convert into warrants to purchase common stock on a 1-for-2.6267 basis at a purchase price of $9.56 per share upon the closing of this offering.

 

The credit and security agreement contains limitations, subject to certain exceptions, on, among other things, our ability to incur additional indebtedness or liens, make dividends or distributions to our stockholders, repurchase shares of our stock, acquire or dispose of any assets other than in the ordinary course of business, make investments in other entities, merge or consolidate with another entity or engage in a change of control, a new business or a non-arms’ length transaction with one of our affiliates. Additionally, under the agreement, we are obligated to complete construction of a second OmniPod manufacturing line by March 31, 2009, which deadline may be extended to June 30, 2009 in specified circumstances. If we are not in compliance with these covenants, breach any representation or warranty in the credit and security agreement, default in any payment due under the credit and security agreement or related promissory notes or any other indebtedness above a specified amount, fail to discharge a judgment against us above a specified amount, cease to be solvent or

experience other insolvency related events, then the administrative agent may declare all of the amounts owed under the term loan immediately due and payable.

 

We lease our facilities, which are accounted for as operating leases. The lease generally provides for a base rent plus real estate taxes and certain operating expenses related to the lease. We entered into a new lease in 2004 which contains renewal options, escalating payments and leasehold allowances over the life of the lease. As of December 31, 2006, we had an outstanding letter of credit which totaled $200,000 to cover our security deposits for lease obligations. This letter of credit will expire October 30, 2009.

 

During 2007, we will be expending funds in connection with, among other things, our efforts to expand our automated manufacturing process and increase our manufacturing capacity, and expand our sales and marketing activities. We expect to spend at least $10.0 million or more during 2007 for capital equipment purchases in connection with our efforts to expand our automated manufacturing process and increase our manufacturing capacity.

 

Off-Balance Sheet Arrangements

 

As of December 31, 2006, we did not have any off-balance sheet financing arrangements.

 

 

Critical Accounting Policies and Estimates

 

Our financial statements are based on the selection and application of generally accepted accounting principles, which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying notes. Future events and their effects cannot be determined with certainty. Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial statements. We believe that the policies set forth below may involve a higher degree of judgment and complexity in their application than our other accounting policies and represent the critical accounting policies and estimates used in the preparation of our financial statements. If different assumptions or conditions were to prevail, the results could be materially different from our reported results.

 

Revenue Recognition

 

We generate revenue from the sale of its OmniPod Insulin Management System to diabetes patients. The initial sale to a new customer typically includes OmniPods and Starter Kits, which include the Personal Diabetes Manager (“PDM”), two OmniPods, the OmniPod System User Guide and the OmniPod System Interactive Training CD. We offer a 30-day right of return for our Starter Kits sales (we changed prospectively to a 45-day right of return effective for shipments subsequent to December 1, 2006). Subsequent sales to existing customers typically consist of OmniPods sales. Revenues are recognized in accordance with Staff Accounting Bulletin No. 104, Revenue Recognition in Financial Statements (“SAB 104”), which requires that persuasive evidence of a sales arrangement exists, delivery of goods occurs through transfer of title and risk

and rewards of ownership, the selling price is fixed or determinable and collectibility is reasonably assured. With respect to these criteria:

 

 

We have considered the requirements of Emerging Issues Task Force (“EITF”) No. 00-21, Revenue Arrangements with Multiple Deliverables , when accounting for the OmniPods and Starter Kits. EITF 00-21 requires that we assess whether the different elements qualify for separate accounting. We recognize revenue for the Starter Kits once all elements have been delivered and the right of return has expired.

 

We have applied Statement of Financial Accounting Standards (“SFAS”) No. 48, Revenue Recognition When the Right of Return Exists . In accordance with SFAS No. 48, we defer the revenue and, to the extent allowed, all related costs of all initial shipments until the right of return has lapsed. We have deferred revenue of $284,000 and $116,000 as of December 31, 2006 and 2005, respectively.

 

We recognize subsequent sales of Omnipods upon shipment in accordance with the provisions set forth by SAB 104.

 

Product Warranty Costs

 

We provide a four-year warranty on the PDM and we replace any OmniPods that do not function in accordance with product specifications. Warranty expense is recorded in the period the shipment occurs. The expense is based on historical experience, and the estimated cost to service the claims. While we engage in extensive product quality programs and processes, our warranty obligation is affected by product failure rates, user error, variability in physiology and anatomy of our customers, material usage and delivery costs. Should actual product failure and user error rates, material usage or delivery costs differ from our estimates, the amount of actual warranty costs could materially differ from our estimates.

 

Inventories

 

Inventories are stated at the lower of cost or market. Cost is determined using the first-in, first-out method for all inventories. Costs for the OmniPod System include raw material, labor and manufacturing overhead. Market value is determined as the lower of replacement cost or net realizable value. Currently, the value of inventories is below the cost of manufacturing the OmniPod System; therefore, all labor, overhead and excess materials costs are expensed as incurred and inventory is valued at net realizable value.

 

Asset Valuation

 

Asset valuation includes assessing the recorded value of certain assets, including accounts receivable, inventory and fixed assets. We use a variety of factors to assess valuation, depending upon the asset. Accounts receivable consist of amounts due from third-party payors and patients. We account for bad debts using the allowance method. The bad debt allowances are recorded in the period when the revenue is recorded. Due to our limited operational history, the allowance is based upon competitive benchmarks and is adjusted currently for any changes in estimated collections. Should current market and economic conditions deteriorate, our actual bad debt experience could exceed our estimate. Fixed property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful lives of the respective assets. Leasehold improvements are amortized over their useful life or the life of the lease, whichever is shorter. We review long-lived assets, including property and equipment and intangibles, for impairment whenever events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable. An impairment loss would be recognized when estimated undiscounted future cash flows expected to result

from the use of the asset and its eventual disposition is less than its carrying amount. Impairment, if any, is measured as the amount by which the carrying amount of a long-lived asset exceeds its fair value. We consider various valuation factors, principally discounted cash flows, to assess the fair values of long-lived assets.

 

Income Taxes

 

At December 31, 2006, we had approximately $84.7 million and $2.8 million of federal net operating loss carryforwards and research and development and other tax credits, respectively, that, if not utilized, these carryforwards will begin to expire in 2020 for federal tax purposes and 2005 for state tax purposes. As of December 31, 2005, we had approximately $47.6 million and $2.1 million of federal net operating loss carryforwards and research and development and other tax credits, respectively. The utilization of such net operating loss carryforwards and realization of tax benefits in future years depends predominantly upon having taxable income. Under the provisions of the Internal Revenue Code, certain substantial changes in our ownership may result in a limitation on the amount of net operating loss carryforwards and tax credit carryforwards which may be used in future years. As there were significant issuances of Series C, Series D and Series E redeemable convertible preferred stock in 2003, 2005 and 2006, respectively, to mostly new investors, it is probable that there will be a yearly limitation placed on the amount of net operating loss and tax credit carryforwards available for use in future years.

 

Stock Based Compensation

 

Effective January 1, 2006, we adopted SFAS No. 123 (revised 2004), Share-Based Payment , or SFAS 123R, which is a revision of Statement No. 123, Accounting for Stock Based Compensation . SFAS 123R supersedes Accounting Principles Board No. 25, Accounting for Stock Issued to Employees , or APB 25, and amends Financial Accounting Standards Board, or FASB, Statement No. 95 Statement of Cash Flows. SFAS 123R requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values. Pro forma disclosure is no longer an alternative.

 

Prior to January 1, 2006, we accounted for employee stock based compensation in accordance with the provisions of APB 25 and FASB Interpretation No. 44, Accounting for Certain Transactions Involving Stock Compensation — an Interpretation of APB No. 25 , and complied with the disclosure provisions of SFAS 123, and related SFAS No. 148, Accounting for Stock-Based Compensation — Transaction and Disclosure . Under APB 25, compensation expense is based on the difference, if any, on the date of the grant, between the fair value of the stock and the exercise price of the option. The stock based compensation is amortized using the straight-line method over the vesting period.

 

SFAS 123R requires nonpublic companies that used the minimum value method in SFAS 123R for either recognition or pro forma disclosures to apply SFAS 123R using the prospective-transition method. As such, we will continue to apply APB 25 in future periods to equity awards outstanding at the date of SFAS 123R’s adoption that were measured using the minimum value method. In accordance with the requirements of SFAS 123R, we will not present pro forma disclosures for periods prior to the adoption of SFAS 123R, as the estimated fair value of our stock options granted through December 31, 2005 was determined using the minimum value method.

 

Effective January 1, 2006 with the adoption of SFAS 123R, we elected to use the Black-Scholes option pricing model to determine the weighted-average fair value of options granted. In accordance with SFAS 123R, we will recognize the compensation expense of share-based awards on a straight-line basis over the vesting period of the award. Stock based compensation expense recognized under SFAS 123R for the year ended December 31, 2006 was $307,000.

 

The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by the stock price and a number of assumptions, including expected volatility, expected life, risk-free interest rate and expected dividends. We do not have a history of market prices of our common stock as we are not a public company, and as such, we estimate volatility in accordance with Securities and Exchange Commission’s Staff Accounting Bulletin No. 107, Share-Based Payment , or SAB 107, using historical volatilities of similar public entities. The expected life of the awards is estimated based on the “SEC Shortcut

Approach” as defined in SAB 107 , which is the midpoint between the vesting date and the end of the contractual term. The risk-free interest rate assumption is based on observed interest rates appropriate for the terms of the awards. The dividend yield assumption is based on company history and expectation of paying no dividends. Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock based compensation expense recognized in the financial statements in 2006 and thereafter is based on awards that are ultimately expected to vest. We evaluate the assumptions used to value the awards on a quarterly basis and if factors change and different assumptions are utilized, stock based compensation expense may differ significantly from what has been recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, we may be required to accelerate, increase or cancel any remaining unearned stock based compensation expense.

 

The assumptions used in the Black-Scholes option-pricing model are as follows:

 

 

The following table presents the exercise price and fair value per share for grants issued during 2006:

 

 

Prior to April 1, 2006, the exercise prices for options granted were set by our board of directors based upon guidance set forth by the American Institute of Certified Public Accountants, or the AICPA, in the AICPA Technical Practice Aid, “Valuation of Privately-Held-Company Equity Securities Issued as Compensation,” or the AICPA Practice Aid. To that end, our board of directors considered a number of factors in determining the option price, including the following factors: (1) prices for our preferred stock, which we had sold to outside investors in arms-length transactions, and the rights, preferences and privileges of our preferred stock and common stock in the Series A through Series E financing, (2) obtaining FDA 510(k) clearance, (3) launching the OmniPod System and (4) achievement of budgeted revenue and results.

 

In connection with the preparation of the financial statements for this offering, we retrospectively estimated the fair value of our common stock based upon several factors, including the following factors: (1) operating and financial performance, (2) progress and milestones attained in the business, (3) past sales of convertible preferred stock, (4) the results of retrospective independent valuations, and (5) the expected valuation obtained in an initial public offering. We believe this to have been a reasonable methodology based on the factors above and based on several arm’s-length transactions involving our stock supportive of the results produced by this valuation methodology.

 

See note 10 to our consolidated financial statements included in this prospectus for a summary of the stock option activity under our employee stock based compensation plan.

 

Warrants

 

In connection with the term loans with Lighthouse Capital Partners and a group of lenders led by Merrill Lynch Capital, we issued warrants to the lenders to purchase shares of its redeemable convertible preferred stock. These warrants have been recorded as “warrants to purchase shares subject to redemption” in current liabilities in accordance with FASB Statement No. 150, Accounting for Certain Financial Instruments with