Insulet Corporation — Q3 2015 Form 10-Q
Business context and period. Insulet develops, manufactures and sells the OmniPod insulin management system and other diabetes products. This unaudited report covers the quarter and nine months ended September 30, 2015, compared with the same 2014 periods. In July, Insulet acquired GSK’s Canadian distribution operations for approximately $4.7 million and assumed local sales, distribution, training and support.
Financial performance and liquidity
| Metric | Q3 2015 | Q3 2014 | Nine months 2015 | Nine months 2014 |
|---|---|---|---|---|
| Revenue | $87.3 million | $75.0 million | $224.1 million | $216.2 million |
| Gross profit | $35.7 million | $38.0 million | $102.8 million | $106.6 million |
| Gross margin | 40.8% | 50.7% | 45.9% | 49.3% |
| Operating loss | $(15.7) million | $(2.9) million | $(36.7) million | $(10.0) million |
| Net loss | $(18.9) million | $(10.8) million | $(46.2) million | $(46.1) million |
| Net loss per diluted share | $(0.33) | $(0.19) | $(0.81) | $(0.83) |
For the nine months, operating cash flow was $6.0 million, versus $4.3 million in 2014. Investing cash use was $11.8 million, including $7.1 million of property and equipment purchases and $4.7 million for the Canadian acquisition; financing provided $0.3 million. Cash and equivalents were $145.5 million at quarter-end, down from $151.2 million at December 31, 2014. Current assets were $194.3 million and current liabilities $59.4 million, implying working capital of approximately $134.9 million.
At September 30, total debt included $201.3 million principal of 2% convertible notes due June 2019, carried net of discount at $173.9 million, plus $7.1 million of capital lease obligations. Lease obligations carry effective rates of 13%–17%. Management said cash, together with expected cash from sales, should fund projected operating and debt-service needs for at least 12 months. The company has incurred losses every quarter since inception and reported an accumulated deficit of $624.2 million.
Material changes and drivers
- Q3 revenue grew 16%, led by U.S. OmniPod revenue of $50.0 million (+12%), drug-delivery revenue of $7.1 million (up $4.8 million), international OmniPod revenue of $13.5 million (+9%) and Neighborhood Diabetes revenue of $16.7 million (+8%).
- Nine-month revenue rose 4%. U.S. OmniPod revenue increased 3% to $133.9 million and drug-delivery revenue increased $14.7 million to $19.3 million. International OmniPod revenue fell 32% to $24.9 million, reflecting distributor ordering patterns and a lower transfer price.
- Gross profit and margins declined despite revenue growth. Q3 cost of revenue increased 40% to $51.7 million; operating expenses increased 26% to $51.4 million, including higher R&D and sales and marketing investment.
- Interest and other expense fell to $3.1 million for Q3 and $9.3 million for nine months, primarily because 2014 included debt-extinguishment losses of $4.3 million and $23.2 million, respectively.
Outlook, unusual items and risks
- Management expected revenue to continue increasing in 2015, driven by U.S. customer growth, international expansion and drug-delivery partners. U.S. new patient starts rose 24% in Q3; management cautioned that quarterly starts are an early indicator and generally represent less than 10% of that quarter’s revenue. No quantified full-year revenue or earnings guidance was provided.
- Management expected near-term net losses and higher 2015 R&D and sales and marketing spending. It expected R&D spending to increase for product and manufacturing improvements, a new PDM, CGM integration and other drug-delivery programs.
- Product quality was a significant unusual item: a specific $6.4 million inventory reserve and approximately $1.3 million of inefficiency and warranty-related costs contributed to roughly $7.7 million of Q3 cost. The company expected an additional $1.0 million reserve in Q4 for products in the affected configuration. Warranty expense also included $0.5 million related to product that did not meet quality expectations.
- A change in estimate regarding software project feasibility resulted in $2.6 million of additional Q3 R&D expense and $7.3 million for the nine months, including previously capitalized costs. A June FDA warning letter concerned OmniPod lots that failed final acceptance criteria; a voluntary recall occurred, and the FDA indicated corrective actions appeared adequate.
- Other contingencies include unresolved New York/CMS and Connecticut Medicaid audit allegations and one remaining shareholder securities class action; the company said it could not reasonably estimate potential losses. It settled a Massachusetts sales-and-use-tax matter, recording a $0.8 million liability, and paid approximately $1.5 million to resolve a separate Massachusetts Attorney General matter.
- Key operating risks include dependence on the OmniPod and a single-source OmniPod supplier, Flextronics; reimbursement and payer retention; product quality and regulatory compliance; competition; and the concentration of manufacturing in China and inventory in Massachusetts. Management reported disclosure controls were effective and no material changes in internal control during the quarter.
Important facts for investors to verify
- Whether the product-quality issue, related inventory reserve and expected Q4 reserve are complete, and whether warranty claims or further corrective actions will increase.
- Whether revenue growth—particularly U.S. OmniPod and drug-delivery sales—can offset weaker international distributor shipments and the continued investment-driven operating losses.
- Cash burn, capital spending, lease obligations and the company’s ability to service or refinance the $201.3 million convertible notes due in 2019.
- Progress and potential financial exposure from the Medicaid audits and remaining securities lawsuit, for which losses were not estimable in the filing.
- Execution of the Canadian distribution transition and the effect of customer retention, reimbursement coverage and supplier concentration on margins and growth.