FILED PURSUANT TO RULE 424(b)(4)
REGISTRATION NO. 333-64456
6,000,000 Shares
THERASENSE, INC.
[LOGO OF THERASENSE, INC.]
Common Stock
$19.00 per share
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. TheraSense, Inc. is offering . Trading symbol: Nasdaq National
6,000,000 shares. Market - THER
. This is our initial public
offering and no public market
existed for our shares prior to
this offering.
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This investment involves risk. You should carefully consider the "Risk
Factors" beginning on page 5.
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Per Share Total
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Public offering price................................... $19.00 $114,000,000
Underwriting discounts and commissions.................. $ 1.33 $ 7,980,000
Proceeds to TheraSense, Inc. ........................... $17.67 $106,020,000
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The underwriters have a 30-day option to purchase up to 900,000 additional
shares of common stock from us to cover over-allotments, if any.
Neither the Securities and Exchange Commission nor any state securities
commission has approved of anyone's investment in these securities or
determined if this prospectus is truthful or complete. Any representation to
the contrary is a criminal offense.
U.S. Bancorp Piper Jaffray
SG Cowen
Thomas Weisel Partners LLC
The date of this prospectus is October 11, 2001.
[Inside Front Cover]
DESCRIPTION OF GRAPHIC
Graphic depicting the important functions of FreeStyle.
Two-step graphic depicting FreeStyle's testing procedure. The first picture
depicts a lanced forearm with FreeStyle pressed on top. The second picture
depicts a blood sample applied to the FreeStyle test strip for testing.
Picture of a FreeStyle Blood Glucose Monitoring System.
Graphic depicting the sample sizes required by other meters along with the
sample size required by FreeStyle, which is shown to be significantly smaller.
Picture depicting a fingertip being lanced by a traditional lancing device.
TEXT ACCOMPANYING THE GRAPHIC
"The FreeStyle Blood Glucose Monitoring System."
"Pain is one of the biggest barriers to frequent testing."
"FreeStyle lets people test on their forearm, thigh, calf, upper arm and hand
where it's much less painful to test than their fingers."
"FreeStyle uses the world's smallest blood sample."
"FreeStyle is quick and easy to use."
"Most people said, 'FreeStyle is painless.' (During clinical studies, most
people said testing on their forearms was painless.*)"
TABLE OF CONTENTS
Page
----
Summary............................................................. 1
Risk Factors........................................................ 5
Information Regarding Forward-Looking Statements.................... 18
Use of Proceeds..................................................... 19
Dividend Policy..................................................... 19
Capitalization...................................................... 20
Dilution............................................................ 21
Selected Financial Data............................................. 23
Management's Discussion and Analysis of Financial Condition and
Results of Operations.............................................. 25
Business............................................................ 34
Management.......................................................... 51
Related Party Transactions.......................................... 61
Principal Stockholders.............................................. 64
Description of Capital Stock........................................ 67
Shares Eligible for Future Sale..................................... 71
Underwriting........................................................ 74
Legal Matters....................................................... 77
Experts............................................................. 77
Where You Can Find Additional Information........................... 77
Index to Financial Statements....................................... F-1
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You should rely only on the information contained in this prospectus. We have
not, and the underwriters have not, authorized any other person to provide you
with different information. This prospectus is not an offer to sell, nor is it
seeking an offer to buy, these securities in any state where the offer or sale
is not permitted. The information in this prospectus is complete and accurate
as of the date on the front cover, but the information may have changed since
that date.
SUMMARY
Because this is only a summary, it does not contain all the information that
may be important to you. You should read the entire prospectus, especially
"Risk Factors" and the financial statements and notes to those statements
appearing elsewhere in this prospectus, before deciding to invest in our common
stock.
Our Business
We develop, manufacture and sell easy to use glucose self-monitoring systems
that dramatically reduce the pain of testing for people with diabetes. Our
first product, FreeStyle, received FDA clearance in January 2000, and we began
selling FreeStyle in the United States in June 2000. The FDA is currently
reviewing our recent FreeStyle labeling changes, which are subject to
clearance. In March 2001, we obtained the CE Mark, which permits us to
commercially distribute FreeStyle throughout the European Union. As of July 31,
2001, we have shipped over 390,000 meters and over 79 million test strips. For
the quarter ended June 30, 2001, our total revenues were $17.8 million. Meter
and test strip shipments for the quarter ended June 30, 2001 increased 72% and
71%, respectively, compared to the preceding quarter. We are also developing a
Continuous Glucose Monitoring System that is intended to permit people with
diabetes to accurately and discreetly measure their glucose levels on a
continuous basis.
The Opportunity
The blood glucose self-monitoring market is the largest self-test market for
medical diagnostic products in the world, with a size of approximately $2.0
billion in the United States and $3.5 billion worldwide in 2000. It is
estimated that the worldwide blood glucose self-monitoring market will amount
to $9.0 billion by 2005.
Government studies in the United States and the United Kingdom have shown that
complications from diabetes can be significantly reduced through regular
testing--four or more times per day for Type 1 diabetes and two or more times
per day for Type 2 diabetes--and improved therapy. Self-monitoring of blood
glucose has become a standard of care, and glucose self-monitoring devices and
disposable test strips are typically covered by health insurance, including
Medicare and Medicaid. Despite the ability to significantly reduce
complications of diabetes through regular testing and treatment and the
availability of reimbursement, many people with diabetes under-test or fail to
test at all. A study prepared for us indicated that pain is a leading factor
that discourages people with diabetes from testing as recommended.
Our Solution
FreeStyle utilizes patented technologies that can accurately measure glucose
concentrations from a tiny 0.3 microliter sample of blood, as opposed to
competitive products that require from 1.0 to 10.0 microliters of blood. Our
tiny sample size is easily obtained by lancing the forearm, thigh, calf, upper
arm or hand and therefore avoids the pain associated with drawing a larger
blood sample from the fingertip. These alternate sites are significantly less
painful to lance than the traditional fingertip test site, which is more
densely populated with highly sensitive nerve endings but yields the larger
blood volumes required by competitive products. Nine out of ten people in our
clinical studies found using FreeStyle less painful than their current finger-
stick-based system. Because our product is less painful to use, we believe
FreeStyle will enable us to both penetrate and expand the glucose self-
monitoring market.
Our FreeStyle System kit includes a FreeStyle meter, an initial supply of
proprietary FreeStyle test strips, a FreeStyle lancing device, FreeStyle
lancets and FreeStyle control solution. We believe FreeStyle provides the
following significant advantages over competing systems:
. reduction in pain;
. better performance; and
. improved quality of life.
1
Our direct sales force promotes FreeStyle in the United States to health care
professionals who advise patients on the monitoring and management of their
diabetes. We distribute and sell FreeStyle in the United States to nine of the
ten largest national retailers, including Walgreens, Wal-Mart and CVS, through
wholesalers, including McKesson, Cardinal Health and Bergen Brunswig, and
directly to end users over the telephone and through our website. FreeStyle is
currently being sold in Germany and Sweden by Disetronic Group, our European
distributor that has exclusive distribution rights to FreeStyle in selected
European countries. In April 2001, we entered into an agreement with Nipro
Corporation for the exclusive distribution of FreeStyle in Japan, and an
application for approval to market FreeStyle in Japan was recently submitted.
We are also developing a Continuous Glucose Monitoring System that utilizes a
disposable miniaturized sensor that can be inserted under the skin by the user
and incorporates a wireless display unit that can be worn like a pager. This
sensor system is intended to continuously measure and display a person's
glucose levels in real time for up to three days. The ability of people with
diabetes to adjust insulin dose, oral medication, diet and exercise according
to the glucose readings obtained from the system should result in significantly
improved health. We have recently commenced a pilot clinical study with people
who have diabetes using our Continuous Glucose Monitoring System. We expect
that this product will require premarket approval by the FDA. Therefore, even
if the product is successfully developed, it will not be commercially available
for a number of years.
Our Strategy
Our objective is to be a leading provider of innovative glucose monitoring
products that reduce the pain of testing, are easy to use, accurate, cost
effective and improve the lives of people with diabetes. To achieve this
objective, we are pursuing the following business strategies:
. establish FreeStyle as a leading blood glucose self-monitoring device;
. maintain and enhance retail distribution of FreeStyle;
. focus on our core competencies in electrochemistry and sensor
manufacturing technologies, while outsourcing other aspects of our
business;
. provide high quality customer service;
. establish an international presence for FreeStyle; and
. leverage our proprietary technology platform.
Additional Information
We have a limited operating history and we have significant losses. As of June
30, 2001, our accumulated deficit was approximately $89.7 million. We will
continue to have substantial future capital requirements. We expect to continue
to incur significant net losses for the foreseeable future. In addition, we
expect substantially all of our revenue will be derived from sales of
FreeStyle, our only commercial product. FreeStyle faces intense competition in
a market where four companies control approximately 90% of worldwide sales. We
are subject to extensive regulation by the FDA and foreign regulatory bodies,
and a recent FreeStyle labeling change is being reviewed by the FDA as a
510(k) submission. For a discussion of the foregoing factors and other factors
that could adversely affect us, you should read "Risk Factors."
We were incorporated in California in 1996 and reincorporated in Delaware in
2000. Our principal executive offices are located at 1360 South Loop Road,
Alameda, California 94502. Our telephone number at this location is (510) 749-
5400. Our Internet address is www.therasense.com. The information contained on
our website is not a part of this prospectus.
TheraSense(R), FreeStyle(TM), The Technology of Caring(TM), NanoSample(TM) and
Wired Enzyme(TM) are trademarks and service marks of ours. Other service marks,
trademarks and trade names referred to in this prospectus are the property of
their respective owners.
2
The Offering
Common stock offered by us...................... 6,000,000 shares
Common stock to be outstanding after this
offering....................................... 38,089,847 shares
Use of proceeds................................. We intend to use the net
proceeds from this offering
for additional sales and
marketing efforts, research
and development, expansion of
our facilities, as well as
for working capital and other
general corporate purposes.
Nasdaq National Market symbol................... THER
The number of shares of common stock to be outstanding after this offering is
based on 32,089,847 shares outstanding as of June 30, 2001, and excludes:
. 521,013 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $2.07 per share;
. 4,882,303 shares issuable upon exercise of outstanding options under
our 1997 Stock Plan at a weighted average exercise price of $3.73 per
share; and
. a total of 9,053,832 shares available for future issuance under our
equity incentive plans.
Except as otherwise noted, all information in this prospectus:
. assumes the underwriters do not exercise their over-allotment option;
. reflects the filing of our amended and restated certificate of
incorporation; and
. reflects the conversion of each share of preferred stock into one
share of common stock immediately prior to the closing of this
offering.
3
Summary Financial Data
(in thousands, except per share data)
The following table sets forth our summary financial data. This data has been
derived from our financial statements for the years ended December 31, 1998,
1999 and 2000, the six month periods ended June 30, 2000 and 2001, and as of
June 30, 2001 included elsewhere in this prospectus. You should read this
information in conjunction with "Management's Discussion and Analysis of
Financial Condition and Results of Operations" and our financial statements and
the related notes included elsewhere in this prospectus.
Six Months Ended
Years Ended December 31, June 30,
--------------------------- ------------------
1998 1999 2000 2000 2001
------- -------- -------- -------- --------
(unaudited)
Statement of Operations Data:
Total revenues................ $ 60 $ 85 $ 5,503 $ 511 $ 25,524
Cost of revenues.............. -- -- 11,948 296 19,668
------- -------- -------- -------- --------
Gross profit (loss)........... 60 85 (6,445) 215 5,856
Operating expenses:
Research and development..... 3,056 7,672 12,019 5,841 6,332
Selling, general and
administrative.............. 1,810 5,557 25,460 9,787 26,843
------- -------- -------- -------- --------
Total operating expenses.... 4,866 13,229 37,479 15,628 33,175
Loss from operations.......... (4,806) (13,144) (43,924) (15,413) (27,319)
Interest income, net.......... 142 86 332 354 386
------- -------- -------- -------- --------
Net loss...................... (4,664) (13,058) (43,592) (15,059) (26,933)
Deemed dividend related to
beneficial conversion feature
of preferred stock........... -- -- (14,773) (14,773) (26,783)
------- -------- -------- -------- --------
Net loss attributable to
common stockholders.......... $(4,664) $(13,058) $(58,365) $(29,832) $(53,716)
======= ======== ======== ======== ========
Net loss per common share,
basic and diluted............ $ (2.31) $ (4.32) $ (14.69) $ (8.03) $ (11.35)
======= ======== ======== ======== ========
Weighted-average shares used
in computing net loss per
common share, basic and
diluted...................... 2,015 3,024 3,973 3,713 4,732
======= ======== ======== ======== ========
Pro forma net loss per common
share, basic and diluted
(unaudited).................. $ (2.06) $ (0.92)
======== ========
Weighted-average shares used
in computing pro forma net
loss per common share, basic
and diluted (unaudited)...... 21,129 29,331
======== ========
As of June 30, 2001
---------------------
Actual As Adjusted
-------- -----------
(unaudited)
Balance Sheet Data:
Cash and cash equivalents................................. $ 45,152 $150,422
Working capital........................................... 34,806 140,076
Total assets.............................................. 78,982 184,252
Deferred revenue.......................................... 17,684 17,684
Long-term obligations, less current portion............... 3,685 3,685
Convertible preferred stock............................... 119,246 --
Deferred stock-based compensation, net.................... (15,645) (15,645)
Accumulated deficit....................................... (89,657) (89,657)
Total stockholders' equity (deficit)...................... (84,319) 140,197
The as adjusted column of the balance sheet data reflects the conversion of all
of our outstanding shares of convertible preferred stock into shares of common
stock immediately prior to the closing of this offering and the sale of
6,000,000 shares of common stock offered by us at an initial public offering
price of $19.00 per share, after deducting underwriting discounts and
commissions and estimated offering expenses payable by us.
4
RISK FACTORS
An investment in our common stock offered by this prospectus involves a
substantial risk of loss. You should carefully consider these risk factors,
together with all of the other information included in this prospectus, before
you decide to purchase shares of our common stock. The risks and uncertainties
described below are not the only ones we face. Additional risks and
uncertainties not presently known to us or that we currently deem immaterial
may also impair our operations. The occurrence of any of the following risks
could harm our business. In that case, the trading price of our common stock
could decline, and you may lose all or part of your investment.
Risks Related to Our Business
We have limited operating experience and a history of net losses and may never
achieve or maintain profitability.
We have a limited history of operations and have focused primarily on research
and development, product engineering, clinical trials and seeking FDA
regulatory clearance to market our products. We received FDA clearance for
FreeStyle, our first commercial product, in January 2000, and we commenced
commercial shipments in June 2000. We have generated only limited revenues from
the sale of our products to date and have incurred losses every year since
1997. We incurred losses of $13.1 million in 1999, $43.6 million in 2000 and
$26.9 million in the six months ended June 30, 2001. As of June 30, 2001, we
had an accumulated deficit of approximately $89.7 million. It is possible that
we will never generate sufficient revenues from product sales to achieve
profitability. Even if we do achieve significant revenues from our product
sales, we expect that increased operating expenses will result in significant
operating losses over the next several quarters as we, among other things:
. expand our domestic and international selling and marketing
activities as we attempt to gain market share for FreeStyle;
. increase our research and development efforts to improve our existing
products and develop new products such as our Continuous Glucose
Monitoring System;
. perform clinical research and trials in an effort to obtain
governmental clearance and approval for the commercial sale of our
Continuous Glucose Monitoring System; and
. expand our facilities in Alameda, California, including an expansion
of our test strip manufacturing capacity.
We will need to significantly increase the revenues we receive from sales of
our products. We may be unable to do so, and therefore, may never achieve
profitability. Even if we do achieve profitability, we may not be able to
sustain or increase profitability on a quarterly or annual basis.
We have limited experience manufacturing our FreeStyle test strips in
substantial quantities, and if we are unable to purchase additional equipment
or are otherwise unable to meet customer demand, we may not improve our sales
growth sufficiently to achieve profitability.
To be successful, we must manufacture our FreeStyle test strips in substantial
quantities at acceptable costs. If we do not succeed in manufacturing
sufficient quantities of our test strips to meet customer demand, we could lose
customers. We currently manufacture our FreeStyle test strips using a process
with which we have limited experience. If demand for FreeStyle increases, we
will need to purchase additional specialized equipment with substantial lead
times and obtain additional raw materials in order to increase the output
volume of our test strips. If we are unable to obtain the necessary equipment
or raw materials to effectively manufacture and meet customer demand for our
FreeStyle test strips, we may not improve our sales growth sufficiently to
achieve profitability.
5
We expect to derive substantially all of our future revenue from sales of
FreeStyle, a product we recently introduced, and this product could fail to
generate significant revenues and achieve market acceptance.
Currently, the primary products we market are the FreeStyle System kit,
FreeStyle lancets and FreeStyle test strips, all of which we commercially
introduced in June 2000. Our FreeStyle products are expected to account for
substantially all of our revenues for at least the next several years.
Accordingly, our success depends upon the acceptance by people with diabetes,
as well as health care providers and third-party payors of FreeStyle as a
preferred blood glucose self-monitoring device. As a relatively new company in
the area of glucose self-monitoring, we may have difficulty raising the brand
awareness necessary to generate interest in FreeStyle.
To date, only a limited number of people have used FreeStyle, and people with
diabetes or the medical community may not endorse FreeStyle as a preferred
blood glucose self-monitoring device. In addition, FreeStyle may not achieve
market acceptance on a timely basis, if at all, due to:
. the significant influence of established glucose monitoring products;
. the ability of some of our competitors to price products below a
price at which we can competitively manufacture and sell our
products;
. cost constraints; and
. the introduction or acceptance of competing products or technologies.
Furthermore, FreeStyle may not encourage more active testing, and participants
in the glucose self-monitoring market may gravitate toward more established
brands. If we are unable to successfully market and sell our FreeStyle
products, we may not be able to generate significant revenues or achieve
profitability because we do not have alternative products.
In addition, to encourage market acceptance of our products, we currently
distribute the FreeStyle System kit at a financial loss through samples,
discounts and rebates. In order to generate sufficient revenues in the future,
we will therefore have to rely on recurring revenue from the repeated purchase
of our FreeStyle test strips. If FreeStyle does not gain sufficient market
share to generate significant recurring revenue from the sale of our test
strips, we may not achieve profitability.
We face competition from competitors with greater resources, which may make it
more difficult for us to achieve significant market penetration.
The market for medical devices is intensely competitive, subject to rapid
change and significantly affected by new product introductions and other market
activities of industry participants. We compete directly with Roche Diagnostics
Corporation, LifeScan, Inc., a division of Johnson & Johnson, MediSense, a
division of Abbott Laboratories, and Bayer AG, which currently account for
approximately 90% of the worldwide sales of blood glucose self-monitoring
systems. Each of these companies is either publicly traded or a division of a
publicly-traded company, and enjoys several competitive advantages, including:
. significantly greater name recognition;
. established relations with health care professionals, customers and
third-party payors;
. additional lines of products, and the ability to offer rebates or
bundle products to offer higher discounts or incentives to gain a
competitive advantage;
. established distribution networks and relationships with retailers;
and
. greater resources for product development, sales and marketing and
patent litigation.
6
These companies and others have developed and will continue to develop new
products that compete directly with our products. In addition, our competitors
spend significantly greater funds for the research, development, promotion and
sale of new and existing products. These resources can allow them to respond
more quickly to new or emerging technologies and changes in customer
requirements. For all the foregoing reasons, we may not be able to compete
successfully against our current and future competitors.
If we fail to obtain or maintain necessary FDA clearances or approvals for
products, or if approvals are delayed, we will be unable to commercially
distribute and market our products in the United States.
Our products are medical devices that are subject to extensive regulation in
the United States and in foreign countries where we do business. Unless an
exemption applies, each medical device that we wish to market in the United
States must first receive either 510(k) clearance or premarket approval from
the FDA. Either process can be lengthy and expensive. The FDA's 510(k)
clearance process usually takes from four to twelve months from the date the
application is complete, but may take longer. Although we have obtained 510(k)
clearance for our initial product, FreeStyle, our 510(k) clearance can be
revoked if safety or effectiveness problems develop. The premarket approval
process is much more costly, lengthy and uncertain. It generally takes from one
to three years from the date the application is complete or even longer.
However, achieving a completed application is a process that may take numerous
clinical trials and require the filing of amendments over time. We expect that
our Continuous Glucose Monitoring System under development will require
premarket approval. Therefore, even if the product is successfully developed,
it may not be commercially available for a number of years. We may not be able
to obtain additional clearances or approvals in a timely fashion, or at all.
Delays in obtaining clearance or approval could adversely affect our revenues
and profitability.
Modification to our marketed devices may require new 510(k) clearances or
premarket approvals or require us to cease marketing or recall the modified
devices until these clearances are obtained.
Any modification to an FDA cleared device that could significantly affect its
safety or effectiveness, or that would constitute a major change in its
intended use, requires a new FDA 510(k) clearance or possibly premarket
approval. The FDA requires every manufacturer to make this determination in the
first instance, but the FDA can review any such decision. We have modified
aspects of FreeStyle since receiving regulatory approval, but we believe that
new 510(k) clearances are not required. We may make additional modifications to
FreeStyle and future products after they have received clearance or approval,
and in appropriate circumstances, determine that new clearance or approval is
unnecessary. The FDA may not agree with any of our decisions not to seek new
clearance or approval. If the FDA requires us to seek 510(k) clearance or
premarket approval for any modifications to a previously cleared product, we
may be required to cease marketing or recall the modified device until we
obtain this clearance or approval. Also, in these circumstances, we may be
subject to significant regulatory fines or penalties.
If the FDA does not clear our recent FreeStyle labeling changes, we may be
required to include significantly more restrictive labeling, cease marketing
FreeStyle under this labeling or recall FreeStyle.
In June 2001, we submitted additional information to the FDA in support of a
labeling change we previously implemented. This labeling change sought to
clarify the safe and effective use of FreeStyle in light of physiological
differences between the finger and alternate blood glucose testing sites. The
FDA has decided to review our submission as a 510(k). Because FreeStyle is
currently being marketed with the revised more cautionary labeling, unless and
until we obtain clearance of that 510(k), we are technically out of compliance
with FDA regulations. In response, the FDA could require us to cease marketing
FreeStyle with the more cautionary labeling, publish a public health
notification disclosing warnings regarding the use of blood glucose monitoring
systems that can be utilized with blood samples obtained from sites other than
the fingertip or recall FreeStyle until we obtain 510(k) clearance. Also, in
these circumstances, we may be subject to significant regulatory fines or
penalties.
7
We will work closely with the FDA to address their questions and resolve any
issues around our labeling. However, the FDA may not accept our cautionary
language as sufficient, and the FDA could require us to include significant
restrictions on use in the labeling. In discussions with the FDA, we have been
informed that, since the labeling changes are due to human physiology, all
manufacturers of off-fingertip glucose self-monitoring products are being
treated the same, and when such a manufacturer has submitted a labeling change
similar to ours, the FDA has required a 510(k). If the FDA orders us to cease
marketing FreeStyle with its current labeling, to recall such product, to pay
fines or penalties, or to include significant restrictions on use in the
FreeStyle labeling, our sales growth would be adversely impacted, and we may
not reach profitability.
If we or our suppliers fail to comply with the FDA's Quality System Regulation,
our manufacturing operations could be delayed, and our product sales and
profitability could suffer.
Our manufacturing processes for our FreeStyle test strips, as well as the
manufacturing processes utilized by our suppliers of FreeStyle meters, lancing
devices and lancets, are required to comply with the FDA's Quality System
Regulation, which covers the methods and documentation of the design, testing,
production, control, quality assurance, labeling, packaging, storage and
shipping of our products. The FDA enforces the Quality System Regulation
through unannounced inspections. We recently went through a Quality System
Regulation inspection at our facilities in Alameda, California and have
submitted a corrective action plan to the FDA addressing the observations noted
in the audit. The manufacturing line for our FreeStyle meters at Flextronics
International USA Inc. has not been inspected to date. If we or one of our
suppliers fail a Quality System Regulation inspection or if our corrective
action plan is not sufficient, our operations could be disrupted and our
manufacturing delayed. If we fail to take adequate corrective action in
response to any FDA observations, we could face various enforcement actions,
which could include a shut-down of our manufacturing operations and a recall of
our products, which would cause our product sales and profitability to suffer.
Furthermore, our key component suppliers may not currently be or may not
continue to be in compliance with applicable regulatory requirements.
Our products are subject to product recalls even after receiving FDA clearance
or approval, which would harm our reputation.
The FDA and similar governmental authorities in other countries have the
authority to require the recall of our products in the event of material
deficiencies or defects in design or manufacture. A government mandated or
voluntary recall by us could occur as a result of component failures,
manufacturing errors or design defects, including our new labeling for
FreeStyle. Any recall of product would divert managerial and financial
resources and harm our reputation with customers.
Because the medical device industry is litigious, we may be sued for allegedly
violating the intellectual property rights of others.
The medical technology industry has in the past been characterized by a
substantial amount of litigation and related administrative proceedings
regarding patents and intellectual property rights. In addition, major medical
device companies have used litigation against emerging growth companies as a
means of gaining a competitive advantage.
Should third parties file patent applications or be issued patents claiming
technology also claimed by us in pending applications, we may be required to
participate in interference proceedings in the U.S. Patent and Trademark Office
to determine the relative priorities of our inventions and the third parties'
inventions. We could also be required to participate in interference
proceedings involving our issued patents and pending applications of another
entity. An adverse outcome in an interference proceeding could require us to
cease using the technology or to license rights from prevailing third parties.
8
Third parties may claim we are using their patented inventions and may go to
court to stop us from engaging in our normal operations and activities. These
lawsuits are expensive to defend and conduct and would also consume and divert
the time and attention of our management. A court may decide that we are
infringing a third party's patents and may order us to cease the infringing
activity. The court could also order us to pay damages for the infringement.
These damages could be substantial and could harm our business, financial
condition and operating results. We have recently received a letter from the
exclusive licensee of a recently issued patent alleging that FreeStyle
infringes the patent and requesting that we contact the licensee regarding
sublicense opportunities. We are evaluating the patent and have responded to
the letter indicating that we would be willing to discuss potential
sublicensing terms.
If we were unable to obtain any necessary license following a determination of
infringement or an adverse determination in litigation or in interference or
other administrative proceedings, we would have to redesign our products to
avoid infringing a third party's patent and could temporarily or permanently
have to discontinue manufacturing and selling some of our products. If this
were to occur, it would negatively impact future sales.
If we fail to protect our intellectual property rights, our competitors may
take advantage of our ideas and compete directly against us.
We rely on patent protection, as well as a combination of copyright, trade
secret and trademark laws, and nondisclosure, confidentiality agreements and
other contractual restrictions to protect our proprietary technology. However,
these legal means afford only limited protection and may not adequately protect
our rights or permit us to gain or keep any competitive advantage. For example,
our patents may be challenged, invalidated or circumvented by third parties.
Our patent applications, including those already allowed, may not be issued as
patents in a form that will be advantageous to us. We may not be able to
prevent the unauthorized disclosure or use of our technical knowledge or other
trade secrets by employees. Furthermore, the laws of foreign countries may not
protect our intellectual property rights to the same extent as the laws of the
United States. Even if our intellectual property rights are adequately
protected, litigation may be necessary to enforce our intellectual property
rights, which could result in substantial costs to us and result in a
substantial diversion of management attention. If our intellectual property is
not adequately protected, our competitors could use our intellectual property
to enhance their products. This would harm our competitive position, decrease
our market share or otherwise harm our business.
The prosecution and enforcement of patents licensed to us by third parties are
not within our control, and without these technologies, our products may not be
successful and our business would be harmed.
We rely on licenses to use various technologies that are material to our
business. We do not own the patents that underlie these licenses. The licenses
from Asulab, SA and Unilever PLC grant us the right under specific patents to
make and sell diagnostic devices for diabetes monitoring. Our rights to use
these technologies and employ the inventions claimed in the licensed patents
are subject to our licensors abiding by the terms of those licenses. In
addition, we do not control the prosecution of the patents to which we hold
licenses, and we do not control the strategy for determining when any patents
to which we hold licenses should be enforced. Instead, we rely upon our
licensors to determine the appropriate strategy for prosecuting and enforcing
those patents.
If we are unable to continue to develop innovative products in the glucose
monitoring market, our business would be harmed.
The glucose monitoring market is subject to rapid technological change and
product innovations. Our products are based on our proprietary technology, but
our competitors may succeed in developing or marketing products that will be
technologically superior to ours. In addition, over $44 billion is spent
annually on diabetes treatment and the National Institutes for Health and other
supporters of diabetes research are continually seeking ways to prevent or cure
diabetes. Therefore, our products may also be rendered obsolete by
technological breakthroughs in diabetes prevention, monitoring or treatment.
9
We are currently developing additional enhancements for FreeStyle, as well as
new products such as our Continuous Glucose Monitoring System. Marketing of
these products will require FDA and other regulatory clearances and approvals.
Development of these products will require additional research and development
expenditures. We may not be successful in developing, marketing or
manufacturing these new products. In addition, several of our competitors are
in various stages of development of products similar to our Continuous Glucose
Monitoring System, and the FDA has approved two of these products. If any of
our competitors succeeds in developing a commercially viable product and
obtains government approval or successfully commercializes its FDA-approved
product, this could negatively affect our future revenues.
We have limited sales and marketing experience and any failure to expand sales
of FreeStyle will negatively impact future revenues.
We currently have limited experience in marketing and selling our products. We
received regulatory clearance for our initial product in January 2000 and
commenced commercial shipments in June 2000. We currently sell our products in
the United States directly, using a sales organization that we assembled
following regulatory clearance. Our products require a complex marketing and
sales effort targeted at health care professionals, diabetes educators, people
with diabetes, retail pharmacists and national retailers. We significantly
expanded our sales and marketing teams in 2000, and we are continuing this
expansion in 2001. We will face significant challenges and risks in training,
managing and retaining these teams, including managing geographically dispersed
efforts and adequately training our people in the use and benefits of our
products. We may not be able to hire sufficient additional personnel to create
increasing demand for our products. In addition, we have distribution
arrangements for the sale of our products internationally and are dependent
upon the sales and marketing efforts of our third-party distributors. These
distributors may not commit the necessary resources to effectively market and
sell our products. Further, they may not be successful in selling our products.
Our financial condition would be harmed if our marketing and sales efforts are
unsuccessful.
We currently depend on single suppliers and manufacturers for our FreeStyle
products, and the loss of any of these suppliers or manufacturers could harm
our business.
Our FreeStyle meters, along with our FreeStyle lancing devices and lancets, are
each currently manufactured according to our specifications by single third-
party manufacturers. The meters, lancing devices and lancets are manufactured
from components purchased from outside suppliers, and some of these components
are currently single-sourced. Our FreeStyle test strips, which we manufacture
ourselves, are comprised of several components obtained from single-source
suppliers. In the event we are unable, for whatever reason, to obtain
components from suppliers, or if our contract manufacturers are unable to meet
our manufacturing requirements, we may not be able to obtain components from
alternate suppliers or engage an additional manufacturer in a timely manner.
Any disruption or delay in shipments of FreeStyle meters, test strips, lancing
devices or lancets would negatively affect our revenues.
We outsource several key parts of our operations and any interruption in the
services provided could prevent us from expanding our business.
We currently outsource several aspects of our business, including the
manufacture of FreeStyle meters, lancing devices and lancets, the functioning
of our procurement systems and the operation of our customer service function.
Since outsourcing leaves us without direct control over these business
functions, interruptions in the services of our third-party providers may be
difficult or impossible to remedy in a timely fashion. In addition, we may be
unable to obtain the necessary resources from our third-party providers to meet
realized growth in our business.
10
We may have difficulty managing our growth.
We expect to continue to experience significant growth in the scope of our
operations and the number of our employees. This growth may continue to place a
significant strain on our management and operations. Our ability to manage this
growth will depend upon our ability to attract, hire and retain skilled
employees. Our success will also depend on the ability of our officers and key
employees to continue to implement and improve our operational and other
systems, to manage multiple, concurrent development projects and to hire, train
and manage our employees. Our future success is heavily dependent upon growth
and acceptance of new products. If we cannot scale our business appropriately
or otherwise adapt to anticipated growth and new product introduction, our
business, financial condition and results of operations will be adversely
affected.
Our success will depend on our ability to attract and retain key personnel and
scientific staff.
We believe our future success will depend upon our ability to successfully
manage our growth, including attracting and retaining scientists, engineers and
other highly skilled personnel. Our employees may terminate their employment
with us at any time and are not subject to employment contracts. Hiring
qualified management and technical personnel will be difficult due to the
limited number of qualified professionals. Competition for these types of
employees is intense in the field of diabetes monitoring and management. We
have in the past experienced difficulty in recruiting qualified personnel. If
we fail to attract and retain personnel, particularly management and technical
personnel, we may not be able to execute on our business plan.
Our products carry return policies that do not permit us to recognize revenue
from sales to retailers and wholesalers prior to resale to end users.
Our return policy allows end users in the United States to return FreeStyle
System kits to us for any reason for a full refund within 30 days of purchase.
In addition, our FreeStyle System kits and FreeStyle test strips currently have
an 18 month shelf life, and retailers and wholesalers in the United States can
return these products to us within six months after this expiration date. If we
experience significant returns from retailers, wholesalers or end users, this
could seriously harm our business and results of operations. As a result of
these rights to return and the unavailability of historical return rates, we
defer revenue recognition on sales of test strips until resold by the retailers
and wholesalers to end users, and we defer revenue recognition on FreeStyle
System kits until 30 days after purchase by the end user.
Because we lack a sufficient historical basis from which we could estimate
return rates, we are required to rely on data estimates provided to us by
third-party data providers in order to recognize revenue from sales to end
users by retailers and wholesalers. These data estimates may cause imprecise
revenue recognition and we do not know how long we will be required to rely on
these estimates. Further, these third parties may not provide consistent,
reliable data.
If we do not provide quality customer service, we would lose customers and our
operating results would suffer.
Our ability to provide superior customer service to our customers, health care
professionals and educators is critical. To effectively compete, we must build
strong brand awareness among our customers, much of which is based upon
personal referrals. In order to gain these referrals, we must provide customer
service representatives who are able and available to provide our customers
with answers to questions regarding our products. This will require us to
continue to build and maintain customer service operations, for which we
currently rely on a single third-party provider. We will require increased
staff at our third-party provider to further support a growth in new customers.
Any failures or disruption to our customer services operations, or the
termination of our contract with our only third-party provider, could cause us
to lose customers.
11
We currently have only one distributor in Europe and one distributor in Japan,
and if these distributors are not successful or we are unable to attract
additional distributors, we may never realize significant international
revenues.
In September 2000, we entered into an agreement for the exclusive marketing and
sale of FreeStyle in several European countries, subject to regulatory
approval. In May 2001, our third-party distributor commercially introduced
FreeStyle in Germany and Sweden. In April 2001, we entered into an agreement
for the exclusive marketing and sale of FreeStyle in Japan, subject to
regulatory approval. We will be dependent on these distributors in those
markets, and we will need to attract additional distributors in other markets.
If our current or future third-party distributors do not succeed, we may never
realize significant international revenues.
Complying with international regulatory requirements is an expensive, time-
consuming process and approval is never certain.
International sales of our products are subject to strict regulatory
requirements. The review process varies from country to country, is typically
lengthy and expensive, and approval is never certain. Nipro Corporation, our
exclusive distributor in Japan, submitted an application for approval to market
FreeStyle in Japan with the Ministry of Health, Labor and Welfare. Failure to
receive the approval in Japan or in other countries would prevent us from
expanding international sales of FreeStyle, which would negatively impact our
future revenues.
If we choose to acquire new and complementary businesses, products or
technologies instead of developing them ourselves, we may be unable to complete
these acquisitions or to successfully integrate an acquired business or
technology in a cost-effective and non-disruptive manner.
Our success depends on our ability to continually enhance and broaden our
product offerings in response to changing technologies, customer demands and
competitive pressures. Accordingly, we may, in the future, acquire
complementary businesses, products, or technologies instead of developing them
ourselves. We do not know if we will be able to complete any acquisitions, or
whether we will be able to successfully integrate any acquired business,
operate it profitably or retain its key employees. Integrating any business,
product or technology we acquire could be expensive and time consuming, disrupt
our ongoing business and distract our management. If we are unable to integrate
any acquired entities, products or technologies effectively, our business will
suffer. In addition, any amortization of goodwill or other assets or charges
resulting from the costs of acquisitions could harm our business and operating
results.
Any adverse changes in reimbursement procedures by Medicare or other third-
party payors may limit our ability to market and sell our products.
In the United States, glucose self-monitoring devices and test strips are
generally covered by Medicare and other third-party payors, which provide for
reimbursement of all or part of the cost of the product. Medicare and other
third-party payors are increasingly scrutinizing whether to cover new products
and the level of reimbursement for covered products. FreeStyle is currently
being reimbursed through Medicare, Medicaid, open formulary plans and certain
preferred provider organizations.
International market acceptance of our products may depend, in part, upon the
availability of reimbursement within prevailing health care payment systems.
Reimbursement and health care payment systems in international markets vary
significantly by country, and include both government sponsored health care and
private insurance. We may not obtain international reimbursement approvals in a
timely manner, if at all. Our failure to receive international reimbursement
approvals may negatively impact market acceptance of our products in the
international markets in which those approvals are sought.
12
We believe that in the future, reimbursement will be subject to increased
restrictions both in the United States and in international markets. Third-
party reimbursement and coverage may not be available or adequate in either the
United States or international markets. Future legislation, regulation or
reimbursement policies of third-party payors may adversely affect the demand
for our existing products or our products currently under development or our
ability to sell our products on a profitable basis. The lack of third-party
payor coverage or the inadequacy of reimbursement could have a material adverse
effect on our business, financial condition and results of operations.
If we become subject to product liability claims, we may be required to pay
damages that exceed our insurance coverage.
Our business exposes us to potential product liability claims that are inherent
in the testing, production, marketing and sale of human diagnostic products.
While we believe that we are reasonably insured against these risks, we may not
be able to obtain insurance in amounts or scope sufficient to provide us with
adequate coverage against all potential liabilities. Currently, we maintain
product liability insurance in the amount of $20.0 million. A product liability
claim in excess of our insurance coverage would have to be paid out of cash
reserves and would harm our reputation in the industry.
We are subject to additional risks associated with international operations.
We believe that a significant amount of our future revenues may come from
international sales, and these sales are subject to a number of risks. For
example, foreign regulatory agencies often establish requirements different
from those in the United States. Fluctuations in exchange rates of the U.S.
dollar against foreign currencies may affect demand for our products overseas.
In addition, our international sales may be adversely affected by export
license requirements, the imposition of governmental controls, political and
economic instability, trade restrictions, changes in tariffs and difficulties
in staffing and managing international operations.
If we require future capital, we may not be able to secure additional funding
in order to expand our operations and develop new products.
We may seek additional funds from public and private stock offerings,
borrowings under lease lines of credit or other sources. This additional
financing may not be available on a timely basis on terms acceptable to us, or
at all. This financing may be dilutive to stockholders or may require us to
grant a lender a security interest in our assets. The amount of money we will
need will depend on many factors, including:
. revenues generated by sales of FreeStyle and our future products, if
any;
. expenses we incur in developing and selling our products;
. the commercial success of our research and development efforts; and
. the emergence of competing technological developments.
If adequate funds are not available, we may have to delay development or
commercialization of our products or license to third parties the rights to
commercialize products or technologies that we would otherwise seek to
commercialize. We also may have to reduce marketing, customer support or other
resources devoted to our products. Any of these results would harm our
financial condition.
We may have warranty claims that exceed our reserves.
FreeStyle meters carry a five-year warranty against defects in materials and
workmanship. We will be responsible for all claims, actions, damages, liens,
liabilities, costs and expenses for defects attributable to the FreeStyle
meter. We have established reserves for the liability associated with product
warranties. However, any unforeseen warranty exposure could adversely affect
our operating results.
13
All of our operations are currently conducted at a single location, and a
disaster at this facility is possible and could result in a prolonged
interruption of our business.
We currently conduct all our scientific, test strip manufacturing and
management activities at a single location in Alameda, California near known
earthquake fault zones. In addition, our facilities were built on fill material
dredged from the San Francisco Bay in the 1960s. Our sole supplier of FreeStyle
meters also currently manufactures these devices at a single facility in San
Jose, California near known earthquake fault zones. We have taken precautions
to safeguard our facilities, including insurance, health and safety protocols,
and off-site storage of computer data. However, a natural disaster, such as an
earthquake, 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. A disaster could seriously harm our business and
adversely affect our reputation with customers. The insurance we maintain
against fires, floods, and earthquakes may not be adequate to cover our losses
in any particular case.
Power outages in California may adversely affect us.
We conduct all of our scientific, test strip manufacturing and management
activities in California and rely on a continuous power supply to conduct
operations. Our sole-source supplier of FreeStyle meters is currently
manufacturing our meters in a single facility that is also in California.
California's current energy crisis could substantially disrupt our operations
and increase our expenses. California has recently implemented, and may in the
future continue to implement, rolling blackouts throughout the state. If
blackouts interrupt our power supply, we may be temporarily unable to continue
operations at our facilities, which includes the manufacture and production of
our FreeStyle test strips. Interruptions in our ability to continue operations
at our facilities could delay our shipments of FreeStyle test strips, delay the
development of our products, and disrupt communications with our customers,
suppliers and third-party manufacturing operations. Future interruptions could
result in lost revenue and damage our reputation, either of which could harm
our business and results of operations. Furthermore, shortages in wholesale
electricity supplies have caused power prices to increase. If wholesale prices
continue to increase, our operating expenses will likely increase, which will
have a negative effect on our operating results.
We may be liable for contamination or other harm caused by materials that we
use, and changes in environmental regulations could cause us to incur
additional expense.
Our research and development and clinical processes involve the use of
potentially harmful biological materials as well as hazardous materials. We are
subject to federal, state and local laws and regulations governing the use,
handling, storage and disposal of hazardous and biological materials and we
incur expenses relating to compliance with these laws and regulations. If
violations of environmental, health, and safety laws occur, we could be held
liable for damages, penalties and costs of remedial actions. These expenses or
this liability could have a significant negative impact on our financial
condition. We may violate environmental, health and safety laws in the future
as a result of human error, equipment failure, or other causes. Environmental
laws could become more stringent over time, imposing greater compliance costs
and increasing risks and penalties associated with violations. We are subject
to potentially conflicting and changing regulatory agendas of political,
business, and environmental groups. Changes to or restrictions on permitting
requirements or processes, hazardous or biological material storage or handling
might require an unplanned capital investment and/or relocation. Compliance
with new laws or regulations could harm our business, financial condition and
results of operations.
14
Risks Related 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 common stock sold in this offering was determined by
negotiation between the underwriters and us. This price will not necessarily
reflect the market price of the common stock following this offering. The
market price for the common stock following this offering will be affected by a
number of factors, including:
. volume and timing of orders for our products;
. our ability to develop, obtain regulatory clearance for, and market,
new and enhanced products on a timely basis;
. the announcement of new products or product enhancements by us or our
competitors;
. announcements of technological or medical innovations in the
monitoring or treatment of diabetes;
. product liability claims or other litigation;
. quarterly variations in our or our competitors' results of
operations;
. changes in governmental regulations or in the status of our
regulatory approvals or applications;
. changes in the availability of third-party reimbursement in the
United States or other countries;
. changes in earnings estimates or recommendations by securities
analysts; and
. general market conditions and other factors, including factors
unrelated to our operating performance or the operating performance
of our competitors.
There is a large number of shares that may be sold in the market following this
offering which may cause the price of our common stock to decline.
After this offering, we will have 38,089,847 shares of common stock
outstanding, or 38,989,847 shares if the underwriters' over-allotment is
exercised in full. The 6,000,000 shares sold in this offering, or 6,900,000
shares if the underwriters' over-allotment is exercised in full, will be freely
tradable without restriction or further registration under the federal
securities laws unless purchased by our affiliates. The remaining 32,089,847
shares of common stock outstanding after this offering, based upon shares
outstanding as of June 30, 2001, assuming no exercise of outstanding options
prior to completion of this offering, will be available for sale in the public
market as follows:
Number of Shares Date of Availability for Sale
---------------- -----------------------------
0 Immediately after the date of this prospectus
32,089,847 180 days after the effective date of the registration
statement containing this prospectus (subject in some
cases to volume and other limitations)
The above table assumes the effectiveness of the lock-up agreements under which
holders of substantially all of our common stock have agreed not to sell or
otherwise dispose of their shares of
15
common stock. Approximately 16.0 million of the shares that will be available
for sale after the expiration of the lock-up period will be subject to volume
restrictions because they are held by our affiliates. In addition, U.S. Bancorp
Piper Jaffray Inc. may waive these lock-up restrictions prior to the expiration
of the lock-up period without prior notice.
If our common stockholders sell substantial amounts of common stock in the
public market, or the market perceives that these sales may occur, the market
price of our common stock could fall. After this offering, the holders of
approximately 27,243,164 shares of common stock issued upon conversion of our
preferred stock and upon exercise of outstanding warrants will have rights,
subject to some conditions, to require us to file registration statements
covering their shares or to include their shares in registration statements
that we may file for ourselves or other stockholders. Furthermore, if we were
to include in a company-initiated registration statement shares held by those
holders pursuant to the exercise of their registration rights, those sales
could impair our ability to raise needed capital by depressing the price at
which we could sell our common stock.
Purchasers in this offering will experience immediate and substantial dilution.
The initial public offering price of our shares is substantially higher than
the net tangible book value per share of the outstanding common stock.
Accordingly, investors purchasing shares of common stock in this offering will:
. pay a price per share that substantially exceeds the value of our
assets after subtracting liabilities; and
. contribute 48.6% of the total amount invested to date to fund us, but
will own only 15.8% of the shares of common stock outstanding. To the
extent outstanding stock options or warrants are exercised, there
will be further dilution to new investors.
Our principal stockholders, executive officers and directors own a significant
percentage of our stock, and as a result, the trading price for our shares may
be depressed and these stockholders can take actions that may be adverse to
your interests.
Our executive officers and directors and entities affiliated with them will, in
the aggregate, beneficially own approximately 37.8% of our common stock
following this offering. This significant concentration of share ownership may
adversely affect the trading price for our common stock because investors often
perceive disadvantages in owning stock in companies with controlling
stockholders. These stockholders, acting together, will have the ability to
exert substantial influence over all matters requiring approval by our
stockholders, including the election and removal of directors and any proposed
merger, consolidation or sale of all or substantially all of our assets. In
addition, they could dictate the management of our business and affairs. This
concentration of ownership could have the effect of delaying, deferring or
preventing a change in control, or impeding a merger or consolidation, takeover
or other business combination that could be favorable to you.
Our charter documents and Delaware law may inhibit a takeover that stockholders
consider favorable and could also limit the market price of your stock.
Our amended and restated certificate of incorporation and bylaws will contain
provisions that could delay or prevent a change in control of our company. Some
of these provisions:
. authorize the issuance of preferred stock which can be created and
issued by the board of directors without prior stockholder approval,
commonly referred to as "blank check" preferred stock, with rights
senior to those of common stock;
16
. prohibit stockholder actions by written consent; and
. provide for a classified board of directors.
In addition, we are governed by the provisions of Section 203 of Delaware
General Corporate Law. These provisions may prohibit stockholders owning 15% or
more of our outstanding voting stock, from merging or combining with us. These
and other provisions in our amended and restated certificate of incorporation
and bylaws and under Delaware law could reduce the price that investors might
be willing to pay for shares of our common stock in the future and result in
the market price being lower than it would be without these provisions.
17
INFORMATION REGARDING FORWARD-LOOKING STATEMENTS
This prospectus, including the sections entitled "Summary," "Risk Factors,"
"Management's Discussion and Analysis of Financial Condition and Results of
Operations" and "Business," may contain forward-looking statements. These
statements relate to future events or our future financial performance and
involve known and unknown risks, uncertainties and other factors that may cause
our or our industry's actual results, levels of activity, performance or
achievements to be materially different from any future results, levels of
activity, performance or achievements expressed or implied by the forward-
looking statements. These risks and other factors include those listed under
"Risk Factors"and elsewhere in this prospectus. We believe that the section
entitled "Risk Factors" includes all material risks that could harm our
business. In some cases, you can identify forward-looking statements by
terminology such as "may," "will," "should," "expects," "plans," "anticipates,"
"believes," "estimates," "predicts," "intends," "potential," "continue" or the
negative of these terms or other comparable terminology. These statements are
only predictions. Actual events or results may differ materially.
We believe that it is important to communicate our future expectations to our
investors. However, there may be events in the future that we are not able to
accurately predict or control and that may cause our actual results to differ
materially from the expectations we describe in our forward-looking statements.
Investors are cautioned that all forward-looking statements involve risks and
uncertainties, and actual results may differ materially from those discussed as
a result of various factors, including those factors described in the "Risk
Factors" section of this prospectus.
Potential investors should not place undue reliance on our forward-looking
statements. Before you invest in our common stock, you should be aware that the
occurrence of the events described in the "Risk Factors" section and elsewhere
in this prospectus could harm our business, prospects, operating results and
financial condition.
Although we believe that the expectations reflected in the forward-looking
statements are reasonable, we cannot guarantee future results, levels of
activity, performance or achievements.
18
USE OF PROCEEDS
We estimate that the net proceeds from the sale of the 6,000,000 shares of
common stock that we are selling in this offering will be approximately $105.3
million based on an initial public offering price of $19.00 per share, and
after deducting the underwriting discounts and commissions and estimated
offering expenses payable by us. If the underwriters' over-allotment option is
exercised in full, we estimate that we will receive net proceeds of
approximately $121.2 million.
We currently estimate that we will use the net proceeds of this offering,
together with our cash on hand, to fund our operations, including:
. approximately $50.0 million to fund continued sales and marketing
efforts for FreeStyle, including increases in advertising and product
sampling;
. approximately $10.0 million for research and development of enhanced
FreeStyle products and our Continuous Glucose Monitoring System;
. approximately $10.0 million to expand our facility in Alameda,
California, including an expansion of our test strip manufacturing
capacity; and
. the remainder for working capital and other general corporate
purposes.
The amounts actually expended for these purposes may vary significantly and
will depend on a number of factors, including the amount of our future
revenues, expenses and the other factors described under "Risk Factors." In
addition, we will retain broad discretion in the allocation of the net proceeds
of this offering. Should we determine to employ cash resources for the
acquisition of complementary businesses, products or technologies, the amounts
available for the purposes cited above may be significantly reduced. Although
we evaluate potential acquisitions in the ordinary course of business, we have
no specific understandings, commitments or agreements with respect to any
acquisition or investment at this time.
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 the proceeds invested will yield a
favorable return.
DIVIDEND POLICY
Since our incorporation, we have never declared or paid any dividends on our
capital stock. We currently expect to retain our future earnings, if any, for
use in the operation and expansion of our business and do not anticipate paying
any dividends in the foreseeable future.
19
CAPITALIZATION
The following table sets forth our actual capitalization as of June 30, 2001.
Our capitalization is also presented:
. on a pro forma basis to give effect to the conversion of all
outstanding shares of convertible preferred stock into shares of
common stock immediately prior to the completion of this offering;
and
. on a pro forma as adjusted basis to reflect the sale in this offering
of 6,000,000 shares of common stock at an initial public offering
price of $19.00 per share, after deducting underwriting discounts and
commissions and estimated offering expenses payable by us.
As of June 30, 2001
--------------------------------
Pro Forma
Actual Pro Forma As Adjusted
-------- --------- -----------
(in thousands, except share
data)
(unaudited)
Long-term obligations, less current portion.... $ 3,685 $ 3,685 $ 3,685
-------- -------- --------
Convertible preferred stock, $0.001 par value;
28,309,647 shares authorized, 26,722,151
shares issued and outstanding, actual; no
shares authorized, issued and outstanding, pro
forma and pro forma as adjusted............... 119,246 -- --
-------- -------- --------
Stockholders' equity (deficit):
Preferred stock, $0.001 par value; no shares
authorized, issued or outstanding, actual and
pro forma; 5,000,000 shares authorized, no
shares issued or outstanding, pro forma as
adjusted..................................... -- -- --
Common stock, $0.001 par value; 50,000,000
shares authorized, 5,367,696 shares issued
and outstanding, actual; 32,089,847 shares
issued and outstanding, pro forma;
200,000,000 shares authorized and 38,089,847
shares issued and outstanding, pro forma as
adjusted..................................... 5 32 38
Additional paid-in capital..................... 21,272 140,491 245,755
Notes receivable from stockholders............. (294) (294) (294)
Deferred stock-based compensation, net......... (15,645) (15,645) (15,645)
Accumulated deficit............................ (89,657) (89,657) (89,657)
-------- -------- --------
Total stockholders' equity (deficit)......... (84,319) 34,927 140,197
-------- -------- --------
Total capitalization....................... $ 38,612 $ 38,612 $143,882
======== ======== ========
In addition to the shares of common stock to be outstanding after the offering,
we may issue additional shares of common stock under the following plans and
arrangements:
. 521,013 shares issuable upon exercise of outstanding warrants as of
June 30, 2001 at a weighted average exercise price of $2.07 per
share;
. 4,882,303 shares issuable upon exercise of outstanding options under
our 1997 Stock Plan at a weighted average exercise price of $3.73 per
share as of June 30, 2001; and
. a total of 9,053,832 shares available for future issuance under our
equity incentive plans.
You should read the capitalization table together with the sections of this
prospectus entitled "Selected Financial Data" and "Management's Discussion and
Analysis of Financial Condition and Results of Operations" and with the
financial statements and related notes beginning on page F-1.
20
DILUTION
Our pro forma net tangible book value at June 30, 2001 was approximately $34.9
million, or $1.09 per share, after giving effect to the conversion of all
outstanding shares of our convertible preferred stock into shares of common
stock upon completion of this offering. Pro forma net tangible book value per
share is equal to our total tangible assets less our total liabilities, divided
by the total number of shares of our common stock outstanding. After giving
effect to the sale of the 6,000,000 shares of our common stock offered in this
offering at an initial public offering price of $19.00 per share, and after
deducting underwriting discounts and commissions and estimated offering
expenses payable by us, our pro forma as adjusted net tangible book value at
June 30, 2001 would have been approximately $140.2 million, or $3.68 per share.
This represents an immediate increase in net tangible book value of $2.59 per
share to existing stockholders and an immediate dilution of $15.32 per share to
new investors purchasing shares of our common stock in this offering.
The following table illustrates the per share dilution to the new investors:
Initial public offering price per share........................... $19.00
Pro forma net tangible book value per share at June 30, 2001.... $1.09
Increase in pro forma net tangible book value per share
attributable to this offering.................................. 2.59
-----
Pro forma net tangible book value per share as adjusted after this
offering......................................................... 3.68
------
Dilution per share to new investors in this offering.............. $15.32
======
If the underwriters exercise their over-allotment option in full, there will be
an increase in pro forma net tangible book value to $4.00 per share to existing
stockholders and an immediate dilution in pro forma net tangible book value of
$15.00 to new investors.
The following table summarizes, on a pro forma basis as of June 30, 2001, the
total number of stockholders and new investors with respect to the number of
shares of common stock purchased from us, the total consideration paid and the
average price per share paid by the existing stockholders and by the new
investors in this offering before deducting the underwriting discounts and
commissions and estimated offering expenses payable by us:
Shares Purchased Total Consideration
------------------ -------------------- Average Price
Numbers Percent Amount Percent Per Share
---------- ------- ------------ ------- -------------
Existing stockholders..... 32,089,847 84.25% $120,396,078 51.36% $ 3.75
New investors............. 6,000,000 15.75% 114,000,000 48.64% $19.00
---------- ------ ------------ ------
Total................... 38,089,847 100.00% $234,396,078 100.00%
========== ====== ============ ======
If the underwriters exercise their over-allotment option in full, our existing
stockholders would own 82.3% and our new investors would own 17.7% of the total
number of shares of our common stock outstanding after this offering.
Assuming the exercise in full of all options and warrants outstanding and
exercisable as of June 30, 2001, the average price per share paid by our
existing stockholders would be reduced by $0.02 per share to $3.73 per share.
21
The preceding discussion and tables assume no exercise of stock options or
warrants outstanding as of June 30, 2001. As of June 30, 2001, there were:
. 521,013 shares issuable upon exercise of outstanding warrants at a
weighted average exercise price of $2.07 per share;
. 4,882,303 shares issuable upon exercise of outstanding options under
our 1997 Stock Plan at a weighted average exercise price of $3.73 per
share; and
. a total of 9,053,832 shares available for future issuance under our
equity incentive plans.
After this offering and assuming the exercise in full of all options and
warrants outstanding and exercisable as of June 30, 2001, our pro forma net
tangible book value per share as of June 30, 2001 would be $3.67 per share,
representing an immediate increase in net tangible book value of $2.58 per
share to existing stockholders and an immediate dilution in net tangible book
value of $15.33 per share to new investors.
22
SELECTED FINANCIAL DATA
The selected financial data set forth below are derived from our financial
statements. The statement of operations data for the years ended December 31,
1996 and 1997, and the balance sheet data as of December 31, 1996, 1997 and
1998 are derived from our audited financial statements not included in this
prospectus. The statement of operations data for the years ended December 31,
1998, 1999 and 2000, and the balance sheet data as of December 31, 1999 and
2000 are derived from our audited financial statements included in this
prospectus. The statement of operations data for the six months ended June 30,
2000 and 2001 and the balance sheet data as of June 30, 2001 are derived from
our unaudited financial statements included in this prospectus. Our unaudited
financial statements have been prepared by us on a basis consistent with our
audited financial statements and, in management's opinion, include all
adjustments necessary, consisting only of normal recurring adjustments, for a
fair presentation of this information. The results of operations for the six
months ended June 30, 2001 are not necessarily indicative of the results to be
expected for the entire year, for any other interim period or for any future
year. The selected financial data set forth below should be read in conjunction
with our financial statements, the related notes and "Management's Discussion
and Analysis of Financial Condition and Results of Operations" included
elsewhere in this prospectus.
Period from Six Months Ended
April 3, 1996 Years Ended December 31, June 30,
(inception) to ------------------------------------ ------------------
December 31, 1996 1997 1998 1999 2000 2000 2001
----------------- ------- ------- -------- -------- -------- --------
(in thousands, except per share
data) (unaudited)
Statement of Operations
Data:
Research grant revenue.. $618 $ -- $ 60 $ 60 $ 3 $ 3 $ --
Product sales........... -- -- -- 25 5,000 8 25,274
License income.......... -- -- -- -- 500 500 250
---- ------- ------- -------- -------- -------- --------
Total revenues....... 618 -- 60 85 5,503 511 25,524
Cost of revenues........ -- -- -- -- 11,948 296 19,668
---- ------- ------- -------- -------- -------- --------
Gross profit (loss)..... 618 -- 60 85 (6,445) 215 5,856
---- ------- ------- -------- -------- -------- --------
Operating expenses:
Research and
development........... 228 977 3,056 7,672 12,019 5,841 6,332
Selling, general and
administrative........ 199 703 1,810 5,557 25,460 9,787 26,843
---- ------- ------- -------- -------- -------- --------
Total operating
expenses............ 427 1,680 4,866 13,229 37,479 15,628 33,175
---- ------- ------- -------- -------- -------- --------
Income (loss) from
operations............. 191 (1,680) (4,806) (13,144) (43,924) (15,413) (27,319)
Interest income
(expense), net......... (9) 163 142 86 332 354 386
---- ------- ------- -------- -------- -------- --------
Net income (loss)....... 182 (1,517) (4,664) (13,058) (43,592) (15,059) (26,933)
Deemed dividend related
to beneficial
conversion feature of
preferred stock........ -- -- -- -- (14,773) (14,773) (26,783)
---- ------- ------- -------- -------- -------- --------
Net income (loss)
attributable to common
stockholders........... $182 $(1,517) $(4,664) $(13,058) $(58,365) $(29,832) $(53,716)
==== ======= ======= ======== ======== ======== ========
Net income (loss) per
common share, basic and
diluted................ $ (1.66) $ (2.31) $ (4.32) $ (14.69) $ (8.03) $ (11.35)
======= ======= ======== ======== ======== ========
Weighted-average shares
used in computing net
loss per common share,
basic and diluted...... 914 2,015 3,024 3,973 3,713 4,732
======= ======= ======== ======== ======== ========
Pro forma net loss per
common share, basic and
diluted (unaudited).... $ (2.06) $ (0.92)
======== ========
Weighted-average shares
used in computing pro
forma net loss per
common share, basic and
diluted (unaudited).... 21,129 29,331
======== ========
23
As of December 31, As of
------------------------------------------ June 30,
1996 1997 1998 1999 2000 2001
----- ------- ------- -------- -------- -----------
(in thousands)
(unaudited)
Balance Sheet Data:
Cash and cash
equivalents............ $ 122 $ 4,088 $11,438 $ 2,322 $ 12,532 $ 45,152
Working capital......... 121 3,595 10,956 792 4,240 34,806
Total assets............ 178 4,680 12,379 8,026 37,565 78,982
Deferred revenue........ -- 72 11 511 8,687 17,684
Long-term obligations,
less current portion... -- -- 520 3,321 7,994 3,685
Convertible preferred
stock.................. -- 5,526 17,361 20,472 62,883 119,246
Deferred stock-based
compensation, net...... -- -- -- (1,244) (11,263) (15,645)
Retained earnings
(accumulated deficit).. 107 (1,410) (6,074) (19,132) (62,724) (89,657)
Total stockholders'
equity (deficit)....... 129 (1,387) (6,047) (18,159) (59,848) (84,319)
See our financial statements and related notes for a description of the
calculation of the historical and pro forma net loss per common share and the
weighted-average number of shares used in computing the historical and pro
forma per common share data.
24
MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion should be read in conjunction with our financial
statements and related notes appearing elsewhere in this prospectus. This
discussion may contain forward-looking statements based upon current
expectations that involve risks and uncertainties. Our actual results and the
timing of selected events could differ materially from those anticipated in
these forward-looking statements as a result of selected factors, including
those set forth under "Risk Factors" and elsewhere in this prospectus. We
believe that the section entitled "Risk Factors" includes all material risks
that could harm our business.
Overview
We develop, manufacture and sell easy to use glucose self-monitoring systems
that dramatically reduce the pain of testing for people with diabetes. Our
first product, FreeStyle, received FDA clearance in January 2000, and we
commenced commercial shipments in the United States in June 2000. We sell
FreeStyle in the United States through national retailers and wholesalers, and
directly to consumers over the telephone and through our website. In March
2001, we obtained the CE Mark for FreeStyle, and our European distributor
commenced sales of FreeStyle in Germany and Sweden in May 2001.
We incurred significant operating losses and negative cash flows from
operations in each full fiscal year since inception. We incurred net losses of
$4.7 million in 1998, $13.1 million in 1999, $43.6 million in 2000 and $26.9
million for the six months ended June 30, 2001. As of June 30, 2001, we had an
accumulated deficit of $89.7 million. We expect to incur significant additional
losses as we expand our sales and marketing efforts and continue to develop new
products.
Revenues are generated from sales of our FreeStyle System kit and from the
recurring sales of disposable FreeStyle test strips and lancets. Our return
policy allows end users in the United States to return FreeStyle System kits to
us for a full cash refund within 30 days of purchase. There are no end-user
return rights on sales of FreeStyle test strips and lancets. In addition, our
FreeStyle System kit and FreeStyle test strips currently have an 18 month shelf
life, and retailers and wholesalers in the United States can return these
products to us up to six months beyond this expiration date. As a result of
these rights of return and the current unavailability of historical trends in
sales and product returns, we defer recognition of revenue on sales of
FreeStyle test strips until resold by the retailers and wholesalers to end
users, and we defer recognition of revenue on FreeStyle System kits until 30
days after purchase by the end user. Because we lack a sufficient historical
basis from which we could estimate return rates, we are required to rely on
data estimates provided to us by third-party data providers in order to
recognize revenue from sales to end users by retailers and wholesalers. These
data estimates may cause imprecise revenue recognition and we do not know how
long we will be required to rely on these estimates. Further, these third
parties may not provide consistent, reliable data.
Our products distributed internationally have no right of return, and we
recognize revenue on these products upon shipment. We recognize revenue on
direct product sales over the telephone or through our website to end users
upon shipment for FreeStyle test strips and lancets and 30 days after purchase
on sales of FreeStyle System kits. Our current sales terms to retailers and
wholesalers provide for customer payment within 60 days of shipment on initial
orders and payment within 30 days for subsequent orders. We perform ongoing
credit evaluations of our customers' financial condition and, generally,
require no collateral from our customers. We believe our terms to retailers,
wholesalers and end users, including their rights to return, are similar to our
competitors' terms.
Manufacturers typically sell their glucose monitoring devices at substantial
discounts to list prices, offer customer rebates or provide free product
samples to expand their installed base of monitoring devices and thus increase
the market for their disposable test strips and lancets. We have been offering
and
25
expect to continue to offer similar discounts and rebates on, and free samples
of, our FreeStyle System kits to establish an installed base of systems from
which we expect to generate recurring revenues from our disposable FreeStyle
test strips and lancets. Due to the recent commencement of our sales, we do not
have significant historical trends in rebates claimed by end users. As a
result, we record an allowance for 100% of the allowable rebate as a reduction
of revenues reported. As we accumulate trend data in rebates claimed, we are
likely to change the percentage of the allowable rebate.
The initial product mix of FreeStyle System kits when compared to disposable
FreeStyle test strips and lancets will negatively impact our gross margins
until we have established a sufficiently large installed base of users, as we
currently distribute the FreeStyle System kit at a financial loss due in part
to samples, discounts and rebates. In the event we establish an installed base
of systems, we expect to generate an increasing portion of our revenues through
recurring sales of our FreeStyle test strips.
Cost of revenues consists primarily of:
. payments to our manufacturing and distribution partners;
. expenses relating to our disposable test strip manufacturing;
. expenses relating to our internal operations;
. expenses relating to our five-year warranty on our FreeStyle meter;
. amortization of deferred stock-based compensation; and
. royalties payable under technology licenses.
We manufacture our disposable test strips ourselves at our facility in Alameda,
California. We outsource the manufacturing, packaging and testing of our
FreeStyle meters to Flextronics International Ltd., an electronics contract
manufacturer. Our FreeStyle lancing device and disposable lancets are
manufactured by Facet Technologies LLC, a wholly-owned subsidiary of Matria
Healthcare, Inc. Our distribution services are performed by Livingston Health
Care Systems Inc., a division of UPS Global Logistics.
Research and development expenses include costs associated with the design,
development, testing and enhancement of our products. These costs consist
primarily of:
. salaries and related personnel expenses;
. fees paid to outside service providers;
. expenditures for purchases of laboratory supplies and clinical
trials;
. amortization of deferred stock-based compensation; and
. overhead allocated to product development.
At the time we commenced commercial shipments in June 2000, we transitioned the
recording of manufacturing-related costs from research and development expense
to cost of revenues. All research and development costs are expensed as
incurred. Our research and development efforts are periodically subject to
significant non-recurring costs and fees that can cause significant variability
in our quarterly research and development expenses.
Selling, general and administrative expenses primarily consist of:
. salaries, commissions and related expenses for personnel engaged in
sales, marketing, customer service and administrative functions;
26
. costs associated with advertising, product sampling, trade shows,
promotional and other marketing activities;
. legal and regulatory expenses;
. amortization of deferred stock-based compensation; and
. general corporate expenses.
Deferred stock-based compensation consists of amortization of deferred
compensation in connection with stock option grants and sales of stock to
employees at exercise or sales prices below the deemed fair market value of our
common stock. Deferred stock-based compensation for options granted to non-
employees has been determined as the fair value of the equity instruments
issued. Deferred stock-based compensation for options granted to non-employees
is periodically remeasured as the underlying options vest. As of June 30, 2001,
we have recorded aggregate deferred stock-based compensation of $19.6 million,
of which $15.6 million will be amortized to expense on a straight line basis
through 2005. This amount is being amortized over the respective vesting
periods of these equity instruments, which is typically four years. Deferred
stock-based compensation expense has been allocated according to employees and
their respective departments and by function for non-employees.
In September 2000, we entered into a five-year exclusive distribution agreement
with Disetronic Group relating to the distribution of FreeStyle in Germany,
Switzerland, Denmark, Austria, Sweden, Finland, Norway and the Netherlands.
Disetronic commenced sales in Germany and Sweden in May 2001. In connection
with this agreement, we received an advance payment on a purchase order from
Disetronic of $1.5 million, which we recognized in the second quarter of 2001
as we shipped products.
In April 2001, we entered into a five-year exclusive distribution agreement
with Nipro Corporation relating to the distribution of FreeStyle in Japan. In
connection with this agreement, we received a $5.0 million payment from Nipro,
which is being recognized as revenue ratably over the term of the agreement
commencing in April 2001.
Results of Operations
Six Months Ended June 30, 2000 and June 30, 2001
Revenues. There were nominal product revenues for the six months ended June 30,
2000. However, we recognized revenue of $0.5 million from a specific non-
refundable negotiation fee related to a potential distribution arrangement,
which was never consummated. We recognized revenues of $25.5 million for the
six months ended June 30, 2001, principally consisting of sales of FreeStyle
System kits and FreeStyle test strips. Two of our customers, McKesson and
Walgreens, and our European distributor, Disetronic, individually accounted for
more than 10% and collectively accounted for approximately 40% of our revenues
for the six months ended June 30, 2001. As of June 30, 2001, deferred revenue,
awaiting sale through to end users and for the 30-day cash refund period on
FreeStyle System kit sales to lapse, was approximately $12.9 million. In
addition, we recognized revenues of $0.3 million for the six months ended June
30, 2001 related to the $5.0 million distribution agreement payment received
from Nipro.
Cost of revenues. Cost of revenues for the six months ended June 30, 2000 was
$0.3 million, and principally related to start-up production costs, as there
was no cost associated with the nonrefundable negotiation fee income earned.
Cost of revenues for the six months ended June 30, 2001 was $19.7 million,
attributable to product sales, as there was no cost associated with the license
fee income earned. Amortization of stock-based compensation expense reported in
cost of revenues for the six months ended June 30, 2001 was $0.2 million, as
compared to an insignificant amount in the same prior year period.
27
Research and development expenses. Research and development expenses increased
from $5.8 million for the six months ended June 30, 2000 to $6.3 million for
the six months ended June 30, 2001, representing an increase of $0.5 million,
or 8%. This increase was primarily attributable to $0.5 million from hiring
additional personnel, $0.5 million spent on clinical trials and $0.4 million
from increased spending on product development efforts. Prior to commencing
commercial shipments of FreeStyle in June 2000, costs associated with start-up
manufacturing activities were reported as research and development expenses.
These expenses, which occurred in the first half of 2000, totaled $1.2 million,
partially offsetting the increase in research and development expenses for the
six months ended June 30, 2001 over research and development expenses for the
six months ended June 30, 2000. Amortization of deferred stock-based
compensation was $0.5 million for the six months ended June 30, 2001 as
compared to $0.2 million in the same prior year period. We expect research and
development spending to increase over the next several years as we increase
clinical trials for our Continuous Glucose Monitoring System and expand our
research and development activities to support our current and future products.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $9.8 million for the six months ended
June 30, 2000 to $26.8 million for the six months ended June 30, 2001,
representing an increase of $17.0 million, or 174%. This increase was primarily
attributable to increases of $6.0 million spent on product sampling, $4.0
million for marketing activities and other spending associated with expanding
distribution and developing consumer awareness of FreeStyle, $3.3 million for
personnel costs largely related to expanding our U.S. direct sales force as
well as marketing and business support functions, $1.0 million spent for
customer service and support operations, and $0.5 million for travel costs,
largely related to our sales force. Amortization of deferred stock-based
compensation was $1.3 million for the six months ended June 30, 2001, as
compared to $0.3 million in the same prior year period. We expect our selling,
general and administrative expenses to increase as we increase product
sampling, expand our sales force, increase our marketing and promotional
activities, and operate as a public company.
Interest income, net. Net interest income remained relatively flat at $0.4
million for the six months ended June 30, 2000 and 2001. Interest income
results from our interest on cash and cash equivalents, while interest expense
is associated with borrowings under lines of credit and capital lease
obligations. Interest income for the six months ended June 30, 2001 increased
due to higher average cash and cash equivalents balances, resulting from the
net proceeds of a private equity offering initiated in January 2001. Interest
expense for the six months ended June 30, 2000 increased to a lesser extent, as
a result of additional borrowings under available lines of credit, amortization
of debt issuance costs associated with warrants issued in connection with lines
of credit and capital lease obligations arising under a particular sale and
leaseback transaction.
Dividend related to beneficial conversion feature of preferred stock. Dividends
relating to beneficial conversion of our preferred stock of $26.8 million were
recorded in the six months ended June 30, 2001. These dividends arose due to
the issuance of 6,643,371 shares of Series D preferred stock in January,
February and April 2001 for net proceeds of $56.4 million.
Years Ended December 31, 1998, 1999 and 2000
Revenues. Revenues in 1998 and 1999 principally related to research grants and
the sale of clinical evaluation units. Revenues recognized in 2000 totaled $5.5
million, principally consisting of product sales of FreeStyle System kits and
FreeStyle test strips which commenced in June 2000. Revenue in 2000 also
included $0.5 million from a specific non-refundable negotiation fee related to
a potential distribution arrangement, which was never consummated. Four of our
customers, CVS, Walgreens, Wal-Mart and McKesson, individually accounted for
more than 10% and collectively accounted for approximately 53% of our revenues
for the year ended December 31, 2000. As of December 31, 2000,
28
deferred revenue, awaiting sale through to end users and for the 30-day cash
refund period on FreeStyle System kit sales to lapse, was approximately $8.7
million.
Cost of revenues. There was no cost of revenues recorded in fiscal years 1998
and 1999. Cost of revenues in 2000 was $11.9 million and was comprised of
internal manufacturing costs, purchase costs for FreeStyle System kits and
FreeStyle lancets from our contract manufacturing partners, costs of product
warranties, royalties payable under technology licenses, start-up production
costs and a $3.5 million charge to reduce FreeStyle System kit inventories to
estimated net realizable value. Amortization of stock-based compensation
expense reported in cost of revenues for 2000 was insignificant. Prior to
commencing commercial shipments of FreeStyle in June 2000, costs associated
with start-up manufacturing-related activities, including stock-based
compensation expense, were reported as research and development expenses. There
was no cost associated with the license fee income earned.
Research and development expenses. Research and development expenses increased
from $3.1 million in 1998 to $7.7 million in 1999 and to $12.0 million in 2000.
The increase from 1998 to 1999 was principally due to $2.2 million from hiring
of additional personnel and increased spending of $1.6 million associated with
the development of FreeStyle. The increase from 1999 to 2000 was primarily
attributable to increases of $1.6 million for materials and supplies used in
product development efforts, $1.1 million from hiring of additional personnel,
a $0.5 million payment for the purchase of technology and license rights from
E. Heller & Co., which owns more than five percent of our stock, $0.4 million
for overhead costs associated with our new facility and $0.2 million for
payments to outside service providers. The technology and license rights
purchased from E. Heller & Co. concern the measurement of biochemicals other
than glucose. This technology is at an early stage of development, and it is
currently uncertain whether it will have commercial application. Amortization
of deferred stock-based compensation was $0.6 million for the year ended
December 31, 2000. Stock-based compensation expense for the corresponding
period in 1999 was insignificant.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $1.8 million in 1998 to $5.6 million in
1999 and to $25.5 million in 2000. The increase from 1998 to 1999 was primarily
attributable to increases of $1.5 million in personnel costs, $0.8 million in
marketing expenses, $0.7 million in costs associated with moving into our new
facility in August 1999, $0.3 million in legal and professional services and
$0.2 million in travel costs. The increase from 1999 to 2000 was primarily
attributable to increases of $6.2 million for personnel costs, largely related
to recruiting and hiring our U.S. direct sales force, as well as expanding
marketing and business support functions, $4.6 million for advertising,
marketing activities and other spending associated with the launch of
FreeStyle, $2.8 million spent on the cost of product sampling, $1.5 million
spent on establishing customer service and support operations, $1.1 million for
overhead costs, $1.0 million for travel costs, largely related to our new sales
force, $0.9 million spent on professional fees relating to a proposed public
offering withdrawn in December 2000 and $0.5 million for legal fees for both
patent and general corporate matters. Amortization of deferred stock-based
compensation was $1.2 million for the year ended December 31, 2000. Stock-based
compensation expense for the corresponding period in 1999 was insignificant.
Interest income, net. Net interest income remained relatively flat at $0.1
million in 1998 and 1999, and $0.3 million in 2000. Interest income in 2000
increased due to higher average cash and cash equivalents balances, resulting
from the net proceeds of a private equity offering completed in February 2000.
Interest expense for the same period increased to a lesser extent, reflecting
additional borrowings under available lines of credit, amortization of debt
issuance costs associated with warrants issued in connection with lines of
credit and capital lease obligations arising under a particular sale and
leaseback transaction.
29
Provision for income taxes. We incurred net operating losses for the years
ended December 31, 1998, 1999 and 2000 and, accordingly, we did not pay any
federal or state income taxes. As of December 31, 2000, we had accumulated
approximately $44.8 million and $31.2 million in federal and state net
operating loss carryforwards, respectively, to reduce future taxable income. If
not utilized, the federal carryforward will expire in various amounts beginning
in 2012, and the state carryforward will expire in 2005. Our net operating loss
carryforwards are subject to annual limitation under Internal Revenue Code
Section 382 due to substantial changes in ownership. Changes have already
occurred on April 21, 1997 and February 23, 1999 as a result of our preferred
stock financings. An additional change may occur as a result of this offering.
The annual limitations do not result in the expiration of net operating losses
prior to utilization. We have not recorded a benefit from our net operating
loss carryforwards because we believe that it is uncertain that we will have
sufficient income from future operations to realize the carryforwards prior to
their expiration. Accordingly, we have established a valuation allowance
against the deferred tax asset arising from the carryforwards.
We also had federal and state research and development tax credit carryforwards
as of December 31, 2000 of approximately $0.7 million and $0.6 million,
respectively. If not utilized, the federal research credit will expire in
various amounts beginning in 2012. The state research credit can be carried
forward indefinitely.
Dividend related to beneficial conversion feature of preferred stock. Dividends
relating to beneficial conversion of our preferred stock of $14.8 million were
recorded in the year ended December 31, 2000. These dividends arose due to the
issuance of 8,490,159 shares of Series C preferred stock in February 2000 for
net proceeds of $42.4 million.
Quarterly Results of Operations
The following table sets forth selected quarterly statement of operations data
for each of the five quarters indicated below. This information is derived from
our unaudited financial statements, which have been prepared by us on a basis
consistent with our audited financial statements and, in management's opinion,
include all adjustments necessary, consisting only of normal recurring
adjustments, for a fair presentation of this information. These quarterly
results of operations are not necessarily indicative of results of operations
in any future period.
Quarter Ended
--------------------------------------------------------
June 30, September 30, December 31, March 31, June 30,
2000 2000 2000 2001 2001
-------- ------------- ------------ --------- --------
(in thousands)
(unaudited)
Revenues................ $ 11 $ 1,280 $ 3,712 $ 7,677 $ 17,847
Cost of revenues........ 306 6,763 4,879 6,225 13,443
------- -------- -------- -------- --------
Gross profit (loss)..... (295) (5,483) (1,167) 1,452 4,404
------- -------- -------- -------- --------
Operating expenses:
Research and
development.......... 2,633 3,561 2,615 2,798 3,534
Selling, general and
administrative....... 5,444 5,522 10,163 11,033 15,810
------- -------- -------- -------- --------
Total operating
expenses........... 8,077 9,083 12,778 13,831 19,344
------- -------- -------- -------- --------
Loss from operations.... (8,372) (14,566) (13,945) (12,379) (14,940)
Interest income
(expense), net......... 218 11 (32) 199 187
------- -------- -------- -------- --------
Net loss................ $(8,154) $(14,555) $(13,977) $(12,180) $(14,753)
======= ======== ======== ======== ========
30
Revenues. The increase in revenues beginning with the quarter ended September
30, 2000 reflects increased market acceptance of FreeStyle since commercial
shipments commenced in June 2000.
Gross profit (loss). Gross profit (loss) is influenced by both sales volume and
the product mix between FreeStyle System kits and FreeStyle test strips, as we
currently distribute the FreeStyle System kit at a financial loss due in part
to samples, discounts and rebates. The gross loss for the quarter ended
September 30, 2000 was negatively impacted by a $3.5 million charge to reduce
FreeStyle System kit inventories to estimated net realizable value. The gross
profit for the two most recent quarters resulted from higher sales volume and
an increased percentage of FreeStyle test strip revenues versus FreeStyle
System kit revenues.
Operating expenses. Prior to commencing commercial shipments of FreeStyle in
June 2000, costs associated with start-up manufacturing activities were
reported as research and development expenses. These expenses, which occurred
in the first half of 2000, totaled $1.2 million. Research and development
expenses for the third quarter of 2000 included an expense accrual in the
amount $1.2 million related to incorporating engineering modifications into
FreeStyle. Selling, general and administrative expenses increased in absolute
dollars throughout 2000 and the first half of 2001, reflecting increased
personnel costs, including recruiting and hiring our U.S. direct sales force,
advertising, marketing and other spending associated with the launch of
FreeStyle. In addition, costs were incurred beginning in the fourth quarter of
2000 related to increases in product sampling to stimulate consumer adoption of
FreeStyle.
Liquidity and Capital Resources
From our inception through June 30, 2001, we have financed our operations
primarily through private placements of convertible preferred stock resulting
in net proceeds of $119.2 million. We have also financed our operations through
equipment financing arrangements and other loans with $6.9 million in principal
outstanding at June 30, 2001. Our current principal debt arrangements include
both a $5.0 million subordinated debt agreement at an effective interest rate
of 22.3% per annum and a $2.5 million equipment line of credit at effective
interest rates between 8.5% and 9.5% per annum with Comdisco Ventures, and a
$2.0 million senior loan and security agreement at an effective interest rate
of 13.1% per annum with Phoenix Capital. These effective annual interest rates
include the amortization of the fair value of warrants issued to each of these
lenders. We may no longer borrow capital under these debt arrangements. As of
June 30, 2001, we had cash and cash equivalents of $45.2 million.
Cash used in operations. Net cash used in operating activities was
approximately $4.5 million, $11.8 million, $36.8 million and $19.4 million for
the years ended December 31, 1998, 1999, 2000 and for the six months ended June
30, 2001, respectively. For these periods, net cash used in operating
activities resulted primarily from net losses. For the year ended December 31,
2000 and the six months ended June 30, 2001, increases in accounts receivable
and inventories, which reflected commencement of commercial product shipments
in June 2000, were partially offset by increases in deferred revenue and
accrued liabilities.
Cash used in or provided by investing activities. Net cash used in investing
activities was approximately $0.6 million, $3.3 million and $0.9 million for
the years ended December 31, 1998 and 1999 and for the six months ended June
30, 2001, respectively. These investing activities consisted of capital
expenditures. The increase in 1999 resulted from purchases of machinery and
equipment for manufacturing our FreeStyle test strips in addition to expenses
associated with our move into a new facility in August 1999. For the year ended
December 31, 2000, net cash provided by investing activities, totaling $0.6
million, included $2.7 million in proceeds from the sale of capital assets
under sale and leaseback transactions.
31
Cash provided by financing activities. Net cash provided by financing
activities was approximately $12.5 million, $6.0 million, $46.4 million and
$52.9 million for the years ended December 31, 1998, 1999, 2000 and the six
months ended June 30, 2001, respectively. The net cash provided by financing
activities was primarily attributable to the proceeds from private placements
of equity securities and proceeds from long-term borrowings.
We expect to have negative cash flow from operations for at least the next 12
months. We also expect increased sales and marketing expenses related to the
promotion of FreeStyle, increased research and development expenses, as well as
expenses for additional personnel and product enhancement efforts. Our future
capital requirements will depend on a number of factors, including market
acceptance of FreeStyle, the resources we devote to developing and supporting
our products, continued progress of our research and development of potential
products, the need to acquire licenses to technology and the availability of
other financing. Our capital expenditures for the year ended December 31, 2000
were $2.1 million, and we believe that our capital requirements for the next 12
months will increase as a result of expanding our facilities and our test strip
manufacturing capacity. We believe that our current cash balances, together
with the net proceeds of this offering and revenue to be derived from sales of
FreeStyle, will be sufficient to fund our operations for at least the next 18
months. To the extent our capital resources are insufficient to meet our future
capital requirements, we will need to raise additional capital or incur
additional indebtedness to fund our operations. Additional equity or debt
financing, if required, may not be available on acceptable terms, or at all. If
we are unable to obtain additional capital, we may be required to reduce our
selling and marketing activities for FreeStyle, delay, reduce the scope of or
eliminate our research and development programs, or relinquish rights to
technologies or products that we might otherwise seek to develop or
commercialize. In the event that we do raise additional equity financing,
investors in this offering will be further diluted. In the event we incur
additional indebtedness to fund our operations, we may have to grant the lender
a security interest in our assets.
Quantitative and Qualitative Discussion of Market Risk
Although we transact our business in U.S. dollars, future fluctuations in the
value of the U.S. dollar may affect the price competitiveness of our products.
However, we do not believe that we currently have any significant direct
foreign currency exchange rate risk and have not hedged exposures denominated
in foreign currencies or any other derivative financial instruments.
The primary objective of our investment activities is to preserve principal
while at the same time maximizing the income we receive from our invested cash
without significantly increasing risk of loss. As of June 30, 2001, our cash
and cash equivalents consisted primarily of money market funds maintained at
one major U.S. financial institution. The recorded carrying amounts of cash and
cash equivalents approximate fair value due to their short-term maturities. We
do not believe that an increase in market rates would have any significant
negative impact on the realized value of our investments, but an increase in
market rates could negatively impact the interest expense associated with a
portion of our long-term debt. Substantially all of our long-term debt
obligations have a fixed rate of interest.
Inflation
The impact of inflation on our business has not been material to date.
Recently Issued Accounting Pronouncements
Effective January 1, 2001, we adopted SFAS No. 133, "Accounting for Derivative
Instruments and Hedging Activities." SFAS No. 133 establishes accounting and
reporting standards for derivative instruments and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. To date, we
32
have not engaged in derivative and hedging activities, and therefore the
adoption had no impact on our financial statements.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 141
"Business Combinations" which establishes financial accounting and reporting
for business combinations and supersedes APB Opinion No. 16, Business
Combinations, and FASB Statement No. 38, Accounting for Preacquisition
Contingencies of Purchased Enterprises. SFAS No. 141 requires that all business
combinations be accounted for using one method, the purchase method. The
provisions of this statement apply to all business combinations initiated after
June 30, 2001. We will adopt SFAS No. 141 during the first quarter of fiscal
2002, and this adoption is expected to have no impact on our financial
reporting and related disclosures.
In July 2001, the Financial Accounting Standards Board issued SFAS No. 142
"Goodwill and Other Intangible Assets," which establishes financial accounting
and reporting for acquired goodwill and other intangible assets and supersedes
APB Opinion No. 17, Intangible Assets. SFAS No. 142 addresses how intangible
assets that are acquired individually or with a group of other assets (but not
those acquired in a business combination) should be accounted for in financial
statements upon their acquisition, and after they have been initially
recognized in the financial statements. The provisions of this statement are
effective for fiscal years beginning after December 15, 2001. We will adopt
SFAS No. 142 during the first quarter of fiscal 2002, and this adoption is
expected to have no material impact on our financial reporting and related
disclosures.
33
BUSINESS
Overview
We develop, manufacture and sell easy to use glucose self-monitoring systems
that dramatically reduce the pain of testing for people with diabetes. Our
first product, FreeStyle, received FDA clearance in January 2000, and we began
selling FreeStyle in the United States in June 2000. FreeStyle utilizes
patented technologies that can accurately measure glucose concentrations from a
tiny 0.3 microliter sample of blood, as opposed to competitive products that
require from 1.0 to 10.0 microliters of blood. Our tiny sample size is easily
obtained by lancing the forearm, thigh, calf, upper arm or hand and therefore
avoids the pain associated with drawing a larger blood sample from the
fingertip. These alternate sites are significantly less painful to lance than
the traditional fingertip test site, which is more densely populated with
highly sensitive nerve endings but yields the larger blood volumes required by
competitive products. Nine out of ten people in our clinical studies found
using FreeStyle less painful than their current finger-stick-based system.
We believe that FreeStyle is well positioned to capture a meaningful share of
the blood glucose self-monitoring market. The blood glucose self-monitoring
market is the largest self-test market for medical diagnostic products in the
world, with a size of approximately $2.0 billion in the United States and $3.5
billion worldwide in 2000. It is estimated that the worldwide blood glucose
self-monitoring market will amount to $9.0 billion by 2005. We believe that
FreeStyle and other products based on our proprietary technologies can expand
this market by substantially reducing the pain associated with testing and
thereby bring non-testers into the market and encourage under-testers to test
more regularly. We are also developing a Continuous Glucose Monitoring System
that is intended to permit people with diabetes to accurately and discreetly
measure their glucose levels on a continuous basis.
Our direct sales force promotes FreeStyle in the United States to health care
professionals who advise patients on the monitoring and management of their
diabetes. We distribute and sell FreeStyle in the United States to nine of the
ten largest national retailers, including Walgreens, Wal-Mart and CVS, through
wholesalers, including McKesson, Cardinal Health and Bergen Brunswig, and
directly to end users over the telephone and through our website. In September
2000, we entered into an agreement with Disetronic Group for the exclusive
distribution of FreeStyle in selected European countries. In March 2001, we
obtained the CE Mark, which permits us to commercially distribute FreeStyle
throughout the European Union. Disetronic commenced sales in Germany and Sweden
in May 2001. In April 2001, we entered into an agreement with Nipro Corporation
for the exclusive distribution of FreeStyle in Japan, and an application for
approval to market FreeStyle in Japan was recently submitted. Disetronic and
Nipro are the leading suppliers of insulin pumps in Europe and Japan,
respectively. Insulin pump users are typically highly motivated insulin-
dependent diabetes patients who frequently test their blood glucose levels.
Market Opportunity
Diabetes
Diabetes is a chronic, life-threatening disease for which there is no known
cure. Diabetes occurs when the body does not produce sufficient levels of, or
fails to effectively utilize, insulin. Insulin is a hormone that regulates the
storage and metabolism of glucose. Glucose levels in the blood must be
maintained within a specific concentration range to ensure optimal cellular
function and health. Under normal conditions, the body maintains proper blood
glucose levels by releasing insulin in response to increases in blood sugar.
Diabetes is typically classified as Type 1 or Type 2. Type 1 diabetes is the
most serious form of the disease and is characterized by a severe lack of
insulin secretion by the body. Type 1 diabetes usually
34
occurs during childhood or adolescence, but it can occur at any age.
Individuals with Type 1 diabetes require daily insulin injections to survive.
Type 2 diabetes is the most common form of the disease and is characterized by
the body's inability to produce enough insulin or to properly utilize insulin.
Type 2 diabetes typically occurs in adulthood. However, because of sedentary
lifestyles and inappropriate diet, Type 2 diabetes is increasing in incidence
among the younger population. Type 2 diabetes is initially managed with diet,
exercise and oral medication. However, many people with Type 2 diabetes will
eventually require daily insulin injections.
In the United States, approximately 16 million people, about 6% of the
population, have diabetes, although only approximately 10 million of these
people have been diagnosed with the disease. The share of the United States
population diagnosed with diabetes increased 33% between 1990 and 1998,
primarily due to the aging of the population, inappropriate diets and
increasingly sedentary lifestyles. The most rapid onset was in adults ages 30
through 39. It is also on the rise among a younger population base, including
children and teenagers. Worldwide, approximately 175 million people, about 3%
of the population, have been diagnosed with diabetes. The worldwide prevalence
of diagnosed diabetics is expected to increase to 239 million by 2010.
Importance of Glucose Monitoring
Diabetes is the sixth leading cause of death by disease in the United States,
with one death due to diabetic complications occurring every three minutes. The
failure to frequently monitor and control blood glucose levels leads to severe
medical complications over time, including blindness, loss of kidney function,
nerve degeneration and cardiovascular disease. Diabetes is estimated to cost
the United States economy over $98 billion annually, including indirect costs
such as lost productivity.
The goal of glucose monitoring is to avoid the complications of diabetes by
allowing patients and their health care providers to determine a treatment
regimen, to monitor the effectiveness of the regimen, and to alter it as needed
for better overall control of blood glucose levels. Every person's blood
glucose level varies during the course of the day, depending upon factors such
as diet, insulin availability, exercise, illness and stress. To successfully
maintain blood glucose levels within the proper range, a person with diabetes
must first measure his or her glucose level and then manage this level by
adjusting insulin intake, oral medication, diet and exercise. Then the person
must take additional blood glucose measurements to gauge his or her individual
response to the adjustments. The more frequently people with diabetes test
their blood glucose levels and track their activities and food intake, the
better they will be able to understand and manage their diabetes.
Studies show that active monitoring and management of diabetes reduces the risk
of associated diabetes complications. The landmark Diabetes Control and
Complications Trial, or DCCT, showed that the onset and progression of eye,
kidney and nerve disease in people with Type 1 diabetes can be slowed by
intensive therapy to maintain blood glucose levels as close to normal as
possible. The DCCT demonstrated that the risk of complications could be reduced
by 76% for eye disease, 50% for kidney disease and 60% for nerve disease.
Similar studies in the United Kingdom and Japan involving people with Type 2
diabetes support the conclusion of the DCCT study that actively managing blood
glucose levels reduces the risk of complications associated with diabetes.
People with Type 1 diabetes are encouraged to test four or more times per day,
and those with Type 2 diabetes are typically expected to test two or more times
per day.
Limitations of Existing Glucose Monitoring Products
Despite the proven benefits of frequent monitoring and intensive management of
blood glucose levels, a significant number of people fail to test at their
recommended frequency, or at all. The American Diabetes Association estimates
that people with diabetes test, on average, slightly more than once per day. To
obtain a sample with current glucose monitoring systems, users generally are
required to prick
35
one of their fingertips with a lancing device, which typically consists of a
spring-loaded needle that penetrates a measured distance into the finger. Users
must then draw a sample of blood from the finger, which often requires
squeezing of the fingertips and may require another finger prick if a
sufficient volume of blood is not obtained the first time. After drawing a
blood sample, users generally are required to drop the blood sample on a
disposable test strip or place the test strip on the blood sample. We believe
that under-testing is due to the limitations of existing products including:
. Pain. Although the fingertips are rich in capillary beds and provide
a good site to obtain a blood sample, they are also more densely
populated with highly sensitive nerve endings. This makes the lancing
and subsequent manipulation of the finger painful. The pain and
discomfort are compounded by the fact that fingers offer limited
surface area, so tests are often performed on areas that are sore
from prior tests. Users also suffer pain when the lance wound is
disturbed during regular activities. A wound on the finger is also
more susceptible to infection.
. Large Sample Size. Competitive blood glucose meters require users to
draw a sample size from 1.0 to 10.0 microliters of blood to
accurately measure blood glucose levels. These larger sample sizes
are difficult or impossible to obtain on sites other than the finger.
Furthermore, the larger the blood sample required, the wider or
deeper the lancing must be in order to reliably draw the sample. This
leads to increased pain, greater likelihood of residual bleeding and
longer healing time.
. Susceptibility to Interference. The accuracy of other
electrochemical-based glucose monitoring systems can be compromised
in the presence of many substances commonly found in blood, such as
aspirin, acetaminophen, Vitamin C and uric acid. Accuracy can also be
compromised by unusually high or low levels of red blood cells. These
levels can be present in infants, pregnant women, patients on
dialysis, athletes and those living at high altitudes.
. Lifestyle Disruption. The process of measuring blood glucose levels
causes significant disruption in the daily lives of people with
diabetes and their families. Children must be awakened in the middle
of the night for a blood glucose test to avoid dangerous episodes of
sleeping hypoglycemia, a condition in which glucose levels are too
low. Lancing the fingertips on infants is traumatizing to both parent
and child. Obtaining large blood samples is inconvenient and may
cause embarrassment in social situations, particularly for young
children who are often required to be removed from class or
activities to test themselves in the nurse's office. Children may
also avoid, or be prevented from, playing with their classmates
following a test because of the fear that continued bleeding may
cause contamination.
As a result, we believe a significant market opportunity exists for a glucose
self-monitoring system that requires a sufficiently small sample of blood so
users can avoid the pain, inconvenience and social embarrassment of drawing
large blood samples from their fingertips.
The TheraSense Solution
FreeStyle is easy to use, accurate and competitively priced. We believe
FreeStyle also offers the following significant advantages over existing blood
glucose monitoring systems:
. Reduction in Pain. FreeStyle requires a tiny blood sample of 0.3
microliters, just a fraction of the sample size required by other
systems. The extremely small volume of blood required enables people
using FreeStyle to obtain blood not only from their fingertips as
required by most other systems on the market today, but alternatively
from their forearm, hand, thigh, upper arm or calf. Ninety percent of
people in our clinical studies found using FreeStyle less painful
than their current finger-stick-based systems. FreeStyle also
eliminates soreness from repeated testing on a small surface area.
36
. Better Performance. FreeStyle's proprietary measurement technology is
extremely accurate, operates over a broad temperature range and is
unaffected by common interfering substances, such as aspirin,
acetaminophen, Vitamin C and uric acid. It is also unaffected by
unusually high or low levels of red blood cells. The tiny blood
sample required by FreeStyle can be reliably obtained from sites
other than the fingertip.
. Improved Quality of Life. The combination of a smaller sample size
and off-fingertip testing enabled by FreeStyle significantly reduces
residual bleeding. This reduces the embarrassment of testing felt by
some people with diabetes and affords them more discretion in
testing. The pain and awkwardness of publicly obtaining large blood
samples have deterred people with diabetes from testing frequently
enough to manage their disease.
Our Strategy
Our objective is to be a leading provider of innovative glucose self-monitoring
products that reduce the pain of testing, are easy to use, accurate, cost
effective and improve the lives of people with diabetes. To achieve this
objective, we are pursuing the following business strategies:
. Establish FreeStyle as a leading blood glucose self-monitoring
device. We are creating awareness of the advantages of FreeStyle in
the United States among health care professionals and people with
diabetes. We do this through advertising, extensive retail
distribution and a sales force of more than 80 people. We believe an
increased awareness of FreeStyle's less painful, more discreet and
reliable process will lead many current testers to switch to
FreeStyle. In addition, we believe we can expand the market to those
people who have been diagnosed with diabetes but are currently not
testing, as well as increase testing frequency for those who are
under-testing.
. Maintain and enhance retail distribution. We currently have
authorized shelf space with eight of the ten largest chain drug
stores, the three largest mass market retailers and the three largest
supermarket retailers. These retailers represent over 20,000 pharmacy
outlets in the United States. We plan to continue to expand
FreeStyle's availability within these distribution channels through
our national accounts sales representatives.
. Focus on our core competencies. We plan to continue to focus our
internal resources on our core competencies--electrochemistry and
sensor manufacturing technologies. Consequently, we have entered into
strategic relationships to enhance speed to market and cost
effectiveness for those business functions not included in our core
competencies. For example, we have a strategic relationship with
Flextronics International, which assisted us with the FreeStyle meter
development and is currently manufacturing our meters and assembling
our FreeStyle System kits. Through these relationships, we believe
that we will be able to quickly and efficiently build infrastructure
and services needed to meet anticipated market demand.
. Provide high quality customer service. We provide all of our
customers with easy, comprehensive access to our products and
services through the use of sophisticated software systems and an
educated and caring customer service team. Our approach is to partner
with a service organization while maintaining a small team of in-
house service specialists to monitor quality. We offer customer
service 24 hours per day, seven days per week with access to
dedicated representatives via telephone or the Internet. In addition,
we use the Internet to enable customers to purchase our products
online, enhance awareness of our products, establish e-mail
management, facilitate loyalty programs and provide product support
and training.
. Establish an international presence for FreeStyle. We intend to
expand our international sales of FreeStyle and enter new global
markets through relationships with established health care companies
that have developed distribution channels. The Disetronic Group is
37
our exclusive distributor of FreeStyle in selected European
countries. Disetronic commenced sales in Germany and Sweden in May
2001. In April 2001, we entered into an agreement with Nipro
Corporation for the exclusive distribution of FreeStyle in Japan. We
anticipate that Nipro will commence sales in 2002, subject to
regulatory approval. Disetronic and Nipro are the leading suppliers
of insulin pumps in Europe and Japan, respectively. Insulin pump
users are typically highly motivated insulin-dependent diabetes
patients who frequently test their blood glucose levels.
. Leverage our proprietary technology platform. We intend to leverage
our proprietary electrochemical sensor technologies to develop new
glucose monitoring products. We are currently developing a Continuous
Glucose Monitoring System intended to continuously measure and
display a person's glucose levels in real time for up to three days.
We are also expanding our current FreeStyle product family by
developing enhanced versions of FreeStyle and a module for the
Handspring Visor personal digital assistant that would enable it to
act as a glucose monitor and sophisticated diabetes management
system. We may also develop a lower priced glucose monitor or a
hospital version of FreeStyle for multiple users.
Our Products
FreeStyle Blood Glucose Monitoring System. Our initial product, the FreeStyle
blood glucose monitoring system, received FDA clearance in January 2000 for use
on the forearm and fingers. We began selling FreeStyle in the United States in
June 2000. In December 2000, we received FDA clearance that permits FreeStyle
to be used on the thigh, calf, upper arm and hand. This represents the broadest
array of off-finger testing sites cleared by the FDA. The FreeStyle System kit
includes a FreeStyle meter, an initial supply of 10 proprietary disposable
FreeStyle test strips, a FreeStyle lancing device, an initial supply of 10
disposable FreeStyle lancets, FreeStyle control solution and instructional
materials. We also sell additional supplies of disposable FreeStyle test strips
in quantities of 50 and 100 and additional supplies of disposable FreeStyle
lancets in quantities of 100.
. FreeStyle meter. The FreeStyle meter contains a large display screen
to read test results, a slot where the test strip is inserted to get
a blood glucose reading, and buttons to change the calibration code
and review results in the system memory. It also contains a data port
for interfacing with FreeStyle Connect data management software,
which allows users to download information from the meter to personal
computers and analyze glucose levels. The ergonomically designed
meter fits easily in the hand and weighs 2.1 ounces. The meter
displays blood glucose results in a range of 20 to 500 mg/dl. Once
the sample is acquired, the meter takes about 15 seconds to display
the result. The meter has the ability to store the last 250 blood
glucose test results and to display a 14-day average blood glucose
level.
. FreeStyle test strips. FreeStyle test strips are proprietary
disposable sensors that are used with the FreeStyle meter to measure
blood glucose levels. The test strips are clearly marked to indicate
proper placement in the meter. Inserting the test strip into the
meter activates the system and either side of the test strip can be
used for measurement. The FreeStyle meter beeps one time when
sufficient blood has been drawn into the test strip and beeps two
times when the test is complete. Our proprietary FreeStyle test
strips may only be used with our FreeStyle meter.
. FreeStyle lancing device and lancets. The FreeStyle lancing device is
designed specifically to make blood sample acquisition reliable and
convenient. It requires no mechanical or vacuum assistance to draw
blood. The lancing device offers five adjustable depth settings to
allow for comfort and adequate sample size. Although FreeStyle
lancets are available, other standard lancets are compatible with our
system. It is recommended that a new, sterile lancet be inserted into
the lancing device every time a test is administered. The
38
reduction in pain from FreeStyle is attributable to the lancing site
and the small sample size required, not the type of lancing device or
lancet.
. FreeStyle control solution. The FreeStyle control solution contains a
fixed amount of glucose that may be used periodically to ensure the
FreeStyle System is functioning correctly and users are following
correct testing procedures.
FreeStyle Connect. In May 2000, we received FDA clearance for FreeStyle
Connect, a data management software product. FreeStyle Connect downloads data
from FreeStyle to a personal computer and displays glucose values in eight
different statistical reports, including the number of blood glucose values
above, within, and below a given target range. The FreeStyle meter stores up
to 250 glucose values each with time and date. This data allows health care
providers to help patients appropriately adjust their diet, exercise and
medication to improve and maintain their health.
Products Under Development
Continuous Glucose Monitoring System. We are developing a continuous
monitoring device that will utilize a disposable, miniaturized electrochemical
sensor that can be inserted under the skin by the user utilizing a spring-
loaded insertion device. This sensor system will enable users to continuously
measure and display glucose levels and store the results for further analysis
by the user or a physician. This product is intended to act as a substitute
for current glucose self-monitoring devices. The increased number of glucose
readings will allow people with diabetes to more effectively adjust insulin,
oral medication, diet and exercise, which should result in significantly
improved health outcomes for people with diabetes. The Continuous Glucose
Monitoring System is being designed to offer people with diabetes the
following benefits:
. accurate and discreet measurement of glucose levels on a continuous
basis;
. elimination of the anxiety of not knowing glucose levels between
periodic measurements;
. minimally invasive insertion procedure;
. comfortable to wear during use;
. warnings against dangerously high or low glucose levels, even while
sleeping; and
. ability to improve health through intensively managed therapy from
continuous glucose information.
We believe each sensor used with our system will provide up to three days of
continuous glucose measurement. The accuracy and precision of our Continuous
Glucose Monitoring System will be dependent on the initial calibration.
Therefore, our system will have a built-in FreeStyle meter that will allow for
accurate and convenient calibration using FreeStyle test strips. The
integrated calibration will help eliminate the risk of human error during data
entry. The display unit, which can be worn like a pager, will translate the
sensor's information into a numerical value and periodically, or on demand,
display the glucose level and trend. This information will allow users to
determine whether glucose levels are rising, falling or remaining stable. The
sensor system is designed to communicate to the wireless display unit within a
10-foot range, so it can be conveniently worn on a belt, carried in a purse or
left on a bed stand at night.
We recently commenced two pilot clinical studies, one with people who do not
have diabetes and one with people who have diabetes. We expect that our
Continuous Glucose Monitoring System will require premarket approval, which
will require considerably more data and FDA review time than the
510(k) clearance process that was applicable to FreeStyle. The premarket
approval process generally takes between one and three years from completion
of an application or even longer. However, achieving a completed application
is a process that may take numerous clinical trials and require filing
39
of amendments over time. Therefore, even if the product is successfully
developed, it will not be commercially available for a number of years.
Additional FreeStyle Products. We are also expanding our current FreeStyle
product family by developing enhanced versions of FreeStyle and a module for
the Handspring Visor personal digital assistant that would enable it to act as
a glucose monitor and sophisticated diabetes management system. We may also
develop a lower priced glucose monitor or a hospital version of FreeStyle for
multiple users. We will also continue to identify and develop products that
fulfill unmet consumer needs and address strategic or competitive issues.
Our Sensor Technologies
We have developed two proprietary miniaturized electrochemical sensor
technologies. The first, NanoSample technology, is used in our FreeStyle
System. The second, Wired Enzyme chemistry, is used in our Continuous Glucose
Monitoring System under development.
NanoSample Technology. NanoSample technology enables FreeStyle to measure
glucose levels in blood samples of only 0.3 microliters, a fraction of the
sample size required by competitive products. We have pioneered techniques to
obtain accurate, reliable and fast responses when measuring glucose in sub-
microliter sample sizes. This technology allows us to measure the total
electrical charge generated by the reaction of all of the glucose in the
sample, a process referred to as coulometry. In contrast, the most advanced
competitive products generally determine glucose levels by taking a measurement
of the current generated by the sensor at a point in time, a process referred
to as amperometry. Amperometry requires the use of a larger blood sample to
achieve accurate results. Use of coulometry substantially eliminates some of
the errors frequently associated with amperometry, such as dependence of sensor
output on temperature and potential interference from commonly found substances
in the blood, such as aspirin, acetaminophen, Vitamin C and uric acid, which
can distort the glucose measurement.
Wired Enzyme Chemistry. Our Wired Enzyme chemistry is allowing us to develop
miniaturized, self-insertable, biocompatible, disposable sensors. We are
currently using this technology to develop our Continuous Glucose Monitoring
System. Our Continuous Glucose Monitoring System sensor, which will be inserted
under the skin by the user, will react with the glucose near or at the implant
site to produce an electrical signal that enables glucose concentration
measurement. We believe our technology will successfully address the core
technical issues that have limited the performance of other implantable glucose
sensors, including oxygen dependence and interference from commonly found
substances in blood, such as aspirin, acetaminophen, Vitamin C and uric acid.
We also believe our system will be calibrated easily and accurately.
Marketing and Sales
United States. Our marketing and sales program is intended to generate
awareness of FreeStyle and penetrate and expand the glucose self-monitoring
market. We currently have a national sales force comprised of more than 80
people. The sales force promotes FreeStyle to the health care professionals who
strongly influence the health care decisions made by people with diabetes, a
group which includes endocrinologists, certified diabetes educators and
internal medicine physicians. In addition, our sales force promotes FreeStyle
to retail outlets at the individual store level. The primary goal of our sales
force is to educate and train health care professionals on the benefits of our
products. We also provide these health care professionals with free samples of
our products. We believe these efforts will ultimately result in
recommendations and referrals for our products. There are also members of our
sales force dedicated to serving retail and managed care accounts at the
corporate level. We believe that our strategy of selling through our own direct
sales force is an important factor in achieving market penetration.
40
Our direct-to-consumer advertising campaign is aimed at health care
professionals, people with diabetes and people who know people with diabetes.
Our belief is that pain, reliability and quality of life issues are so
important in glucose testing that they are recognized and understood not only
by people with diabetes, but also by their co-workers, friends, and families,
each of whom will be willing to tell others. To further generate awareness and
penetrate the market, our sales and marketing organization provides a wide
range of programs, support materials and events that support our national sales
force. These include public relations efforts, product training, conference and
trade show attendance, and educational and promotional literature.
We primarily sell our products through retail pharmacies. We sell our products
directly to national retail pharmacies and supply other retail pharmacies
through wholesalers. We also sell to durable medical equipment suppliers and
directly to end users through phone orders and our website. Although there is
substantial competition from existing products, the consolidation of the retail
industry has allowed us to concentrate our sales efforts. The following is a
list of our top five retailers and top five wholesalers, ranked by dollar
volume of sales through July 31 , 2001:
Retailers Wholesalers
--------- -----------
Walgreens McKesson
Wal-Mart Cardinal Health
CVS Bergen Brunswig
Eckerd Bindley Western
Rite Aid AmeriSource
International. We intend to expand our international sales efforts for
FreeStyle and enter new global markets by establishing relationships with
international partners who have established relationships with healthcare
professionals and developed distribution channels. In March 2001, we obtained
the CE Mark, which permits us to commercially distribute FreeStyle throughout
the European Union. In September 2000, we entered into an agreement with
Disetronic Group for the exclusive distribution of FreeStyle in Germany,
Switzerland, Denmark, Austria, Sweden, Finland, Norway and the Netherlands. In
April 2001, we entered into an agreement with Nipro Corporation for the
exclusive distribution of FreeStyle in Japan. Disetronic and Nipro are the
leading suppliers of insulin pumps in Europe and Japan, respectively. Insulin
pump users are typically highly motivated insulin-dependent diabetes patients
who frequently test their blood glucose levels.
Under terms of the Disetronic Group agreement, Disetronic has exclusive
responsibility for sales, marketing and customer service in its territory in
Europe. We may terminate the agreement if Disetronic does not meet specified
minimum purchase requirements. Disetronic is also entitled to market FreeStyle
to Disetronic's pump users in North America. The initial term of the Disetronic
agreement is five years, ending in September 2005. Disetronic commenced sales
in Germany and Sweden in May 2001.
Under terms of the Nipro Corporation agreement, Nipro will have exclusive
responsibility for sales, marketing and customer service in Japan. We may
terminate the agreement if Nipro does not meet specified minimum purchase
requirements. The initial term of the Nipro agreement is five years, ending in
April 2006. We anticipate that Nipro will commence sales of FreeStyle in Japan
in 2002, subject to regulatory approval.
Distribution. To establish a worldwide distribution capability for end users,
health care professionals and retail customers, we have established
relationships with expert distribution partners. For retail order management
and shipping of our FreeStyle System kit and other products, we have entered
into an exclusive services agreement with Livingston Healthcare Services, Inc.,
a division of UPS Global Logistics that specializes in providing outsourced
distribution services for large pharmaceutical and
41
medical device companies. The initial term of this agreement is three years,
ending in March 2003. We may terminate this agreement prior to March 2003,
subject to payment of a termination fee. Livingston has an extensive network of
distribution centers and a sophisticated order management and product tracking
system. Livingston also manages our billing process. Our relationship with
Livingston allows us to meet shipment, delivery and billing expectations while
minimizing our internal infrastructure requirements.
Customer Service. We provide customer service 24 hours per day, seven day per
week through ICT Group. This service is transparent to the caller and provides
a standard of service expected in the industry. This relationship with ICT
Group provides customer service, technical support, a help desk and order
processing. ICT Group is an international telemarketing and e-support company,
with a medical marketing division which has developed a special facility and
dedicated customer care agents for us. ICT Group's agents have the systems
capability to handle large volumes of our customer contacts at any time, both
over the phone or through our web site. We select and train the ICT Group
agents who work on our account, as well as maintain in-house customer service
personnel that monitor quality. Our non-exclusive contract with ICT has an
initial term of three years, ending in April 2003, although it can be
terminated by either party without cause upon 120 days notice.
Manufacturing
The primary components of the FreeStyle System kit are the FreeStyle meter,
FreeStyle disposable test strips, the FreeStyle lancing device, FreeStyle
disposable lancets and FreeStyle control solution. We manufacture the FreeStyle
test strips and contract with third parties for the manufacture of the other
FreeStyle products. These contract manufacturing relationships minimize our
capital investment, help control costs and allow us to compete with larger
volume manufacturers of blood glucose self-monitoring systems.
We manufacture the FreeStyle test strips at our facility in Alameda,
California. We have developed a manufacturing process for the test strips that
we believe is robust, cost effective and scaleable to meet higher volumes. The
test strip is composed of chemicals, adhesive and a printed polyester similar
to the material used in credit cards.
Flextronics International assisted us in the design of our meter and is
responsible for manufacturing the FreeStyle meter and assembling the FreeStyle
System kits in San Jose, California. Flextronics has 12 years of experience
building blood glucose meters, and has facilities in Asia, Europe and the
Americas. Flextronics has demonstrated strong process control and knowledge of
just-in-time and total quality management techniques and has software tools to
handle product tracking. We have an on-site manager at Flextronics who is
responsible for the day-to-day interface with Flextronics. Production release
to finished goods inventory is done through our quality assurance department.
Our contract with Flextronics expires in November 2004, and is renewable
annually thereafter. Either party may terminate this contract for any reason
upon one year's prior written notice to the other.
Facet Technologies LLC, a wholly-owned subsidiary of Matria Healthcare,
assisted us in the design of the FreeStyle lancing device and we have agreed to
purchase the FreeStyle lancing devices and lancets exclusively from Facet until
June 1, 2007. Facet is a leading supplier of lancing devices and lancets,
including our lancets. Our FreeStyle lancing device can also use conventional
lancets, which are widely available.
Each of the production processes utilized in the manufacture of our products
has been verified and validated, as required by the FDA's quality system
regulations. As a medical device manufacturer, our manufacturing facility and
the facilities of Flextronics and Facet Technologies are subject to periodic
unannounced inspection by regulatory authorities and these operations may
undergo compliance inspections conducted by the FDA and corresponding state
agencies.
42
Intellectual Property
We rely on a combination of copyright, patent, trademark, trade secret and
other intellectual property laws, nondisclosure agreements and other measures
to protect our proprietary rights. As of June 30, 2001, we had 21 issued U.S.
patents, had received notices of allowance with respect to six U.S. patent
applications, and had numerous additional U.S. patent applications pending. We
believe it will take up to five years, and possibly longer, for these U.S.
patent applications to result in issued patents. We have also filed foreign
patent applications on our technology. Our issued patents expire between
November 2010 and April 2018. The issued and allowed patents cover, among other
things:
. glucose measurement in a small sample volume using a coulometric
measurement;
. our Wired Enzyme chemistry;
. one point calibration of the Continuous Glucose Monitoring System;
. manufacturing processes for the Continuous Glucose Monitoring System
sensor; and
. the components of the Continuous Glucose Monitoring System.
We have obtained registrations for the trademark TheraSense in the U.S., Europe
and Japan and have applied to register TheraSense in Canada, South Korea and
Taiwan as well. We have applied to register FreeStyle in the U.S., Europe,
Japan and South Korea.
In addition to developing our own technology, we have entered into several
license agreements. We have acquired patents from the University of Texas at
Austin developed by Professor Adam Heller, a co-founder of our company, and his
collaborators. We also fund ongoing research at the University of Texas at
Austin in the field of biosensors, and we obtain some of the intellectual
property rights to resulting inventions. We have also obtained non-exclusive,
worldwide licenses to specific patents owned by Asulab SA and Unilever PLC.
Each of these licenses grants us the right to use the licensed patents to make
and sell diagnostic devices for diabetes monitoring that contain the licensed
technology. We pay for these licenses through a combination of fixed payments
and royalties on sales of covered products. Each of these licenses continues
until expiration of the licensed patents.
Research and Development
Our research and development efforts are currently focused on developing
further enhancements to FreeStyle as well as developing our Continuous Glucose
Monitoring System. Our research and development staff consists of 51 people,
including seven who hold Ph.D. degrees. Our research and development staff has
extensive experience in the glucose monitoring industry and has been
instrumental in technology development and commercialization of glucose
monitoring products. Research and development expenses, including clinical and
regulatory expenses, were $3.1 million in 1998, $7.7 million in 1999, $12.0
million in 2000 and $6.3 million for the six months ended June 30, 2001. We
expect research and development expenses to continue to increase as we seek to
enhance our existing products and develop additional products.
We also fund biosensor research under a Sponsored Research Agreement with the
University of Texas at Austin. We have specific rights with regard to
inventions resulting from the research. The research is currently under the
direction of Professor Adam Heller and is focused on improvements to
implantable glucose sensors and on extension of the Wired Enzyme technology for
the measurement of other biochemicals. This agreement continues on a year-to-
year basis unless otherwise agreed by the parties and so long as the University
has received sponsored research funds from us in the prior six month period. We
fund such research on a cost plus reasonable overhead basis.
43
Competition
The medical device industry is subject to intense competition. Four companies,
Roche Diagnostics, LifeScan, Inc., a division of Johnson & Johnson, Bayer
Corporation and MediSense, a division of Abbott Laboratories, currently account
for approximately 90% of the worldwide sales of blood glucose self-monitoring
systems. All of these competitors' products use a meter and disposable test
strips to test blood obtained by lancing the finger or, in some cases, the
forearm. All of the competitive products require significantly larger blood
samples than required by FreeStyle. One product approved for use on the finger
and forearm offers a faster test time than FreeStyle, once the required sample
has been obtained, and operates over a broader temperature range.
In addition, other companies are developing and/or marketing minimally invasive
or noninvasive glucose monitoring devices and technologies that could compete
with FreeStyle and our proposed Continuous Glucose Monitoring System. There are
also a number of academic and other institutions involved in various phases of
our industry's technology development. Many of these competitors have
significantly greater financial and human resources than we do. At this time,
there are two approved products for continuous glucose monitoring, neither of
which is presently approved as a substitute for current glucose self-monitoring
devices. The continuous glucose monitoring system developed by MiniMed Inc.,
which recently entered into an agreement to be acquired by Medtronic, Inc.,
includes an implantable sensor that measures and stores glucose values every
five minutes, for a period of two to three days. The MiniMed system is not a
consumer product, rather, it is a physician product. The sensor is required to
be implanted by a physician, and the results of the data aggregated by the
MiniMed system can only be viewed by the physician, who must extract the sensor
and download the results for viewing using customized software. The second
approved product for continuous glucose monitoring, developed by Cygnus Inc.,
is worn on the wrist like a watch and can take glucose readings as frequently
as every twenty minutes for up to twelve hours at a time. This product has only
recently been approved by the FDA for prescription to adults ages 18 and older
who have diabetes.
We believe that the principal competitive factors in our market include:
. improved outcomes for people with diabetes through less painful and
accurate testing methods;
. technological leadership and superiority;
. reliability and ease of use;
. customer focus and service;
. effective marketing and distribution;
. acceptance by health care professionals;
. speed to market; and
. exclusivity agreements between third-party payors and competitive
brands.
Government Regulation
Our products are medical devices subject to extensive regulation by the FDA and
other regulatory bodies. FDA regulations govern, among other things, the
following activities that we or our partners perform and will continue to
perform:
. product design and development;
. product testing;
. product manufacturing;
. product labeling;
44
. product storage;
. premarket clearance or approval;
. advertising and promotion; and
. product sales and distribution.
FDA's Premarket Clearance and Approval Requirements
Unless an exemption applies, each medical device we wish to commercially
distribute in the United States will require either prior 510(k) clearance or
prior premarket approval from the FDA. The FDA classifies medical devices into
one of three classes. Devices deemed to pose lower risk are placed in either
class I or II, which requires the manufacturer to submit to the FDA a premarket
notification requesting permission for commercial distribution. This process is
known as 510(k) clearance. Some low risk devices are exempted from this
requirement. Devices deemed by the FDA to pose the greatest risk, such as life-
sustaining, life-supporting or implantable devices, or devices deemed not
substantially equivalent to a previously cleared 510(k) device are placed in
class III, requiring premarket approval.
510(k) Clearance Pathway. To obtain 510(k) clearance, we must submit a
premarket notification demonstrating that the proposed device is substantially
equivalent to a previously cleared 510(k) device or a device that was in
commercial distribution before May 28, 1976 for which the FDA has not yet
called for the submission of premarket approval applications. The FDA's 510(k)
clearance pathway usually takes from four to twelve months from the date the
application is completed, but it can take significantly longer.
Blood glucose testing systems have generally qualified for clearance under
510(k) procedures. We received 510(k) clearance for FreeStyle in January 2000
for use on the fingers and forearm. In May 2000, we also obtained 510(k)
clearance for FreeStyle Connect, our data management system that enables
downloading of blood glucose data stored in a user's FreeStyle monitor to a
personal computer for use by the user or his or her health care provider. In
December 2000, we received 510(k) clearance allowing us to promote FreeStyle
for use on the thigh, calf, upper arm, and hand, in addition to the fingers and
forearm.
After a device receives 510(k) clearance, any modification that could
significantly affect its safety or effectiveness, or that would constitute a
major change in its intended use, will require a new 510(k) clearance or could
require premarket approval. The FDA requires each manufacturer to make this
determination initially, but the FDA can review any such decision and can
disagree with a manufacturer's determination. If the FDA disagrees with a
manufacturer's determination, the FDA can require the manufacturer to cease
marketing and/or recall the modified device until 510(k) clearance or premarket
approval is obtained. We have modified aspects of FreeStyle since receiving
regulatory approval, but we believe that new 510(k) clearances are not
required. If the FDA requires us to seek 510(k) clearance or premarket approval
for any modifications to a previously cleared product, we may be required to
cease marketing or recall the modified device until we obtain this clearance or
approval. Also, in these circumstances, we may be subject to significant
regulatory fines or penalties. We have made and plan to continue to make
additional product enhancements to our FreeStyle System that we believe do not
require new 510(k) clearances.
Pending 510(k) for New FreeStyle Labeling. In our original 510(k) submission,
the performance of FreeStyle was determined by the FDA to be substantially
equivalent to other currently marketed blood glucose monitoring systems.
Shortly after clearance to market FreeStyle, we initiated additional clinical
studies to better understand off-fingertip testing of blood glucose levels.
After reviewing the data from these post-clearance clinical studies we
concluded that:
. Due to human physiology, changes in blood glucose can be detected
first on the finger, and changes can lag on the forearm.
45
. Vigorously rubbing the test site prior to lancing stimulates blood
flow and minimizes the difference between readings on the forearm and
the finger.
. The faster the rate of change in blood glucose, the greater the
difference in readings between the finger and the forearm.
. There are significant differences from person to person with regard
to lag time, and in some people, the lag between arm and finger is
negligible.
. The lag is most clinically significant when testing for low blood
sugar (hypoglycemia).
These discoveries prompted us to implement more cautionary labeling to clarify
the safe and effective use of FreeStyle. This labeling emphasized rubbing the
test site before lancing and instructed both users and health care
professionals that when they are testing because they think blood glucose is
low (hypoglycemia), they may want to obtain a blood sample from the fingertip
rather than alternative sites such as the forearm. In April 2001, we notified
the FDA of these labeling changes. In May 2001, the FDA responded that, based
on the information provided, they believed the labeling changes required
submission and clearance of an additional 510(k). In June 2001, we submitted
additional information to the FDA in support of our labeling changes and our
belief that an additional 510(k) was not necessary. The FDA is reviewing that
submission as a 510(k). Because FreeStyle is currently being marketed with the
revised more cautionary labeling, unless and until we obtain clearance of that
510(k), we are technically out of compliance with FDA regulations. As a result,
the FDA could order us to cease marketing FreeStyle with its current labeling,
to recall such product, to pay fines or penalties, or to include significant
restrictions on use in FreeStyle labeling. We continue to study off-fingertip
testing in an effort to build greater knowledge around this new paradigm for
blood glucose testing. We have studies underway examining whether less painful
alternate site testing impacts test frequency and results in better diabetes
management. We are also examining specific alternate sites, such as the thigh
and hand, and specific user groups, such as children and women with gestational
diabetes. All of this data will be made available to the FDA, and we will work
closely with the FDA to address their questions and resolve any issues around
our labeling. The FDA had scheduled a meeting of its Clinical Chemistry and
Clinical Toxicology Panel for September 24, 2001 to provide advice and
recommendations on the types of data and/or labeling needed in 510(k)
submissions for blood glucose monitoring systems that can be utilized with
blood samples obtained from sites other than the fingertip. As a result of the
national tragedies on September 11, 2001, the FDA canceled this Panel meeting
and rescheduled the meeting for October 29, 2001. In addition, the FDA has
agreed to an individual meeting with us, scheduled for October 19, 2001, to
specifically discuss our pending FreeStyle 510(k).
Premarket Approval Pathway. A premarket approval application must be submitted
if the device cannot be cleared through the 510(k) process. A premarket
approval application must be supported by extensive data including, but not
limited to, technical, preclinical, clinical trials, manufacturing and labeling
to demonstrate to the FDA's satisfaction the safety and effectiveness of the
device.
After a premarket approval application is complete, the FDA begins an in-depth
review of the submitted information, which generally takes between one and
three years, but may take significantly longer. During this review period, the
FDA may request additional information or clarification of information already
provided. Also during the review period, an advisory panel of experts from
outside the FDA will be convened to review and evaluate the application and
provide recommendations to the FDA as to the approvability of the device. In
addition, the FDA will conduct a preapproval inspection of the manufacturing
facility to ensure compliance with quality system regulations. New premarket
approval applications or premarket approval application supplements are
required for significant modifications to the manufacturing process, labeling
and design of a device that is approved through the premarket approval process.
Premarket approval supplements often require submission of the same type of
information as a premarket approval application, except that the supplement is
limited to information needed to support any changes from the device covered by
the original premarket approval application, and may not require as extensive
clinical data or the convening of an advisory panel.
46
We expect that our Continuous Glucose Monitoring System will require premarket
approval. We recently commenced two pilot clinical studies, one with people who
do not have diabetes and one with people who have diabetes. A premarket
approval application may never be submitted, or if submitted, approval may not
be obtained for this device in a timely fashion, or at all.
Clinical Trials. A clinical trial is almost always required to support a
premarket approval application and is sometimes required for a 510(k) premarket
notification. These trials generally require submission of an application for
an investigational device exemption to the FDA. The investigational device
exemption application must be supported by appropriate data, such as animal and
laboratory testing results, showing that it is safe to test the device in
humans and that the testing protocol is scientifically sound. The
investigational device exemption application must be approved in advance by the
FDA for a specified number of patients, unless the product is deemed a non-
significant risk device and eligible for more abbreviated investigational
device exemption requirements. Clinical trials for a significant risk device
may begin once the investigational device exemption application is approved by
the FDA and the appropriate institutional review boards at the clinical trial
sites. Future clinical trials of our Continuous Glucose Monitoring System may
require that we obtain an investigational device exemption from the FDA prior
to commencing clinical trials. Our clinical trials must be conducted in
accordance with FDA regulations. The results of clinical testing may not be
sufficient to obtain approval of the product.
Pervasive and Continuing FDA Regulation
After a device is placed on the market, numerous regulatory requirements apply.
These include:
. quality system regulation, which requires manufacturers to follow
design, testing, control, documentation and other quality assurance
procedures during the manufacturing process;
. labeling regulations, which prohibit the promotion of products for
unapproved or "off-label" uses and impose other restrictions on
labeling; and
. medical device reporting regulations, which require that
manufacturers report to the FDA if their device may have caused or
contributed to a death or serious injury or malfunctioned in a way
that would likely cause or contribute to a death or serious injury if
it were to recur.
Failure to comply with applicable regulatory requirements can result in
enforcement action by the FDA, which may include any of the following
sanctions:
. fines, injunctions, and civil penalties;
. recall or seizure of our products;
. operating restrictions, partial suspension or total shutdown of
production;
. refusing our request for 510(k) clearance or premarket approval of
new products;
. withdrawing 510(k) clearance or premarket approvals that are already
granted; and
. criminal prosecution.
We are subject to unannounced inspections by the FDA and the Food and Drug
Branch of the California Department of Health Services, and these inspections
may include the manufacturing facilities of our subcontractors. In May 2001,
the FDA conducted an inspection of our facility in Alameda, California. The FDA
issued a Form 483 that noted five observations. One observation was corrected
and verified during the audit. In June 2001, we submitted a corrective action
plan to the FDA addressing the remaining four observations.
47
International
International sales of medical devices are subject to foreign government
regulations, which vary substantially from country to country. The time
required to obtain approval by a foreign country may be longer or shorter than
that required for FDA approval, and the requirements may differ.
The primary regulatory environment in Europe is that of the European Union,
which consists of 15 countries encompassing most of the major countries in
Europe. Other countries, such as Switzerland, have voluntarily adopted laws and
regulations that mirror those of the European Union with respect to medical
devices. The European Union has adopted numerous directives and standards
regulating the design, manufacture, clinical trials, labeling, and adverse
event reporting for medical devices. Devices that comply with the requirements
of a relevant directive will be entitled to bear CE conformity marking,
indicating that the device conforms with the essential requirements of the
applicable directives and, accordingly, can be commercially distributed
throughout Europe. CE is an abbreviation for European Compliance. The method of
assessing conformity varies depending on the class of the product, but normally
involves a combination of self-assessment by the manufacturer and a third-party
assessment by a "Notified Body." This third-party assessment may consist of an
audit of the manufacturer's quality system and specific testing of the
manufacturer's product. An assessment by a Notified Body in one country within
the European Union is required in order for a manufacturer to commercially
distribute the product throughout the European Union. In March 2001, FreeStyle
was certified by TUV Product Service, a Notified Body, under the European Union
In-Vitro Diagnostic Directive allowing the CE conformity marking to be applied.
Nipro Corporation, our exclusive distributor in Japan, submitted an application
for approval to market FreeStyle in Japan with the Ministry of Health, Labor
and Welfare. Failure to receive this approval would prevent us from selling
FreeStyle in Japan, which would negatively impact future revenues.
Third-Party Reimbursement
Self-monitoring of blood glucose is a standard of care in the United States and
other developed countries. The costs associated with the purchase of blood
glucose monitoring products such as meters and test strips by people with
diabetes are generally reimbursed. FreeStyle is currently being reimbursed
through Medicare, Medicaid, open formulary plans and certain preferred provider
organizations in the United States. International market acceptance of our
products may depend, in part, upon the availability of reimbursement within
prevailing health care payment systems. Reimbursement and health care payment
systems in international markets vary significantly by country, and include
both government-sponsored health care and private insurance. Reimbursement has
not yet been determined for our Continuous Glucose Monitoring System.
Advisory Boards
Medical Advisory Board
We have established a medical advisory board, consisting of individuals with
recognized expertise in fields relating to diabetes treatment. Our members
advise us concerning long-term product planning, research, development and
marketing. Members of our medical advisory board meet formally and informally
with us. Several of the members of our medical advisory board are employed by
academic institutions and may have commitments to or agreements with other
entities that may limit their availability to us. Members of our medical
advisory board may also serve as consultants to other medical product
companies. The members of our medical advisory board have agreed to maintain
the confidentiality of all proprietary information we disclose to them, and
each member has executed a confidentiality agreement with us.
48
Currently, the following persons comprise our medical advisory board:
Richard Bergenstal, MD is an endocrinologist and is currently the Executive
Director of the International Diabetes Center in Minneapolis, Minnesota. Dr.
Bergenstal's focus has been the development of diabetes treatment algorithms
and education of primary care physicians to improve the level of clinical care
for people with diabetes. Dr. Bergenstal received the Charles H. Best Medal
from the American Diabetes Association for distinguished service for his role
as an investigator in the Diabetes Control and Complications Trial.
John Buse, MD, Ph.D. is an endocrinologist and is currently an Associate
Professor, Division of Endocrinology, at the University of North Carolina
Medical School, Chapel Hill, North Carolina. Dr. Buse has a large clinical
practice as Director of the Diabetes Program and a significant research
practice as Director of Endocrinology Clinics at UNC. Dr. Buse has published
widely on diabetes and drug therapies and is a frequent presenter at
professional conferences around the world.
Alan Moses, MD is an endocrinologist and is currently the Chief Medical Officer
of the Joslin Clinic and Diabetes Center in Boston, Massachusetts. Dr. Moses is
also an Associate Professor of Medicine at Harvard Medical School and
participates in the administration and leadership of numerous diabetes related
clinical and research initiatives. Dr. Moses' research is focused on severe
insulin resistance and novel routes of drug delivery and therapies for
diabetes. He is known as being a vocal advocate of issues involving children
with diabetes.
Anne Peters, MD is an endocrinologist and is currently a Director of the
University of Southern California Diabetes Program in Los Angeles, California.
She has researched and published on diabetes drug therapies and clinical
treatment of diabetes, and has a particular research interest in outcomes
studies in diabetes.
Philip Raskin, MD is an endocrinologist and is currently a Professor of
Medicine for the Department of Internal Medicine at Southwestern Medical
School, University of Texas Health Science Center in Dallas, Texas. Dr. Raskin
was involved in the Diabetes Complications and Control Trial study and was
recognized for achieving the best clinical results among all the clinical study
sites.
Harry Shamoon, MD is an endocrinologist and is currently a Professor for the
Department of Medicine, Division of Endocrinology and Metabolism at the Albert
Einstein College of Medicine in New York, New York. Dr. Shamoon is a leading
expert on hypoglycemia and diabetes and was involved as an investigator in the
Diabetes Control and Complications Trial. He is on the National Board of
Directors for the American Diabetes Association and the American Board of
Endocrinology and Metabolism.
Educator Advisory Board
We have also established an educator advisory board of consultants with
expertise in educating people with diabetes. The educator advisory board meets
formally and informally and provides us advice on training materials,
patient/product acceptance criteria and product marketing. The members of our
educator advisory board have agreed to maintain the confidentiality of all
proprietary information we disclose to them, and each member has executed a
confidentiality agreement.
Currently the following persons comprise our educator advisory board:
Nancy Bristow, RN, BSN, CDE is the Clinical Nurse of the Diabetes and Endocrine
Associates of Tarrant County in Fort Worth, Texas. She supports numerous people
with diabetes as well as endocrinologists and has been involved in clinical
studies with several local universities and major diabetes related companies.
49
Nedra Christensen, RD, Ph.D. is an Assistant Professor at Utah State
University, Logan, Utah. She has practiced diabetes clinical dietetics with the
Joslin Clinic, Vanderbilt University and children's diabetes camps. Dr.
Christensen publishes extensively on diabetes treatment and dietetics.
Carol Homko, RN, CDE, MS, Ph.D. is a Clinical Nurse Practitioner at the General
Clinical Research Center at Temple University Hospital in Philadelphia,
Pennsylvania. Her academic and clinical focus has been on diabetes and
pregnancy.
Marsha McCleskey, RD, MS, CDE is the Clinical Dietician for the Diabetes and
Endocrine Associates of Tarrant County in Fort Worth, Texas. She teaches people
in a large clinical practice, consults and speaks extensively on diabetes care.
She has a particular interest in diabetes data management.
Jim Pichert, Ph.D. is the Diabetes Education Program Director of the Diabetes
Research and Training Center at the Vanderbilt University Medical Center in
Nashville, Tennessee. He has researched and published extensively on
educational methods that improve diabetes care. He has held numerous national
positions in diabetes professional organizations and is a popular speaker on
improved diabetes outcomes with innovative teaching methods.
Employees
As of June 30, 2001, we had 241 full-time employees, including 87 in sales and
marketing, 63 in operations and manufacturing, 51 in research and development,
15 in customer service and 25 in general and administrative functions. None of
our employees is represented by a collective bargaining agreement and we have
never experienced any work stoppage. We believe that our employee relations are
good.
Facilities
We lease approximately 54,500 square feet of manufacturing, laboratory and
office space at 1360 South Loop Road in Alameda, California under a lease
expiring in April 2009. We are also leasing 17,000 square feet of office space
in an adjacent building at 1350 South Loop Road under a lease expiring in May
2004. An additional 3,000 square feet of office space at 1320 South Loop Road
is subject to a lease which expires in October 2002. We are in the planning
stages of a 40,000 square foot expansion of the manufacturing and office areas
at our main building at 1360 South Loop Road. We believe that our current
facilities and the planned expansion will be sufficient for the next few years.
Legal Proceedings
We are not currently subject to any material pending or threatened legal
proceedings.
50
MANAGEMENT
Executive Officers and Directors
The following table sets forth, as of June 30, 2001, information about our
executive officers, directors and Chief Scientific Advisor:
Name Age Position
---- --- --------
W. Mark Lortz................... 49 Chairman of the Board, Chief Executive
Officer and President
Tae Andrews..................... 38 Vice President of Marketing and Sales
W. Patrick Bengtsson............ 44 Vice President of Intellectual Property
Robert D. Brownell.............. 39 Vice President of Human Resources,
General Counsel and Secretary
Eve A. Conner, Ph.D. ........... 55 Vice President of Quality Assurance and
Regulatory Affairs
Timothy T. Goodnow, Ph.D. ...... 40 Vice President of Research and
Development
Claire D. Heiss................. 54 Vice President of Operations
Adam Heller, Ph.D. ............. 67 Co-Founder and Chief Scientific Advisor
Ephraim Heller.................. 39 Co-Founder, Vice President of Business
Development and Director
Lawrence W. Huffman............. 56 Vice President of International Business
Development
Holly D. Kulp................... 43 Vice President of Professional Relations
and Customer Services
Charles T. Liamos............... 42 Vice President and Chief Financial
Officer
Annette J. Campbell-White(/1/).. 54 Director
Mark J. Gainor.................. 45 Director
Ross A. Jaffe, M.D.(/2/)........ 42 Director
Michael M. McNamara(/1/)........ 44 Director
Robert R. Momsen(/2/)........... 54 Director
Richard P. Thompson(/2/)........ 49 Director
-------------------------------
(/1/)Member of Compensation Committee
(/2/)Member of Audit Committee
W. Mark Lortz has served as our President and Chief Executive Officer since
December 1997 and as Chairman of the Board since October 1998. From July 1991
to October 1997, Mr. Lortz held several positions at LifeScan, Inc., a division
of Johnson & Johnson, a diversified health care company, including Vice
President, Operations and Group Vice President, Worldwide Business Operations
and International Franchise Development. Mr. Lortz holds an M.B.A. in
Management from Xavier University and a B.S. in Engineering Science from Iowa
State University.
Tae Andrews has served as our Vice President of Marketing and Sales since May
1999. From January 1997 to May 1999, Mr. Andrews was the Vice President of
Marketing for Enamelon, Inc., a start-up oral care technology company. From
July 1994 to January 1997, Mr. Andrews was a Senior Product Manager for Kraft
Foods, a consumer packaged foods company. Mr. Andrews holds an M.B.A. from
Columbia University and a B.S. in Engineering and Political Science from the
United States Naval Academy.
W. Patrick Bengtsson has served as our Vice President of Intellectual Property
since January 2001. From August 1998 to January 2001, Mr. Bengtsson was a
partner at Pillsbury Winthrop LLP, an international law firm, where he headed
the San Francisco patent practice and was co-chairman of the national
intellectual property practice. From January 1992 to August 1998, Mr. Bengtsson
was a
51
partner at Limbach & Limbach L.L.P., a law firm that specialized in the
practice of intellectual property law. Mr. Bengtsson holds a J.D., cum laude,
from the University of San Diego School of Law and a B.S. in Chemical
Engineering from the University of California, Berkeley. Mr. Bengtsson is a
registered patent attorney.
Robert D. Brownell has served as our Vice President and General Counsel since
March 2001 and Vice President of Human Resources and Secretary since June 2001.
From February 1996 to April 2000, Mr. Brownell was a member of Wilson Sonsini
Goodrich & Rosati, P.C., a leading technology law firm. Prior to becoming a
member, Mr. Brownell was an associate at Wilson Sonsini Goodrich & Rosati, P.C.
Mr. Brownell holds a J.D. from the University of California, Los Angeles and a
B.A. in Jurisprudence and Social Policy from the University of California,
Berkeley.
Eve A. Conner, Ph.D. has served as our Vice President of Quality Assurance and
Regulatory Affairs since January 1999. From June 1996 to December 1998 she
served as Vice President, Clinical/Regulatory Affairs and Quality Assurance for
Somnus Medical Technologies, Inc., a manufacturer of electrosurgical devices.
From October 1991 to June 1996, Dr. Conner was Vice President,
Regulatory/Clinical Affairs and Quality Assurance for Baxter Healthcare's
Novacor Division, a manufacturer of implantable heart assist devices. Dr.
Conner holds a Ph.D. in Pharmacology from the University of Minnesota and a
B.A. in Biology from Keuka College.
Timothy T. Goodnow, Ph.D. has served as our Vice President of Research and
Development since November 2000. From June 1999 to October 2000, Dr. Goodnow
held the position of Vice President of Research and Development for Verax
Biomedical Incorporated, a blood safety start-up company. From July 1998 to
June 1999, Dr. Goodnow served in the capacity of Vice President of Research and
Development for ZymeQuest, Inc., a start-up company specializing in the
development of enzymic blood conversion processing systems for use in blood
transfusion medicine. From January 1983 to July 1998, he served in various
positions of increasing responsibility, including Vice President of Research
and Development for Baxter Healthcare/Dade Behring, a global corporation
providing products and support services to clinical laboratories. Dr. Goodnow
holds a B.S. and Ph.D. in Chemistry from the University of Miami.
Claire D. Heiss has served as our Vice President of Operations since August
1999. From May 1994 to November 1997, Ms. Heiss served as the Vice President
and General Manager of Cooking Products for AB Electrolux's Frigidaire Company,
a producer of major appliances for the home. She took a brief retirement from
November 1997 until August 1999. Ms. Heiss has over twenty five years of
operations experience with General Electric and Motorola. Ms. Heiss holds a
B.S. in Industrial Engineering from the University of Illinois and has served
as an examiner for the Malcolm Baldrige National Quality Award, a management
standards organization.
Adam Heller, Ph.D. co-founded TheraSense with Ephraim Heller in December 1996
and has served as our Chief Scientific Advisor since the founding. Since August
1988, Dr. Heller has been the Ernest Cockrell, Sr. Chair in Engineering at the
University of Texas at Austin. He is a Member of the National Academy of
Engineering of the United States of America. Dr. Heller was awarded an honorary
doctorate by Sweden's Uppsala University and awards from the American Chemical
Society, the Royal Society of Chemistry (U.K.) and The Electrochemical Society.
Dr. Heller has a Ph.D. in Chemistry, and an M.Sc. in Chemistry and Physics from
the Hebrew University in Jerusalem. He did postdoctoral research at the
University of California, Berkeley and at Bell Laboratories, a research and
development organization.
Ephraim Heller served as our President from our founding in December 1996 until
October 1997, and currently serves as a director and as our Vice President of
Business Development. Prior to co-founding TheraSense, from August 1991 to
December 1996, Mr. Heller was the Founder and President of E. Heller & Company,
a company involved in the development and commercialization of new technologies
in materials science, which involves the study of the physical and chemical
properties of
52
different compounds. Mr. Heller holds an M.B.A. from Yale University and a B.A.
in Physics from Harvard University.
Lawrence W. Huffman has served as our Vice President of International Business
Development since December 2000. From March 1995 to December 2000, Mr. Huffman
held various positions at MediSense Inc., a glucose monitoring company, and
following its acquisition of MediSense, at Abbott Laboratories, a diversified
health care company, including Vice President of International Sales and
Marketing and Vice President of Business Development. Mr. Huffman holds an
M.B.A. from the Wharton School of Business at the University of Pennsylvania
and a B.S. in Economics from the University of Pennsylvania.
Holly D. Kulp has served as our Vice President of Professional Relations and
Customer Service since January 1999. From October 1986 to December 1998, she
held numerous positions at LifeScan, Inc., including the position of Vice
President of Quality Assurance, Regulatory Affairs and Legal from April 1994
through December 1998. Ms. Kulp holds an M.Ed. in Medical Education from
Vanderbilt University and a B.S. in Dietetics and Distributed Sciences from
David Lipscomb University.
Charles T. Liamos has served as our Vice President and Chief Financial Officer
since July 1999 and as our Director of Purchasing and Finance from April 1998
to July 1999. From May 1995 to April 1998, Mr. Liamos was Director, Worldwide
Sourcing at LifeScan, Inc. He holds a B.S. in Business Administration from the
University of Vermont and is a graduate of the General Electric Financial
Management Program.
Annette J. Campbell-White has served on our board of directors since April
1997. She has been the Managing Partner of MedVenture Associates I, II and III,
which are venture partnerships investing primarily in early stage businesses in
the health care field, since May 1986. Ms. Campbell-White currently serves on
the board of directors of ArthroCare Corporation, a company that designs,
manufactures and markets surgical instruments. Ms. Campbell-White holds a B.S.
degree and an M.S. degree in Chemical Engineering, both from the University of
Cape Town, South Africa.
Mark J. Gainor has served on our board of directors since January 2000. Mr.
Gainor currently serves as President of Lucor Holdings, LLC, a private
investment company investing primarily in health care technology companies.
From January 1999 to August 2000, Mr. Gainor served as President of the
diabetes management services subsidiary of Matria Healthcare, Inc., a leading
provider of population-based disease management programs. From 1986 to January
1999, Mr. Gainor was President and Chief Executive Officer of Gainor Medical
Management LLC, a multinational manufacturer and distributor of diabetes
supplies, which was acquired by Matria Healthcare, Inc. in January 1999 and was
recently renamed Facet Technologies LLC. Mr. Gainor has a degree in Business
Administration and Commerce from the University of Alberta, Canada.
Ross A. Jaffe, M.D. has served on our board of directors since October 1998.
Dr. Jaffe joined Brentwood Venture Capital, a private venture capital firm, in
August 1990, and continues to serve as a Managing Member of Brentwood VIII
Ventures LLC, the general partner of Brentwood Associates VIII, L.P. and
Brentwood Affiliates Fund II, L.P. Dr. Jaffe is a Managing Director of Versant
Ventures, a health care-focused venture capital firm that was formed in
November 1999. Dr. Jaffe holds an M.D. from the Johns Hopkins University School
of Medicine and completed his residency in internal medicine at the University
of California, San Francisco. He received an M.B.A. from Stanford University
and an A.B. in Policy Studies from Dartmouth College.
Michael M. McNamara has served on our board of directors since May 1997. He has
served as President, Americas Operations of Flextronics International Ltd., an
electronics manufacturing services provider, since April 1994. Mr. McNamara
received a B.S. from the University of Cincinnati and an M.B.A. from Santa
Clara University.
53
Robert R. Momsen has served on our board of directors since October 1998. He
has been a General Partner at InterWest Partners, a private venture capital
firm, since September 1982. Mr. Momsen serves as a director of ArthroCare
Corporation, a company that designs, manufactures and markets surgical
instruments, and Corixa Corporation Inc., a developer of immunotherapeutic
products. Mr. Momsen received a B.S. in engineering and an M.B.A. from Stanford
University.
Richard P. Thompson has served on our board of directors since November 1998.
He has been President, Chief Executive Officer and a director of Aradigm
Corporation, a developer of pulmonary drug delivery systems, since 1994 and was
Chief Financial Officer of Aradigm from April 1996 until December 1996. He was
named Chairman of the Board of Aradigm in August 1999. From 1991 to 1994, Mr.
Thompson was President of LifeScan, Inc. In 1981, Mr. Thompson founded
LifeScan, Inc., which was sold to Johnson & Johnson in 1986. Mr. Thompson holds
a B.S. in biological sciences from the University of California, Irvine and an
M.B.A. from California Lutheran University.
Executive officers are appointed by our board of directors and serve until
their successors have been duly elected and qualified. Ephraim Heller, our Vice
President of Business Development and a director, is the son of Dr. Adam
Heller, our Chief Scientific Advisor. There are no other family relationships
among any of our directors, executive officers and advisors.
Board of Directors
We currently have eight authorized directorships. In accordance with the terms
of our amended and restated certificate of incorporation, the terms of office
of the directors are divided into three classes:
. Class I, whose term will expire at the annual meeting of stockholders
to be held in 2002;
. Class II, whose term will expire at the annual meeting of
stockholders to be held in 2003; and
. Class III, whose term will expire at the annual meeting of
stockholders to be held in 2004.
The Class I directors are Mr. Ephraim Heller and Ms. Campbell-White, the Class
II directors are Messrs. Lortz and Gainor and Dr. Jaffe and the Class III
directors are Messrs. McNamara, Momsen and Thompson. At each annual meeting of
stockholders, or special meeting in lieu thereof, after the initial
classification of the board of directors, the successors to directors whose
terms will then expire will be elected to serve from the time of election and
qualification until the third annual meeting following election or special
meeting held in lieu thereof. The authorized number of directors may be changed
only by resolution of the board of directors or a super-majority vote of the
stockholders. Any additional directorships resulting from an increase in the
number of directors will be distributed among the three classes so that, as
nearly as possible, each class will consist of one-third of the directors. This
classification of the board of directors may have the effect of delaying or
preventing changes in control or management.
Board Committees
Our audit committee consists of Messrs. Momsen and Thompson and Dr. Jaffe. The
audit committee reviews and monitors our financial statements and internal
accounting procedures, makes recommendations to our board of directors
regarding the selection of independent accountants and consults with and
reviews the services provided by our independent accountants.
Our compensation committee consists of Ms. Campbell-White and Mr. McNamara. The
compensation committee reviews and recommends to the board of directors the
compensation and benefits of our executive officers and administers our stock
plans and employee benefit plans.
Our option committee is comprised of Mr. Lortz. The function of the option
committee is to determine stock option grants for employees and consultants who
are not executive officers or directors.
54
Compensation Committee Interlocks and Insider Participation
Prior to establishing the compensation committee, the board of directors as a
whole performed the functions delegated to the compensation committee. No
member of the board of directors or the compensation committee serves as a
member of the board of directors or compensation committee of any entity that
has one or more executive officers serving as a member of our board of
directors or compensation committee.
Director Compensation
We reimburse our non-employee directors for their expenses incurred in
connection with attending board and committee meetings, but do not compensate
them for their services as board or committee members. In the past, we have
granted non-employee directors options to purchase our common stock under our
1997 Stock Plan. Specifically, during 1997, the board granted Mr. McNamara an
option to purchase 43,344 shares of our common stock with an exercise price of
$0.14 per share, and, during 1998, the board granted Mr. Thompson an option to
purchase 30,000 shares of our common stock with an exercise price of $0.28 per
share. In September 2000, the board granted each of Messrs. Gainor, McNamara,
Momsen, Thompson, Ms. Campbell-White and Dr. Jaffe an option to purchase 30,000
shares of our common stock with an exercise price of $5.00 per share.
Our board will continue to have discretion to grant options to non-employee
directors from time to time under our 2001 Stock Plan. Each non-employee
director who joins our board following this offering will receive a
nondiscretionary, automatic grant of options to purchase 30,000 shares of our
common stock upon joining our board of directors. In addition, each of our non-
employee directors will receive yearly nondiscretionary, automatic grants of
options to purchase 5,000 shares of our common stock, pursuant to our 2001
Stock Plan.
Executive Compensation
The following table summarizes the compensation earned for services rendered to
us in all capacities for the year ended December 31, 2000 by our chief
executive officer and our four other most highly paid executive officers. These
executives are referred to as the named executive officers elsewhere in this
prospectus.
Summary Compensation Table
Long-Term
Compensation
------------
2000 Annual
Compensation Securities
---------------------- Underlying
Name and Principal Position Salary Bonus Options(/2/)
--------------------------- ----------- ---------- ------------
W. Mark Lortz......................... $250,000.00 $25,000.00(/1/) 525,000
Chief Executive Officer and President
Tae Andrews........................... $170,523.48 -- 80,000
Vice President of Marketing and Sales
Eve A. Conner, Ph.D................... $165,000.00 -- 88,500
Vice President of Quality Assurance
and Regulatory Affairs
Holly D. Kulp......................... $163,750.00 -- 91,000
Vice President of Professional
Relations and Customer Service
Charles T. Liamos..................... $159,999.96 -- 110,500
Chief Financial Officer and Vice
President
-------------------------------
(/1/Represents)a bonus earned in 2000 but paid in 2001.
55
(/2/) On August 3, 2001, our board of directors granted the following options
to purchase shares of our common stock to our named executive officers:
W. Mark Lortz, our President, Chief Executive Officer and Chairman of the
Board, was granted an option to purchase 250,000 shares; Charles T.
Liamos, our Chief Financial Officer, was granted an option to purchase
37,400 shares; Tae Andrews, our Vice President of Marketing and Sales,
was granted an option to purchase 15,000 shares; Eve A. Conner, our Vice
President of Quality Assurance and Regulatory Affairs, was granted an
option to purchase 30,000 shares; and Holly D. Kulp, our Vice President
of Professional Relations and Customer Services, was granted an option to
purchase 33,000 shares. Each option has an exercise price of $9.00 per
share and vests at a rate of 1/48th per month over a four year period,
commencing August 1, 2001.
2000 Option Grants
The following table summarizes the stock options granted to each named
executive officer during the year ended December 31, 2000, including the
potential realizable value over the 10-year term of the options, based on
assumed rates of stock appreciation of 5% and 10%, compounded annually. These
assumed rates of appreciation comply with the rules of the Securities and
Exchange Commission and do not represent our estimate of future stock price.
Actual gains, if any, on stock option exercises will be dependent on the future
performance of our common stock. The assumed 5% and 10% rates of stock
appreciation are based on the initial public offering price of $19.00 per
share.
In the year ended December 31, 2000, we granted options to purchase up to an
aggregate of 2,759,346 shares to employees. All options were granted under our
1997 Stock Plan at exercise prices at or above the fair market value of our
common stock on the date of grant, as determined in good faith by our board of
directors. Option shares generally vest over four years.
Potential Realizable
Value at Assumed Annual
Rates of Stock Price
Appreciation for Option
Individual Grants Term
--------------------------------------------- -----------------------
Number of
Securities Percent of
Underlying Total Options Exercise
Options Granted to Price Expiration
Name Granted Employees Per Share Date 5% 10%
---- ---------- ------------- --------- ---------- ----------- -----------
W. Mark Lortz........... 400,000 14.50% $3.00 3/17/10 $11,179,599 $18,512,443
75,000 2.72% $4.00 7/31/10 $ 2,021,175 $ 3,396,083
50,000 1.81% $5.00 9/29/10 $ 1,297,450 $ 2,214,055
Tae Andrews............. 18,000 0.65% $3.00 3/17/10 $ 503,082 $ 833,060
42,000 1.52% $4.00 7/31/10 $ 1,131,858 $ 1,901,806
20,000 0.72% $5.00 9/29/10 $ 518,980 $ 885,622
Eve A. Conner, Ph.D. ... 36,000 1.30% $3.00 3/17/10 $ 1,006,164 $ 1,666,120
37,500 1.36% $4.00 7/31/10 $ 1,010,587 $ 1,698,042
15,000 0.54% $5.00 9/29/10 $ 389,235 $ 664,217
Holly D. Kulp........... 32,000 1.16% $3.00 3/17/10 $ 894,368 $ 1,480,995
39,000 1.41% $4.00 7/31/10 $ 1,051,011 $ 1,765,963
20,000 0.72% $5.00 9/29/10 $ 518,980 $ 885,622
Charles T. Liamos....... 45,000 1.63% $3.00 3/17/10 $ 1,257,705 $ 2,082,650
40,500 1.47% $4.00 7/31/10 $ 1,091,434 $ 1,833,885
25,000 0.91% $5.00 9/29/10 $ 648,725 $ 1,107,028
56
Aggregate Option Exercises and Option Values
The following table describes for the named executive officers their option
exercises for the year ended December 31, 2000, and exercisable and
unexercisable options held by them as of December 31, 2000.
The value realized and the value of unexercised in-the-money options at
December 31, 2000 are based on the initial public offering price of $19.00 per
share, less the per share exercise price, multiplied by the number of shares
issued or issuable, as the case may be, upon exercise of the option. All
options were granted under our 1997 Stock Plan.
Number of
Securities Underlying Value of Unexercised
Number Unexercised Options at In-The-Money Options
of Shares December 31, 2000 at December 31, 2000
Acquired Value ------------------------- -------------------------
Name on Exercise Realized Exercisable Unexercisable Exercisable Unexercisable
---- ----------- ---------- ----------- ------------- ----------- -------------
W. Mark Lortz........... -- -- 104,166 420,834 $1,650,970 $6,574,030
Tae Andrews............. -- -- 68,750 161,250 $1,248,749 $2,694,251
Eve A. Conner, Ph.D. ... 68,500 $1,266,000 23,501 146,499 $ 411,874 $2,478,626
Holly D. Kulp........... -- -- 80,958 160,042 $1,479,781 $2,672,220
Charles T. Liamos....... -- -- 16,939 93,561 $ 262,776 $1,414,724
Change of Control and Severance Agreements
We have agreements with each of our executive officers that contain provisions
that will be triggered in the event of a change of control. Upon a change of
control, our executive officers will receive accelerated vesting on 75% of
their then unvested shares and the remaining unvested shares will vest in the
event their employment relationship is terminated under certain circumstances
thereafter. In addition, Mr. Lortz is entitled to receive a severance payment
equal to six months of his then current salary in the event he is terminated
without cause.
Benefit Plans
1997 Stock Plan
Our 1997 Stock Plan was adopted by our board of directors in March 1997, and
our stockholders initially approved the plan in April 1997. Our 1997 Stock Plan
provides for the grant of incentive stock options, which may provide for
preferential tax treatment to our employees, and for the grant of nonstatutory
stock options to our employees, directors and consultants. As of June 30, 2001,
we have reserved an aggregate of 7,607,032 shares of our common stock for
issuance under this plan. As of June 30, 2001, 1,670,897 of our outstanding
shares have been issued pursuant to the exercise of options, options to
purchase 4,882,303 shares of common stock were outstanding, and
1,053,832 shares were available for future grant. In August 2001, we reserved
an additional 500,000 shares of common stock for issuance under our 1997 Stock
Plan that we had previously reserved under our 2001 Stock Plan. Following this
offering, the 1997 Stock Plan will terminate, and we will not grant any
additional stock options under our 1997 Stock Plan. Instead we will grant
options under our 2001 Stock Plan. The 1997 Stock Plan provides that in the
event of a change in control, each outstanding option will be assumed or an
equivalent option will be granted in its place by the successor corporation. If
the successor corporation refuses to assume or substitute for the options, the
options will terminate as of the closing of the merger or sale of assets.
57
2001 Stock Plan
In connection with this offering, our board of directors and stockholders
approved the 2001 Stock Plan in June 2001. Our 2001 Stock Plan provides for the
grant of incentive stock options to our employees, and for the grant of
nonstatutory stock options and stock purchase rights to our employees,
directors and consultants.
Number of Shares of Common Stock Available under the 2001 Stock Plan. As of
June 30, 2001, we have reserved a total of 7,000,000 shares of our common stock
for issuance pursuant to the 2001 Stock Plan plus (i) any shares which have
been reserved but not issued under our 1997 Stock Plan and (ii) any shares
returned to our 1997 Stock Plan as a result of termination of options. In
August 2001, we decreased the number of shares reserved for issuance under the
2001 Stock Plan by 500,000 shares and instead reserved these shares under our
1997 Stock Plan. In addition, our 2001 Stock Plan provides for annual increases
in the number of shares available for issuance under our 2001 Stock Plan on the
first day of each fiscal year, beginning with our fiscal year 2002, equal to
the lesser of:
. 5% of the outstanding shares of common stock on the first day of our
fiscal year;
. 2,500,000 shares; or
. a lesser amount as our board may determine.
Administration of the 2001 Stock Plan. Our board of directors or a committee of
our board administers the 2001 Stock Plan. In the case of options intended to
qualify as "performance-based compensation" within the meaning of Section
162(m) of the Internal Revenue Code of 1986, as amended, or the Code, the
committee will consist of two or more "outside directors" within the meaning of
Section 162(m) of the Code. The administrator has the power to determine the
terms of the options or stock purchase rights granted, including the exercise
price, the number of shares subject to each option or stock purchase right, the
exercisability of the options and the form of consideration payable upon
exercise.
Options. The administrator determines the exercise price of options granted
under the 2001 Stock Plan, but with respect to nonstatutory stock options
intended to qualify as "performance-based compensation" within the meaning of
Section 162(m) of the Code and all incentive stock options, the exercise price
must at least be equal to the fair market value of our common stock on the date
of grant. The term of an incentive stock option generally may not exceed ten
years and the administrator determines the term of all other options.
No optionee may be granted an option to purchase more than 1,000,000 shares in
any fiscal year. In connection with his or her initial service, an optionee may
be granted an additional option to purchase up to 1,000,000 shares.
After termination of one of our employees, directors or consultants, he or she
may exercise his or her option to the extent it is vested for the period of
time stated in the option agreement. Generally, if termination is due to death
or disability, the option will remain exercisable for 12 months. In all other
cases, the option will generally remain exercisable for one to three months.
However, an option may never be exercised later than the expiration of its
term.
Stock Purchase Rights. The administrator determines the exercise price of stock
purchase rights granted under our 2001 Stock Plan. Unless the administrator
determines otherwise, the restricted stock purchase agreement will grant us a
repurchase option that we may exercise upon the voluntary or involuntary
termination of the purchaser's service with us for any reason, including death
or disability. The purchase price for shares we repurchase will generally be
the original price paid by the purchaser and may be paid by cancellation of any
indebtedness of the purchaser to us. The administrator determines the rate at
which our repurchase option will lapse.
58
Transferability of Options and Stock Purchase Rights. Our 2001 Stock Plan
generally does not allow for the transfer of options or stock purchase rights
and only the optionee may exercise an option and stock purchase right during
his or her lifetime.
Automatic Option Grants to Non-Employee Directors. Our 2001 Stock Plan also
provides for the automatic grant of 30,000 shares of common stock to a director
who first becomes a non-employee director (except those directors who become
non-employee directors by ceasing to be employee directors) on or after the
date of this offering. This option will vest as to one-third of the shares
subject to the option on each anniversary of the date of grant. Each non-
employee director will automatically be granted an option to purchase 5,000
shares each year following the date of our annual stockholder's meeting (except
after the first such annual meeting if it is held within six months of the date
of this offering) if on such date, he or she will have served on our board of
directors for at least the previous six months. This option will vest as to
100% of the shares subject to the option on each anniversary of the date of
grant. All options automatically granted to non-employee directors will have a
term of 10 years and the exercise price will be 100% of the fair market value
per share of common stock on the date of grant.
Adjustments upon Merger or Asset Sale. Our 2001 Stock Plan provides that in the
event of our merger with or into another corporation or a sale of substantially
all of our assets, the successor corporation will assume or substitute an
equivalent option or right for each outstanding option or stock purchase right.
If there is no assumption or substitution of outstanding options or stock
purchase rights, all such options and stock purchase rights shall immediately
vest and the administrator will provide notice to the optionee that he or she
has the right to exercise the option or stock purchase right as to all of the
shares subject to the option or stock purchase right, including shares which
would not otherwise be exercisable, for a period of 15 days from the date of
the notice. The option or stock purchase right will terminate upon the
expiration of the 15-day period.
Amendment and Termination of our 2001 Stock Plan. Our 2001 Stock Plan will
automatically terminate in 2011, unless we terminate it sooner. In addition,
our board of directors has the authority to amend, suspend or terminate the
2001 Stock Plan provided it does not adversely affect any option previously
granted under it.
2001 Employee Stock Purchase Plan
In connection with this offering, we established an Employee Stock Purchase
Plan. Our board of directors and stockholders approved the 2001 Employee Stock
Purchase Plan in June 2001.
Number of Shares of Common Stock Available under the Employee Stock Purchase
Plan. A total of 1,000,000 shares of our common stock will be made available
for sale. In addition, our Employee Stock Purchase Plan provides for annual
increases in the number of shares available for issuance under the Employee
Stock Purchase Plan on the first day of each fiscal year, beginning with our
fiscal year 2002, equal to the lesser of:
. 1.5% of the outstanding shares of our common stock on the first day
of the fiscal year;
. 1,000,000 shares; or
. a lesser amount as our board may determine.
Administration of the Employee Stock Purchase Plan. Our board of directors or a
committee of our board administers the Employee Stock Purchase Plan. Our board
of directors or its committee has full and exclusive authority to interpret the
terms of the Employee Stock Purchase Plan and determine eligibility.
59
Eligibility to Participate. All of our employees are eligible to participate if
they are customarily employed by us or any participating subsidiary for at
least 20 hours per week and more than five months in any calendar year.
However, an employee may not be granted an option to purchase stock if such
employee:
. immediately after grant owns stock possessing 5% or more of the total
combined voting power or value of all classes of our capital stock;
or
. whose rights to purchase stock under all of our employee stock
purchase plans accrues at a rate that exceeds $25,000 worth of stock
for each calendar year.
Offering Periods and Contributions. Our Employee Stock Purchase Plan is
intended to qualify under Section 423 of the Code and contains consecutive,
overlapping 24-month offering periods (provided that the first offering period
will be a 25-month period). Each offering period includes four six-month
purchase periods. The offering periods generally start on the first trading day
on or after May 1 and November 1 of each year, except for the first such
offering period which will commence on the first trading day on or after the
effective date of this offering and will end on the last trading day on or
before November 1, 2003.
Our Employee Stock Purchase Plan permits participants to purchase common stock
through payroll deductions of up to 100% of their eligible compensation in 2001
and up to 15% of their eligible compensation thereafter. Eligible compensation
includes only a participant's base salary, wages, commissions, shift premium
and overtime. A participant may purchase a maximum of 10,000 shares during a
six-month purchase period.
Purchase of Shares. Amounts deducted and accumulated by the participant are
used to purchase shares of our common stock at the end of each six-month
purchase period. The price is 85% of the lower of the fair market value of our
common stock at the beginning of an offering period or at the end of the
particular purchase period. If the fair market value at the end of a purchase
period is less than the fair market value at the beginning of the offering
period, participants will be withdrawn from the current offering period
following their purchase of shares on the purchase date and will be
automatically re-enrolled in a new offering period. Participants may end their
participation at any time during an offering period, and will be paid their
payroll deductions to date. Participation in the Employee Stock Purchase Plan
ends up to three months after termination of employment with us.
Transferability of Rights. A participant may not transfer rights granted under
the Employee Stock Purchase Plan other than by will, the laws of descent and
distribution or as otherwise provided under the Purchase Plan.
Adjustments upon Merger or Change in Control. In the event of our merger with
or into another corporation or change in control, a successor corporation may
assume or substitute each outstanding option. If the successor corporation
refuses to assume or substitute for the outstanding options, the offering
period then in progress will be shortened, and a new exercise date will be set.
Amendment and Termination of the Employee Stock Purchase Plan. Our Employee
Stock Purchase Plan will terminate in 2011. However, our board of directors has
the authority to amend or terminate our Employee Stock Purchase Plan, except
that, subject to certain exceptions described in the Employee Stock Purchase
Plan, no such action may adversely affect any outstanding rights to purchase
stock under our Employee Stock Purchase Plan.
60
RELATED PARTY TRANSACTIONS
Common Stock Issuances
In March 1999, we issued W. Mark Lortz, our President, Chief Executive Officer
and Chairman of the Board, 144,990 shares of our common stock at a price of
$0.50 per share. The shares issued to Mr. Lortz are subject to a restricted
stock purchase agreement. The agreement provides that the shares are subject to
a right of repurchase in our favor, which right lapses over a four year period.
As of June 30, 2001, 81,556 of the shares are fully vested, and 63,434 of the
shares remain subject to our right of repurchase.
In July 1998, we issued 62,500 shares of our common stock to Charles T. Liamos,
our Chief Financial Officer, at a price of $0.28 per share. In March 1999, we
issued Mr. Liamos 30,375 shares of our common stock at a price of $0.50 per
share. In September 1999, we issued Mr. Liamos 87,500 shares of our common
stock at a price of $0.70 per share. The shares issued to Mr. Liamos are
subject to restricted stock purchase agreements. The agreements each provide
that the shares are subject to a right of repurchase in our favor, which right
lapses over a four year period. As of June 30, 2001, an aggregate of 108,492 of
the shares are fully vested and 71,883 of the shares remain subject to our
right of repurchase.
Preferred Stock Issuances
From October 1998 through April 2001, we sold shares of our preferred stock in
private financings as follows:
. 7,142,851 shares of Series B preferred stock at a price of $2.10 per
share in October 1998 and February 1999;
. 8,490,159 shares of Series C preferred stock at a price of $5.00 per
share in February 2000; and
. 6,643,371 shares of Series D preferred stock at a price of $8.50 per
share in January, February and April 2001.
Each share of preferred stock will convert automatically into one share of
common stock upon the closing of this offering. The purchasers of these shares
of preferred stock are entitled to certain registration rights. See
"Description of Capital Stock--Registration Rights." The investors in these
financings included the following executive officers, directors and holders of
more than 5% of our securities and their affiliated entities:
Investor Series B Series C Series D
-------- --------- --------- ---------
Brentwood Venture Capital(/1/)................... 3,123,236 400,000 117,647
Delphi Ventures and affiliates................... 238,095 800,000 470,588
InterWest Partners(/2/).......................... 3,123,237 1,254,160 470,588
Lehman Brothers and affiliates................... -- 1,999,999 294,117
MedVentures Associates and affiliates(/3/)....... 476,190 200,000 323,529
MJG Partners, L.P.(/4/).......................... 800,000 150,000
Sequoia Capital and affiliates................... -- -- 588,235
Disetronic Holding AG............................ -- -- 2,352,941
Robert D. Brownell............................... 3,571 4,300 --
Claire D. Heiss.................................. -- 10,000 --
Lawrence W. Huffman.............................. -- -- 20,000
Robert R. Momsen................................. -- -- 17,647
61
-------------------------------
(/1/)Ross A. Jaffe, M.D., one of our directors, is a Managing Member of
Brentwood VIII Ventures LLC, the General Partner of Brentwood Associates
VIII, L.P. and Brentwood Affiliates Fund II, L.P. The Brentwood Venture
Capital shares include shares purchased by Brentwood Associates VIII, L.P.
and Brentwood Affiliates Fund II, L.P.
(/2/)Robert R. Momsen, one of our directors, is a General Partner of InterWest
Partners VI, L.P and InterWest Investors VI, L.P. The InterWest Partners
shares include shares purchased by InterWest Partners VII, L.P., InterWest
Partners VI, L.P., InterWest Investors, VII, L.P., and InterWest
Investors, VI, L.P.
(/3/)Annette J. Campbell-White, one of our directors, is the Managing Partner
of MedVentures Associates II and III.
(/4/)Mark J. Gainor, one of our directors, is President of MJG Partners, L.P.
Indemnification Agreements of Officers and Directors
Our amended and restated certificate of incorporation and bylaws provide that
we will indemnify each of our directors and officers to the fullest extent
permitted by the Delaware General Corporation Law. Further, we have entered
into indemnification agreements with each of our directors and officers. For
further information, see "Description of Capital Stock--Limitation of Liability
and Indemnification Matters."
Loans to Directors and Executive Officers
In December 1997 and March 1999, we loaned an aggregate of $135,145 to W. Mark
Lortz, our President, Chief Executive Officer and Chairman of the Board, in
connection with his purchase of an aggregate of 592,490 shares of our
restricted common stock. The loans were made pursuant to two full-recourse
promissory notes in the amounts of $62,650 and $72,495. The notes do not bear
interest and are secured by the shares of common stock purchased. The notes are
payable upon the earlier of December 1, 2001 and March 5, 2003, respectively,
or termination of Mr. Lortz's employment with or services to us.
In July 1998, March 1999 and September 1999, we loaned an aggregate of $93,938
to Charles T. Liamos, our Chief Financial Officer, in connection with the
purchase of an aggregate of 180,375 shares of our restricted common stock. The
loans were made pursuant to three full-recourse promissory notes in the amounts
of $17,500, $15,188 and $61,250. The notes do not bear interest and are secured
by the shares of common stock purchased. The notes are payable upon the earlier
of April 6, 2002, March 5, 2003 and September 1, 2003, respectively, or
termination of Mr. Liamos' employment with or services to us.
Agreement with Flextronics
In November 1999, we entered into an agreement with Flextronics International
related to the manufacturing of the FreeStyle meter. Flextronics is exclusively
responsible for building the FreeStyle meter and assembling the FreeStyle
System kits. Our contract with Flextronics expires in November 2004, and is
renewable annually thereafter. This agreement may be terminated by either party
upon one year's prior written notice. In 1999 and 2000, we purchased $261,195
and $20.6 million under this agreement, respectively. Michael McNamara, a
member of our board of directors, is President of Americas Operations of
Flextronics.
Agreement with Facet Technologies
Pursuant to an agreement we entered into with Facet Technologies LLC in
December 1998, as amended in July 2001, Facet has provided financial support
for the development and design of the FreeStyle lancing device. Under the
agreement, we are obligated to pay royalties, based upon a fixed fee per
FreeStyle System kit shipped. Pursuant to an agreement we entered into with
Facet in July 2001, we have agreed to purchase the FreeStyle lancing devices
and lancets exclusively from Facet through June 1, 2007. In 1999 and 2000, we
purchased $4,675 and $402,356 of lancing devices and lancets from Facet,
respectively. Mark J. Gainor, a former principal of Facet Technologies LLC and
a former director of Matria Healthcare, Inc., which wholly owns Facet
Technologies LLC, is a member of our board of directors.
62
Agreement with E. Heller & Co.
In October 2000, we entered into a Technology Purchase Agreement with E. Heller
& Co., providing for the transfer and assignment of several licenses and rights
to us in exchange for $500,000. E. Heller & Co. is controlled by Ephraim
Heller, a co-founder, Vice President of Business Development and member of our
board of directors.
Agreement with Adam Heller
Dr. Adam Heller, our Chief Scientific Advisor, has performed consulting
services for us since April 1997. The terms of our consulting agreement with
Dr. Heller provide that we pay Dr. Heller a consulting fee of $1,200 per day of
service, plus reimbursement for travel and business expenses. The agreement has
a term of one year with automatic one year renewals. The agreement is
terminable by either party upon 30 days written notice. In 1998, 1999 and 2000,
we paid Dr. Heller $55,260, $85,760 and $110,141, respectively, in connection
with this agreement. Dr. Adam Heller is the father of Ephriam Heller,
co-founder, Vice President of Business Development and director.
Agreement with Disetronic Group
In September 2000, we entered into an International Distributor Agreement with
Disetronic Handels A.G. relating to the distribution of FreeStyle in Germany,
Switzerland, Denmark, Austria, Sweden, Finland, Norway and the Netherlands.
Under terms of the agreement, Disetronic will have exclusive responsibility for
sales, marketing and customer service in its territory in Europe. In addition,
Disetronic is also entitled to market FreeStyle to its pump users in North
America. The initial term of the Disetronic agreement is five years, ending in
September 2005. At the end of the initial term, the agreement will
automatically renew for additional three year terms unless one of the parties
provides written notice of termination at least on year prior to the end of the
Agreement. Under the terms of the agreement, we received a $1.5 million
nonrefundable pre-payment which has been deferred and is being credited as
revenues are recognized. Disetronic is required to meet specified minimum
purchase requirements or we may terminate the agreement. Disetronic
beneficially owns greater than 5% of our outstanding shares of capital stock.
63
PRINCIPAL STOCKHOLDERS
The following table sets forth information about the beneficial ownership of
our common stock on June 30, 2001, and as adjusted to reflect the sale of the
shares of common stock in this offering, by:
. each person known to us to be the beneficial owner of more than 5% of
our common stock;
. each named executive officer;
. each of our directors; and
. all of our executive officers and directors as a group.
Unless otherwise noted below, the address of each beneficial owner listed on
the table is c/o TheraSense, Inc., 1360 South Loop Road, Alameda, California
94501. We have determined beneficial ownership in accordance with the rules of
the Securities and Exchange Commission. Except as indicated by the footnotes
below, we believe, based on the information furnished to us, that the persons
and entities named in the tables below have sole voting and investment power
with respect to all shares of common stock that they beneficially own, subject
to applicable community property laws. We have based our calculation of the
percentage of beneficial ownership on 32,089,847 shares of common stock
outstanding on June 30, 2001 and 38,089,847 shares of common stock outstanding
upon completion of this offering.
In computing the number of shares of common stock beneficially owned by a
person and the percentage ownership of that person, we deemed outstanding
shares of common stock subject to options held by that person that are
currently exercisable or exercisable within 60 days of June 30, 2001. We did
not deem these shares outstanding, however, for the purpose of computing the
percentage ownership of any other person.
Number of Shares
Underlying Options Percentage of Shares
Exercisable Outstanding
Number of Shares Within 60 Days of -----------------------
Beneficial Owner Owned June 30, 2001 Before After
---------------- ---------------- ------------------ ---------- ----------
Five Percent
Stockholders
InterWest
Partners(/1/).......... 4,847,983 -- 15.11% 12.73%
Brentwood Venture
Capital(/2/)........... 3,640,883 -- 11.35% 9.56%
Delphi Ventures(/3/).... 3,302,941 -- 10.29% 8.67%
E. Heller & Co.......... 3,129,375 -- 9.75% 8.22%
Sequoia Capital(/4/).... 2,382,492 -- 7.42% 6.25%
Disetronic Holding
AG(/5/)................ 2,352,941 -- 7.33% 6.18%
Lehman Brothers(/6/).... 2,294,116 -- 7.15% 6.02%
MedVentures
Associates(/7/)........ 1,797,167 -- 5.60% 4.72%
Directors and Named
Executive Officers
W. Mark Lortz(/8/)...... 592,490 191,660 2.43% 2.05%
Tae Andrews............. -- 108,330 * *
Eve A. Conner, Ph.D..... 68,500 63,245 * *
Holly D. Kulp........... -- 122,371 * *
Charles T. Liamos....... 180,375 35,352 * *
Ephraim Heller(/9/)..... 3,129,375 -- 9.75% 8.22%
Annette J. Campbell-
White(/7/)............. 1,797,167 9,167 5.63% 4.74%
Mark J. Gainor(/10/).... 950,000 9,167 2.99% 2.52%
Ross A. Jaffe,
M.D.(/2/).............. 3,640,883 9,167 11.37% 9.58%
64
Number of Shares
Underlying Options Percentage of Shares
Exercisable Outstanding
Number of Shares Within 60 Days of -----------------------
Beneficial Owner Owned June 30, 2001 Before After
---------------- ---------------- ------------------ ---------- ----------
Michael M. McNamara..... 43,344 9,167 * *
Robert R. Momsen(/11/).. 3,347,152 9,167 10.46% 8.81%
Richard P. Thompson..... 30,000 9,167 * *
All directors and
executive officers as a
group (17 people)...... 13,930,565 764,926 44.73% 37.82%
-------------------------------
* Less than one percent
(/1/)The InterWest Partners shares include 3,228,289 shares purchased by
InterWest Partners VI, L.P., 1,449,082 shares purchased by InterWest
Partners VII, L.P., 101,216 shares purchased by InterWest Investors, VI,
L.P., and 69,396 shares purchased by InterWest Investors, VII, L.P.
InterWest Partners VII, L.P. and InterWest Investors VII, L.P. are
managed by InterWest Management Partners VII, LLC. InterWest Management
Partners VII, LLC has sole voting and investment control over shares
owned by InterWest Partners VII and InterWest Investors VII. The managing
directors of InterWest Management Partners VII, LLC are Harvey B. Cash,
Alan W. Crites, Philip T. Gianos, W. Scott Hedrick, W. Stephen Holmes,
Gilbert H. Kliman, Thomas L. Rosch and Arnold L. Oronsky. Stephen C.
Bowsher is a venture member. Managing Directors and Venture members share
voting and investment control. InterWest Management Partners VI, LLC has
sole voting and investment control over the shares held by InterWest
Partners VI, L.P. and InterWest Investors VI, L.P. Managing Directors are
Harvey B. Cash, Alan W. Crites, Philip T. Gianos, W. Scott Hedrick, W.
Stephen Holmes, Robert R. Momsen and Arnold L. Oronsky. The sole Venture
Member is Gilbert H. Kliman. Managing Directors and Venture Members share
voting and investment control. The address of InterWest Partners is
3000 Sand Hill Road, Building 3, Suite 255, Menlo Park, California 94025.
(/2/)The Brentwood Venture Capital shares include 3,495,247 shares purchased
by Brentwood Associates VIII, L.P. and 145,636 shares purchased by
Brentwood Affiliates Fund II, L.P. Brentwood VIII Ventures LLC, the
general partner of Brentwood Associates VIII, L.P. and Brentwood
Affiliates Fund II, L.P., has sole voting and dispositive power over
these shares. The managing members of Brentwood VIII Ventures LLC, Dr.
Ross A. Jaffe (one of our directors), Brian G. Atwood, Jeffrey C. Brody,
G. Bradford Jones, William J. Link and John L. Walecka, share voting and
investment control over the shares held by these funds, but none of them
individually possesses voting or dispositive power over the shares. The
managing members disclaim beneficial ownership of these shares except to
the extent of their respective pecuniary interests therein. The address
of each of the Brentwood entities referred to herein is 11150 Santa
Monica Blvd., Suite 1200, Los Angeles, California 90025.
(/3/)The Delphi Ventures shares include 2,389,337 shares purchased by Delphi
Ventures III, L.P., 853,002 shares purchased by Delphi Ventures IV, L.P.,
43,017 shares purchased by Delphi BioInvestments III, L.P. and 17,586
shares purchased by Delphi BioInvestments IV, L.P. The managing members
of Delphi Management Partners III, L.L.C., which is the general partner
of Delphi Ventures III, L.P. and Delphi BioInvestments III, L.P.,
disclaim beneficial ownership except to the extent of their pecuniary
interest therein. The managing members of Delphi Management Partners III,
L.P., all of whom share voting and dispositive power over these shares,
are James J. Bochnowski, David L. Douglass and Donald J. Lothrop. The
managing members of Delphi Management Partners IV, L.L.C., which is the
general partner of Delphi Ventures IV, L.P. and Delphi BioInvestments IV,
L.P., disclaim beneficial ownership except to the extent of their
pecuniary interest therein. The managing members of Delphi Management
Partners IV, L.P., all of whom share voting and dispositive power over
these shares, are James J. Bochnowski, David L. Douglass and Donald J.
Lothrop. The address of Delphi Ventures is 3000 Sand Hill Road, Building
1, Suite 135, Menlo Park, California 94025.
(/4/)The Sequoia Capital shares include 1,618,421 shares purchased by Sequoia
Capital VII, 78,947 shares purchased by Sequoia Technology Partners VII,
44,856 shares purchased by Sequoia International Partners, 52,033 shares
purchased by Sequoia 1997, LLC, 517,647 shares purchased by Sequoia
Capital Franchise Fund, and 70,588 shares purchased by Sequoia Capital
Franchise Partners. The general partner of Sequoia Capital VII, Sequoia
Technology Partners VII and Sequoia International Partners is SC VII
Management-A, LLC., whose managing members are Douglas Leone, Michael
Moritz, Thomas McMurray, Thomas Stephenson and Mark Stevens. These
individuals also have signing power over Sequoia 1997, LLC. The general
partner of Sequoia Capital Franchise Fund and Sequoia Capital Franchise
Partners is SCFF Management, LLC, whose managing members are
Michael Goguen, Douglas Leone, Michael Moritz, Thomas Stephenson and Mark
Stevens. The managing members of the respective funds share voting and
investment control over all shares held by those funds. The address of
Sequoia Capital is 3000 Sand Hill Road, Building 4, Suite 280, Menlo
Park, California 94025.
(/5/)The address of Disetronic Holding AG is Brunnmattstrasse 6, Burgdorf, CH
3401 Switzerland.
(/6/)The Lehman Brothers shares include 957,193 shares purchased by LB I
Group, Inc., 832,235 shares purchased by Lehman Brothers Venture
Partners, L.P., and 504,688 shares purchased by Lehman Brothers Venture
Capital Partners I, L.P. The above-listed entities are controlled by
subsidiaries of Lehman Brothers Holdings, Inc., a publicly held
corporation. The address of Lehman Brothers is 3 World Financial Center,
8th Floor, New York, New York 10285-0800.
65
(/7/The)MedVentures Associates shares include 1,561,873 shares purchased by
MedVentures Associates II, L.P., 225,694 shares purchased by MedVentures
Associates III, L.P., and 9,600 shares purchased by MedVen Affiliates III,
L.P. Ms. Campbell-White is a member of MedVentures Associates Management
II Co., LLC, which is the general partner of MedVentures Associates II,
and a member of MedVentures Associates Management III Co., LLC, which is
the general partner of MedVentures Associates III, L.P. and MedVen
Affiliates III, L.P. Ms. Campbell-White disclaims beneficial ownership of
these shares except to the extent of her pecuniary interest therein.
Annette Campbell-White and George Choi share voting and investment control
in MedVentures Associates Management II Co., LLC, and MedVentures
Associates Management II Co., LLC. The address of MedVentures Associates
is 4 Orinda Way, Building D, Suite 150, Orinda, California 94563.
(/8/Includes)592,490 shares held by the W. Mark Lortz And Patrice Rae Lortz,
Co-Trustees or Successor Trustee, of the W. Mark Lortz and Patrice Rae
Lortz Revocable Living Trust, under Agreement Dated February 10, 1999, as
community property.
(/9/Represents)3,129,375 shares owned by E. Heller & Co., of which Ephraim
Heller is the controlling stockholder. Mr. Heller disclaims beneficial
ownership of these shares except to the extent of his pecuniary interest
therein.
(/10/Represents)950,000 shares owned by MJG Partners, L.P., of which Mr. Gainor
is president. Mr. Gainor disclaims beneficial ownership of these shares
except to the extent of his pecuniary interest therein. The address of MJG
Partners, L.P. is 40301 Fisher Island Drive, Fisher Island, Florida 33109.
(/11/Includes)17,647 shares purchased by the Momsen Living Trust U/A/D 1/5/95,
Robert Momsen Trustee and shares purchased by InterWest Partners, as
follows: 3,228,289 shares purchased by InterWest Partners VI, L.P. and
101,216 shares purchased by InterWest Investors VI, L.P. Mr. Momsen is a
general partner of InterWest Partners VI, L.P. and InterWest Investors VI,
L.P., and a limited partner of InterWest Investors VI, L.P. Mr. Momsen
disclaims beneficial ownership of these shares except to the extent of his
pecuniary interest therein.
66
DESCRIPTION OF CAPITAL STOCK
Upon the closing of this offering, our authorized capital stock, after giving
effect to the conversion of all outstanding preferred stock into common stock
and the amendment of our certificate of incorporation, will consist of
200,000,000 shares of common stock, $0.001 par value, and 5,000,000 shares of
preferred stock, $0.001 par value. The following description summarizes the
most important terms of our capital stock. Because it is only a summary, it
does not contain all the information that may be important to you. For a
complete description you should refer to our certificate of incorporation and
bylaws, effective upon completion of this offering, copies of which have been
filed as exhibits to the registration statement of which the prospectus is a
part.
Common Stock
As of June 30, 2001, there were 32,089,847 shares of common stock outstanding
and held by approximately 166 stockholders of record, assuming the automatic
conversion of each outstanding share of preferred stock upon the closing of
this offering. After this offering, there will be 38,089,847 shares of our
common stock outstanding, or 38,989,847 shares if the underwriters exercise
their over-allotment option in full.
The holders of our common stock are entitled to one vote for each share held of
record on all matters submitted to a vote of the stockholders, including the
election of directors, and do not have cumulative voting rights. Accordingly,
the holders of a majority of the shares of common stock entitled to vote in any
election of directors can elect all of the directors standing for election, if
they so choose. Subject to preferences that may be applicable to any then
outstanding preferred stock, holders of common stock are entitled to receive
ratably those dividends, if any, as may be declared by the board of directors
out of legally available funds. Upon our liquidation, dissolution or winding
up, the holders of common stock will be entitled to share ratably in the net
assets legally available for distribution to stockholders after the payment of
all of our debts and other liabilities of our company, subject to the prior
rights of any preferred stock then outstanding. Holders of common stock have no
preemptive or conversion rights or other subscription rights and there are no
redemption or sinking funds provisions applicable to the common stock. All
outstanding shares of common stock are, and the common stock to be outstanding
upon completion of this offering will be, fully paid and nonassessable.
Preferred Stock
As of June 30, 2001, there were 26,722,151 shares of preferred stock
outstanding. Upon the closing of this offering, each outstanding share of
preferred stock will be converted into one share of common stock. Following the
conversion, our certificate of incorporation will be amended and restated to
delete all references to the prior series of preferred stock, and 5,000,000
shares of undesignated preferred stock will be authorized.
The board of directors will have the authority, without further action by the
stockholders, to issue from time to time the preferred stock in one or more
series and to fix the number of shares, designations, preferences, powers, and
relative, participating, optional or other special rights and the
qualifications or restrictions thereof. The preferences, powers, rights and
restrictions of different series of preferred stock may differ with respect to
dividend rates, amounts payable on liquidation, voting rights, conversion
rights, redemption provisions, sinking fund provisions, and purchase funds and
other matters. The issuance of preferred stock could decrease the amount of
earnings and assets available for distribution to holders of common stock or
adversely affect the rights and powers, including voting rights, of the holders
of common stock, and may have the effect of delaying, deferring or preventing a
change in control of our company.
67
Warrants
As of June 30, 2001, there were warrants outstanding to purchase 54,348 shares
of Series A preferred stock and 466,665 shares of Series B preferred stock at a
per share exercise price of $1.84 and $2.10, respectively. Upon completion of
this offering, the warrants will be exercisable for an aggregate of 521,013
shares of common stock, at a per share weighted average exercise price of
$2.07. The warrant exercisable to purchase 54,348 shares of Series A preferred
stock can be exercised at any time prior to December 31, 2001, at a per share
exercise price of $1.84. Warrants exercisable to purchase 380,952 and 47,619
shares of Series B preferred stock, respectively, can be exercised at any time
prior to the earlier of five years after the effective date of this offering,
or October 7, 2009 or August 24, 2008, respectively, at a per share exercise
price of $2.10. Warrants exercisable to purchase 3,809, 8,928 and 25,357 shares
of Series B preferred stock, respectively, can be exercised at any time prior
to the later of five years after the effective date of this offering, or April
1, 2007, at a per share exercise price of $2.10.
Registration Rights
After this offering, the holders of 27,243,164 shares of common stock issued
upon conversion of our preferred stock, and upon exercise of outstanding
warrants, are entitled to rights with respect to the registration of these
shares under the Securities Act of 1933, as amended. These shares are referred
to as registrable securities. The registration rights provide that if we
propose to register any of our securities under the Securities Act for our own
account, holders of common stock issuable upon conversion of the Series A,
Series B, Series C and Series D preferred stock, or issuable upon exercise of
outstanding warrants, are entitled to notice of such registration and are
entitled to include their registrable securities in that registration, subject
to various conditions. The underwriters of any such offering have the right to
limit the number of shares included in such registration. These registration
rights have been waived with respect to this offering.
Anti-Takeover Effects of Provisions of our Amended and Restated Certificate of
Incorporation and Bylaws and Delaware Law
Some provisions of Delaware law and our amended and restated certificate of
incorporation and bylaws contain provisions that could make the following
transactions more difficult:
. acquisition of us by means of a tender offer;
. acquisition of us by means of a proxy contest or otherwise; or
. removal of our incumbent officers and directors.
These provisions, summarized below, are expected to discourage coercive
takeover practices and inadequate takeover bids. These provisions are also
designed to encourage persons seeking to acquire control of us to first
negotiate with our board of directors. We believe that the benefits of
increased protection of our potential ability to negotiate with the proponent
of an unfriendly or unsolicited proposal to acquire or restructure us outweigh
the disadvantages of discouraging such proposals because negotiation of such
proposals could result in an improvement of their terms.
Undesignated Preferred Stock. The ability to authorize undesignated preferred
stock makes it possible for our board of directors to issue preferred stock
with voting or other rights or preferences that could impede the success of any
attempt to change control of TheraSense. These and other provisions may have
the effect of deferring hostile takeovers or delaying changes in control or
management of our company.
Stockholder Meetings. Our charter documents provide that a special meeting of
stockholders may be called only by the chairman of the board, the chief
executive officer or the president of our company, or by a resolution adopted
by a majority of our board of directors.
68
Requirements For Advance Notification Of Stockholder Nominations And
Proposals. Our bylaws establish advance notice procedures with respect to
stockholder proposals and the nomination of candidates for election as
directors, other than nominations made by or at the direction of the board of
directors or a committee of the board of directors.
Elimination of Stockholder Action by Written Consent. Our certificate of
incorporation eliminates the right of stockholders to act by written consent
without a meeting.
Election and Removal of Directors. Our board of directors is divided into three
classes. The directors in each class will serve for a three-year term, one
class being elected each year by our stockholders. For more information on the
classified board, see the section entitled "Management--Board of Directors."
This system of electing and removing directors may tend to discourage a third
party from making a tender offer or otherwise attempting to obtain control of
us because it generally makes it more difficult for stockholders to replace a
majority of the directors.
Delaware Anti-Takeover Statute. We are subject to Section 203 of the Delaware
General Corporation Law which prohibits persons deemed "interested
stockholders" from engaging in a "business combination" with a Delaware
corporation for three years following the date these persons become interested
stockholders. Generally, an "interested stockholder" is a person who, together
with affiliates and associates, owns, or within three years prior to the
determination of interested stockholder status did own, 15% or more of a
corporation's voting stock. Generally, a "business combination" includes a
merger, asset or stock sale, or other transaction resulting in a financial
benefit to the interested stockholder. The existence of this provision may have
an anti-takeover effect with respect to transactions not approved in advance by
the board of directors.
Amendment of Charter Provisions. The amendment of any of the above provisions
would require approval by holders of at least 66 2/3% of our then outstanding
common stock.
The provisions of Delaware law and our amended and restated certificate of
incorporation and bylaws could have the effect of discouraging others from
attempting hostile takeovers and, as a consequence, they may also inhibit
temporary fluctuations in the market price of our common stock that often
result from actual or rumored hostile takeover attempts. Such provisions may
also have the effect of preventing changes in our management. It is possible
that these provisions could make it more difficult to accomplish transactions
which stockholders may otherwise deem to be in their best interests.
Limitations of Liability and Indemnification Matters
We have adopted provisions in our amended and restated certificate of
incorporation that limit the liability of our directors for monetary damages
for breach of their fiduciary duties, except for liability that cannot be
eliminated under the Delaware General Corporation Law. Delaware law provides
that directors of a corporation will not be personally liable for monetary
damages for breach of their fiduciary duties as directors, except liability for
any of the following:
. any breach of their duty of loyalty to the corporation or the
stockholder;
. acts or omissions not in good faith or that involve intentional
misconduct or a knowing violation of law;
. unlawful payments of dividends or unlawful stock repurchases or
redemptions as provided in Section 174 of the Delaware General
Corporation Law; or
. any transaction from which the director derived an improper personal
benefit.
This limitation of liability does not apply to liabilities arising under the
federal securities laws and does not affect the availability of equitable
remedies such as injunctive relief or rescission.
69
Our amended and restated certificate of incorporation and bylaws also provide
that we will indemnify our directors and executive officers and we may
indemnify our other officers and employees and other agents to the fullest
extent permitted by law. We believe that indemnification under our bylaws
covers at least negligence and gross negligence on the part of indemnified
parties. Our bylaws also permit us to secure insurance on behalf of any
officer, directors employee or other agent for any liability arising out of his
or her actions in such capacity, regardless of whether our bylaws would permit
indemnification.
We have entered into separate indemnification agreements with our directors and
executive officers, in addition to indemnification provided for in our charter
documents. These agreements among other things, will provide for
indemnification of our directors and executive officers for expenses,
judgments, fines and settlement amounts incurred by any such person in any
action or proceeding arising out of such person's services as a director or
executive officer or at our request. We believe that these provisions and
agreements are necessary to attract and retain qualified persons as directors
and executive officers.
Transfer Agent And Registrar
The transfer agent and registrar for the common stock is Computershare Investor
Services LLC.
70
SHARES ELIGIBLE FOR FUTURE SALE
Prior to this offering there has been no public market for our common stock,
and no predictions can be made regarding the effect, if any, that market sales
of shares or the availability of shares for sale will have on the market price
prevailing from time to time. As described below, only a limited number of
shares will be available for sale shortly after this offering due to
contractual and legal restrictions on resale. Nevertheless, sales of our common
stock in the public market after the restrictions lapse, or the perception that
such sales may occur, could adversely affect the prevailing market price.
Sale of Restricted Shares and Lock-Up Agreements
Upon completion of this offering, we will have an aggregate of 38,089,847
outstanding shares of common stock based upon shares outstanding as of June 30,
2001, assuming no exercise of the underwriters' over-allotment option and no
exercise of outstanding options prior to completion of this offering. As of
June 30, 2001, we had:
. outstanding stock options held by employees, consultants and
directors for the purchase of an aggregate of 4,882,303 shares of
common stock; and
. outstanding warrants to purchase 521,013 shares of preferred stock
which will automatically convert into warrants to purchase an equal
number of shares of common stock upon the completion of this
offering.
The 6,000,000 shares of common stock being sold in this offering will be freely
tradeable without restriction or further registration under the Securities Act,
unless the shares are purchased by affiliates of our company, as that term is
defined in Rule 144 of the Securities Act. All remaining shares were issued and
sold by us in private transactions and are eligible for public sale if
registered under the Securities Act or sold in accordance with Rule 144 or Rule
701 thereunder.
Eligibility of Restricted Shares for Sale in the Public Market
All of our officers and directors and substantially all of our stockholders are
subject to lock-up agreements under which they will agree not to transfer or
dispose of, directly or indirectly, any shares of common stock or any
securities convertible into or exercisable or exchangeable for shares of common
stock, for a period of 180 days after the date of this prospectus. Transfers or
dispositions can be made sooner with the prior written consent of U.S. Bancorp
Piper Jaffray Inc.
Following the expiration of the lock-up period, approximately 32,089,847 shares
of common stock will be available for sale in the public market, subject in
some instances to compliance with Rule 144, Rule 144(k) or Rule 701.
Rule 144
In general, under Rule 144, a person or persons whose shares are aggregated who
has beneficially owned restricted securities for at least one year, including
the holding period of any holder who is not an affiliate, and who files a Form
144 with respect to such sale, is entitled to sell within any three-month
period commencing 90 days after the date of this prospectus a number of shares
of common stock that does not exceed the greater of:
. 1% of the then outstanding shares of our common stock, or
approximately 380,000 shares immediately after this offering, or
. the average weekly trading volume during the four calendar weeks
preceding such sale.
Sales under Rule 144 are also subject to restrictions relating to manner of
sale, notice and the availability of current public information about us.
71
We cannot estimate the number of shares that will be sold under Rule 144, as
this will depend on the market price for our common stock, the personal
circumstances of the sellers and other factors. Prior to this offering, there
has been no public market for our common stock, and a significant public market
for our common stock may never develop or be sustained after this offering. Any
future sale of substantial amounts of our common stock in the open market may
adversely affect the market price of our common stock.
Rule 144(k)
A person who is not deemed to have been our affiliate at any time during the 90
days immediately preceding a sale and who has beneficially owned his or her
shares for at least two years, including the holding period of any prior owner
who is not an affiliate, is entitled to sell these shares of common stock
pursuant to Rule 144(k) without regard to the volume limitations, manner of
sale provisions, public information or notice requirements of Rule 144.
Affiliates must always sell pursuant to Rule 144, even after the applicable
holding periods have been satisfied.
Rule 701
Rule 701 may be relied upon with respect to the resale of securities originally
purchased from us by our employees, directors, officers, consultants or
advisers prior to the closing of this offering and pursuant to written
compensatory benefit plans or written contracts relating to the compensation of
such persons. In addition, the SEC has indicated that Rule 701 will apply to
stock options granted by us before this offering, along with the shares
acquired upon exercise of such options. Securities issued in reliance on Rule
701 are deemed to be restricted shares and, beginning 90 days after the date of
this prospectus, may be sold by persons other than affiliates subject only to
the manner of sale provisions of Rule 144 and by affiliates under Rule 144
without compliance with the holding period requirements. As of June 30, 2001,
542,206 of our outstanding shares of common stock had been issued in reliance
on Rule 701 as a result of exercise of stock options, and all of these shares
are subject to 180 day lock-up agreements.
Stock Options
We intend to file registration statements under the Securities Act covering
approximately 13,936,135 shares of common stock reserved for issuance under our
1997 Stock Plan, 2001 Stock Plan and 2001 Employee Stock Purchase Plan. These
registration statements are expected to be filed soon after the date of this
prospectus and will automatically become effective upon filing. In addition,
within 90 days following the date of this prospectus, we intend to file a
registration statement on Form S-8/S-3 under the Securities Act covering, as of
June 30, 2001, approximately 1,655,997 shares of common stock issued to certain
of our employees upon exercise of options granted in reliance on Rule 701,
Section 4(2) of the Securities Act and applicable state securities laws.
Accordingly, shares registered under such registration statements will be
available for sale in the open market, unless such shares are subject to
vesting restrictions with us or are otherwise subject the contractual
restrictions described above.
Registration Rights
In addition, after this offering, the holders of shares of preferred stock
convertible into 26,722,151 shares of common stock and warrants exercisable for
an aggregate of 521,013 shares of common stock will be entitled to rights to
cause us to register the sale of such shares under the Securities Act. These
shares are referred to as registrable securities. Specifically, commencing 180
days after the effective date of the registration statement of which this
prospectus is a part, a holder or holder of at least 50% of the registrable
securities may require us to prepare and file a registration statement under
the Securities Act at our expense covering at least 50% of the registrable
securities, or any lesser amount if the shares to be included in such
registration will generate anticipated aggregate net proceeds to TheraSense of
at least $15,000,000. Under these demand registration rights, we are
72
required to use our best efforts to cause the shares requested to be included
in the registration statement, subject to customary conditions and limitations.
We are not obligated to effect more than two of these stockholder-initiated
registrations. Once we become eligible to file a registration statement on Form
S-3, the holders of registrable securities may require us to register all or a
portion of their securities on a registration statement on Form S-3 and may
participate in a Form S-3 registration by us, subject to specific conditions
and limitations. Registration rights terminate no later than five years after
this offering. Registration of these shares under the Securities Act would
result in these shares, other than shares purchased by our affiliates, becoming
freely tradable without restriction under the Securities Act.
73
UNDERWRITING
The underwriters named below, for whom U.S. Bancorp Piper Jaffray Inc., SG
Cowen Securities Corporation and Thomas Weisel Partners LLC are acting as
representatives, have agreed to buy, subject to the terms of a purchase
agreement, the number of shares listed opposite their names below. The
underwriters are committed to purchase and pay for all of the shares if any are
purchased, other than those shares covered by the over-allotment option
described below.
Number of
Underwriters Shares
------------ ---------
U.S. Bancorp Piper Jaffray Inc. ................................. 2,475,000
SG Cowen Securities Corporation.................................. 1,237,500
Thomas Weisel Partners LLC....................................... 1,237,500
Banc of America Securities LLC................................... 100,000
CIBC World Markets Corp.......................................... 100,000
Credit Suisse First Boston Corporation........................... 100,000
Dain Rauscher Incorporated....................................... 100,000
First Union Securities, Inc...................................... 100,000
Merrill Lynch, Pierce, Fenner & Smith Incorporated............... 100,000
J.P. Morgan Securities Inc....................................... 100,000
Salomon Smith Barney Inc......................................... 100,000
UBS Warburg LLC.................................................. 100,000
William Blair & Company, L.L.C................................... 50,000
McDonald Investments Inc., a KeyCorp Company..................... 50,000
Raymond James & Associates, Inc.................................. 50,000
---------
Total.......................................................... 6,000,000
=========
The underwriters have advised us that they propose to offer the shares
initially to the public at $19.00 per share. The underwriters propose to offer
the shares to certain dealers at the same price less a concession of not more
than $0.80 per share. The underwriters may allow and the dealers may reallow a
concession of not more than $0.10 per share on sales to certain other brokers
and dealers. After the offering, these figures may be changed by the
underwriters.
At our request, the underwriters have reserved for sale at the initial public
offering price up to 300,000 shares of common stock to directors, employees and
persons having business relationships with or otherwise related to TheraSense.
The number of shares of common stock available for sale to the general public
will be reduced to the extent that such individuals purchase all or a portion
of these reserved shares. Any reserved shares which are not purchased will be
offered by the underwriters to the general public on the same basis as the
shares of common stock offered hereby.
We have granted to the underwriters an option to purchase up to an additional
900,000 shares of common stock from us at the same price to the public, and
with the same underwriting discount, as set forth on the cover page of this
prospectus. The underwriters may exercise this option any time during the 30-
day period after the date of this prospectus, but only to cover over-
allotments, if any. To the extent the underwriters exercise the option, each
underwriter will become obligated, subject to certain conditions, to purchase
approximately the same percentage of the additional shares as it was obligated
to purchase under the purchase agreement.
The following table shows the underwriting fees to be paid to the underwriters
in connection with this offering. These amounts are shown assuming both no
exercise and full exercise of the over-allotment option.
No Full
Exercise Exercise
---------- ----------
Per share............................................ $ 1.33 $ 1.33
Total................................................ $7,980,000 $9,177,000
74
We estimate that the total expenses of the offering payable by us, excluding
underwriting discounts and commissions, will be approximately $750,000.
We have agreed to indemnify the underwriters against certain liabilities,
including civil liabilities under the Securities Act, or to contribute to
payments that the underwriters may be required to make in respect of those
liabilities.
The underwriters have informed us that neither they, nor any other underwriter
participating in the distribution of the offering, will make sales of the
common stock offered by this prospectus to accounts over which they exercise
discretionary authority without the prior specific written approval of the
customer.
The offering of our shares of common stock is made for delivery when, and as if
accepted by the underwriters and subject to prior sale and to withdrawal,
cancellation or modification of the offering without notice. The underwriters
reserve the right to reject an order for the purchase of shares in whole or
part.
We and each of our directors and executive officers and substantially all of
our stockholders have agreed to certain restrictions on our ability to sell
additional shares of our common stock for a period of 180 days after the date
of this prospectus. We have agreed not to directly or indirectly, offer for
sale, sell, contract to sell, grant any option for the sale of, pledge,
transfer, establish an open "put equivalent position" within the meaning of
Securities Act Rule 16A-1(h) or otherwise dispose of, any shares of common
stock, options or warrants to acquire shares of common stock, or security or
instrument related to common stock, subject to limited exceptions, without the
prior written consent of U.S. Bancorp Piper Jaffray Inc.
Prior to the offering, there has been no established trading market for the
common stock. The initial public offering price for the shares of common stock
offered by this prospectus was negotiated by us and the underwriters. The
factors considered in determining the initial public offering price included:
. the history of and the prospects for the industry in which we
compete;
. our past and present operations;
. our historical results of operations;
. our prospects for future earnings;
. the recent market prices of securities of generally comparable
companies; and
. the general condition of the securities markets at the time of the
offering and other relevant factors.
The initial public offering price of the common stock may not correspond to the
price at which the common stock will trade in the public market subsequent to
this offering and an active public market for the common stock may never
develop and continue after this offering.
To facilitate the offering, the underwriters may engage in transactions that
stabilize, maintain or otherwise affect the price of the common stock during
and after the offering. Specifically, the underwriters may over-allot or
otherwise create a short position in the common stock for their own account by
selling more shares of common stock than have been sold to them by us. Short
sales involve the sale by the underwriters of a greater number of shares than
they are required to purchase in the offering. "Covered" short sales are sales
made in an amount not greater than the underwriters' option to purchase
additional shares from the issuer in the offering. The underwriters may close
out any covered short position by either exercising their option to purchase
additional shares or purchasing shares in the open market. In determining the
source of shares to close out the covered short position, the underwriters will
consider, among other things, the price of shares available for purchase in the
75
open market as compared to the price at which they may purchase shares through
the over-allotment option. "Naked" short sales are sales in excess of this
option. The underwriters must close out any naked short position by purchasing
shares in the open market. A naked short position is more likely to be created
if the underwriters are concerned that there may be downward pressure on the
price of the common stock in the open market after pricing that could adversely
affect investors who purchase in the offering.
In addition, the underwriters may stabilize or maintain the price of the common
stock by bidding for or purchasing shares of common stock in the open market
and may impose penalty bids. If penalty bids are imposed, selling concessions
allowed to syndicate members or other broker-dealers participating in the
offering are reclaimed if shares of common stock previously distributed in the
offering are repurchased, whether in connection with stabilization transactions
or otherwise. The effect of these transactions may be to stabilize or maintain
the market price of the common stock at a level above that which might
otherwise prevail in the open market. The imposition of a penalty bid may also
effect the price of the common stock to the extent that it discourages resales
of the common stock. The magnitude or effect of any stabilization or other
transactions is uncertain. These transactions may be effected on The Nasdaq
National Market or otherwise and, if commenced, may be discontinued at any
time.
Due to the fact that Thomas Weisel Partners LLC, one of the underwriters, was
organized within the last three years, we are providing you the following
information. Thomas Weisel Partners LLC was organized and registered as a
broker-dealer in December 1998. Since December 1998, Thomas Weisel Partners LLC
has been named as a lead or co-manager of, or as a syndicate member in,
numerous public offerings of equity securities. Thomas Weisel Partners LLC does
not have any material relationship with us or any of our officers, directors or
other controlling persons, except with respect to its contractual relationship
with us pursuant to the purchase agreement entered into in connection with this
offering.
One investment fund and three individuals affiliated with U.S. Bancorp Piper
Jaffray Inc., one of the representatives, purchased an aggregate of 89,177
shares of Series D preferred stock at a purchase price of $8.50 per share in
our Series D financing in February and April, 2001. The NASD has determined
that the difference between the public offering price of our common stock and
the purchase price paid by this fund and individuals for the Series D preferred
stock is underwriting compensation. As a result, each of the investment fund
and the individuals has agreed that, for a period of one year from the
effective date of this offering, it will not sell, transfer, assign, pledge or
hypothecate any of its shares of Series D preferred stock (or shares of our
common stock into which it may be converted in connection with this offering).
In addition, the investment fund and two of these individuals also purchased an
aggregate of 200,000 shares of Series C preferred stock at $5.00 per share in
our Series C financing in February 2000. Each of the investment fund and the
individuals has agreed that, for a period of 90 days from the effective date of
this offering, it will not sell, transfer, assign, pledge or hypothecate any of
its shares of Series C preferred stock (or shares of our common stock into
which it may be converted in connection with this offering).
76
LEGAL MATTERS
Various legal matters with respect to the validity of the common stock offered
by this prospectus will be passed upon for us by Wilson Sonsini Goodrich &
Rosati, P.C., San Francisco, California. An investment partnership comprised of
some current and former members of Wilson Sonsini Goodrich & Rosati and one
current member of Wilson Sonsini Goodrich & Rosati, will beneficially own an
aggregate of 34,153 shares of our common stock assuming conversion of all
outstanding shares of preferred stock. These shares have an aggregate value of
$648,907, based on the initial public offering price of $19.00 per share.
Various legal matters relating to the offering will be passed upon for the
underwriters by Brobeck, Phleger & Harrison LLP, San Diego, California.
EXPERTS
The financial statements of TheraSense, Inc. as of December 31, 1999 and 2000,
and for each of the three years in the period ended December 31, 2000 included
in this prospectus have been so included in reliance on the report of
PricewaterhouseCoopers LLP, independent accountants, given on the authority of
said firm as experts in auditing and accounting.
WHERE YOU CAN FIND ADDITIONAL INFORMATION
We have filed a registration statement on Form S-1 with the SEC for the stock
we are offering by this prospectus. This prospectus does not include all of the
information contained in the registration statement and its exhibits. We have
included all material terms of the registration statement and the related
exhibits and schedules that are referred to in this prospectus. You should
refer to the registration statement and its exhibits for additional
information. When we complete this offering, we will also be required to file
annual, quarterly and special reports, proxy statements and other information
with the SEC.
You can read our SEC filings, including the registration statement, over the
Internet at the SEC's web site at www.sec.gov. You may also read and copy any
document we file with the SEC at its public reference facilities at 450 Fifth
Street, N.W., Washington, D.C. 20549 and Citicorp Center, 500 West Madison
Street, Suite 1400, Chicago, Illinois 60661-2511. You may also obtain copies of
the documents at prescribed rates by writing to the Public Reference Section of
the SEC at 450 Fifth Street, N.W., Washington, D.C. 20549. Please call the SEC
at 1-800-SEC-0330 for further information on the operation of the public
reference facilities.
77
THERASENSE, INC.
INDEX TO FINANCIAL STATEMENTS
Page
----
Report of Independent Accountants.......................................... F-2
Balance Sheets............................................................. F-3
Statements of Operations................................................... F-4
Statements of Stockholders' Deficit........................................ F-5
Statements of Cash Flows................................................... F-7
Notes to Financial Statements.............................................. F-8
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Board of Directors and Stockholders
of TheraSense, Inc.
In our opinion, the financial statements listed in the accompanying index
present fairly, in all material respects, the financial position of TheraSense,
Inc. (the "Company") at December 31, 1999 and 2000 and the results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2000 in conformity with accounting principles generally accepted
in the United States of America. In addition, in our opinion, the financial
statement schedule appearing under Item 16(b) on page II-4 presents fairly, in
all material respects, the information set forth therein when read in
conjunction with the related financial statements. These financial statements
and financial statement schedule are the responsibility of the Company's
management; our responsibility is to express an opinion on these financial
statements and financial statement schedule based on our audits. We conducted
our audits of these statements in accordance with auditing standards generally
accepted in the United States of America, which require that we plan and
perform the audit to obtain reasonable assurance about whether the financial
statements are free of material misstatement. An audit includes examining, on a
test basis, evidence supporting the amounts and disclosures in the financial
statements, assessing the accounting principles used and significant estimates
made by management, and evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
/s/ PricewaterhouseCoopers LLP
San Jose, California
June 21, 2001, except for the sixth paragraph of Note 6,
as to which the date is June 27, 2001
F-2
THERASENSE, INC.
BALANCE SHEETS
Pro Forma
December 31, at June 30,
-------------------------- June 30, 2001
1999 2000 2001 (see Note 2)
------------ ------------ ------------ ------------
(unaudited)
Assets
Current assets:
Cash and cash
equivalents........... $ 2,322,424 $ 12,532,474 $ 45,152,387
Accounts receivable,
net of allowance for
doubtful accounts of
none in 1999,
$150,000 in 2000 and
$285,425 (unaudited)
in 2001............... 25,000 6,174,697 10,767,414
Inventories............ -- 3,493,777 3,951,874
Deferred cost of
products sold......... -- 7,396,547 9,759,940
Prepaid expenses and
other current
assets................ 836,005 1,178,435 1,783,514
------------ ------------ ------------
Total current
assets.............. 3,183,429 30,775,930 71,415,129
Property and equipment,
net.................... 3,998,451 4,838,682 4,856,194
Other assets............ 844,203 1,950,303 2,710,773
------------ ------------ ------------
Total assets......... $ 8,026,083 $ 37,564,915 $ 78,982,096
============ ============ ============
Liabilities, Convertible
Preferred Stock and
Stockholders' Equity
(Deficit)
Current liabilities:
Accounts payable....... $ 678,684 $ 10,624,731 $ 10,317,865
Accrued liabilities.... 585,160 4,421,512 9,151,079
Deferred revenue....... 511,341 8,686,547 13,923,140
Current portion of
capital lease
obligations........... 109,356 844,394 1,029,927
Current portion of
borrowings under
lines of credit....... 507,276 1,958,958 2,187,394
------------ ------------ ------------
Total current
liabilities......... 2,391,817 26,536,142 36,609,405
Deferred revenue........ -- -- 3,761,341
Capital lease
obligations, less
current portion........ 219,367 2,037,140 1,569,331
Borrowings under lines
of credit, less current
portion................ 3,101,658 3,457,345 2,115,476
Convertible promissory
note................... -- 2,500,000 --
------------ ------------ ------------
Total liabilities.... 5,712,842 34,530,627 44,055,553
------------ ------------ ------------
Commitments and
contingencies (Note 6)
Convertible preferred
stock, $0.001 par
value:
Authorized: 20,609,647
shares; Issued and
outstanding:
11,588,621 shares in
1999, 20,078,780
shares in 2000,
26,722,151 shares in
2001 (unaudited) and
none pro forma
(unaudited)
(Liquidation
preferences:
$20,574,983,
$63,025,778 and
$119,494,432 at
December 31, 1999,
2000 and June 30,
2001 (unaudited),
respectively.......... 20,471,813 62,882,739 119,245,825 $ --
------------ ------------ ------------ ------------
Stockholders' equity
(deficit):
Common stock: $0.001
par value:
Authorized:
50,000,000 shares;
Issued and
outstanding:
4,976,932 shares in
1999,
5,139,392 shares in
2000, 5,367,696
shares in 2001
(unaudited) and
32,089,847 shares
pro forma
(unaudited)......... 4,977 5,140 5,368 32,090
Additional paid-in
capital............... 2,543,858 14,427,351 21,271,769 140,490,872
Notes receivable from
stockholders.......... (331,195) (294,750) (294,750) (294,750)
Deferred stock-based
compensation, net..... (1,244,418) (11,262,561) (15,644,609) (15,644,609)
Accumulated deficit.... (19,131,794) (62,723,631) (89,657,060) (89,657,060)
------------ ------------ ------------ ------------
Total stockholders'
equity (deficit).... (18,158,572) (59,848,451) (84,319,282) $ 34,926,543
------------ ------------ ------------ ============
Total liabilities,
convertible
preferred stock and
stockholders' equity
(deficit)........... $ 8,026,083 $ 37,564,915 $ 78,982,096
============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-3
THERASENSE, INC.
STATEMENTS OF OPERATIONS
Years Ended December 31, Six Months Ended June 30,
--------------------------------------- --------------------------
1998 1999 2000 2000 2001
----------- ------------ ------------ ------------ ------------
(unaudited)
Revenues:
Research grant
revenue............... $ 60,296 $ 60,296 $ 3,000 $ 3,000 $ --
Product sales.......... -- 25,000 5,000,250 8,251 25,273,773
License income......... -- -- 500,000 500,000 250,000
----------- ------------ ------------ ------------ ------------
Total revenues......... 60,296 85,296 5,503,250 511,251 25,523,773
Cost of revenues........ -- -- 11,948,283 296,020 19,668,068
----------- ------------ ------------ ------------ ------------
Gross profit (loss)..... 60,296 85,296 (6,445,033) 215,231 5,855,705
----------- ------------ ------------ ------------ ------------
Operating expenses:
Research and
development........... 3,055,819 7,672,517 12,019,110 5,841,296 6,332,483
Selling, general and
administrative........ 1,809,978 5,556,708 25,460,349 9,786,893 26,842,800
----------- ------------ ------------ ------------ ------------
Total operating
expenses.............. 4,865,797 13,229,225 37,479,459 15,628,189 33,175,283
----------- ------------ ------------ ------------ ------------
Loss from operations.... (4,805,501) (13,143,929) (43,924,492) (15,412,958) (27,319,578)
Interest income......... 167,312 295,307 1,488,049 811,986 1,049,100
Interest and other
expense, net........... (25,762) (209,100) (1,155,394) (457,861) (662,951)
----------- ------------ ------------ ------------ ------------
Net loss................ (4,663,951) (13,057,722) (43,591,837) (15,058,833) (26,933,429)
Deemed dividend related
to beneficial
conversion feature of
preferred stock........ -- -- (14,772,878) (14,772,878) (26,782,911)
----------- ------------ ------------ ------------ ------------
Net loss attributable to
common stockholders.... $(4,663,951) $(13,057,722) $(58,364,715) $(29,831,711) $(53,716,340)
=========== ============ ============ ============ ============
Net loss per common
share, basic and
diluted................ $ (2.31) $ (4.32) $ (14.69) $ (8.03) $ (11.35)
=========== ============ ============ ============ ============
Weighted-average shares
used in computing net
loss per common share,
basic and diluted...... 2,015,032 3,023,636 3,973,250 3,712,999 4,732,091
=========== ============ ============ ============ ============
Pro forma net loss per
common share, basic and
diluted (unaudited)
(see Note 10).......... $ (2.06) $ (0.92)
============ ============
Weighted-average shares
used in computing pro
forma net loss per
common share, basic and
diluted (unaudited)
(see Note 10).......... 21,129,193 29,330,866
============ ============
The accompanying notes are an integral part of these financial statements.
F-4
THERASENSE, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
AND THE SIX MONTHS ENDED JUNE 30, 2001
Notes
Common Stock Additional Receivable Deferred Total
----------------- Paid-In from Stock-based Accumulated Stockholders'
Shares Amount Capital Stockholders Compensation Deficit Deficit
--------- ------ ------------ ------------ ------------ ------------ -------------
Balances, January 1,
1998................... 4,419,794 $4,420 $ 111,172 $ (91,993) $ -- $ (1,410,121) $ (1,386,522)
Repurchase and
retirement of common
stock................. (53,203) (53) (3,353) -- -- -- (3,406)
Exercise of stock
options for cash and
in exchange for notes
receivable from
stockholders.......... 216,159 216 53,104 (52,500) -- -- 820
Repayment of notes
receivable from
stockholders.......... -- -- -- 6,068 -- -- 6,068
Net loss............... -- -- -- -- -- (4,663,951) (4,663,951)
--------- ------ ------------ --------- ------------ ------------ ------------
Balances, December 31,
1998................... 4,582,750 4,583 160,923 (138,425) -- (6,074,072) (6,046,991)
Exercise of stock
options for cash and
in exchange for notes
receivable from
stockholders.......... 394,182 394 198,566 (192,770) -- -- 6,190
Issuance of warrants to
purchase Series B
preferred stock....... -- -- 819,760 -- -- -- 819,760
Deferred stock-based
compensation.......... -- -- 1,364,609 -- (1,364,609) -- --
Amortization of
deferred stock-based
compensation.......... -- -- -- -- 120,191 -- 120,191
Net loss............... -- -- -- -- -- (13,057,722) (13,057,722)
--------- ------ ------------ --------- ------------ ------------ ------------
Balances, December 31,
1999................... 4,976,932 4,977 2,543,858 (331,195) (1,244,418) (19,131,794) (18,158,572)
Exercise of stock
options for cash and
in exchange for notes
receivable from
stockholders.......... 213,671 214 86,435 (6,068) -- -- 80,581
Repurchase of shares
and cancellation of
stockholder note
receivable............ (51,211) (51) (14,333) 14,384 -- -- --
Repayment of notes
receivable from
stockholders.......... -- -- -- 28,129 -- -- 28,129
Deferred stock-based
compensation.......... -- -- 11,811,391 -- (11,811,391) -- --
Amortization of
deferred stock-based
compensation.......... -- -- -- -- 1,793,248 -- 1,793,248
Beneficial conversion
feature related to
issuance of Series C
convertible preferred
stock................. -- -- 14,772,878 -- -- -- 14,772,878
Deemed dividend related
to beneficial
conversion feature of
Series C convertible
preferred stock....... -- -- (14,772,878) -- -- -- (14,772,878)
Net loss............... -- -- -- -- -- (43,591,837) (43,591,837)
--------- ------ ------------ --------- ------------ ------------ ------------
Balances, December 31,
2000................... 5,139,392 5,140 14,427,351 (294,750) (11,262,561) (62,723,631) (59,848,451)
The accompanying notes are an integral part of these financial statements.
F-5
THERASENSE, INC.
STATEMENTS OF STOCKHOLDERS' DEFICIT
FOR THE YEARS ENDED DECEMBER 31, 1998, 1999 AND 2000
AND THE SIX MONTHS ENDED JUNE 30, 2001
(CONTINUED)
Notes
Common Stock Additional Receivable Deferred Total
---------------- Paid-In from Stock-based Accumulated Stockholders'
Shares Amount Capital Stockholders Compensation Deficit Deficit
--------- ------ ------------ ------------ ------------ ------------ -------------
Balances, December 31,
2000.................... 5,139,392 5,140 14,427,351 (294,750) (11,262,561) (62,723,631) (59,848,451)
Exercise of common
stock options for cash
(unaudited)............ 228,304 228 450,304 -- -- -- 450,532
Deferred stock-based
compensation
(unaudited)............ -- -- 6,394,114 -- (6,394,114) -- --
Amortization of
deferred stock-based
compensation
(unaudited)............ -- -- -- -- 2,012,066 -- 2,012,066
Beneficial conversion
feature related to
issuance of Series D
convertible preferred
stock (unaudited)...... -- -- 26,782,911 -- -- -- 26,782,911
Deemed dividend related
to beneficial
conversion feature of
Series D convertible
preferred stock
(unaudited)............ -- -- (26,782,911) -- -- -- (26,782,911)
Net loss (unaudited)... -- -- -- -- -- (26,933,429) (26,933,429)
--------- ------ ------------ --------- ------------ ------------ ------------
Balances, June 30, 2001
(unaudited)............. 5,367,696 $5,368 $ 21,271,769 $(294,750) $(15,644,609) $(89,657,060) $(84,319,282)
========= ====== ============ ========= ============ ============ ============
The accompanying notes are an integral part of these financial statements.
F-6
THERASENSE, INC.
STATEMENTS OF CASH FLOWS
Six Months Ended
Years Ended December 31, June 30,
--------------------------------------- --------------------------
1998 1999 2000 2000 2001
----------- ------------ ------------ ------------ ------------
(unaudited)
Cash flows from
operating activities:
Net loss............... $(4,663,951) $(13,057,722) $(43,591,837) $(15,058,833) $(26,933,429)
Adjustments to
reconcile net loss to
net cash used in
operating activities:
Depreciation and
amortization......... 253,700 569,074 1,546,556 618,665 873,770
Provision for doubtful
accounts............. -- -- 150,000 -- 135,425
Amortization of debt
issuance costs....... -- 74,268 268,489 134,238 134,244
Loss on disposal and
sales of property and
equipment............ -- 132 5,637 5,637 --
Amortization of
deferred stock-based
compensation......... -- 120,191 1,793,248 485,561 2,012,066
Changes in operating
assets and
liabilities:
Accounts receivable... -- (25,000) (6,299,697) (574,848) (4,728,142)
Inventories........... -- -- (3,493,777) (5,771,598) (458,097)
Deferred cost of
products sold........ -- -- (7,396,547) (491,753) (2,363,393)
Prepaid expenses and
other current
assets............... (37,466) (773,699) (342,430) (1,493,068) (605,079)
Other assets.......... 70,089 (98,711) (1,374,589) (2,219) (894,714)
Accounts payable...... (218,012) 549,291 9,946,047 3,351,783 (306,866)
Accrued liabilities... 111,988 350,766 3,836,352 1,624,902 4,729,567
Deferred revenue...... (60,296) 500,000 8,175,206 145,662 8,997,934
----------- ------------ ------------ ------------ ------------
Net cash used in
operating
activities.......... (4,543,948) (11,791,410) (36,777,342) (17,025,871) (19,406,714)
----------- ------------ ------------ ------------ ------------
Cash flows from
investing activities:
Purchase of property
and equipment......... (634,309) (3,323,407) (2,088,594) (1,364,944) (854,511)
Proceeds from sale of
property and
equipment............. -- -- 2,666,374 1,603,769 --
----------- ------------ ------------ ------------ ------------
Net cash provided by
(used in) investing
activities.......... (634,309) (3,323,407) 577,780 238,825 (854,511)
----------- ------------ ------------ ------------ ------------
Cash flows from
financing activities:
Proceeds from issuance
of convertible
preferred stock, net.. 11,835,840 3,110,471 42,410,926 42,410,926 53,863,086
Proceeds from issuance
of common stock and
exercise of stock
options............... 820 6,190 80,581 11,526 450,532
Proceeds from lines of
credit................ 758,590 3,090,953 3,000,000 2,000,000 --
Proceeds from
convertible promissory
note.................. -- -- 2,500,000 -- --
Repurchase and
retirement of common
stock................. (3,406) -- -- -- --
Principal payments on
capital lease
obligations........... -- (37,410) (417,393) (52,793) (319,047)
Principal payments on
lines of credit....... (69,444) (171,163) (1,192,631) (309,482) (1,113,433)
Repayment of notes
receivable from
stockholders.......... 6,068 -- 28,129 28,129 --
----------- ------------ ------------ ------------ ------------
Net cash provided by
financing
activities.......... 12,528,468 5,999,041 46,409,612 44,088,306 52,881,138
----------- ------------ ------------ ------------ ------------
Net increase (decrease)
in cash and cash
equivalents........... 7,350,211 (9,115,776) 10,210,050 27,301,260 32,619,913
Cash and cash
equivalents, beginning
of period............. 4,087,989 11,438,200 2,322,424 2,322,424 12,532,474
----------- ------------ ------------ ------------ ------------
Cash and cash
equivalents, end of
period................ $11,438,200 $ 2,322,424 $ 12,532,474 $ 29,623,684 $ 45,152,387
=========== ============ ============ ============ ============
Noncash financing
activities:
Common stock issued for
notes receivable from
stockholders.......... $ 52,500 $ 192,770 $ 6,068 $ 6,068 $ --
Repurchase of
restricted common
stock and cancellation
of notes receivable... $ -- $ -- $ 14,384 $ 14,384 $ --
Issuance of warrants to
purchase Series B
preferred stock in
connection with
borrowings under lines
of credit............. $ -- $ 819,760 $ -- $ -- $ --
Conversion of
promissory note into
Series D preferred
stock................. $ -- $ -- $ -- $ -- $ 2,500,000
Acquisition of property
and equipment under
capital lease......... $ -- $ 366,133 $ 2,970,204 $ 1,757,348 $ 36,771
Deferred stock-based
compensation.......... $ -- $ 1,364,609 $ 11,811,391 $ 4,968,317 $ 6,394,114
Supplemental disclosure
of cash flow
information:
Cash paid for
interest.............. $ 25,762 $ 134,833 $ 881,265 $ 434,668 $ 509,102
The accompanying notes are an integral part of these financial statements.
F-7
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS
NOTE 1--FORMATION AND BUSINESS OF THE COMPANY:
TheraSense, L.L.C. was formed in the state of California on April 3, 1996.
TheraSense, Inc. was incorporated in the state of California on December 6,
1996. In April 1997, all assets and liabilities of TheraSense, L.L.C. were
transferred to TheraSense, Inc. TheraSense, L.L.C. and TheraSense, Inc. are
collectively referred to as the "Company." In September 2000, the Company's
Board of Directors authorized the reincorporation of the Company in the state
of Delaware, which was approved by the stockholders in October 2000. In
conjunction with the reincorporation, the Company's Board of Directors approved
a one-for-two reverse stock split of its common and convertible preferred
stock, which was approved by the stockholders in October 2000. All convertible
preferred and common stock data and common stock option plan information in
these financial statements has been restated to reflect the split. In addition,
the conversion prices of the Company's preferred stock have also been adjusted
to reflect the effect of the split.
The Company develops and sells easy to use glucose self-monitoring systems that
dramatically reduce the pain of testing for people with diabetes. In June 2000,
the Company commenced commercial shipments of its products, its planned
principal operations, and emerged from the development stage.
In June 2001, the Company's Board of Directors authorized management to file a
registration statement with the Securities and Exchange Commission to permit
the Company to sell its common stock to the public. Upon completion of the
Company's initial public offering, all of the outstanding convertible preferred
stock will be converted into shares of common stock.
NOTE 2--SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Unaudited interim results
The accompanying balance sheet as of June 30, 2001, the statements of
operations and of cash flows for the six months ended June 30, 2000 and 2001,
and the statement of stockholders' deficit for the six months ended June 30,
2001 are unaudited. The unaudited interim financial statements have been
prepared on the same basis as the annual financial statements and, in the
opinion of management, reflect all adjustments, which include only normal
recurring adjustments, necessary to present fairly the Company's financial
position and results of operations and cash flows for the six months ended
June 30, 2000 and 2001. The financial data and other information disclosed in
these notes to financial statements related to the six-month periods are
unaudited. The results for the six months ended June 30, 2001 are not
necessarily indicative of the results to be expected for the year ending
December 31, 2001 or for any other interim period or for any future year.
Unaudited pro forma stockholders' equity
If the offering contemplated by this prospectus is consummated, all of the
convertible preferred stock outstanding will automatically convert into
26,722,151 shares of common stock based on the shares of convertible preferred
stock outstanding at June 30, 2001. Unaudited pro forma stockholders' equity,
as adjusted for the assumed conversion of the preferred stock, is set forth on
the balance sheet.
Use of estimates
The preparation of financial statements in conformity with accounting
principles generally accepted in the United States of America require
management to make estimates and assumptions that affect the reported amounts
of assets and liabilities and disclosure of contingent assets and liabilities
at the date of the financial statements and the reported amounts of revenues
and expenses during the reporting period. Actual results could differ from
those estimates.
F-8
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Cash and cash equivalents
The Company considers all highly liquid investments purchased with original
maturities of three months or less to be cash equivalents. Cash and cash
equivalents include money market funds and various deposit accounts.
Inventories
Inventories are stated at the lower of cost (principally standard cost, which
approximates actual cost on a first-in, first-out basis) or market value.
Property and equipment
Property and equipment are stated at cost less accumulated depreciation and
amortization. Depreciation is provided on a straight-line basis over the
estimated useful lives of the assets, which is generally two to five years.
Amortization of leased assets and leasehold improvements is computed using the
straight-line method over the shorter of the remaining lease term or the
estimated useful life of the related assets, typically three to seven years.
Upon sale or retirement of assets, the cost and related accumulated
depreciation and amortization are removed from the balance sheet and the
resulting gain or loss is reflected in operations.
Impairment of long-lived assets
The Company accounts for long-lived assets under Statement of Financial
Accounting Standards ("SFAS") No. 121 ("SFAS No. 121"), "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
SFAS No. 121 requires the Company to review for impairment of long-lived
assets, whenever events or changes in circumstances indicate that the carrying
amount of an asset might not be recoverable. When such an event occurs,
management determines whether there has been an impairment by comparing the
anticipated undiscounted future net cash flows to the related asset's carrying
value. If an asset is considered impaired, the asset is written down to fair
value, which is determined based either on discounted cash flows or appraised
values, depending on the nature of the asset.
Concentration of credit risk and other risks and uncertainties
The Company's cash and cash equivalents are maintained with one major financial
institution in the United States of America. Deposits in this institution may
exceed the amount of insurance provided on such deposits.
For financial instruments consisting of cash and cash equivalents, accounts
receivable, accounts payable and accrued liabilities included in the Company's
financial statements, the carrying amounts approximate fair value due to their
short maturities. Based on borrowing rates currently available to the Company
for loans with similar terms, the carrying value of notes payable and capital
lease obligations approximate fair value.
As of December 31, 1999 and 2000, the Company's accounts receivable are derived
from revenue earned from customers located in the United States of America. The
Company performs ongoing credit evaluations of its customers' financial
condition and, generally, requires no collateral from its customers.
For the year ended December 31, 1998, all revenues were generated from a
research grant from one customer.
F-9
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Three customers individually accounted for greater than 10% of total revenues
and accounted for 100% of total revenues in aggregate for the year ended
December 31, 1999. All revenues were generated from research grants and
clinical product shipments. One customer accounted for 100% of total accounts
receivable at December 31, 1999.
Revenues from four customers individually accounted for greater than 10% of
total revenues and accounted for 53% of total revenues in aggregate for the
year ended December 31, 2000. Three customers accounted for 29%, 15% and 11% of
total accounts receivable at December 31, 2000.
The Company's products require clearance or approval from the Food and Drug
Administration ("FDA") and other international regulatory agencies prior to
commercial sales. The Company's products may not receive the necessary
approvals. If the regulatory approvals for the Company's products are denied or
delayed, it may have a material adverse impact on the Company. In January 2000,
the Company received FDA approval for its first product, FreeStyle.
The Company is subject to risks common to companies in the medical device
industry. These risks include, but are not limited to, new technological
innovations, dependence on key personnel, protection of proprietary technology,
compliance with government regulations, uncertainty of market acceptance of
products, product liability and the need to obtain additional financing.
The Company subcontracts the manufacturing of its FreeStyle meters through one
subcontractor and subcontracts the manufacturing of the FreeStyle lancet
devices through one subcontractor. The Company believes that there are a number
of alternative contract manufacturers that could produce the Company's
products, but in the event of a reduction or interruption of supply, it could
take a significant period of time to qualify an alternative subcontractor and
commence manufacturing. The effect of such reduction or interruption in supply
on results of operations would be material.
Revenue recognition
The Company recognizes revenue in accordance with Staff Accounting Bulletin No.
101, "Revenue Recognition in Financial Statements." Product revenues are
generated from sales of the Company's FreeStyle System kit and from the
recurring sales of disposable FreeStyle test strips and lancets. The Company's
return policy allows end users in the United States of America to return
FreeStyle System kits to the Company for a full cash refund within 30 days of
purchase. There are no end-user return rights on sales of disposable FreeStyle
test strips and lancets. In addition, the Company's FreeStyle System kit and
FreeStyle test strips currently have an 18 month shelf life, and retailers and
wholesalers in the United States of America can return these products to the
Company up to six months beyond this expiration date. As a result of these
rights of return and the current unavailability of historical trends in sales
and product returns, the Company defers recognition of revenues and the related
cost of revenues on sales of FreeStyle test strips until resold by the
retailers and wholesalers to end users, and the Company defers recognition of
revenues and the related cost of revenues on FreeStyle System kits until 30
days after purchase by the end user. At that time, the Company recognizes
revenues net of allowances for customer rebates and coupons. Because the
Company lacks a sufficient historical basis from which to estimate return
rates, the Company is required to rely on data estimates provided to the
Company by third-party data providers in order to recognize revenue from sales
to end users by retailers and wholesalers. In addition, due to the lack of
significant historical trends in rebates claimed by end users, the Company is
accruing 100% of the allowable rebate.
In September 2000, the Company entered into an agreement for the exclusive
distribution of FreeStyle products in certain European countries and the
nonexclusive distribution to certain of the distributor's
F-10
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
existing customers in North America. Under the terms of the agreement, the
Company received a $1.5 million nonrefundable pre-payment, which has been
deferred and is being credited as revenues are recognized. In April 2001, the
Company entered into an agreement for the exclusive distribution of FreeStyle
products in Japan through April 2006. Under the terms of the agreement, the
Company received a $5.0 million noncreditable up-front payment which has been
deferred and is being recognized as revenue ratably over the term of the
agreement. If the agreement is terminated prior to the expiration of its term,
under limited circumstances, the Company would be obligated to a return of a
portion of the up-front payment for each full-year remaining in the initial
term. Products shipped to the Company's distributors do not have a right of
return although end users in North America are allowed to return FreeStyle
System kits within 30 days of purchase.
The Company's FreeStyle System kits and disposable FreeStyle test strips and
lancets shipped internationally have no right of return, and the Company
recognizes revenue on these products upon shipment. The Company recognizes
revenue on direct product sales over the telephone or through the Company's
website to end users upon shipment for FreeStyle test strips and lancets and 30
days after purchase on sales of FreeStyle System kits.
The Company recognizes license and other up-front fees on a ratable basis over
the term of the respective agreement. Any amounts received in advance of
performance are recorded as deferred revenue. All revenues recognized to date
are not refundable.
Research and development grant agreements provide for periodic payments in
support of the Company's research activities. Grant revenue is recognized as
earned based on actual costs incurred or as milestones are achieved. All
revenues recognized to date are not refundable if the relevant research effort
is not successful.
Research and development
Research and development costs are charged to operations as incurred. Research
grant revenue projects are funded under agreements with third parties and the
costs related to these activities are included in research and development
expense.
Advertising costs
Advertising costs, included in selling, general and administrative expenses,
are expensed as incurred. No expenses were incurred in 1998 and 1999.
Advertising expense in 2000 was $1,878,396.
Income taxes
The Company accounts for income taxes under the liability method whereby
deferred tax asset or liability account balances are calculated at the balance
sheet date using current tax laws and rates in effect for the year in which the
differences are expected to affect taxable income. Valuation allowances are
established when necessary to reduce deferred tax assets to the amounts
expected to be realized.
Segments
The Company operates in one business segment. As of December 31, 1999 and 2000,
all long-lived assets are maintained in the United States of America. All
revenue was generated in the United States of America during the years ended
December 31, 1998, 1999 and 2000.
F-11
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Stock-based compensation
The Company uses the intrinsic value method of Accounting Principles Board
Opinion No. 25 ("APB 25"), "Accounting for Stock Issued to Employees," in
accounting for its employee stock options, and presents disclosure of pro forma
information required under SFAS No. 123, "Accounting for Stock-Based
Compensation." The Company adopted Financial Accounting Standards Board
("FASB") Interpretation No. 44 ("FIN No. 44"), effective July 1, 2000. The
adoption of FIN No. 44 did not have a material impact on the Company's
financial statements.
The Company accounts for equity instruments issued to non-employees in
accordance with the provisions of SFAS No. 123 and Emerging Issues Task Force
("EITF") Issue No. 96-18, "Accounting for Equity Instruments That Are Issued to
Other Than Employees for Acquiring, or in Conjunction with Selling, Goods or
Services," which require that such equity instruments are recorded at their
fair value on the measurement date. The measurement of stock-based compensation
is subject to periodic adjustment as the underlying equity instruments vest.
Net loss per common share
Basic net loss per share is computed by dividing net loss attributable to
common stockholders by the weighted-average number of vested common shares
outstanding for the period. Diluted net loss per share is computed giving
effect to all potential dilutive common stock, including options, warrants and
convertible preferred stock. Options, warrants, common stock subject to
repurchase and convertible preferred stock were not included in the computation
of diluted net loss per share because the effect would be antidilutive.
A reconciliation of the numerator and denominator used in the calculation of
basic and diluted net loss per common share follows:
Six Months Ended
Years Ended December 31, June 30,
--------------------------------------- --------------------------
1998 1999 2000 2000 2001
----------- ------------ ------------ ------------ ------------
(unaudited)
Numerator:
Net loss............... $(4,663,951) $(13,057,722) $(43,591,837) $(15,058,833) $(26,933,429)
Deemed dividend related
to beneficial
conversion feature of
preferred stock....... -- -- (14,772,878) (14,772,878) (26,782,911)
----------- ------------ ------------ ------------ ------------
Net loss attributable to
common stockholders.... $(4,663,951) $(13,057,722) $(58,364,715) $(29,831,711) $(53,716,340)
=========== ============ ============ ============ ============
Denominator:
Weighted-average common
stock outstanding..... 4,439,214 4,840,006 5,060,774 5,036,141 5,202,150
Less: Weighted-average
shares subject to
repurchase............ (2,424,182) (1,816,370) (1,087,524) (1,323,142) (470,059)
----------- ------------ ------------ ------------ ------------
Weighted-average shares
used in computing basic
and diluted net loss
per common share....... 2,015,032 3,023,636 3,973,250 3,712,999 4,732,091
=========== ============ ============ ============ ============
F-12
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The following outstanding options, common stock subject to repurchase,
convertible preferred stock and warrants were excluded from the computation of
diluted net loss per share attributable to common stockholders as they had an
antidilutive effect:
Six Months Ended
December 31, June 30,
-------------------------------- ---------------------
1998 1999 2000 2000 2001
---------- ---------- ---------- ---------- ----------
(unaudited)
Options to purchase
common stock........... 502,094 1,644,468 4,201,599 2,672,948 4,882,303
Common stock subject to
repurchase............. 2,073,503 1,562,751 612,297 1,040,190 327,822
Convertible preferred
stock.................. 10,104,060 11,588,621 20,078,780 20,078,780 26,722,151
Warrants................ 101,967 521,013 521,013 521,013 521,013
Reclassification
Certain amounts in the prior year financial statements have been reclassified
to conform to the current year's presentation. The reclassification had no
impact on the previously reported net loss.
Recent accounting pronouncements
On January 1, 2001, the Company adopted SFAS No. 133, "Accounting for
Derivative Instruments and Hedging Activities," which establishes accounting
and reporting standards for derivative instruments and hedging activities. It
requires that an entity recognize all derivatives as either assets or
liabilities in the statement of financial position and measure those
instruments at fair value. The Company, to date, has not engaged in derivative
and hedging activities and therefore, the adoption had no impact on the
Company's financial statements.
In July 2001, the FASB issued SFAS No. 141 "Business Combinations" ("SFAS No.
141") which establishes financial accounting and reporting for business
combinations and supersedes APB Opinion No. 16, "Business Combinations," and
FASB Statement No. 38, "Accounting for Preacquisition Contingencies of
Purchased Enterprises". SFAS No. 141 requires that all business combinations be
accounted for using one method, the purchase method. The provisions of SFAS No.
141 apply to all business combinations initiated after June 30, 2001. The
Company will adopt SFAS No. 141 during the first quarter of fiscal 2002, and
the adoption of SFAS No. 141 is expected to have no material impact on
financial reporting and related disclosures of the Company.
In July 2001, the FASB issued SFAS No. 142 "Goodwill and Other Intangible
Assets," ("SFAS No. 142") which establishes financial accounting and reporting
for acquired goodwill and other intangible assets and supersedes APB Opinion
No. 17, "Intangible Assets". SFAS No. 142 addresses how intangible assets that
are acquired individually or with a group of other assets (but not those
acquired in a business combination) should be accounted for in financial
statements upon their acquisition, and after they have been initially
recognized in the financial statements. The provisions of SFAS No. 142 are
effective for fiscal years beginning after December 15, 2001. The Company will
adopt SFAS No. 142 during the first quarter of fiscal 2002, and the adoption of
SFAS No. 142 is expected to have no material impact on financial reporting and
related disclosures of the Company.
F-13
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 3--BALANCE SHEET ACCOUNTS:
At December 31, 1999, the Company held no inventory. At December 31, 2000 and
June 30, 2001 (unaudited), inventories consisted of the following:
December 31, June 30,
2000 2001
------------ -----------
(unaudited)
Raw materials..................................... $1,175,408 $ 2,113,679
Work-in-process................................... 782,838 1,175,079
Finished goods.................................... 1,535,531 663,116
---------- -----------
$3,493,777 $ 3,951,874
========== ===========
Property and equipment consisted of the following:
December 31,
------------------------
1999 2000
------------ -----------
Laboratory equipment.............................. $ 997,964 $ 1,162,101
Leasehold improvements............................ 909,542 1,051,983
Office equipment.................................. 513,747 580,017
Computer equipment................................ 895,779 1,294,610
Tooling........................................... 434,832 788,040
Manufacturing equipment........................... 958,141 2,082,398
---------- -----------
4,710,005 6,959,149
Less: Accumulated depreciation and amortization... (711,554) (2,120,467)
---------- -----------
$3,998,451 $ 4,838,682
========== ===========
Included in property and equipment are assets acquired under capital leases
with a cost of $366,133 and $3,334,412, and accumulated amortization of $50,852
and $844,691 as of December 31, 1999 and 2000, respectively.
Other assets consisted of the following:
December 31,
------------------------
1999 2000
------------ -----------
Manufacturing equipment deposits.................. $ -- $ 709,845
Facility deposits................................. -- 578,136
Debt issuance costs............................... 745,492 477,003
Other............................................. 98,711 185,319
---------- -----------
$ 844,203 $ 1,950,303
========== ===========
F-14
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Accrued liabilities consisted of the following:
December 31,
--------------------
1999 2000
--------- ----------
Distributor prepayments................................ $ -- $1,343,147
Salaries and related expense........................... 220,838 783,853
Rebates................................................ -- 758,965
Professional and other outside services................ 137,468 645,687
Royalties.............................................. -- 383,651
Warranties............................................. -- 269,392
Other liabilities...................................... 226,854 236,817
--------- ----------
$ 585,160 $4,421,512
========= ==========
NOTE 4--NOTES PAYABLE:
During 1998, the Company entered into an equipment line of credit agreement
with a financial institution under which the Company could borrow up to
$500,000 for equipment purchases prior to July 10, 1998. Borrowings under the
equipment line of credit are collateralized by the equipment purchased, accrue
interest at the rate of the prime rate plus 1.25% (10.75% at December 31, 2000)
and are due in monthly installments through June 2001.
During 1998, the Company entered into an equipment line of credit agreement
under which the Company could borrow up to $2,500,000 for equipment purchases
prior to December 31, 1999. During 1998, the Company executed two promissory
notes under this agreement for $184,711 and $73,879 which accrue interest at
the rate of 8.5% and 9.5%, respectively, and are due in forty-eight and thirty-
six monthly installments, respectively. During 1999, the Company executed an
additional two promissory notes under this agreement for $35,833 and $285,574
which accrue interest at the rate of 9.5% and 8.5%, respectively, and are due
in thirty-six and forty-eight monthly installments, respectively. All
borrowings under the equipment line of credit are collateralized by the
equipment purchased. In connection with this agreement, the Company issued
warrants to purchase 47,619 shares of Series B preferred stock (Note 7).
During 1999, the Company entered into a subordinated debt agreement with a
lending company under which the Company could borrow up to $5,000,000 for
equipment purchases prior to July 7, 2000. In December 1999 and January and
July 2000, the Company executed $2,000,000, $2,000,000 and $1,000,000
promissory notes under this agreement, respectively. The notes accrue interest
at an annual rate of 11.5% and are each due in thirty-six monthly installments.
All borrowings under this agreement are collateralized by the equipment
purchased. In connection with this agreement, the Company issued warrants to
purchase 380,952 shares of Series B preferred stock (Note 7). The effective
annual interest rate, including warrant amortization, is 22.3%.
During 1999, the Company entered into a senior loan and security agreement with
a lending company to borrow up to $2,000,000 for equipment purchases prior to
December 31, 1999. The Company executed promissory notes under this agreement
for $253,864, $253,055 and $262,625. Principal and interest are payable in
consecutive monthly installments, each of which are equal to 1.0% of the
principal sum for months one through twelve and 3.075% of the principal sum for
months thirteen through forty-eight, yielding an annual interest rate of 8.7%.
All borrowings under this agreement are collateralized by the equipment
purchased. In connection with this agreement, the Company issued
F-15
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
warrants to purchase 38,094 shares of Series B preferred stock (Note 7). The
effective annual interest rate, including warrant amortization, is 13.1%.
As of December 31, 2000, aggregate future principal payments under the lines of
credit are as follows:
2001............................................................ $ 1,958,958
2002............................................................ 2,500,952
2003............................................................ 956,393
-----------
5,416,303
Less: Current portion........................................... (1,958,958)
-----------
$ 3,457,345
===========
NOTE 5--CONVERTIBLE PROMISSORY NOTE:
In September 2000, the Company entered into an agreement for the exclusive
distribution of FreeStyle products in certain European countries and the
nonexclusive distribution to certain of the distributor's customers in North
America. In connection with the agreement, the Company received a $2.5 million
convertible promissory note, all of which was outstanding as of December 31,
2000. Upon the first closing of the Series D convertible preferred stock
financing in January 2001, the note automatically converted into 294,118 shares
of Series D convertible preferred stock. In accordance with the agreement, no
interest was payable as the note was outstanding for less than one year. As of
June 30, 2001, revenues of $4,742,502 (unaudited) have been generated from this
agreement.
NOTE 6--COMMITMENTS AND CONTINGENCIES:
Facility lease
The Company leases its facilities under an operating lease agreement which
expires in April 2009. The Company has the option to terminate the lease in
April 2006. Under the terms of the agreement, the initial base monthly rent
shall be adjusted as specified under the terms of the agreement and every two
and one half years based on changes in the Consumer Price Index by amounts not
to be less than 5.0%, nor to exceed 7.5%, over each two and one half year
period. At the expiration of the lease term, the Company has the option to
extend the facility lease for an additional five years. Future minimum facility
lease payments are as follows:
2001.............................................................. $ 791,098
2002.............................................................. 823,788
2003.............................................................. 823,788
2004.............................................................. 851,244
2005.............................................................. 864,972
Thereafter........................................................ 2,991,360
----------
$7,146,250
==========
Rent expense for the years ended December 31, 1998, 1999 and 2000 was $223,892,
$619,766 and $674,959, respectively.
In April 2001, the Company entered into a facility lease agreement expiring in
October 2002. Total future minimum lease payments at the date of signing
amounted to approximately $123,000.
F-16
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
In June 2001, the Company entered into facility lease agreement expiring in May
2004. Total future minimum lease payments at the date of signing amounted to
$883,295.
Office equipment lease
The Company leases certain office equipment under an operating lease agreement
which expires in June 2005. As of December 31, 2000, future minimum lease
payments are as follows:
2001............................................................... $12,768
2002............................................................... 12,768
2003............................................................... 12,768
2004............................................................... 12,768
2005............................................................... 6,384
-------
$57,456
=======
In March 2001, the Company entered into an operating lease agreement for
computer equipment expiring in March 2003. Total future minimum lease payments
at the date of signing amounted to $93,875.
In June 2001, the Company entered into an operating lease agreement for office
equipment expiring in June 2003. Total future minimum lease payments at the
date of signing amounted to $285,938.
Capital lease obligations
During 1999 and 2000, the Company acquired office furniture under capital lease
agreements. Payments, comprising both principal and interest, are due in
thirty-six equal monthly installments through October 2003.
During February 2000, the Company entered into a sale and leaseback transaction
whereby the Company sold and leased back under capital lease agreements, assets
with a net book value of $1,607,557 for total proceeds of $1,603,769,
recognizing a loss on the sale of $3,788. In addition, the Company leased
$153,579 of computer equipment under a capital lease agreement. Payments,
comprising both principal and interest, are due in thirty-six to forty-eight
monthly installments through April 2004.
During April 2000, the Company entered into sale and leaseback transaction
whereby the Company sold and leased back under capital lease agreements, assets
with a net book value of $1,062,605 for an equal amount of total proceeds. In
addition, the Company financed $126,756 of property and equipment purchases
under capital lease agreements. Payments, comprising both principal and
interest, are due in forty-eight equal monthly installments through March 2004.
F-17
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
As of December 31, 2000, aggregate future minimum lease payments are as
follows:
2001........................................................... $1,052,771
2002........................................................... 1,202,557
2003........................................................... 812,935
2004........................................................... 180,249
----------
Minimum payments............................................... 3,248,512
Less: Amount representing interest............................. (366,978)
----------
Principal amount of minimum payments........................... 2,881,534
Less: Current portion.......................................... (844,394)
----------
$2,037,140
==========
Licensing agreements
The Company has entered into several licensing agreements with various
universities, institutions and companies under which it obtained rights to
certain patents, patent applications, and other technology. As of December 31,
2000, future minimum payments, which will be expensed to cost of revenues,
pursuant to these agreements are as follows:
2001.............................................................. $ 420,000
2002.............................................................. 620,000
2003.............................................................. 620,000
2004.............................................................. 620,000
----------
$2,280,000
==========
In addition to the payments summarized above, the Company is required to make
royalty payments based upon a percentage of net sales of any products developed
from certain of the licensed technologies. These royalties, which are
creditable against the minimum payment summarized above, are expensed to cost
of revenues upon product shipment.
In December 1998, the Company entered into an agreement with Facet
Technologies, LLC, formerly Gainor Medical North America LLC ("Facet
Technologies"), whereby the Company is obligated to pay royalties, based upon a
fixed fee per FreeStyle System kit shipped, to Facet Technologies of up to
$2,800,000 in exchange for research and development services provided by Facet
Technologies. For the years ended December 31, 1998, 1999 and 2000, none, none
and $331,578 of royalties have been expensed to cost of revenues, respectively.
As of December 31, 1999 and 2000, the Company has accrued none and $331,578,
respectively, of royalties relating to this agreement.
At December 31, 2000, the Company has included $1.1 million of a $2.0 million
paid-up licensing fee in prepaid expenses and other current assets, which is
being amortized ratably to cost of revenues over the annual term of the
license. At the Company's option, the Company can extend this non-exclusive
paid-up licensing agreement with future license payments.
Contingencies
From time to time, the Company may become involved in litigation relating to
additional claims arising from the ordinary course of business. Management does
not believe the final disposition of these matters will have a material adverse
affect on the financial position, results of operations or cash flows of the
Company.
F-18
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 7--CONVERTIBLE PREFERRED STOCK:
Under the Company's Certificate of Incorporation, as amended, the Company's
convertible preferred stock is issuable in series.
As of December 31, 1998, the convertible preferred stock comprises:
Proceeds,
Number of Number of Net of Annual
Shares Shares Issued Issuance Liquidation Dividends
Authorized and Outstanding Costs Preference per Share
---------- --------------- ----------- ----------- ---------
Series A....... 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B....... 7,609,524 5,658,284 11,835,840 $2.100 $0.16
---------- ---------- -----------
12,109,647 10,104,054 $17,361,342
========== ========== ===========
As of December 31, 1999, the convertible preferred stock comprises:
Proceeds,
Number of Number of Net of Annual
Shares Shares Issued Issuance Liquidation Dividends
Authorized and Outstanding Costs Preference per Share
---------- --------------- ----------- ----------- ---------
Series A....... 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B....... 7,609,524 7,142,851 14,946,311 $2.100 $0.16
---------- ---------- -----------
12,109,647 11,588,621 $20,471,813
========== ========== ===========
As of December 31, 2000, the convertible preferred stock comprises:
Proceeds,
Number of Number of Net of Annual
Shares Shares Issued Issuance Liquidation Dividends
Authorized and Outstanding Costs Preference per Share
---------- --------------- ----------- ----------- ---------
Series A....... 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B....... 7,609,524 7,142,851 14,946,311 $2.100 $0.16
Series C....... 8,500,000 8,490,159 42,410,926 $5.000 $0.40
---------- ---------- -----------
20,609,647 20,078,780 $62,882,739
========== ========== ===========
As of June 30, 2001, the convertible preferred stock comprises (unaudited):
Proceeds,
Number of Number of Net Annual
Shares Shares Issued of Issuance Liquidation Dividends
Authorized and Outstanding Costs Preference per Share
---------- --------------- ------------ ----------- ---------
Series A...... 4,500,123 4,445,770 $ 5,525,502 $1.254 $0.10
Series B...... 7,609,524 7,142,851 14,946,311 $2.100 $0.16
Series C...... 8,500,000 8,490,159 42,410,926 $5.000 $0.40
Series D...... 7,700,000 6,643,371 56,363,086 $8.500 $0.68
---------- ---------- ------------
28,309,647 26,722,151 $119,245,825
========== ========== ============
F-19
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The Company's Board of Directors is authorized to determine the rights,
preferences and terms of each series which are as follows:
Dividends
The holders of Series A, Series B, Series C and Series D convertible preferred
stock are entitled to receive dividends, out of any assets legally available,
prior and in preference to any declaration or payment of any dividend for the
common stock, at the rate stated above per share per annum or, if greater (as
determined on a per annum basis and on an as converted basis for the Series A,
Series B, Series C and Series D preferred stock), an amount equal to that paid
on any other outstanding stock of the Company. Such dividends are payable when,
as and if declared by the Board of Directors, and are not cumulative. As of
June 30, 2001, no dividends have been declared.
In February 2000, the Company issued 8,490,159 shares of Series C convertible
preferred stock at $5.00 per share for gross cash proceeds of $42,450,800. The
issuance resulted in a beneficial conversion feature of $14,772,878, calculated
in accordance with EITF No. 98-5, "Accounting for Convertible Securities with
Beneficial Conversion Features." The beneficial conversion feature is reflected
as a preferred stock deemed dividend in the Statement of Operations for the
year ended December 31, 2000.
In January, February and April 2001 (all amounts unaudited), the Company issued
6,643,371 shares of Series D convertible preferred stock at $8.50 per share for
gross cash proceeds of $56,468,654. The issuance resulted in a beneficial
conversion feature of $26,782,911, calculated in accordance with EITF No. 98-5.
The beneficial conversion feature is reflected as a preferred stock deemed
dividend in the Statement of Operations for the six months ended June 30, 2001.
Liquidation
In the event of any liquidation, dissolution or winding up for the Company,
either voluntary or involuntary, the holders of Series A, Series B, Series C
and Series D convertible preferred stock are entitled to receive, prior and in
preference to any distribution of any of the assets of the Company to the
holders of common stock by reason of their ownership, an amount per share equal
to the liquidation preference per share stated in the table above, (as adjusted
for any stock splits, combinations, reorganizations and the like) plus any
declared but unpaid dividends on such shares.
After payment has been made to the holders of the convertible preferred stock,
any remaining assets and funds are to be distributed among the holders of
common stock pro rata based on the number of shares of common stock held by
each stockholder.
A merger, reorganization or sale of all or substantially all of the assets of
the Company in which the stockholders of the Company immediately prior to the
transaction do not possess more than 50% of the voting power of the surviving
entity (or its parent) immediately after the transaction shall be deemed to be
a liquidation, dissolution or winding up.
Voting
Except as otherwise required by law or as required by the Company's amended and
restated Certificate of Incorporation, the holders common and convertible
preferred stock vote together as a single class. The holders of the convertible
preferred stock are entitled to the number of votes equal to the number of
common stock into which the convertible preferred stock could be converted on
the record date for the vote or written consent of stockholders.
F-20
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Conversion
Each Series A, Series B, Series C and Series D convertible preferred stock, at
the option of the holder and at any time after the date of issuance, is
convertible into common stock on a one-for-one basis.
Conversion is automatic at the conversion price (i) immediately upon the
closing of a firm commitment underwritten public offering pursuant to an
effective registration statement under the Securities Act of 1933, as amended,
in which the public offering price equals or exceeds $10.00 per share (as
adjusted for any stock dividends, stock splits or recapitalizations) and the
aggregate proceeds raised equal or exceed $25,000,000, or (ii) at the election
of stockholders of a majority of the outstanding preferred shares.
Warrants
During April 1997, the Company issued warrants to purchase 54,348 shares of its
Series A convertible preferred stock at $1.84 per share in connection with the
Series A preferred stock financing. The warrants are exercisable at any time
and expire on December 31, 2001. The Company has reserved 54,348 shares of its
Series A convertible preferred stock for issuance in the event of exercise.
During August 1998, the Company issued warrants to purchase 47,619 shares of
its Series B convertible preferred stock at $2.10 per share in connection with
the execution of an equipment line of credit agreement. The warrants are
exercisable at any time and expire in August 2008 or five years from the
effective date of the Company's initial public offering, whichever is earlier.
The Company has reserved 47,619 shares of Series B convertible preferred stock
for issuance in the event of exercise.
The fair value of the above warrants was calculated using the Black-Scholes
pricing model and deemed to be immaterial.
During April 1999, the Company issued warrants to purchase 38,094 shares of
Series B convertible preferred stock at $2.10 per share in connection with the
execution of a senior loan and security agreement. The warrants are exercisable
at any time and expire in April 2007 or five years from the effective date of
the Company's initial public offering, whichever is later. The fair value of
the warrants calculated using the Black-Scholes pricing model, of $57,167, has
been reflected as a debt issuance cost included in other assets and amortized
as interest expense over the life of the line of credit. The Company has
reserved 38,094 shares of Series B convertible preferred stock for issuance in
the event of exercise.
During October 1999, the Company issued warrants to purchase a total of 380,952
shares of Series B convertible preferred stock at $2.10 per share in connection
with the execution of a subordinated debt agreement. The warrants are
exercisable at any time and expire in October 2009 or five years from the
effective date of the Company's initial public offering, whichever is earlier.
The fair value of the warrants calculated using the Black-Scholes pricing
model, of $762,593, has been reflected as a debt issuance cost included in
other assets and amortized as interest expense over the life of the line of
credit. The Company has reserved 380,952 shares of Series B convertible
preferred stock for issuance in the event of exercise.
F-21
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 8--STOCKHOLDERS' EQUITY (DEFICIT):
Common stock
Each share of common stock is entitled to one vote. The holders of common stock
are also entitled to receive dividends whenever funds are legally available and
when declared by the Board of Directors, subject to the prior rights of holders
of all convertible preferred stock.
The Company has issued a total of 3,525,000 shares of common stock under
restrictive stock purchase agreements, under which the Company has the option
to repurchase unvested shares of stock upon the termination of employment or
services to the Company. The number of shares subject to repurchase is
generally reduced by 1/48th of the initial number subject to repurchase for
each month that the holder continues to serve as a consultant, employee or
director. As of December 31, 2000 and June 30, 2001, 206,836 and no (unaudited)
shares of common stock are subject to repurchase, respectively.
Incentive Stock Plan
In March 1997, the Company approved the 1997 Stock Option Plan (the "Plan")
under which the officers of the Company are authorized to enter into stock
option agreements with selected individuals. The Board of Directors has the
authority to determine to whom options will be granted, the number of shares,
the term and exercise price (which cannot be less than estimated fair market
value at date of grant for incentive stock options or 85% of estimated fair
market value for nonqualified stock options). If an employee owns stock
representing more than 10% of the outstanding shares, the price of each share
shall be at least 110% of estimated fair market value, as determined by the
Board of Directors. Options granted under the Plan generally become exercisable
1/4 on the first anniversary of the vesting commencement date and an additional
1/48 of the total number of shares subject to the option shares shall become
exercisable on the last day of each calendar month thereafter until all of the
shares have become exercisable. Unvested option exercises are subject to
repurchase upon termination of the holder's status as an employee or
consultant. At December 31, 2000 and June 30, 2001, 405,461 and 327,822
(unaudited) shares of common stock were subject to the Company's repurchase
rights, respectively. The options have a maximum term of ten years.
F-22
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Activity under the Plan is as follows:
Outstanding Options
-------------------------------
Weighted
Shares Average
Available Number of Exercise Aggregate
for Grant Shares Price Price
---------- --------- -------- -----------
Balances, January 1, 1998......... 575,454 190,922 $0.14 $ 26,729
Additional shares reserved...... 500,000 -- -- --
Options granted................. (532,700) 532,700 $0.28 147,056
Options exercised............... -- (216,159) $0.25 (53,320)
Options canceled................ 5,369 (5,369) $0.15 (822)
---------- --------- -----------
Balances, December 31, 1998....... 548,123 502,094 $0.24 119,643
Additional shares reserved...... 1,500,000 -- -- --
Options granted................. (1,568,245) 1,568,245 $0.77 1,211,198
Options exercised............... -- (394,182) $0.50 (198,960)
Options canceled................ 31,689 (31,689) $0.33 (10,361)
---------- --------- -----------
Balances, December 31, 1999....... 511,567 1,644,468 $0.68 1,121,520
Additional shares reserved...... 2,670,865 -- -- --
Options granted................. (2,922,596) 2,922,596 $4.01 11,727,269
Options exercised............... -- (213,671) $0.41 (86,649)
Options canceled/shares
repurchased.................... 203,004 (151,794) $1.55 (235,318)
---------- --------- -----------
Balances, December 31, 2000....... 462,840 4,201,599 $2.98 12,526,822
Additional shares reserved
(unaudited).................... 1,500,000 -- -- --
Options granted (unaudited)..... (1,066,450) 1,066,450 $6.13 6,534,325
Options exercised (unaudited)... -- (228,304) $1.97 (450,532)
Options canceled (unaudited).... 157,442 (157,442) $2.45 (385,684)
---------- --------- -----------
Balances, June 30, 2001
(unaudited)...................... 1,053,832 4,882,303 $3.73 $18,224,931
========== ========= ===========
The options outstanding and exercisable by exercise price at December 31, 2000
are as follows:
Outstanding Options
--------------------------------------------------------
Weighted
Average
Remaining
Contractual
Exercise Number Life Options
Price Outstanding (Years) Exercisable
-------- ----------- ----------- -----------
$0.14 61,563 6.6 51,375
0.28 162,272 7.8 42,550
0.50 315,380 8.1 142,614
0.70 218,500 8.4 84,535
1.10 580,000 8.8 180,295
3.00 1,011,633 9.1 133,132
3.50 122,350 9.4 729
4.00 550,598 9.6 52,151
4.40 46,400 9.7 781
5.00 1,132,903 9.8 12,388
--------- -------
4,201,599 700,550
========= =======
F-23
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
The options outstanding and exercisable by exercise price at June 30, 2001
(unaudited) are as follows:
Outstanding Options
--------------------------------------------------------
Weighted
Average
Remaining
Contractual
Exercise Number Life Options
Price Outstanding (Years) Exercisable
-------- ----------- ----------- -----------
$0.14 59,063 6.1 55,856
0.28 145,710 7.3 66,102
0.50 254,553 7.6 141,488
0.70 216,250 7.9 110,723
1.10 406,079 8.3 128,821
3.00 976,915 8.5 311,581
3.50 109,135 8.9 34,198
4.00 530,398 9.1 117,708
4.40 46,400 9.2 2,343
5.00 1,124,753 9.3 36,509
5.50 568,090 9.6 24,578
7.00 444,957 9.9 82
--------- ---------
4,882,303 1,029,989
========= =========
Stock-based compensation
The Company has adopted the disclosure only provisions of SFAS No. 123. In
accordance with the provisions of SFAS No. 123, the Company's filing of a
registration statement with the Securities and Exchange Commission in October
2000 required that the fair value of all options granted after that date be
calculated using the Black-Scholes option pricing model and contain an expected
volatility factor as an assumption. The Company previously calculated the fair
value of each option on the date of grant using the minimum value method as
prescribed by SFAS No. 123. The assumptions used are as follows:
Years Ended Six Months Ended
December 31, June 30,
---------------- ------------------
1998 1999 2000 2000 2001
---- ---- ---- -------- --------
(unaudited)
Risk-free interest rate................ 4.80% 5.55% 5.21% 6.48% 5.47%
Expected life (in years)............... 4 4 4 4 4
Dividend yield......................... -- -- -- -- --
Expected volatility.................... -- -- 70% -- 70%
As the determination of fair value of all options granted after the Company
filed the registration statement with the Securities and Exchange Commission
will include an expected volatility factor in addition to the factors described
in the preceding table, the following results may not be representative of
future periods.
F-24
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Had compensation costs been determined based upon the fair value at the grant
date, consistent with the methodology prescribed under SFAS No. 123, the
Company's pro forma net loss and pro forma basic and diluted net loss per share
under SFAS No. 123 would have been as follows:
Six Months Ended
Years Ended December 31, June 30,
--------------------------------------- --------------------------
1998 1999 2000 2000 2001
----------- ------------ ------------ ------------ ------------
(unaudited)
Net loss attributable to
common stockholders--
as reported............ $(4,663,951) $(13,057,722) $(58,364,715) $(29,831,711) $(53,716,340)
=========== ============ ============ ============ ============
Net loss attributable to
common stockholders--
pro forma.............. $(4,666,570) $(13,101,987) $(59,150,002) $(29,998,389) $(55,501,949)
=========== ============ ============ ============ ============
Net loss per common
share, basic and
diluted--as reported... $ (2.31) $ (4.32) $ (14.69) $ (8.03) $ (11.35)
=========== ============ ============ ============ ============
Net loss per common
share, basic and
diluted--pro forma..... $ (2.32) $ (4.33) $ (14.89) $ (8.08) $ (11.73)
=========== ============ ============ ============ ============
The weighted-average per share grant date fair value of options granted during
the years ended December 31, 1998, 1999 and 2000 and for the six months ended
June 30, 2001 was $0.02, $0.15, $0.76 and $3.37 (unaudited), respectively.
Deferred stock-based compensation
During 1999, 2000 and the six months ended June 30, 2001, the Company issued
options to certain employees under the Plan with exercise prices below the
deemed fair market value of the Company's common stock at the date of grant. In
accordance with the requirements of APB 25, the Company has recorded deferred
stock-based compensation for the difference between the exercise price of the
stock options and the deemed fair market value of the Company's stock at the
date of grant. This deferred stock-based compensation is amortized to expense
on a straight line basis over the period during which the Company's right to
repurchase the stock lapses or the options become vested, generally four years.
During the years ended December 31, 1999 and 2000 and the six months ended June
30, 2001, the Company had recorded deferred stock-based compensation related to
these options in the amounts of $1,118,400, $11,008,675 and $6,008,228
(unaudited), net of cancellations, respectively, of which $76,121, $1,501,948
and $1,755,644 (unaudited) had been amortized to expense during 1999, 2000 and
the six months ended June 30, 2001, respectively.
F-25
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Stock-based compensation expense related to stock options granted to non-
employees is recognized on a straight line basis, as the stock options are
earned. During the years ended December 31, 1998, 1999, 2000 and the six months
ended June 30, 2001, the Company granted options to purchase 2,200, 73,000,
13,250 and 11,500 (unaudited) shares of common stock to non-employees,
respectively. The Company believes that the fair value of the stock options is
more reliably measurable than the fair value of the services received. The fair
value of the stock options granted is calculated at each reporting date using
the Black-Scholes option pricing model as prescribed by SFAS No. 123 using the
following assumptions:
Six Months Ended
Years Ended December 31, June 30,
------------------------------ -------------------
1998 1999 2000 2000 2001
-------- -------- -------- -------- --------
(unaudited)
Risk-free interest
rate................... 4.93% 6.05% 5.75% 6.03% 5.42%
Expected life (in
years)................. 10 10 10 10 10
Dividend yield.......... -- -- -- -- --
Expected volatility..... 70% 70% 70% 70% 70%
The stock-based compensation expense will fluctuate as the deemed fair market
value of the common stock fluctuates. In connection with the grant of stock
options to non-employees, the Company recorded deferred stock-based
compensation of none, $246,209, $802,716 and $385,886 (unaudited) for the years
ended December 31, 1998, 1999, 2000 and for the six months ended June 30, 2001,
respectively, of which none, $44,070, $291,300 and $256,422 (unaudited) has
been amortized to expense in 1998, 1999, 2000 and in the six months ended June
30, 2001, respectively.
Note receivable from stockholders
During 1998, 1999 and 2000, the Company sold common stock to certain of its
officers in exchange for full recourse notes receivable. The notes are non-
interest bearing, have due dates through September 2003, and are collateralized
by the underlying shares of common stock.
2000 Stock Plan
In September 2000, the Board of Directors adopted the 2000 Stock Plan ("2000
Plan"). The 2000 Plan was approved by the stockholders in October 2000 and was
to be effective upon the completion of an initial public offering of the
Company's common stock. In June 2001, the Board of Directors terminated the
2000 Plan.
2001 Stock Plan
In June 2001, the Board of Directors adopted the 2001 Stock Plan ("2001 Plan"),
subject to stockholder approval. The 2001 Plan, which will terminate no later
than 2011, provides for the granting of incentive stock options to employees
and nonstatutory stock options to employees, directors and consultants.
7,000,000 shares of common stock are reserved for issuance plus any shares
which have been reserved but not issued under the 1997 Stock Plan, plus any
shares returned thereafter. The 1997 Stock Plan will be cancelled upon the
effectiveness of the 2001 Plan. In addition, the number of shares available for
issuance will be increased on the first day of each fiscal year, commencing in
2002, by an amount equal to the lesser of (i) 2,500,000, (ii) 5.0% of the
outstanding shares of common stock on the last day of the preceding fiscal year
or (iii) an amount as determined by the Board of Directors.
F-26
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Under the terms of the 2001 Plan, on or after the effectiveness of an initial
public offering of the Company's stock, each newly-elected non-employee
director will be granted a nonstatutory option to purchase 30,000 shares of
common stock which vests annually over a three year period. Thereafter, on an
annual basis, on the date of the annual stockholder meeting, commencing in
2002, each non-employee director will be granted a nonstatutory option to
purchase 10,000 shares of common stock which vests after one year. The exercise
price of an option shall not be less than 100% of the fair market value of the
common stock on the date of grant and the term shall not exceed 10 years.
2000 Employee Stock Purchase Plan
In September 2000, the Board of Directors adopted the 2000 Employee Stock
Purchase Plan ("2000 ESPP"). The 2000 Plan was approved by the stockholders in
October 2000 and was to be effective upon the completion of an initial public
offering of the Company's common stock. In June 2001, the Board of Directors
terminated the 2000 ESPP.
2001 Employee Stock Purchase Plan
In June 2001, the Board of Directors adopted the 2001 Employee Stock Purchase
Plan ("2001 ESPP"), subject to stockholder approval, under which eligible
employees are permitted to purchase common stock at a discount through payroll
deductions. 1,000,000 shares of common stock are reserved for issuance and will
be increased on the first day of each fiscal year, commencing in 2002, by an
amount equal to the lesser of (i) 1,000,000, (ii) 1.5% of the outstanding
shares of common stock on such date or (iii) an amount as determined by the
Board of Directors.
The 2001 ESPP contains consecutive, overlapping twenty-four month offering
periods. Each offering period includes four six-month purchase periods. The
price of the common stock purchased shall be 85% of the lower of the fair
market value of the common stock at the beginning of an offering period or at
the end of a purchase period. The initial offering period will commence on the
effective date of the Company's initial public offering.
NOTE 9--INCOME TAXES:
At December 31, 2000, the Company has approximately $44.8 million and $31.2
million in federal and state net operating loss carryforwards, respectively, to
reduce future taxable income. These carryforwards have expiration dates from
2012 through 2020 for federal and in 2005 for state, if not utilized.
At December 31, 2000, the Company had research credit carryforwards of
approximately $718,000 and $569,000 for federal and state income tax purposes,
respectively. If not utilized, the federal carryforwards will expire in various
amounts beginning in 2012. The state research credit can be carried forward
indefinitely.
The Tax Reform Act of 1986 limits the use of net operating loss and tax credit
carryforwards in the case of an "ownership change" of a corporation. Ownership
changes, as defined, have already occurred on April 21, 1997 and February 23,
1999 as a result of the Company's preferred stock financings. In accordance
with Internal Revenue Code Section 382, such losses are subject to annual
limitation. The annual limitations did not result in the expiration of net
operating losses prior to utilization.
F-27
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
Temporary differences and carryforwards which gave rise to significant portions
of deferred tax assets and liabilities are as follows:
December 31,
-------------------------
1999 2000
----------- ------------
Net operating loss carryforwards................ $ 6,924,000 $ 17,047,000
Research and development tax credit
carryforwards.................................. 645,000 1,228,000
Deferred revenue................................ -- 3,456,000
Accruals and reserves not currently deductible
for tax purposes............................... 23,000 2,145,000
Capitalized start-up costs...................... 415,000 348,000
Depreciation and amortization................... (158,000) 189,000
Valuation allowance............................. (7,849,000) (24,413,000)
----------- ------------
$ -- $ --
=========== ============
The Company has established a valuation allowance against its deferred tax
assets due to the uncertainty surrounding the realization of such assets.
NOTE 10--UNAUDITED PRO FORMA NET LOSS PER SHARE:
Pro forma basic and diluted net loss per share have been computed to give
effect to convertible preferred stock that will convert to common stock upon
the closing of the Company's initial public offering (using the as-if-converted
method) for the year ended December 31, 2000 and the six months ended June 30,
2001. A reconciliation of the numerator and denominator used in the calculation
of pro forma basic and diluted net loss per common share follows:
Six Months
Year Ended Ended
December 31, June 30,
2000 2001
------------ ------------
(unaudited)
Pro forma net loss per common share, basic and
diluted:
Net loss attributable to common stockholders..... $(58,364,715) $(53,716,340)
Deemed dividend related to beneficial conversion
feature of preferred stock...................... 14,772,878 26,782,911
------------ ------------
Net loss......................................... $(43,591,837) $(26,933,429)
============ ============
Weighted-average shares used in computing net
loss per common share, basic and diluted........ 3,973,250 4,732,091
Adjustments to reflect the effect of the assumed
conversion of the preferred stock from the date
of issuance..................................... 17,155,943 24,598,775
------------ ------------
Weighted-average shares used in computing pro
forma net loss per common share, basic and
diluted......................................... 21,129,193 29,330,866
============ ============
Pro forma net loss per common share, basic and
diluted........................................... $ (2.06) $ (0.92)
============ ============
F-28
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 11--RELATED PARTIES:
Since April 1997, Dr. Adam Heller, the Chief Scientific Advisor, has performed
consulting services for the Company. The terms of the consulting agreement
provide that the Company pay Dr. Heller a consulting fee of $1,200 per day,
plus reimbursement for travel and business expenses. The agreement has a term
of one year with automatic one year renewals. The agreement is terminable by
the Company or Dr. Heller upon thirty days written notice. Dr. Adam Heller is
the father of Ephriam Heller, Co-Founder, Vice President of Business
Development and Director. During 1998, 1999 and 2000, the Company paid Dr.
Heller $55,260, $85,760 and $110,141, respectively, in connection with these
agreements. At December 31, 1999 and 2000, the Company had no accrued
liabilities relating to Dr. Heller's consulting services.
Pursuant to an agreement with Facet Technologies entered into in December 1998,
Facet Technologies has provided development services for the FreeStyle lancing
device and related products. In exchange for such services, the Company granted
Facet Technologies the exclusive right to manufacture the FreeStyle lancing
device for a period of seven years from the date of the agreement. A former
principal of Facet Technologies is a member of the Company's Board of
Directors. During 1998, 1999 and 2000, Facet Technologies provided development
services of approximately none, $200,000 and $300,000, respectively, and
purchases from Facet Technologies totaled none, $4,675 and $402,356,
respectively. In addition, none and $27,799 is included in accounts payable at
December 31, 1999 and 2000, respectively, and none and $331,578 is included in
accrued liabilities at December 31, 1999 and 2000, respectively, in connection
with this agreement.
In November 1999, the Company entered into an agreement with Flextronics
International ("Flextronics") related to the manufacturing of the FreeStyle
meter. The Company's contract with Flextronics expires in November 2005, and is
renewable annually thereafter. A member of the Company's Board of Directors is
also President Americas Operations of Flextronics. During 1999 and 2000, the
Company purchased $261,195 and $20,639,858 under this agreement, respectively.
Approximately $32,606 and $4,045,179 are included in accounts payable at
December 31, 1999 and 2000, respectively, and none and $314,107 are included in
accrued liabilities at December 31, 1999 and 2000, respectively, relating to
this agreement.
In October 2000, the Company entered into a Technology Purchase Agreement with
E. Heller & Co. The agreement includes a covenant not to compete for three
years and provides for the transfer and assignment of several licenses and
rights to the Company in exchange for $500,000. The portion of the payment
attributable to the covenant not to compete, of $50,000, has been capitalized
and is being amortized to research and development expense on a straight-line
basis over the three-year term. Based upon the early stage of development and
the uncertainty as to the feasibility of the technology and its alternative
uses, the remaining acquisition cost was immediately expensed to research and
development. E. Heller & Co. is controlled by one of the Company's founders,
who is also a Vice President of the Company and a member of the Company's Board
of Directors.
NOTE 12--EMPLOYEE BENEFIT PLAN:
In October 1997, the Company adopted a defined contribution retirement plan
(the "Plan"), which qualifies under Section 401(k) of the Internal Revenue Code
of 1996. The Plan covers essentially all employees. Eligible employees may make
voluntary contributions to the Plan up to 15% of their annual compensation,
subject to statutory annual limitations, and the employer is allowed to make
discretionary contributions. The Company has made no contributions to date.
F-29
THERASENSE, INC.
NOTES TO FINANCIAL STATEMENTS--(Continued)
NOTE 13--SUBSEQUENT EVENTS (UNAUDITED):
Related Parties
In July 2001, the Company and Facet Technologies amended the December 1998
agreement and entered into a new agreement pursuant to which the Company agrees
to purchase the FreeStyle lancing devices and lancets from Facet Technologies
until June 1, 2007.
Option Grants
On August 3, 2001, the Company granted a total of 999,800 options to purchase
shares of common stock under the 1997 Stock Option Plan to employees and non-
employees at an exercise price of $9.00 per share. The total deferred stock-
based compensation related to these grants amounted to $7,198,560 and will be
amortized to expense over the vesting period.
Incentive Stock Plans
In August 2001, the Board of Directors authorized an additional 500,000 shares
of common stock to be available for issuance under the 1997 Stock Option Plan
from 7,607,032 to 8,107,032, and decreased the number of shares available for
issuance under the 2001 Stock Plan by 500,000 from 7,000,000 to 6,500,000.
F-30
[INSIDE BACK COVER ART WORK]
DESCRIPTION OF GRAPHIC
Graphic depicts four primary components of our Continuous Glucose Monitoring
System - the wireless display unit, the sensor, the spring-loaded insertion
device, and the transmitter.
TEXT ACCOMPANYING THE GRAPHIC
"Continuous Glucose Monitoring System."
"Display Unit. Wireless display unit continuously displays glucose levels and
trends and stores them for future use."
"Sensor. Disposable sensor provides up to three days of continuous glucose
measurement."
"Insertion Device. Insertion device places the sensor beneath the skin."
"Transmitter. Transmitter adheres to the skin and broadcasts glucose readings to
the display unit."
"Our Continuous Glucose Monitoring System is in the development stage and has
been tested on humans on a very limited basis. Our Continuous Glucose Monitoring
System will require further development and regulatory approval or registration
before it can be marketed in the United States or internationally. Accordingly,
the final design of our Continuous Glucose Monitoring System may differ from the
conceptual design depicted above."
6,000,000 Shares
THERASENSE, INC.
Common Stock
[THERASENSE INC. LOGO]
---------------------
PROSPECTUS
---------------------
Until November 5, 2001, all dealers that effect transactions in these
securities, whether or not participating in this offering, may be required to
deliver a prospectus. This is in addition to the dealers' obligation to deliver
a prospectus when acting as underwriters and with respect to their unsold
allotments or subscriptions.
U.S. Bancorp Piper Jaffray
SG Cowen
Thomas Weisel Partners LLC
October 11, 2001