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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
_____________________________________________________
Form 10-Q
 _____________________________________________________
x
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2018
OR
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-33462
_____________________________________________________
INSULET CORPORATION
(Exact name of Registrant as specified in its charter)
_____________________________________________________
Delaware
 
04-3523891
(State or Other Jurisdiction of
Incorporation or Organization)
 
(I.R.S. Employer
Identification No.)
 
 
600 Technology Park Drive, Suite 200
Billerica, Massachusetts
 
01821
(Address of Principal Executive Offices)
 
(Zip Code)
Registrant’s Telephone Number, Including Area Code: (978) 600-7000
_____________________________________________________
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. 
Large accelerated filer
x
 
Accelerated filer
¨
 
 
 
 
Non-accelerated filer
¨
(Do not check if a smaller reporting company)
Smaller reporting company
¨
 
 
 
 
 
 
 
 
Emerging growth company
¨
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ¨ 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x
As of August 1, 2018, the registrant had 58,997,012 shares of common stock outstanding.




TABLE OF CONTENTS
 
 
 
 
 
 
 


Table of Contents

PART I - FINANCIAL INFORMATION
Item 1.
Consolidated Financial Statements (Unaudited)
INSULET CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)
June 30,
2018
 
December 31,
2017
ASSETS
(Unaudited)
 
 
Current Assets
 
 
 
Cash and cash equivalents
$
136,246

 
$
272,577

Short-term investments
163,546

 
167,479

Accounts receivable, net
49,676

 
53,373

Unbilled receivable (Note 3)
13,958

 

Inventories
40,808

 
33,793

Prepaid expenses and other current assets (Note 10)
17,559

 
9,949

Total current assets
421,793

 
537,171

Long-term investments
156,060

 
125,549

Property and equipment, net
197,564

 
107,864

Other intangible assets, net
5,747

 
4,351

Goodwill
39,731

 
39,840

Other assets (Note 10)
17,961

 
1,969

Total assets
$
838,856

 
$
816,744

LIABILITIES AND STOCKHOLDERS’ EQUITY
 
 
 
Current Liabilities
 
 
 
Accounts payable
$
25,191

 
$
24,413

Accrued expenses and other current liabilities
48,580

 
59,256

Deferred revenue
2,338

 
2,356

Total current liabilities
76,109

 
86,025

Convertible debt, net (Note 6)
577,119

 
566,173

Other long-term liabilities
6,480

 
6,030

Total liabilities
659,708

 
658,228

Commitments and contingencies (Note 13)

 

Stockholders’ Equity
 
 
 
Preferred stock, $.001 par value:
 
 
 
Authorized: 5,000,000 shares at June 30, 2018 and December 31, 2017.
Issued and outstanding: zero shares at June 30, 2018 and December 31, 2017.


 

Common stock, $.001 par value:
 
 
 
Authorized: 100,000,000 at June 30, 2018 and December 31, 2017.
Issued and outstanding: 58,975,395 and 58,319,348 at June 30, 2018 and December 31, 2017, respectively.
59

 
58

Additional paid-in capital
876,641

 
866,206

Accumulated other comprehensive loss
(2,386
)
 
(493
)
Accumulated deficit
(695,166
)
 
(707,255
)
Total stockholders’ equity
179,148

 
158,516

Total liabilities and stockholders’ equity
$
838,856

 
$
816,744


The accompanying condensed notes are an integral part of these consolidated financial statements.
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INSULET CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands, except per share data)
2018
 
2017
 
2018
 
2017
Revenue
$
124,262

 
$
109,756

 
$
247,840

 
$
211,469

Cost of revenue
42,190

 
45,117

 
89,953

 
87,432

Gross profit
82,072

 
64,639

 
157,887

 
124,037

Operating expenses:
 
 
 
 
 
 
 
Research and development
18,418

 
18,029

 
38,330

 
35,529

Sales and marketing
35,605

 
29,475

 
67,738

 
57,570

General and administrative
23,724

 
20,493

 
47,494

 
39,604

Total operating expenses
77,747

 
67,997

 
153,562

 
132,703

Operating income (loss)
4,325

 
(3,358
)
 
4,325

 
(8,666
)
Interest expense
7,290

 
4,796

 
15,208

 
9,803

Other income, net
1,686

 
488

 
3,368

 
922

Interest expense and other income, net
5,604

 
4,308

 
11,840

 
8,881

Loss before income taxes
(1,279
)
 
(7,666
)
 
(7,515
)
 
(17,547
)
Income tax expense
412

 
101

 
745

 
197

Net loss
$
(1,691
)
 
$
(7,767
)
 
$
(8,260
)
 
$
(17,744
)
Net loss per share basic and diluted:
 
 
 
 
 
 
 
Net loss per share
$
(0.03
)
 
$
(0.13
)
 
$
(0.14
)
 
$
(0.31
)
Weighted-average number of shares used in calculating net loss per share
58,833

 
57,977

 
58,659

 
57,836


The accompanying condensed notes are an integral part of these consolidated financial statements.
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INSULET CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)

 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Net loss
$
(1,691
)
 
$
(7,767
)
 
$
(8,260
)
 
$
(17,744
)
Other comprehensive income, net of tax
 
 
 
 
 
 
 
Foreign currency translation adjustment, net of tax
(741
)
 
186

 
(1,059
)
 
264

Unrealized loss on available-for-sale debt securities, net of tax
(109
)
 
(57
)
 
(834
)
 
(67
)
Total other comprehensive (loss) income, net of tax
(850
)
 
129

 
(1,893
)
 
197

Total comprehensive loss
$
(2,541
)
 
$
(7,638
)
 
$
(10,153
)
 
$
(17,547
)

The accompanying condensed notes are an integral part of these consolidated financial statements.
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INSULET CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
Cash flows from operating activities
 
 
 
Net loss
$
(8,260
)
 
$
(17,744
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
Depreciation and amortization
7,131

 
6,707

Non-cash interest expense
14,427

 
8,067

Stock-based compensation expense
15,117

 
14,655

Provision for bad debts
1,586

 
722

Other
(130
)
 
374

Changes in operating assets and liabilities:
 
 
 
Accounts receivable and unbilled receivable
(7,217
)
 
(9,630
)
Inventories
(7,959
)
 
1,527

Prepaid expenses and other assets
(4,823
)
 
(1,662
)
Accounts payable, accrued expenses and other current liabilities
(17,873
)
 
(7,408
)
Deferred revenue
(2,626
)
 
44

Other long-term liabilities
232

 
477

Net cash used in operating activities
(10,395
)
 
(3,871
)
Cash flows from investing activities
 
 
 
Purchases of property, equipment and software(1)
(89,937
)
 
(39,068
)
Purchases of investments
(117,940
)
 
(93,383
)
Receipts from the maturity or sale of investments
90,774

 
68,185

Net cash used in investing activities
(117,103
)
 
(64,266
)
Cash flows from financing activities
 
 
 
Principal payments of capital lease obligations

 
(269
)
Repayment of convertible notes
(6,687
)
 

Proceeds from exercise of stock options (2)
11,206

 
7,891

Payment of withholding taxes in connection with vesting of restricted stock units
(12,691
)
 
(3,428
)
Net cash (used in) provided by financing activities
(8,172
)
 
4,194

Effect of exchange rate changes on cash
(661
)
 
257

Net decrease in cash, cash equivalents and restricted cash
(136,331
)
 
(63,686
)
Cash, cash equivalents and restricted cash, beginning of period
272,577

 
137,174

Cash, cash equivalents and restricted cash, end of period
$
136,246

 
$
73,488

(1) Cash outflows from purchases of property, equipment and software for the six months ended June 30, 2018 includes $4.0 million of purchases made in prior periods that were included in accounts payable and accrued expenses as of December 31, 2017 and excludes $12.3 million of purchases made during the six months ended June 30, 2018 that were included in accounts payable and accrued expenses as of June 30, 2018.
(2) During the period, the Company acquired 9,733 shares of its common stock with a value of $0.8 million in return for the exercise of stock options. The acquired shares were subsequently retired.


The accompanying condensed notes are an integral part of these consolidated financial statements.
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Table of Contents

INSULET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Nature of the Business
Insulet Corporation (the "Company") is primarily engaged in the development, manufacturing and sale of its proprietary Omnipod Insulin Management System (the “Omnipod System”), an innovative, discreet and easy-to-use continuous insulin delivery system for people with insulin-dependent diabetes. There are two primary types of insulin therapy practiced today: multiple daily injection (“MDI”) therapy using syringes or insulin pens; and pump therapy using insulin pumps. Insulin pumps are used to perform continuous subcutaneous insulin infusion, or insulin pump therapy, and typically use a programmable device and an infusion set to administer insulin into the person’s body. Insulin pump therapy has been shown to provide people with insulin-dependent diabetes with numerous advantages relative to MDI therapy. The Company estimates that approximately one-third of the Type 1 diabetes population in the United States use insulin pump therapy, and that less than 10% of the Type 2 diabetes population in the United States who are insulin-dependent use insulin pump therapy. The Omnipod System features a small, lightweight, self-adhesive disposable tubeless Omnipod device, which is worn on the body for approximately three days at a time, and its wireless companion, the handheld Personal Diabetes Manager ("PDM"). The Omnipod System, which features two discreet, easy-to-use devices that communicate wirelessly and provide for virtually pain-free automated cannula insertion and blood glucose meter integration, eliminates the need for traditional MDI therapy or the use of traditional pump and tubing. The Company believes that the Omnipod System’s unique proprietary design and features allow people with insulin-dependent diabetes to manage their diabetes with unprecedented freedom, comfort, convenience, and ease.
Commercial sales of the Omnipod System began in the United States in 2005. The Company sells the Omnipod System in the United States through direct sales to customers or through its distribution partners. The Omnipod System is currently available in multiple countries in Europe, as well as in Canada and Israel.
To lower manufacturing costs, increase supply redundancy, add capacity closer to its largest customer base and support growth, the Company is constructing a highly-automated manufacturing facility in Acton, Massachusetts, with planned production out of the facility beginning in early 2019. The facility will also serve as the Company's global headquarters.
The Company assumed on July 1, 2018, all commercial activities (including, among other things, distribution, sales, marketing, training and support) of its Omnipod System across Europe following the expiration of its prior distribution agreement with Ypsomed Distribution AG ("Ypsomed" or the "European distributor") on June 30, 2018. The Company will be required to pay to the former European distributor a per unit fee for sales of the Company's Omnipod device over the twelve months following the expiration of the distribution agreement. The fee will be based on sales of the Omnipod device to identified customers (as that term is defined in the distribution agreement) of the former European distributor who had previously entered into an agreement with the former European distributor for the purchase of Omnipod devices. The Company expects to recognize a liability and an associated intangible asset for this fee as qualifying sales of its Omnipod device are made to these identified customers during the twelve-month period between July 1, 2018 and June 30, 2019. The intangible asset will be amortized over its estimated useful life.
In addition to using the Omnipod System for insulin delivery, the Company also partners with global pharmaceutical and biotechnology companies to tailor the Omnipod System technology platform for the delivery of subcutaneous drugs across multiple therapeutic areas.


Note 2. Basis of Presentation and Summary of Significant Accounting Policies

Basis of Presentation
The unaudited consolidated financial statements in this Quarterly Report on Form 10-Q have been prepared in accordance with generally accepted accounting principles (“U.S. GAAP” or "GAAP") for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, these unaudited consolidated financial statements do not include all of the information and footnotes required by GAAP for complete financial statements. In the opinion of management, all adjustments, consisting of normal recurring adjustments, considered necessary for a fair presentation have been included. Operating results for the three and six months ended June 30, 2018 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2018, or for any other subsequent interim period.
The unaudited consolidated financial statements in this Quarterly Report on Form 10-Q should be read in conjunction with the Company’s consolidated financial statements and notes thereto contained in the Company’s Annual Report on Form 10-K for the year ended December 31, 2017.

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Use of Estimates in Preparation of Financial Statements
The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions in the application of certain of its significant accounting policies that may materially affect the reported amounts of assets, liabilities, equity, revenue and expenses. Actual results may differ from those estimates. See Note 3 related to the Company's adoption of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, for a discussion of judgments associated with the recognition of revenue and deferral of cost to obtain a contract.

Principles of Consolidation
The consolidated financial statements include the accounts of the Company and its wholly-owned subsidiaries. All intercompany balances and transactions have been eliminated in consolidation.

Foreign Currency Translation
For foreign operations, asset and liability accounts are translated at exchange rates as of the balance sheet date; income and expenses are translated using weighted average exchange rates for the reporting period. Resulting translation adjustments are reported in accumulated other comprehensive loss, a separate component of stockholders' equity. Gains and losses arising from transactions and revaluation of period-end balances denominated in currencies other than the local entity's functional currency, primarily the Canadian dollar and the Euro, are included in other income, net, and were not material in the three and six months ended June 30, 2018 and 2017.

Cash and Cash Equivalents
For the purpose of financial statement classification, the Company considers all highly-liquid investment instruments with original maturities of 90 days or less, when purchased, to be cash equivalents. Cash equivalents include money market mutual funds, corporate bonds, U.S. government and agency bonds, and certificates of deposit, and are carried at cost which approximates their fair value. Included in the Company's cash and cash equivalents are restricted cash amounts set aside for collateral on outstanding letters of credit and for European cash management and VAT filing collateral, totaling $2.0 million as of June 30, 2018 and $0.5 million as of December 31, 2017.

Investments in Marketable Securities
Short-term and long-term investment securities consist of available-for-sale marketable debt securities and are carried at fair value with unrealized gains or losses included as a component of other comprehensive loss in stockholders' equity. Investments with a stated maturity date of one year or more from the balance sheet date and that are not expected to be used in current operations, are classified as long-term investments. Short-term and long-term investments include U.S. government and agency bonds, corporate bonds, and certificates of deposit.
The Company reviews investments for other-than-temporary impairment when the fair value of an investment is less than its amortized cost. If an available-for-sale security is other than temporarily impaired, the loss is charged to earnings.

Fair Value Measurements
To measure fair value of assets and liabilities required to be measured or disclosed at fair value, the Company uses the following fair value hierarchy based on three levels of inputs of which the first two are considered observable and the last unobservable:
Level 1 — quoted prices in active markets for identical assets or liabilities
Level 2 — observable inputs other than quoted prices in active markets for identical assets or liabilities
Level 3 — unobservable inputs in which there is little or no market data available, which require the reporting entity to develop its own assumptions
Certain of the Company’s financial instruments, including cash and cash equivalents, accounts receivable, accounts payable, accrued expenses and other liabilities are carried at cost, which approximates their fair value because of the short-term maturity of these financial instruments.

Property and Equipment
Property and equipment is stated at cost and depreciated using the straight-line method over the estimated useful life of the respective assets. Leasehold improvements are amortized over their useful life or the life of the lease, whichever is shorter. Assets acquired under capital leases are amortized in accordance with the respective class of owned assets and the amortization is included within depreciation expense. Maintenance and repair costs are expensed as incurred.
Property and equipment included $57.9 million and $51.6 million of accumulated depreciation as of June 30, 2018 and December 31, 2017, respectively.

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Segment Reporting
Operating segments are defined as components of an enterprise about which separate financial information is available that is evaluated on a regular basis by the chief operating decision-maker ("CODM") in deciding how to allocate resources to an individual segment and in assessing performance of the segment. The Company has concluded that its Chief Executive Officer is the CODM as he is the ultimate decision maker for key operating decisions, determining the allocation of resources and assessing the financial performance of the Company. These decisions, allocations and assessments are performed by the CODM using consolidated financial information. The Company’s products are relatively consistent and manufacturing is centralized and consistent across product offerings. Based on these factors, key operating decisions and resource allocations are made by the CODM using consolidated financial data and as such the Company has concluded that it operates as one segment.

Goodwill
Goodwill represents the excess of the cost of acquired businesses over the fair value of identifiable net assets acquired. The Company follows the provisions of Financial Accounting Standards Board ("FASB") Accounting Standards Codification (“ASC”) 350-20, Intangibles - Goodwill and Other (“ASC 350-20”). The Company performs an assessment of its goodwill for impairment on at least an annual basis or whenever events or changes in circumstances indicate there might be impairment. The Company's annual impairment test date is October 1st.
As the Company operates in one segment, the Company has considered whether that segment contains multiple components which represent separate reporting units. The Company has concluded that it has a single reporting unit. In reaching this conclusion, the Company considered how components of the business are managed, whether discrete financial information at the component level is reviewed on a regular basis by segment management and whether components may be aggregated based on economic similarity.
In performing its annual goodwill test, the Company utilizes the two-step approach as currently prescribed by ASC 350-20. The first step compares the carrying value of the reporting unit to its fair value. If the reporting unit’s carrying value exceeds its fair value, the Company would perform the second step and record an impairment loss to the extent that the carrying value of the reporting unit's goodwill exceeds its implied fair value. There was no impairment of goodwill during the three and six months ended June 30, 2018.

Shipping and Handling Costs
The Company does not typically charge its customers for shipping and handling costs associated with shipping its product to its customers unless non-standard shipping and handling services are requested. These shipping and handling costs are included in general and administrative expenses and were $1.4 million and $0.9 million for the three months ended June 30, 2018 and 2017, respectively, and were $2.5 million and $2.2 million for the six months ended June 30, 2018 and 2017, respectively.

Concentration of Credit Risk
Financial instruments that subject the Company to credit risk primarily consist of cash and cash equivalents, short-term and long-term investments in marketable debt securities and accounts receivable. The Company maintains the majority of its cash with one financial institution. Accounts are partially insured up to various amounts mandated by the Federal Deposit Insurance Corporation or by the foreign country where the account is held.
The Company purchases Omnipod Systems from Flex Ltd., its single source contract manufacturer. As of each of June 30, 2018 and December 31, 2017, liabilities to this vendor represented approximately 16% and 20%, respectively, of the combined balance of accounts payable, accrued expenses and other current liabilities.
Revenue for customers comprising more than 10% of total revenue were as follows:
 
Three Months Ended June 30,
 
Six Months Ended June 30,


2018
 
2017
 
2018
 
2017
Amgen, Inc.
14%
 
16
%
 
13%
 
16%
Ypsomed
*
 
20
%
 
17%
 
20%
Cardinal Health Inc. and affiliates
13%
 
10
%
 
12%
 
10%
* Represents less than 10% of consolidated revenue.

Other Significant Policies:
The following table identifies the Company's other significant accounting policies and the note and page where a detailed description of each policy can be found.


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Revenue Recognition
Note
3

Page
Convertible Debt, Net
Note
6

Page
Note
8

Page
Note
9

Page
Other Intangible Assets
Note
11

Page
Accrued Product Warranty Costs
Note
12

Page
Commitments and Contingencies
Note
13

Page
Note
14

Page
Note
15

Page

Recently Adopted Accounting Standards:
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). ASU 2014-09 and its related amendments (collectively referred to as ASC 606) requires that an entity recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. Under this guidance, an entity makes additional estimates regarding performance conditions and the allocation of variable consideration and must evaluate whether revenue derived from a contract should be recognized at a point in time or over time. The Company adopted the standard as of the required effective date of January 1, 2018 using the modified retrospective method. Under this method, the new guidance was applied to contracts that were not yet completed as of January 1, 2018 with the cumulative effect of initially applying the guidance recognized through accumulated deficit as the date of initial application. See Note 3 "Revenue from Contracts with Customers".
Effective January 1, 2018, the Company adopted ASU 2016-01, Recognition and Measurement of Financial Assets and Financial Liabilities ("ASU 2016-01"). ASU 2016-01 changes the GAAP model for the accounting of equity investments, whereby equity investments with readily determinable fair value will be carried at fair value with changes reported in net income (loss) as opposed to other comprehensive income (loss). The Company adopted ASU 2016-01 as of the required effective date of January 1, 2018. There was no impact on the consolidated financial statements upon the adoption of ASU 2016-01 as of the effective date or as of and for the period ended June 30, 2018.
Effective January 1, 2018, the Company retrospectively adopted ASU 2016-15, Statement of Cash Flows (Topic 230), Classification of Certain Cash Receipts and Cash Payments (a consensus of the Emerging Issues Task Force) ("ASU 2016-15"). ASU 2016-15 clarifies how entities should classify certain cash receipts and cash payments on the statement of cash flows. The guidance also clarifies how the predominance principle should be applied when cash receipts and cash payments have aspects of more than one class of cash flows. There was no impact on the consolidated statements of cash flows upon the adoption of ASU 2016-15.
Effective January 1, 2018, the Company adopted ASU 2017-09, Compensation-Stock Compensation (Topic 718): Scope of Modification Accounting. ("ASU 2017-09"). ASU 2017-09 specifies the types of changes to the terms or conditions of a share-based payment award that require an entity to apply modification accounting in accordance with Topic 718. The adoption of ASU 2017-09 did not have a material impact on the Company's consolidated financial statements.
Effective January 1, 2018, the Company adopted ASU 2016-16, Income Taxes (Topic 740): Intra-Entity Transfers of Assets Other Than Inventory ("ASU 2016-16"). ASU 2016-16 requires than an entity recognized the income tax effects of an intra-entity transfer of an asset, other than inventory, when the transfer occurs as opposed to when the asset is sold to a third party. The adoption of this guidance did not have a material impact on the Company's consolidated financial statements.
Accounting Standards Issued and Not Yet Adopted:
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 and its related amendments (collectively referred to as ASC 842) requires lessees to recognize the assets and liabilities on their balance sheet for the rights and obligations created by most leases and continue to recognize expenses on their income statements over the lease term. It will also require disclosures designed to give financial statement users information on the amount, timing, and uncertainty of cash flows arising from leases. ASU 2016-02 also amends ASC 420, Exit or Disposal Cost Obligations, to exclude costs to terminate a lease from its scope. The guidance is effective for annual reporting periods beginning after December 15, 2018, and interim periods within those years. Early adoption is permitted for all entities. While the Company continues to evaluate the impact of ASU 2016-02, the Company plans to adopt this standard in the first quarter of 2019 and expects to record right-of-use assets and associated lease obligations on its balance sheet primarily related to its leased office and warehousing space. The Company is also evaluating whether its supplier agreements may contain embedded leases. The Company expects that the adoption of this standard will require updates to its processes and internal controls over financial reporting.

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In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment ("ASU 2017-04"). ASU 2017-04 simplifies the accounting for goodwill impairments by eliminating "Step 2" from the goodwill impairment test, which requires an entity to calculate the implied fair value of goodwill to measure a goodwill impairment charge, and alternatively, requires an entity to measure the impairment of goodwill assigned to a reporting unit as the amount by which the carrying value of the assets and liabilities of the reporting unit, including goodwill, exceeds the reporting unit's fair value. The guidance is effective for annual reporting periods beginning after December 15, 2019, and interim periods within those years. Early adoption is permitted for all entities. The Company is currently evaluating the impact of ASU 2017-04 but does not expect it to be material to the consolidated financial statements.
In August 2017, the FASB issued ASU 2017-12, Targeted Improvements to Accounting for Hedging Activities. ("ASU 2017-12"). ASU 2017-12 updates the current hedge accounting guidance with the objective of improving the financial reporting of hedging activities by better portraying the economic results of an entity's risk management activities in its financial statements. The new guidance is effective for the Company on January 1, 2019 and early adoption is permitted. The Company is currently evaluating the impact of ASU 2017-12 on its consolidated financial statements.

Note 3. Revenue from Contracts with Customers
The Company adopted ASC 606 on January 1, 2018 using the modified retrospective method for all contracts not completed as of the date of adoption. Under this method, the new guidance was applied to contracts that were not yet completed as of January 1, 2018 with the cumulative effect of initially applying the guidance recognized through accumulated deficit as the date of initial application. For contracts that were modified before the effective date, the Company reflected the aggregate effect of all modifications when identifying performance obligations and allocating transaction price, which did not have a material effect on the adjustment to accumulated deficit. The reported results for 2018 reflect the application of ASC 606 guidance while the reported results for 2017 were prepared under the guidance of ASC 605, Revenue Recognition (ASC 605), which is also referred to herein as the "previous guidance". The adoption of ASC 606 represents a change in accounting principle that will primarily impact how revenue is recognized for the Company's drug delivery product line and how the Company accounts for contract acquisition costs such as commissions. In accordance with ASC 606, revenue is recognized when a customer obtains control of the promised products. The amount of revenue recognized reflects the consideration to which the Company expects to be entitled to receive in exchange for these products. To achieve this core principle, the Company applies the following five steps as outlined in ASC 606:
1) Identify the contract with a customer;
2) Identify the performance obligations in the contract;
3) Determine the transaction price;
4) Allocate the transaction price to performance obligations in the contract;
5) Recognize revenue when or as the Company satisfies a performance obligation.

The following table summarizes revenue from contracts with customers for the three and six months ended June 30, 2018 and 2017:

 
Three months
 
Six months
(in thousands)
2018
 
2017
 
2018
 
2017
U.S. Omnipod
$
78,047

 
$
65,361

 
$
148,319

 
$
125,016

International Omnipod
28,509

 
26,575

 
66,913

 
51,719

Drug Delivery
17,706

 
17,820

 
32,608

 
34,734

Total
$
124,262

 
$
109,756

 
$
247,840

 
$
211,469


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U.S. and International Omnipod
The Company generates the majority of its revenue from sales of its Omnipod, which is sold in the U.S., Canada, Europe and Israel. The Omnipod is sold either directly to end users or indirectly through intermediaries, such as independent distributors who resell the Omnipod to end users or wholesalers who sell the Company's product to end users through the pharmacy channel. The Company's exclusive European distribution agreement with its former European distributor expired on June 30, 2018, at which time the Company assumed all commercial activities (including, among other things, distribution, sales, marketing, training and support) of the Omnipod across Europe.
Contracts with Customers. The Company's contracts with its direct customers generally consist of a physician order form, a patient information form and, if applicable, third-party insurance (payor) approval. Contracts with the Company's intermediaries are generally in the form of master service agreements against which firm purchase orders are issued. The Company applies judgment in determining the customer’s ability and intention to pay, which is based on a variety of factors including historical payment experience or, in the case of a new intermediary, published credit, credit references and other available financial information pertaining to the customer and in the case of a new direct customer, an investigation of insurance eligibility.
Performance Obligations. The performance obligations in contracts for the delivery of the Omnipod to new end users, either directly to end users or through intermediaries, consist of the PDM, the initial quantity of Pods ordered, training, and in Canada a service-type warranty. To the extent a contract includes multiple promised items, the Company must apply judgment to determine whether promised items are capable of being distinct and distinct in the context of the contract. If these criteria are not met the promised services are accounted for as a combined performance obligation.
Transaction Price. The price charged for the PDM and Pods is dependent on the Company's pricing as established with third party payors and intermediaries. The Company provides a right of return for sales of its Omnipod to new patients. The Company also provides for certain rebates and discounts for sales of its product through intermediaries. These rights of return, discounts and rebates represent variable consideration and reduce the transaction price at the outset of the contract based on the Company's estimates, which are primarily based on the expected value method using historical and other data related to actual product returns, discounts and rebates paid in each market in which the Omnipod is sold. Variable consideration is included in the transaction price if, in the Company’s judgment, it is probable that a significant future reversal of cumulative revenue under the contract will not occur. There were no constraints recorded to variable consideration and none of the Company's contracts as of January 1, 2018 or June 30, 2018 contained a significant financing component.
Allocation of Transaction Price. The Company allocates the transaction price to each performance obligation based on its relative stand-alone selling price, which is determined based on the price at which the Company typically sells the deliverable or, if the performance obligation is not typically sold separately, the stand-alone selling price is estimated based on cost plus a reasonable profit margin or the price that a third party would charge for a similar product or service.
Recognition of Revenue. The Company transfers the Omnipod at a point in time, which is determined based on when the customer gains control of the product. Generally, intermediaries obtain control upon shipment based on the contractual terms including right to payment and transfer of title and risk of loss. For sales directly to end users, control is generally transferred at the time of delivery based on customary business practices related to risk of ownership. Training is delivered at a point in time when the end user receives the training. Service warranty revenue is recognized over the service warranty period, which is typically five years.

Drug Delivery
The Company's drug delivery product line includes sales of a modified version of the Omnipod to pharmaceutical and biotechnology companies who uses the Company’s technology as a delivery method for their drugs. Under ASC 606, for the majority of this product line, revenue is recognized as the product is produced pursuant to the customer’s firm purchase commitments as the Company has an enforceable right to payment for performance completed to date and the inventory has no alternative use to the Company. Judgment is required in the assessment of progress toward completion of in-process inventory. The Company recognizes revenue over time using a blend of costs incurred to date relative to total estimated costs at completion and time incurred to date relative to total production time to measure progress toward the satisfaction its performance obligations. The Company believes that both incurred cost and elapsed time reflect the value generated, which best depicts the transfer of control to the customer. Contract costs include third party costs as well as an allocation of manufacturing overhead. Changes from quarter to quarter in quantity and stage of production of in-process inventory could have a significant quarterly impact on revenue.
Material Right
The adoption of ASC 606 required the Company to record a contract liability, which the Company refers to as deferred revenue, on January 1, 2018, associated with a volume-based pricing discount granted to the Company's European distributor at the outset of the distribution contract in 2010. The deferred revenue was recognized as revenue through the completion of the distributor contract during the first half of 2018 as the distributor purchased the product.
Costs to Obtain and Fulfill a Contract
The Company capitalizes commission costs that are related to new patient starts. These costs are deferred in other assets on the Company's consolidated balance sheet, net of the short term portion included in prepaid and other current assets. The judgments made

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in determining the amount of costs incurred include whether the commissions are incremental and would not have occurred absent the customer contract. Costs to obtain a contract are amortized as sales and marketing expense on a straight line basis over the expected period of benefit, which considers future product upgrades for which a commission would be paid. These capitalized costs are periodically reviewed for impairment. As of June 30, 2018, capitalized contract acquisition costs were $22.1 million, including a current balance of $6.6 million and a non-current balance of $15.5 million. The Company recognized $3.3 million of amortization of capitalized commission costs during the six months ended June 30, 2018. There were no impairments to capitalized costs to obtain a contract recorded during the period.
Financial Statement Impact of Adopting ASC 606
The cumulative effect of applying the new guidance to all contracts with customers that were not completed as of January 1, 2018 was recorded as an adjustment to accumulated deficit as of the adoption date. The following table shows the adjustments made to accounts on the condensed consolidated balance sheet as of January 1, 2018 as a result of adopting the new guidance. The table also compares the reported condensed consolidated balance sheet accounts as of June 30, 2018 that were impacted by the new guidance to pro forma balance sheet amounts had the previous guidance been in effect.

 
As Reported (1)
 
Adjustments (2)
 
As Adjusted
 
As Reported (3)
 
Adjustments
 
Pro forma (4)
(in thousands)
12/31/2017
 
1/1/2018
 
1/1/2018
 
6/30/2018
 
6/30/2018
 
6/30/2018
Assets
 
 
 
 
 
 
 
 
 
 
 
Unbilled receivable (a)
$

 
$
5,119

 
$
5,119

 
$
13,958

 
$
(13,958
)
 
$

Inventories
33,793

 
(753
)
 
33,040

 
40,808

 
2,103

 
42,911

Prepaid expenses and other current assets (b)
9,949

 
5,568

 
15,517

 
17,559

 
(6,554
)
 
11,005

Total current assets
537,171

 
9,934

 
547,105

 
421,793

 
(18,409
)
 
403,384

Other assets (b)
1,969

 
13,326

 
15,295

 
17,961

 
(15,491
)
 
2,470

Total assets
816,744

 
23,260

 
840,004

 
838,856

 
(33,900
)
 
804,956

Liabilities and Stockholder's Equity
 
 
 
 
 
 
 
 
 
 
Deferred revenue (c)
2,356

 
2,625

 
4,981

 
2,338

 
(854
)
 
1,484

Total current liabilities
86,025

 
2,625

 
88,650

 
76,109

 
(854
)
 
75,255

Other long-term liabilities
6,030

 
271

 
6,301

 
6,480

 
(270
)
 
6,210

Total liabilities
658,228

 
2,896

 
661,124

 
659,708

 
(1,124
)
 
658,584

Accumulated deficit
(707,255
)
 
20,349

 
(686,906
)
 
(695,166
)
 
(32,786
)
 
(727,952
)
Total stockholders' equity
158,516

 
20,364

 
178,880

 
179,148

 
(32,776
)
 
146,372

Total liabilities and stockholders' equity
816,744

 
23,260

 
840,004

 
838,856

 
(33,900
)
 
804,956


(1) Financial statement amounts as reported in the Company's consolidated balance sheet as of December 31, 2017. Financial statement amounts that are not shown on the above table were not impacted by the adoption of ASC 606.
(2) Adjustments made on January 1, 2018 to adopt ASC 606.
(3) Financial statement amounts as reported in the interim condensed consolidated balance sheet as of June 30, 2018. Financial statement amounts that are not shown on the above table were not impacted by the adoption of ASC 606.
(4) Pro forma balance sheet amounts that would have been reported as of June 30, 2018 had the Company applied the previous guidance under ASC 605.

(a) Unbilled receivable that reflects revenue for a portion of the Company's drug delivery product line as the product is produced. The unbilled receivable is reclassified to accounts receivable as the product is completed and shipped to the customer.
(b) Other current and non-current assets include contract acquisition costs related to the sale of the Omnipod. These costs are amortized over the estimated period of benefit.
(c) The Company recorded deferred revenue for a material right associated with a volume-based pricing discount granted to the Company's European distributor at the outset of the distribution contract in 2010. The deferred revenue related to this material right was recognized as revenue through the completion of the distributor contract during the first half of 2018.
The following summarizes the significant changes on the Company’s consolidated statement of operations for the three and six months ended June 30, 2018 as a result of the adoption of ASC 606 on January 1, 2018 compared to if the Company had continued to recognize revenue under ASC 605:

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Three months ended June 30, 2018
 
Six months ended June 30, 2018
(in thousands, except per share amounts)
 
As reported
 
Adjustments
 
Pro forma as if the previous accounting guidance was in effect
 
As reported
 
Adjustments
 
Pro forma as if the previous accounting guidance was in effect
U.S. Omnipod
 
$
78,047

 
$
77

 
$
78,124

 
$
148,319

 
$
126

 
$
148,445

International Omnipod (a)
 
28,509

 
(621
)
 
27,888

 
66,913

 
(1,898
)
 
65,015

Drug Delivery (b)
 
17,706

 
(8,512
)
 
9,194

 
32,608

 
(8,839
)
 
23,769

Revenue
 
124,262

 
(9,056
)
 
115,206

 
247,840

 
(10,611
)
 
237,229

Cost of revenue
 
42,190

 
(1,283
)
 
40,907

 
89,953

 
(1,351
)
 
88,602

Gross profit
 
82,072

 
(7,773
)
 
74,299

 
157,887

 
(9,260
)
 
148,627

Sales and marketing (c)
 
35,605

 
736

 
36,341

 
67,738

 
3,173

 
70,911

Total operating expenses
 
77,747

 
736

 
78,483

 
153,562

 
3,173

 
156,735

Operating income (loss)
 
4,325

 
(8,509
)
 
(4,184
)
 
4,325

 
(12,433
)
 
(8,108
)
Loss before income taxes
 
(1,279
)
 
(8,509
)
 
(9,788
)
 
(7,515
)
 
(12,433
)
 
(19,948
)
Net loss
 
$
(1,691
)
 
$
(8,509
)
 
$
(10,200
)
 
$
(8,260
)
 
$
(12,433
)
 
$
(20,693
)
Net loss per basic and diluted share
 
$
(0.03
)
 
$
(0.14
)
 
$
(0.17
)
 
$
(0.14
)
 
$
(0.21
)
 
$
(0.35
)
(a) International Omnipod revenue under ASC 606 includes the amortization of a material right associated with a volume-based pricing discount granted to the Company's European distributor at the outset of the distribution contract in 2010. The deferred revenue was recognized as revenue through the completion of the distributor contract during the first half of 2018.
(b) ASC 606 accelerated the recognition of revenue and fulfillment costs related to certain drug delivery contracts for which recognition was previously recorded when the product was shipped to the customer and is recorded as the product is produced under ASC 606.
(c) ASC 606 resulted in the amortization of capitalized commission costs that were recorded as part of the cumulative effect adjustment upon adoption and during the six months ended June 30, 2018. Amortization of these capitalized costs to selling and marketing expenses, net of commission costs that were capitalized in the three and six month periods, reduced sales and marketing expenses in each period.
 
 
Six Months Ended June 30, 2018
Statement of Cash Flows (in thousands)
 
As Reported
 
Adjustments
 
Pro Forma
Net loss
 
$
(8,260
)
 
$
(12,433
)
 
$
(20,693
)
Adjustments to reconcile net loss to net cash used in operating activities
 
 
 
 
 
 
Non-cash items
 
38,131

 

 
38,131

Changes in operating assets and liabilities:
 
 
 
 
 

Accounts receivable and unbilled receivable
 
(7,217
)
 
8,839

 
1,622

Inventories
 
(7,959
)
 
(1,351
)
 
(9,310
)
Prepaid expenses and other assets
 
(4,823
)
 
3,174

 
(1,649
)
Accounts payable, accrued expenses and other current liabilities
 
(17,873
)
 

 
(17,873
)
Deferred revenue
 
(2,626
)
 
1,771

 
(855
)
Other long-term liabilities
 
232

 

 
232

Net cash used in operating activities
 
$
(10,395
)
 
$

 
$
(10,395
)
The adoption of ASC 606 had no net impact on the Company’s cash used in operating, investing or financing activities.
Revenue recognized during the three and six months ended June 30, 2018 from amounts included in deferred revenue at the beginning of the period was approximately $1.1 million and  $2.4 million, respectively. No revenue was recognized during the three and six months ended June 30, 2018 from performance obligations satisfied or partially satisfied in previous periods. During the six months ended June 30, 2018, a $5.1 million unbilled receivable became billable. There were no contract modifications entered into during the three and six months ended June 30, 2018 impacting the Company’s unbilled receivable or deferred revenue.


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Note 4. Fair Value Measurements
The following table provides a summary of assets that are measured at fair value as of June 30, 2018 and December 31, 2017, aggregated by the level in the fair value hierarchy within which those measurements fall:
(in thousands)
Fair Value Measurements
June 30, 2018
Total
 
Level 1
 
Level 2
 
Level 3
Recurring fair value measurements:
 
 
 
 
 
 
 
Money market mutual funds
$
85,905

 
$
85,905

 
$

 
$

U.S. government and agency bonds
9,989

 
9,989

 

 

Total cash equivalents
$
95,894

 
$
95,894

 
$

 
$

U.S. government and agency bonds
$
120,653

 
$
84,591

 
$
36,062

 
$

Corporate bonds
40,940

 

 
40,940

 

Certificates of deposit
1,953

 

 
1,953

 

Total short-term investments
$
163,546

 
$
84,591

 
$
78,955

 
$

U.S. government and agency bonds
$
100,817

 
$
68,950

 
$
31,867

 
$

Corporate bonds
47,510

 

 
47,510

 

Certificates of deposit
7,733

 

 
7,733

 

Total long-term investments
$
156,060

 
$
68,950

 
$
87,110

 
$

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
Recurring fair value measurements:
 
 
 
 
 
 
 
Money market mutual funds
$
236,936

 
$
236,936

 
$

 
$

U.S. government and agency bonds
5,000

 
5,000

 

 

Total cash equivalents
$
241,936

 
$
241,936

 
$

 
$

U.S. government and agency bonds
$
112,076

 
$
90,703

 
$
21,373

 
$

Corporate bonds
47,681

 

 
47,681

 

Certificates of deposit
7,722

 

 
7,722

 

Total short-term investments
$
167,479

 
$
90,703

 
$
76,776

 
$

U.S. government and agency bonds
$
92,464

 
$
49,651

 
$
42,813

 
$

Corporate bonds
27,812

 

 
27,812

 

Certificates of deposit
5,273

 

 
5,273

 

Total long-term investments
$
125,549

 
$
49,651

 
$
75,898

 
$



Convertible Debt
The estimated fair value of the Company's convertible debt is based on the Level 2 quoted market prices for the same or similar issues and includes the impact of the conversion features.

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The carrying amounts, net of unamortized discounts and issuance costs, and the estimated fair values of the Company's convertible debt as of June 30, 2018 and December 31, 2017 are as follows:
 
June 30, 2018
 
December 31, 2017
(in thousands)
Carrying
Value
 
Estimated Fair
Value
 
Carrying
Value
 
Estimated Fair
Value
2% Convertible Senior Notes
$

 
$

 
$
3,421

 
$
5,467

1.375% Convertible Senior Notes
283,436

 
455,831

 
276,172

 
407,652

1.25% Convertible Senior Notes
293,683

 
522,116

 
286,580

 
450,881

Total
$
577,119

 
$
977,947

 
$
566,173

 
$
864,000


Note 5. Investments
The Company's short-term and long-term investments in debt securities have maturity dates that range from 13 days to 23.5 months as of June 30, 2018. Amortized costs, gross unrealized holding gains and losses, and fair values at June 30, 2018 and December 31, 2017 are as follows:
(in thousands)
Amortized cost
 
Gross Unrealized Gains
 
Gross Unrealized Losses
 
Fair Value
June 30, 2018
 
 
 
 
 
 
 
U.S. government and agency bonds
$
120,965

 
$

 
$
(312
)
 
$
120,653

Corporate bonds
41,054

 

 
(114
)
 
40,940

Certificates of deposit
1,953

 

 

 
1,953

Total short-term investments
$
163,972

 
$

 
$
(426
)
 
$
163,546

 
 
 
 
 
 
 
 
U.S. government and agency bonds
$
101,485

 
$
3

 
$
(672
)
 
$
100,816

Corporate bonds
47,789

 

 
(278
)
 
47,511

Certificates of deposit
7,733

 

 

 
7,733

Total long-term investments
$
157,007

 
$
3

 
$
(950
)
 
$
156,060

 
 
 
 
 
 
 
 
December 31, 2017
 
 
 
 
 
 
 
U.S. government and agency bonds
$
112,311

 
$

 
$
(235
)
 
$
112,076

Corporate bonds
47,713

 
3

 
(35
)
 
47,681

Certificates of deposit
7,722

 

 

 
7,722

Total short-term investments
$
167,746

 
$
3

 
$
(270
)
 
$
167,479

 
 
 
 
 
 
 
 
U.S. government and agency bonds
$
92,677

 
$

 
$
(213
)
 
$
92,464

Corporate bonds
27,871

 

 
(59
)
 
27,812

Certificates of deposit
5,273

 

 

 
5,273

Total long-term investments
$
125,821

 
$

 
$
(272
)
 
$
125,549

 
 
 
 
 
 
 
 

The Company’s investment portfolio included approximately 150 available-for-sale debt securities that had insignificant unrealized loss positions as of June 30, 2018. The Company does not intend to sell these investments prior to maturity and has concluded that it will not be required to sell these securities prior to the recovery of amortized costs at maturity. There were no charges recorded in the period for other-than-temporary declines in the fair value of available-for-sale debt securities.
The Company had insignificant realized gains or losses for the six months ended June 30, 2018 and in the year ended December 31, 2017.


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Note 6. Convertible Debt, Net
The Company had outstanding convertible debt and related deferred financing costs on its condensed consolidated balance sheet as follows:
 
As of
(in thousands)
June 30, 2018
 
December 31, 2017
Principal amount of 2.0% Convertible Senior Notes
$

 
$
3,664

Principal amount of 1.25% Convertible Senior Notes
345,000

 
345,000

Principal amount of 1.375% Convertible Senior Notes
402,500

 
402,500

Unamortized debt discount
(157,152
)
 
(170,448
)
Deferred financing costs
(13,229
)
 
(14,543
)
Total convertible debt, net
$
577,119

 
$
566,173

Interest expense related to the convertible notes was as follows: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Contractual coupon interest
$
2,462

 
$
1,413

 
$
4,942

 
$
2,827

Accretion of debt discount
6,616

 
3,572

 
13,138

 
7,077

Amortization of debt issuance costs
648

 
500

 
1,289

 
990

Total interest expense related to convertible debt
$
9,726

 
$
5,485

 
$
19,369

 
$
10,894

Interest expense related to convertible debt for the three and six months ended June 30, 2018 is as follows:  
 
Three Months Ended June 30, 2018
 
Six Months Ended June 30, 2018
(in thousands)
1.375%
 
1.25%
 
2.0%
 
Total
 
1.375%
 
1.25%
 
2.0%
 
Total
Contractual coupon interest
$
1,383

 
$
1,078

 
$
1

 
$
2,462

 
$
2,767

 
$
2,156

 
$
19

 
$
4,942

Amortization of debt discount and issuance costs
3,654

 
3,589

 
21

 
7,264

 
7,265

 
7,102

 
60

 
14,427

Total interest expense
$
5,037

 
$
4,667

 
$
22

 
$
9,726

 
$
10,032

 
$
9,258

 
$
79

 
$
19,369

Interest expense related to convertible debt for the three and six months ended June 30, 2017 is as follows:  
 
Three Months Ended June 30, 2017
 
Six Months Ended June 30, 2017
(in thousands)
1.25%
 
2.0%
 
Total
 
1.25%
 
2.0%
 
Total
Contractual coupon interest
$
1,078

 
$
335

 
$
1,413

 
$
2,157

 
$
670

 
$
2,827

Amortization of debt discount and issuance costs
3,367

 
705

 
4,072

 
6,670

 
1,397

 
8,067

Total interest expense
$
4,445

 
$
1,040

 
$
5,485

 
$
8,827

 
$
2,067

 
$
10,894


1.375% Convertible Senior Notes
In November 2017, the Company issued and sold $402.5 million in aggregate principal amount of 1.375% Convertible Senior Notes, due November 15, 2024 (the "1.375% Notes"). The interest rate on the notes is 1.375% per annum, payable semi-annually in arrears in cash on May 15 and November 15 of each year. Interest began accruing on November 10, 2017 and the first interest payment was made on May 15, 2018. The 1.375% Notes are convertible into the Company’s common stock at an initial conversion rate of 10.7315 shares of common stock per $1,000 principal amount of the 1.375% Notes, which is equivalent to a conversion price of approximately $93.18 per share, subject to adjustment under certain circumstances. The 1.375% Notes will be convertible prior to the close of business on the business day immediately preceding August 15, 2024 only under certain circumstances and during certain periods, and will be convertible on or after August 15, 2024 until the close of business on the second scheduled trading day immediately preceding November 15, 2024, regardless of those circumstances.
The Company recorded a debt discount of $120.7 million related to the 1.375% Notes resulting from the allocation of a portion of the

17

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proceeds to the fair value of the conversion feature reflecting a nonconvertible debt borrowing rate of 6.8% per annum. The debt discount was recorded as additional paid-in capital and is being amortized as non-cash interest expense over the seven year term of the 1.375% Notes. The Company also incurred debt issuance costs and other expenses related to the 1.375% Notes of approximately $10.9 million, of which $3.3 million was reclassified as a reduction to the value of the conversion feature allocated to equity. The remaining $7.6 million of debt issuance costs is presented as a reduction of debt in the consolidated balance sheet and is being amortized using the effective interest method as non-cash interest expense over the seven year term of the 1.375% Notes. As of June 30, 2018, the Company included $283.4 million on its balance sheet in long-term debt related to the 1.375% Notes.
1.25% Convertible Senior Notes
In September 2016, the Company issued and sold $345.0 million in principal amount of 1.25% Convertible Senior Notes, due September 15, 2021 (the "1.25% Notes"). The interest rate on the notes is 1.25% per annum, payable semi-annually in arrears in cash on March 15 and September 15 of each year. The 1.25% Notes are convertible into the Company’s common stock at an initial conversion rate of 17.1332 shares of common stock per $1,000 principal amount of the 1.25% Notes, which is equivalent to a conversion price of approximately $58.37 per share, subject to adjustment under certain circumstances. The 1.25% Notes will be convertible prior to the close of business on the business day immediately preceding June 15, 2021 only under certain circumstances and during certain periods, and will be convertible on or after June 15, 2021 until the close of business on the second scheduled trading day immediately preceding September 15, 2021, regardless of those circumstances.
The Company recorded a debt discount of $66.7 million related to the 1.25% Notes resulting from allocating a portion of the proceeds to the fair value of the conversion feature reflecting a nonconvertible debt borrowing rate of 5.8% per annum. The debt discount is being amortized as non-cash interest expense over the five year term of the 1.25% Notes. The Company incurred debt issuance costs and other expenses related to this offering of approximately $11.3 million, of which $2.2 million was reclassified as a reduction to the value of the amount allocated to equity. The remainder is presented as a reduction of debt in the consolidated balance sheet and is being amortized using the effective interest method as non-cash interest expense over the five year term of the 1.25% Notes. As of June 30, 2018, the Company has $293.7 million, net of discounts and issuance costs, on its balance sheet in long-term debt related to the 1.25% Notes.
2% Convertible Senior Notes
In June 2014, the Company issued and sold $201.3 million in principal amount of 2% Convertible Senior Notes due June 15, 2019 (the "2% Notes"). The 2% Notes were convertible into the Company’s common stock at an initial conversion rate of 21.5019 shares of common stock per $1,000 principal amount of the 2% Notes, which is equivalent to a conversion price of approximately $46.51 per share. In separately negotiated transactions, the Company repurchased $134.2 million in principal of the notes in September 2016 and $63.4 million in principal of the notes in November 2017. The Company elected to call the remaining notes in March 2018 and settled the outstanding principal and conversion feature of the notes for $6.7 million in cash in the second quarter of 2018. The Company allocated approximately $3.2 million of the settlement to the fair value of the equity component and $3.5 million to the debt component, which was consistent with the carrying value of the notes as of the settlement date, resulting in no gain or loss on extinguishment.


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Note 7. Net Loss Per Share
Basic net loss per share is computed by dividing net loss by the weighted average number of common shares outstanding for the period, excluding unvested restricted common shares. Diluted net loss per share is computed using the weighted average number of common shares outstanding and, when dilutive, potential common share equivalents from options, restricted stock units and warrants (using the treasury-stock method), and potential common shares from convertible securities (using the if-converted method). Because the Company reported a net loss for the three and six months ended June 30, 2018 and 2017, all potential dilutive common shares have been excluded from the computation of the diluted net loss per share for all periods presented, as the effect would have been anti-dilutive.
Potential dilutive common share equivalents consist of the following:
 
Three and Six Months Ended June 30,
 
2018
 
2017
1.375% Convertible Senior Notes
4,319,429

 

2.00% Convertible Senior Notes

 
1,442,433

1.25% Convertible Senior Notes
5,910,954

 
5,910,954

Unvested restricted stock units
914,710

 
978,683

Outstanding stock options
3,199,238

 
3,582,149

Total dilutive common share equivalents
14,344,331

 
11,914,219


Note 8. Accounts Receivable, Net
Accounts receivable consist of amounts due from third-party payors, patients and third-party intermediaries. The Company records an allowance for doubtful accounts at the time potential collection risk is identified. The Company estimates its allowance based on historical experience, assessment of specific risk, and discussions with individual customers. The Company believes the reserve is adequate to mitigate current collection risk.
Customers that represented greater than 10% of gross accounts receivable as of June 30, 2018 and December 31, 2017 were as follows:
 
As of
 
June 30, 2018
 
December 31, 2017
Amgen, Inc.
*
 
10
%
Ypsomed
*
 
31
%
* Represents less than 10% of gross accounts receivable as of June 30, 2018.

The components of accounts receivable are as follows:
 
As of
(in thousands)
June 30, 2018
 
December 31, 2017
Trade receivables
$
52,895

 
$
55,914

Allowance for doubtful accounts
(3,219
)
 
(2,541
)
    Total accounts receivable, net
$
49,676

 
$
53,373


Note 9. Inventories
Inventories are held at the lower of cost or market, determined under the first-in, first-out method, and include the costs of material, labor and overhead. Inventory has been recorded at cost, or net realizable value as appropriate, as of June 30, 2018 and December 31, 2017. The Company reviews inventories for net realizable value based on quantities on hand and expectations of future use. Work in process is calculated based upon a buildup in the stage of completion using estimated labor inputs for each stage in production.

19



The components of inventories are as follows:
 
As of
(in thousands)
June 30, 2018
 
December 31, 2017
Raw materials
$
5,243

 
$
2,146

Work-in-process
8,128

 
23,918

Finished goods, net
27,437

 
7,729

    Total inventories
$
40,808

 
$
33,793


Note 10. Prepaid Expenses and Other Assets
The components of prepaid expenses and other current assets are as follows:
 
 
As of
(in thousands)
 
June 30, 2018
 
December 31, 2017
Prepaid expenses
 
$
11,005

 
$
9,949

Capitalized contract acquisition costs, current portion
 
6,554

 

Total prepaid expenses and current other assets
 
$
17,559

 
$
9,949


The components of other assets are as follows:
 
 
As of
(in thousands)
 
June 30, 2018
 
December 31, 2017
Other assets
 
$
2,486

 
$
1,969

Capitalized contract acquisition costs, net of current portion
 
15,475

 

Total other assets
 
$
17,961

 
$
1,969

Upon the adoption of ASC 606 on January 1, 2018, the Company capitalizes commission costs that are related to new patient starts. These costs are deferred in other assets on the Company's consolidated balance sheet, net of the current portion included in prepaid and other current assets. See Note 3 "Revenue from Contracts with Customers" for a further discussion of the accounting for costs to obtain and fulfill a contract and the impact on the consolidated balance sheet upon adoption of this new guidance.

Note 11. Other Intangible Assets, Net
The Company’s finite-lived intangible assets are stated at cost less accumulated amortization. The Company assesses its intangible and other long-lived assets for impairment whenever events or changes in circumstances suggest that the carrying value of an asset may not be recoverable. The Company recognizes an impairment loss for intangible and other finite-lived assets if the carrying amount of a long-lived asset is not recoverable based on its undiscounted future cash flows. Any such impairment loss is measured as the difference between the carrying amount and the fair value of the asset.
The components of other intangible assets are as follows:
 
As of
 
June 30, 2018
 
December 31, 2017
(in thousands)
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
 
Gross Carrying Amount
 
Accumulated Amortization
 
Net Book Value
Customer and contractual relationships
$
2,040

 
$
(1,764
)
 
$
276

 
$
2,135

 
$
(1,764
)
 
$
371

Internal-use software
9,751

 
(4,280
)
 
5,471

 
7,545

 
(3,565
)
 
3,980

Total intangible assets
$
11,791

 
$
(6,044
)
 
$
5,747

 
$
9,680

 
$
(5,329
)
 
$
4,351


Amortization expense for intangible assets was approximately $0.4 million and $0.3 million for the three months ended June 30, 2018 and 2017, respectively. Amortization expense for intangible assets was approximately $0.8 million and $0.6 million for the six months

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ended June 30, 2018 and 2017, respectively. Amortization expense is recorded in general and administrative expenses in the consolidated statements of operations.
Amortization expense expected for the next five years and thereafter is as follows:
(in thousands)
 
 
 
 
 
Years Ending December 31,
Customer and Contractual Relationships
 
Internal-Use Software
 
Total
2018 (remaining)
$
79

 
$
863

 
$
942

2019
132

 
1,519

 
1,651

2020
65

 
1,257

 
1,322

2021

 
979

 
979

2022

 
683

 
683

Thereafter

 
170

 
170

     Total
$
276

 
$
5,471

 
$
5,747


As of June 30, 2018, the weighted average amortization period of the Company’s intangible assets is approximately 3.8 years.

Note 12. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows:
 
As of
(in thousands)
June 30, 2018
 
December 31, 2017
Employee compensation and related costs
$
21,470

 
$
34,942

Professional and consulting services
8,512

 
9,273

Supplier charges
3,651

 
3,542

Other
14,947

 
11,499

Total accrued expenses and other current liabilities
$
48,580

 
$
59,256

Product Warranty Costs
The Company provides a four-year warranty on its PDMs sold in the United States and a five-year warranty on its PDMs sold in Canada and may replace any Omnipod that does not function in accordance with product specifications. The Company estimates its warranty at the time the product is shipped based on historical experience and the estimated cost to service the claims. Warranty expense is recorded in cost of goods sold on the statement of operations. Cost to service the claims reflects the current product cost. As these estimates are based on historical experience, and the Company continues to introduce new products and versions, the Company also considers the anticipated performance of the product over its warranty period in estimating warranty reserves.
A reconciliation of the changes in the Company’s product warranty liability is as follows: 
 
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
 
2018
 
2017
Product warranty liability at the beginning of the period
$
5,386

 
$
4,562

 
$
5,337

 
$
4,388

Warranty expense
1,529

 
1,135

 
3,501

 
1,641

Warranty claims settled
(1,412
)
 
(880
)
 
(3,335
)
 
(1,212
)
Product warranty liability at the end of the period
$
5,503

 
$
4,817

 
$
5,503

 
$
4,817


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As of
(in thousands)
June 30, 2018
 
December 31, 2017
Composition of balance:
 
 
 
Short-term
$
2,335

 
$
1,653

Long-term
3,168

 
3,684

Total warranty liability:
$
5,503

 
$
5,337


Note 13. Commitments and Contingencies
The Company records a liability in the consolidated financial statements for loss contingencies when a loss is known or considered probable and the amount can be reasonably estimated. If the reasonable estimate of a known or probable loss is a range, and no amount within the range is a better estimate than any other, the minimum amount of the range is accrued. If a loss is reasonably possible but not known or probable, and can be reasonably estimated, the estimated loss or range of loss is disclosed.
Operating Leases
The Company leases facilities in Massachusetts, California, Tennessee, the United Kingdom, Canada and China. The Company’s leases are accounted for as operating leases. The leases generally provide for a base rent plus real estate taxes and certain operating expenses related to the leases.
The Company leases approximately 100,000 square feet of laboratory and office space for its corporate headquarters in Billerica, Massachusetts. The lease expires in November 2022 and contains escalating payments over the life of the lease. Additionally, the Company leases approximately 29,000 square feet of warehousing space in Billerica, Massachusetts under a lease expiring in September 2019. The Company leases other facilities in Canada, China, the United Kingdom, France, Germany, California, Tennessee and Utah containing a total of approximately 20,000 square feet under leases expiring from August 2018 to June 2021.
Certain of the Company’s operating lease agreements contain scheduled rent increases. Rent expense is recorded using the straight-line method and deferred rent is included in other liabilities in the accompanying consolidated balance sheets. Rental expense under operating leases was $0.9 million and $0.7 million for the three months ended June 30, 2018 and 2017, respectively. Rental expense under operating leases was $1.7 million and $1.4 million for the six months ended June 30, 2018 and 2017, respectively.
The aggregate future minimum lease payments related to these leases as of June 30, 2018 are as follows:
(in thousands)

 

Years Ending December 31,
Minimum Lease
Payments
2018 (remaining)
$
1,691

2019
3,035

2020
2,651

2021
2,402

2022
2,131

Thereafter

Total
$
11,910

Legal Proceedings
Between May 5, 2015 and June 16, 2015, three class action lawsuits were filed by shareholders in the U.S. District Court, for the District of Massachusetts, against the Company and certain individual current and former executives of the Company. Two suits subsequently were voluntarily dismissed. Arkansas Teacher Retirement System v. Insulet, et al., 1:15-cv-12345, (“ATRS”) alleged that the Company (and certain executives) committed violations of Sections 10(b) and 20(a) and Rule 10b-5 of the Securities Exchange Act of 1934 by making allegedly false and misleading statements about the Company’s business, operations, and prospects. On December 14, 2017, following a series of negotiations, the Company, the individual defendants and their insurers reached an agreement in principle with the plaintiffs in the ATRS matter, individually and on behalf of the respective classes they purport to represent, to settle and release all claims with respect to the matter. On February 8, 2018, the parties executed a binding stipulation of settlement. On April 6, 2018, the court preliminarily approved the settlement, and scheduled a final settlement approval hearing for August 2, 2018. Under the terms of the settlement stipulation, a payment will be made to the plaintiffs and the classes they purport to represent. The Company has accrued fees and expenses in connection with this matter up to and including the amount of the expected residual settlement liability that would not be covered by insurance, and such amount is not material to the Company's consolidated financial statements.

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Table of Contents

In addition, on April 26, 2017, a derivative action (Walker v. DeSisto, et al., 1:17-cv-10738) (“Walker”) was filed, and on October 13, 2017, a second derivative action (Carnazza v. DeSisto, et al., 1:17-cv-11977) (“Carnazza”) was filed, both on behalf of the Company, each by a shareholder in the U.S. District Court for the District of Massachusetts against the Company (as a nominal defendant) and certain individual current and former officers and directors of the Company. Both actions were filed as related actions to the securities class action referenced above, and the allegations in the actions are substantially similar to those alleged in the securities class action. The actions seek, among other things, damages, disgorgement of certain types of compensation or profits, and attorneys’ fees and costs. On May 10, 2018, following a series of negotiations, the Company, the individual defendants, and their insurers reached an agreement in principle with the plaintiffs in both of the derivative actions to settle and release all claims with respect to the matters. On July 11, 2018, the parties executed a binding stipulation of settlement. On July 13, 2018, the plaintiffs filed a motion for preliminary approval of the settlement. Under the terms of the settlement stipulation, a payment of attorneys’ fees and reimbursement of expenses will be paid to plaintiffs’ counsel, subject to the Court’s approval.
The Company has accrued fees and expenses in connection with this matter up to and including the amount of any expected residual settlement that would not be covered by insurance, and such amount is not material to the Company's consolidated financial statements.
The Company is, from time to time, involved in the normal course of business in various legal proceedings, including intellectual property, contract, employment and product liability suits. Although the Company is unable to quantify the exact financial impact of any of these matters, the Company believes that none of these currently pending matters will have an outcome material to its financial condition or business.


Note 14. Stock-Based Compensation and Stockholder' Equity
The Company accounts for stock-based compensation under the provisions of ASC 718-10, Compensation — Stock Compensation (“ASC 718-10”), which requires all share-based payments to employees and directors, including grants of stock options and restricted stock units, to be recognized in the income statement based on their fair values. Share-based payments that contain performance conditions are recognized when such conditions are probable of being achieved.
The Company grants share-based awards to employees in the form of options to purchase the Company’s common stock, the ability to purchase stock at a discounted price under the employee stock purchase plan and restricted stock units. The Company uses the Black-Scholes option pricing model to determine the weighted-average fair value of options granted and determines the intrinsic value of restricted stock units based on the closing price of its common stock on the date of grant. The Company recognizes the compensation expense of share-based awards on a straight-line basis for awards with only service conditions and on an accelerated basis for awards with performance conditions. Compensation expense is recognized over the vesting period of the awards.
The following table reflects the Company's stock-based compensation expense related to share-based awards recognized in the three and six months ended June 30, 2018 and 2017:
 
Three Months Ended June 30,
 
Six Months Ended June 30,
 
Unamortized Expense
 
Weighted Average Remaining Expense Period (Years)
($ in thousands)
2018
 
2017
 
2018
 
2017
 
At June 30, 2018
Stock options
$
2,272

 
$
2,909

 
$
4,630

 
$
5,688

 
$
17,424

 
2.6
Restricted stock units
4,371

 
4,500

 
9,899

 
8,737

 
35,936

 
2.0
Employee stock purchase plan
294

 
122

 
588

 
230

 
494

 
0.4
Total
$
6,937

 
$
7,531

 
$
15,117

 
$
14,655

 
$
53,854

 
 

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Table of Contents

Equity Award Plans
In May 2007, in conjunction with the Company's initial public offering, the Company adopted its 2007 Stock Option and Incentive Plan (the "2007 Plan"). The 2007 Plan was amended and restated in November 2008, May 2012 and May 2015 to provide for the issuance of additional shares and to amend certain other provisions. Under the 2007 Plan, awards were granted to persons who were, at the time of grant, employees, officers, non-employee directors or key persons (including consultants and prospective employees) of the Company or the Company's subsidiaries. The 2007 Plan provided for the grant of stock options, restricted stock units, stock appreciation rights, deferred stock awards, restricted stock, unrestricted stock, cash-based awards, performance share awards or dividend equivalent rights. Options granted under the 2007 Plan generally vest over a period of four years and expire ten years from the date of grant. In May 2017, the Company adopted the 2017 Stock Option and Incentive Plan (the "2017 Plan"), which has replaced the 2007 Plan as the means by which the Company makes equity and cash awards. Effective May 18, 2017, the 2017 Plan became effective (the "2017 Plan Effective Date") and the Company ceased granting awards under the 2007 Plan. Outstanding awards under the 2007 Plan remain subject to the terms of the 2007 Plan. Under the 2017 Plan, awards may be granted to persons who are, at the time of grant, employees, officers, non-employee directors, consultants, or advisers of the Company or the Company's subsidiaries and affiliates. The 2017 Plan provides for the grant of stock options, restricted stock units, stock appreciation rights, deferred stock awards, restricted stock, unrestricted stock, cash-based awards, performance share awards or dividend equivalent rights. Stock options granted under the 2017 Plan generally vest over a period of four years and expire ten years from the date of grant. Shares of stock subject to awards granted under the 2007 Plan and the 2017 Plan that are forfeited, expire or otherwise terminate without delivery generally become available for future issuance under the 2017 Plan.

Stock Options
There were no shares of performance-based incentive stock options awarded in the six months ended June 30, 2018 and there were 34,500 shares of performance-based incentive stock options awarded in the six months ended June 30, 2017. The stock options were granted under the 2007 and 2017 Plans and vest over a four year period from the grant date with the potential of an accelerated vesting period pursuant to the achievement of certain performance conditions.
The determination of the fair value of share-based payment awards utilizing the Black-Scholes model is affected by the stock price and the following assumptions, including expected volatility, expected life of the awards, the risk-free interest rate, and the dividend yield.
Expected volatility measures the amount that a stock price has fluctuated or is expected to fluctuate during a period and is computed over expected terms based upon the historical volatility of the Company's stock.
The expected life of the awards is estimated based on the midpoint scenario, which combines historical exercise data with hypothetical exercise data for outstanding options, as the Company believes this data currently represents the best estimate of the expected life of a new employee option. The Company stratifies its employee population into two groups based upon organizational hierarchy.
The risk-free interest rate assumption is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.
The dividend yield assumption is based on Company history and expectation of paying no dividends. The Company has never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future, and, therefore, used an expected dividend yield of zero in the valuation.
Forfeitures are estimated at the time of grant and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates. Stock-based compensation expense recognized in the financial statements is based on awards that are ultimately expected to vest. If the Company’s actual forfeiture rate is materially different from its estimate, the stock-based compensation expense could be significantly different from what the Company has recorded in the current period.
The Company evaluates the assumptions used to value the awards on a quarterly basis and if factors change and different assumptions are utilized, stock-based compensation expense may differ significantly from what has been recorded in the past. If there are any modifications or cancellations of the underlying unvested securities, the Company may be required to accelerate, increase or cancel any remaining unearned stock-based compensation expense.
The following summarizes the activity under the Company’s stock option plans during the six months ended June 30, 2018:

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Table of Contents

 
Number of
Options (#)
 
Weighted Average
Exercise Price ($)
 
Aggregate
Intrinsic
Value ($ in thousands)
 
Weighted Average
Remaining Contractual Term (Years)
Outstanding at December 31, 2017
3,377,220

 
$
35.10

 
 
 
 
Granted
269,853

 
76.32

 
 
 
 
Exercised
(318,102
)
 
32.91

 
$
17,024

 
 
Canceled
(129,733
)
 
40.28

 
 
 
 
Outstanding at June 30, 2018
3,199,238

 
$
38.59

 
$
150,872

 
7.3
Vested, June 30, 2018
2,007,167

 
$
34.29

 
$
103,188

 
6.7
Vested or expected to vest, June 30, 2018 (1)
3,066,211

 

 
$
146,303

 
 
 
 
 
 
 
(1) 
Represents total outstanding stock options as of June 30, 2018, adjusted for estimated forfeitures.

The aggregate intrinsic value of stock options exercised was calculated based on the positive difference between the estimated fair value of the Company’s common stock on the date of exercise and the exercise price of the underlying options. The aggregate intrinsic value of options exercised in the six months ended June 30, 2018 and 2017 was $17.0 million and $5.4 million, respectively. The aggregate intrinsic value for outstanding awards as of June 30, 2018 was calculated based on the positive difference between the Company’s closing stock price of $85.70 on June 30, 2018 and the exercise price of the underlying options.

Employee stock-based compensation related to stock options in the six months ended June 30, 2018 and 2017 was $4.6 million and $5.7 million, respectively, and was based on awards ultimately expected to vest. At June 30, 2018, the Company had $17.4 million of total unrecognized compensation expense related to stock options that will be recognized over a weighted average period of 2.6 years.
Restricted Stock Units
In the six months ended June 30, 2018, the Company awarded 326,144 restricted stock units to certain employees and non-employee members of the Board of Directors, which included 111,239 restricted stock units subject to the achievement of performance conditions (performance-based restricted stock units). For performance-based restricted stock units for which the performance criteria has not yet been achieved, the Company recognized stock compensation expense of $1.0 million and $2.1 million in the three and six months ended June 30, 2018 as it expects a portion of the performance-based restricted stock units granted in 2017 and 2018 will be earned based on its evaluation of the performance criteria. An additional $0.3 million and $1.4 million of stock compensation expense was recognized in the three and six months ended June 30, 2018 for performance-based restricted stock units for which the performance criteria has been achieved. The restricted stock units were granted under the 2007 and 2017 Plans and generally vest annually over a one or three year period from the grant date, except for the performance-based restricted stock units, which follow different vesting patterns.
The restricted stock units granted during the six months ended June 30, 2018 have a weighted average fair value of $75.36 per share based on the closing price of the Company’s common stock on the date of grant and were valued at approximately $24.1 million on their grant date. The Company is recognizing the compensation expense over the vesting period. Approximately $3.2 million and $3.2 million in the three months ended June 30, 2018 and 2017, respectively, of stock-based compensation expense related to the vesting of non-performance based restricted stock units was recognized. Approximately $6.4 million and $6.2 million in the six months ended June 30, 2018 and 2017, respectively, of stock-based compensation expense related to the vesting of non-performance based restricted stock units was recognized. Under the terms of the awards, the Company will issue shares of common stock on each of the vesting dates.

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Table of Contents

The following table summarizes the status of the Company’s restricted stock units during the six months ended June 30, 2018:
 
Number of
Shares (#)
 
Weighted
Average
Fair Value ($)
Outstanding at December 31, 2017
994,364

 
$
38.08

Granted
326,144

 
75.36

Adjustment (1)
147,301

 
29.54

Vested
(487,001
)
 
33.39

Forfeited
(66,098
)
 
44.43

Outstanding at June 30, 2018
914,710

 
$
52.04

(1) Certain performance-based restricted stock units are subject to a three-year vesting period subject to meeting performance targets and continued employment. During the three months ended March 31, 2018, the Compensation Committee of the Board of Directors determined that the performance was achieved at 200% of target for certain performance-based awards issued in 2016, resulting in an adjustment to the shares that will ultimately vest for these awards.
Employee Stock Purchase Plan
The Employee Stock Purchase Plan (“ESPP”) authorizes the issuance of up to a total of 380,000 shares of common stock to participating employees. The Company typically makes two offerings each year to eligible employees to purchase stock under the ESPP. Offering periods begin on the first business day occurring on or after each December 1 and June 1 and end on the last business day occurring on or before the following May 31 and November 30, respectively.
Each employee who is a participant in the Company’s ESPP may purchase up to a maximum of 800 shares per offering period or $25,000 worth of common stock, valued at the start of the purchase period, per year by authorizing payroll deductions of up to 10% of his or her base salary. Unless the participating employee withdraws from the offering period, his or her accumulated payroll deductions will be used to purchase common stock. The purchase price for each share purchased is 85% of the lower of (i) the fair market value of the common stock on the first day of the offering period or (ii) the fair market value of the common stock on the last day of the offering period.
     
Note 15. Income Taxes
The Company accounts for income taxes in accordance with ASC 740-10, Income Taxes (“ASC 740-10”) under the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements. Deferred tax assets and liabilities are determined based on differences between the financial reporting and tax bases of assets and liabilities and are measured using the enacted tax rates that will be in effect in the years in which the differences are expected to reverse. The Company reviews its deferred tax assets for recoverability considering historical profitability, projected future taxable income, and the expected timing of the reversals of existing temporary differences and tax planning strategies. The effect of a change in enacted tax rates on deferred tax assets and liabilities is recognized in income in the period that includes the enactment date. As of June 30, 2018, the Company had no uncertain tax positions.
On December 22, 2017, the President of the United States signed into law the Tax Cuts and Jobs Act ("Tax Reform Act"). The legislation significantly changes U.S. tax law by, among other things, lowering corporate income tax rates, implementing a territorial tax system, expanding the tax base and imposing a tax on deemed repatriated earnings of foreign subsidiaries. The Tax Reform Act permanently reduces the U.S. corporate federal income tax rate from a maximum of 35% to a flat 21% rate, effective January 1, 2018. The Company recognized the impact of the Tax Reform Act in the consolidated financial statements as of December 31, 2017. Staff Accounting Bulletin No. 118 ("SAB 118") provides guidance on accounting for the impact of the Tax Reform Act. Specifically, SAB 118 provides for a measurement period, not to exceed one year, that begins on the date of enactment of December 22, 2017, and ends when the Company has obtained, prepared, and analyzed information needed to complete accounting requirements. In accordance with SAB 118, the Company recorded provisional amounts reflecting the impact of the Tax Reform Act in its consolidated financial statements and related disclosures as of December 31, 2017. As of December 31 2017, the Company recorded a reduction in net operating losses in 2017 of $0.8 million offset by an associated reduction in the valuation allowance of the $0.8 million related to the deemed repatriation. However, the final impact of the deemed repatriation tax computation is still open due to finalization of the earnings and profits of the Company's foreign subsidiaries, as well as the Company’s evaluation of certain elections and guidance. The Company expects to complete its evaluation upon the filing of its federal and state tax returns, generally in its third quarter of 2018.
The Tax Reform Act subjects the Company to current tax on global intangible low-taxed income, or ("GILTI") earned by certain of its foreign subsidiaries. The Company has elected to recognize the income tax related to GILTI as a period expense in the period the tax is incurred or expected to occur for the year ended December 31, 2018. The inclusion of GILTI had no impact on the Company's income tax expense or effective tax rate in the period due to the full valuation allowance applied to the U.S. entity.

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Table of Contents

The Company files federal, state and foreign tax returns. These returns are generally open to examination by the relevant tax authorities from three to four years from the date they are filed. The tax filings relating to the Company's federal and state tax returns are currently open to examination for tax years 2014 through 2016 and 2013 through 2016, respectively. In addition, the Company has generated tax losses since its inception in 2000. These years may be subject to examination if the losses are carried forward and utilized in future years.
At June 30, 2018 and December 31, 2017, the Company provided a full valuation allowance against its domestic net deferred tax asset because it is not more likely than not that the future tax benefit will be realized. In addition, the Company has a net deferred tax asset in foreign jurisdictions where no valuation allowance is recorded as it is more likely than not that the future tax benefit will be realized.
Income tax expense was $0.4 million and $0.1 million for the three months ended June 30, 2018 and 2017. Income tax expense was $0.7 million and $0.2 million for the six months ended June 30, 2018 and 2017, respectively. Income tax expense for both periods in the current year was primarily driven by income generated in foreign jurisdictions, mainly the United Kingdom and Canada. 



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Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
This quarterly report on Form 10-Q contains forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “targets,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, results of operations and financial condition.
The outcomes of the events described in these forward-looking statements are subject to risks, uncertainties and other factors described in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 22, 2018 in the section entitled “Risk Factors" as updated by Item 1A "Risk Factors" herein, and in our other filings from time to time with the Securities and Exchange Commission. Accordingly, you should not rely upon forward-looking statements as predictions of future events. We cannot assure you that the events and circumstances reflected in the forward-looking statements will be achieved or occur, and actual results could differ materially from those projected in the forward-looking statements. The forward-looking statements made in this quarterly report on Form 10-Q relate only to events as of the date of this report. We undertake no obligation to update any forward-looking statement to reflect events or circumstances after the date on which the statement is made or to reflect the occurrence of unanticipated events.

Executive Level Overview
We are primarily engaged in the development, manufacturing and sale of our proprietary Omnipod System, an innovative, discreet and easy-to-use continuous insulin delivery system for people with insulin-dependent diabetes. There are two primary types of insulin therapy practiced today: MDI therapy using syringes or insulin pens; and pump therapy using insulin pumps. Insulin pumps are used to perform continuous subcutaneous insulin infusion, or insulin pump therapy, and typically use a programmable device and an infusion set to administer insulin into the person’s body. Insulin pump therapy has been shown to provide people with insulin-dependent diabetes with numerous advantages relative to MDI therapy. We estimate that approximately one-third of the Type 1 diabetes population in the United States use insulin pump therapy, and that less than 10% of the Type 2 diabetes population in the United States who are insulin-dependent use insulin pump therapy. The Omnipod System features a small, lightweight, self-adhesive disposable tubeless Omnipod device which is worn on the body for approximately three days at a time and its wireless companion, the handheld PDM. The Omnipod System, which features two discreet, easy-to-use devices that communicate wirelessly and provide for virtually pain-free automated cannula insertion and blood glucose meter integration, eliminates the need for traditional MDI therapy or the use of traditional pump and tubing. We believe that the Omnipod System’s unique proprietary design and features allow people with insulin-dependent diabetes to manage their diabetes with unprecedented freedom, comfort, convenience, and ease.
We began commercial sale of the Omnipod System in the United States in 2005. We sell the Omnipod System in the United States through direct sales to customers or through our distribution partners. The Omnipod System is currently available in multiple countries in Europe, as well as Canada and Israel.
In addition to the diabetes market space, we have partnered with pharmaceutical and biotechnology companies that utilize a customized form of the Omnipod System to deliver a drug over a specified interval of time, at a certain administered volume. The majority of our drug delivery revenue currently consists of sales to Amgen for its Neulasta Onpro kit.
We are constructing a highly-automated manufacturing facility in Acton, Massachusetts, with planned production out of the facility beginning in early 2019. The facility will also serve as our global headquarters. We expect that the new facility will allow us to lower our manufacturing costs, increase supply redundancy, add capacity closer to our largest customer base and support growth. We expect capital expenditures for the construction of the Acton facility and related equipment purchases will be approximately $200 million when production begins in 2019 and will be funded by our cash flows from operations and proceeds from our senior convertible debt offerings.
On July 1, 2018 we assumed all commercial activities (including, among other things, distribution, sales, marketing, training and support) for our Omnipod System across Europe following the expiration of our prior distribution agreement with our former European distributor on June 30, 2018. As a result of this mid-year transition, we expect our revenue and gross margins to increase, as average customer pricing in Europe is higher than the pricing under the prior agreement with the former European distributor. Throughout 2018, we expect to incur increased operating expenses as we invest in our European operations. Once European operations are firmly established, excluding nonrecurring transition-related costs, we expect that our assumption of the direct distribution model in Europe will be accretive to our consolidated results of operations.
In January 2018, we announced that the Centers for Medicare & Medicaid Services ("CMS") has issued guidance clarifying that Medicare Part D Plan Sponsors are permitted to provide coverage for products such as the Omnipod System under the Medicare Part

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D (prescription drug) program. We have begun working with Medicare Part D carriers to ensure beneficiaries living with diabetes have access to the Omnipod System. Securing Medicare Part D coverage also provides us with a direct pathway to gain Medicaid coverage at the state level, as many state-run Medicaid programs follow CMS prescription drug guidance to determine coverage. This allows access for lower-income individuals and families on Medicaid for whom Omnipod currently is not a covered option. We estimate that obtaining Medicare and Medicaid coverage extends Omnipod System coverage access to approximately 450,000 additional individuals with Type 1 diabetes in the United States.
In June 2018, the U.S. Food and Drug Administration ("FDA") provided clearance for the commercial distribution of our DASH TM System, which is our next generation of the Omnipod System, featuring a secured Bluetooth Low Energy enabled Pod and PDM with a touch screen color user interface supported by smartphone connectivity. We commenced a U.S. limited commercial release of Omnipod DASH TM in Q3 2018 prior to a full market launch in early 2019.
Second Quarter 2018 Revenue Results:
Total revenue of $124.3 million
U.S. Omnipod revenue of $78.1 million
International Omnipod revenue of $28.5 million
Drug Delivery revenue of $17.7 million
Our long-term financial objective is to achieve and sustain profitable growth. We expect our efforts in 2018 and 2019 to focus primarily on constructing and commissioning our U.S. manufacturing facility, continuing to establish our European operations, launching new products, such as the DASH TM Omnipod System, continuing our product development efforts, and taking the necessary actions such as amending or creating payor or distributor contracts to allow us to service patients who receive benefits through the Medicare Part D and Medicaid programs through the pharmacy channel. Achieving these objectives is expected to require additional investments in certain personnel and initiatives, as well as enhancements to our supply chain operation capacity, efficiency and effectiveness. We believe that we may continue to incur net losses in the near term in order to achieve these objectives. However, we believe that the accomplishment of our near term objectives will have a positive impact on our financial condition in the future.

Components of Financial Operations
Revenue.  We derive the majority of our revenue from global sales of the Omnipod System. Our revenue also includes sales of devices based on the Omnipod System technology platform to global pharmaceutical and biotechnology companies for the subcutaneous delivery of drugs across therapeutic areas.
Cost of revenue. Cost of revenue consists primarily of raw material, labor, warranty, inventory reserve and overhead costs such as freight-in and depreciation and the cost of products we acquire from third party suppliers.
Research and development. Research and development expenses consist primarily of personnel costs and outside services within our product development, regulatory and clinical functions and product development projects. We generally expense research and development costs as incurred.
Sales and marketing. Sales and marketing expenses consist primarily of personnel costs within our sales, marketing, reimbursement support, customer care, sales commissions paid to our sales representatives, costs associated with promotional activities and participation in industry trade shows. Commissions costs that are direct and incremental to obtaining a new customer are capitalized and amortized to sales and marketing expense over the expected period of benefit.
General and administrative. General and administrative expenses consist primarily of salaries and other related costs for personnel serving the executive, finance, legal, information technology and human resource functions, as well as legal fees, accounting fees, insurance costs, bad debt expenses, shipping, handling and facilities-related costs.


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Results of Operations
This section discusses our consolidated results of operations for the second quarter and the six months ended June 30, 2018 compared to the same periods of 2017, and should be read in conjunction with the consolidated financial statements and accompanying condensed notes included in this Form 10-Q.
TABLE 1: RESULTS OF OPERATIONS
(Unaudited)
Three Months Ended June 30,
 
Six Months Ended June 30,
(in thousands)
2018
 
2017
 
Change $
 
Change %
 
2018
 
2017
 
Change $
 
Change %
Revenue:
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
U.S. Omnipod
$
78,047

 
$
65,361

 
$
12,686

 
19
 %
 
$
148,319

 
$
125,016

 
$
23,303

 
19
 %
International Omnipod
28,509

 
26,575

 
1,934

 
7