Table of Contents

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549

Form 10-Q
 _____________________________________________________
xQUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended SeptemberJune 30, 20172018
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 filerx 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 NovemberAugust 1, 2017,2018, the registrant had 58,187,75658,997,012 shares of common stock outstanding.

INSULET CORPORATION
QUARTERLY REPORT ON FORM 10-Q FOR THE PERIOD ENDED
September 30, 2017
Table Of ContentsTABLE OF CONTENTS
 
PART I. FINANCIAL INFORMATION
 
  
Item 1. Consolidated Financial Statements
3
Consolidated Balance Sheets as of SeptemberJune 30, 20172018 (Unaudited) and December 31, 20162017
3
Consolidated Statements of Operations (Unaudited) for the three and ninesix months ended SeptemberJune 30, 20172018 and 2016 (Unaudited)2017
4
Consolidated Statements of Comprehensive Loss (Unaudited) for the three and ninesix months ended SeptemberJune 30, 20172018 and 2016 (Unaudited)2017
5
Consolidated Statements of Cash Flows (Unaudited) for the ninesix months ended SeptemberJune 30, 20172018 and 2016 (Unaudited)2017
6
Condensed Notes to Consolidated Financial Statements (Unaudited)
7
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
2728
Item 3. Quantitative and Qualitative Disclosures About Market Risk
3433
Item 4. Controls and Procedures
34
  
PART II. OTHER INFORMATION
 
Item 1. Legal Proceedings
3534
Item 1A. Risk Factors
3534
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
3534
Item 3. Defaults Upon Senior Securities
3534
Item 4. Mine Safety Disclosures
3534
Item 5. Other Information
35
Item 6. Exhibits
36
Signatures
37

PART I - FINANCIAL INFORMATION
Item 1.Consolidated Financial Statements (Unaudited)
INSULET CORPORATION
CONSOLIDATED BALANCE SHEETS
(in thousands, except share and per share data)September 30,
2017		 December 31,
2016		June 30,
2018		 December 31,
2017
ASSETS(Unaudited)  (Unaudited)  
Current Assets      
Cash and cash equivalents$102,233
 $137,174
$136,246
 $272,577
Short-term investments173,523
 161,396
163,546
 167,479
Accounts receivable, net47,173
 28,803
49,676
 53,373
Inventories, net35,054
 35,514
Prepaid expenses and other current assets8,037
 7,073
Unbilled receivable (Note 3)13,958
 —
Inventories40,808
 33,793
Prepaid expenses and other current assets (Note 10)17,559
 9,949
Total current assets366,020
 369,960
421,793
 537,171
Long-term investments156,060
 125,549
Property and equipment, net88,491
 44,753
197,564
 107,864
Other intangible assets, net4,369
 2,041
5,747
 4,351
Goodwill39,854
 39,677
39,731
 39,840
Other assets1,614
 216
Other assets (Note 10)17,961
 1,969
Total assets$500,348
 $456,647
$838,856
 $816,744
LIABILITIES AND STOCKHOLDERS’ EQUITY      
Current Liabilities      
Accounts payable$28,648
 $13,160
$25,191
 $24,413
Accrued expenses and other current liabilities44,897
 41,228
48,580
 59,256
Deferred revenue1,395
 1,309
2,338
 2,356
Total current liabilities74,940
 55,697
76,109
 86,025
Long-term debt, net of discount344,953
 332,768
Convertible debt, net (Note 6)577,119
 566,173
Other long-term liabilities6,201
 5,032
6,480
 6,030
Total liabilities426,094
 393,497
659,708
 658,228
Commitments and contingencies (Note 12)
 
Commitments and contingencies (Note 13)
 
Stockholders’ Equity      
Preferred stock, $.001 par value:      
Authorized: 5,000,000 shares at September 30, 2017 and December 31, 2016.
Issued and outstanding: zero shares at September 30, 2017 and December 31, 2016.
—
 —
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 shares at September 30, 2017 and December 31, 2016.
Issued and outstanding: 58,156,128 and 57,457,967 shares at September 30, 2017 and December 31, 2016, respectively.		58
 57
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 capital774,714
 744,243
876,641
 866,206
Accumulated other comprehensive loss(123) (726)(2,386) (493)
Accumulated deficit(700,395) (680,424)(695,166) (707,255)
Total stockholders’ equity74,254
 63,150
179,148
 158,516
Total liabilities and stockholders’ equity$500,348
 $456,647
$838,856
 $816,744

INSULET CORPORATION
CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,
(in thousands, except per share data)2017 2016 2017 20162018 2017 2018 2017
Revenue$121,775
 $94,871
 $333,244
 $263,414
$124,262
 $109,756
 $247,840
 $211,469
Cost of revenue48,151
 39,230
 135,583
 113,265
42,190
 45,117
 89,953
 87,432
Gross profit73,624
 55,641
 197,661
 150,149
82,072
 64,639
 157,887
 124,037
Operating expenses:              
Research and development20,141
 13,734
 55,670
 39,676
18,418
 18,029
 38,330
 35,529
Sales and marketing28,718
 22,147
 86,288
 69,119
35,605
 29,475
 67,738
 57,570
General and administrative22,718
 17,342
 62,322
 47,923
23,724
 20,493
 47,494
 39,604
Total operating expenses71,577
 53,223
 204,280
 156,718
77,747
 67,997
 153,562
 132,703
Operating income (loss)2,047
 2,418
 (6,619) (6,569)4,325
 (3,358) 4,325
 (8,666)
Interest expense4,709
 3,029
 14,512
 9,252
7,290
 4,796
 15,208
 9,803
Other income (expense), net556
 211
 1,478
 510
Loss on extinguishment of long-term debt—
 2,551
 —
 2,551
Other income, net1,686
 488
 3,368
 922
Interest expense and other income, net4,153
 5,369
 13,034
 11,293
5,604
 4,308
 11,840
 8,881
Loss from continuing operations before income taxes(2,106) (2,951) (19,653) (17,862)
Loss before income taxes(1,279) (7,666) (7,515) (17,547)
Income tax expense121
 66
 318
 195
412
 101
 745
 197
Net loss from continuing operations(2,227) (3,017) (19,971) (18,057)
Loss from discontinued operations, net of tax ($0 for each of the three months ended September 30, 2017 and 2016 and $0 and $408 for the nine months ended September 30, 2017 and 2016, respectively)—
 (64) —
 (1,703)
Net loss$(2,227) $(3,081) $(19,971) $(19,760)$(1,691) $(7,767) $(8,260) $(17,744)
Net loss per share basic and diluted:              
Net loss from continuing operations per share$(0.04) $(0.05) $(0.34) $(0.32)
Net loss from discontinued operations per share$—
 $—
 $—
 $(0.03)
Net loss per share$(0.03) $(0.13) $(0.14) $(0.31)
Weighted-average number of shares used in calculating net loss per share58,100
 57,341
 57,925
 57,189
58,833
 57,977
 58,659
 57,836

INSULET CORPORATION
CONSOLIDATED STATEMENTS OF COMPREHENSIVE LOSS
(UNAUDITED)

Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,
(in thousands)2017 2016 2017 20162018 2017 2018 2017
Net loss$(2,227) $(3,081) $(19,971) $(19,760)$(1,691) $(7,767) $(8,260) $(17,744)
Other comprehensive income, net of tax              
Foreign currency translation adjustment, net of tax329
 (102) 594
 302
(741) 186
 (1,059) 264
Unrealized gain (loss) income on available-for-sale securities, net of tax76
 (43) 9
 (35)
Total other comprehensive income (loss), net of tax405
 (145) 603
 267
Unrealized loss on available-for-sale debt securities, net of tax(109) (57) (834) (67)
Total other comprehensive (loss) income, net of tax(850) 129
 (1,893) 197
Total comprehensive loss$(1,822) $(3,226) $(19,368) $(19,493)$(2,541) $(7,638) $(10,153) $(17,547)

INSULET CORPORATION
CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
Nine Months Ended September 30,Six Months Ended June 30,
(in thousands)2017 20162018 2017
Cash flows from operating activities      
Net loss$(19,971) $(19,760)$(8,260) $(17,744)
Adjustments to reconcile net loss to net cash provided by (used in) operating activities   
Adjustments to reconcile net loss to net cash used in operating activities   
Depreciation and amortization10,533
 10,474
7,131
 6,707
Non-cash interest and other expense12,185
 6,117
Non-cash interest expense14,427
 8,067
Stock-based compensation expense23,551
 16,850
15,117
 14,655
Loss on extinguishment of long-term debt—
 2,551
Provision for bad debts1,502
 1,889
1,586
 722
Other519
 139
(130) 374
Changes in operating assets and liabilities:      
Accounts receivable(19,757) 2,994
Accounts receivable and unbilled receivable(7,217) (9,630)
Inventories428
 (21,287)(7,959) 1,527
Prepaid expenses and other assets(1,290) (3,268)(4,823) (1,662)
Accounts payable, accrued expenses and other current liabilities10,502
 (632)(17,873) (7,408)
Deferred revenue537
 (982)(2,626) 44
Other long-term liabilities668
 756
232
 477
Net cash provided by (used in) operating activities(1)
19,407
 (4,159)
Net cash used in operating activities(10,395) (3,871)
Cash flows from investing activities      
Purchases of property, equipment and software(2)
(47,813) (19,205)
Purchases of property, equipment and software(1)
(89,937) (39,068)
Purchases of investments(115,056) (76,241)(117,940) (93,383)
Receipts from the maturity or sale of investments101,384
 8,905
90,774
 68,185
Proceeds from divestiture of business, net—
 5,714
Net cash used in investing activities(61,485) (80,827)(117,103) (64,266)
Cash flows from financing activities      
Principal payments of capital lease obligations(269) (4,727)—
 (269)
Proceeds from issuance of convertible notes, net of issuance costs—
 333,904
Repayment of convertible notes—
 (153,628)(6,687) —
Proceeds from exercise of stock options and issuance of common stock10,735
 4,848
Proceeds from exercise of stock options (2)
11,206
 7,891
Payment of withholding taxes in connection with vesting of restricted stock units(3,816) (2,839)(12,691) (3,428)
Net cash provided by financing activities6,650
 177,558
Net cash (used in) provided by financing activities(8,172) 4,194
Effect of exchange rate changes on cash487
 158
(661) 257
Net (decrease) increase in cash and cash equivalents(34,941) 92,730
Cash and cash equivalents, beginning of period137,174
 122,672
Cash and cash equivalents, end of period$102,233
 $215,402
Net decrease in cash, cash equivalents and restricted cash(136,331) (63,686)
Cash, cash equivalents and restricted cash, beginning of period272,577
 137,174
Cash, cash equivalents and restricted cash, end of period$136,246
 $73,488
(1)2016 includes activity related to discontinued operations. See Note 3 to the consolidated financial statements for discussion of discontinued operations.
(2) Cash outflows from purchases of property, equipment and software for the ninesix months ended SeptemberJune 30, 20172018 includes $2.0$4.0 million of purchases made in prior periods that were included in accounts payable and accrued expenses as of December 31, 20162017 and excludes $10.7$12.3 million of purchases made during the ninesix months ended SeptemberJune 30, 20172018 that were included in accounts payable and accrued expenses as of SeptemberJune 30, 2017.2018.
(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.


INSULET CORPORATION
CONDENSED NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(UNAUDITED)
Note 1. Nature of the Business
Insulet Corporation the "Company,"(the "Company") is primarily engaged in the development, manufacturing and sale of its proprietary Omnipod Insulin Management System (“Omnipod(the “Omnipod System”), an innovative, discreet and easy-to-use continuous insulin delivery system for people with insulin-dependent diabetes. There are twoprimary 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"). Conventional insulin pumps require people with insulin-dependent diabetes to learn to use, manage and wear a number of cumbersome components, including up to 42 inches of tubing. In contrast, theThe Omnipod System, which features only two discreet, easy-to-use devices that eliminate the need for a bulky pump, tubingcommunicate wirelessly and separate blood glucose meter, providesprovide for virtually pain-free automated cannula insertion communicates wirelessly and integrates a blood glucose meter.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 announced on July 20, 2017 its plans to assume,assumed on July 1, 2018, theall commercial activities (including, among other things, distribution, sales, marketing, training and support activitiessupport) of its Omnipod System across Europe following the expiration of its globalprior distribution agreement with Ypsomed Distribution AG ("Ypsomed'Ypsomed" or the "European distributor") on June 30, 2018. Until the expiration of the agreement, Ypsomed will remain the distributor of the Company's Omnipod products in Europe. The Company will be required to pay to Ypsomedthe former European distributor a per unit fee for direct sales of the Company's Omnipod device over the 12 month periodtwelve months following the expiration of the global 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 to former customers of Ypsomed, as defined in the distribution agreement. The Company will recognize a liability for this fee as it sells its Omnipod deviceare made to these identified customers during the twelve-month period beginningbetween July 1, 2018.2018 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.
The Company acquired Neighborhood Holdings, Inc. and its wholly-owned subsidiaries (collectively, “Neighborhood Diabetes”) in June 2011. Through Neighborhood Diabetes, the Company provided customers with blood glucose testing supplies, traditional insulin pumps, pump supplies and pharmaceuticals and had the ability to process claims as either durable medical equipment or through pharmacy benefits. In February 2016, the Company sold Neighborhood Diabetes to Liberty Medical LLC ("Liberty Medical"). Additional information regarding the disposition and treatment of the Neighborhood Diabetes business as discontinued operations is provided in Note 3 to these consolidated financial statements.


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 ninesix months ended SeptemberJune 30, 20172018 are not necessarily indicative of the results that may be expected for the full year ending December 31, 2017,2018, 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, 2016.


Reclassification of Prior Period Balances
Certain reclassifications have been made to prior period amounts to conform to the current period financial statement presentation including the reclassification of capitalized internal-use software costs from property and equipment to other intangible assets for the year ended December 31, 2016 upon adoption of Accounting Standards Update ("ASU") 2016-19, Technical Corrections and Improvements2017.

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. The most significant estimates used in these financial statements include the valuation of stock-based compensation expense; the fair value of intangible assets acquired in businesses combinations; the valuation of inventory; the fair value of reporting units used to calculate the potential impairment of goodwill; the valuation of deferred revenue; the calculation of gains and losses, if any, on the retirement or conversion of convertible debt; the estimated useful lives of property and equipment and intangible assets; the amount of internal use software development costs that qualify for capitalization; the estimated amount, if any, of accrued contingent liabilities as well as warranty and doubtful accounts allowance reserve calculations. 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, (expense), net, and were not material in the three and ninesix months ended SeptemberJune 30, 20172018 and 2016. Exposure to gains and losses from such transactions and revaluations are primarily related to Canadian dollar exchange rate fluctuations.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, whichand 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 an outstanding letterletters of credit related to a security depositand for a lease obligation,European cash management and VAT filing collateral, totaling $0.5$2.0 million as of SeptemberJune 30, 20172018 and $1.2$0.5 million as of December 31, 2016.2017.

Short-term 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 exclusive of cash equivalents, with a stated maturity date of one year or lessmore from the balance sheet date orand that are not expected to be used in current operations, are classified as short-termlong-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 withwithin depreciation expense. Maintenance and repair costs are expensed as incurred.
Property and equipment included $49.0$57.9 million and $39.0$51.6 million of accumulated depreciation as of SeptemberJune 30, 20172018 and December 31, 2016,2017, respectively.


Business Combinations
The Company recognizes the assets and liabilities assumed in business combinations on the basis of their fair values at the date of acquisition. The Company assesses the fair value of assets, including intangible assets, using a variety of methods and each asset is measured at fair value from the perspective of a market participant. The method used to estimate the fair values of intangible assets incorporates significant assumptions regarding the estimates a market participant would make in order to evaluate an asset, including a market participant’s use of the asset and the appropriate discount rates for a market participant. Assets recorded from the perspective of a market participant that are determined to not have economic use for the Company are expensed immediately. Any excess purchase price over the fair value of the net tangible and intangible assets acquired is allocated to goodwill. Transaction costs and restructuring costs associated with a business combination are expensed as incurred.

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. Consolidated financial information is utilized by the CODM as the Company’s current product offering primarily consists of drug delivery and the Omnipod System. 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 there isit has a single reporting unit asunit. In reaching this conclusion, the Company does not have segment managers andconsidered how components of the business are managed, whether discrete financial information below consolidated resultsat the component level is not reviewed on a regular basis. Basedbasis by segment management and whether components may be aggregated based on this conclusion,economic similarity.
In performing its annual goodwill is tested for impairment attest, the enterprise level. The Company has the option to first assess the qualitative factors to determine whether it is more likely than not that the fair value of its sole reporting unit is less than its carrying amount. This qualitative analysis is used as a basis for determining whether it is necessary to performutilizes the two-step goodwill impairment analysis. If the Company determines that it is more likely than not that its fair value is less than its carrying amount, then the two-step goodwill impairment test will be performed.approach as currently prescribed by ASC 350-20. The first step compares the carrying value of the reporting unit to its fair value using either a market approach or a discounted cash flow analysis.value. If the reporting unit’s carrying value of the reporting unit, including goodwill, exceeds its fair value, the Company willwould perform the second step and record an impairment loss to the extent that the carrying value of the reporting unit's carrying valuegoodwill exceeds its implied fair value as determined in step two of the impairment test.value. There was no impairment of goodwill during the three and ninesix months ended SeptemberJune 30, 2017 and 2016.

Revenue Recognition
The Company generates the majority of its revenue from sales of its Omnipod System to customers and third-party distributors who resell the products to patients with diabetes, and to a lesser extent from product sales to pharmaceutical companies who use the Company’s technology as a delivery method for their pharmaceuticals.
Revenue recognition requires that persuasive evidence of a sales arrangement exists, delivery of goods occurs through transfer of title and risk and rewards of ownership, the selling price is fixed or determinable and collectibility is reasonably assured. With respect to these criteria:
The evidence of an arrangement generally consists of a physician order form, a patient information form and, if applicable, third-party insurance approval for sales directly to patients or a purchase order for sales to a third-party distributor.
Revenue is recognized when title and risk and rewards of ownership have transferred to the customer.

The selling prices for all sales are fixed and agreed with the patient or third-party distributor and, if applicable, the patient’s third-party insurance provider(s) prior to shipment and are based on established list prices or, in the case of certain third-party insurers, contractually agreed upon prices. Provisions for discounts, rebates and other adjustments to customers are established as a reduction to revenue in the same period the related sales are recorded.
The Company offers a 45-day right of return for sales of its Omnipod System in the United States, and a 90-day right of return for sales of its Omnipod System in Canada to new patients and defers revenue to reflect estimated sales returns in the same period that the related product sales are recorded. Returns are estimated through a comparison of the Company’s historical return data to its related sales. Historical rates of return are adjusted for known or expected changes in the marketplace when appropriate. When doubt exists about reasonable assuredness of collectibility from specific customers, the Company defers revenue from sales of products to those customers until payment is received.
As of September 30, 2017 and December 31, 2016, the Company had deferred revenue of $2.6 million and $1.9 million, respectively, which included $1.2 million and $0.6 million classified in other long-term liabilities as of September 30, 2017 and December 31, 2016, respectively. Deferred revenue primarily relates to undelivered elements within certain of the Company's developmental arrangements and other instances where the Company has not yet met the revenue recognition criteria.

Collaborative Arrangements
The Company enters into collaborative arrangements for ongoing initiatives to develop products. Although the Company does not consider any individual alliance to be material, certain of the more notable alliances are described below.
Eli Lilly and Company and Concentrated Insulins2018: In May 2013 and January 2016, the Company entered into agreements with Eli Lilly and Company to develop new versions of the Omnipod tubeless insulin delivery system specifically designed to deliver a concentrated form of insulin used by higher insulin-requiring patients with diabetes. Under the terms of these arrangements, the parties share the responsibility of the permissible costs that are incurred. Consideration received and payments made by the Company under the terms of the arrangements are recorded within research and development expense..

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 $1.3$1.4 million and $1.1$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 threesix months ended SeptemberJune 30, 2018 and 2017, and 2016, respectively, and were $3.5 million and $2.8 million for the nine months ended September 30, 2017 and 2016, 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 and short-term investments 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 SeptemberJune 30, 20172018 and December 31, 2016,2017, liabilities to this vendor represented approximately 21%16% and 16%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 September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,


2017 2016 2017 20162018 2017 2018 2017
Amgen, Inc.16% 17% 16% 17%14% 16% 13% 16%
Ypsomed23% 16% 21% 15%* 20% 17% 20%
RGH Enterprises, Inc.11% 10% 10% 10%
Cardinal Health Inc. and affiliates13% 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.


Fair Value Measurements
Note4
Page
14
   
Convertible DebtNote6
Page
16
   
Revenue RecognitionNote3
Page
11
Convertible Debt, NetNote6
Page
17
Accounts Receivable and Allowance for Doubtful Accounts
Note8
Page
18
Note8
Page
19
   
Inventories
Note9
Page
19
Note9
Page
19
   
Other Intangible AssetsNote10
Page
19
Note11
Page
20
   
Accrued Expenses and Other Current Liabilities - Product Warranty CostsNote11
Page
20
   
Accrued Product Warranty CostsNote12
Page
21
Commitments and ContingenciesNote12
Page
21
Note13
Page
22
   
Equity: Stock-Based Compensation
Note13
Page
22
Note14
Page
23
   
Income Taxes
Note14
Page
25
Note15
Page
26

Recently Adopted Accounting Standards:
In December 2016, the FASB issued ASU 2016-19, Technical Corrections and Improvements ("ASU 2016-19"). ASU 2016-19 includes numerous technical corrections and clarifications to GAAP that are designed to remove inconsistencies in the board’s accounting guidance. Several provisions in this accounting guidance were effective immediately and did not have an impact on the Company’s consolidated financial statements. Additional provisions in this accounting guidance are effective for the Company in the current fiscal year, including the clarification that the license of internal-use software shall be accounted for as the acquisition of an intangible asset. The standard allows for prospective or retrospective adoption and the Company has elected retrospective adoption. As a result of adoption, the Company reclassified $4.1 million of gross internal-use software costs, net of accumulated amortization of $2.6 million, from property and equipment to other intangible assets as of December 31, 2016.
In July 2015, the FASB issued ASU 2015-11, Simplifying the Measurement of Inventory ("ASU 2015-11"). ASU 2015-11 amends existing guidance and requires entities to measure most inventory at the lower of cost and net realizable value. The guidance is effective prospectively for annual reporting periods beginning after December 15, 2016. Early adoption is permitted. Upon adoption, entities must disclose the nature of and reason for the accounting change. The Company adopted ASU 2015-11 on January 1, 2017 and its adoption did not have a material impact on the consolidated financial statements.
The Company adopted ASU 2016-09, Improvements to Employee Share-Based Payment Accounting ("ASU 2016-09") on January 1, 2017 using the modified retrospective method. ASU 2016-09 simplifies several aspects of the accounting for employee share-based payment transactions, including the accounting for income taxes, forfeitures, and statutory tax withholding requirements, as well as classification in the statement of cash flows. The adoption of ASU 2016-09 resulted in the Company increasing its deferred tax assets (tax effected) by approximately $23.8 million, which is offset by a full valuation allowance. Overall, adoption of the standard did not have a material impact on the Company's consolidated financial statements.
The Company adopted ASU 2016-18, Restricted Cash (a consensus of the Emerging Issues Task Force) ("ASU 2016-18") as of January 1, 2017 using the retrospective transition method. ASU 2016-18 requires the statement of cash flows to show the changes in the total of cash, cash equivalents, and restricted cash. As the Company includes restricted cash within cash and cash equivalents on the consolidated balance sheet and discloses the carrying value of restricted cash in the notes to the consolidated financial statements, there was no impact on the statement of cash flows upon the adoption of ASU 2016-18.
Accounting Standards Issued and Not Yet Adopted:
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 knownreferred 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 guidance is effective in fiscal years beginning January 1, 2018, with early adoption permitted. The Company plans to adoptadopted the standard as of the required effective date of January 1, 2018 using the modified retrospective method. Under this method, the new guidance iswas applied to contracts that arewere not yet completed as of the date of adoptionJanuary 1, 2018 with the cumulative effect of initially applying the guidance recognized through accumulated deficit atas the date of initial application. See Note 3 "Revenue from Contracts with Customers".
The Company continues to evaluate the potential impact of ASC 606 on its consolidated financial statements and related disclosures. As part of the Company's assessment work to date, the Company has formed an implementation work team, completed training on the ASC 606 revenue recognition model and is continuing to review and finalize its conclusions relative to its contracts with customers. For the remainder of 2017, the Company plans to finalize its evaluation and implement any required policy, process, and internal control changes required as a result of that evaluation.
While the Company continues to assess all potential impacts of the new standard on its consolidated financial statements, the Company currently expects that the adoption of ASC 606 will accelerate the timing of revenue recognition relative to a portion of its drug delivery product line whereby revenue will be recognized as the product is produced pursuant to the customer’s firm purchase commitments (as opposed to at a point in time when the product is shipped to the customer) as the Company has an enforceable right to payment for performance completed to date and the inventory has no alternative use. Upon the adoption of ASC 606 using the modified retrospective method onEffective January 1, 2018, the Company expects to record an adjustment to accumulated deficit for the amount that would have been recognized in 2017 under the new guidance and would not have been recognized until shipment of the product in 2018 under the current guidance. In addition to the aforementioned impact on drug delivery revenue, the adoption of ASC 606 will impact the treatment of contract acquisition costs such as commissions, which will be capitalized and amortized over the expected period of benefit. Upon adoption, the Company expects to increase its current and other assets for the net value of commissions paid prior to adoption less amortization to date. The new standard will also require an enhanced level of disclosures in the Company’s quarterly and annual consolidated financial statements.
In January 2016, the FASB issuedadopted ASU 2016-01, ("ASU 2016-01"), Financial Instruments-Overall: Recognition and Measurement of Financial Assets and Financial Liabilities("ASU 2016-01"). ASU 2016-01 changes the current GAAP model for the accounting of equity investments, financial liabilities under the fair value option, and the presentation and disclosure requirements for financial instruments. Allwhereby equity investments in unconsolidated entities (other than those accounted for using the equity method of accounting) will generally be measured at fair value through earnings. There will no longer be an available-for-sale classification (changes in fair value reported in other comprehensive income (loss)) for equity securities with readily determinable fair values. In addition, the FASB clarified guidance related to the valuation allowance assessment when recognizing deferred tax assets resulting from unrealized losses on available-for-sale debt securities. The classification and measurement guidancevalue will be effectivecarried at fair value with changes reported in fiscal years beginning after December 15, 2017, and interim periods within those years. While thenet income (loss) as opposed to other comprehensive income (loss). The Company is continuing to evaluate the potential impact ofadopted ASU 2016-01 as of the Company anticipates thatrequired effective date of January 1, 2018. There was no impact on the new guidance may create some volatility in earnings related to changes in fair value of its short term marketable securities. The Company does not expectconsolidated financial statements upon the adoption of ASU 2016-01 to have a material impact on its consolidated financial statements.as of the effective date or as of and for the period ended June 30, 2018.
In February 2016, the FASB issued ASU 2016-02, Leases ("ASU 2016-02"). ASU 2016-02 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. The guidance is effective for annual reporting periods beginning after December 15,Effective January 1, 2018, and interim periods within those years. Early adoption is permitted for all entities. While the Company is currently evaluating the impact of ASU 2016-02, the Company currently expects that the new guidance will require an increase in the Company's long-lived assets and a corresponding increase to long-term obligations associated with leased office and warehouse space.
In August 2016, the FASB issuedretrospectively 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, 2017,2018, and interim periods within those years. Early adoption is permitted for all entities. TheWhile the Company is currently evaluatingcontinues to evaluate the impact of ASU 2016-15 but does not expect it2016-02, the Company plans to be materialadopt 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 consolidatedadoption of this standard will require updates to its processes and internal controls over financial statements.reporting.

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 May 2017, the FASB issued 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 new standard is effective for the Company on January 1, 2018 and early adoption is permitted. The Company does not believe that the adoption of ASU 2017-09 will have a material impact on its 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. Discontinued OperationsRevenue from Contracts with Customers
In February 2016,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 sold Neighborhood Diabetesreflected 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 Liberty Medicalaccumulated deficit. The reported results for approximately $6.2 million2018 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 cash, which included $1.2 million of closing adjustments finalized in June 2016accounting principle that will primarily impact how revenue is recognized for the Company's drug delivery product line and paid by Liberty Medical. The results of operations, assets, and liabilities of Neighborhood Diabetes are classified as discontinued operations for all periods presented, except for certain corporate overhead costs which remain in continuing operations.
In connection with the 2016 disposition,how the Company entered intoaccounts for contract acquisition costs such as commissions. In accordance with ASC 606, revenue is recognized when a transition services agreement pursuantcustomer obtains control of the promised products. The amount of revenue recognized reflects the consideration to which Insulet provided various servicesthe Company expects to Liberty Medical on an interim transitional basis. The services generally commenced onbe entitled to receive in exchange for these products. To achieve this core principle, the closing date and terminated six monthsCompany applies the following five steps as outlined in ASC 606:
1) Identify the closing. Services provided by Insulet included certain information technology and back office support. The charges for such services were generally intended to allowcontract with a customer;
2) Identify the service provider to recover all out-of-pocket costs. Billings by Insulet under the transition services agreement were recorded as a reduction of the costs to provide the respective serviceperformance obligations in the applicable expense categorycontract;
3) Determine the transaction price;
4) Allocate the transaction price to performance obligations in the consolidated statements of operations. This transitional support provided Liberty Medicalcontract;
5) Recognize revenue when or as the time required to establish its stand-alone processes for such activities that were previously provided by Insulet as described above and did not constitute significant continuing support of Liberty Medical's operations. Total expenses incurred for such transition services, which were reimbursed in full, were $0.1 million and $0.8 millionCompany satisfies a performance obligation.

The following table summarizes revenue from contracts with customers for the three and ninesix months ended SeptemberJune 30, 2016, respectively. No expenses were incurred for2018 and 2017:

 Three months Six months
(in thousands)2018 2017 2018 2017
U.S. Omnipod$78,047
 $65,361
 $148,319
 $125,016
International Omnipod28,509
 26,575
 66,913
 51,719
Drug Delivery17,706
 17,820
 32,608
 34,734
Total$124,262
 $109,756
 $247,840
 $211,469

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 transition services foras independent distributors who resell the three and nine months ended September 30, 2017.
FollowingOmnipod to end users or wholesalers who sell the disposition,Company's product to end users through the Company entered into apharmacy channel. The Company's exclusive European distribution agreement with its former European distributor expired on June 30, 2018, at which time the Neighborhood Diabetes subsidiaryCompany assumed all commercial activities (including, among other things, distribution, sales, marketing, training and support) of Liberty Medicalthe 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 continuepay, 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 actthe 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 distributorcombined performance obligation.
Transaction Price. The price charged for the PDM and Pods is dependent on the Company's products.pricing as established with third party payors and intermediaries. The Company provides a right of return for sales of its Omnipod Systemto new patients. The Company also provides for certain rebates and discounts for sales transactedof its product through Neighborhood Diabetes priorintermediaries. 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 divestiturecustomer’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

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 previously eliminatednot 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 consolidation were $0.0 million and $0.3 million for the three and nine months ended September 30, 2016, respectively. This amount was historicallyeffect.

 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) $—
Inventories33,793
 (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 assets537,171
 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 assets816,744
 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 liabilities86,025
 2,625
 88,650
 76,109
 (854) 75,255
Other long-term liabilities6,030
 271
 6,301
 6,480
 (270) 6,210
Total liabilities658,228
 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' equity158,516
 20,364
 178,880
 179,148
 (32,776) 146,372
Total liabilities and stockholders' equity816,744
 23,260
 840,004
 838,856
 (33,900) 804,956

(1) Financial statement amounts as reported in the Neighborhood DiabetesCompany'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 resultsfor 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 is being presented based on current market terms of products soldshipped to the Neighborhood Diabetes subsidiary of Liberty Medical.customer.
Post divestiture, Omnipod System sales(b) Other current and non-current assets include contract acquisition costs related to the Neighborhood Diabetes subsidiary of Liberty Medical were $0.0 million and $0.4 million for the three and nine months ended September 30, 2016, respectively. There were no salessale of the Omnipod SystemOmnipod. 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 entity in 2017.material right was recognized as revenue through the completion of the distributor contract during the first half of 2018.
The following is a summarysummarizes the significant changes on the Company’s consolidated statement of the operating results of Neighborhood Diabetes included in discontinued operations for the three and ninesix months ended SeptemberJune 30, 2016:2018 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:

(In thousands)Three Months Ended September 30, 2016 Nine Months Ended September 30, 2016
Discontinued operations:   
Revenue (1)
$—
 $7,730
Cost of revenue133
 5,502
Gross profit(133) 2,228
          Total operating, interest and other (income) expenses (2)
(69) 3,523
Loss from discontinued operations before taxes(64) (1,295)
Income tax expense—
 408
Net loss from discontinued operations$(64) $(1,703)
  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)
(1)
Revenue includes revenue from the operations of Neighborhood Diabetes through date of sale in February 2016.
(2)
Includes $1.3 million loss on sale of Neighborhood Diabetes for the nine months ended September 30, 2016.
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 results from discontinued operations for Neighborhood Diabetes forcontract modifications entered into during the three and ninesix months ended SeptemberJune 30, 2017.2018 impacting the Company’s unbilled receivable or deferred revenue.
Depreciation and amortization expense included in discontinued operations was $0.0 million and $0.1 million for the three and nine months ended September 30, 2016, respectively. There was no depreciation and amortization expense included in discontinued operations for the three and nine months ended September 30, 2017.
Net operating cash flows used in discontinued operations in the nine months ended September 30, 2016 were $2.0 million. There were no net operating cash flows used in discontinued operations in the nine months ended September 30, 2017.

Note 4. Fair Value Measurements
The Company applies ASC 820, Fair Value Measurements and Disclosures (“ASC 820”) related to the fair value measurement of certain of its assets and liabilities. ASC 820 defines fair value as the price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. A single estimate of fair value results from a complex series of judgments about future events and uncertainties and relies heavily on estimates and assumptions. When estimating fair value, depending on the nature and complexity of the asset or liability, the Company may use one or all of the following approaches:
Market approach, which is based on market prices and other information from market transactions involving identical or comparable assets or liabilities.
Cost approach, which is based on the cost to acquire or construct comparable assets less an allowance for functional and/or economic obsolescence.
Income approach, which is based on the present value of the future stream of net cash flows.
To measure fair value, the Company uses the following fair value hierarchy based on three levels of inputs, as described in ASC 820, 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.

The following table provides a summary of assets that are measured at fair value as of SeptemberJune 30, 20172018 and December 31, 2016,2017, aggregated by the level in the fair value hierarchy within which those measurements fall:
Fair Value Measurements
(in thousands)Total Level 1 Level 2 Level 3Fair Value Measurements
September 30, 2017       
June 30, 2018Total Level 1 Level 2 Level 3
Recurring fair value measurements:              
Cash equivalents:
 
 
 
Money market mutual funds$45,343
 $45,343
 $—
 $—
$85,905
 $85,905
 $—
 $—
U.S. government and agency bonds9,989
 9,989
 —
 —
Total cash equivalents$45,343
 $45,343
 $—
 $—
$95,894
 $95,894
 $—
 $—
Short-term investments:       
U.S. government and agency bonds$113,294
 $92,344
 $20,950
 $—
$120,653
 $84,591
 $36,062
 $—
Corporate bonds47,625
 —
 47,625
 —
40,940
 —
 40,940
 —
Certificates of deposit12,604
 —
 12,604
 —
1,953
 —
 1,953
 —
Total short-term investments$173,523
 $92,344
 $81,179
 $—
$163,546
 $84,591
 $78,955
 $—
       
December 31, 2016       
Recurring fair value measurements:       
Cash equivalents:       
Money market mutual funds$93,467
 $93,467
 $—
 $—
U.S. government and agency bonds$100,817
 $68,950
 $31,867
 $—
Corporate bonds4,203
 —
 4,203
 —
47,510
 —
 47,510
 —
Certificates of deposit735
 —
 735
 —
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 bonds5,000
 5,000
 —
 —
Total cash equivalents$98,405
 $93,467
 $4,938
 $—
$241,936
 $241,936
 $—
 $—
Short-term investments:       
U.S. government and agency bonds$79,093
 $49,963
 $29,130
 $—
$112,076
 $90,703
 $21,373
 $—
Corporate bonds56,653
 —
 56,653
 —
47,681
 —
 47,681
 —
Certificates of deposit25,650
 —
 25,650
 —
7,722
 —
 7,722
 —
Total short-term investments$161,396
 $49,963
 $111,433
 $—
$167,479
 $90,703
 $76,776
 $—
U.S. government and agency bonds$92,464
 $49,651
 $42,813
 $—
Corporate bonds27,812
 —
 27,812
 —
Certificates of deposit5,273
 —
 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.

The carrying amounts, net of unamortized discounts and issuance costs, and the estimated fair values of the Company's convertible debt as of SeptemberJune 30, 20172018 and December 31, 20162017 are as follows:
September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
(in thousands)
Carrying
Value
 
Estimated Fair
Value
 Carrying
Value		 Estimated Fair
Value
Carrying
Value
 
Estimated Fair
Value
 Carrying
Value		 Estimated Fair
Value
2% Convertible Senior Notes$61,849
 $84,097
 $59,737
 $71,909
$—
 $—
 $3,421
 $5,467
       
1.375% Convertible Senior Notes283,436
 455,831
 276,172
 407,652
1.25% Convertible Senior Notes$283,104
 $391,196
 $273,031
 $320,969
293,683
 522,116
 286,580
 450,881
Total$577,119
 $977,947
 $566,173
 $864,000

Note 5. Short-term Investments
The Company's short-term and long-term investments are classified as available-for-sale andin debt securities have maturity dates that range from zero months13 days to 12.523.5 months as of SeptemberJune 30, 2017. The investments are all classified as short-term as they are available for current operations.2018. Amortized costs, gross unrealized holding gains and losses, and fair values at SeptemberJune 30,

2017 2018 and December 31, 20162017 are as follows:
(in thousands)Amortized cost Gross Unrealized Gains Gross Unrealized Losses Fair ValueAmortized cost Gross Unrealized Gains Gross Unrealized Losses Fair Value
September 30, 2017       
June 30, 2018       
U.S. government and agency bonds$113,456
 $—
 $(162) $113,294
$120,965
 $—
 $(312) $120,653
Corporate bonds47,660
 1
 (37) 47,624
41,054
 —
 (114) 40,940
Certificates of deposit12,605
 —
 —
 12,605
1,953
 —
 —
 1,953
Total short-term investments$173,721
 $1
 $(199) $173,523
$163,972
 $—
 $(426) $163,546
              
December 31, 2016       
U.S. government and agency bonds$101,485
 $3
 $(672) $100,816
Corporate bonds47,789
 —
 (278) 47,511
Certificates of deposit7,733
 —
 —
 7,733
Total long-term investments$157,007
 $3
 $(950) $156,060
       
December 31, 2017       
U.S. government and agency bonds$79,211
 $—
 $(118) $79,093
$112,311
 $—
 $(235) $112,076
Corporate bonds56,742
 —
 (89) 56,653
47,713
 3
 (35) 47,681
Certificates of deposit25,650
 —
 —
 25,650
7,722
 —
 —
 7,722
Total short-term investments$161,603
 $—
 $(207) $161,396
$167,746
 $3
 $(270) $167,479
       
U.S. government and agency bonds$92,677
 $—
 $(213) $92,464
Corporate bonds27,871
 —
 (59) 27,812
Certificates of deposit5,273
 —
 —
 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 noinsignificant realized gains or losses as of Septemberfor the six months ended June 30, 2017 or2018 and in the year ended December 31, 2016.2017.


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 ofAs of
(in thousands)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Principal amount of the 2% Convertible Senior Notes$67,084
 $67,084
Principal amount of the 1.25% Convertible Senior Notes345,000
 345,000
Principal amount of 2.0% Convertible Senior Notes$—
 $3,664
Principal amount of 1.25% Convertible Senior Notes345,000
 345,000
Principal amount of 1.375% Convertible Senior Notes402,500
 402,500
Unamortized debt discount(58,994) (69,684)(157,152) (170,448)
Deferred financing costs(8,137) (9,632)(13,229) (14,543)
Long-term debt, net of discount$344,953
 $332,768
Total convertible debt, net$577,119
 $566,173
Interest expense related to the convertible notes was as follows: 
Three Months Ended September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,
(in thousands)2017 2016 2017 20162018 2017 2018 2017
Contractual coupon interest$1,449
 $1,041
 $4,276
 $3,054
$2,462
 $1,413
 $4,942
 $2,827
Accretion of debt discount3,612
 1,901
 10,690
 5,330
6,616
 3,572
 13,138
 7,077
Amortization of debt issuance costs505
 222
 1,495
 785
648
 500
 1,289
 990
Loss on extinguishment of long-term debt—
 2,551
 —
 2,551
Total interest and other expense$5,566
 $5,715
 $16,461
 $11,720
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 costs3,654
 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 costs3,367
 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

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. Interest began accruing on September 13, 2016; the first interest payment was paid in March 2017. 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 which resultsresulting from allocating a portion of the proceeds to the fair value of the conversion feature. The fair value of the debt discount was estimated usingfeature reflecting a

trinomial lattice model based on the following inputs: Company's stock price, expected volatility, term to maturity, risk-free interest rate, and dividend yield. The debt discount was recorded as additional paid-in capital and the remaining liability reflects the value of the Company’s nonconvertible debt borrowing rate of 5.8% per annum. ThisThe 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 has beenwas 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 and is recorded as non-cash interest expense over the five year term of the 1.25% Notes.
The 1.25% Notes contain provisions that allow for additional interest to holders As of the notes upon failure to timely file documents or reports thatJune 30, 2018, the Company is required to file with the SEC. The additional interest is at a ratehas $293.7 million, net of 0.50% per annum of the principal amounts of the notes outstanding for a period of 360 days.
If the Company merges or consolidates with a foreign entity, then additional taxes may be required to be paid by the Company under the terms of the 1.25% Notes.
The Company determined that the higher interest payments requireddiscounts and tax payments required in certain circumstances are considered embedded derivatives and should be bifurcated and accounted for at fair value. The Company assesses the value of the embedded derivatives at each balance sheet date. The derivatives had de minimis value at the balance sheet date.
Cash interest expense related to the 1.25% Notes was $1.1 million and $3.3 million in the three and nine months ended September 30, 2017, respectively. Non-cash interest expense related to the 1.25% Notes was comprised of the amortization of the debt discount and debt issuance costs, and was $3.4 million and $10.1 million in the three and nine months ended September 30, 2017, respectively.
As of September 30, 2017, the Company included $283.1 million 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 interest rate on the notes is 2% per annum, payable semi-annually in arrears in cash on June 15 and December 15 of each year. The 2% Notes arewere 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, subject to adjustment under certain circumstances.
The Company recorded a debt discount of $35.6 million related to the 2% Notes. The debt discount was recorded as additional paid-in capital to reflect the value of the Company’s nonconvertible debt borrowing rate of 6.2% per annum. This debt discount is being amortized as non-cash interest expense over the five year term of the 2% Notes. The Company incurred deferred financing costs related to this offering of approximately $6.7 million, of which $1.2 million has been reclassified as an offset to the value of the amount allocated to equity. The remainder is recorded as a reduction to debt in the consolidated balance sheet and is being amortized as non-cash interest expense over the five year term of the 2% Notes.
share. In September 2016, in connection with the issuance of $345 million in principal amount of the 1.25% Notes,separately negotiated transactions, the Company repurchased approximately $134.2 million in principal amount of the 2% Notes for $153.6 million. The extinguishmentnotes in September 2016 and $63.4 million in principal of the 2% Notes was accounted for separately fromnotes in November 2017. The Company elected to call the issuanceremaining notes in March 2018 and settled the outstanding principal and conversion feature of the 1.25% Notes as both transactions were arm's-lengthnotes for $6.7 million in nature and were not contingent upon one another.cash in the second quarter of 2018. The $153.6Company allocated approximately $3.2 million paidof the settlement to extinguish the debt was allocated to debt and equity based on their respective fair values immediately prior to the transaction. The fair value of the debt was estimated using a trinomial lattice model based on the following inputs: Company's stock price, expected volatility, term to maturity, risk-free interest rate,equity component and dividend yield. The Company allocated $121.4$3.5 million of the payment to the debt and $32.9 million to equity.
The Company recorded a loss on extinguishment of debt of $2.6 million in connectioncomponent, which was consistent with the repurchase and redemption of the 2% Notes during the year ended December 31, 2016, representing the excess of the $121.4 million allocated to the debt over its carrying value net of unamortized debt discount, deferred financing costs and accrued interest.
The 2% Notes contain provisions that allow for additional interest to the holders of the notes upon the failure to timely file documents or reports that the Company is required to file with the SEC. The additional interest is at a rate of 0.25% per annumas of the principal amount of the notes outstanding for the first 180 days and 0.50% per annum of the principal amount of the notes outstanding for a period up to 360 days.
If the Company is purchased by a company outside of the U.S., then additional taxes may be required to be paid by the Company under the terms of the 2% Notes.settlement date, resulting in no gain or loss on extinguishment.

The Company determined that the higher interest and tax payments required in certain circumstances are considered embedded derivatives and should be bifurcated and accounted for at fair value. The Company assesses the value of the embedded derivatives at each balance sheet date. The derivatives had de minimis value at the balance sheet date.
Cash interest expense related to the 2% Notes was $0.3 million and $0.9 million in the three months ended September 30, 2017 and 2016, respectively. Cash interest expense related to the 2% Notes was $1.0 million and $2.9 million in the nine months ended September 30, 2017 and 2016, respectively.
Non-cash interest expense related to the 2% Notes was comprised of the amortization of the debt discount and debt issuance costs and was $0.7 million and $1.6 million in the three months ended September 30, 2017 and 2016, respectively. Non-cash interest expense related to the 2% Notes was comprised of the amortization of the debt discount and debt issuance costs and was $2.1 million and $5.6 million in the nine months ended September 30, 2017 and 2016, respectively.
As of September 30, 2017, the Company included $61.8 million on its balance sheet in long-term debt related to the 2% Notes.

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 ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, 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 Nine Months Ended September 30,Three and Six Months Ended June 30,
2017 20162018 2017
1.375% Convertible Senior Notes4,319,429
 —
2.00% Convertible Senior Notes1,442,433
 1,442,433
—
 1,442,433
1.25% Convertible Senior Notes5,910,954
 5,910,954
5,910,954
 5,910,954
Unvested restricted stock units1,007,729
 971,814
914,710
 978,683
Outstanding options3,489,393
 3,541,936
Outstanding stock options3,199,238
 3,582,149
Total dilutive common share equivalents11,850,509
 11,867,137
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 distributors and government agencies.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 or various assumptions and estimates that are believed to be reasonable under the circumstances.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 SeptemberJune 30, 20172018 and December 31, 20162017 were as follows:
As of
June 30, 2018December 31, 2017
Amgen, Inc.*10%
Ypsomed*31%
 As of
 September 30, 2017 December 31, 2016
Amgen, Inc.13% 16%
Ypsomed28% 19%
* 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)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Trade receivables$50,210
 $31,714
$52,895
 $55,914
Allowance for doubtful accounts(3,037) (2,911)(3,219) (2,541)
Total accounts receivable, net$47,173
 $28,803
$49,676
 $53,373

Note 9. Inventories Net
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 SeptemberJune 30, 20172018 and December 31, 2016.2017. 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.


The components of inventories are as follows:
As ofAs of
(in thousands)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Raw materials$2,289
 $1,911
$5,243
 $2,146
Work-in-process15,168
 15,681
8,128
 23,918
Finished goods, net17,597
 17,922
27,437
 7,729
Total inventories$35,054
 $35,514
$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 10.11. 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 intangiblesintangible 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 estimation of useful lives and expected cash flows requires the Company to make significant judgments regarding future periods that are subject to some factors outside its control. Changes in these estimates can result in significant revisions to the carrying value of these assets and may result in material charges to the results of operations.
The Company recorded $2.1 million of other intangible assets in 2015 as a result of the July 2015 acquisition of its Canadian distribution business. The Company determined that the estimated useful life of the contractual relationship asset is 5 years and is amortizing the asset over their estimated lives, based on the expected cash flows of the assets.
The Company adopted ASU 2016-19 on January 1, 2017 and, as a result, reclassified $1.5 million of net internal-use software costs from property and equipment to other intangible assets as of December 31, 2016.
The components of other intangible assets are as follows:
As ofAs of
September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
(in thousands)Gross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book ValueGross Carrying Amount Accumulated Amortization Net Book Value Gross Carrying Amount Accumulated Amortization Net Book Value
Customer and contractual relationships, net$2,149
 $(1,726) $423
 $1,994
 $(1,466) $528
Customer and contractual relationships$2,040
 $(1,764) $276
 $2,135
 $(1,764) $371
Internal-use software7,175
 (3,229) 3,946
 4,064
 (2,551) 1,513
9,751
 (4,280) 5,471
 7,545
 (3,565) 3,980
Total intangible assets$9,324
 $(4,955) $4,369
 $6,058
 $(4,017) $2,041
$11,791
 $(6,044) $5,747
 $9,680
 $(5,329) $4,351

Amortization expense for intangible assets was approximately $0.3$0.4 million and $0.3 million for the three months ended SeptemberJune 30, 20172018 and 2016,2017, respectively. Amortization expense for intangible assets was approximately $0.8 million and $0.9$0.6 million for the ninesix months

ended SeptemberJune 30, 20172018 and 2016,2017, 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 TotalCustomer and Contractual Relationships Internal-Use Software Total
2017 (remaining)$66
 $324
 $390
2018159
 1,171
 1,330
2018 (remaining)$79
 $863
 $942
2019132
 881
 1,013
132
 1,519
 1,651
202066
 661
 727
65
 1,257
 1,322
2021—
 578
 578
—
 979
 979
2022—
 683
 683
Thereafter—
 331
 331
—
 170
 170
Total$423
 $3,946
 $4,369
$276
 $5,471
 $5,747

As of SeptemberJune 30, 2017,2018, the weighted average amortization period of the Company’s intangible assets is approximately 3.93.8 years.

Note 11.12. Accrued Expenses and Other Current Liabilities
The components of accrued expenses and other current liabilities are as follows:
As of
(in thousands)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Employee compensation and related costs$27,389
 $21,999
$21,470
 $34,942
Professional and consulting services8,972
 6,753
8,512
 9,273
Supplier charges932
 2,886
3,651
 3,542
Warranty1,583
 1,642
Other6,021
 7,948
14,947
 11,499
Total accrued expenses and other current liabilities$44,897
 $41,228
$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 Systems that dodoes 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 revenuegoods sold on the statement of operations. Cost to service the claims reflects the current product cost, which has been decreasing over time.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 September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,
(in thousands)2017 2016 2017 20162018 2017 2018 2017
Balance at the beginning of the period$4,817
 $4,294
 $4,388
 $4,152
Product warranty liability at the beginning of the period$5,386
 $4,562
 $5,337
 $4,388
Warranty expense1,483
 1,149
 3,123
 3,288
1,529
 1,135
 3,501
 1,641
Warranty claims settled(1,303) (1,101) (2,514) (3,098)(1,412) (880) (3,335) (1,212)
Balance at the end of the period$4,997
 $4,342
 $4,997
 $4,342
Product warranty liability at the end of the period$5,503
 $4,817
 $5,503
 $4,817

As of
(in thousands)September 30, 2017 December 31, 2016June 30, 2018 December 31, 2017
Composition of balance:      
Short-term$1,583
 $1,642
$2,335
 $1,653
Long-term3,414
 2,746
3,168
 3,684
Total warranty liability:$4,997
 $4,388
$5,503
 $5,337

Note 12.13. 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 leases expirelease expires in November 2022 and containcontains escalating payments over the life of eachthe 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 TennesseeUtah containing a total of approximately 11,00020,000 square feet under leases expiring from 2017August 2018 to 2020.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. The Company has considered ASC 840-20, Leases in accounting for these lease provisions. Rental expense under operating leases was $0.7$0.9 million and $0.7 million for the three months ended SeptemberJune 30, 2018 and 2017, and 2016.respectively. Rental expense under operating leases was $2.1$1.7 million and $1.9$1.4 million for the ninesix months ended SeptemberJune 30, 2018 and 2017, and 2016.respectively.
The aggregate future minimum lease payments related to these leases as of SeptemberJune 30, 20172018 are as follows:
(in thousands)
Years Ending December 31,
Minimum Lease
Payments
2017 (remaining)$725
20182,702
(in thousands)

 

Years Ending December 31,
Minimum Lease
Payments
2018 (remaining)$1,691
20192,681
3,035
20202,402
2,651
20212,383
2,402
20222,131
Thereafter2,131
—
Total$13,024
$11,910
Legal Proceedings
In December 2015, the Company received a revised audit report on behalf of the Centers for Medicare and Medicaid Services and the State of New York alleging overpayment of certain Medicaid claims to Neighborhood Diabetes. As of December 31, 2015, the Company had determined that it was probable that a loss had been incurred and recorded an aggregate liability of $0.4 million within loss from discontinued operations, which was subsequently reduced to $0.3 million during 2016. The change in the liability was recorded in discontinued operations. In June 2017, the Company reached an agreement to settle the claim for $0.3 million, which was subsequently paid in July 2017.
In May 2016, the Company reached a settlement agreement for $0.5 million with the Connecticut Department of Social Services Office of Quality Assurance relating to an audit alleging overpayment of certain Medicaid claims to Neighborhood Diabetes. The settlement amount for this audit was consistent with the amount previously accrued.
In April 2016, the Company reached a settlement agreement for $0.5 million with the Massachusetts Department of Revenue for sales and use tax audits related to Insulet Corporation, which resulted in a $0.2 million reduction of the previously recorded liability and a credit to general and administrative expenses during 2016.
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, which remains outstanding, alleges(“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. The lawsuit seeks, among other things, compensatory damagesOn December 14, 2017, following a series of negotiations, the Company, the individual defendants and their insurers reached an agreement in connectionprinciple with the Company’s allegedly inflated stock price between May 7, 2013plaintiffs 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 30, 2015, as well as

attorneys’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 costs. The Company currently cannot reasonably estimate a possible loss, or range of loss,expenses in connection with this matter.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.
On
In addition, on April 26, 2017, a derivative action (Walker(Walker v. DeSisto, et al., 1:17-cv-10738) (“Walker”) was filed, and on October 13, 2017, a second derivative action (Carnazza(Carnazza v. DeSisto, et al.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 currently cannot reasonably estimate a possible loss, or range of loss,has accrued fees and expenses in connection with this matter up to and including the eitheramount of these actions.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 13.14. 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 ninesix months ended SeptemberJune 30, 20172018 and 2016:2017:
Three Months Ended September 30, Nine Months Ended September 30, Unamortized Expense Weighted Average Remaining Expense Period (Years)Three Months Ended June 30, Six Months Ended June 30, Unamortized Expense Weighted Average Remaining Expense Period (Years)
($ in thousands)2017 2016 2017 2016 At September 30, 20172018 2017 2018 2017 At June 30, 2018
Stock options$3,127
 $2,578
 $8,815
 $7,372
 $18,264
 2.4$2,272
 $2,909
 $4,630
 $5,688
 $17,424
 2.6
Restricted stock units5,621
 3,439
 14,358
 9,359
 30,411
 1.94,371
 4,500
 9,899
 8,737
 35,936
 2.0
Employee stock purchase plan149
 71
 379
 142
 99
 0.2294
 122
 588
 230
 494
 0.4
Total$8,897
 $6,088
 $23,552
 $16,873
 $48,774
 $6,937
 $7,531
 $15,117
 $14,655
 $53,854
 

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 fromunder 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. As of September 30, 2017, approximately 5.1 million shares remain available for future grant under the 2017 Plan.

Stock Options
The Company awardedThere were 34,500 shares of performance-based incentive stock options in the nine months ended September 30, 2017. There were 55,000no shares of performance-based incentive stock options awarded in the ninesix months ended SeptemberJune 30, 2016.2018 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 estimated grant date fair values of the employee stock options were calculated using the Black-Scholes option pricing model.

The following summarizes the activity under the Company’s stock option plans during the ninesix months ended SeptemberJune 30, 2017:2018:

 
Number of
Options (#)
 
Weighted Average
Exercise Price ($)
 
Aggregate
Intrinsic
Value ($ in 000s)
 
Weighted Average
Remaining Contractual Term (Years)
Balance, December 31, 20163,441,303
 $32.27
    
Granted519,231
 45.23
    
Exercised(1)
(385,345) 26.11
 $7,696
  
Canceled(85,796) 34.82
    
Balance, September 30, 20173,489,393
 $34.82
 $70,718
 7.8
Vested, September 30, 2017(2)
1,860,596
 $33.41
 $40,326
 7.1
Vested or expected to vest, September 30, 2017(2)(3)
3,282,804
 
 $67,057
  
 
Number of
Options (#)
 
Weighted Average
Exercise Price ($)
 
Aggregate
Intrinsic
Value ($ in thousands)
 
Weighted Average
Remaining Contractual Term (Years)
Outstanding at December 31, 20173,377,220
 $35.10
    
Granted269,853
 76.32
    
Exercised(318,102) 32.91
 $17,024
  
Canceled(129,733) 40.28
    
Outstanding at June 30, 20183,199,238
 $38.59
 $150,872
 7.3
Vested, June 30, 20182,007,167
 $34.29
 $103,188
 6.7
Vested or expected to vest, June 30, 2018 (1)
3,066,211
 
 $146,303
  
     
(1) 
The aggregate intrinsic value was calculated based on the positive difference between the estimated fair value of the Company’s commonRepresents total outstanding stock as of the date of exercise and the exercise price of the underlying options. The aggregate intrinsic value of options exercised in the nine months ended September 30, 2017 and 2016 was $7.7 million and $4.4 million, respectively.
(2)
The aggregate intrinsic value was calculated based on the positive difference between the estimated fair value of the Company’s common stock as of September 30, 2017, and the exercise price of the underlying options.
(3)
Represents the number of vested options as of SeptemberJune 30, 2017, plus the number of unvested options expected to vest.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 ninesix months ended SeptemberJune 30, 2017,2018, the Company awarded 432,877326,144 restricted stock units to certain employees and non-employee members of the Board of Directors, which included 168,857111,239 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 $1.8$1.0 million and $4.0$2.1 million in the three and ninesix months ended SeptemberJune 30, 20172018 as it expects a portion of the performance-based restricted stock units granted in 20162017 and 20172018 will be earned based on its evaluation of the performance criteria at December 31, 2017 and December 31, 2019, respectively.criteria. An additional $0.1$0.3 million and $0.4$1.4 million of stock compensation expense was recognized in the three and ninesix months ended SeptemberJune 30, 2017, respectively,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 ninesix months ended SeptemberJune 30, 20172018 have a weighted average fair value of $47.48$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 $20.6$24.1 million on their grant date. The Company is recognizing the compensation expense over the vesting period. Approximately $3.8$3.2 million and $2.6$3.2 million in the three months ended SeptemberJune 30, 20172018 and 2016,2017, respectively, of stock-based compensation expense related to the vesting of non-performance based restricted stock units was recognized. Approximately $10.0$6.4 million and $7.3$6.2 million in the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, 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.

The following table summarizes the status of the Company’s restricted stock units during the ninesix months ended SeptemberJune 30, 2017:2018:
Number of
Shares (#)
 
Weighted
Average
Fair Value ($)
Number of
Shares (#)
 
Weighted
Average
Fair Value ($)
Balance, December 31, 2016962,219
 $31.14
Outstanding at December 31, 2017994,364
 $38.08
Granted432,877
 47.48
326,144
 75.36
Adjustment (1)
147,301
 29.54
Vested(375,050) 31.51
(487,001) 33.39
Forfeited(12,317) 34.23
(66,098) 44.43
Balance, September 30, 20171,007,729
 $37.98
Outstanding at June 30, 2018914,710
 $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 will make one or moretypically makes two offerings each year to eligible employees to purchase stock under the ESPP. Between January 1, 2008 and June 30, 2016, offering periods began on the first business day occurring on or after each January 1 and July 1 and ended on the last business day occurring on or before the following June 30 and December 31, respectively. Beginning as of July 1, 2016, offeringOffering periods begin on the first business day occurring on or after each December 1 and June 1 and will end on the last business day occurring on or before the following May 31 and November 30, respectively. In order to permit a transition to the new offering cycle, a one-time offering period began on July 1, 2016 and ended on November 30, 2016.
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.
For all offering periods ending on or before June 30, 2016, the purchase price for each share purchased was 85% of the fair market value of the common stock on the last day of the offering period. For all offering periods beginning on or after July 1, 2016, the 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.
The accumulated payroll deductions of any employee who is not a participant on the last day of an offering period will be refunded. An employee’s rights under the ESPP terminate upon voluntary withdrawal from the plan or when the employee ceases employment with the Company for any reason.
The ESPP may be terminated or amended by the Board of Directors at any time. An amendment to increase the number of shares of common stock that is authorized under the ESPP, and certain other amendments, require the approval of stockholders.
     
Note 14.15. 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 followsrecognized the provisionsimpact of ASC 740-10, Income Taxes (“ASC 740-10”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 uncertainty in income taxes recognizedthe 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. ASC 740-10 prescribesstatements and related disclosures as of December 31, 2017. As of December 31 2017, the Company recorded a recognition thresholdreduction 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 measurement attribute forprofits of the financial statement recognitionCompany's foreign subsidiaries, as well as the Company’s evaluation of certain elections and measurementguidance. 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 position takenis incurred or expected to be taken in a tax return. In addition, ASC 740-10 provides guidanceoccur for the year ended December 31, 2018. The inclusion of GILTI had no impact on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The Company recognizes estimated interest and penalties for uncertain tax positions inthe Company's income tax expense.expense or effective tax rate in the period due to the full valuation allowance applied to the U.S. entity.

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 20122013 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 SeptemberJune 30, 20172018 and December 31, 2016,2017, 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 each of the three months ended SeptemberJune 30, 20172018 and 2016.2017. Income tax expense was $0.3$0.7 million and $0.2 million for the ninesix months ended SeptemberJune 30, 20172018 and 2016,2017, 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. 
The Company had no unrecognized tax benefits at September 30, 2017.

15. Segment Reporting
As further described in Note 2, the Company has concluded that it operates as one segment.
Worldwide revenue for the Company's products is categorized as follows:
 Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2017 2016 2017 2016
U.S. Omnipod$70,065
 $59,641
 $195,081
 $166,691
International Omnipod32,481
 19,107
 84,200
 51,046
Drug Delivery19,229
 16,123
 53,963
 45,677
Total$121,775
 $94,871
 $333,244
 $263,414
Geographic information about revenue, based on the region of the customer's shipping location, is as follows:
 Three Months Ended September 30, Nine Months Ended September 30,
(in thousands)2017 2016 2017 2016
United States$89,294
 $75,764
 $249,044
 $212,368
All other32,481
 19,107
 84,200
 51,046
Total$121,775
 $94,871
 $333,244
 $263,414
Geographic information about long-lived assets, net, excluding goodwill and other intangible assets is as follows:
(in thousands)September 30, 2017 December 31, 2016
United States$68,106
 $19,341
China20,456
 25,431
Other60
 197
Total$88,622
 $44,969


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations
FORWARD-LOOKING STATEMENTS
You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying condensed notes to those financial statements included in this Quarterly Report on Form 10-Q. This Quarterly Reportquarterly report on Form 10-Q contains forward-looking statements. Forward-looking statements whichrelate 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 made pursuant to the safe harbor provisions of Section 27A of the Securities Act of 1933 and of Section 21E of the Securities Exchange Act of 1934. Theseonly predictions. We have based these forward-looking statements are basedlargely on our current expectations and beliefs concerningprojections about future developmentsevents and their potential effects on us. There can be no assurance that future developments affecting us will be thosefinancial trends that we have anticipated. Thesebelieve may affect our business, results of operations and financial condition.
The outcomes of the events described in these forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements.
These risks and uncertainties include, but are not limited to:
risks associated with our dependence on our principal product, the Omnipod System;
fluctuations in quarterly results of operations;
our ability to sustain or reduce production costs and increase customer orders and manufacturing volumes;
adverse changes in general economic conditions;
impact of healthcare reform laws;
our inability to raise additional funds in the future on acceptable terms or at all;
potential supply problems or price fluctuations with sole source or third-party suppliers on which we are dependent;
the potential establishment of a competitive bid program;
failure to retain supplier pricing discounts and achieve satisfactory gross margins;
failure to retain key supplier and payor partners;
international business risks;
our inability to effectively assume the distribution and commercial support for our Omnipod System in Europe following the expiration of our global distribution agreement with Ypsomed on June 30, 2018;
our inability to secure and retain adequate coverage or reimbursement for the Omnipod System by third-party payors and potential adverse changes in reimbursement rates or policies relating to the Omnipod System;
failure to retain key payor partners and their members;
failure to retain and manage successfully our Medicare and Medicaid business;
potential adverse effects resulting from competition;
reliance on information technology systems and our ability to control related risks, including a cyber-attack or other breach or disruption of these systems;
technological breakthroughs and innovations adversely affecting our business, and our own new product development initiatives may prove to be ineffective or not commercially successful;
potential termination of our license to incorporate a blood glucose meter into the Omnipod System, or our inability to enter into new license agreements;
challenges to the further development of our non-insulin drug delivery business;
our ability to protect our intellectual property and other proprietary rights; conflicts with the intellectual property of third-parties, including claims that our current or future products infringe or misappropriate the proprietary rights of others;
adverse regulatory or legal actions relating to the Omnipod System;
our products and operations are subject to extensive government regulation, which could restrict our ability to carry on or expand our operations;
failure of our contract manufacturers or component suppliers to comply with the FDA’s quality system regulations;

potential adverse impact resulting from a recall, or discovery of serious safety issues, of our products;
the potential violation of federal or state laws prohibiting “kickbacks” or protecting the confidentiality of patient health information, or any challenge to or investigation into our practices under these laws;
product liability lawsuits that may be brought against us;
reduced retention rates of our customer base;
unfavorable results of clinical studies relating to the Omnipod System or the products of our competitors;
potential future publication of articles or announcement of positions by diabetes associations or other organizations that are unfavorable to the Omnipod System;
the concentration of substantially all of our manufacturing operations at a single location in China and substantially all of our inventory at a single location in Massachusetts;
our ability to effectively manage the construction of our planned manufacturing facility in the U.S.;
our ability to attract and retain personnel;
our ability to manage our growth;
risks, associated with potential future acquisitions or investments in new businesses;
our ability to generate sufficient cash to service all of our indebtedness;
the expansion of our distribution network;
our ability to successfully maintain effective internal control over financial reporting;
the volatility of the price of our common stock;
risks related to future sales of our common stock or the conversion of any of our 2% Convertible Senior Notes due June 15, 2019 and 1.25% Convertible Senior Notes due September 15, 2021;
potential indemnification obligations in connection with the disposition of our former Neighborhood Diabetes supplies business;
potential limitations on our ability to use our net operating loss carryforwards; and
anti-takeover provisions in our organizational documents.
The factors discussed above are not intended to be a complete statement of all risks and uncertainties and should be evaluated with all other risksfactors described in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on February 28, 201722, 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. Should oneAccordingly, 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 more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect,occur, and actual results may vary in material respectscould differ materially from those projected in thesethe 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 publicly update or revise any forward-looking statements.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 twoprimary 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. Conventional insulin pumps require people with insulin-dependent diabetes to learn to use, manage and wear a number of cumbersome components, including up to 42 inches of tubing. In contrast, theThe Omnipod System, which features only two discreet, easy-to-use devices that eliminate the need for a bulky pump, tubingcommunicate wirelessly and separate blood glucose meter, providesprovide for virtually pain-free automated cannula insertion communicates wirelessly and integrates a blood glucose meter.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 using the Omnipod System for insulin delivery,diabetes market space, we also partnerhave partnered with global pharmaceutical and biotechnology companies to tailorthat utilize a customized form of the Omnipod System technology platformto 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 deliveryconstruction of subcutaneous drugs across multiple therapeutic areas.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.

In June 2011, we acquired Neighborhood Diabetes. Through Neighborhood Diabetes, we provided customers with blood glucose testing supplies, traditional insulin pumps, pump supplies and pharmaceuticals and had the ability to process claims as either durable medical equipment or through pharmacy benefits. In February 2016, we sold Neighborhood Diabetes to Liberty Medical. Additional information regarding the sale of Neighborhood Diabetes is provided in Note 3 to the consolidated financial statements included in this Form 10-Q.
We announced on July 20, 2017 our plans to assume, onOn July 1, 2018 thewe assumed all commercial activities (including, among other things, distribution, sales, marketing, training and support activities ofsupport) for our Omnipod System across Europe following the expiration of our globalprior distribution agreement with Ypsomedour former European distributor on June 30, 2018. Until the expirationAs a result of the distribution agreement, Ypsomed will remain the distributor of our Omnipod products in Europe. We do not expect that the anticipatedthis mid-year transition, will have a material impact on our financial trends for the remainder of 2017. Once we assume direct distribution and commercial support following the expiration of the distribution agreement with Ypsomed on June 30, 2018, we expect our revenue and gross margins to increase, as average customer pricing in Europe is higher than our current distributorthe pricing to Ypsomed.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. In addition, we will be required to pay to Ypsomed a per unit fee for direct sales over the 12 months following the expiration of the global distribution agreement of our Omnipod device to former customers of Ypsomed, as defined in the distribution agreement. The actual amount of the fee is dependent on a number of factors, such as the European Omnipod customer installed base as of June 30, 2018, the number of customers who choose to continue to purchase Omnipod devices over the successive 12 months, and the volume of the devices sold to these customers during the 12-month period following the expiration of the distribution agreement. While the actual fee could vary significantly, assuming the continued growth of Omnipod in Europe through June 30, 2018, and limited attrition in the 12 months thereafter, we estimate that the fee could total approximately $50 million. Once European operations are firmly established, excluding nonrecurring transition-related costs, we expect that theour 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

ThirdD (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 20172018 Revenue Results:
Total revenue of $121.8$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
U.S. Omnipod revenue of $70.1 million
◦
International Omnipod revenue of $32.5 million
◦
Drug Delivery revenue of $19.2 million
Our long-term financial objective is to achieve and sustain profitable growth. OurWe expect our efforts in 2017 are2018 and 2019 to focus primarily focused on constructing and commissioning our U.S. manufacturing facility, continuing to establish our European operations, launching new products, such as the expansion ofDASH TM Omnipod System, continuing our customer base inproduct development efforts, and taking the United Statesnecessary 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 internationally, increasing our gross profit and product development.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 willmay continue to incur net losses in the near term in order to achieve these objectives. However, we believe that the accomplishment of our near-termnear term objectives will have a positive impact on our financial condition in the future.

Components of Financial Operations
Revenue.  We derive mostthe 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 subcutaneous drugs across multiple 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, and training functions, 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.


Results of Operations
This section discusses our consolidated results of operations for the thirdsecond quarter and the ninesix months ended SeptemberJune 30, 20172018 compared to the same periods of 2016,2017, 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 September 30, Nine Months Ended September 30,Three Months Ended June 30, Six Months Ended June 30,
(in Thousands)2017 2016 Change $ Change % 2017 2016 Change $ Change %
(in thousands)2018 2017 Change $ Change % 2018 2017 Change $ Change %
Revenue:                              
U.S. Omnipod$70,065
 $59,641
 $10,424
 17 % $195,081
 $166,691
 $28,390
 17 %$78,047
 $65,361
 $12,686
 19 % $148,319
 $125,016
 $23,303
 19 %
International Omnipod32,481
 19,107
 13,374
 70 % 84,200
 51,046
 33,154
 65 %28,509
 26,575
 1,934
 7 % 66,913
 51,719
 15,194
 29 %
Drug Delivery19,229
 16,123
 3,106
 19 % 53,963
 45,677
 8,286
 18 %17,706
 17,820
 (114) (1)% 32,608
 34,734
 (2,126) (6)%
Total revenue121,775
 94,871
 26,904
 28 % 333,244
 263,414
 69,830
 27 %124,262
 109,756
 14,506
 13 % 247,840
 211,469
 36,371
 17 %
Cost of revenue48,151
 39,230
 8,921
 23 % 135,583
 113,265
 22,318
 20 %42,190
 45,117
 (2,927) (6)% 89,953
 87,432
 2,521
 3 %
Gross profit73,624
 55,641
 17,983
 32 % 197,661
 150,149
 47,512
 32 %82,072
 64,639
 17,433
 27 % 157,887
 124,037
 33,850
 27 %
Gross margin60.5% 58.6%   

 59.3% 57.0% 

 

66.0% 58.9%   

 63.7% 58.7% 

 

Operating expenses:            

 

            

 

Research and development20,141
 13,734
 6,407
 47 % 55,670
 39,676
 15,994
 40 %18,418
 18,029
 389
 2 % 38,330
 35,529
 2,801
 8 %
Sales and marketing28,718
 22,147
 6,571
 30 % 86,288
 69,119
 17,169
 25 %35,605
 29,475
 6,130
 21 % 67,738
 57,570
 10,168
 18 %
General and administrative22,718
 17,342
 5,376
 31 % 62,322
 47,923
 14,399
 30 %23,724
 20,493
 3,231
 16 % 47,494
 39,604
 7,890
 20 %
Total operating expenses71,577
 53,223
 18,354
 34 % 204,280
 156,718
 47,562
 30 %77,747
 67,997
 9,750
 14 % 153,562
 132,703
 20,859
 16 %
Operating income (loss)2,047
 2,418
 (371) (15)% (6,619) (6,569) (50) 1 %4,325
 (3,358) 7,683
 229 % 4,325
 (8,666) 12,991
 150 %
Interest expense and other, net4,153
 5,369
 (1,216) (23)% 13,034
 11,293
 1,741
 15 %5,604
 4,308
 1,296
 30 % 11,840
 8,881
 2,959
 33 %
Loss from continuing operations before income taxes(2,106) (2,951) 845
 (29)% (19,653) (17,862) (1,791) 10 %
Loss before income taxes(1,279) (7,666) 6,387
 83 % (7,515) (17,547) 10,032
 57 %
Income tax expense121
 66
 55
 83 % 318
 195
 123
 63 %412
 101
 311
 308 % 745
 197
 548
 278 %
Net loss from continuing operations(2,227) (3,017) 790
 (26)% (19,971) (18,057) (1,914) 11 %
Loss from discontinued operations, net of tax—
 (64) 64
 (100)% —
 (1,703) 1,703
 (100)%
Net loss$(2,227) $(3,081) $854
 (28)% $(19,971) $(19,760) $(211) 1 %$(1,691) $(7,767) $6,076
 78 % $(8,260) $(17,744) $9,484
 53 %

Revenue
Our total revenue increased to $121.8$124.3 million, up $26.9$14.5 million, or 28%13%, in the thirdsecond quarter of 2018 compared to the second quarter of 2017, due to continued growth in our U.S. Omnipod and International Omnipod revenue. Our U.S. Omnipod revenue increased to $78.0 million, up $12.7 million, or 19%, primarily due to growth in our Omnipod customer base as we continue to expand awareness of and access to the Omnipod System. Our International Omnipod revenue increased to $28.5 million, up $1.9 million, or 7%, over the prior period. The growth during the quarter was unfavorably impacted by fewer shipments to our former European distributor as we approached the expiration date of our distribution agreement with them and by a reduction in revenue to account for $7.4 million of Omnipod inventory that we decided to repurchase from this former distributor as of June 30, 2018 to minimize channel conflict following the expiration of the distribution agreement. This unfavorable impact was offset in part by our initial shipments to country-level intermediaries to ensure an effective transition and product availability upon the expiration of our distribution agreement with our former European distributor.

Our total revenue increased to $247.8 million, up $36.4 million, or 17%, in the six months ended June 30, 2018 compared to the third quarter of 2016,six months ended June 30, 2017, due to strong growth in our U.S. Omnipod revenue, International Omnipod revenue, andpartially offset by a decline in revenue for our on-body injection device for drug delivery. Our U.S. Omnipod revenue increased to $70.1$148.3 million, up $10.4$23.3 million, or 17%19%, primarily due to growth in our installedOmnipod customer base of Omnipod users as we continue to expand awareness of and access to the Omnipod System. Our International Omnipod revenue increased to $32.5$66.9 million, up $13.4$15.2 million, or 70%29%, primarily due to growth in distributor sales fromthe continued adoption of our product in existing international markets and newer markets such as France.partially offset by our transition to direct operations in Europe. Our drug delivery revenue increaseddecreased to $19.2$32.6 million, up $3.1down $2.1 million, or 19%6%, due to strong growth in demand for our primary drug delivery device on greater market adoptionreflecting the number of Amgen's Neulasta Onpro kit.
Our total revenue increased to $333.2 million, up $69.8 million, or 27%,shipments in the nine months ended September 30, 2017 compared toperiod and the nine months ended September 30, 2016, due to strong growth intiming of our U.S. Omnipod revenue, International Omnipod revenue and our on-body injection device for drug delivery. Our U.S. Omnipod revenue increased to $195.1 million, up $28.4 million, or 17%, primarily due to growth in our installed base of Omnipod users as we continue to expand awareness of the Omnipod System. Our International Omnipod revenue increased to $84.2 million, up $33.2 million, or 65%, primarily due to growth in distributor sales from continued adoption in existing and newer markets such as France. Our drug delivery revenue increased to $54.0 million, up $8.3 million, or 18%, due to strong growth in demand for our primary drug delivery device on greater market adoption of Amgen's Neulasta Onpro kit.production activity.

For the year ending December 31, 2017,2018, we expect strong revenue growth across all of our product lines as we continuedriven by our expansion in the U.S. and internationally.internationally, as well as the transition to direct distribution of our Omnipod System across Europe following the expiration of our global distribution agreement with our European distributor on June 30, 2018, partially offset by lower drug delivery revenue.

Cost of Revenue
Cost of revenue increaseddecreased to $48.2$42.2 million, up $8.9down $2.9 million, or 23%6%, in the thirdsecond quarter of 20172018 compared to the same period in 2016 and2017 due to improvements in supply-chain operations, partially offset by an increase in volumes. Cost of revenue increased to $135.6$90.0 million, up $22.3$2.5 million, or 20%3%, in the ninesix months ended SeptemberJune 30, 20172018 compared to the same period in 2016,2017, reflecting an increase in sales volumes partially offset by improvements in supply chain operations.

gross margins.
Gross Margin
Gross margin increased to 60%66.0%, up 1.9%710 basis points in the thirdsecond quarter of 20172018 compared to the same period in 2016.2017. Gross margin for the ninesix months ended SeptemberJune 30, 20172018 was 59%63.7% compared with 57%58.7% for the ninesix months ended SeptemberJune 30, 2016.2017. The margin increase in each period was primarily due to improvements in supply chain operations partially offset byand, to a lesser extent, the unfavorablegeographic mix impact of higher distributor sales in Europe.
Forour global Omnipod sales. We expect gross margin to increase for the year ending December 31, 2017, we expect gross margin to increase2018 as compared to 20162017 primarily due to improvements in supply chain operations partially offset by the unfavorable mix impactand our assumption of higher distributor salescommerical activities associated with of our Omnipod System in Europe.
Research and Development
Research and development expenses increased to $20.1$18.4 million, up $6.4$0.4 million, or 47%2%, for the three month period ended SeptemberJune 30, 20172018 compared to the same period in 20162017 and increased to $55.7$38.3 million, up $16.0$2.8 million, or 40%8%, for the ninesix months ended SeptemberJune 30, 20172018 compared to the same period in 2016.2017. The increase in both periods was primarily due to an increase in expenses related to our development projects, including our DASH TM System, our next-generation digital mobile Omnipod platform, which involves interaction with continuous glucose monitoring technology, and our artificial pancreas program.
platform. For the year ending December 31, 2017,2018, we expect overall research and development spending to increase as compared to 20162017 due to the development efforts on our on-going projects described above.projects.
Sales and Marketing
Sales and marketing expenses increased to $28.7$35.6 million, up $6.6$6.1 million, or 30%21%, for the three month period ended SeptemberJune 30, 20172018 compared to the same period in 20162017 and increased to $86.3$67.7 million, up $17.2$10.2 million, or 25%18%, for the ninesix months ended SeptemberJune 30, 20172018 compared to the same period in 2016. The increase in sales and marketing expenses in both periods was2017. These increases were primarily attributable to investments to support our assumption in mid-2018 of direct commercial support for Omnipod in Europe, increased personnel-related expenses associated with the expansion of our customer support, market access and sales force personnel, investments to support our assumption in mid-2018 of direct commercial support for Omnipod in Europe, and increased advertising expenses associated with direct to patient marketing activities.

These increases were partially offset by incremental capitalized commission costs of $2.5 million during the three months ended June 30, 2018 and $6.5 million during the six months ended June 30, 2018 related to the acquisition of new customer contracts, less quarterly amortization of previously capitalized costs of $1.7 million for the three month period ended June 30, 2018 and $3.3 million for the six month period ended June 30, 2018. This method of accounting for commission costs was adopted in the first quarter of 2018 with the adoption ASC 606. For the year ending December 31, 2017,2018, we expect sales and marketing expense to increase as compared to 20162017 due to the sales and marketing effortseffort as described above.above, partially offset by the capitalization of commission costs under ASC 606.
General and Administrative
General and administrative expenses increased to $22.7$23.7 million, up $5.4$3.2 million, or 31%16%, for the three month period ended SeptemberJune 30, 20172018 compared to the same period in 20162017 and increased to $62.3$47.5 million, up $14.4$7.9 million, or 30%20%, for the nine monthssix month period ended SeptemberJune 30, 20172018 compared to the same period in 2016.2017. This increase was primarily attributable to increased personnel-related costs and fees related to external consultants and professional service providers to support the growthour assumption in our business.
mid-2018 of direct support for Omnipod in Europe. For the year ending December 31, 2017,2018, we expect overall general and administrative expenses to increase as compared to 20162017 as we continue to grow the business and make investments in our operating structure to support this continued growth.growth as well as the establishment of direct commercial operations in Europe.
Interest Expense and Other, Net
Interest expense and other, net, decreasedincreased to $4.2$5.6 million, down $1.2up $1.3 million, or 23%30%, for the three month period ended SeptemberJune 30, 20172018 compared to the same period in 20162017 and increased to $13.0$11.8 million, up $1.7$3.0 million, or 15%33%, for the nine monthssix month period ended SeptemberJune 30, 2017 compared to the same period2018. The increase in 2016. The decrease in the three month periodboth periods is primarily due to a $2.6 million charge related to the extinguishmenteffect of debt in the prior period, partially offset by additional interest expense, including cash and non-cash interest, associated with the issuancerelated to our 1.375% Notes, which were issued in September 2016 of 1.25% convertible senior notes, which increased our net outstanding long-term debt. The increase in the nine month period is due to a net increase on our outstanding long-term debt,November 2017, partially offset by a lower effectivereduction in interest rateexpense related to our 2% Notes, which were retired in 2018, and an increase in interest income on outstanding debt. Please refer to Liquidity and Capital Resources for further discussion of our convertible debt.




investments in marketable securities.





Liquidity and Capital Resources
As of SeptemberJune 30, 2017,2018, we had $102.2$136.2 million in cash and cash equivalents and $173.5$319.6 million of investments in short-term investments.marketable securities. We believe that our current liquidity together with the cash expected to be generated from sales, will be sufficient to meet our projected operating, investing and debt service requirements for at least the next twelve months.

To lower our manufacturing costs, increase supply redundancy, add capacity closer to our largest customer base and support growth, we are constructing a highly-automated manufacturing facility in Acton, Massachusetts, with planned production out of the facility beginning in 2019. We expectThis facility will also serve as our global headquarters. As a result, capital expenditures to increasehave increased above historic levels to fund the construction of the manufacturingActon facility and related equipment purchases. As of June 30, 2018, investments in construction-in-progress related to the Acton facility were approximately $146 million. We believeexpect that capital expenditures for this facility will approach $200 million when production begins in 2019.
In connection with our current liquidityassumption on July 1, 2018, of all commercial activities of our Omnipod System across Europe following the expiration of our distribution agreement with our European distributor on June 30, 2018, we will be sufficientrequired to meetpay to the European distributor a per unit fee for sales of our projected expenditures associatedOmnipod device over the subsequent twelve months following the expiration of the global distribution agreement. The fee will be based on our sales of the Omnipod device to identified customers (as that term is defined in the distribution agreement) of the European distributor who had previously entered into an agreement with this project.the distributor for the purchase of Omnipod devices. While the actual total fee could vary significantly, we estimate that the total fee could be in the range of approximately $10 million to $55 million. The fee will be determined and paid on a quarterly basis following the expiration of the distribution agreement and the actual amount of the fee will depend on a number of factors and will not be known until the number of qualifying sales of Omnipod devices is determined following each quarter beginning with the quarter ending September 30, 2018.
Convertible Debt
In September 2016,order to finance our operations and global expansion, we have periodically issued and sold $345.0 million in principal amount of 1.25% Convertible Senior Notes, due September 15, 2021 ("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. Interest began accruing on September 13, 2016; the first interest payment was paid in March 2017. The 1.25% Noteswhich are convertible into our common stock at an initial conversion ratestock. As of 17.1332 shares of common stock per $1,000 principal amount ofJune 30, 2018, the 1.25%following 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.were outstanding:
Cash interest expense related to the 1.25% Notes was $1.1 million and $3.3 million in the three and nine months ended September 30, 2017, respectively. Non-cash interest expense related to the 1.25% Notes of $3.4 million and $10.1 million was comprised of the amortization of the debt discount and debt issuance costs in the three and nine months ended September 30, 2017, respectively.
In June 2014, we issued and sold $201.3 million in principal amount of 2% Convertible Senior Notes due June 15, 2019 ("2% Notes"). The interest rate on the notes is 2% per annum, payable semi-annually in arrears in cash on June 15 and December 15 of each year. The
      
Issuance DateCouponPrincipal Outstanding (in thousands)Due DateInitial Conversion Rate per Share of Common StockConversion Price per Share of Common Stock
September 20161.250%$345,000
September 15, 202117.1332$58.37
November 20171.375%402,500
November 15, 202410.7315$93.18
Total $747,500
   

We called our 2% Notes are convertible into our common stock at an initial conversion rate of 21.5019 shares of common stock per $1,000 principal amount ofin March 2018 and settled the 2% Notes, which is equivalent to a conversion price of approximately $46.51 per share, subject to adjustment under certain circumstances.
In September 2016,outstanding notes in connection with the issuance of $345.0 million in principal amount of 1.25% Notes discussed above, we repurchased approximately $134.2 million in principal amount of the 2% Notes for $154.3 million, including $0.7 million of accrued interest. The $154.3 million paid to extinguish the debt was allocated to debt and equity based on their respective fair values immediately prior to the transaction. We allocated $121.4 million of the payment to the debt and $32.9 million to equity.
Cash interest expense related to the 2% Notes was $0.3 million and $0.9 million in the three months ended September 30, 2017 and 2016, respectively, and was $1.0 million and $2.9 million in the nine months ended September 30, 2017 and 2016, respectively.
Non-cash interest expense related to the 2% Notes of $0.7 million and $1.6 million was comprised of the amortization of the debt discount and debt issuance costs in the three months ended September 30, 2017 and 2016, respectively. Non-cash interest expense related to the 2% Notes of $2.1 million and $5.6 million was comprised of the amortization of the debt discount and debt issuance costs in the nine months ended September 30, 2017 and 2016, respectively.May 2018.
Additional information regarding our debt issuances is provided in Note 6 to the consolidated financial statements included in this Form 10-Q.

Summary of Cash Flows
 Nine Months Ended September 30, Six Months Ended June 30,
(In thousands) 2017 2016 2018 2017
Cash provided by (used in):        
Operating activities $19,407
 $(4,159) $(10,395) $(3,871)
Investing activities (61,485) (80,827) (117,103) (64,266)
Financing activities 6,650
 177,558
 (8,172) 4,194
Effect of exchange rate changes on cash 487
 158
 (661) 257
Net (decrease) increase in cash and cash equivalents $(34,941) $92,730
Net decrease in cash and cash equivalents $(136,331) $(63,686)

Operating Activities
Our net cash provided byused in operating activities for the ninesix months ended SeptemberJune 30, 20172018 was $19.4$10.4 million,compared tonet cash used in operating activities of $4.2$3.9 million in the same period of 2016, an increase of $23.6 million.2017. The increase in cash provided byused in operating activities in the current period is primarily due to additional inventory purchasesa $10.5 million increase in 2016 in orderdisbursements due to support customer demand and to allow for alternative shipping methods, the growth of our business in the current period and the timing of cash disbursements. This impact wasthe settlement of accounts payable and a $9.5 million increase in inventory in anticipation of future demand, partially offset by an increasea $9.5 million improvement in accounts receivable, which was primarily due to an increase in sales.operating results.




Investing Activities
Our net cash used in investing activities for the ninesix months ended SeptemberJune 30, 20172018 was $61.5$117.1 million compared to $80.8$64.3 million in the same period of 2016. Investing2017. The increase in cash used in investing activities in the current period is primarily consists of $47.8due to a $50.9 million ofincrease in capital expenditures, primarily associated with investments in our supply chain operations, which include approximately $29.8 $64million for facility and equipment in process of construction to support our U.S. manufacturing initiatives, and $13.7 million of investments in marketable securities, net of sales and maturities. Cash used in investing activities in the nine months ended September 30, 2016 primarily related to investments in marketable securities of $76.2 million.initiatives.
Financing Activities
Our net cash provided byused in financing activities for the ninesix months ended SeptemberJune 30, 20172018 was $8.2 million as compared to net cash provided by financing activities of $4.2 million in the same period of 2017. The increase in cash used in financing activities was primarily due to a $9.3 million increase in payments for amounts withheld for taxes related to the vesting of restricted stock units and $6.7 million which primarily includesin payments for the settlement of our 2% Notes, partially offset by an increase in proceeds from the exercise of stock options, as compared to net cash of $177.6 million provided in the same period of 2016. The decrease in cash provided by financing activities in the current period as compared to the same period in the prior year was primarily attributable to proceeds from the issuance of our 1.25% Notes, net of the retirement of our 2% Notes as further described above, that occurred in the nine months ended September 30, 2016 where no such convertible debt financing activity occurred in the current period.options.
Commitments and Contingencies
We lease our facilities in Massachusetts, California, Tennessee, Utah, the United Kingdom, France, Germany, Canada and China. These leases are accounted for as operating leases and generally provide for a base rent plus real estate taxes and certain operating expenses related to the leases. Certain of our 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.
Legal Proceedings
The significant estimates and judgments related with establishing litigation reserves are discussed under "Legal Proceedings" in Note 1213 to the consolidated financial statements included in this Form 10-Q.

Off-Balance Sheet Arrangements
As of SeptemberJune 30, 20172018, we did not have any off-balance sheet financing arrangements.

Critical Accounting Policies and Estimates
Our financial statements are based on the selection and application of generally accepted accounting principles, which require us to make estimates and assumptions about future events that affect the amounts reported in our financial statements and the accompanying condensed notes. Future events and their effects cannot be determined with certainty.

Therefore, the determination of estimates requires the exercise of judgment. Actual results could differ from those estimates, and any such differences may be material to our financial statements.
We have reviewed our policies and estimates to determine our critical accounting policies for the ninesix months ended SeptemberJune 30, 2017.2018. We have made no material changes to the critical accounting policies described in our Annual Report on Form 10-K for the year ended December 31, 2016.2017 other than our accounting policies related to revenue recognition and our policies related to the accounting for commissions expense as a result of the adoption of Accounting Standards Update No. 2014-09, Revenue from Contracts with Customers, which was adopted on January 1, 2018 as further described in Note 3 to the consolidated financial statements included in this Form 10-Q.
Recent Accounting Pronouncements
Information with respect to recent accounting pronouncements is provided in Note 2 to the consolidated financial statements included in this Form 10-Q.

Item 3. Quantitative and Qualitative Disclosures about Market Risk
We do not use derivative financial instruments in our investment portfolio and have no foreign exchange contracts. Our financial instruments consist of cash, cash equivalents, short-term and long-term investments, accounts receivable, accounts payable, accrued expenses, debt and long-term obligations. We consider investments that, when purchased, have a remaining maturity of 90 days or less to be cash equivalents. The primary objectives of our investment strategy are to preserve principal, maintain proper liquidity to meet operating needs and maximize yields. To minimize our exposure to an adverse shift in interest rates, we invest mainly in short-term investments and cash equivalents. We do not believe that a 10% change in interest rates would have a material impact on the fair value of our investment portfolio or our interest income.
As of SeptemberJune 30, 2017,2018, we had outstanding debt related to our Convertible Senior Notes recorded on our consolidated balance sheet of $345.0$577.1 million, net of unamortized discount and issuance costs totaling $170.4 million. Changes in the fair value of our deferred financing costs and unamortizedoutstanding debt, discount totaling $67.1 million, related to our 2% and 1.25% Notes. As the interest rates are fixed,which could be impacted by changes in interest rates, doare not affectrecorded in these consolidated financial statements as the debt is accounted for at cost less unamortized discount and issuance costs. The fair value of the debt, which is disclosed in Note 4 to the consolidated financial statements, is also impacted by changes on our debt.stock price.

Our business is subject to risks, including, but not limited to: unique economic conditions, changes in political climate, differing tax structures, other regulations and restrictions, and foreign exchange rate volatility.  WeA substantial portion of our operations are primarily exposedlocated in the United States, and the majority of our sales since inception have been made in United States dollars. Accordingly, we have assessed that we do not have any material net exposure to foreign currency exchange rate fluctuations at this time. However, as our business in markets outside of the United States continues to increase, we will be exposed to foreign currency exchange risk related to our subsidiary operationforeign operations. Fluctuations in Canada. The majoritythe rate of exchange between the United States dollar and foreign currencies, primarily the Euro, Canadian Dollar, and the British Pound, could adversely affect our sales outside of the U.S. are currently transacted in U.S. dollarsfinancial results, including our revenues, revenue growth rates, gross margins, income and are not subjectlosses as well as assets and liabilities.
We will continue to materialmonitor and evaluate our internal processes relating to foreign currency fluctuations.
Fluctuations in foreign currency rates could affect our revenue, costexchange, including the potential use of revenue and operating margins and could result in exchange losses. In addition, currency devaluations can result in a loss if we hold deposits of that currency. A hypothetical 10% increase or decrease in foreign currencies that we transact in would not have a material adverse impact on our business, financial condition or results of operations.hedging strategies.

Item 4. Controls and Procedures
Disclosure Controls and Procedures
Our management, with the participation of our chief executive officer and chief financial officer, evaluated the effectiveness of our disclosure controls and procedures as of SeptemberJune 30, 2017.2018. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”) means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the Securities and Exchange Commission’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of SeptemberJune 30, 2017,2018, our chief executive officer and chief financial officer concluded that, as of such date, our disclosure controls and procedures were effective at a reasonable assurance level.
Changes in Internal Control Over Financial Reporting
There were no changes in our internal control over financial reporting that occurred during the ninesix months ended SeptemberJune 30, 20172018 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings
Information regarding our material pending legal proceedings, which is incorporated herein by reference, is provided in Note 1213 to the consolidated financial statements in this Form 10-Q.

Item 1A. Risk Factors
In addition to the other information set forth in this report, you should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2016,2017, which could materially affect our business, financial condition or future results. These risks are not the only risks we face. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results. Other than the risks listed below, thereThere have been no material changes in our risk factors from those disclosed in our Annual Report on Form 10-K for the year ended December 31, 2016.
Our planned assumption on July 1, 2018 of the distribution, sales, marketing, training and support activities of our Omnipod System in Europe following the expiration of our current third-party global distribution agreement creates several business and operational risks related to the future sales of our Omnipod System in Europe.

On July 20, 2017, we announced our plan to assume, on July 1, 2018, the distribution, sales, marketing, training and support activities of our Omnipod System across Europe following the expiration of our global distribution agreement with Ypsomed on June 30, 2018. Until the expiration of the agreement, Ypsomed will remain the distributor of our Omnipod products in Europe. While we do not expect this transition to materially affect our financial trends for the remainder of 2017, there could be a negative effect on our sales during the transition period if Ypsomed places more emphasis on selling its own proprietary products and other products, instead of ours, during this period, thereby reducing our sales. In addition, to retain current revenue streams after July 1, 2018, we will need to secure the existing customer installed base of Omnipod users in Europe, and there can be no assurance that we will succeed in doing so. More generally, if we are unable to effectively establish direct distribution and commercial support for the Omnipod System in Europe in a timely manner (which may include hiring employees in many of these jurisdictions), we may not be able to service the current Omnipod users in Europe and grow the business as we anticipate. We expect to incur increased operating expenses as we invest in these European operations, and it is possible that the ultimate economic benefits that we derive from these investments could be less than anticipated, or that such expected economic benefits could fail to materialize at all. Any of the foregoing risks could negatively affect our future revenues and, depending on severity, potentially cause a materially adverse effect on our business and results of operations.2017.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.

Item 3. Defaults Upon Senior Securities
None.

Item 4. Mine Safety Disclosures
Not applicable.

Item 5. Other Information
None.

Item 6. Exhibits
Number Description
   
3.1
Certificate of Elimination of Series A Junior Participating Cumulative Preferred Stock of Insulet Corporation (Incorporated by reference to Exhibit 3.1 to the Company’s Current Report on Form 8-K filed May 7, 2018).

   
10.14.1
 
Amendment No. 3 to Shareholder Rights Agreement, dated May 7, 2018 (Incorporated by reference to Exhibit 4.1 to the Company’s Current Report on Form of8-K filed May 7, 2018).

10.1 +
First Amendment to Materials Supplier Agreement between Insulet Corporation 2017 Stock Option and Incentive Plan Performance Vesting Restricted Stock UnitFlextronics Medical Sales and Marketing, Ltd, entered into on June 29, 2018 and made effective as of January 1, 2018.

10.2
Letter Agreement for Officersbetween Brad Thomas and Insulet Corporation, dated April 27, 2018 (Incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed May 1, 2018).

   
31.1
 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Executive Officer.
   
31.2
 Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 by Chief Financial Officer.
   
32.1*
 Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, by Chief Executive Officer and Chief Financial Officer.
   
101 The following materials from Insulet Corporation’s Quarterly Report on Form 10-Q for the quarter ended June 30, 20172018 formatted in XBRL (eXtensible Business Reporting Language), as follows:
   
  (i) Consolidated Balance Sheets as of SeptemberJune 30, 20172018 (Unaudited) and December 31, 20162017
   
  (ii) Consolidated Statements of Operations for the Three and NineSix Months Ended SeptemberJune 30, 20172018 and 20162017 (Unaudited)
   
  (iii) Consolidated Statements of Comprehensive Loss for the Three and NineSix Months Ended SeptemberJune 30, 20172018 and 20162017 (Unaudited)
   
  (iv) Consolidated Statements of Cash Flows for the NineSix Months Ended SeptemberJune 30, 20172018 and 20162017 (Unaudited)
   
  (iv) Condensed Notes to Consolidated Financial Statements (Unaudited)
   
* This certification shall not be deemed “filed” for purposes of Section 18 of the Securities Exchange Act of 1934, or otherwise subject to the liability of that Section, nor shall it be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934.
+
Confidential treatment requested as to certain portions of this exhibit.


SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
  
INSULET CORPORATION
 
(Registrant)
   
Date:NovemberAugust 2, 20172018/s/ Patrick J. Sullivan
  Patrick J. Sullivan
  
Chief Executive Officer
(Principal Executive Officer)
 
   
Date:NovemberAugust 2, 20172018/s/ Michael L. Levitz
  Michael L. Levitz
  
Chief Financial Officer
(Principal Financial and Accounting Officer)



37