# Insulet Corp: Form 10-Q for the period ended Sep 30, 2011

- Company: [Insulet Corp](/companies/podd.md) (CIK 1145197)
- Form: 10-Q
- Filed: 2011-11-08
- Accepted by EDGAR: Nov 8, 2011, 21:05 ET
- Period: 2011-09-30
- Accession: 0000950123-11-096474
- Inline XBRL: yes
- Main document: https://www.sec.gov/Archives/edgar/data/1145197/000095012311096474/b87826e10vq.htm
- All documents and exhibits: https://www.sec.gov/Archives/edgar/data/1145197/000095012311096474/

## Figures reported in this filing

Standardized XBRL line items for the period ended 2011-09-30.

| Line item | Period | Value | XBRL concept |
| --- | --- | ---: | --- |
| Revenue | 3 months, 2011-07-01 to 2011-09-30 | $44.6m | us-gaap:SalesRevenueNet |
| Revenue | 9 months, 2011-01-01 to 2011-09-30 | $105.1m | us-gaap:SalesRevenueNet |
| Cost of revenue | 3 months, 2011-07-01 to 2011-09-30 | $26.0m | us-gaap:CostOfGoodsAndServicesSold |
| Cost of revenue | 9 months, 2011-01-01 to 2011-09-30 | $58.4m | us-gaap:CostOfGoodsAndServicesSold |
| Gross profit | 3 months, 2011-07-01 to 2011-09-30 | $18.6m | us-gaap:GrossProfit |
| Gross profit | 9 months, 2011-01-01 to 2011-09-30 | $46.6m | us-gaap:GrossProfit |
| Research and development | 3 months, 2011-07-01 to 2011-09-30 | $4.6m | us-gaap:ResearchAndDevelopmentExpense |
| Research and development | 9 months, 2011-01-01 to 2011-09-30 | $16.1m | us-gaap:ResearchAndDevelopmentExpense |
| Operating income | 3 months, 2011-07-01 to 2011-09-30 | −$9.8m | us-gaap:OperatingIncomeLoss |
| Operating income | 9 months, 2011-01-01 to 2011-09-30 | −$32.0m | us-gaap:OperatingIncomeLoss |
| Net income | 3 months, 2011-07-01 to 2011-09-30 | −$13.6m | us-gaap:NetIncomeLoss |
| Net income | 9 months, 2011-01-01 to 2011-09-30 | −$42.8m | us-gaap:NetIncomeLoss |
| Diluted EPS | 3 months, 2011-07-01 to 2011-09-30 | −$0.29 | us-gaap:EarningsPerShareBasicAndDiluted |
| Diluted EPS | 9 months, 2011-01-01 to 2011-09-30 | −$0.92 | us-gaap:EarningsPerShareBasicAndDiluted |
| Operating cash flow | 9 months, 2011-01-01 to 2011-09-30 | −$17.8m | us-gaap:NetCashProvidedByUsedInOperatingActivities |
| Capital expenditure | 9 months, 2011-01-01 to 2011-09-30 | $8.8m | us-gaap:PaymentsToAcquirePropertyPlantAndEquipment |
| Cash and equivalents | at 2011-09-30 | $103.8m | us-gaap:CashAndCashEquivalentsAtCarryingValue |
| Current assets | at 2011-09-30 | $137.9m | us-gaap:AssetsCurrent |
| Total assets | at 2011-09-30 | $215.8m | us-gaap:Assets |
| Current liabilities | at 2011-09-30 | $24.8m | us-gaap:LiabilitiesCurrent |
| Total liabilities | at 2011-09-30 | $132.3m | us-gaap:Liabilities |
| Shareholders' equity | at 2011-09-30 | $83.4m | us-gaap:StockholdersEquity |

## Management's discussion and analysis

As filed, 63,541 characters.

*You should read the following discussion of our financial condition and results of operations in conjunction with our consolidated financial statements and the accompanying notes to those financial statements included in this Quarterly Report on Form 10-Q. This Quarterly Report on Form 10-Q contains forward-looking statements. These forward-looking statements are based on our current expectations and beliefs concerning future developments and their potential effects on us. There can be no assurance that future developments affecting us will be those that we have anticipated. These forward-looking statements involve a number of risks, uncertainties (some of which are beyond our control) or other assumptions that may cause actual results or performance to be materially different from those expressed or implied by these forward-looking statements. These risks and uncertainties include, but are not limited to: risks associated with our dependence on the OmniPod System; our ability to increase customer orders and manufacturing volumes; adverse changes in general economic conditions; impact of healthcare reform legislation; 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 other third-party suppliers on which we are dependent; international business risks; our inability to obtain adequate coverage or reimbursement from third-party payors for the OmniPod System and potential adverse changes in reimbursement rates or policies relating to the OmniPod; potential adverse effects resulting from competition with competitors; technological innovations adversely affecting our business; potential termination of our license to incorporate a blood glucose meter into the OmniPod System; 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 the proprietary rights of others; adverse regulatory or legal actions relating to the OmniPod System; failure to obtain timely regulatory approval for the sale of the next generation OmniPod System; failure of our contract manufacturers or component suppliers to comply with FDA’s quality system regulations, the potential violation of federal or state laws prohibiting “kickbacks” or protecting patient health information, or any challenges to or investigations into our practices under these laws; product liability lawsuits that may be brought against us; reduced retention rates; 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 physician associations or other organizations that are unfavorable to our products; the expansion, or attempted expansion, into foreign markets; the concentration of substantially all of our manufacturing capacity at a single location in China and substantially all of our OmniPod System inventory at a single location in Massachusetts; our ability to attract and retain key personnel; our ability to manage our growth; failure to integrate successfully the Neighborhood Diabetes business; intense competition among distributors of diabetes supplies impairing Neighborhood Diabetes’ business; loss by Neighborhood Diabetes of an opportunity to sell insulin pumps supplied by our competitors; failure by Neighborhood Diabetes to retain key supplier and payor partners; failure by Neighborhood Diabetes to retain supplier pricing discounts and achieve satisfactory gross margins; failure by Neighborhood Diabetes to retain and manage successfully its Medicare and Medicaid business; existence of unanticipated liabilities arising in connection with the Neighborhood Diabetes business; fluctuations in quarterly results of operations; risks associated with potential future acquisitions; 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 controls; and other risks and uncertainties described in our Annual Report on Form 10-K, which was filed with the Securities and Exchange Commission on March 10, 2011 in the section entitled “Risk Factors,” and in our other filings from time to time with the Securities and Exchange Commission. Should one or more of these risks or uncertainties materialize, or should any of our assumptions prove incorrect, actual results may vary in material respects from those projected in these forward-looking statements. We undertake no obligation to publicly update or revise any forward-looking statements.*

### Overview

We are a medical device company that develops, manufactures and markets an insulin infusion system for people with insulin-dependent diabetes. Our proprietary OmniPod Insulin Management System (the “OmniPod System”) consists of our disposable OmniPod insulin infusion device and our handheld, wireless Personal Diabetes Manager, (‘PDM”). The U.S. Food and Drug Administration, (“FDA”), approved the OmniPod System in January 2005. In October 2005, we shipped our first commercial OmniPod System.

We have progressively expanded our marketing efforts from an initial focus in the Eastern United States to having availability of the OmniPod System across the entire United States. In January 2010, we entered into a five year distribution agreement with Ypsomed Distribution AG, (“Ypsomed”), to become the exclusive distributor of the OmniPod System in eleven countries, subject to approved reimbursement. Through our partnership with Ypsomed, the OmniPod System is now available in seven markets, namely Germany, the United Kingdom, France, the Netherlands, Sweden, Norway and Switzerland. We expect that Ypsomed will begin distribution of the OmniPod System, subject to approved reimbursement, in the other markets under the agreement in 2012. In February 2011, we entered into a distribution agreement with GlaxoSmithKline Inc., (“GSK”), to become the exclusive distributor of the OmniPod System in Canada. We made an initial shipment of OmniPods to GSK during the second quarter of 2011, and GSK began distributing the OmniPod System during the third quarter of 2011. We focus our sales initiatives towards key diabetes practitioners, academic centers and clinics specializing in the treatment of diabetes patients, as well as individual diabetes patients.

On June 1, 2011, we completed the acquisition of Neighborhood Holdings, Inc. and its wholly-owned subsidiaries (collectively, “Neighborhood Diabetes”), a leading durable medical equipment distributor, specializing in direct to consumer sales of diabetes supplies. Neighborhood Diabetes is based in Woburn, Massachusetts with additional facilities in Brooklyn, New York and Orlando, Florida. Neighborhood Diabetes serves more than 60,000 customers with Type 1 and Type 2 diabetes primarily in the northeast and southeast regions of the United States. Neighborhood Diabetes supplies these customers with blood glucose testing supplies, insulin pumps, pump supplies, pharmaceuticals, and other products for the management and treatment of diabetes.

We currently produce the OmniPod System on a partially automated manufacturing line at a facility in China operated by a subsidiary of Flextronics International Ltd. (“Flextronics”). We purchase complete OmniPods pursuant to our agreement with Flextronics. Under the agreement, Flextronics has agreed to supply us, as a non-exclusive supplier, with OmniPods at agreed upon prices per unit pursuant to a rolling 12-month forecast that we provide. The agreement may be terminated at any time by either party upon prior written notice given no less than a specified number of days prior to the date of termination. The specified number of days is intended to provide the parties with sufficient time to make alternative arrangements in the event of termination. By purchasing OmniPods manufactured by Flextronics in China, we have been able to substantially increase production volumes for the OmniPod and reduce our per unit production cost.

To achieve profitability, we continue to seek to increase manufacturing volume and reduce the per-unit production cost for the OmniPod. By increasing production volumes of the OmniPod, we have been able to reduce our per-unit raw material costs and improve absorption of manufacturing overhead costs. This, as well as the introduction of our next generation OmniPod, is important as we strive to achieve profitability. We believe our current manufacturing capacity is sufficient to meet our expected 2011 demand for OmniPods.

Neighborhood Diabetes is a distributor of blood glucose testing supplies, insulin pumps, pump supplies, pharmaceuticals and other products for the management and treatment of diabetes. Neighborhood Diabetes purchases products from manufacturers at contracted rates and supplies these products to its customers. Based on market penetration, payor plans and other factors, certain manufacturers provide rebates based on product sold. Neighborhood Diabetes records these rebates as a reduction to cost of goods sold as they are earned.

Our sales and marketing effort is focused on generating demand and acceptance of the OmniPod System among healthcare professionals, people with insulin-dependent diabetes, third-party payors, government agencies, and third-party distributors. Our marketing strategy is to build awareness for the benefits of the OmniPod System through a wide range of education programs, social networking, patient demonstration programs, support materials, media advertisements and events at the national, regional and local levels. We are using third-party distributors to improve our access to managed care and government reimbursement programs, expand our commercial presence and provide access to additional potential patients.

Neighborhood Diabetes has built a strong infrastructure in the reimbursement, billing and collection areas that provide for adjudication of claims as either durable medical equipment or through pharmacy benefits. Claims are adjudicated under private insurers, Medicaid or Medicare. Neighborhood Diabetes’ business model requires collaboration with physicians, medical device manufacturers, pharmaceutical distributors, private insurers and public insurers such as The Center for Medicare & Medicaid Services, (“CMS”), who we collectively refer to as partners. Neighborhood Diabetes’ net sales are primarily generated from distributing diabetes supplies and pharmaceuticals pursuant to agreements with its partners.

As a medical device company, reimbursement from third-party payors is an important element of our success. If patients are not adequately reimbursed for the costs of using the OmniPod System, it will be much more difficult for us to penetrate the market. We continue to negotiate contracts establishing reimbursement for the OmniPod System with national and regional third-party payors. As part of the integration of Neighborhood Diabetes, we are aligning third-party payor contracts, both ours and those of Neighborhood Diabetes, to be able to better leverage our cross-selling initiatives. As we expand our sales and marketing focus, increase our manufacturing capacity, expand to international markets and leverage the Neighborhood Diabetes model, we will need to maintain and expand available reimbursement for our product offerings.

Since our inception in 2000, we have incurred losses every quarter. In the three and nine months ended September 30, 2011, we incurred net losses of $13.6 million and $42.8 million, respectively. As of September 30, 2011, we had an accumulated deficit of $426.7 million. We have financed our operations through private placements of debt and equity securities, public offerings of our common stock and issuances of convertible debt and borrowings under certain other debt agreements. As of September 30, 2011, we had $158.8 million of convertible debt outstanding. Of the $158.8 million of convertible debt outstanding, approximately $15 million matures in June 2013 and approximately $143.8 million matures in June 2016.

Our long-term financial objective is to achieve and sustain profitable growth. Our efforts for the remainder of 2011 are focused primarily on the development, production and regulatory approval of our next generation OmniPod System, the expansion of sales by continuing to add new patients as well as increasing the sales to existing patients by offering additional products and services, and the integration of Neighborhood Diabetes. Achieving these objectives is expected to require additional investments in certain personnel and initiatives to allow for us to increase our penetration in the United States and international markets. We believe that we will continue to incur net losses in the near term in order to achieve these objectives. However, we believe that the accomplishment of our near term objectives will have a positive impact on our financial condition in the future.

We believe that our cash and cash equivalents, together with the cash expected to be generated from product sales, will be sufficient to meet our projected operating and debt service requirements for the next twelve months.

### Acquisition of Neighborhood Diabetes

On June 1, 2011, we acquired all of the outstanding shares of Neighborhood Diabetes, a durable medical equipment distributor specializing in direct to consumer sales of diabetes supplies, including pharmaceuticals, and support services. Neighborhood Diabetes serves more than 60,000 customers with Type 1 and Type 2 diabetes primarily in the northeast and southeast regions of the United States with blood glucose testing supplies, insulin pumps, pump supplies, pharmaceuticals, as well as other products for the management and treatment of diabetes. Neighborhood Diabetes is based in Woburn, Massachusetts, with additional offices in Brooklyn, New York and Orlando, Florida. At the time of the acquisition, Neighborhood Diabetes employed approximately 200 people across its three locations. The acquisition of Neighborhood Diabetes provides us with full suite diabetes management product offerings, accelerates our sales force expansion, strengthens our back office support capabilities, expands our access to insulin dependent patients, and provides pharmacy adjudication capabilities to drive incremental sales higher. The aggregate purchase price of approximately $62.4 million consisted of approximately $37.9 million in cash paid at closing, 1,197,631 shares of our common stock valued at approximately $24.4 million, or $20.40 per share based on the closing price of our common stock on the acquisition date, and contingent consideration with a fair value of approximately $0.1 million. Of the $37.9 million of cash, $6.6 million is being held in an escrow account to reimburse us and our affiliates, if necessary, for certain claims for which they are entitled to be indemnified pursuant to the terms of the agreement and plan of merger with Neighborhood Diabetes.

We have accounted for the acquisition of Neighborhood Diabetes as a business combination. Under business combination accounting, the assets and liabilities of Neighborhood Diabetes were recorded as of the acquisition date, at their respective fair values, and consolidated with our results. The excess of the purchase price over the fair value of net assets acquired was recorded as goodwill. The operating results of Neighborhood Diabetes have been included in the consolidated financial statements since June 1, 2011, the date the acquisition was completed. If the acquisition had occurred as of January 1, 2010, consolidated revenue would have been approximately $130.0 million and $113.1 million for the nine months ended September 30, 2011 and 2010, respectively. Consolidated net loss would have been approximately $44.1 million and $38.8 million for the nine months ended September 30, 2011 and 2010, respectively. For the three and nine months ended September 30, 2011, we included approximately $10.4 million and $14.1 million of revenue related to pharmacy and testing supplies sold by Neighborhood Diabetes, respectively. The purchase price allocation, including an independent appraisal for intangible assets, has been prepared based on the information that was available to management at the time the consolidated financial statements were prepared, and revisions to the preliminary purchase price allocation will be made as additional information becomes available with respect to the fair value of the net assets acquired. The preliminary purchase price at June 1, 2011 has been allocated as follows (in thousands):

| Calculation of allocable purchase price: |  |
| --- | ---: |
| Cash | $37,855 |
| Common stock | 24,432 |
| Contingent consideration obligations | 61 |
| Total allocable purchase price | $62,348 |
| Preliminary allocation of purchase price: |  |
| Accounts receivable | $5,387 |
| Inventories | 2,336 |
| Prepaid expenses and other current assets | 242 |
| Property and equipment | 391 |
| Customer relationships | 30,100 |
| Tradenames | 2,800 |
| Goodwill | 26,727 |
| Other assets | 233 |
| Accounts payable | 4,109 |
| Accrued expenses | 1,700 |
| Other long-term liabilities | 59 |
|  | $62,348 |

In the three months ended September 30, 2011 we recorded certain adjustments to the initial purchase price accounting. The adjustments to goodwill are as follows (in thousands):

|  | Purchase accounting adjustments offset to goodwill |
| --- | ---: |
| Collection of fully reserved receivable | $(543) |
| Other | (20) |
| Total | $(563) |

We incurred transaction costs of approximately $3.2 million, which consisted primarily of banking, legal, accounting and other administrative fees. These costs have been recorded as general and administrative expense in the three and nine months ended September 30, 2011.

### Financial Operations Overview

*Revenue.* Prior to the acquisition of Neighborhood Diabetes, we derived nearly all of our revenue from the sale of the OmniPod System to customers and third-party distributors who resell the product to customers. Neighborhood Diabetes is a durable medical equipment distributor that sells other diabetes related products including blood glucose testing supplies, insulin pumps, pump supplies and pharmaceuticals to customers. The OmniPod System is comprised of two devices: the OmniPod, a disposable insulin infusion device that the patient wears for up to three days and then replaces; and the PDM, a handheld device much like a personal digital assistant that wirelessly programs the OmniPod with insulin delivery instructions, assists the patient with diabetes management and incorporates a blood glucose meter. We are currently selling our OmniPod System through our partnership with Ypsomed in seven markets, namely Germany, the United Kingdom, France, the Netherlands, Sweden, Norway and Switzerland. We expect that Ypsomed will begin distributing the OmniPod System, subject to approved reimbursement, in the other markets under the agreement in 2012. In February 2011, we entered into a distribution agreement with GSK to become the exclusive distributor of the OmniPod System in Canada. We shipped OmniPods to GSK during the second quarter 2011, and GSK began distributing the OmniPod System in the third quarter 2011. In connection with our June 1, 2011 acquisition of Neighborhood Diabetes, we also provide more than 60,000 Type 1 and Type 2 diabetes patients with blood glucose testing supplies, insulin pumps, pump supplies and pharmaceuticals.

In March 2008, we received a cash payment from Abbott Diabetes Care, Inc., (“Abbott”), for an agreement fee in connection with execution of the first amendment to the development and license agreement with Abbott. We are recognizing the payment as revenue over the five year term of the agreement. In addition, Abbott agreed to pay us certain amounts for services performed in connection with each sale of a PDM that includes an Abbott Discrete Blood Glucose Monitor to customers in certain territories. We recognize the revenue related to this portion of the Abbott agreement at the time we meet the criteria for revenue recognition, typically at the time of the sale of the PDM to the patient.

In June 2011, we entered into a development agreement with a U.S. based pharmaceutical company ( the “Development Agreement”). Under the Development Agreement, we are required to perform design, development, regulatory, and other services to support the pharmaceutical company as it works to obtain regulatory approval to use our drug delivery technology as a delivery method for its pharmaceutical. Over the estimated two year term of the Development Agreement, we will invoice amounts as we meet certain defined deliverable milestones. Revenue on the Development Agreement is recognized using a proportional performance methodology based on costs incurred and total payments under the agreement.

As of September 30, 2011 and December 31, 2010, we had deferred revenue of $2.4 million and $4.8 million, respectively. These amounts include product-related revenue, unrecognized amounts related to the Development Agreement, as well as the unrecognized portion of the agreement fee related to the Abbott agreement. For the year ending December 31, 2011, we expect our revenue to continue to increase as we gain new customers and increase our product offerings to existing customers in the

United States and continue expansion in Europe, Canada and certain other international markets. Increased revenue will be dependent upon the success of our sales efforts, our ability to produce OmniPods in sufficient volumes and other risks and uncertainties.

*Cost of revenue.* Cost of revenue consists primarily of raw material, labor, warranty and overhead costs such as freight, depreciation and packaging costs, related to the OmniPod System and the cost for which we acquire our other products from third party suppliers distributed through our Neighborhood Diabetes business, and costs incurred related to the Development Agreement. On a per unit basis for the OmniPod System, the cost of revenue is expected to be consistent for the remainder of the year. Cost of revenue related to the Neighborhood Diabetes business is expected to reduce our overall gross margin as we resell other diabetes supplies to our combined customers. We have filed for 510(K) clearance from the FDA on our next generation OmniPod. Once approved, we expect improvement in our gross margins in connection with the introduction of this next generation product.

*Research and development.* Research and development expenses consist primarily of personnel costs within our product development, regulatory and clinical functions, and the costs of market studies and product development projects, including regulatory approval of our next generation product. We expense all research and development costs as incurred. For the year ending December 31, 2011, we expect overall research and development spending to remain higher than in 2010 as we finalize the validation of our next generation product manufacturing line with Flextronics and work with the regulatory agencies on obtaining approval of the next generation product.

*General and administrative.* General and administrative expenses consist primarily of salaries and other related costs for personnel serving the executive, finance, information technology and human resource functions, as well as legal fees, accounting fees, insurance costs, bad debt expenses, shipping, handling and facilities-related costs. We expect general and administrative expenses to remain higher in 2011 compared to 2010, mainly as a result of our acquisition of Neighborhood Diabetes on June 1, 2011.

*Sales and marketing.* Sales and marketing expenses consist primarily of personnel costs within our sales, marketing, reimbursement support, customer support and training functions, sales commissions paid to our sales representatives and costs associated with participation in medical conferences, physician symposia and promotional activities, including distribution of units used in our demonstration kit programs. We expect sales and marketing expenses to remain higher in 2011 as compared to 2010 as a result of the growth of our existing business, our acquisition of Neighborhood Diabetes as well as our efforts to enhance the products we offer to our existing patients.

### Results of Operations

The following table presents certain statement of operations information for the three and nine months ended September 30, 2011 and 2010:

*(in thousands)*

*(in thousands)*

|  | Three months ended September 30, 2011 | 2010 | % Change | September 30, 2011 | Nine months ended 2010 | % Change |
| --- | ---: | ---: | ---: | ---: | ---: | ---: |
| Revenue | $44,594 | $25,455 | 75% | $105,063 | $69,199 | 52% |
| Cost of revenue | 26,033 | 13,826 | 88% | 58,431 | 39,299 | 49% |
| Gross profit | 18,561 | 11,629 | 60% | 46,632 | 29,900 | 56% |
| Operating expenses: |  |  |  |  |  |  |
| Research and development | 4,638 | 3,698 | 25% | 16,059 | 12,128 | 32% |
| General and administrative | 11,379 | 7,230 | 57% | 31,585 | 20,379 | 55% |
| Sales and marketing | 12,312 | 8,979 | 37% | 30,943 | 26,301 | 18% |
| Total operating expenses | 28,329 | 19,907 | 42% | 78,587 | 58,808 | 34% |
| Operating loss | (9,768) | (8,278) | 18% | (31,955) | (28,908) | 11% |
| Other expense, net | (3,794) | (3,822) | 1% | (10,876) | (11,393) | 5% |
| Net loss | $(13,562) | $(12,100) | 12% | $(42,831) | $(40,301) | 6% |

### Comparison of the Three and Nine Months Ended September 30, 2011 and 2010

#### Revenue

Our total revenue was $44.6 million and $105.1 million for the three and nine months ended September 30, 2011, compared to $25.5 million and $69.2 million for the same periods in 2010. The increase in revenue is primarily due to continued adoption of the OmniPod System by patients in the United States and internationally, as well of the sale of testing and other supplies related to our acquisition of Neighborhood Diabetes. We expect our revenue to increase as we continue to add new patients, introduce the OmniPod System in additional territories, generate a higher volume of reorders based on our expanding patient base and continue to realize revenue growth from our Neighborhood Diabetes business.

#### Cost of Revenue

Cost of revenue was $26.0 million and $58.4 million for the three and nine months ended September 30, 2011, compared to $13.8 million and $39.3 million for the same periods in 2010. The increase in cost of revenue is primarily due to a significant increase in sales volume offset by cost efficiencies related to the bill of material and production volume on our OmniPod System as well as the impact on cost of sales of the lower gross margin profile Neighborhood Diabetes business. We expect gross margins for the remainder of the year in the range of 42% to 45% of revenue.

#### Research and Development

Research and development expenses increased $0.9 million, or 25%, to $4.6 million for the three months ended September 30, 2011, compared to $3.7 million for the same period in 2010. For the three months ended September 30, 2011, the increase was primarily a result of $0.9 million of testing and tooling expenses on the current version of the OmniPod and an increase of $0.6 million in employee related expenses. These increases are offset by a $0.7 million decrease in expenses related to our next generation OmniPod System as we move closer to production.

Research and development expenses increased $4.0 million, or 32%, to $16.1 million for the nine months ended September 30, 2011, compared to $12.1 million for the same period in 2010. For the nine months ended September 30, 2011, the increase was primarily a result of $0.6 million of additional materials and equipment utilized in the development of our next generation OmniPod System, a $1.6 million increase in employee related expenses, $0.9 million in other outside services, and $0.6 million increase in depreciation.

#### General and Administrative

General and administrative expenses increased $4.2 million, or 57%, to $11.4 million for the three months ended September 30, 2011, compared to $7.2 million for the same period in 2010. This increase was primarily a result of an increase in employee related expenses of $2.1 million, including $1.1 million related to Neighborhood Diabetes and $0.8 million related to new hires, merit increases and stock based compensation, $0.4 million related to higher legal fees, and a $1.7 million of amortization on acquired intangibles.

General and administrative expenses increased $11.2 million, or 55%, to $31.6 million for the nine months ended September 30, 2011, compared to $20.4 million for the same period in 2010. This increase was primarily a result of $3.2 million of transaction costs for the acquisition of Neighborhood Diabetes, $0.9 million related to higher audit and legal fees, $2.2 million of amortization on acquired intangibles, and an increase in employee related expenses of $4.9 million, including $2.0 million related to the acquisition of Neighborhood Diabetes and $2.9 million related to new hires, merit increases, bonus and stock based compensation.

#### Sales and Marketing

Sales and marketing expenses increased $3.3 million, or 37%, to $12.3 million for the three months ended September 30, 2011, compared to $9.0 million for the same period in 2010. This increase in sales and marketing expenses was due to an increase of $2.0 million in employee related expenses, including $1.9 million from the acquisition of Neighborhood Diabetes, an increase of $0.4 million in shipping costs related to Neighborhood Diabetes, an increase of $0.3 million in customer support due to a higher patient volume, and $0.3 million in advertising expenses.

Sales and marketing expenses increased $4.6 million, or 18%, to $30.9 million for the nine months ended September 30, 2011, compared to $26.3 million for the same period in 2010. The increase in sales and marketing expenses for the nine months ended September 30, 2011 was due to an increase of $3.1 million in employee related expenses, including $2.1 million from Neighborhood Diabetes, an increase of $0.8 million in outside services and an increase of $0.4 million in shipping costs related to Neighborhood Diabetes, and $0.3 million increase for patient training.

#### Other Expense, Net

Net interest expense was $3.8 million for the three months ended September 30, 2011, compared to $3.8 million for the same period in 2010. Net interest expense was $10.9 million for the nine months ended September 30, 2011, compared to $11.4 million for the same period in 2010. Net interest expense remained relatively consistent due to additional cash and non-cash interest expense related to the issuance of the 3.75% Notes which was offset by the decrease in the interest expense related to the Facility Agreement, which was repaid in 2010 and the repurchase of a portion of our 5.375% Notes.

### Liquidity and Capital Resources

We commenced operations in 2000 and to date we have financed our operations primarily through private placements of common and preferred stock, secured indebtedness, public offerings of our common stock and issuances of convertible debt. On June 1, 2011, we acquired all of the outstanding shares of Neighborhood Diabetes. The aggregate purchase price of approximately $62.4 million included approximately $37.9 million in cash paid at closing. As of September 30, 2011, we had $103.8 million in cash and cash equivalents. We believe that our current cash and cash equivalents, together with the cash expected to be generated from product sales, will be sufficient to meet our projected operating and debt service requirements for at least the next twelve months.

### Equity

In June 2010, the lenders under the Facility Agreement exercised warrants to acquire 2,125,000 shares of our common stock at an exercise price of $3.13 per share. We received cash totaling $6.7 million as a result of this exercise.

In December 2010, we issued and sold 3,450,000 shares of our common stock at a price of $13.27 per share. In connection with the offering, we received total gross proceeds of $47.8 million, or approximately $45.4 million in net proceeds after deducting underwriting discounts and offering expenses. Approximately $33.3 million of the proceeds was used to repay all amounts outstanding under our Facility Agreement.

In June 2011, in connection with the acquisition of Neighborhood Diabetes, we issued 1,197,631 shares of our common stock with a value of $20.40 per share on the issuance date, as partial consideration for the acquisition.

### Long-Term Debt

At September 30, 2011 and December 31, 2010, we had outstanding long-term debt and related deferred financing costs on our balance sheet as follows (in thousands):

| Liabilities: | As of September 30, 2011 | December 31, 2010 |
| --- | ---: | ---: |
| Principal amount of the 5.375% Convertible Notes | $15,000 | $85,000 |
| Principal amount of the 3.75% Convertible Notes | 143,750 | — |
| Unamortized discount of liability component | (52,431) | (15,567) |
|  | $106,319 | $69,433 |
| Deferred financing costs | $2,660 | $1,173 |

Interest expense related to the Notes and Facility Agreement was included in interest expense on the consolidated statements of operations as follows (in thousands):

|  | Three months ended September 30, 2011 | September 30, 2010 | Nine months ended September 30, 2011 | September 30, 2010 |
| --- | ---: | ---: | ---: | ---: |
| Contractual coupon interest | $1,549 | $1,838 | $3,834 | $5,501 |
| Accretion of debt discount | 2,143 | 1,887 | 4,992 | 5,493 |
| Amortization of debt issuance costs | 146 | 214 | 389 | 654 |
|  | $3,838 | $3,939 | $9,215 | $11,648 |

### 5.375% Convertible Notes

In June 2008, we sold $85.0 million principal amount of 5.375% Convertible Senior Notes due June 15, 2013 (the “5.375% Notes”) in a private placement to qualified institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as amended. The interest rate on the notes is 5.375% per annum on the principal amount from June 16, 2008, payable semi-annually in arrears in cash on December 15 and June 15 of each year. The 5.375% Notes are convertible into our common stock at an initial conversion rate of 46.8467 shares of common stock per $1,000 principal amount of the 5.375% Notes, which is equivalent to a conversion price of approximately $21.35 per share, representing a conversion premium of 34% to the last reported sale price of our common stock on the NASDAQ Global Market on June 10, 2008, subject to adjustment under certain circumstances, at any time beginning on March 15, 2013 or under certain other circumstances and prior to the close of business on the business day immediately preceding the final maturity date of the notes. The 5.375% Notes will be convertible for cash up to their principal amount and shares of our common stock for the remainder of the conversion value in excess of the principal amount.

If a fundamental change, as defined in the Indenture for the 5.375% Notes, occurs at any time prior to maturity, holders of the 5.375% Notes may require us to repurchase their notes in whole or in part for cash equal to 100% of the principal amount of the notes to be repurchased, plus accrued and unpaid interest, including any additional interest, to, but excluding, the date of repurchase. If a holder elects to convert its 5.375% Notes upon the occurrence of a make-whole fundamental change, as defined in the Indenture for the 5.375% Notes, the holder may be entitled to receive an additional number of shares of common stock on the conversion date. These additional shares are intended to compensate the holders for the loss of the time value of the conversion option and are set forth in the Indenture to the 5.375% Notes. In no event will the number of shares issuable upon conversion of a note exceed 62.7746 per $1,000 principal amount (subject to adjustment as described in the Indenture for the 5.375% Notes).

We recorded a debt discount of $26.9 million to equity to reflect the value of our nonconvertible debt borrowing rate of 14.5% per annum. This debt discount is being amortized as interest expense over the five year term of the 5.375% Notes. We incurred deferred financing costs related to this offering of approximately $3.5 million, of which $1.1 million has been reclassified as an offset to the value of the amount allocated to equity. The remainder is recorded as other assets in the consolidated balance sheet and is being amortized as a component of interest expense over the five year term of the 5.375% Notes.

On June 29, 2011, in connection with the issuance of $143.8 million of 3.75% Convertible Notes due June 2016 (the “3.75% Notes”), we repurchased $70 million in principal amount of the 5.375% Notes for $85.1 million, a 21.5% premium on the principal amount. The investors that held the $70 million of repurchased 5.375% Notes purchased $59.5 million in principal amount of the 3.75% Notes and retained approximately $13.5 million of the remaining 5.375% Notes. The investors’ combined $73.0 million of convertible debt ($13.5 million of 5.375% Notes and $59.5 million of 3.75% Notes) were considered to be a modification of a portion of the 5.375% Notes. See “3.75% Convertible Notes” for additional detail on the modification.

Non-cash interest expense related to the amortization of the debt discount and the deferred financing costs on the $85 million of principal 5.375% Notes was $3.1 million in the nine months ended September 30, 2011. There was no non-cash interest expense in the three months ended September 31, 2011. Non-cash interest expense related to the amortization of the debt discount and the deferred financing costs on the $85 million of principal 5.375% Notes was $1.4 million and $4.1 million in the three and nine months ended September 30, 2010, respectively.

Cash interest expense related to the 5.375% Notes was $0.2 million and $2.5 million in the three and nine months ended September 30, 2011, respectively. Cash interest expense related to the 5.375% Notes was $1.1 million and $3.4 million for the three and nine months ended September 30, 2010, respectively.

As of September 30, 2011, we included $1.3 million on our balance sheet related to the unmodified portion of the 5.375% Notes. The 5.375% Notes have a remaining term of 1.75 years.

### Facility Agreement and Common Stock Warrants

In March 2009, we entered into the facility agreement with certain institutional accredited investors (the“Facility Agreement”), pursuant to which the investors agreed to loan us up to $60 million, subject to the terms and conditions set forth in the Facility Agreement. Total financing costs, including the transaction fee, were $3.0 million and were amortized as interest expense over the 42 months of the Facility Agreement. In September 2009, we entered into an amendment to the Facility Agreement whereby we repaid the $27.5 million originally drawn and promptly drew down the remaining $32.5 million available under the Facility Agreement. The annual interest rate was 8.5%, payable quarterly in arrears. In connection with the amendment to the Facility Agreement, we entered into a securities purchase agreement with the lenders whereby we sold 2,855,659 shares of our common stock to the lenders at $9.63 per share, a $1.9 million discount based on the closing price of our common stock of $10.28 on that date. We recorded the $1.9 million as a debt discount which was amortized as interest expense over the remaining term of the loan. We received aggregate proceeds of $27.5 million in connection with the sale of our shares. All principal amounts outstanding under the Facility Agreement were payable in September 2012.

In connection with the execution of the Facility Agreement, we issued to the lenders fully exercisable warrants to purchase an aggregate of 3.75 million shares of our common stock at an exercise price of $3.13 per share. The warrants qualified for permanent treatment as equity, and their relative fair value of $6.1 million on the issuance date was recorded as additional paid-in capital and debt discount. The debt discount was amortized as non-cash interest expense over the term of the loan. As of September 30, 2011, all warrants to acquire 3.75 million shares of our common stock issued in connection with the Facility Agreement were exercised.

In December 2010, we paid $33.3 million to the lenders, of which $32.5 million related to principal and $0.8 million related to interest and prepayment fees, to extinguish this debt. We recorded a non-cash interest charge of $7.0 million in the fourth quarter of 2010 related to the write-off of the remaining debt discounts and financing costs included in other assets which were being amortized to interest expense over the term of the debt. At September 30, 2011 and December 31, 2010, there were no amounts related to the Facility Agreement included in long-term debt on our balance sheet.

As the Facility Agreement was repaid in December 2010, no amounts were included in interest expense in the consolidated statements of operations in the three and nine months ended September 30, 2011.

### 3.75% Convertible Notes

In June 2011, we sold $143.8 million principal amount of the 3.75% Notes. The interest rate on the notes is 3.75% per annum, payable semi-annually in arrears in cash on December 15 and June 15 of each year. The 3.75% Notes are convertible into our common stock at an initial conversion rate of 38.1749 shares of common stock per $1,000 principal amount of the 3.75% Notes, which is equivalent to a conversion price of approximately $26.20 per share, subject to adjustment under certain circumstances. The 3.75% Notes are convertible prior to March 15, 2016 only upon the occurrence of certain circumstances. On and after March 15, 2016 and prior to the close of business on the second scheduled trading day immediately preceding the final maturity date of the 3.75% Notes, the notes may be converted without regard to the occurrence of any such circumstances. The 3.75% Notes and any unpaid interest will be convertible at our option for cash, shares of our common stock or a combination of cash and shares of our common stock for the principal amount. We intend to settle the principal in cash.

We may not redeem the 3.75% Notes prior to June 20, 2014. From June 20, 2014 to June 20, 2015, we may redeem the 3.75% Notes, at our option, in whole or in part only if the last reported sale price per share of our common stock has been at least 130% of the conversion price then in effect for at least 20 trading days during a period of 30 consecutive trading days. On and after June 25, 2015, we may redeem the 3.75% Notes, at our option (without regard to such sale price condition), in whole or in part. If a fundamental change, as defined in the Indenture for the 3.75% Notes, occurs at any time prior to maturity, holders of the 3.75% Notes may require us to repurchase their notes in whole or in part for cash equal to 100% of the principal amount of the notes to be repurchased, plus accrued and unpaid interest. If a holder elects to convert its 3.75% Notes upon the occurrence of a make-whole fundamental change, as defined in the Indenture for the 3.75% Notes, the holder may be entitled to receive an additional number of shares of common stock on the conversion date. These additional shares are intended to compensate the holders for the loss of the time value of the conversion option and are set forth in the Indenture to the 3.75% Notes. In no event will the number of shares issuable upon conversion of a 3.75% Note exceed 50.5816 per $1,000 principal amount (subject to adjustment as described in the Indenture for the 3.75% Notes). The 3.75% Notes are unsecured and are equal in right of payment to the 5.375% Notes.

We evaluated certain features of the 3.75% Notes to determine whether these features are derivatives which should be bifurcated and valued. We identified certain features related to a portion of the 3.75% Notes, including the holders’ ability to require us to repurchase their notes and the higher interest payments required in an event of default, which are considered embedded derivatives and should be valued. We assess the value of each of these embedded derivatives at each balance sheet date. At September 30, 2011, we determined that these derivatives have de minimus value.

In connection with the issuance of the 3.75% Notes, we repurchased $70 million in principal amount of the 5.375% Notes for $85.1 million, a 21.5% premium on the principal amount. The investors that held the $70 million of repurchased 5.375% Notes purchased $59.5 million in principal amount of the 3.75% Notes and retained approximately $13.5 million of the remaining 5.375% Notes. This transaction was treated as a modification of the existing 5.375% Notes. We accounted for this modification of a portion of the 5.375% Notes separately from the issuance of the remainder of the 3.75% Notes.

Prior to the transaction, the $70 million principal of repurchased 5.375% Notes had a debt discount of $10.5 million. This amount remained in debt discount related to the modified $13.5 million of 5.375% Notes and $59.5 million of 3.75% Notes. We recorded additional debt discount of $15.1 million related to the premium payment in connection with the repurchase and $0.2 million related to the increase in the value of the conversion feature. The offset to the debt discount related to the value of the conversion feature was recorded as additional paid-in capital. The total debt discount of $25.8 million related to the modified debt is being amortized as interest expense at the effective rate of 16.5% over the five year term of the modified debt. We paid transaction fees of approximately $2.0 million related to the modification which were recorded as interest expense in the nine months ended September 30, 2011. Non-cash interest expense related to the amortization of the debt discount and the deferred financing costs on $73 million of the modified debt was $1.2 million in the three and nine months ended September 30, 2011 As the debt was considered to be modified in connection with the issuance of 3.75% Notes in June 2011, there was no non-cash interest expense related to the modified debt in the three and nine months ended September 30, 2010.

Of the $143.8 million of 3.75% Notes issued in June 2011, $84.3 million was considered to be an issuance of new debt. We recorded a debt discount of $26.6 million related to the $84.3 million. We included $58.7 million on our balance sheet related to these notes at September 30, 2011. The debt discount was recorded as additional paid-in capital to reflect the value of our nonconvertible debt borrowing rate of 12.4% per annum. This debt discount is being amortized as interest expense over the five year term of the 3.75% Notes. We incurred deferred financing costs related to this offering of approximately $2.8 million, of which $0.9 million has been reclassified as an offset to the value of the amount allocated to equity. The remainder is recorded as other assets in the consolidated balance sheet and is being amortized as a component of interest expense over the five year term of the 3.75% Notes. Non-cash interest expense related to the amortization of the debt discount and the deferred financing costs on the new portion of the 3.75% Notes was $1.1 million in the three and nine months ended September 30, 2011. There was no non-cash interest recorded on the new portion of the 3.75% Notes in the three and nine months ended September 30, 2010.

Cash interest expense related to the $143.8 million of 3.75% Notes was $1.3 million in the three and nine months ended September 30, 2011. No cash interest was recorded on the 3.75% Notes in the three and nine months ended September 30, 2010.

As of September 30, 2011, the 3.75% Notes have a remaining term of 4.75 years.

#### Operating Activities

The following table sets forth the amounts of cash used in operating activities and net loss for each of the periods indicated:

*(In thousands)*

|  | Nine months ended September 30, 2011 | 2010 |
| --- | ---: | ---: |
| Cash used in operating activities | $(17,784) | $(27,922) |
| Net loss | $(42,831) | $(40,301) |

For each of the periods above, the net cash used in operating activities was attributable primarily to the growth of our operations after adjustment for non-cash expenses. Adjustments for non-cash items were approximately $20.4 million and $17.6 million in the nine months ended September 30, 2011 and September 30, 2010, respectively. Non-cash items mainly consist of depreciation and amortization, stock-based compensation and non-cash interest expense. Uses of cash from operations in the nine months ended September 30, 2011 include a decrease in deferred revenue of $2.1 million. Uses of cash from operations in the nine months ended September 30, 2011 were offset by a reduction in accounts receivable of $3.8 million, primarily attributable to improved collections, and an increase of $1.9 million in accounts payable and accruals.

#### Investing and Financing Activities

The following table sets forth the amounts of cash used in investing activities and cash provided by financing activities for each of the periods indicated:

*(In thousands)*

|  | Nine months ended September 30, 2011 | 2010 |
| --- | ---: | ---: |
| Cash used in investing activities | $(46,693) | $(3,632) |
| Cash provided by financing activities | $55,015 | $7,476 |

Cash used in investing activities in the nine months ended September 30, 2011 primarily related to the acquisition of Neighborhood Diabetes. We paid approximately $37.9 million in cash as partial consideration. In addition, we purchased fixed assets primarily for use in the development and manufacturing of the OmniPod System. In the nine months ended September 30, 2010, cash used in investing activities was primarily for the purchase of fixed assets for use in the development and manufacturing of the OmniPod System. Capital expenditures are expected to continue to increase in 2011 as we complete our first manufacturing line for our next generation product.

In the nine months ended September 30, 2011 cash provided by financing activities related to the net proceeds from the issuance of the 3.75% Notes, offset by the repurchase of $70 million principal of the 5.375% Notes for $85.1 million. Cash provided by financing activities in the nine months ended September 30, 2010 mainly consisted of the net proceeds from the issuance of common stock in connection with the exercise of employee stock options.

#### Contractual Obligations

We lease our facilities, which are accounted for as operating leases. The lease of our facilities in Bedford and Billerica, Massachusetts, generally provides for a base rent plus real estate taxes and certain operating expenses related to the lease. In addition, in connection with our acquisition of Neighborhood Diabetes, we acquired leases of facilities in Woburn, Massachusetts, Brooklyn, New York and Orlando, Florida. As of September 30, 2011, we had an outstanding letter of credit which totaled $0.1 million to cover our security deposits for lease obligations. As a result of the leases acquired, we expect to pay additional rent of $0.1 million in 2011, $0.5 million in 2012 and $0.3 million in 2013.

As a result of the issuance of the 3.75% Notes and the repurchase of $70 million of the 5.375% Notes in June 2011, we expect to pay cash interest of $5.4 million in 2011, $6.2 million in 2012, $5.7 million in 2013, $5.4 million in 2014 and 2015 and $2.5 million in 2016. Additionally we expect to repay the $15 million of the 5.375% Notes in 2013 and the $143.8 million of the 3.75% Notes in 2016.

### Off-Balance Sheet Arrangements

As of September 30, 2011, we did not have any off-balance sheet financing arrangements.

### Critical Accounting Policies and Estimates

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

### Revenue Recognition

We generate nearly all of our revenue from sales of our OmniPod Insulin Management System and other diabetes related products including blood glucose testing supplies, insulin pumps, pump supplies and pharmaceuticals to customers and third-party distributors who resell the product to patients with diabetes.

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 collectability 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.
- Transfer of title and risk and rewards of ownership are passed to the patient or third-party distributor typically upon shipment of the products.
- 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 and rebates to customers are established as a reduction to revenue in the same period the related sales are recorded.

We assess whether the different elements qualify for separate accounting. We recognize revenue once all elements have been delivered.

We offer a 45-day right of return for our OmniPod Insulin Management System Starter Kits sales, and we defer revenue to reflect estimated sales returns in the same period that the related product sales are recorded. Returns are estimated through a comparison of historical return data to their related sales. Historical rates of return are adjusted for known or expected changes in the marketplace when appropriate. Historically, sales returns have amounted to approximately 3% of gross product sales.

When doubt exists about reasonable assuredness of collectability from specific customers, we defer revenue from sales of products to those customers until payment is received.

In March 2008, we received a cash payment from Abbott for an agreement fee in connection with execution of the first amendment to the development and license agreement between us and Abbott. We recognize the agreement fee received from Abbott over the initial five year term of the agreement, and the non-current portion of the agreement fee is included in other long-term liabilities. In addition, Abbott agreed to pay us certain amounts for services performed in connection with each sale of a PDM that includes an Abbott Discrete Blood Glucose Monitor to customers in certain territories. We recognize revenue related to this portion of the Abbott agreement at the time we meet the criteria for revenue recognition, typically at the time the revenue is recognized on the sale of the PDM to the patient.

In June 2011, we entered into the Development Agreement. Under the Development Agreement, we are required to perform design, development, regulatory, and other services to support the pharmaceutical company as it works to obtain regulatory approval to use our drug delivery technology as a delivery method for its pharmaceutical. Over the estimated two year term of the Development Agreement, we will invoice amounts as we meet certain defined deliverable milestones. Revenue on the Development Agreement is recognized using a proportional performance methodology based on costs incurred and total payments under the agreement.

We had deferred revenue of $2.4 million as of September 30, 2011. The deferred revenue recorded as of September 30, 2011 was comprised of product-related revenue, unrecognized amounts related to the Development Agreement, as well as the non-amortized agreement fee related to the Abbott agreement.

### Income Taxes

FASB Accounting Standards Codification 740-10, *Income Taxes (“*FASB ASC 740-10”), clarifies the accounting for uncertainty in income taxes recognized in an entity’s financial statements. FASB ASC 740-10 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. In addition, FASB ASC 740-10 provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. As of September 30, 2011, we had $0.2 million of unrecognized tax benefits recorded.

### Stock-Based Compensation

We account for stock-based compensation under the provisions of FASB ASC 718-10, *Compensation — Stock Compensation. (“*FASB ASC 718-10”) requires all share-based payments to employees, including grants of employee stock options, to be recognized in the income statement based on their fair values.

We use the Black-Scholes option pricing model to determine the weighted average fair value of options granted. We determine the intrinsic value of restricted stock and restricted stock units based on the closing price of our common stock on the date of grant. We recognize the compensation expense of share-based awards on a straight-line basis over the vesting period of the award.

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

In the three and nine months ended September 30, 2011, we recorded $1.8 million and $5.6 million of stock based compensation expense, respectively. In the three and nine months ended September 30, 2010, we recorded $1.3 million and $4.0 million of stock based compensation expense, respectively.

### Accounts Receivable and Allowance for Doubtful Accounts

Accounts receivable consist of amounts due from third-party payors, patients, third-party distributors and government agencies. The allowance for doubtful accounts is recorded in the period in which revenue is recorded or at the time potential collection risk is identified. We estimate our allowance based on historical experience, assessment of specific risk, discussions with individual customers and various assumptions and estimates that we believe to be reasonable under the circumstances.

### Intangibles and Other Long-Lived Assets

Our finite-lived intangible assets are stated at cost less accumulated amortization. We assess our 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. At September 30, 2011, intangibles assets related to the acquisition of Neighborhood Diabetes and consisted of $27.9 million of customer relationships and $2.7 million of tradenames. We assess the need for an impairment of intangibles and other long-lived assets if the carrying amount of the 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 us 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 estimated life of the acquired tradename is fifteen years. The estimated life of the acquired customer relationships asset is ten years. Intangible assets with determinable estimated lives are amortized over these lives.

### Goodwill

Goodwill represents the excess of the cost of the acquired Neighborhood Diabetes business over the fair value of identifiable net assets acquired. We perform an assessment of our goodwill for impairment on at least an annual basis or whenever events or changes in circumstances indicate there might be impairment.

Goodwill is evaluated at the reporting unit level. To test for impairment, we compare the carrying value of the reporting unit to its fair value. If the reporting unit’s carrying value exceeds its fair value, we would record an impairment loss to the extent that the carrying value of goodwill exceeds its implied fair value.

### Warranty

We provide a four year warranty on our PDMs and may replace any OmniPods that do not function in accordance with product specifications. We estimate our warranty at the time the product is shipped based on historical experience and the estimated cost to service the claims. Cost to service the claims reflects the current product cost which has been decreasing over time. As these estimates are based on historical experience, and we continue to introduce new versions of existing products, we also consider the anticipated performance of the product over its warranty period in estimating warranty reserves. At September 30, 2011 and December 31, 2010, the warranty reserve was $1.9 million.

## Market risk

As filed, 1,156 characters.

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, accounts receivable, accounts payable, accrued expenses 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 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 September 30, 2011, we had outstanding debt recorded on our consolidated balance sheet of $15.0 million related to our 5.375% Notes and $143.8 million related to our 3.75% Notes. These amounts were offset by related debt discounts of $52.4 million. As the interest rate on the 5.375% and 3.75% Notes is fixed, changes in interest rates do not affect the value of our debt.

## Controls and procedures

As filed, 1,890 characters.

### Disclosure Controls and Procedures

As of September 30, 2011, our management conducted an evaluation of the effectiveness of the design and operation of our disclosure controls and procedures, (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended) under the supervision and with the participation of our chief executive officer and chief financial officer. In designing and evaluating our disclosure controls and procedures, we and our management recognize that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and our management necessarily was required to apply its judgment in evaluating and implementing possible controls and procedures. Based upon that evaluation of our disclosure controls and procedures as of September 30, 2011, our chief executive officer and chief financial officer concluded that as of such date, our disclosure controls and procedures were effective to provide reasonable assurance that material information required to be disclosed in the reports that we file or submit 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, including ensuring that such material information is accumulated and communicated to our management, including our chief executive officer and our chief financial officer, as appropriate to allow timely decisions regarding required disclosure.

### Changes in Internal Control Over Financial Reporting

There were no changes in our internal control over financial reporting that occurred during the three months ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

## Risk factors

As filed, 917 characters.

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, 2010 as well as the factors discussed in part II, Item 1A. “Risk Factors” in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011, 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. There 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, 2010 and in our Quarterly Report on Form 10-Q for the quarter ended June 30, 2011.

Filed Nov 8, 2011.
Source: SEC EDGAR, the filing index for accession 0000950123-11-096474. Last ingested by Listed: Nov 4, 2026, 16:38 ET. No prices; not investment advice.