Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our selected financial data and our consolidated financial statements and the accompanying notes included in this annual report. The following discussion may contain forward-looking statements that reflect our plans, estimates and beliefs, which are subject to risks, uncertainties and assumptions. Our actual results could differ materially from those discussed in these forward-looking statements. Factors that could cause or contribute to these differences include those discussed under the headings “Risk Factors” and “Forward-Looking Statements.”

Overview

We are primarily engaged in the development, manufacture and sale of our proprietary Omnipod System, an innovative, continuous insulin delivery system for people with insulin-dependent diabetes. There are two primary types of insulin therapy practiced today: MDI therapy using syringes or insulin pens; and pump therapy using insulin pumps. Insulin pumps are used to perform continuous subcutaneous insulin infusion, or insulin pump therapy, and typically use a programmable device and an infusion set to administer insulin into a person’s body. Insulin pump therapy has been shown to provide people with insulin-dependent diabetes with numerous advantages relative to MDI therapy. The Omnipod System features a small, lightweight, self-adhesive disposable tubeless Omnipod device that is worn on the body for up to three days at a time and its wireless companion, the handheld PDM. The Omnipod System, which features two discreet and easy-to-use devices, communicates wirelessly, provides for virtually pain-free automated cannula insertion and 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.

The Omnipod is currently available in the United States, Canada and certain countries in Europe and the Middle East. We sell the Omnipod through direct sales to consumers or through our distribution partners and most recently in the U.S. through the pharmacy channel.

In addition to the diabetes market space, we have partnered with pharmaceutical and biotechnology companies to tailor the Omnipod System technology platform for the delivery of subcutaneous drugs across other therapeutic areas. Most of our drug delivery revenue currently consists of sales of Pods to Amgen for use in the Neulasta Onpro kit, an innovative delivery system for Amgen’s white blood cell booster to help reduce the risk of infection after intense chemotherapy.

Our mission is to improve the lives of people with diabetes. To assist in achieving this mission, we are focused on the following strategic objectives:

•	delivering consumer-focused innovation;

•	ensuring the best customer experience globally;

•	expanding our global footprint; and

•	driving operational excellence.

In the first half of 2019, we began production at our new highly automated manufacturing facility in Acton, Massachusetts, which also serves as our new global headquarters. We expect that, following start up related activities, 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. As of December 31, 2019, we had made cumulative investments of approximately $320 million in property, plant and infrastructure related to the new facility. We expect to continue to expand our investment in this facility in 2020 to support the growth of our business.

Additionally, in the first half of 2019, we completed a full market launch of Omnipod DASH in the United States. Omnipod DASH is our next-generation digital mobile Omnipod platform, featuring a secure Bluetooth enabled Pod and PDM with a color touch screen user interface supported by smartphone connectivity. In December of 2019, we introduced DASH to select European markets.

In late 2019, we completed our pre-pivotal trial for Omnipod Horizon, a closed loop control system that utilizes the DASH mobile platform to allow the Pod to communicate with a continuous glucose monitor and help control insulin delivery utilizing an algorithm located on the Pod. In December 2019, we began patient enrollment in our pivotal trial. We expect to launch Omnipod Horizon in the second half of 2020. While we expect Horizon to contribute to our long-term revenue growth, we do not expect it to meaningfully contribute to growth in 2020.

Our long-term financial objective is to sustain profitable growth. To achieve this goal, we expect our efforts in 2020 to focus primarily on the launch of Omnipod Horizon in the United States. In order to support our continued growth and the expected launch of Omnipod Horizon, in 2020 we also plan to focus on the startup of our second manufacturing line in our Acton facility and the installation of a third U.S. manufacturing line, which we expect to begin production on in 2021. Additionally, in 2020, we

expect to enter five new countries in Western Europe and the Middle East and further roll out DASH in Europe and Canada to expand the commercial sale of Omnipod and our global footprint. While we expect these new countries to contribute to our long-term revenue growth, we do not expect them to have a meaningful contribution in 2020. Finally, we plan to continue our product development efforts and expand awareness of and access to our products. Achieving these objectives is expected to require additional investments in certain initiatives and personnel, as well as enhancements to our supply chain operation capacity, efficiency and effectiveness.

Results of Operations

	Years Ended December 31,															Years Ended December 31,
(In millions)	2019				2018				Change $				Change %			2018				2017				Change $				Change %
Revenue
U.S. Omnipod	$	420.4			$	323.5			$	96.9			30	%		$	323.5			$	271.6			$	51.9			19	%
International Omnipod	253.1				172.0				81.1				47	%		172.0				120.0				52.0				43	%
Total Omnipod	673.5				495.5				178.0				36	%		495.5				391.6				103.9				27	%
Drug Delivery	64.7				68.3				(3.6		)		(5	)%		68.3				72.2				(3.9		)		(5	)%
Total revenue	738.2				563.8				174.4				31	%		563.8				463.8				100.0				22	%
Cost of revenue	257.9				193.6				64.3				33	%		193.6				186.6				7.0				4	%
Gross profit	480.3				370.2				110.1				30	%		370.2				277.2				93.0				34	%
Gross margin	65.1		%		65.7		%									65.7		%		59.8		%
Operating expenses:
Research and development	129.7				90.5				39.2				43	%		90.5				75.7				14.8				20	%
Sales and marketing	185.1				146.2				38.9				27	%		146.2				124.2				22.0				18	%
General and administrative	115.5				106.1				9.4				9	%		106.1				84.7				21.4				25	%
Total operating expenses	430.3				342.8				87.5				26	%		342.8				284.6				58.2				20	%
Operating income (loss)	50.0				27.4				22.6				82	%		27.4				(7.4		)		34.8				470	%
Interest expense, net of portion capitalized	(34.6		)		(28.9		)		(5.7		)		20	%		(28.9		)		(21.2		)		(7.7		)		36	%
Loss on extinguishment of debt	(8.7		)		—				(8.7		)		NM			—				(0.6		)		0.6				NM
Interest and other income, net	7.8				6.7				1.1				16	%		6.7				2.6				4.1				158	%
Income (loss) before income taxes	14.5				5.2				9.3				179	%		5.2				(26.6		)		31.8				120	%
Income tax expense	(2.9		)		(1.9		)		(1.0		)		53	%		(1.9		)		(0.2		)		(1.7		)		850	%
Net income (loss)	$	11.6			$	3.3			$	8.3			252	%		$	3.3			$	(26.8	)		$	30.1			112	%

NM = Not meaningful

Comparison of the Years Ended December 31, 2019 and December 31, 2018

Revenue

Total revenue for 2019 increased $174.4 million, or 31%, to $738.2 million, compared with $563.8 million in 2018 due to strong growth in our U.S. and International Omnipod revenue. U.S. Omnipod revenue increased $96.9 million, or 30%, to $420.4 million, primarily due to higher volumes as we continue to expand awareness of and access to the Omnipod, and increased sales through the pharmacy channel, which has higher average selling prices due in part to the fact that we offer the PDM for no charge. International Omnipod revenue increased $81.1 million, or 47%, to $253.1 million, primarily due to the continued adoption of our product and more favorable pricing as a result of our shift to direct sales of the Omnipod in Europe in July 2018. Drug Delivery revenue decreased $3.6 million, or 5%, to $64.7 million, compared with 2018.

For 2020, we expect strong Omnipod revenue growth driven by continued market penetration and continued volume growth of Omnipod DASH, primarily in the U.S. pharmacy channel, partially offset by lower Drug Delivery revenue, due to a lower demand forecast. Internationally, we expect higher revenues primarily due to increasing sales volume as a result of greater awareness and availability of the Omnipod and further roll out of Omnipod DASH in Europe and Canada. In the U.S., we expect higher revenues primarily due to an increase in sales volume as a result of expanded payor coverage, greater awareness and availability of the Omnipod, commercial expansion strategies and the move into the pharmacy channel.

Gross Margin

Gross margin was 65.1% of revenue in 2019, compared with 65.7% in 2018. The decrease in gross margin was primarily due to start-up costs and inefficiencies related to our new U.S. manufacturing operations and product mix, which more than offset favorable distribution channel mix, favorable pricing following the expiration of our former distribution agreement in Europe and favorable geographic mix. We expect full year 2020 gross margin to be relatively consistent with 2019, which reflects the benefits of continued

improvements in manufacturing and supply chain operations and the move into the pharmacy channel in the U.S., offset by start-up costs and inefficiencies as we continue to ramp up our U.S. manufacturing operations.

Research and Development

Research and development expenses for 2019 increased $39.2 million, or 43%, to $129.7 million, compared with $90.5 million in 2018. This increase was primarily due to an increase in research and development expenses related to Omnipod DASH and our Omnipod Horizon automated insulin delivery system. Research and development expenses also increased due to engineering and operational costs, such as training and start up activities, associated with our newly constructed U.S. manufacturing facility. We expect research and development spending for the full year 2020 to increase compared with 2019.

Sales and Marketing

Sales and marketing expenses for 2019 increased $38.9 million, or 27%, to $185.1 million, compared with $146.2 million in 2018. This increase was primarily attributable to investments to support our mid-2018 transition to direct sales of Omnipod in Europe, the expansion of our U.S. sales force and investments in customer support. We expect sales and marketing expenses for the full year 2020 to increase compared with 2019 due to additional expansion of our U.S. sales force and customer support personnel to facilitate our continued growth and expected entry into five new countries.

General and Administrative

General and administrative expenses for 2019 increased $9.4 million, or 9%, to $115.5 million, compared with $106.1 million in 2018. This increase was primarily attributable to increased personnel-related costs related to 2018 hires to support the establishment of our direct operations in Europe and increased depreciation related to our new headquarters facility, partially offset by $12.6 million of severance charges in 2018 related to the retirement of our former CEO, including stock-based compensation expense for the accelerated vesting of equity awards. We expect general and administrative expenses for 2020 to increase compared with 2019 as we continue to grow our business and make investments in our operating structure to support growth.

Interest Expense, Net of Portion Capitalized

Interest expense, net for 2019 increased $5.7 million, or 20%, to $34.6 million, compared with 2018. Interest expense, net for 2019 includes $9.5 million of cash interest expense and $35.6 million of non-cash interest expense associated with our convertible debt, partially offset by $10.5 million of interest capitalized as part of the cost of our U.S. manufacturing facility. The increase in interest expense, net primarily resulted from a $6.3 million increase in non-cash interest expense resulting from net impact of the issuance of $800.0 million of 0.375% convertible notes and the repayment of $402.5 million principal amount of 1.25% convertible notes. We expect interest expense for 2020 to increase compared with 2019 due to the annualized impact of the higher non-cash interest expense associated with the 0.375% convertible notes, compared with the 1.25% convertible notes.

Loss on Extinguishment of Debt

During 2019, we incurred an $8.7 million loss on extinguishment of debt related to the repurchase of our 1.25% Notes.

Interest and Other Income, Net

Other income, net for 2019 increased $1.1 million, to $7.8 million, compared with $6.7 million in 2018. This increase was primarily due to a $1.8 million insurance settlement received, partially offset by a decrease in interest income on our investment portfolio.

Income Tax Expense

Income tax expense was $2.9 million and $1.9 million on pre-tax income of $14.5 million and $5.2 million for 2019 and 2018, respectively. Our effective tax rate was 19.8% and 37.0% for 2019 and 2018, respectively. The decrease in our effective tax rate primarily resulted from an increase in earnings in the U.S., which has a full valuation allowance. See Note 18 to the consolidated financial statements for additional information on our income tax expense.

Comparison of the Years Ended December 31, 2018 and December 31, 2017

Revenue

Total revenue for 2018 increased $100.0 million, or 22%, to $563.8 million, compared with $463.8 million in 2017, primarily due to continued growth in our International and U.S. Omnipod revenue. International Omnipod revenue increased $52.0 million, or 43%, to $172.0 million, primarily due to both higher volumes and pricing as a result of our shift to direct sales of the Omnipod in Europe in July 2018. U.S. Omnipod revenue increased $51.9 million, or 19%, to $323.5 million due to expanded access to and awareness of the Omnipod System. Our Drug Delivery revenue decreased $3.9 million, or 5%, to $68.3 million, primarily reflecting a lower number of shipments during the year, partially offset by the favorable impact of adoption of new accounting guidance that requires our drug delivery revenue to be recognized as the product is produced rather than at time of shipment as further described in Note 2 to the consolidated financial statements.

Gross Margin

Cost of revenue was 65.7% of revenue in 2018, compared with 59.8% in 2017. The significant increase in gross margin was primarily due to favorable pricing resulting from our shift to direct sales in Europe following the expiration of our former distributor agreement and lower product cost as a result of continued improvements in manufacturing and supply chain operations.

Research and Development

Research and development expenses for 2018 increased $14.8 million, or 20%, to $90.5 million, compared with $75.7 million in 2017. This increase in research and development expenses was primarily due to an increase in expenses related to Omnipod DASH and our Omnipod Horizon automated insulin delivery system. Research and development expenses also increased due to engineering and operational costs, such as training and start up activities, associated with our newly constructed U.S. manufacturing facility at which production began in 2019.

Sales and Marketing

Sales and marketing expenses for 2018 increased $22.0 million, or 18% to $146.2 million in 2018, compared with $124.2 million in 2017. This increase in sales and marketing expenses was primarily due to investments to support our mid-2018 transition to direct sales of Omnipod in Europe as well as the expansion of our U.S. sales force and customer support personnel. These increases were partially offset by the capitalization of commission costs related to new customer contracts in connection with the adoption of new revenue recognition guidance described in Note 2 to the consolidated financial statements.

General and Administrative

General and administrative expenses for 2018 increased $21.4 million, or 25%, to $106.1 million, compared with $84.7 million in 2017. This increase in general and administrative expenses was primarily due to $12.6 million of severance charges associated with the retirement of our former CEO, of which $8.2 million related to stock-based compensation expense for the accelerated vesting of equity awards. General and administrative expenses also increased due to personnel costs to support the establishment of our direct commercial operations in Europe.

Interest Expense, Net of Portion Capitalized

Interest expense, net for 2018 increased $7.7 million, or 36%, to $28.9 million, compared with to 2017. Interest expense, net for 2018 includes $9.8 million of cash interest expense and $29.3 million of non-cash interest expense associated with our convertible debt, partially offset by $10.2 million of interest capitalized as part of the cost of our U.S. manufacturing facility. The increase in interest expense, net was primarily due to the full year effect of interest expense associated with our 1.375% Notes, which were issued in November 2017, partially offset by a $7.1 million increase in capitalized interest.

Interest and Other Income, Net

Interest and other income, net increased $4.1 million, to $6.7 million for 2018, compared with 2017. This increase was primarily due to an increase in interest income on our investment portfolio.

Income Tax Expense

Income tax expense was $1.9 million in 2018, compared with $0.2 million in 2017. The increase of $1.7 million in income tax expense was primarily due to growth in our international operations where we do not have net operating loss carryforwards. See Note 18 to the consolidated financial statements for additional information on our income tax expense.

Liquidity and Capital Resources

As of December 31, 2019, we had $213.7 million in cash and cash equivalents and $220.8 million of investments in marketable securities. We believe that our current liquidity will be sufficient to meet our projected operating, investing and debt service requirements for at least the next twelve months.

Convertible Debt

To finance our operations and global expansion, we have periodically issued convertible senior notes, which are convertible into our common stock. In September 2019, we issued $800.0 million aggregate principal amount of 0.375% Convertible Senior Notes due September 2026. The net proceeds of $780.2 million were used to partially fund the redemption of our 1.25% Convertible Senior Notes due September 2021 and for the purchase of capped call options (“Capped Calls”) on our common stock. By entering into the Capped Calls, we expect to reduce the potential dilution to our common stock (or, in the event the conversion is settled in cash, to provide a source of cash to settle a portion of our cash payment obligation) in the event that at the time of conversion our stock price exceeds the conversion price under the Convertible Senior Notes. The Capped Calls have an initial strike price of $335.90 per share and cover 3.5 million shares of our common stock.

As of December 31, 2019, the following notes were outstanding:

Issuance Date		Coupon		Principal Outstanding (in millions)				Due Date		Initial Conversion Rate per Share of Common Stock		Conversion Price per Share of Common Stock
November 2017		1.375%		$	402.5			November 2024		10.7315		$93.18
September 2019		0.375%		800.0				September 2026		4.4105		$226.73
Total				$	1,202.5

Additional information regarding our debt issuances is provided in Note 12 to the consolidated financial statements.

Summary of Cash Flows

		Years Ended December 31,
(in millions)		2019				2018
Cash provided by (used in):
Operating activities		$	98.4			$	35.9
Investing activities		(73.6		)		(184.5		)
Financing activities		73.5				(8.7		)
Effect of exchange rate changes on cash		1.5				(1.4		)
Net increase (decrease) in cash and cash equivalents		$	99.8			$	(158.7	)

The discussion of our operating, financing and investing activities for 2017 has been omitted from this Form 10-K but can be found in Item 7. Management’s Discussion and Analysis and Results of Operations in our Form 10-K/A for the fiscal year ended December 31, 2018 filed with the Securities and Exchange Commission on February 28, 2019.

Operating Activities

Net cash provided by operating activities of $98.4 million in 2019 was primarily attributable to net income, as adjusted for non-cash interest, stock-based compensation, depreciation and amortization, partially offset by a $19.7 million working capital cash outflow. The working capital outflow was driven by a $30.2 million increase in inventories and a $21.9 million increase in prepaid expenses and other assets, partially offset by a $36.2 million increase in accounts payable, accrued expenses and other current liabilities, primarily driven by timing of payments. The increase in inventories was primarily due to an increase in raw materials and finished goods related to the startup of our U.S. manufacturing plant and an increase in work-in-process to support demand for our product. The increase in prepaid expenses and other assets was primarily driven by an increase in operating lease assets resulting from new leases entered into during the year and an increase in deferred commissions.

Net cash provided by operating activities of $35.9 million in 2018 was primarily attributable to net income, as adjusted for stock-based compensation, non-cash interest, depreciation and amortization, partially offset by a $52.8 million working capital cash outflow. The working capital outflow was driven by a $38.8 million increase in inventories to support higher demand for our product and a $22.9 million increase in accounts and unbilled receivables driven by our shift to direct sales of the Omnipod in Europe and the adoption of new revenue guidance on January 1, 2018, which resulted in recording $13.4 million of unbilled revenue at December 31, 2018.

Investing Activities

Net cash used in investing activities was $73.6 million and $184.5 million in 2019 and 2018, respectively.

Capital Spending—Capital expenditures were $163.7 million and $157.4 million for 2019 and 2018, respectively, primarily associated with the construction of our manufacturing and corporate headquarters facility in Acton, Massachusetts. We expect capital expenditures for 2020 to be relatively consistent with 2019 as we continue to expand manufacturing capacity to support our growth and the launch of Omnipod Horizon. We expect to fund our capital expenditures using a combination of existing cash and investments as well as cash generated from operations.

Purchases and Sales of Investments—During 2019, net sales of marketable securities were $97.3 million, compared with net purchases of marketable securities of $22.1 million for 2018. The increase in net sales of marketable securities was driven by a shift in a portion of our investment portfolio to investments that are classified as cash equivalents in order to satisfy future cash needs.

Financing Activities

Net cash provided by financing activities was $73.5 million in 2019, compared with net cash used in financing activities of $8.7 million in 2018.

Debt Issuance and Repayment—As previously discussed under “Convertible Debt” during 2019, we received net proceeds of $780.2 million from the issuance of our 0.375% Notes. We used $663.6 million of the proceeds to partially fund the redemption of our 1.25% Notes and $85.4 million to purchase Capped Calls. During 2018, we paid $6.7 million to settle all our outstanding 2% Notes.

Option Exercises and Issuance of Shares Under Employee Stock Purchase Plan (“ESPP”)—Total proceeds from option exercises and the issuance of common stock under our ESPP increased $35.1 million to $50.9 million in 2019, compared with $15.8 million in 2018. This increase was primarily driven by option exercises stemming from the retirement of our former CEO and the departure of other executives, partially offset by a $9.2 million decrease in payments of withholding taxes related to net restricted share settlements. The decrease in tax payments was driven by a reduction in the vesting of restricted shares in 2019, compared with 2018, which was also due to the retirement of our former CEO and departure of other executives in 2018 and 2019, respectively.

Commitments and Contingencies

Contractual Obligations—A summary of our contractual obligations and commitments for debt, operating lease obligations and other obligations at December 31, 2019 is presented in the following table:

(in millions)		Total				2020				2021				2022				2023				2024				Thereafter
Operating lease obligations		$	20.6			$	4.7			$	5.0			$	4.7			$	2.3			$	2.4			$	1.5
Debt obligations		1,202.5				—				—				—				—				402.5				800.0
Interest payments		46.9				8.5				8.5				8.5				8.5				7.8				5.1
Purchase obligations (1)		158.7				115.8				40.9				2.0				—				—				—
Total contractual obligations		$	1,428.7			$	129.0			$	54.4			$	15.2			$	10.8			$	412.7			$	806.6

(1)	Purchase obligations include commitments for the purchase of Omnipod System components, commitments related to establishing additional manufacturing capabilities and other commitments for purchases of goods or services in the normal course of business. These commitments are derived from purchase orders, supplier contracts and open orders based on projected demand information.

Following the expiration of an agreement with a former European distributor on June 30, 2018, we were required to pay a quarterly per-unit fee for Omnipod sales to certain customers of the former European distributor for a one-year period through June 30, 2019. The methodology applicable for determining the total fee under the distribution agreement is subject to an active arbitration proceeding in Switzerland. The final amount of the fee could vary significantly depending on the number of customers who count for purposes of calculating the fee under the terms of the agreement; accordingly, this fee has been excluded from the contractual obligations table above. We estimate that the final aggregate fee for the applicable twelve-month period could be in the range of $5 million to $55 million. We paid $3.8 million and $1.3 million of this fee during 2019 and 2018, respectively.

Off-Balance Sheet Arrangements

As of December 31, 2019, we had various outstanding letters of credit and bank guarantees totaling $2.9 million, none of which are individually significant. The Company has restricted cash that serves as collateral for these outstanding letters of credit and bank guarantees that is included in cash and cash equivalents on the consolidated balance sheet.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in conformity with U.S. GAAP requires management to use judgment in making estimates and assumptions that affect the reported amounts of assets, liabilities, revenue and expenses, and related disclosure of contingent assets and liabilities. The following accounting policies are based on, among other things, judgments and assumptions made by management that include inherent risks and uncertainties. Management’s estimates are based on the relevant information available at the end of each period.

Revenue Recognition

We recognize revenue when a customer obtains control of the promised products in an amount that reflects the net consideration to which we expect to be entitled. We sell products both direct to consumers and through distributors who resell the products to consumers. Transaction price is typically based on contracted rates less any estimates of claim denials and historical reimbursement experience, guidelines and payor mix, and less estimated variable consideration adjustments including rebates. Recognizing revenue requires us to exercise judgment and use estimates that can have a significant impact on the amount and timing of revenue we report. We exercise significant judgment when we determine the transaction price, including variable consideration adjustments. The amount of variable consideration that is included in the transaction price is included in revenue only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized will not occur in a future period. We estimate reductions to our revenues for rebates paid to distributors in the United States and Canada and pharmacy benefit managers (“PBM”) in the United States. Rebates are based on contractual arrangements, which may vary. Our estimates are based on products

sold, historical experience, trends and, as available, channel inventory data. Rebates charged against gross sales amounted to $59.1 million, $34.1 million and $16.1 million in 2019, 2018 and 2017, respectively. Provisions for rebates, sales discounts and returns, are accounted for as a reduction of sales when revenue is recognized and are included within accounts receivable trade or accrued expenses and other current liabilities on our consolidated balance sheets, based upon the recipient of the rebate. If the actual amounts of consideration that we receive differ from our estimates, we would adjust our estimates and that would affect reported revenue in the period that such variances become known.

Our drug delivery product line includes sales of a modified version of the Omnipod to pharmaceutical and biotechnology companies who use our technology as a delivery method for their drugs. Revenue from the drug delivery product was $64.7 million for 2019. Revenue for this product line is recognized as the product is produced. Accounting for drug delivery revenue requires us to select a method to measure progress towards the satisfaction of the performance obligation. This election of the most meaningful measure of progress by which to recognize drug delivery revenue requires the application of judgment. We elected the input method and selected a blend of cost and time to produce as the measure of progress. Accordingly, revenue is recognized 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 of our performance obligations. We believe 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.

Product Warranty

We provide a four-year warranty on our PDMs sold in the United States and Europe and a five-year warranty on PDMs sold in Canada and may replace Pods that do not function in accordance with product specifications. We estimate our warranty obligation at the time the product is shipped based on historical experience and the estimated cost to service the claims. Warranty expense is recorded in cost of goods sold in the consolidated statements of operations. Costs to service the claims reflect the current product cost. Since we continue to introduce new products and versions, the anticipated performance of the product over the warranty period is also considered in estimating warranty reserves. Changes to the actual replacement rates, which are evaluated quarterly, could have a material impact on our estimated warranty reserve.

Accounts Receivable and Allowance for Doubtful Accounts

We maintain an allowance for doubtful accounts for estimated losses resulting from the inability of our customers to make required payments. We evaluate the collectability of our accounts receivable based on a combination of factors. We regularly analyze customer accounts, review the length of time receivables are outstanding, review historical loss rates and assess current economic trends that may impact the level of credit losses in the future. Our allowance for doubtful accounts has generally been adequate to cover our actual credit losses. However, since we cannot reliably predict future changes in the financial stability of our customers, we may need to increase our reserves if the financial conditions of our customers deteriorate.

Contingencies

We are involved in various legal proceedings that arise in the ordinary course of business as further discussed in Note 13 to our consolidated financial statements, including an ongoing arbitration proceeding with a former European distributor. Accruals recorded for various contingencies including legal proceedings, self-insurance and other claims, are based on judgment, both regarding the probability of losses and range of loss, and, where applicable, include the consideration of opinions of internal and/or external legal counsel. When a range is established but a best estimate cannot be made, we record the minimum loss contingency amount, which could be zero. An estimate is often initially developed substantially earlier than the ultimate loss is known and is reevaluated each accounting period. As information becomes known, additional loss provision is recorded when either a best estimate can be made, or the minimum loss amount is increased. When events result in an expectation of a more favorable outcome than previously expected, our best estimate is changed to a lower amount. We record receivables from third-party insurers up to the amount of the related liability when we have determined that existing insurance policies will provide reimbursement. In making this determination, we consider applicable deductibles, policy limits and the historical payment experience of the insurance carriers.

Accounting Standards Issued and Not Yet Adopted as of December 31, 2019

In December 2019, the Financial Accounting Standards Board (“FASB”) issued ASU 2019-12, Income Taxes (Topic 740): Simplifying the Accounting for Income Taxes. ASU 2019-12 eliminates certain exceptions in the current guidance regarding the approach for intraperiod tax allocations, the methodology for calculating income taxes in an interim period and the recognition of deferred tax liabilities for outside basis differences. This new guidance also simplifies the accounting for franchise taxes and enacted changes in tax laws or rates and clarifies such things as the accounting for transactions that result in a step up in the tax basis of goodwill. The guidance is effective for us beginning in the first quarter of 2021 with early adoption permitted. We are currently evaluating the impact of this guidance on our consolidated financial statements.

In January 2017, the FASB issued ASU 2017-04, Simplifying the Test for Goodwill Impairment (“ASU 2017-04”). ASU 2017-04 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 us beginning in the first quarter of 2020. Early adoption is permitted. We do not expect the adoption of this guidance to impact our consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Credit Losses (Topic 326) (“ASU 2016-13”). ASU 2016-13 requires financial assets measured at amortized cost, such as our trade receivables and contract assets, to be presented net of expected credit losses, which may be estimated based on relevant information such as historical experience, current conditions and future expectation for each pool of similar financial assets. The new guidance also requires enhanced disclosures related to trade receivables and associated credit losses. The guidance is effective for us beginning in the first quarter of 2020. The adoption of this guidance is not expected to have a material impact on our consolidated financial statements.

Forward-Looking Statements

This Annual Report on Form 10-K contains forward-looking statements. Forward-looking statements relate to future events or our future financial performance. We generally identify forward looking statements by terminology such as “may,” “will,” “should,” “expects,” “plans,” “anticipates,” “could,” “intends,” “targets,” “projects,” “contemplates,” “believes,” “estimates,” “predicts,” “potential” or “continue” or the negative of these terms or other similar words. These statements are only predictions. We have based these forward-looking statements largely on our current expectations and projections about future events and financial trends that we believe may affect our business, results of operations and financial condition.

Forward-looking statements involve risks, uncertainties and assumptions. Actual results may differ materially from those expressed in these forward-looking statements. You should not put undue reliance on any forward-looking statements.

The risk factors discussed in “Risk Factors” could cause our results to differ materially from those expressed in forward-looking statements. In addition, there may be other risks and uncertainties that we are unable to predict at this time or that we currently do not expect to have a material adverse effect on our business. We expressly disclaim any obligation to update these forward-looking statements other than as required by law.