SEC Filing - Kala Bio

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KALA_Current_Folio_10Q

Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

☒QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2019

☐TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to

Commission file number 001-38150

KALA PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)


Delaware	27-0604595
(State or other jurisdiction of	(I.R.S. Employer
incorporation or organization)	Identification No.)


490 Arsenal Way, Suite 120
Watertown, MA	02453
(Address of principal executive offices)	(Zip Code)

(781) 996-5252

(Registrant’s telephone number, including area code)

Securities registered pursuant to Section 12(b) of the Act

Title of each class

Common Stock, $0.001 par value per share

Trading symbol(s)

KALA

Name of each exchange on which registered

The Nasdaq Global Select Market

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes ☒ No ☐

Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). Yes ☒ No ☐

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company,” and “emerging growth company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer ☐	Accelerated filer ☒	Non-accelerated filer ☐	Smaller reporting company ☒
			Emerging growth company ☒

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. ☒

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes ☐ No ☒

There were 34,006,631 shares of Common Stock, $0.001 par value per share, outstanding as of August 2, 2019

Table of Contents

TABLE OF CONTENTS


		Page
PART I – FINANCIAL INFORMATION

Item 1.	Financial Statements (Unaudited)	3

	Condensed Consolidated Balance Sheets as of June 30, 2019 and December 31, 2018	3

	Condensed Consolidated Statement of Operations for the three and six months ended June 30, 2019 and 2018	4

	Condensed Consolidated Statements of Changes in Stockholders' Equity for the three and six months ended June 30, 2019 and 2018	5

	Condensed Consolidated Statements of Cash Flows for the six months ended June 30, 2019 and 2018	6

	Notes to Condensed Consolidated Financial Statements	7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	23

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	36

Item 4.	Controls and Procedures	36

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	36

Item 1A.	Risk Factors	37

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	84

Item 6.	Exhibits	85

SIGNATURES		86

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PART I – FINANCIAL INFORMATION

Item 1 Financial Statements

KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except share and per share amounts)



	June 30,		December 31,
	2019		2018

Assets
Current assets:
Cash	$	118,006	$	170,898
Accounts receivable, net		5,648		—
Inventory		8,219		4,095
Prepaid expenses and other current assets		930		2,035
Total current assets		132,803		177,028
Noncurrent assets:
Property and equipment, net		2,721		2,166
Right-of-use assets		30,713		29,566
Restricted cash		12,578		12,206
Total assets	$	178,815	$	220,966
Liabilities and Stockholders' Equity
Current liabilities:
Accounts payable	$	3,196	$	5,446
Accrued expenses and other current liabilities		12,878		11,101
Current portion of lease liabilities		1,627		463
Total current liabilities		17,701		17,010
Long-term liabilities:
Long-term lease liability - less current portion		29,356		28,752
Long-term debt		70,692		70,226
Total long-term liabilities		100,048		98,978
Total liabilities		117,749		115,988
Commitments and Contingencies (Note 11)
Stockholders' equity:
Common stock, $0.001 par value; 120,000,000 shares authorized as of June 30, 2019 and December 31, 2018; 33,882,967 and 33,863,077 shares issued and outstanding as of June 30, 2019 and December 31, 2018, respectively		34		34
Additional paid-in capital		311,354		306,053
Accumulated deficit		(250,322)		(201,109)
Total stockholders' equity		61,066		104,978
Total liabilities and stockholders' equity	$	178,815	$	220,966

See accompanying notes to these unaudited condensed consolidated financial statements.

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KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(In thousands, except share and per share amounts)


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018

Product revenues, net	$	2,057	$	—	$	3,443	$	—
Costs and expenses:
Cost of product revenues		352		—		593		—
Selling, general and administrative		17,007		7,151		35,243		12,633
Research and development		7,108		7,368		14,067		13,024
Total costs and expenses		24,467		14,519		49,903		25,657
Loss from operations		(22,410)		(14,519)		(46,460)		(25,657)
Other income (expense):
Interest income		646		313		1,402		522
Interest expense		(2,061)		(414)		(4,155)		(781)
Total other income (expense)		(1,415)		(101)		(2,753)		(259)
Net loss	$	(23,825)	$	(14,620)	$	(49,213)	$	(25,916)
Net loss per share—basic and diluted	$	(0.70)	$	(0.60)	$	(1.45)	$	(1.06)
Weighted average shares outstanding—basic and diluted		33,882,939		24,567,103		33,880,494		24,554,834

See accompanying notes to these unaudited condensed consolidated financial statements.

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KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS CHANGES IN STOCKHOLDERS’ EQUITY

(In thousands, except share data)




	Common Stock			Additional				Total
	$0.001 Par Value			Paid-In		Accumulated		Stockholders'
	Shares	Amount		Capital		Deficit		Equity
Three Months Ended June 30, 2018
Balance as of March 31, 2018	24,556,094	$	25	$	225,914	$	(145,668)	$	80,271
Exercise of stock options	36,180		—		150		—		150
Stock-based compensation expense	—		—		2,291		—		2,291
Net loss	—		—		—		(14,619)		(14,619)
Balance as of June 30, 2018	24,592,274	$	25	$	228,355	$	(160,287)	$	68,093

Three Months Ended June 30, 2019
Balance as of March 31, 2019	33,882,857	$	34	$	308,830	$	(226,497)	$	82,367
Exercise of stock options	110		—		—		—		—
Stock-based compensation expense	—		—		2,524		—		2,524
Net loss	—		—		—		(23,825)		(23,825)
Balance as of June 30, 2019	33,882,967	$	34	$	311,354	$	(250,322)	$	61,066

Six Months Ended June 30, 2018
Balance as of December 31, 2017	24,538,309	$	25	$	224,025	$	(134,371)	$	89,679
Exercise of stock options	53,965		—		178		—		178
Stock-based compensation expense	—		—		4,152		—		4,152
Net loss	—		—		—		(25,916)		(25,916)
Balance as of June 30, 2018	24,592,274	$	25	$	228,355	$	(160,287)	$	68,093

Six Months Ended June 30, 2019
Balance as of December 31, 2018	33,863,077	$	34	$	306,053	$	(201,109)	$	104,978
Exercise of stock options	19,890		—		39		—		39
Stock-based compensation expense	—		—		5,262		—		5,262
Net loss	—		—		—		(49,213)		(49,213)
Balance as of June 30, 2019	33,882,967	$	34	$	311,354	$	(250,322)	$	61,066

See accompanying notes to these unaudited condensed consolidated financial statements

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KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(In thousands)


		Six Months Ended
		June 30,
	2019		2018
Cash flows from operating activities:
Net loss	$	(49,213)	$	(25,916)
Adjustments to reconcile net loss to cash used in operating activities:
Depreciation		388		173
Non-cash operating lease cost		840		187
Amortization of debt discount and other non-cash interest		466		51
Stock-based compensation		5,094		4,152
Change in operating assets and liabilities:
Accounts receivable		(5,648)		—
Prepaid expenses and other current assets		1,106		12
Inventory		(3,955)		—
Accounts payable		(2,249)		1,085
Accrued expenses		1,776		(1,460)
Lease liabilities and other long-term liabilities		(201)		(203)
Net cash used in operating activities		(51,596)		(21,919)
Cash flows from investing activities:
Purchases of property and equipment		(943)		(541)
Net cash used in investing activities		(943)		(541)
Cash flows from financing activities:
Proceeds from venture debt, net of debt issuance costs of $50		—		2,728
Payment of principal and prepayment penalty on venture debt		—		(1,667)
Payment of principal on finance lease		(20)		—
Proceeds from exercise of stock options		39		83
Net cash provided by financing activities		19		1,144
Net decrease in cash and restricted cash:		(52,520)		(21,316)
Cash and restricted cash at beginning of period		183,104		114,699
Cash and restricted cash at end of period		130,584		93,383
Reconciliation of cash and restricted cash:
Cash and restricted cash at end of period		130,584		93,383
Less restricted cash		(12,578)		(2,178)
Cash at end of period	$	118,006	$	91,205
Non-cash investing and financing activities:
Right-of-use asset obtained in exchange for finance lease obligation	$	136	$	—
Purchases of property and equipment in accounts payable		—		95
Exercise of stock options in prepaid expenses and other current assets		—		95

Supplemental disclosure:
Cash paid for interest	$	3,683	$	800
Right-of-use assets obtained in exchange of operating lease obligations		1,852		—

See accompanying notes to these unaudited condensed consolidated financial statements.

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. NATURE OF BUSINESS AND BASIS OF PRESENTATION

Nature of Business—Kala Pharmaceuticals, Inc. (the “Company”) was incorporated on July 7, 2009, and is a biopharmaceutical company focused on the development and commercialization of therapeutics using its AMPPLIFY mucus-penetrating particle (“MPP”) Drug Delivery Technology, with an initial focus on the treatment of eye diseases. The Company has applied the AMPPLIFY technology to loteprednol etabonate (“LE”), a corticosteroid designed for ocular applications, resulting in the U.S. Food and Drug Administration’s (the “FDA”) approval of INVELTYS ® (loteprednol etabonate ophthalmic suspension) 1% as the first and only twice-daily ocular corticosteroid for treatment of post-operative inflammation and pain following ocular surgery, and the development of its lead product candidate, KPI-121 0.25%, for the temporary relief of the signs and symptoms of dry eye disease. On October 16, 2018, the Company submitted a New Drug Application to the FDA for KPI-121 0.25%, for which the FDA has granted a target action date under the Prescription Drug User Fee Act (“PDUFA”) of August 15, 2019. In addition, based upon the recommendation of the FDA, the Company initiated an additional Phase 3 clinical trial (“STRIDE 3”) (STRIDE- Short Term Relief In Dry Eye), in the third quarter of 2018 evaluating KPI-121 0.25% for the temporary relief of the signs and symptoms of dry eye disease. The Company is targeting topline data for STRIDE 3 by the end of 2019. The Company is evaluating opportunities for MPP nanosuspensions of LE with less frequent daily dosing regimens for the temporary relief of the signs and symptoms of dry eye disease and for potential chronic treatment of dry eye disease. The Company is also evaluating compounds in its receptor Tyrosine Kinase Inhibitor program (the “rTKI program”), that inhibit the vascular endothelial growth factor (“VEGF”), pathway, for the potential treatment of a number of retinal diseases.

In January 2019, the Company launched its first commercial product, INVELTYS, in the United States. The Company is currently engaged in the commercialization of INVELTYS, research and development activities, raising capital and recruiting skilled personnel. The Company is subject to a number of risks similar to those of other companies conducting high‑risk, early‑stage research and development of pharmaceutical product candidates and launching a product for the first time. Principal among these risks are dependence on key individuals and intellectual property, competition from other products and companies and the technical risks associated with the successful research, development and marketing of its product candidates. The Company’s success is dependent upon its ability to raise additional capital in order to fund ongoing and future research and development, obtain regulatory approval of its product candidates, successfully commercialize its products, generate revenue, meet its obligations, and, ultimately, attain profitable operations.

Liquidity— Since inception, the Company has incurred significant losses from operations and negative cash flows from operations. As of June 30, 2019, the Company had an accumulated deficit of $250.3 million. The Company has generated only limited revenues to date from product sales and has financed operations primarily through its initial public offering of common stock (“IPO”), private placements of preferred stock, convertible debt financings, borrowings under credit facilities, warrants, public common stock offerings, sales of its common stock under its at-the-market offering facility and to a lesser extent, payments received in connection with various feasibility studies. The Company has devoted substantially all of its financial resources and efforts to research and development, including preclinical studies and clinical trials and engaging in activities to commercialize INVELTYS. The Company expects to continue to incur significant expenses and operating losses over the next several years. Net losses may fluctuate significantly from quarter-to-quarter and year-to-year.

The Company believes that its existing cash on hand as of June 30, 2019, will enable it to fund its planned operating expenses, debt service obligations and capital expenditure requirements for at least twelve months from the date these condensed consolidated financial statements were issued. This evaluation is based on relevant conditions and events that are known and reasonably knowable at the date that the condensed consolidated financial statements are issued. As a result, the Company could deplete its available capital resources sooner than it currently expects.

Use of Estimates—The preparation of condensed consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”) requires management to make

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, expense, and related disclosures. The Company bases estimates and assumptions on historical experience when available and on various factors that it believes to be reasonable under the circumstances. The Company evaluates its estimates and assumptions on an ongoing basis. Estimates and assumptions relied upon in preparing these condensed consolidated financial statements relate to, but are not limited to, revenue recognition, inventory, the present value of lease liabilities and the corresponding right-of-use assets, the fair value of warrants, stock compensation, accrued expenses and the recoverability of the Company’s net deferred tax assets and related valuation allowance. Actual results may differ from these estimates under different assumptions or conditions.

Net Loss per Share—Basic net loss per share is computed using the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed using the sum of the weighted average number of common shares outstanding during the period and, if dilutive, the weighted average number of potential shares of common stock, including the assumed exercise of stock options and warrants.

Basic and diluted shares outstanding are the same for each period presented as all common stock equivalents would be antidilutive due to the net losses incurred.

Unaudited Interim Financial Information—The condensed consolidated financial statements of the Company included herein have been prepared, without audit, pursuant to the rules and regulations of the Securities Exchange Commission (“SEC”). Certain information and footnote disclosures normally included in financial statements prepared in accordance with U.S. GAAP have been condensed or omitted from this report, as is permitted by such rules and regulations. The accompanying condensed consolidated financial statements reflect all adjustments consisting of normal, recurring adjustments, that are necessary for a fair presentation of the financial position, results of operations, statement of stockholders’ equity and cash flows for the interim periods presented. Interim results are not necessarily indicative of results for a full year. Accordingly, these condensed consolidated financial statements should be read in conjunction with the financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2018 (the “Annual Report”).

The unaudited condensed consolidated financial statements include the accounts of Kala Pharmaceuticals, Inc. and its wholly owned subsidiary, Kala Pharmaceuticals Security Corporation. All intercompany transactions and balances have been eliminated in consolidation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

The Company’s significant accounting policies are described in Note 2, “Summary of Significant Accounting Policies,” to the consolidated financial statements included in the Annual Report. There have been no material changes to the significant accounting policies during the period ended June 30, 2019 other than those noted below.

Revenue

The Company accounts for revenue in accordance with Accounting Standards Codification (“ASC”) Topic 606, Revenue from Contracts with Customers. Under ASC Topic 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration that the entity expects to be entitled in exchange for those goods or services. The Company performs the following five steps to recognize revenue under ASC Topic 606: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. The Company only recognizes revenue when it is probable that it will collect the consideration to which it is entitled in exchange for the goods or services that will be transferred to the customer.

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Product revenues, net

The Company sells INVELTYS to wholesalers and/or specialty distributors in the United States (collectively, “Customers”). These Customers subsequently resell the Company’s products to specialty and other retail pharmacies. In addition to agreements with Customers, the Company enters into arrangements with payors that provide for government-mandated and/or privately-negotiated rebates, chargebacks and discounts for the purchase of the Company’s products.

The goods promised in the Company’s product sales contracts represent a single performance obligation; as the promise to transfer the individual products to the Customer is not separately identifiable from other promises in the contracts and, therefore, not distinct. The Company recognizes revenue from product sales at the point the Customer obtains control of the product, which occurs upon delivery. The transaction price (“net sales price”) that is recognized as revenue for product sales includes the selling price to the Customer and an estimate of variable consideration. Components of variable consideration include prompt pay and other discounts, product returns, government rebates, third-party payor rebates, coverage gap rebates, incentives such as patient co-pay assistance, and other fees paid to Customers where a distinct good or service is not received. Variable consideration is recorded on the consolidated balance sheet as either a reduction of accounts receivable, if payable to a Customer, or as a current liability, if payable to a third-party other than a Customer. The Company considers all relevant information when estimating variable consideration such as assessment of its current and anticipated sales and demand forecasts, specific known market events and trends, industry data and current contractual and statutory requirements that are reasonably available. The Company includes estimated amounts in the net sales price to the extent it is determined probable that a significant reversal of cumulative revenue recognized will not occur when the uncertainty associated with the variable consideration is resolved.

Payment terms with Customers do not exceed one year and, therefore, the Company does not account for a significant financing component in its arrangements. The Company expenses incremental cost of obtaining a contract with a Customer when incurred as the period of benefit is less than one year.

Reserves for Variable Consideration:

Trade Discounts and Allowances

The Company provides its Customers with certain trade discounts and allowances including discounts for prompt payments and fees paid for distribution, data and administrative services. These discounts and fees are based on contractually-determined percentages and are recorded as a reduction of revenue and accounts receivable in the period in which the related product revenue is recognized.

Chargebacks

Chargebacks for fees and discounts to providers represent the estimated obligations resulting from contractual commitments to sell products to qualified healthcare providers at prices lower than the list prices charged to Customers who directly purchase the product from the Company. Customers charge the Company for the difference between what they pay for the product and the ultimate selling price to the qualified healthcare providers. These components of variable consideration are established in the same period that the related revenue is recognized, resulting in a reduction of product revenue and accounts receivable. Reserves for chargebacks consist of credits the Company expects to issue for units that remain in the distribution channel at the end of each reporting period and that the Company expects will be sold to qualified healthcare providers, as well as chargebacks that Customers have claimed, but for which the Company has not yet issued a credit.

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

Product Returns

Consistent with industry practice, the Company has a product returns policy that provides Customers a right of return for product purchased within a specified period prior to and subsequent to the product’s expiration date. The Company estimates the amount of its products that may be returned and presents this amount as a reduction of revenue in the period the related product revenue is recognized, in addition to establishing a liability. The Company’s estimates for product returns are based upon available industry data and its own sales information, including its visibility into the inventory remaining in the distribution channel.

Commercial Payor and Medicare Part D Rebates

The Company contracts with certain third-party payors, primarily pharmacy benefit managers (“PBMs”) and health plans (“Plans”), for the payment of rebates with respect to utilization of its product. These rebates are based on contractual percentages applied to the amount of product prescribed to patients who are covered by the PBMs or the Plans with which it contracts. The Company estimates the rebates for commercial and Medicare Part D payors based on the contractual discount percentage, the various payor mix for INVELTYS as well as future rebates that will be made for product that has been recognized as revenue but remains in the distribution channel at the end of each reporting period. The Company also estimates the number of patients in the prescription drug coverage gap for whom it will owe an additional liability under the Medicare Part D program. Such estimates are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability.

Government Rebates

The Company is subject to discount obligations under Medicaid and other government programs. For Medicaid, reserves are based on estimates of future Medicaid beneficiary utilization applied to the Medicaid unit rebate formula established by the Centers for Medicaid and Medicare Services. The Company’s liability for these rebates consists of estimates of claims for the current period and estimated future claims that will be made for product that has been recognized as revenue but remains in the distribution channel at the end of each reporting period. These reserves are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability.

Co-pay Assistance Program

The Company offers a co-pay assistance program (the “co-pay program”), which is intended to provide financial assistance to patients who may or may not be covered by commercial insurance or who opt out of government insurance programs. The calculation of accruals for the co-pay program is based on actual claims processed during the period as well as an estimate of the number and cost per claim that the Company expects to receive associated with product that has been recognized as revenue but remains in the distribution channel at the end of each reporting period. Allowances for estimated co-pay claims are recorded in the same period the related revenue is recognized, resulting in a reduction of product revenue and the establishment of a current liability.

Accounts Receivable, net

Accounts receivable are reported on the consolidated balance sheets at outstanding amounts due from Customers for product sales. The Company deducts sales discounts for prompt payments and contractual fees for service arrangements from accounts receivable. The Company evaluates the collectability of accounts receivable on a regular basis, by reviewing the financial condition and payment history of Customers, an overall review of collections

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

experience on other accounts, and economic factors or events expected to affect future collections experience. An allowance for doubtful accounts is recorded when a receivable is deemed to be uncollectible.

The Company recorded no allowance for doubtful accounts as of June 30, 2019. The Company recorded an allowance of approximately $0.9 million for expected sales discounts, related to prompt pay discounts and contractual fee for service arrangements, to wholesalers and distributors as of June 30, 2019.

Cost of Product Revenues

The cost of product revenues consists primarily of materials, third-party manufacturing costs, freight and distribution costs, royalty expense, allocation of labor, quality control and assurance, spoilage and other manufacturing overhead costs. The Company expenses costs of product revenues related to product candidates as research and development expenses prior to regulatory approval in the respective territory. The Company received regulatory approval for INVELTYS on August 22, 2018.

Recent Accounting Pronouncements

In May 2014, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“ASU”) 2014-09, Revenue from Contracts with Customers (Topic 606) (“ASU 2014-09”). ASU 2014-09 states that an entity should recognize revenue based on the transfer of promised goods or services to customers in an amount that reflects the consideration to which the entity expects to be entitled in exchange for those goods or services. The FASB subsequently issued amendments to ASU 2014-09 that had the same effective date of January 1, 2018. Revenue from sales of INVELTYS, as well as any other future revenue arrangements, are and will be recognized under the provisions of ASU 2014-09. While the Company adopted ASU 2014-09 effective January 1, 2018, the Company did not generate any revenue from product sales prior to 2019.

In June 2018, the FASB issued ASU 2018-07, Compensation-Stock Compensation Improvements to Nonemployee Share-Based Payment Accounting (“ASU 2018-07”). ASU 2018-07 substantially aligns accounting for share-based payments to employees and non-employees. This ASU became effective for annual periods beginning after December 15, 2018, including interim periods within that period, and early adoption is permitted. The new standard was effective on January 1, 2019 and the adoption of ASU 2018-07 did not have an impact on the Company’s condensed consolidated financial statements and related disclosures.

In August 2018, the FASB issued ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement (“ASU 2018-13”). ASU 2018-13 is intended to improve the effectiveness of disclosures in the notes to financial statements related to fair value measurements in Topic 820. This ASU will become effective for annual periods beginning after December 15, 2019, including interim periods within that period, and early adoption is permitted. The Company is currently evaluating the effect of this new guidance on its condensed consolidated financial statements.

In August 2018, the FASB issued ASU 2018-15, Intangibles - Goodwill and Other - Internal-Use Software -Customer’s Accounting for Implementation Costs Incurred in a Cloud Computing Arrangement That Is a Service Contract (“ASU 2018-15”). ASU 2018-15 aligns the accounting for implementation costs incurred in a hosting arrangement that is a service contract with the guidance on capitalizing costs associated with developing or obtaining internal-use software. This ASU will become effective for annual periods beginning after December 15, 2019, including interim periods within that period, and early adoption is permitted. The Company does not expect the adoption of ASU 2018-15 to have a material effect on its condensed consolidated financial statements.

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KALA PHARMACEUTICALS, INC.

NOTES TO UNAUDITED CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Continued)

3. INVENTORY

Inventory is stated at the lower of cost or net realizable value, on a first in, first out basis. Costs include amounts related to third-party manufacturing, freight and distribution costs, allocation of labor, quality control and quality assurance and other manufacturing overhead. Capitalization of costs as inventory begins when the product has received regulatory approval in the United States. The Company expensed inventory costs related to product candidates as research and development expenses prior to regulatory approval. For INVELTYS, capitalization of costs as inventory began upon U.S. regulatory approval on August 22, 2018. Inventory produced that will be used in a promotional sample program is expensed to selling, general and administrative expense when it is selected for use and shipped as part of a marketing program.

Inventory consists of the following (in thousands):


	June 30,		December 31,
	2019		2018

Raw materials	$	706	$	350
Work in progress		6,928		3,357
Finished goods		585		388
Inventory	$	8,219	$	4,095

4. ACCRUED EXPENSES


	June 30,		December 31,
	2019		2018

Compensation and benefits	$	4,662	$	5,352
Accrued revenue reserves (1)		3,444		—
Development costs		1,314		1,223
Professional services		828		1,019
Commercial cost		835		1,722
Contract manufacturing		1,347		434
Payable related to construction of facility		—		1,026
Other		448		325
Accrued expenses	$	12,878	$	11,101

(1) As of June 30, 2019, $0.5 million of additional revenue reserves were in accounts payable.

5. LEASES

Operating leases

The Company entered into a three‑year lease agreement for its former headquarters (the “Waltham Lease”) on September 30, 2013, with a commencement date of February 1, 2014. On June 30, 2016, the lease was amended to extend the term from January 31, 2017 to January 31, 2019. In connection with the lease agreement, the Company issued a letter of credit to the landlord for $0.1 million. The Company secured the letter of credit for the full amount of the letter with cash on deposit, which was reported as restricted cash as of December 31, 2018. Upon the expiration of the lease

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term on January 31, 2019, the deposit was returned and was no longer restricted. With the adoption of ASU 2016-02, Leases, the Company has recorded a right-of-use asset and corresponding lease liability.

On March 15, 2018, the Company entered into a lease agreement with Duffy Associates, LLC for the lease of a portion of the building located at 465 Waverley Oaks Road, Suite 301, Waltham, Massachusetts (the “Waverley Oaks Lease”). The term of the Waverley Oaks Lease was one-year, and as a result, a right-of-use asset and corresponding lease liability was not recorded.

On February 28, 2018, the Company entered into a lease agreement with 480 Arsenal Group LLC (the “Arsenal Group”) for the lease of a portion of the building located at 490 Arsenal Way, Watertown, Massachusetts (the “Watertown Lease”) to be used as its new corporate headquarters. The Company recognized the right-of-use asset and corresponding lease liability on November 15, 2018, by calculating the present value of lease payments, discounted at 9.9%, the Company’s estimated incremental borrowing rate, over the 13-year expected term.

In connection with the Watertown Lease, the Company issued a letter of credit to the Arsenal Group for $2.0 million. The Company secured the letter of credit for the full amount of the letter with cash on deposit, which is reported as restricted cash as of June 30, 2019 and December 31, 2018.

As of June 30, 2019, the variable lease expense for the Watertown Lease, which includes common area maintenance and real estate taxes was $0.5 million and the remaining lease term was 12.3 years. As of December 31, 2018, the remaining lease term on the lease for the Waltham Lease was 0.08 years and for the Watertown Lease was 12.83 years.

Vehicle Fleet lease

During the six months ended June 30, 2019, the Company entered into a master fleet lease agreement (the “Vehicle Fleet Lease”), pursuant to which it currently leases 65 vehicles. In connection with the Vehicle Fleet Lease, the company issued a letter of credit for $0.5 million, which was reported as restricted cash on the balance sheet. The lease has an expected term of three years, which commenced upon the delivery of the vehicles in March 2019. As of June 30, 2019, the remaining lease term was 2.7 years.

The components of lease expense and related cash flows were as follows (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2019		2018		2019		2018
Lease cost
Operating lease cost	$	1,187	$	99	$	2,243	$	198
Short-term lease cost		—		53		—		62
Total lease cost	$	1,187	$	152	$	2,243	$	260

Operating cash outflows from operating leases	$	911	$	103	$	1,654	$	205

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Future minimum commitments due under the Company’s lease agreements as of June 30, 2019 were as follows (in thousands):


Years Ending December 31,		Operating Lease Obligations (1)		Finance Lease Obligation (2)		Total
2019 (remaining six months)	$	2,433	$	21	$	2,454
2020		4,141		41		4,182
2021		4,233		41		4,274
2022		4,021		41		4,062
2023		3,960		—		3,960
Thereafter		35,415		—		35,415
Present value adjustment		(23,339)		(25)		(23,364)
Present value of lease payments	$	30,864	$	119	$	30,983

(1)

Future minimum lease payments under the Company’s Watertown Lease and its Vehicle Fleet Lease.

(2)

Future minimum lease payments under the Company’s finance lease obligation.

6. DEBT

2014 Debt Facility

In November 2014, the Company entered into a venture debt facility (“2014 Debt Facility”), which was subsequently amended in October 2016, November 2017 and March 2018. The 2014 Debt Facility, as amended, increased the initial commitment under the debt facility to a total of $20.0 million of funding and extended the interest-only end date for 12 months following the execution of the March 2018 amendment. The maturity date of the 2014 Debt Facility was also extended from October 13, 2020 to March 29, 2022.

The unpaid principal balance under the 2014 Debt Facility was $20.0 million as of June 30, 2018. The unamortized discount was $0.2 million as of June 30, 2018. During the three months ended June 30, 2018, the Company recognized interest expense of $0.4 million which consisted of amortization of the debt discount of $21,000 and the contractual coupon interest expense of $0.4 million. During the six months ended June 30, 2018, the Company recognized interest expense of $0.8 million which consisted of amortization of the debt discount of $51,000 and the contractual coupon interest expense of $0.7 million. On October 1, 2018, the Company repaid the outstanding principal balance under the 2014 Debt Facility of $20.0 million. In connection with the repayment of the 2014 Debt Facility, the Company paid a prepayment fee of $0.2 million.

Athyrium Credit Facility

On October 1, 2018, the Company entered into a credit agreement (the “Athyrium Credit Facility”), with Athyrium Opportunities III Acquisition LP (“Athyrium”) for up to $110.0 million. The Athyrium Credit Facility provides for a Term Loan A in the aggregate principal amount of $75.0 million (the “Term Loan A”), and a Term Loan B in the aggregate principal amount of $35.0 million (the “Term Loan B”). On October 1, 2018, the Company borrowed the entire principal amount of the Term Loan A. The Company may draw down the Term Loan B upon either (i) FDA approval of KPI-121 0.25% for a dry eye disease indication or (ii) reaching certain net product revenues for INVELTYS, in each case on or prior to June 30, 2020. The maturity date of the Athyrium Credit Facility is October 1, 2024.

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The Term Loan A bears interest at a rate of 9.875% per annum, with quarterly, interest-only payments until the fourth anniversary of the Term Loan A. The unpaid principal amount of the Term Loan A is due and payable in quarterly installments starting on the fourth anniversary of the loan. The Company may make voluntary prepayments, in whole or in part, and subject to certain exceptions, is required to make mandatory prepayments upon the occurrence of certain events of default as defined in the agreement, including but not limited to, the occurrence of a change of control. In addition, upon payment or repayment of any outstanding balance under the Athyrium Credit Facility, the Company will have to pay a 1% exit fee of the total principal payments (whether mandatory, voluntary, or at maturity) made throughout the term. The exit fee of $0.8 million based on the $75.0 million principal amount outstanding, will be accreted to the carrying amount of the debt using the effective interest method over the term of the loan.

All mandatory and voluntary prepayments of the Athyrium Credit Facility are subject to the payment of prepayment premiums as follows: (i) if prepayment occurs prior to the second anniversary of the applicable date of issuance, an amount equal to the amount by which (a) the present value of 105% of the principal prepaid plus all interest that would have accrued on such principal through such second anniversary exceeds (b) the amount of principal prepaid, (ii) if prepayment occurs on or after the second anniversary of the applicable date of issuance but prior to the third anniversary of such issuance, an amount equal to 3% of the principal prepaid, and (iii) if prepayment occurs on or after the third anniversary of the applicable date of issuance but prior to the fourth anniversary of such issuance, an amount equal to 2% of the principal prepaid. No prepayment premium is due on any principal prepaid after the fourth anniversary of the applicable date of issuance.

The Athyrium Credit Facility includes features requiring (1) additional interest rate upon an event of default accrued at an additional 3%, or a total interest rate of 12.875%, and (2) the lender’s right to declare all outstanding principal and interest immediately payable upon an event of default. These two features were analyzed and determined to be embedded derivatives to be valued as separate financial instruments. These embedded derivatives were bundled and valued as one compound derivative in accordance with the applicable accounting guidance for derivatives and hedging transactions. The Company determined that, due to the unlikely event of default, the embedded derivatives have a de minimus value as of June 30, 2019. The derivative liability will be remeasured at fair value at each reporting date, with changes in fair value being recorded as other income (expense) in the consolidated statements of operations.

The Athyrium Credit Facility is secured by a pledge of substantially all of the Company’s assets and contains affirmative and negative covenants customary for financings of this type, including limitations on the Company’s and its subsidiaries’ ability to, among other things, incur and prepay additional debt, grant or permit additional liens, make investments and acquisitions, merge or consolidate with others, dispose of assets, change in the nature of business, enter into sale and leaseback transactions, make distributions, and enter into affiliate transactions, in each case, subject to certain exceptions. In addition, the Athyrium Credit Facility also contains a financial covenant requiring the Company to maintain at least $10.0 million of cash and cash equivalents. As a result of this financial covenant, the Company has recorded $10.0 million as restricted cash as of June 30, 2019 and December 31, 2018.

In connection with the Athyrium Credit Facility, the Company issued a warrant (“Warrant”), to purchase up to 270,835 shares of the Company’s common stock, at an exercise price per share of $12.18456. The Warrant is immediately exercisable as to 184,660 shares and will become exercisable as to the remaining 86,175 shares only upon the Company’s draw of the Term Loan B. The Warrant is exercisable through October 1, 2025 and is classified as an equity instrument. The Company allocated the proceeds from the Term Loan A to the Warrant using the relative fair value method. The fair value of the Warrant of $1.9 million was recognized as equity and a corresponding debt discount.

In addition, the Company paid certain fees to Athyrium and other third-party service providers in the aggregate amount of $3.0 million. These fees paid to Athyrium were recorded as a debt discount while the fees paid to other third-party service providers were recorded as debt issuance cost, respectively, in the aggregate amount of $3.0 million. These costs, along with the fair value of the Warrant of $1.9 million are being amortized using the effective interest method

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over the term of the Athyrium Credit Facility. The amortization of debt discount and debt issuance cost is included in interest expense within the Condensed Consolidated Statements of Operations. As of June 30, 2019, the effective interest rate was 11.63%, which takes into consideration the non-cash accretion of the exit fee and the amortization of the debt discount and issuance costs. During the three months ended June 30, 2019, the Company recognized interest expense of $2.1 million which consisted of amortization of the debt discount of $0.2 million, and the contractual coupon interest expense of $1.9 million. During the six months ended June 30, 2019, the Company recognized interest expense of $4.1 million which consisted of amortization of the debt discount of $0.4 million, and the contractual coupon interest expense of $3.7 million.

The components of the carrying value of the debt as of June 30, 2019, and December 31, 2018 are detailed below (in thousands):


	June 30,		December 31,
	2019		2018
Principal loan balance	$	75,000	$	75,000
Unamortized debt discount and issuance cost		(4,417)		(4,806)
Accretion of exit fee		109		32
Long-term debt, net	$	70,692	$	70,226

The future annual principal payments due under the Athyrium Credit Facility as of June 30, 2019 were as follows (in thousands):


Years Ending December 31,
2019 (remaining six months)		—
2020		—
2021		—
2022		16,665
2023		33,330
Thereafter		25,005
Total	$	75,000

7. WARRANTS

The Company issued warrants in connection with debt transactions that were completed prior to 2017. Upon the completion of the IPO, the Company’s then outstanding warrants to purchase preferred stock converted into warrants to purchase common stock. The Company also issued the Warrant to purchase common stock in connection with the Athyrium Credit Facility, described further in Note 6.

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The following table summarizes the common stock warrants outstanding as of June 30, 2019 and December 31, 2018, each exercisable into the number of shares of common stock set forth below as of the specified dates:


					Shares Exercisable at
	Exercise		Expiration	Exercisable	June 30,	December 31,
Issued	Price		Date	From	2019	2018
2013	$	7.50	April 2021	July 2017	82,816	82,816
2014	$	7.50	November 2024	July 2017	16,000	16,000
2016	$	8.27	October 2026	September 2017	14,512	14,512
2018	$	12.18	October 2025	October 2018	184,660	184,660
2018	$	12.18	October 2025	(1)	—	—
					297,988	297,988

(1)

As of June 30, 2019 and December 31, 2018, warrants outstanding to acquire 86,175 shares of common stock are not exercisable and are only exercisable upon draw down of the Term Loan B.

8. EQUITY FINANCINGS

On August 9, 2018, the Company filed a shelf registration statement on Form S-3 with the SEC, which was declared effective on August 27, 2018 (the “Shelf Registration”). Under the Shelf Registration, the Company may offer and sell up to $250.0 million of a variety of securities including common stock, preferred stock, warrants, depositary shares, debt securities, purchase contracts, purchase units or any combination of such securities during the three-year period that commenced upon the Shelf Registration becoming effective. On October 5, 2018, the Company sold 7,500,000 shares of the Company’s common stock (the “Shares”) in an underwritten offering pursuant to the Shelf Registration at a public offering price of $8.25 per share, before underwriting discounts and commissions. In addition, the underwriters were granted an overallotment option to purchase an additional 1,125,000 shares of the common stock at the same public offering price, less underwriting discounts and commissions (the “Overallotment Shares”). On October 11, 2018, the underwriters exercised in full their option to purchase the Overallotment Shares. The total number of Shares and Overallotment Shares sold by the Company in the offering was 8,625,000 shares, resulting in net proceeds to the Company, after underwriting discounts and offering expenses, of approximately $66.1 million.

In connection with the filing of the Shelf Registration, the Company entered into a sales agreement with Jefferies, LLC (the “Sales Agreement”) pursuant to which the Company may issue and sell, from time to time, up to an aggregate of $50.0 million of its common stock in an at-the-market equity offering (“ATM Offering”) through Jefferies, LLC, as sales agent. During the fourth quarter of 2018, the Company issued an aggregate of 518,135 shares of its common stock under the ATM Offering, resulting in net proceeds to the Company of approximately $4.6 million.

Under the Shelf Registration, the Company may periodically offer one or more types of securities in amounts, at prices and on terms announced, if and when the securities are ever offered, of up to an additional $174.0 million.

9. STOCK‑BASED COMPENSATION

Stock Incentive Plans—In December 2009, the Board of Directors (the “Board”) adopted the 2009 Employee, Director and Consultant Equity Incentive Plan (the “2009 Plan”) for the issuance of common stock and stock options to employees, officers, directors, consultants, and advisors.

In July 2017, the Company’s 2017 Equity Incentive Plan (the “2017 Plan”) became effective and, as a result, no further stock options or other awards will be made under the 2009 Plan. The 2017 Plan was established to provide equity-based ownership opportunities for employees, officers, directors, consultants, and advisors. As of June 30, 2019,

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there were 636,440 shares of common stock available for grant under the 2017 Plan. In addition, any shares of common stock subject to awards under the 2009 Plan that expire, are forfeited, or are otherwise surrendered, without having been fully exercised or resulting in any common stock being issued will become available for issuance under the 2017 Plan, up to an additional 2,543,292 shares, which is the number of shares issuable pursuant to outstanding awards granted under the 2009 Plan.

Also approved under the 2017 Plan is an annual increase for each of the years through December 31, 2027, equal to the least of (i) 3,573,766 shares of common stock, (ii) 4% of the shares of common stock outstanding on December 31 of the prior year and (iii) an amount determined by the Board.

Under the plans, the Board determines the number of shares of common stock to be granted pursuant to the awards, as well as the exercise price and terms of such awards. The exercise price of incentive stock options could not be less than the fair value of the common stock on the date of grant. Stock options awarded under the plans expire 10 years after the grant date, unless the Board sets a shorter term. Options granted under the plans generally vest over a four‑year period. A portion of the unvested stock options will vest upon the sale of all or substantially all of the stock or assets of the Company.

In the past, the Company had granted stock options which contain performance‑based vesting criteria. These criteria were milestone events that were specific to the Company’s corporate goals. Stock‑based compensation expense associated with performance‑based stock options is recognized if the achievement of the performance condition is considered probable using management’s best estimates. As of June 30, 2019, there were no performance-based awards outstanding.

Employee Stock Purchase Plan—In 2017, the Company approved the 2017 Employee Stock Purchase Plan, which was amended and restated in December 2018 (as amended, the “ESPP”). The ESPP reserved an aggregate of 223,341 shares of common stock and provides for an annual increase on the first day of each fiscal year, beginning on January 1, 2019 and ending on December 31, 2029, in an amount equal to the lowest of: (1) 893,441 shares of the Company’s common stock; (2) 1% of the total number of shares of the Company’s common stock outstanding on the first day of the applicable fiscal year; and (3) an amount determined by the Company’s board of directors.

The ESPP provides for two six-month offering periods each year; the first offering period begins on the first trading day on or after each January 1; the second offering period begins on the first trading day on or after each July 1. Under the ESPP, participating employees can authorize the Company to withhold a portion of their base pay during consecutive six-month payment periods for the purchase of shares of the Company’s common stock. At the conclusion of the period, participating employees can purchase shares of the Company’s common stock at 85% of the lesser of the closing price of the common stock on (i) the first business day of the plan period or (ii) the exercise date. The fair value of the purchase rights granted under the ESPP was estimated on the date of grant, using the Black-Scholes option-pricing model. No shares of the Company’s common stock were purchased under the ESPP during the six months ended June 30, 2019. The first offering period for 2019 ended on June 30, 2019. In July 2019, employees of the Company purchased an aggregate of 123,664 shares under the ESPP.

Inducement Stock Option Awards—During the three months ended June 30, 2019 and 2018, the Company granted non-statutory stock options to purchase an aggregate of 63,000 shares and 150,000 shares of the Company’s common stock, respectively. During the six months ended June 30, 2019 and 2018, the Company granted non-statutory stock options to purchase an aggregate of 148,500 shares and 150,000 shares of the Company’s common stock, respectively. These stock options will vest over a four-year period, with 25% of the shares underlying each option award vesting on the one-year anniversary of the applicable employees’ new hire date and the remaining 75% of the shares underlying each award vesting monthly thereafter for three-years. Vesting of each option is subject to such employee’s continued service with the Company through the applicable vesting dates. These stock options were granted outside of

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the 2017 Plan as an inducement material to each employee’s acceptance of employment with the Company in accordance with Nasdaq Listing Rule 5635(c)(4).

A summary of option activity for employee and non‑employee awards under the 2009 Plan, the 2017 Plan and inducement grants for the six months ended June 30, 2019 is as follows:


				Weighted
		Weighted		Average
		Average		Remaining	Aggregate
	Number of	Exercise		Contractual	Intrinsic
	Shares	Price		Term	Value
				(Years)		(in thousands)
Outstanding at January 1, 2019	5,111,690	$	8.96	8.0	$	3,771
Granted	2,083,425		5.26
Exercised	(19,890)		1.96
Forfeited	(158,550)		13.29
Outstanding at June 30, 2019	7,016,675	$	7.79	8.1	$	9,925
Vested or expected to vest at June 30, 2019	7,016,675	$	7.79	8.1	$	9,925
Options exercisable at June 30, 2019	3,331,360	$	6.68	7.0	$	6,908

The Company records stock‑based compensation related to stock options granted at fair value. The Company utilizes the Black‑Scholes option‑pricing model to estimate the fair value of stock option grants and to determine the related compensation expense. The assumptions used in calculating the fair value of stock‑based payment awards represent management’s best estimates. There were 1,243,390 options granted during the six months ended June 30, 2018.

The assumptions used in determining fair value of the stock options granted and shares purchasable under the ESPP during the six months ended June 30, 2019 and 2018 are as follows:


	Six Months Ended June 30,
	2019			2018
Expected volatility	61%	–	82%	83%	–	85%
Risk-free interest rate	1.87%	–	2.58%	2.63%	–	2.96%
Expected dividend yield		0%			0%
Expected term (in years)	0.50	–	6.63	5.27	–	6.13

The Company derived the risk‑free interest rate assumption from the U.S. Treasury rates for U.S. Treasury zero‑coupon bonds with maturities similar to those of the expected term of the awards being valued. The Company based the assumed dividend yield on its expectation of not paying dividends in the foreseeable future. The Company calculated the weighted‑average expected term of options using the simplified method, as the Company lacks relevant historical data due to the Company’s limited operating experience. The estimated volatility is based upon the historical volatility of comparable companies with publicly available share prices. The impact of forfeitures on compensation expense is recorded as they occur.

During the three months ended June 30, 2019 and 2018, the weighted average grant‑date fair value of options granted was $3.71 and $11.46, respectively. During the six months ended June 30, 2019 and 2018, the weighted average grant‑date fair value of options granted was $3.71 and $10.12, respectively. The fair value is being expensed over the vesting period of the options on a straight‑line basis as the services are being provided. As of June 30, 2019, there was $23.0 million of unrecognized compensation cost related to the stock options granted, which is expected to be expensed over a weighted‑average period of 2.67 years.

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Reserved Shares—As of June 30, 2019 and December 31, 2018, the Company had reserved the following shares of common stock issuable upon exercise of rights under equity compensation plans and inducement stock option awards:


	June 30,	December 31,
	2019	2018

Warrant rights to acquire Common Stock	384,163	384,163
ESPP	561,971	223,341
Shares reserved for outstanding inducement stock option awards	646,500	498,000
2009 Plan	2,543,292	2,563,072
2017 Plan	4,485,323	3,130,910
Total	8,621,249	6,799,486

Stock-based Compensation Expenses—Stock‑based compensation expense was classified in the statements of operations as follows (in thousands):


	Three Months Ended				Six Months Ended
	June 30,				June 30,
	2019		2018		2019		2018

Cost of product revenues	$	39	$	–	$	41	$	–
Research and development		795		741		1,402		1,380
Selling, general and administrative		1,787		1,550		3,651		2,772
Total	$	2,621	$	2,291	$	5,094	$	4,152

Stock-based compensation expense for the Company’s manufacturing employees related to INVELTYS manufactured since the FDA approval of $0.01 million and $0.3 million for the three and six months ended June 30, 2019, respectively, has been capitalized into inventory as a component of overhead expense. Capitalized stock-based compensation is recognized as cost of product revenues when the related product is sold or expensed to research and development when the related sample is issued.

10. INCOME TAXES

The Company did not record a provision or benefit for income taxes during the three and six months ended June 30, 2019 and 2018. The Company continues to maintain a full valuation allowance for its U.S. federal and state deferred tax assets.

The Company has evaluated the positive and negative evidence bearing upon its ability to realize the deferred tax assets. Management has considered the Company’s history of cumulative net losses incurred since inception and its generation of limited revenue from product sales since inception and has concluded that it is more likely than not that the Company will not realize the benefits of the deferred tax assets. Management reevaluates the positive and negative evidence at each reporting period.

Realization of the future tax benefits is dependent on many factors, including the Company’s ability to generate taxable income within the net operating loss carryforward period. Under the provisions of Section 382 of the Internal Revenue Code of 1986, as amended, certain substantial changes in the Company’s ownership, including a sale of the Company, or significant changes in ownership due to sales of equity, may have limited, or may limit in the future, the amount of net operating loss carryforwards, which could be used annually to offset future taxable income. The Company

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has determined that ownership changes have occurred as of April 2016, and such changes have not materially impacted the Company’s ability to utilize its net operating loss carryforwards and research and development tax credits to offset future tax liabilities. The Company may be further limited by any changes that may have occurred or may occur subsequent to December 31, 2017.

The Company files its corporate income tax returns in the United States and Massachusetts, Alabama, California, Montana, Oklahoma, Illinois, Kentucky, Pennsylvania, New Hampshire, New York, North Carolina and Texas. All tax years since the date of incorporation remain open to examination by the major taxing jurisdictions (state and federal) to which the Company is subject, as carryforward attributes generated in years past may still be adjusted upon examination by the Internal Revenue Service (“IRS”) or other authorities if they have or will be used in a future period. The Company is not currently under examination by the IRS or any other jurisdictions for any tax year.

As of June 30, 2019 and 2018, the Company had no uncertain tax positions. The Company’s policy is to recognize interest and penalties related to income tax matters as a component of income tax expense, of which no interest or penalties were recorded for the three and six months ended June 30, 2019 and 2018.

11. COMMITMENTS AND CONTINGENCIES

License Agreement—In 2009, the Company entered into an exclusive license agreement with The Johns Hopkins University (“JHU”), as amended in November 2012, May 2014, August 2014, October 2014 and June 2018, which licensed to the Company a portfolio of specified patent rights and remains in full force and effect. Pursuant to the terms of the agreement, as amended, the Company agreed to pay an initial license fee, minimum annual payments beginning in 2017, certain development and commercial milestone payments, royalties on product sales and reimburse all or a portion of the costs associated with the preparation, filing, prosecution and maintenance of the agreed‑upon patents and patent applications to JHU.

After 2016 and until the first commercial sale of product, which occurred in January 2019, the minimum annual payment was $37,500. Upon the first commercial sale of INVELTYS, the annual minimum payment increased to $0.1 million. The Company is obligated to pay JHU low single‑digit running royalties based upon a percentage of net sales of the licensed products, which is applied to the annual minimum payment. The Company also has an obligation to pay JHU certain one‑time development and commercial milestone payments. During the three and six months ended June 30, 2019 the Company paid JHU $0.3 million related to the first commercial sale milestone and royalty.

The Company recorded other expenses related to the JHU agreement of $0.1 million and $0.2 million, for the three months ended June 30, 2019 and 2018, respectively. The Company recorded other expenses related to the JHU agreement of $0.1 million and $0.2 million for the six months ended June 30, 2019 and 2018, respectively.

Litigation—The Company is not currently subject to any material legal proceedings.

Other Commitments — The Company entered into a commercial supply agreement with Catalent Pharma Solutions, LLC to manufacture commercial supplies of INVELTYS and KPI-121 0.25%, with annual minimum purchase requirements. The Company became subject to the minimum purchase requirements for INVELTYS upon receiving FDA approval for the product.

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12. SUBSEQUENT EVENTS

The Company has evaluated all events and transactions that occurred after the balance sheet date through the date of this filing. During this period, the Company did not have any material subsequent events that impacted its condensed consolidated financial statements or disclosures.

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Item 2. 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 together with our unaudited condensed consolidated financial statements and related notes thereto appearing elsewhere in this Quarterly Report on Form 10-Q and our Annual Report on Form 10-K for the year ended December 31, 2018, which was filed with the Securities and Exchange Commission on March 12, 2019.

This Quarterly Report on Form 10-Q contains forward-looking statements that involve substantial risks and uncertainties. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “might,” “plan,” “predict,” “project,” “target,” “potential,” “would,” “could,” “should,” “continue” and similar expressions are intended to identify forward-looking statements, although not all forward-looking statements contain these identifying words. There are a number of important risks and uncertainties that could cause our actual results to differ materially from those indicated by forward-looking statements. We may not actually achieve the plans, intentions or expectations disclosed in our forward-looking statements, and you should not place undue reliance on our forward-looking statements. Actual results or events could differ materially from the plans, intentions and expectations disclosed in the forward-looking statements we make. We have included important factors in the cautionary statements included in this Quarterly Report on Form 10-Q, particularly in the section entitled “Risk Factors” in Part II, Item 1A that we believe could cause actual results or events to differ materially from the forward-looking statements that we make. Our forward-looking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments that we may make.

We are a biopharmaceutical company focused on the development and commercialization of therapeutics using our proprietary AMPPLIFY™ mucus-penetrating particle, or MPP, drug delivery technology, with an initial focus on the treatment of eye diseases. The innovative MPP technology, which we refer to as our AMPPLIFY technology, uses selectively‑sized nanoparticles that each have a proprietary coating. We believe that these two key attributes enable even distribution of drug particles on mucosal surfaces and significantly increase drug delivery to target tissues by enhancing mobility of drug particles through mucus and preventing drug particles from becoming trapped and eliminated by mucus. We have applied the AMPPLIFY technology to loteprednol etabonate, or LE, a corticosteroid designed for ocular applications, resulting in the August 2018 approval of INVELTYS ® (loteprednol etabonate ophthalmic suspension) 1%, or INVELTYS, the first and only topical twice-a-day ocular steroid for the treatment of inflammation and pain following ocular surgery, by the U.S. Food and Drug Administration, or the FDA, and the development of our lead product candidate, KPI‑121 0.25%, for the temporary relief of the signs and symptoms of dry eye disease. We commercially launched INVELTYS in January 2019.

KPI‑121 0.25% is our product candidate for patients with dry eye disease utilizing a two‑week course of therapy. In January 2018, we announced topline results from two completed Phase 3 clinical trials, which we refer to as STRIDE 1 and STRIDE 2 (STRIDE- Short Term Relief In Dry Eye), evaluating the safety and efficacy of KPI-121 0.25% versus vehicle (placebo) in patients with dry eye disease. In STRIDE 1, statistical significance was achieved for the primary sign endpoint of conjunctival hyperemia and the primary symptom endpoint of ocular discomfort severity change from baseline to day 15 in the intent to treat, or ITT, population; in addition, statistical significance was also achieved in STRIDE 1 for a second pre-specified primary symptom endpoint of ocular discomfort severity change from baseline to day 15 in patients with more severe baseline ocular discomfort. In STRIDE 2, statistical significance was achieved for the primary sign endpoint of conjunctival hyperemia, but statistical significance was not achieved for the primary symptom endpoint of ocular discomfort severity. KPI‑121 0.25% was generally well tolerated in both STRIDE 1 and STRIDE 2, with no clinically significant treatment‑related adverse events observed during the course of either trial, and with elevations in interocular pressure, or IOP, in both trials similar to placebo.

In December 2018, the FDA accepted for filing our new drug application, or NDA, for KPI‑121 0.25% and set a target action date under the Prescription Drug User Fee Act, or PDUFA, of August 15, 2019. Based upon the recommendation of the FDA, we also initiated an additional Phase 3 clinical trial, STRIDE 3, in the third quarter of 2018 evaluating KPI‑121 0.25% for the temporary relief of the signs and symptoms of dry eye disease. We believe we have identified key factors that contributed to the differences observed in the results from STRIDE 2 compared to those of STRIDE 1 and the Phase 2 trial, and that the changes made to the inclusion/exclusion criteria of STRIDE 3 based on these analyses will improve the probability of success of this trial. We are targeting topline data for STRIDE 3 by the

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end of 2019. If approved, KPI-121 0.25% could be the first FDA-approved product for the temporary relief of the signs and symptoms of dry eye disease.

INVELTYS is the first and only FDA‑approved ocular corticosteroid product with a twice-a-day dosing regimen for the treatment of post‑operative inflammation and pain. Other approved topical ocular corticosteroid products for this indication are indicated for dosing three or four times a day. In clinical trials, INVELTYS showed statistical significance in the primary efficacy endpoints of complete resolution of inflammation at day eight maintained through day 15 with no need for rescue medication compared to placebo and complete resolution of pain at day eight maintained through day 15 with no need for rescue medications compared to placebo.

We are evaluating opportunities for MPP nanosuspensions of LE with less frequent daily dosing regimens for the temporary relief of signs and symptoms of dry eye disease and potential chronic treatment of dry eye disease. We also are evaluating compounds in our receptor Tyrosine Kinase Inhibitor program, or rTKI program, that inhibit the vascular endothelial growth factor, or VEGF, pathway, for the potential treatment of a number of retinal diseases.

INVELTYS received FDA approval under Section 505(b)(2) of the U.S. Federal Food, Drug and Cosmetic Act, or the FDCA, which is the pathway we plan to rely on for the approval of KPI‑121 0.25% as well. We have retained worldwide commercial rights for INVELTYS and our current product candidates. Since the FDA approval of INVELTYS, we have built a commercial infrastructure with our own focused, specialty sales force which includes 57 territory sales managers, 7 regional sales leaders and 3 directors of national accounts. If KPI-121 0.25% is approved for the temporary relief of signs and symptoms of dry eye disease, we expect to further expand our sales force by up to an additional 100 personnel. We expect to commercialize in the United States any of our other product candidates that receive marketing approval as well. In anticipation of the potential to commercialize our product candidates in other global markets, we are evaluating a variety of collaboration, distribution and other marketing arrangements with one or more third parties.

Since the initial public offering of our common stock, or IPO, we have financed our operations primarily through common stock offerings pursuant to our shelf registration statement on Form S-3, or Shelf Registration, and sales of our common stock under an at-the-market offerings, or the ATM Offering. We have issued an aggregate of 9,143,135 shares under our Shelf Registration, including the ATM Offerings, resulting in aggregate gross proceeds to us of approximately $76.0 million. Under our Shelf Registration, we may periodically offer one or more types of securities in amounts, at prices and on terms announced, if and when the securities are ever offered, of up to an additional $174.0 million. We also have an aggregate amount of $75.0 million outstanding under our credit facility with Athyrium Opportunities III Acquisition LP, or the Athyrium Credit Facility.

Since inception, we have incurred significant losses from operations and negative cash flows from operations. Our net losses were $49.2 million for the six months ended June 30, 2019 and $66.7 million for the year ended December 31, 2018. As of June 30, 2019, we had an accumulated deficit of $250.3 million. As we commercially launched our first product, INVELTYS, in January 2019, we have had only limited revenues to date from product sales and have financed our operations primarily through our IPO, private placements of preferred stock, convertible debt financings, borrowings under credit facilities, warrants and public common stock offerings, sales of our common stock under our ATM Offering and to a lesser extent, payments received in connection with various feasibility studies. We have devoted substantially all of our financial resources and efforts to research and development, including preclinical studies and clinical trials and engaging in activities to commercialize INVELTYS. Although we expect to continue to generate revenue from sales of INVELTYS, there can be no assurance that we will generate any such revenue or as to the timing of any such revenue, and we expect to continue to incur significant expenses and operating losses over the next several years. Our net losses may fluctuate significantly from quarter‑to‑quarter and year‑to‑year.

Financial Operations Overview

Product Revenues, Net

As a result of the commercial launch of INVELTYS in the United States in early January 2019, we commenced generating product revenues from sales of INVELTYS. Our product revenues are recorded net of provisions relating to

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estimates for (i) trade discounts and allowances, such as discounts for prompt payment and distributor fees, (ii) estimated rebates, chargebacks and co-pay assistance program, and (iii) reserves for expected product returns. These estimates reflect current contractual and statutory requirements, known market events and trends, industry data and forecasted customer buying and payment patterns. Actual amounts may ultimately differ from these estimates. If actual results vary, estimates may be adjusted in the period such change in estimate becomes known, which could have an impact on earnings in the period of adjustment.

Cost of product revenues

Cost of product revenues consists of direct and indirect cost of manufacturing our product, INVELTYS, such as materials, third-party manufacturing costs, freight, distribution, royalty expense, allocation of labor, quality control, quality assurance, spoilage and manufacturing overhead costs. We began capitalizing inventory costs for INVELTYS after receipt of FDA approval of INVELTYS on August 22, 2018. Prior to receiving FDA approval, such costs were expensed as research and development expenses.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries and related benefits, including stock‑based compensation, related to our commercial infrastructure and our executive, finance, legal, business development and support functions. Other general and administrative expenses include travel expenses, professional fees for auditing, tax, consultants and legal services and allocated facility‑related costs not otherwise included in research and development expenses.

We anticipate that our selling, general and administrative expenses will increase in the future if and as we increase our headcount to support our continued research activities and development of our product candidates or additional product candidates and continue to build our commercial infrastructure to support the commercialization of INVELTYS or of any product candidates for which we obtain marketing approval, including KPI-121 0.25%. In addition, we anticipate increased expenses related to supporting a larger organization and increase in selling expense related to INVELTYS.

Research and Development Expenses

Research and development expenses consist of costs associated with our research activities, including compensation and benefits for full‑time research and development employees, an allocation of facilities expenses, overhead expenses, payments to universities under our license agreements and other outside expenses. Our research and development expenses include:

employee‑related expenses, including salaries, related benefits, travel and stock‑based compensation;

expenses incurred for the preclinical and clinical development of our product candidates and under agreements with contract research organizations, or CROs, including costs of manufacturing product candidates prior to receipt of regulatory approval;

facilities, depreciation and other expenses, which include direct and allocated expenses for rent and maintenance of facilities and supplies; and

payments made under our third‑party licensing agreements, including the annual minimum royalty and reimbursable expenses for defense of agreed upon patents under a license agreement with Johns Hopkins University, or JHU.

We expense research and development costs as they are incurred. Research and development costs that are paid in advance of performance are capitalized as a prepaid expense until incurred. We track outsourced development costs by development program but do not allocate personnel costs, payments made under our license agreements or other costs

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to specific product candidates or development programs. These costs are included in Employee‑related costs and Other research and development costs in the line items in the tables under “Results of Operations”.

We expect our research and development expenses to increase for the foreseeable future if and as we advance our product candidate, KPI-121 0.25%, toward regulatory approval, pursue other product candidates and conduct additional clinical trials. Conducting preclinical studies and clinical trials necessary to obtain regulatory approval is costly and time‑consuming. We may never succeed in obtaining marketing approval for any of our product candidates. The probability of success for each product candidate may be affected by numerous factors, including preclinical data, clinical data, competition, manufacturing capability and commercial viability.

Our research and development programs are at various stages of development. Successful development and completion of clinical trials is uncertain and may not result in approved products. Completion dates and completion costs can vary significantly for each product candidate and future product candidate and are difficult to predict. We will continue to make determinations as to which product candidates to pursue and how much funding to direct to each product candidate on an ongoing basis in response to our ability to enter into collaborations with respect to each product candidate, the scientific and clinical success of each product candidate as well as ongoing assessments as to the commercial potential of product candidates. We will need to raise additional capital and may seek collaborations in the future to advance our various product candidates. Additional private or public financings may not be available to us on acceptable terms, or at all. Our failure to raise capital as and when needed would have a material adverse effect on our financial condition and our ability to pursue our business strategy.

Interest Income

Interest income consists of interest earned on our cash balance held in a deposit account.

Interest Expense

Interest expense primarily consists of contractual coupon interest expense, amortization of debt discounts and debt issuance costs recognized on our debt facility.

Critical Accounting Policies and Significant Judgments and Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which we have prepared in accordance with U.S. generally accepted accounting principles. We believe that several accounting policies are important to understanding our historical and future performance. We refer to these policies as critical because these specific areas generally require us to make judgments and estimates about matters that are uncertain at the time we make the estimate, and different estimates—which also would have been reasonable—could have been used. On an ongoing basis, we evaluate our estimates and judgments, including those described in greater detail below. We base our estimates on historical experience and other market-specific or other relevant assumptions that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

There have been no material changes to our critical accounting policies from those described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our Annual Report on Form 10-K, for the fiscal year ended December 31, 2018 except for the addition of a revenue recognition policy as discussed in Note 2 of our unaudited condensed consolidated financial statements in Part I, Item 1 of this Quarterly Report on Form 10-Q.

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Results of Operations

Comparison of the Three Months Ended June 30, 2019 and 2018

The following table summarizes the results of our operations for the three months ended June 30, 2019 and 2018:


	Three Months Ended
	June 30,
	2019		2018		Change
	(in thousands)
Product revenues, net	$	2,057	$	—	$	2,057
Costs and expenses:
Cost of product revenues		352		—		352
Selling, general and administrative		17,007		7,151		9,856
Research and development		7,108		7,368		(260)
Total operating expenses		24,467		14,519		9,948
Loss from operations		(22,410)		(14,519)		(7,891)
Other income (expense)
Interest income		646		313		333
Interest expense		(2,061)		(414)		(1,647)
Net loss	$	(23,825)	$	(14,620)	$	(9,205)

Product revenues, net

Product revenues, net was $2.1 million for the three months ended June 30, 2019 and related to sales of INVELTYS, which we launched in the United States in January 2019. INVELTYS is our first product to receive regulatory approval. We expect product revenues to increase if and as we obtain and maintain coverage and adequate reimbursement for INVELTYS from third-party payors.

Cost of product revenues

Cost of product revenues was $0.4 million for the three months ended June 30, 2019. We began capitalizing inventory costs for INVELTYS after receipt of FDA approval of INVELTYS on August 22, 2018. Prior to receiving FDA approval, such costs were expensed as research and development expenses.

Selling, general and administrative expenses

Selling, general and administrative expenses were $17.0 million for the three months ended June 30, 2019 compared to $7.1 million for the three months ended June 30, 2018, which was an increase of $9.9 million.

The increase was driven by a $5.8 million increase in employee-related costs during the three months ended June 30, 2019 comprised of a $5.7 million increase in expense from an increase in employee headcount and merit-based pay, primarily driven by the hiring of our sales force and a $0.1 million increase in stock compensation expenses primarily related to stock options issued to our sales force. In addition, we incurred a $2.5 million increase in costs for sales and marketing and other activities to support the commercial launch of INVELTYS, a $0.5 million increase in costs associated with legal, accounting and finance, a $1.1 million increase in facility costs related to our Watertown Lease, which commenced in November 2018, along with a larger allocation of our overall facility costs related to this lease. We anticipate that our selling, general and administrative expenses will increase in the future if and as we increase our administrative headcount to support our continued research activities and development of our product candidates or additional product candidates.

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Research and development expenses

The following table summarizes the research and development expenses incurred during the three months ended June 30, 2019 and 2018:


	Three Months Ended
	June 30,
	2019		2018		Change
	(in thousands)
KPI-121 development costs	$	3,208	$	3,692	$	(484)
Employee‑related costs		2,691		3,084		(393)
Other research and development costs		1,209		592		617
Total research and development	$	7,108	$	7,368	$	(260)

Research and development expenses were $7.1 million for the three months ended June 30, 2019 compared to $7.4 million for the three months ended June 30, 2018, representing a decrease of $0.3 million. The KPI-121 development costs for the three months ended June 30, 2019 decreased by $0.5 million. This was driven by a $1.5 million increase in KPI‑121 development costs related to STRIDE 3, our additional Phase 3 clinical trial of KPI-121 0.25%, which began in mid-2018 offset by a decrease of $0.5 million related to external cost for our Phase 3 clinical trial of INVELTYS for the treatment of inflammation and pain following ocular surgery and a decrease of $1.5 million related to manufacturing cost of INVELTYS, which was recognized as research and development cost prior to our receipt of FDA approval. An additional increase of $0.6 million in other research and development costs was offset by a $0.4 million decrease in costs related to employees that were classified under research and development prior to regulatory approval of INVELTYS and are now classified as manufacturing employees and, are accordingly being recorded in inventory and cost of product revenues. We expect that our research and development costs will increase if and as we advance our product candidate, KPI-121 0.25%, pursue other product candidates and conduct additional clinical trials.

Interest income

Interest income increased by $0.3 million to $0.6 million for the three months ended June 30, 2019 compared to $0.3 million for the three months ended June 30, 2018. Interest income consists of interest earned on our cash balance held in an interest-bearing deposit account. The increase was attributable to a higher interest rate on a higher average cash balance during the three months ended June 30, 2019.

Interest expense

We incurred interest expense of $2.1 million for the three months ended June 30, 2019, compared to $0.4 million for the three months ended June 30, 2018, which represented an increase of $1.7 million. Interest expense is comprised of the contractual coupon interest expense and the amortization of the debt discount associated with our venture debt facility, which we refer to as our 2014 Debt Facility, during the three months ended June 30, 2018 and with our Athyrium Credit Facility during the three months ended June 30, 2019. The increase was primarily due to the higher outstanding balance on our debt facility, which increased in October 2018 from $20.0 million under our 2014 Debt Facility to $75.0 million under the Athyrium Credit Facility, which remained outstanding during the three months ended June 30, 2019.

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Comparison of the Six Months Ended June 30, 2019 and 2018

The following table summarizes the results of our operations for the six months ended June 30, 2019 and 2018:


	Six Months Ended
	June 30,
	2019		2018		Change
	(in thousands)
Revenue	$	3,443	$	—	$	3,443
Operating expenses:
Cost of product revenues		593		—		593
Selling, general and administrative		35,243		12,633		22,610
Research and development		14,067		13,024		1,043
Total costs and expenses		49,903		25,657		24,246
Loss from operations		(46,460)		(25,657)		(20,803)
Other income (expense)
Interest income		1,402		522		880
Interest expense		(4,155)		(781)		(3,374)
Net loss	$	(49,213)	$	(25,916)	$	(23,297)

Product revenues, net

Product revenues, net was $3.4 million for the six months ended June 30, 2019 and related to sales of INVELTYS, which we launched in the United States in January 2019. INVELTYS is our first product to receive regulatory approval. We did not generate any revenues from product sales prior to the six months ended June 30, 2019. We expect product revenues to increase if and as we obtain and maintain coverage and adequate reimbursement for INVELTYS from third-party payors.

Cost of product revenues

Cost of product revenues was $0.6 million for the six months ended June 30, 2019. We began capitalizing inventory costs for INVELTYS after receipt of FDA approval of INVELTYS on August 22, 2018. Prior to receiving FDA approval, such costs were expensed as research and development expenses.

Selling, general and administrative expenses

Selling, general and administrative expenses were $35.2 million for the six months ended June 30, 2019 compared to $12.6 million for the six months ended June 30, 2018, which was an increase of $22.6 million.

The increase was driven by a $12.5 million increase in employee-related costs during the six months ended June 30, 2019 comprised of a $11.7 million increase in expenses from an increase in employee headcount and merit-based pay, primarily driven by the hiring of our sales force and a $0.8 million increase in stock compensation expenses primarily related to stock options issued to our sales force. In addition, we incurred a $6.7 million increase in costs for sales and marketing and other activities to support the commercial launch of INVELTYS, a $0.3 million increase in costs associated with legal, accounting and finance, a $2.5 million increase in facilities costs related to our Watertown Lease, which commenced in November 2018, along with a larger allocation of our overall facility costs related to this lease and an aggregate of $0.6 million of expense related to the milestone payable to JHU upon first commercial sale of INVELTYS and the annual product fee for INVELTYS under the PDUFA program. We anticipate that our selling, general and administrative expenses will increase in the future if and as we increase our administrative headcount to support our continued research activities and development of our product candidates or additional product candidates.

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Research and development expenses

The following table summarizes the research and development expenses incurred during the six months ended June 30, 2019 and 2018:


	Six Months Ended
	June 30,
	2019		2018		Change
	(in thousands)
KPI-121 development costs	$	6,649	$	5,928	$	721
Employee‑related costs		5,161		5,893		(732)
Other research and development costs		2,257		1,203		1,054
Total research and development	$	14,067	$	13,024	$	1,043

Research and development expenses were $14.1 million for the six months ended June 30, 2019 compared to $13.0 million for the six months ended June 30, 2018, representing an increase of $1.1 million. The KPI-121 development cost increased by $0.7 million, which was driven by a $4.4 million increase in KPI‑121 development costs related to STRIDE 3, which began in mid-2018 offset by a decrease of $1.0 million related to external cost for our Phase 3 clinical trial of INVELTYS for the treatment of inflammation and pain following ocular surgery and a decrease of $2.7 million related to manufacturing cost of INVELTYS, which was recognized as research and development cost prior to our receipt of FDA approval. An additional increase of $1.1 million in other research and development costs was offset by a $0.7 million decrease in costs related to employees that were classified under research and development prior to regulatory approval of INVELTYS and are now classified as manufacturing employees and, are accordingly being recorded in inventory and cost of product revenues.

We expect that our research and development costs will increase if and as we advance our product candidate, KPI-121 0.25%, pursue other product candidates and conduct additional clinical trials.

Interest income

Interest income increased by $0.9 million to $1.4 million for the six months ended June 30, 2019 compared to $0.5 million for the six months ended June 30, 2018. Interest income consists of interest earned on our cash balance held in an interest-bearing deposit account. The increase was attributable to a higher interest rate on a higher average cash balance during the six months ended June 30, 2019.

Interest expense

We incurred interest expense of $4.2 million for the six months ended June 30, 2019, compared to $0.8 million for the six months ended June 30, 2018, representing an increase of $3.4 million. Interest expense is comprised of the contractual coupon interest expense and the amortization of the debt discount associated with our 2014 Debt Facility, during the six months ended June 30, 2018 and with our Athyrium Credit Facility during the six months ended June 30, 2019. The increase was primarily due to the higher outstanding balance, which increased in October 2018 from $20.0 million under our 2014 Debt Facility to $75.0 million under the Athyrium Credit Facility, which remained outstanding during the six months ended June 30, 2019.

Liquidity and Capital Resources

Since our inception, we have incurred significant operating losses. As we commercially launched our first product, INVELTYS, in January 2019, we have had limited revenues to date from product sales and have financed our operations primarily through our IPO, private placements of preferred stock, convertible debt financings, borrowings under credit facilities, warrants and public common stock offerings, sales of our common stock under our ATM Offering facility and to a lesser extent, payments received in connection with various feasibility studies.

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In July 2017, we completed an IPO pursuant to which we issued and sold 6,900,000 shares of our common stock, which included 900,000 shares sold pursuant to the exercise of the underwriters’ option to purchase additional shares, at a price of $15.00 per share. We received net proceeds of $94.0 million after deducting underwriting discounts and commission of $7.3 million and offering costs incurred in 2017 of $2.2 million.

In November 2014, we entered into our 2014 Debt Facility, which was subsequently amended in October 2016, November 2017 and March 2018. The 2014 Debt Facility, as amended, increased the initial commitment under the debt facility to a total of $20.0 million of funding and extended the interest-only end date for 12 months following the execution of the March 2018 amendment. The maturity date of the 2014 Debt Facility was also extended from October 13, 2020 to March 29, 2022. On October 1, 2018, we repaid the outstanding principal balance under the 2014 Debt Facility of $20.0 million. In connection with the repayment of the 2014 Debt Facility, we paid a prepayment fee of $0.2 million.

On August 9, 2018, we filed a Shelf Registration with the SEC, which was declared effective on August 27, 2018. Under the Shelf Registration, we may offer and sell up to $250.0 million of a variety of securities including common stock, preferred stock, warrants, depositary shares, debt securities, purchase contracts, purchase units or any combination of such securities during the three-year period that commenced upon the Shelf Registration becoming effective. Under the Shelf Registration, we may periodically offer one or more types of securities in amounts, at prices and on terms announced, if and when the securities are ever offered.

On October 1, 2018, we entered into the Athyrium Credit Facility for up to $110 million. The Athyrium Credit Facility provides for a Term Loan A in the aggregate principal amount of $75.0 million, or Term Loan A, and a Term Loan B in the aggregate principal amount of $35.0 million, or Term Loan B. On October 1, 2018, we borrowed the entire principal amount of the Term Loan A. We may draw down the Term Loan B upon either (i) FDA approval of KPI-121 0.25% for a dry eye disease indication or (ii) reaching certain net product revenues for INVELTYS, in each case on or prior to June 30, 2020. The maturity date of the Athyrium Credit Facility is October 1, 2024. The Term Loan A bears interest at a rate of 9.875% per annum, with quarterly, interest-only payments until the fourth anniversary of the Term Loan A. The unpaid principal amount of the Term Loan A is due and payable in quarterly installments starting at the end of the fourth anniversary of the loan.

On October 5, 2018, we sold 7,500,000 shares of common stock in an underwritten offering pursuant to the Shelf Registration at a public offering price of $8.25 per share, before underwriting discounts and commissions. In addition, the underwriters were granted an overallotment option to purchase an additional 1,125,000 shares of the common stock at the same public offering price, less underwriting discounts and commissions. On October 11, 2018, the underwriters exercised in full their option to purchase the overallotment shares. The total number of shares sold by us in the offering was 8,625,000 shares, resulting in net proceeds to us, after underwriting discounts and offering expenses, of approximately $66.1 million.

In connection with the filing of the Shelf Registration, we entered into a sales agreement with Jefferies, LLC pursuant to which we may issue and sell, from time to time, up to an aggregate of $50.0 million of our common stock in an ATM Offering, through Jefferies, LLC, as sales agent. During the fourth quarter of 2018, we issued an aggregate of 518,135 shares of our common stock under the ATM Offering resulting in net proceeds to us of approximately $4.6 million.

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Cash Flows

As of June 30, 2019, we had $118.0 million in cash on hand and $75.0 million in indebtedness. The following table summarizes our sources and uses of cash for the six months ended June 30, 2019 and 2018:


	Six Months Ended
	June 30,
	2019		2018
	(in thousands)
Net cash used in operating activities	$	(51,596)	$	(21,919)
Net cash used in investing activities		(943)		(541)
Net cash provided by financing activities		19		1,144
Decrease in cash and restricted cash	$	(52,520)	$	(21,316)

Net Cash Used in Operating Activities

During the six months ended June 30, 2018, our cash used in operating activities was primarily due to our net loss of $25.9 million primarily consisting of $13.0 million of research and development costs, $12.6 million of general and administrative costs and $0.3 million in other expenses partially offset by non-cash charges of $4.6 million, consisting primarily of $4.2 million in stock-based compensation. Net cash used by changes in our operating assets and liabilities primarily consisted of a $1.5 million decrease in accrued expenses due primarily to the decrease in external costs associated with our two Phase 3 clinical trials of KPI‑121 0.25% for the treatment of dry eye disease and a $0.2 million decrease in lease liabilities. These decreases were partially offset by a $1.1 million increase in accounts payable.

During the six months ended June 30, 2019, our cash used in operating activities was primarily due to our net loss of $49.2 million primarily consisting of $35.2 million of selling, general and administrative costs and $14.0 million of research and development costs partially offset by non-cash charges of $6.8 million, consisting primarily of $5.1 million in stock-based compensation. Net cash used by changes in our operating assets and liabilities primarily consisted of a $5.6 million increase in accounts receivable driven by sales of INVELTYS and a $4.0 million increase in inventory due to increase in manufacturing activity for INVELTYS, which were offset by a $0.4 million decrease in other prepaid and accounts payable balances.

Net Cash Used in Investing Activities

Net cash used in investing activities was $0.5 million for the six months ended June 30, 2018 consisting of
purchases of property and equipment, primarily equipment and software.

Net cash used in investing activities was $0.9 million for the six months ended June 30, 2019 consisting primarily of purchases of furniture and fixtures.

Net Cash Provided by Financing Activities

Net cash provided by financing activities was $1.1 million for the six months ended June 30, 2018, consisting of $2.7 million of proceeds from our 2014 Debt Facility, net of debt issuance costs, offset by principal payments on our venture debt of $1.7 million and $83,000 in proceeds from the exercise of stock options.

Net cash provided by financing activities was $19,000 for the six months ended June 30, 2019, consisting of $39,000 of proceeds from the exercise of stock options, offset by $20,000 of principal payments on our finance lease obligation.

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Funding Requirements

We anticipate that our expenses will increase substantially as compared to prior periods with the January 2019 launch and commercialization of INVELTYS in the United States and as we seek to engage in activities to prepare for commercialization of our lead product candidate, KPI-121 0.25%, for the temporary relief of signs and symptoms of dry eye disease, as a result of increased headcount, including management personnel to support our clinical, manufacturing and commercialization activities, expanded infrastructure, increased legal, compliance, accounting and investor and public relations expenses associated with being a public company and increased insurance premiums, among other factors. Our license agreement with JHU, under which we license certain of our patent rights and a significant portion of the technology for INVELTYS and KPI‑121 0.25%, imposes royalty and other financial obligations on us, and we may enter into additional licensing and funding arrangements with third parties that may impose milestone payment, royalty, insurance and other obligations on us.

Our expenses will also increase if and as we:

continue to grow our sales, marketing and distribution capabilities in connection with the commercialization of INVELTYS and any product candidates for which we may submit for and obtain marketing approval;

conduct any necessary clinical trials, including conducting our ongoing Phase 3 clinical trial, and other development activities and/or seek marketing approvals for KPI‑121 0.25% and any other product candidates;

pursue the clinical development of KPI‑121 for the treatment of other additional indications or for use in other patient populations or, if approved, seek to broaden the label of KPI‑121;

pursue the preclinical and clinical development of product candidates, including our rTKI program, for use in the treatment of retinal diseases;

expand our sales, marketing and distribution capabilities for our other product candidates, prior to or upon receiving marketing approval;

seek regulatory approval for INVELTYS and any other product candidate outside of the United States;

continue to scale up our manufacturing processes and capabilities to support commercialization of INVELTYS, and any of our product candidates, including KPI‑121 0.25%, for which we seek and/or obtain marketing approval;

leverage our proprietary AMPPLIFY technology to advance additional potential high‑value therapeutics into preclinical and clinical development;

in‑license or acquire the rights to other products, product candidates or technologies;

maintain, expand and protect our intellectual property portfolio;

hire additional clinical, quality control, scientific, manufacturing, commercial and management personnel;

expand our operational, financial and management systems and increase personnel, including personnel to support our clinical development, manufacturing and commercialization efforts and our operations as a public company; and

increase our product liability insurance coverage as we expand our commercialization efforts.

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We believe that our existing cash on hand as of June 30, 2019 will enable us to fund our planned operating expenses, debt service obligations and capital expenditure requirements through at least the third quarter of 2020, with additional cash runway expected when including revenues from INVELTYS. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.

Because of the numerous risks and uncertainties associated with pharmaceutical product development, we are unable to accurately predict the timing or amount of increased expenses or when, or if, we will be able to achieve profitability. Our expenses will increase from what we anticipate if:

we elect to or are required by the FDA or non‑U.S. regulatory agencies to perform clinical trials or studies in addition to those expected;

there are any delays in enrollment of patients in or completing our clinical trials or the development of our product candidates; or

there are any third‑party challenges to our intellectual property portfolio, or the need arises to defend against intellectual property‑related claims or enforce our intellectual property rights.

Our ability to become and remain profitable depends on our ability to generate revenue. While we began to generate revenue from the sales of INVELTYS in January 2019, there can be no assurance as to the amount or timing of any such revenue, and we may not achieve profitability for several years, if at all. Achieving and maintaining profitability will require us to be successful in a range of challenging activities, including:

successful launching of INVELTYS, including by further developing our sales force, marketing and distribution capabilities;

achieving an adequate level of market acceptance and obtaining and maintaining coverage and adequate reimbursement from third‑party payors for INVELTYS and any other products we commercialize;

obtaining marketing approval for KPI‑121 0.25% or any other product candidates;

manufacturing at commercial scale, marketing, selling and distributing INVELTYS or any product candidates for which we obtain marketing approval, including KPI‑121 0.25%;

maintaining regulatory and marketing approvals for INVELTYS and for any other product candidates for which we obtain approval;

hiring and building a full commercial organization required for the marketing, selling and distributing those products for which we obtain marketing approval; and

obtaining, maintaining and protecting our intellectual property rights.

INVELTYS is our only product that has been approved for sale and it has only been approved in the United States. Our ability to generate revenue from operations will depend, in part, on the timing and success of commercial sales of INVELTYS, which we commercially launched in the United States in January 2019. However, the successful commercialization of INVELTYS in the United States is subject to many risks. We are currently undertaking our first commercial launch with INVELTYS, and we may not be able to do so successfully. There are numerous examples of unsuccessful product launches and failures to meet expectations of market potential, including by pharmaceutical companies with more experience and resources than us. We do not anticipate our revenue from sales of INVELTYS alone will be sufficient for us to become profitable for several years, if at all.

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annual basis. Our failure to become and remain profitable would decrease the value of our company and could impair our ability to raise capital, expand our business, maintain our research and development efforts, diversify our product offerings or even continue our operations. A decline in the value of our company could also cause you to lose all or part of your investment.

Until such time, if ever, as we can generate substantial product revenues, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaborations, strategic alliances, licensing arrangements, royalty agreements, and marketing and distribution arrangements. To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. The lenders under our Athyrium Credit Facility are currently entitled to exercise warrants for up to 184,660 shares of common stock. If we draw down on the remaining $35.0 million of potentially available borrowings under our Athyrium Credit Facility, the lenders thereunder will be entitled to exercise warrants for up to an additional 86,175 shares of our common stock. Your ownership interest will be diluted to the extent any such warrants are exercised. Debt financing and preferred equity financing, if available, may involve agreements that include pledging of assets as collateral, covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. Our pledge of our assets as collateral to secure our obligations under our Athyrium Credit Facility may limit our ability to obtain additional debt financing. Under our Athyrium Credit Facility, we are also restricted from paying dividends on our common stock without the lenders’ consent.

If we raise additional funds through collaborations, strategic alliances, licensing arrangements, royalty agreements, or marketing and distribution arrangements, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our product development or current or future commercialization efforts or grant rights to develop and market products or product candidates that we would otherwise prefer to develop and market ourselves.

Off‑Balance Sheet Arrangements

We did not have during the periods presented, and we do not currently have, any off‑balance sheet arrangements, as defined in the rules and regulations of the Securities and Exchange Commission.

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Item 3. Quantitative and Qualitative Disclosures About Market Risk.

We did not hold any cash equivalents or investments as of June 30, 2019. As of June 30, 2019, the aggregate principal amount outstanding under the Athyrium Credit Facility was $75.0 million, which bears interest at a fixed rate of 9.875% per annum.

Item 4. Controls and Procedures.

Evaluation of Disclosure Controls and Procedures.

Our management, with the participation of our Chief Executive Officer and Chief Financial Officer, evaluated the effectiveness of our disclosure controls and procedures as of June 30, 2019. The term “disclosure controls and procedures,” as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended, or the Exchange Act, means controls and other procedures of a company that are designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is recorded, processed, summarized and reported, within the time periods specified in the SEC’s rules and forms. Disclosure controls and procedures include, without limitation, controls and procedures designed to ensure that information required to be disclosed by a company in the reports that it files or submits under the Exchange Act is accumulated and communicated to the company’s management, including its principal executive and principal financial officers, as appropriate to allow timely decisions regarding required disclosure. Management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving their objectives and management necessarily applies its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Based on the evaluation of our disclosure controls and procedures as of June 30, 2019, our Chief Executive Officer and Chief Financial Officer concluded that, as of such date, our disclosure controls and procedures were effective at the reasonable assurance level.

Changes in Internal Control over Financial Reporting.

There were no changes in our internal control over financial reporting that occurred during the three-month period ended June 30, 2019 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

PART II - OTHER INFORMATION

Item 1. Legal Proceedings.

We are not currently subject to any material legal proceedings.

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Item 1A RISK FACTORS

Investing in our common stock involves a high degree of risk. You should carefully consider the risks and uncertainties described below together with all of the other information contained in our Annual Report on Form 10‑K and this Quarterly Report on Form 10-Q, including our financial statements and the related notes appearing at the end of our Annual Report on Form 10‑K, before deciding to invest in our common stock. If any of the following risks actually occur, our business, prospects, operating results and financial condition could suffer materially. In such event, the trading price of our common stock could decline and you might lose all or part of your investment.

Risks Related to Our Financial Position and Need For Additional Capital

We have incurred significant losses from operations and negative cash flows from operations since our inception. We expect to incur losses over the next several years and may never achieve or maintain profitability.

Since inception, we have incurred significant losses from operations and negative cash flows from operations. Our net losses were $49.2 million for the six months ended June 30, 2019 and $66.7 million for the year ended December 31, 2018. As of June 30, 2019, we had an accumulated deficit of $250.3 million. As we only recently launched our first product, INVELTYS ® (loteprednol etabonate ophthalmic suspension) 1%, in January 2019, we have had limited revenues to date from product sales and have financed our operations primarily through our initial public offering, or IPO, private placements of preferred stock, convertible debt financings, borrowings under credit facilities, warrants and public common stock offerings, sales under our at-the-market offering facility and to a lesser extent, payments received in connection with various feasibility studies. We have devoted substantially all of our financial resources and efforts to research and development, including preclinical studies and clinical trials and engaging in activities to commercially launch our first FDA approved product, INVELTYS for the treatment of post‑operative inflammation and pain following ocular surgery. Although we expect to continue to generate revenue from sales of INVELTYS, there can be no assurance that we will generate any such revenue or as to the timing of any such revenue, and we expect to continue to incur significant expenses and operating losses over the next several years. Our net losses may fluctuate significantly from quarter‑to‑quarter and year‑to‑year.

We anticipate that our expenses will increase substantially as compared to prior periods as we continue to commercialize INVELTYS in the United States and engage in activities to prepare for commercialization of our lead product candidate, KPI-121 0.25% for the temporary relief of signs and symptoms of dry eye disease, as a result of increased headcount, including management personnel to support our clinical, manufacturing and commercialization activities, expanded infrastructure, increased legal, compliance, accounting and investor and public relations expenses associated with being a public company and increased insurance premiums, among other factors. Our license agreement with The Johns Hopkins University, or JHU, under which we license certain of our patent rights and a significant portion of the technology for INVELTYS and KPI‑121 0.25%, imposes royalty and other financial obligations on us, and we may enter into additional licensing and funding arrangements with third parties that may impose milestone payment, royalty, insurance and other obligations on us.

Our expenses will also increase if and as we:

pursue the clinical development of KPI‑121 for the treatment of other additional indications or for use in other patient populations or, if approved, seek to broaden the label of KPI‑121;

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pursue the preclinical and clinical development of product candidates, including our receptor Tyrosine Kinase Inhibitor program, or rTKI program, for use in the treatment of retinal diseases;