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 March 31, 2020

OR

 

☐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)

 

 

 

 

 

(781) 996-5252

(Registrant’s telephone number, including area code)

 

 

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.

 

 

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 55,715,876 shares of Common Stock, $0.001 par value per share, outstanding as of May 5, 2020

 

 

 

 

 

TABLE OF CONTENTS

 

 

PART I – FINANCIAL INFORMATION

Item 1 Financial Statements

KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED BALANCE SHEETS

(UNAUDITED)

(In thousands, except share and per share amounts)

 

See accompanying notes to these unaudited condensed consolidated financial statements.

KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(In thousands, except share and per share amounts)

 

See accompanying notes to these unaudited condensed consolidated financial statements.

KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY

(UNAUDITED)

(In thousands, except share data)

 

See accompanying notes to these unaudited condensed consolidated financial statements

 

 

KALA PHARMACEUTICALS, INC.

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS 

(UNAUDITED)

(In thousands)

 

See accompanying notes to these 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 discovery, development and commercialization of innovative therapies for diseases of the eye. The Company has applied its AMPPLIFY® mucus-penetrating particle (“MPP”) Drug Delivery 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 topical 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%, which if approved it plans to commercialize under the brand name EYSUVISTM (loteprednol etabonate ophthalmic suspension) 0.25%, for the short-term treatment of the signs and symptoms of dry eye disease. 

In October 2018, the Company submitted a New Drug Application (“NDA”) to the FDA for EYSUVIS. In August 2019, the Company announced that it received a complete response letter (“CRL”) from the FDA indicating that positive efficacy data from an additional clinical trial would be needed to support a resubmission of the NDA. Based upon the previous recommendation of the FDA, the Company initiated an additional Phase 3 clinical trial (“STRIDE 3”) (STRIDE- Short Term Relief In  Dry Eye), in July 2018. On March 9, 2020, the Company announced that STRIDE 3 met both of its primary symptom endpoints and its key secondary sign endpoint. The Company believes that the data from STRIDE 3 replicates the positive efficacy data from previous clinical trials for both signs and symptoms of dry eye disease and will satisfy the recommendation in the CRL for an additional positive trial. On April 30, 2020, the Company resubmitted the NDA for EYSUVIS. The Company believes this application will be considered a Class 2 resubmission, with a targeted six-month review timeline under the Prescription Drug User Fee Act (“PDUFA”).

In January 2019, the Company launched its first commercial product, INVELTYS, in the United States. The Company is engaged in the commercialization of INVELTYS, pursuing FDA approval of, and preparing to launch, EYSUVIS, 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, research and development of pharmaceutical product candidates and launching products 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 obtain regulatory approval of EYSUVIS, the success of commercializing its products, the success of its research and development efforts, its ability to obtain regulatory approval of its other product candidates, its ability to raise additional capital when needed and, ultimately, attain profitable operations.

The Company is evaluating opportunities for MPP nanosuspensions of LE with less frequent daily dosing regimens for the treatment 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, and novel next-generation anti-inflammatories designed to exhibit steroid-like anti-inflammatory action for eye disease with the goal of eliminating the risk of interocular pressure (“IOP”) increase and cataract formation.

 

Liquidity— Since inception, the Company has incurred significant losses from operations and negative cash flows from operations. As of March 31, 2020, the Company had an accumulated deficit of $317.4 million. The Company has generated only limited revenues to date from product sales and has financed operations primarily through proceeds from its initial public offering of common stock (“IPO”), public common stock offerings and sales of its common stock under its at-the-market offering facility, private placements of preferred stock, convertible debt financings, borrowings under credit facilities, and warrants. 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 launch and

commercialize INVELTYS. The Company expects to continue to incur significant expenses and operating losses. Net losses may fluctuate significantly from quarter-to-quarter and year-to-year.

The Company believes that its existing cash on hand as of March 31, 2020, 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.

COVID-19 – The ongoing novel coronavirus pandemic, commonly referred to as COVID-19, which was declared a global pandemic by the World Health Organization on March 11, 2020, has caused federal, state, and local governments to implement measures to slow the spread of the outbreak through quarantines, strict travel restriction and bans, heightened border scrutiny and other measures. The Company is following, and will continue to follow, recommendations from the U.S. Centers for Disease Control and Prevention (“CDC”) as well as federal, state, and local governments regarding working-from-home practices for non-essential employees. As a result, the Company has suspended substantially all in-person interactions with customers, including visits to physician offices, clinics, and hospitals, all office-based personnel have been instructed to work from home and the Company’s laboratory facilities, that support our early-stage research activities, are partially closed. The moratorium on routine medical appointments and elective surgeries in many jurisdictions, including ocular surgeries, has adversely affected the market for INVELTYS, which is indicated for the treatment of inflammation and pain following ocular surgery, resulting in a significant reduction in the demand for INVELTYS. The extent of the impact of COVID-19 on the Company’s operational and financial performance will depend on certain developments, including the length and severity of this pandemic, impact on its customers, employees, vendors, and government agencies, all of which are uncertain and cannot be predicted. The Company cannot reasonably estimate the extent to which the disruption may materially impact its consolidated results of operations or financial position.

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 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.

The weighted average number of common shares included in the computation of diluted net loss gives effect to all potentially dilutive common equivalent shares, including outstanding stock options, and warrants. Common stock equivalent shares are excluded from the computation of diluted net loss per share if their effect is antidilutive. In periods in which the Company reports a net loss attributable to common stockholders, diluted net loss per share attributable to common stockholders is the same as basic net loss per share attributable to common stockholders since dilutive common shares are not assumed to have been issued if their effect is anti‑dilutive. The Company reported a net loss attributable to common stockholders for the three months ended March 31, 2020 and 2019.

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, 2019 (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 March 31, 2020.

Recent Accounting Pronouncements

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 ASU was effective on January 1, 2020 and the adoption of ASU 2018-13 did not have a material effect on the Company’s 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 became effective for annual periods beginning after December 15, 2019, including interim periods within that period, and early adoption is permitted. The ASU was effective on January 1, 2020 and the adoption of ASU 2018-15 did not have a material effect on the Company’s condensed consolidated financial statements.

In June 2016, the FASB issued ASU 2016-13, Financial Instruments - Credit Losses (Topic 326): Measurement of Credit Losses on Financial Instruments (“ASU 2016-13”). ASU 2016-13 significantly changes the impairment model for most financial assets and certain other instruments. ASU 2016-13 will require immediate recognition of estimated credit losses expected to occur over the remaining life of many financial assets, which will generally result in earlier recognition of allowances for credit losses on loans and other financial instruments. In November 2019, the FASB issued ASU 2019-10, Financial Instruments - Credit Losses (Topic 326), Derivatives and Hedging (Topic 815), and Leases (Topic 842) (“ASU 2019-10”),  which is effective for public business entities that meet the definition of an SEC filer, excluding entities eligible to be Smaller Reporting Companies (SRCs) as defined by the SEC, for fiscal years beginning after December 15, 2019, including interim period within those fiscal years and for all other entities, including SRCs, for fiscal years beginning December 15, 2022, including interim periods within those fiscal years. Upon adoption, beginning

January 1, 2023, the Company does not expect ASU 2019-10 to have a material effect on its condensed consolidated financial statements.

3. REVENUE & ACCOUNTS RECEIVEABLE, NET

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.

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, information from third parties regarding the payor mix for products, information from third parties regarding the units remaining in the distribution channel, 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.

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 Medicare Part D 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.

The following table summarizes activity in each of the Company’s product revenue provision and allowance categories for the three months ended March 31, 2020:

 

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 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 March 31, 2020 or March 31, 2019. The Company recorded an allowance of $1.4 million and $0.8 million for expected sales discounts, related to prompt pay discounts and contractual fee for service arrangements, to wholesalers and distributors as of March 31, 2020 and March 31, 2019, respectively.

4. INVENTORY

Current inventory and long-term inventory consist of the following (in thousands):

 

As of March 31, 2020, the Company had $5.3 million of current inventory and $3.8 million of long-term inventory. As of December 31, 2019, the Company had $4.6 million of current inventory and $3.8 million of long-term inventory.

5. ACCRUED EXPENSES

(1) There were additional revenue reserves included in accounts payable of $0 and $0.7 million, as of March 31, 2020 and December 31, 2019, respectively.

 

 

6. LEASES

Operating leases

On February 28, 2018, the Company entered into a lease agreement for the lease of a portion of the building located at 490 Arsenal Way, Watertown, Massachusetts (the “Watertown Lease”) to be used as the Company’s 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 landlord 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 March 31, 2020 and December 31, 2019.

For the three months ended March 31, 2020 and 2019, the variable lease expense for the Watertown Lease, which includes common area maintenance and real estate taxes, was $0.4 million and $0.1 million, respectively. The remaining lease term was 11.6 years as of March 31, 2020.

Vehicle Fleet lease

During the year ended December 31, 2019, the Company entered into a master fleet lease agreement (the “Vehicle Fleet Lease”), pursuant to which it currently leases approximately 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 March 31, 2020, the remaining lease term was 1.9 years.

 

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

 

 

 

7. DEBT

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 EYSUVIS 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; however, the Company does not expect to satisfy either such condition on or prior to June 30, 2020 and, as a result, does not currently expect that it will be eligible to draw down any of the Athyrium Term Loan B funds. The maturity date of the Athyrium Credit Facility is October 1, 2024, the six-year anniversary of the close. 

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 $0.7 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 minimis value as of March 31, 2020. 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 March 31, 2020 and December 31, 2019. 

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; however, as noted above, it is unlikely the Company will satisfy either condition to draw down on 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. 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. These costs, along with the fair value of the Warrant of $1.9 million are being amortized using the effective interest method 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 March 31, 2020, and 2019, the effective interest rate was 11.63% and 11.42%, respectively, which takes into consideration the non-cash accretion of the exit fee and the amortization of the debt discount and issuance costs. During each of the three months ended March 31, 2020 and March 31, 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.

The components of the carrying value of the debt as of March 31, 2020, and December 31, 2019 are detailed below (in thousands):

 

 

The annual principal payments due under the Athyrium Credit Facility as of March 31, 2020 were as follows (in thousands):

 

 

 

8. 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.

The following table summarizes the common stock warrants outstanding as of March 31, 2020 and December 31, 2019, each exercisable into the number of shares of common stock set forth below as of the specified dates:

 

9. 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.

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. As of December 31, 2019, the Company issued 2,592,934 shares of its common stock under the ATM Offering, resulting in net proceeds to the Company of approximately $13.1 million. During the first quarter of 2020, the Company issued an aggregate of 2,352,671 shares of its common stock under the ATM Offering, resulting in net proceeds to the Company of $12.5 million. On March 10, 2020,  the Company notified Jefferies LLC (“Jefferies”) that it was suspending and terminating the prospectus related to the Sales Agreement. The Company will not make any sales of its common stock pursuant to the Sales Agreement unless and until a new prospectus is filed.

On March 11, 2020, the Company sold 16,000,000 shares of the Company’s common stock (the “2020 Offering Shares”) in an underwritten offering (the “2020 Offering”), pursuant to the Shelf Registration filed with the SEC in August 2018, at a public offering price of $7.89 per share, before underwriting discounts, commissions, and offering expenses, resulting in net proceeds of $118.2 million. In addition, the underwriters of the offering were granted the option for a period of 30 days to purchase up to an additional 2,400,000 shares of common stock offered in the public offering at the public offering price, less underwriting discounts, commissions and offering expenses. On April 3, 2020, the underwriters exercised their option and purchased an additional 979,371 shares of common stock at $7.89 per share, before underwriting discounts, commissions, and offering expenses, resulting in net proceeds to the Company of $7.2 million. The total number of shares sold by the Company in the 2020 Offering was 16,979,371, resulting in total net proceeds to the Company, after underwriting discounts, commissions, and offering expenses, of approximately $125.4 million.

As of March 31, 2020, there was approximately $26.1 million of securities available to be issued under the Shelf Registration. As a result of the underwriters’ option exercised as noted above, there was approximately $18.3 million of securities available to be issued under the Shelf Registration as of April 3, 2020.

10. 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. The 2017 Plan was established to provide equity-based ownership opportunities for employees, officers, directors, consultants, and advisors. As of March 31, 2020, there were 138,513 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 prior plan, up to an additional 2,439,678 shares, which is the number of shares issuable pursuant to outstanding awards granted under the prior 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 cannot 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 March 31, 2020, there were no performance-based awards outstanding.

Inducement Stock Option Awards—During the three months ended March 31, 2020 and 2019, the Company granted non-statutory stock options to purchase an aggregate of 4,000 shares and 85,500 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 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 awards under the 2009 Plan, the 2017 Plan and inducement grants for the three months ended March 31, 2020 is as follows:

 

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. The assumptions used in determining fair value of the stock options granted during the three months ended March 31, 2020 and 2019, are as follows:

 

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 March 31, 2020 and 2019, the weighted average grant‑date fair value of options granted was $3.85 and $3.71, 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 March 31, 2020 and 2019, there was $21.7 million and $25.2 million, respectively, of unrecognized compensation cost related to the stock options granted, which is expected to be expensed over a weighted‑average period of 2.77 years and 2.91 years, respectively. Stock‑based compensation expense was classified in the statements of operations as follows (in thousands):

 

Stock-based compensation costs for the Company’s manufacturing employees related to INVELTYS manufactured since FDA approval totaled $0.1 million and $0.3 million for the three months ended March 31, 2020 and 2019, respectively, and has been capitalized into inventory as a component of overhead expense. Capitalized stock-based compensation is recognized as an expense when the related product is sold or expensed to selling, general and administrative expense when the related sample is issued.

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. During the year ended December 31, 2019, employees of the Company purchased an aggregate of 123,664 shares under the ESPP. The second offering period closed on December 31, 2019. In January 2020, employees of the Company purchased an aggregate 85,553 shares under the ESPP.

Reserved Shares—As of March 31, 2020 and December 31, 2019, the Company had reserved the following shares of common stock issuable upon exercise of rights under equity compensation plans, inducement stock option awards, and warrant rights to acquire common stock:

 

 

11. INCOME TAXES

The Company did not record a provision or benefit for income taxes during the three months ended March 31, 2020 and 2019. 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 recently completed an analysis and determined that an ownership change had occurred prior to December 31, 2019 and that such change has materially limited the net operating loss carryforwards and research and development tax credits available 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, 2019.

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 March 31, 2020, and 2019, 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 months ended March 31, 2020 and 2019.

12. 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 months ended March 31, 2020 the Company paid JHU $11,800 in royalty payments associated with the sale of INVELTYS.

The Company recorded other expenses related to the JHU agreement of $45,632 and $0 for the three months ended March 31, 2020 and 2019, 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 EYSUVIS, with annual minimum purchase requirements. The Company is only subject to the minimum purchase requirements for EYSUVIS upon receiving FDA approval for the product.

13. 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.

 

 

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, 2019, which was filed with the Securities and Exchange Commission on February 12, 2020.

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 discovery, development and commercialization of innovative therapies for diseases of the eye. Our innovative mucus-penetrating particle, or MPP, drug delivery 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%, our 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%, which if approved we plan to commercialize under the brand name EYSUVISTM (loteprednol etabonate ophthalmic suspension) 0.25%, for the short-term treatment of the signs and symptoms of dry eye disease. We commercially launched INVELTYS in January 2019.  

EYSUVIS 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 -  S hort  T erm  R elief  I n   D ry  E ye), evaluating the safety and efficacy of EYSUVIS 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. EYSUVIS 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. Based upon the previous recommendation of the FDA, we initiated an additional Phase 3 clinical trial, STRIDE 3, in July 2018. In October 2018, we submitted a New Drug Application, or NDA, to the FDA for EYSUVIS. In August 2019, we announced that we received a complete response letter, or CRL, from the FDA indicating that positive efficacy data from an additional clinical trial would be needed to support a resubmission of the NDA.

On March 9, 2020, we announced that STRIDE 3 achieved both of its independent primary endpoints, demonstrating a statistically significant reduction in the symptom endpoint of ocular discomfort severity, or ODS, from baseline to day 15 compared to vehicle control in both the overall ITT population (p=0.0002) and in a pre-defined

subgroup of ITT patients with more severe baseline ocular discomfort (p=0.0007), defined as patients who scored greater than or equal to 68 mm in baseline ocular discomfort. These data replicate the achievement of both primary symptom endpoints of STRIDE 1 (p<0.0001 in the overall ITT population and p=0.0008 in the pre-defined ITT subgroup with more severe ocular discomfort at baseline). Statistical significance was also achieved in the key secondary endpoint of conjunctival hyperemia at day 15 in the ITT population (p<0.0001). We believe this result replicates the achievement of the positive results of STRIDE 1 and STRIDE 2, where statistical significance was demonstrated for conjunctival hyperemia at day 15 in the ITT population as a prespecified primary endpoint in each of those trials. Statistical significance was also achieved for the key secondary endpoint of ODS at day 8 in the ITT population (p=0.0282), which was consistent with STRIDE 1 (p=0.0011) and STRIDE 2 (p=0.0408). Significant improvement was also observed for corneal staining in the ITT population (p=0.0042), consistent with the result in STRIDE 2 (p=0.0314). Consistent with STRIDE 1 and STRIDE 2, EYSUVIS was generally well tolerated in STRIDE 3, 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. On April 30, 2020, we resubmitted the NDA for EYSUVIS. We believe this application will be considered a Class 2 resubmission, with a targeted six-month review timeline under the Prescription Drug User Fee Act, or PDUFA. If approved, we believe EYSUVIS could become the preferred first-line prescription therapy for the short-term treatment of the signs and symptoms of dry eye disease, which will include treatment of dry eye flares that affect the vast majority of dry eye patients.

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 dosed 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 treatment 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 and novel next-generation anti-inflammatories designed to exhibit steroid-like anti-inflammatory action with the goal of eliminating  the risk of IOP increase and cataract formation.

INVELTYS received FDA approval under Section 505(b)(2) of the Federal Food, Drug and Cosmetic Act, or FDCA, which is the pathway we are pursuing for the approval of EYSUVIS as well. We have retained worldwide commercial rights for INVELTYS and our current product candidates, including EYSUVIS. 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, or TSMs, 7 regional sales leaders, or RSLs, and 3 directors of national accounts. If EYSUVIS is approved by the FDA, we plan to increase our sales force from 57 sales representatives to a total of approximately 100 to 125 sales representatives, who will promote both EYSUVIS and INVELTYS. We expect to commercialize in the United States any of our other product candidates that receive marketing approval as well. We also expect to explore commercialization of EYSUVIS for the treatment of dry eye disease in certain markets outside the United States, including the European Union, or EU, utilizing 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 pursuant to a sales agreement with Jefferies, LLC, or the Sales Agreement, under which we may issue and sell, from time to time, common stock in at-the-market offerings, or the ATM Offering, through Jefferies, LLC, as a sales agent. On March 10, 2020,  the Company notified Jefferies LLC that it was suspending and terminating the prospectus related to the Sales Agreement. We will not make any sales of our common stock pursuant to the Sales Agreement unless and until a new prospectus is filed. Through April 3, 2020, we have issued an aggregate of 30,549,976 shares under our Shelf Registration, including the ATM Offerings, resulting in aggregate gross proceeds to us of $231.7 million. We also have an aggregate amount of $75.0 million of indebtedness 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 $22.0 million for the three months ended March 31, 2020 and $94.3 million for the year ended December 31, 2019. As of March 31, 2020, we had an accumulated deficit of $317.4 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 proceeds from our IPO, public common stock offerings and sales of our common stock under our ATM Offering, private placements of preferred stock, convertible debt financings, borrowings under credit facilities and warrants. 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 as to the amount or timing of any such revenue, and we expect to continue to incur significant expenses and operating losses. 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 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. Beginning in March 2020 and continuing into the second quarter of 2020, prescriptions of INVELTYS and revenue have been adversely affected by the ongoing COVID-19 pandemic as federal, state and local governments implemented restrictions on elective procedures, which include most ocular surgeries. We expect that many deferred ocular surgeries will be rescheduled once conditions permit, and that INVELTYS prescriptions and revenue will return to growth, however we are unable to project the specific timing or potential impact on future revenues given the continued uncertainty around the impact and duration of the restrictions related to COVID-19.     

Cost of product revenues

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, reserves for defective inventory, and other manufacturing overhead costs. We expensed cost of product revenues related to INVELTYS as research and development expenses prior to regulatory approval which we received on August 22, 2018. With respect to the ongoing COVID-19 pandemic, we expect that the cost of product revenues will be impacted consistent with the negative impact to product revenues, net. However, we are unable to predict the specific timing or specific impact on cost of product revenues given the continued uncertainty around the impact and duration of the restrictions related to COVID-19.

Selling, General and Administrative Expenses

Selling, general and administrative expenses consist primarily of salaries, benefits, commissions, stock‑based compensation and travel expenses related to our commercial infrastructure and our executive, finance, human resources, legal, information technology and business development functions. Selling, general and administrative expenses also includes external costs related to marketing, samples and professional fees for auditing, tax, information technology, consultants, 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 as we continue to build our commercial infrastructure to support the commercialization of INVELTYS or of any product candidates for which we obtain marketing approval, and if and as we increase our administrative headcount to support our continued

research activities and development of our product candidates or additional product candidates, including EYSUVIS. In addition, we anticipate increased expenses related to supporting a larger organization and increase in selling expense related to EYSUVIS, if approved. With respect to the ongoing COVID-19 pandemic, we expect that selling, general and administrative expenses could be favorably impacted by a reduction in certain expenses associated with the restriction in the activities of our sales force, which has suspended substantially all in-person interactions with physicians and customers, and are mostly restricted to conducting educational and promotional activities virtually until such time as they can safely return to the field. However, we are unable to predict the specific amount of this impact or the amount of additional facility-related costs, if any, that could be associated with our personnel safely resuming their activities once the pandemic subsides.

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:

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 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 that our research and development costs will decrease in 2020 as compared to the year ended December 31, 2019 as a result of the completion of STRIDE 3. However, we expect that such costs will increase if and as we continue to advance our product candidates and conduct additional late-stage clinical trials. The process of 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, including EYSUVIS. 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. With respect to the ongoing COVID-19 pandemic, we may incur reduced research and development costs resulting from the limitations placed on our laboratory facilities that support our early-stage research. However, we are unable to predict the specific amount of this impact, nor are we able to predict the additional costs, if any, associated with personnel safely resuming their activities.

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 the scientific and clinical success of each product candidate as well as ongoing assessments as to the commercial potential of product candidates and our ability to enter into collaborations with respect to each product candidate. We may 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, 2019.

Results of Operations

Comparison of the Three Months Ended March 31, 2020 and 2019

The following table summarizes the results of our operations for the three months ended March 31, 2020 and 2019:

Product revenues, net

Product revenues, net was $1.1 million for the three months ended March 31, 2020 compared to $1.4 million for the three months ended March 31, 2019. The decrease in net revenue of $0.3 million was driven by higher reserves related to the first quarter of 2020 of $1.3 million as compared to those estimated during the first quarter of 2019, partially offset by a $1.0 million increase in net revenue due to a higher per unit gross selling price. INVELTYS is our first product to receive regulatory approval, which we launched in the United States in January 2019. We expect product revenues to increase if and as we increase our market share, obtain and maintain coverage and adequate reimbursement for INVELTYS from third-party payors; however, we expect full-year product revenues to be negatively impacted for 2020 as a result of the COVID-19 pandemic.

Cost of product revenues

Cost of product revenues was $0.4 million for the three months ended March 31, 2020 compared to $0.2 million for the three months ended March 31, 2019, an increase of $0.2 million. We began capitalizing inventory costs for INVELTYS after receipt of FDA approval of INVELTYS on August 22, 2018 and, as a result, cost of product revenues for the three months ended March 31, 2019 were more favorably impacted by costs which were expensed as research and development prior to FDA approval.

Selling, general and administrative expenses

Selling, general and administrative expenses were $15.4 million for the three months ended March 31, 2020 compared to $18.2 million for the three months ended March 31, 2019, which was a decrease of $2.8 million. The decrease was driven by a reduction in selling and marketing expenses of $1.8 million for the three months ended March 31, 2020 primarily attributable to costs associated with the commercial launch of INVELTYS incurred during the three months ended March 31, 2019. Also contributing to a decrease in selling, general and administrative expenses was a decrease of $0.8 million in employee-related costs including stock compensation as well as reduced relocation and legal fees of $0.4 million partially offset by higher insurance costs of $0.2 million. 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 seek marketing approval for our product candidates.

Research and development expenses

The following table summarizes the research and development expenses incurred during the three months ended March 31, 2020 and 2019:

 

Research and development expenses were $5.4 million for the three months ended March 31, 2020 compared to $7.0 million for the three months ended March 31, 2019, a $1.6 million decrease. The decrease was primarily the result of a $1.7 million decrease in KPI-121 development costs related to lower external cost on the STRIDE 3 dry eye clinical trial for which we announced topline data in March 2020. Other research and development costs include facility related costs, pre-clinical studies, certain medical affairs and associated regulatory costs, which decreased $0.2 million. Offsetting the decrease in KPI-121 development costs was a $0.4 million increase in employee-related costs driven by increased stock-based compensation and an increase in manufacturing employees allocating more time to EYSUVIS research and development.