| Summary of Significant Accounting Policies | Note 2: Summary of Significant Accounting Policies
Principles of consolidation— The accompanying consolidated financial statements include the accounts of Kala Pharmaceuticals, Inc. and its wholly owned subsidiary, Kala Pharmaceuticals Security Corporation, which is a Massachusetts subsidiary created to buy, sell and hold securities. All intercompany transactions and balances have been eliminated.
Basis of Presentation —The accompanying consolidated financial statements have been prepared on a going concern basis which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business. Since inception, the Company has not generated revenue from the sale of products and has incurred recurring losses and negative cash flows from operations, including a net loss of $66.7 million and $42.2 million, for the years ended December 31, 2018 and 2017, respectively, and used cash in operations of $54.1 million and $34.1 million, in the years ended December 31, 2018 and 2017, respectively. The Company has financed its operations to date primarily through the issuance of common stock, convertible preferred stock, convertible promissory notes and debt. The Company expects to incur additional operating losses and negative operating cash flows for the foreseeable future. The Company expects that the existing cash on hand as of December 31, 2018 will enable it to fund its planned operating expenses, debt service obligations and capital expenditure requirements for at least 12 months from the date these 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 consolidated financial statements are issued. As a result, the Company could deplete its available capital resources sooner than it expects.
Common Stock Reverse Stock Split and Adjustment to Preferred Stock Conversion Ratios — On July 7, 2017, the Company effected a one-for-5.2083 reverse stock split of the Company’s issued and outstanding shares of common stock and a proportional adjustment to the existing conversion ratios for the Company’s convertible preferred stock. The par value per share and authorized shares of common and convertible preferred stock were not adjusted as a result of the reverse stock split. All common stock and common stock per share amounts within the financial statements and notes thereto have been retroactively adjusted for all periods presented to give effect to this reverse stock split, including reclassifying an amount equal to the reduction in par value of common stock to additional paid-in capital.
Automatic Conversion of Preferred Stock —On July 7, 2017, the Company effected an amendment to its Amended and Restated Certificate of Incorporation, as amended. This amendment eliminated the minimum price per share of Common Stock for an underwritten public offering that would result in the automatic conversion of all outstanding shares of the Company’s Series Seed, Series A, Series B, Series B-1 and Series C Preferred Stock.
Use of Estimates —The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America (“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 relied upon in preparing these consolidated financial statements relate to, but are not limited to, 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.
Cash and Concentration of Credit Risk —Financial instruments that potentially expose the Company to concentrations of credit risk consist primarily of cash. Periodically, the Company maintains deposits in accredited financial institutions in excess of federally insured limits. The Company deposits its cash in financial institutions that it believes have high credit quality and has not experienced any losses on such accounts and does not believe it is exposed to any unusual credit risk beyond the normal credit risk associated with commercial banking relationships.
Restricted Cash —As of December 31, 2018 and 2017, the Company had restricted cash of $12.2 million and $0.1 million, respectively, which represents cash held in money market accounts to satisfy our financial covenant (See Note 8) and serve as collateral for the Company’s credit cards and facility leases. This cash is classified as a non-current asset in the accompanying consolidated balance sheets.
Inventory — Inventory is stated at the lower of cost or net realizable value, on a first-in, first-out (“FIFO”) method. Costs include amounts related to third party manufacturing, transportation, internal labor and overhead. Capitalization of costs as inventory begins when the product has received regulatory approval in the U.S. We expense inventory costs related to product candidates as research and development expenses prior to regulatory approval in the respective territory, even if this inventory may later be sold. For INVELTYS, capitalization of costs as inventory began upon U.S. regulatory approval on August 22, 2018. Inventory also includes costs of product samples prior to shipment.
Leases —At the inception of an arrangement the Company determines whether the arrangement is or contains a lease based on the unique and circumstances present. Most leases with a term greater than one year are recognized on the balance sheet as right-of-use assets, lease liabilities and, if applicable, long-term lease liabilities. The Company has elected not to recognize on the balance sheet leases with terms of one-year or less. Lease liabilities and their corresponding right-of-use assets are recorded based on the present value of lease payments over the expected lease term. The interest rate implicit in lease contracts is typically not readily determinable. As such, the Company utilizes the appropriate incremental borrowing rate, which is the rate incurred to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment. Certain adjustments to the right-of-use asset may be required for items such as initial direct costs paid or incentives received.
The components of a lease should be split into three categories: lease components (e.g., land, building, etc.), non-lease components (e.g., common area maintenance, maintenance, consumables, etc.), and non-components (e.g., property taxes, insurance, etc.). Then the fixed and in-substance fixed contract consideration (including any related to non-components) must be allocated based on fair values to the lease components and non-lease components. Although separation of lease and non-lease components is required, certain practical expedients are available to entities. Entities electing the practical expedient would not separate lease and non-lease components. Rather, they would account for each lease component and the related non-lease component together as a single component. The Company’s facilities operating leases have lease and non-lease components which the Company has elected to use the practical expedient and account for each lease component and related non-lease component as one single component. The lease component results in a right-of-use asset being recorded on the balance sheet and amortized as lease expense on a straight-line basis to the statements of operations.
Property and Equipment, net —Property and equipment are recorded at cost. Depreciation is provided using the straight‑line method over the estimated useful lives of the related assets. Depreciation expense is included in operations. Laboratory equipment and office and computer equipment is depreciated over three to five years. Leasehold improvements are depreciated over the shorter of their useful life or the life of the lease. Major additions and upgrades are capitalized; maintenance and repairs, which do not improve or extend the life of the respective assets, are expensed as incurred. Upon retirement or sale, the cost of assets disposed of and the related accumulated depreciation are removed from the accounts and any resulting gain or loss is included in loss from operations.
Patent Costs —Costs to secure and defend patents are expensed as incurred and are classified as selling, general and administrative expenses in the Company’s consolidated statements of operations.
Impairment of Long‑Lived Assets —Long‑lived assets are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. When such events occur, the Company compares the carrying amounts of the assets to their undiscounted expected future cash flows. If the undiscounted cash flows are insufficient to recover the carrying value, the assets are recorded at the lesser of the carrying value or fair value. For the years ended December 31, 2018 and 2017, no impairments were recorded.
Fair Value Measurements —Certain assets and liabilities are carried at fair value. Fair value is defined as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. Valuation techniques used to measure fair value must maximize the use of observable inputs and minimize the use of unobservable inputs. Financial assets and liabilities carried at fair value are to be classified and disclosed in one of the following three levels of the fair value hierarchy, of which the first two are considered observable and the last is considered unobservable:
·
Level 1—Quoted prices in active markets for identical assets or liabilities.
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Level 2—Observable inputs (other than Level 1 quoted prices), such as quoted prices in active markets for similar assets or liabilities, quoted prices in markets that are not active for identical or similar assets or liabilities, or other inputs that are observable or can be corroborated by observable market data.
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Level 3—Unobservable inputs that are supported by little or no market activity and that are significant to determining the fair value of the assets or liabilities, including pricing models, discounted cash flow methodologies and similar techniques.
The Company’s preferred stock warrant liability, prior to conversion to common stock warrants, was carried at fair value determined according to the fair value hierarchy described above and classified as a Level 3 measurement. Upon the completion of the IPO, the Company’s outstanding warrants to purchase preferred stock converted into warrants to purchase common stock and the Company reclassified the fair value of the warrant liability to additional paid-in capital (Note 10).The carrying value of accounts payable and accrued expenses approximate their fair value due to the short‑term nature of these assets and liabilities. Management believes that the Company’s long‑term debt (See Note 8 ) bears interest at the prevailing market rate for instruments with similar characteristics and, accordingly, the carrying value of long‑term debt, including the current portion, also approximates its fair value. The fair value of the outstanding debt was estimated using a discounted cash flow analysis based on current market interest rates for debt issuances with similar remaining years to maturity, adjusted for credit risk, which represents a Level 3 measurement.
Segment Information —Operating segments are identified as components of an enterprise about which separate discrete financial information is made available for evaluation by the chief operating decision maker (“CODM”) in making decisions regarding resource allocation and assessing performance. The CODM is the Company’s Chief Executive Officer. The Company manages its operations as a single segment for the purposes of assessing performance and making operating decisions. The Company’s singular focus is on the development and commercialization of therapeutics using its proprietary AMPPLIFY technology. All of the Company’s tangible assets are held in the United States. To date, all of the Company’s revenue has been generated in the United States.
Research and Development Costs —Research and development expenses consist of expenses incurred in performing research and development activities, including compensation and benefits for full‑time research and development employees, an allocation of facilities expenses, overhead expenses, payments to universities under the Company’s license agreements and other outside expenses. Research and development costs are expensed as incurred. Research and development costs that are paid in advance of performance, including nonrefundable prepayments for goods or services, are deferred and capitalized as a prepaid expense. Such amounts are recognized as an expense as the goods are delivered or the related services are performed, or until it is no longer expected that the goods will be delivered or the services rendered.
Accrued Expenses —The Company accrues expenses related to development activities performed by third parties based on an evaluation of services received and efforts expended pursuant to the terms of the contractual arrangements. Payments under some of these contracts depend on clinical trial milestones. There may be instances in which payments made to the Company’s vendors will exceed the level of services provided and result in a prepayment of expenses. In accruing service fees, the Company estimates the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, the Company will adjust the accrual or prepaid expense accordingly.
Stock‑Based Compensation —The Company accounts for all stock‑based payment awards granted to employees and non‑employees as compensation expense at fair value. The Company’s stock‑based payments include stock options and grants of common stock, including common stock subject to vesting. The measurement date for employee awards is the date of grant, and stock‑based compensation costs are recognized as expense over the employees’ requisite service period, which is the vesting period, on a straight‑line basis. The measurement date for nonemployee awards is generally the date the services are completed, resulting in periodic adjustments to stock‑based compensation during the vesting terms for changes in the fair value of the awards. Stock‑based compensation costs for nonemployees are recognized as expense over the vesting period on a straight‑line basis. Stock‑based compensation is classified in the accompanying consolidated statements of operations based on the function to which the related services are provided, or capitalized with inventory until related expense is recognized.
The Company recognizes compensation expense for the portion of awards that have vested. After the adoption of Accounting Standards Update (“ASU”) 2016-09, described in further detail below, forfeitures are recorded as they occur.
The fair value of each stock option grant is estimated on the date of grant using the Black‑Scholes option‑pricing model. The assumptions used in calculating the fair value of stock-based payment awards represent management’s best estimates. The Company lacks sufficient company‑specific historical and implied volatility information. Therefore, it estimates its expected stock volatility based on the historical volatility of a publicly traded set of peer companies and will continue to do so until it has adequate historical data regarding the volatility of its own traded stock price. The expected term of the Company’s stock options has been determined utilizing the “simplified” method for awards that qualify as “plain‑vanilla” options. The expected term of stock options granted to non‑employees is equal to the contractual term of the option award. The risk‑free interest rate is determined by reference to the U.S. Treasury yield curve in effect at the time of grant of the award for time periods approximately equal to the expected term of the award. Expected dividend yield is based on the fact that the Company has never paid cash dividends on common stock and does not expect to pay any cash dividends in the foreseeable future.
Common Stock Valuation Prior to the IPO —Through the consummation of the IPO in July 2017, due to the absence of an active market for the Company’s common stock, the Company utilized methodologies in accordance with the framework of the American Institute of Certified Public Accountants Technical Practice Aid, Valuation of Privately‑Held Company Equity Securities Issued as Compensation, to estimate the fair value of its common stock. In determining the exercise prices for options granted, the Company has considered the estimated fair value of the common stock as of the measurement date. The estimated fair value of the common stock has been determined at each grant date based upon a variety of factors, including the illiquid nature of the common stock, arm’s‑length sales of the Company’s capital stock (including redeemable convertible preferred stock), the effect of the rights and preferences of the preferred shareholders, and the prospects of a liquidity event. Among other factors are the Company’s financial position and historical financial performance, the status of technological developments within the Company’s research, the composition and ability of the current research and management team, an evaluation or benchmark of the Company’s competition, and the current business climate in the marketplace. Significant changes to the key assumptions underlying the factors used could have resulted in different fair values of common stock at each valuation date.
Preferred Stock Warrants —Prior to the completion of the IPO in July 2017, the Company classified warrants to purchase shares of its Series Seed Preferred Stock, Series A Convertible Preferred Stock (“Series A Preferred Stock”), Series B Preferred Stock (“Series B Preferred Stock”), and Series C Preferred Stock (“Series C Preferred Stock”) as a liability on its consolidated balance sheets as these warrants were free‑standing financial instruments that were exercisable for contingently redeemable shares. The warrants were recorded in long‑term liabilities at fair value, estimated using the Black‑Scholes model, and marked to market at each balance sheet date. The change in carrying value was reported as the change in fair value of warrant liability in the accompanying consolidated statements of operations. The Company continued to adjust the liability for changes in fair value until conversion of the preferred stock warrants to warrants to purchase common stock (see Note 10).
Income Taxes —Deferred tax assets and liabilities are recognized for the expected future tax consequences of events that have been included in the Company’s consolidated financial statements and tax returns. Deferred tax assets and liabilities are determined based upon the differences between the consolidated financial statement carrying amounts and the tax bases of existing assets and liabilities and for loss and credit carryforwards using enacted tax rates expected to be in effect in the years in which the differences are expected to reverse. Deferred tax assets are reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized.
The Company provides reserves for potential payments of tax to various tax authorities related to uncertain tax positions and other issues. The Company may recognize the tax benefit from an uncertain tax position only if it is more likely than not that the position will be sustained on examination by the taxing authorities based on the technical merits of the position. The tax benefits recognized in the consolidated financial statements from such a position is measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement. As a result, reserves are based on a determination of whether and how much of a tax benefit taken by the Company in its tax filings or positions is more likely than not to be realized following resolution of any potential contingencies present.
Tax Incentives — The Company recognizes tax incentives when there is reasonable assurance that the Company will comply with the conditions attached to the tax incentive agreement and the tax incentive will be received. The Company evaluates the conditions of each individual tax incentive as of each reporting period to ensure that the Company has reached reasonable assurance of meeting the conditions of each tax incentive agreement and that it is expected that the tax incentive will be received as a result of meeting the necessary conditions. When tax incentives are related to reimbursements for cost of revenues or operating expenses, the tax incentives are recognized as a reduction of the related expense in the consolidated statements of operations when the related expense has been incurred.
The Company records tax incentive receivables in the consolidated balance sheets in prepaid expenses and other current assets or long-term tax incentive receivable, depending on when the amounts are expected to be received from the funding agency. As of December 31, 2018 and 2017, the Company had recorded no receivable from tax incentives.
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 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. Net loss per share attributable to common stockholders is calculated using the two‑class method, which is an earnings allocation formula that determines net loss per share for the holders of the Company’s common shares and participating securities. The Company’s convertible preferred stock contains participation rights in any dividend paid by the Company and is deemed to be a participating security. Net loss attributable to common stockholders and participating preferred shares are allocated to each share on an as‑converted basis as if all of the earnings for the period had been distributed. The participating securities do not include a contractual obligation to share in losses of the Company and are not included in the calculation of net loss per share in the periods in which a net loss is recorded.
Diluted net loss per share is computed using the more dilutive of (a) the two‑class method or (b) the if converted method. The Company allocates earnings first to preferred stockholders based on dividend rights and then to common and preferred stockholders based on ownership interests. 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, warrants, preferred stock and the potential issuance of stock upon the conversion of the Company’s convertible notes. 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. When a gain had been recorded pursuant to a change in fair value of the warrant liability during the period, the Company assessed whether the impact of reversing the gain and including the additional securities was dilutive, and if so, adjusted dilutive EPS. The Company reported a net loss attributable to common stockholders for the years ended December 31, 2018 and 2017.
The Company previously reported weighted average shares outstanding – basic and diluted of 6,903,239 shares and net loss per share attributable to common stockholders – basic and diluted of $6.11 for the year ended December 31, 2017. Subsequent to reporting the Company’s financial statements as of and for the year ended December 31, 2017, an immaterial error was identified resulting in a correction of the weighted average shares outstanding – basic and diluted to 11,375,000 shares and net loss per share – basic and diluted of $3.71 for the year ended December 31, 2017. These financial statements include the corrected amounts.
Comprehensive Loss —Comprehensive loss is equal to net loss for the periods presented.
Recently Adopted Accounting Pronouncements
In March 2016, the Financial Accounting Standards Board (the “FASB”) issued ASU No. 2016‑09, Improvements to Employee Share‑Based Payment Accounting (“ASU 2016‑09”), which simplifies share‑based payment accounting through a variety of amendments. The standard is effective for annual periods beginning after December 15, 2016 and for interim periods within those fiscal years. The changes resulting from the adoption of this standard impact the accounting for income taxes, accounting for forfeitures, statutory tax withholding and the presentation of statutory tax withholding on the consolidated statement of cash flows. The Company adopted this standard on January 1, 2017. Under guidance within ASU 2016‑09, excess tax benefits and deficiencies are to be recognized as income tax expense or benefit in the consolidated statement of operations in the period in which they occur rather than as an increase or decrease in stockholders’ equity (deficit). Since the Company maintains a full valuation allowance on its net deferred tax assets, there was no net impact to its accumulated deficit or its net loss resulting from the adoption of this standard. Also under the guidance in ASU 2016‑09, an entity may elect to account for forfeitures as they occur or continue to estimate the total number of awards that are vested or expected to vest. The Company elected to account for forfeitures as they occur and applied the accounting change on a modified retrospective basis as a cumulative effect adjustment to accumulated deficit as of the date of adoption, January 1, 2017. The adoption of this standard did not have a material impact on the Company’s financial position, results of operations or consolidated statement of cash flows.
In November 2016, the FASB issued ASU 2016‑18, Statement of Cash Flows Restricted Cash (“ASU 2016‑18”). This new standard requires companies to include amounts generally described as restricted cash and restricted cash equivalents in cash and cash equivalents when reconciling beginning‑of‑period and end‑of‑period total amounts shown on the consolidated statement of cash flows. This guidance was effective for annual and interim reporting periods beginning after December 15, 2017, and required retrospective application. The Company elected to early adopt this guidance as of December 31, 2017. The adoption of this standard did not have a material impact on the consolidated financial statements and related disclosures.
In August 2016, the FASB issued ASU No. 2016‑15, Statement of Cash Flows: Classification of Certain Cash Receipts and Cash Payments (“ASU 2016‑15”), to address diversity in practice in how certain cash receipts and cash payments are presented and classified in the statement of cash flows. The standard was effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years.
In May 2017, the FASB issued ASU No. 2017-09, Compensation – Stock Compensation (“Topic 718”): Scope of Modification Accounting (“ ASU 2017-09”), which provides guidance about which changes to the terms or conditions of a share-based payment award require an entity to apply modification accounting. The amendments in ASU 2017-09 are effective f or all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company has prospectively adopted this new standard as of January 1, 2018. The adoption of this standard did not have a material impact on the Company’s consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842) (“ASU 2016-02”), which provides guidance to enhance the transparency and comparability of financial reporting related to leasing arrangements. Under this new lease standard, most leases are required to be recognized on the balance sheet as right-of-use assets and corresponding lease liabilities. Disclosure requirements have been enhanced with the objective of enabling financial statement users to assess the amount, timing, and uncertainty of cash flows arising from leases.
The Company elected to early adopt ASU 2016-02, effective January 1, 2018. The standard has been implemented using the required modified retrospective approach and the Company has also elected to utilize the available practical expedients. In using the modified retrospective approach, the Company was required to recognize and measure leases existing at, or entered into after, the beginning of the earliest comparative period presented. Prior period results have been restated resulting in adjustments to the consolidated balance sheets and the consolidated statement of cash flows. The adoption of this standard did not have a material impact on the consolidated statement of operations. The impact on the consolidated balance sheet as of December 31, 2017 and the consolidated statement of cash flows for the year ended December 31, 2017 is shown below.
Impact to Previously Reported Results
From December 31, 2017 consolidated balance sheet (in thousands):
As Previously Reported
New Lease Standard Adjustment
As Restated
Right-of-use asset
$
—
$
$
Accrued expenses
$
$
$
Other current and long-term liabilities
$
$
(1)
$
Lease liabilities
$
—
$
$
For the year ended December 31, 2017 consolidated statement of cash flows (in thousands):
As Previously Reported
New Lease Standard Adjustment
As Restated
Amortization of right-of-use asset
$
—
$
356
$
356
Accrued expenses
$
2,596
5
$
2,601
Lease liabilities
$
—
$
(361)
$
(361)
Recently Issued Accounting Pronouncements
In June 2018, the FASB issued ASU 2018-07, Compensation-Stock Compensation Improvements to Nonemployee Share-Based Payment Accounting (“Topic 718”). The ASU substantially aligns accounting for share-based payments to employees and non-employees. This ASU will become effective for annual periods beginning after December 15, 2018, including interim periods within that period, and early adoption is permitted. The Company does not expect this ASU to have a material effect on its consolidated financial statements.
In August 2018, the FASB issued ASU 2018-13, Disclosure Framework - Changes to the Disclosure Requirements for Fair Value Measurement ( “Topic 820”) . The ASU 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 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 (“Subtopic 350-40”). This ASU 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 effecti |
