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, 2018

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 and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted 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 and post 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 an 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 24,562,400 shares of Common Stock, $0.001 par value per share, outstanding as of May 9, 2018.

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

(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 CASH FLOWS 

(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 development and commercialization of therapies using its proprietary nanoparticle‑based Mucus Penetrating Particles, or MPP, technology, with an initial focus on the treatment of eye diseases. The Company has applied the MPP technology to lotepredol etabonate, or LE, a corticosteroid designed for ocular applications, resulting in two lead product candidates. These product candidates are INVELTYSTM (KPI‑121 1.0%), for the treatment of inflammation and pain following ocular surgery, for which the U.S. Food and Drug Administration (the “FDA”) has accepted for filing the Company’s New Drug Application, or NDA, and KPI‑121 0.25% for the temporary relief of the signs and symptoms of dry eye disease. The Company is evaluating opportunities for MPP nanosuspensions of LE with less frequent daily dosing regimens for the treatment of inflammation and pain following ocular surgery, for the temporary relief of the signs and symptoms of dry eye disease and for potential chronic treatment of dry eye disease. The Company is also evaluating compounds in its topically applied MPP 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. The brand name INVELTYS has been conditionally approved by the FDA.

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

Initial Public Offering—On July 25, 2017, the Company completed its initial public offering (“IPO”) of common stock pursuant to its registration statement on Form S‑1, as amended (File No. 333‑218936), which was declared effective by the Securities Exchange Commission (the “SEC”) on July 19, 2017. Pursuant to the registration statement, the Company issued and sold 6,900,000 shares of $0.001 par value common stock at an initial offering price of $15.00 per share, which included 900,000 shares of common stock pursuant to the underwriters’ option to purchase additional shares. The Company’s shares began trading on the Nasdaq Global Select Market under the symbol “KALA” on July 20, 2017.

Proceeds from the Company’s IPO were approximately $94.0 million after deducting underwriting discounts and commissions of $7.3 million and offering costs of $2.2 million. Upon the closing of the IPO, all of the Company’s outstanding shares of convertible preferred stock automatically converted into 16,101,970 shares of common stock at the applicable conversion ratio then in effect. All of the Company’s outstanding warrants to purchase preferred stock automatically converted into warrants to purchase 202,020 shares of common stock.

Liquidity— Since inception, we have incurred significant losses from operations and negative cash flows from operations. As of March 31, 2018, we had an accumulated deficit of $145.7 million. We have not generated any revenues to date from product sales and have financed operations primarily through the IPO, private placements of preferred stock, convertible debt financings and borrowings under credit facilities. The Company has devoted substantially all of its financial resources and efforts to research and development, including preclinical studies and clinical trials. The Company expects to continue to incur significant expenses and operating losses over the next several years. Net losses may fluctuate significantly from quarter to quarter and year to year.

The Company believes that its existing cash on hand as of March 31, 2018, will enable it to fund its planned operating expenses, debt service obligations and capital expenditure requirements for at least twelve months from the date these condensed consolidated financial statements were issued.  This evaluation is based on relevant conditions and events that are known and reasonably knowable at the date that the condensed consolidated financial statements are issued. As a result, the Company could deplete its available capital resources sooner than it currently expects.

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

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 Company applies the two-class method to calculate basic and diluted net loss per share attributable to common stockholders as its warrants to purchase common stock are participating securities.

The two-class method is an earnings allocation formula that treats a participating security as having rights to earnings that otherwise would have been available to common stockholders. However, the two-class method does not impact the net loss per share of common stock as the Company has been in a net loss position and the warrant holders do not participate in losses.

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

Unaudited Interim Financial Information—The condensed consolidated financial statements of the Company included herein have been prepared, without audit, pursuant to the rules and regulations of the 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 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, 2017 (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, which was established in November 2017. All intercompany transactions and balances have been eliminated in consolidation.

2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

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 three month period ended March 31, 2018 other than those noted below.

Leases

At the inception of an arrangement, the Company determines whether the arrangement is or contains a lease based on the unique facts 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 account for as one single lease 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.

Recently Adopted Accounting Pronouncements

In May 2017, the Financial Accounting Standards Board (“FASB”) issued Accounting Standards Update (“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 for all entities for annual periods, and interim periods within those annual periods, beginning after December 15, 2017, with early adoption permitted. The Company has adopted this new standard as of January 1, 2018. The adoption of this standard did not have a material impact on the Company’s condensed consolidated financial statements.    

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 is effective for annual periods beginning after December 15, 2017, including interim periods within those fiscal years. ASU 2016-15 should be applied retrospectively and early adoption is permitted, including adoption in an interim period. The Company has adopted this new standard as of January 1, 2018. The adoption of this standard did not have a material impact on the Company’s condensed 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, as permitted in the guidance. 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 a material impact on the condensed consolidated balance sheets and the condensed consolidated statement of cash flows. The adoption of this standard did not have a material impact on the condensed consolidated statement of operations. The impact on the consolidated balance sheet as of December 31, 2017 and the condensed consolidated statement of cash flows for the three months ended March 31, 2017 is shown below.

Impact to Previously Reported Results

From December 31, 2017 consolidated balance sheet (in thousands):

For the three months ended March 31, 2017 condensed consolidated statement of cash flows (in thousands):

3. ACCRUED EXPENSES

Accrued expenses consist of the following (in thousands):

4. LEASES

The Company entered into a three‑year lease agreement for its headquarters on September 30, 2013, with a commencement date of February 1, 2014. On June 30, 2016, the lease was amended to extend the term from January 31, 2017 to January 31, 2019. In connection with the lease agreement, the Company issued a letter of credit to the landlord for $84,000. The Company secured the letter of credit for the full amount of the letter with cash on deposit, which is reported as restricted cash. The restricted cash as of March 31, 2018 is included in other noncurrent assets in the accompanying balance sheets. With the adoption of ASU 2016-02, the Company has recorded a right-of-use asset and corresponding lease liability.

On February 28, 2018, the Company entered into a lease agreement with 480 Arsenal Group LLC (“the Arsenal Group”) for the lease of a portion of the building located at 490 Arsenal Way Watertown, Massachusetts (the “Watertown Lease”). The initial term of the Watertown Lease is eight years with an option to extend for an additional five years. The Company expects to occupy the premises by the end of 2018. The Company plans to use the premises as its new corporate headquarters and for research and development. The Company has not yet occupied this space as it is being renovated for the Company’s use. The Company has concluded that it does not control the space as defined in ASU 2016-02 during the construction period and does not expect to gain control of the space until on or near construction completion and, as such, a right-of-use asset and corresponding lease liability have not been recorded.

In connection with the Watertown Lease, the Company issued a letter of credit to the Arsenal Group for $2.0 million. The Company secured the letter of credit for the full amount of the letter with cash on deposit, which is reported as restricted cash. The restricted cash as of March 31, 2018 is included in other noncurrent assets in the accompanying balance sheets.

On March 15, 2018, the Company entered into a lease agreement with Duffy Associates, LLC for the lease of a portion of the building located at 465 Waverley Oaks Road Suite 301, Waltham, Massachusetts (the “Waverley Oaks Lease”). The term of the Waverley Oaks Lease is one year, and as such a right-of-use asset and corresponding lease liability has not been recorded. The Company plans to use this location for additional corporate offices before moving to its new corporate headquarters in Watertown, MA.

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

As of March 31, 2018 and December 31, 2017, the remaining lease term on the operating lease was 0.84 years and 1.08 years, respectively. As of March 31, 2018 and December 31, 2017, the discount rate was 6.50%.

Future minimum commitments due under these lease agreements as of March 31, 2018 are as follows (in thousands):

5. DEBT

2014 Debt Facility

In November 2014, the Company entered into a venture debt facility (“2014 Debt Facility”) for a total loan commitment of $10.0 million. On October 13, 2016, the Company entered into a First Amendment to the 2014 Debt Facility the (“First Amendment”), which reaffirmed the initial commitment to a total of $10.0 million of funding (“Term Loan A”) and increased the Company’s total borrowing capacity by an additional $10.0 million (“Term Loan B” and together with Term Loan A, “Term Loans”). On September 28, 2017, the Company drew the additional $10.0 million available under Term Loan B. On November 22, 2017, the Company entered into a Second Amendment to the 2014 Debt Facility to account for the formation of the Company’s wholly-owned subsidiary. On March 29, 2018, the Company entered into a Third Amendment to the 2014 Debt Facility the (“Third Amendment”), which reaffirmed the initial commitment to a total of $20.0 million of funding (“Term Loan A”), increased the Company’s total borrowing capacity by an additional $5.0 million and extended the interest-only end date for 12 months following the execution of the Third Amendment. The maturity date of the 2014 Debt Facility was also extended from October 13, 2020 to March 29, 2022. Under the terms of the facility, the borrowings accrue interest at an annual rate equal to 3.00% above the Prime Rate then in effect. The interest rate was 7.75% as of March 31, 2018 and 7.50% as of December 31, 2017.

The unpaid principal balance under the 2014 Debt Facility was $20.0 million and $18.9 million as of March 31, 2018 and December 31, 2017, respectively. The unamortized discount was $254,000 and $235,000 as of March 31, 2018 and December 31, 2017, respectively. During the three months ended March 31, 2018 and 2017, the Company recognized interest expense of $367,000 and $198,000, respectively, which consisted of amortization of the debt discount of $31,000 and $28,000 and the contractual coupon interest of $336,000 and $170,000, respectively.

The 2014 Debt Facility, as amended, is senior debt and is secured by substantially all of the assets of the Company other than intellectual property. The Company’s ability to pay cash dividends is currently restricted by the

terms of the 2014 Debt Facility. In the event the Company is determined to be in default under the 2014 Debt Facility, the outstanding balance accrues interest at five percentage points above the interest rate applicable immediately prior to the occurrence of the event of default and the lender has the right to declare all outstanding principal and interest payable. Under the terms of the 2014 Debt Facility, certain events including but not limited to, the Company’s failure to pay obligations when due, failure to perform obligations under the agreement, insolvency or the occurrence of any circumstance that could reasonably be expected to have a material adverse effect on the Company, constitute events of default.

In connection with its borrowings under the 2014 Debt Facility the Company issued preferred stock warrants. Upon each issuance of such preferred stock warrants, the Company estimated the fair value using the Black‑Scholes option‑pricing model, and recorded the estimated fair value as a liability separate from the loan balance, and an additional debt discount included within long‑term debt that is amortized to interest expense over the term of the loan using the effective interest method. The initial fair value of all issuances of such preferred stock warrants on an aggregate basis was $365,000. Upon the Company's IPO on July 25, 2017, all of the underlying preferred stock warrants were converted into warrants for common stock (see Note 6), and the warrant liability was re-measured to fair value and reclassified to additional paid-in capital.

The future annual principal payments due under the 2014 Debt Facility as of March 31, 2018 were as follows (in thousands):

6. WARRANTS

The Company has issued warrants in connection with debt transactions that were completed prior to 2014. Upon the completion of the IPO, the Company’s outstanding warrants to purchase preferred stock converted into warrants to purchase common stock.

The following table summarizes the common stock warrants outstanding, each exercisable into the number of shares of common stock set forth below as of the specified dates:

7. FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company classifies fair value based measurements using a three-level hierarchy that prioritizes the inputs used to measure fair value. This hierarchy requires entities to maximize the use of observable inputs and minimize the

use of unobservable inputs. The three levels of inputs used to measure fair value are as follows: Level 1, quoted market prices in active markets for identical assets or liabilities; Level 2, observable inputs other than quoted market prices included in Level 1 such as quoted market prices for markets that are not active or other inputs that are observable or can be corroborated by observable market data; and Level 3, unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities, including estimates and assumptions developed by the Company, reflective of those that a market participant would use, as inputs to certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

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 5) 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. There were no transfers between fair value measurement levels during the three months ended March 31, 2018 or March 31, 2017.

The Company has historically classified the value of the warrant liability as Level 3 measurements within the fair value hierarchy because the fair value is derived using significant unobservable inputs, which included the estimated volatility, the estimated fair value of the underlying preferred stock, and to the extent that the number of exercisable shares underlying the warrants were adjustable based on the amount of the Term Loans drawn down or the probability that the Company would draw down on the debt facility. 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. All warrants are currently classified as equity and their fair value is not recorded or re-measured.

The following table provides a summary of changes in the fair value of the Company’s warrant liability, which is included as a component of other (income) expense (in thousands) which was remeasured to the fair value at the date of the IPO and reclassified to additional paid-in capital:

8. STOCK‑BASED COMPENSATION

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

In July 2017, the Company’s 2017 Equity Incentive Plan (the “2017 Plan”) became effective and no further stock options or other awards will be made under the 2009 Plan. The 2017 Plan was established to provide equity based ownership opportunities for employees, officers, directors, consultants, and advisors. As of March 31, 2018, there were 1,368,715 shares of common stock available for grant under the 2017 Plan. In addition, any shares of common stock

subject to awards under the 2009 Plan that expire, are forfeited, or are otherwise surrendered, without having been fully exercised or resulting in any common stock being issued will become available for issuance under the 2017 Plan, up to an additional 2,832,362 shares, which is the number of shares issuable pursuant to outstanding awards granted under the 2009 Plan.

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

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

In the past, the Company had granted stock options which contain performance‑based vesting criteria. These criteria were milestone events that were specific to the Company’s corporate goals. Stock‑based compensation expense associated with performance‑based stock options is recognized if the achievement of the performance condition is considered probable using management’s best estimates. As of March 31, 2018 there were no performance-based awards outstanding.

The Company granted no stock options to non‑employee consultants for the three months ended March 31, 2018 and 2017. During the three months ended March 31, 2018 and 2017, the Company recognized $11,000 and $15,000, respectively, in stock compensation expense related to non‑employee consultants.

A summary of option activity for employee and non‑employee awards under the 2009 Plan and the 2017 Plan for the three months ended March 31, 2018 is as follows (in thousands, except share and per share amounts):

The Company records stock‑based compensation related to stock options granted at fair value. The Company utilizes the Black‑Scholes option‑pricing model to estimate the fair value of stock option grants and to determine the related compensation expense. The assumptions used in calculating the fair value of stock‑based payment awards represent management’s best estimates. There were no stock options granted during the three months ended March 31, 2017. The assumptions used in determining fair value of the stock options granted in the three months ended March 31, 2018 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 are recorded as they occur.

During the three months ended March 31, 2018, the weighted average grant‑date fair value of options granted was $9.25. 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, 2018, there was $21.4 million of unrecognized compensation cost related to the stock options granted, which is expected to be expensed over a weighted‑average period of 3.26 years.

Employee Stock Purchase Plan—In 2017, the Company approved the 2017 Employee Stock Purchase Plan (the “ESPP”). 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 initial six-month period will not commence until January 1, 2019.

Reserved Shares—As of March 31, 2018 and December 31, 2017, the Company had reserved the following shares of common stock issuable upon exercise of rights under equity compensation plans:

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

9. INCOME TAXES

The Company did not record a provision or benefit for income taxes during the three months ended March 31, 2018 and 2017. The Company continues to maintain a 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 lack of commercialization of any products or generation of any 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, 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 files its corporate income tax returns in the United States and Massachusetts, California, 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, 2018 and 2017, 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, 2018 and 2017.

10. 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 and October 2014, 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 (“Prosecution Costs”).

After 2016 and until the first commercial sale of product, the minimum annual payment will be $38,000. If the Company achieves the first commercial sale of the product in the United States, European Union, or Japan, the annual minimum payment will increase to $113,000. The Company is obligated to pay JHU low single‑digit running royalties based upon a percentage of net sales of the licensed products. The Company also has an obligation to pay JHU certain one‑time development and commercial milestone payments.

The Company recorded research and development expenses related to the JHU agreement of $82,000 and $18,000, respectively, for the three months ended March 31, 2018 and 2017.

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

11. 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 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, 2017, which was filed with the Securities and Exchange Commission on April 2, 2018.

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 could cause actual results or events to differ materially from the forward-looking statements that we make. Our forwardlooking statements do not reflect the potential impact of any future acquisitions, mergers, dispositions, joint ventures or investments that we may make.

Overview

We are a biopharmaceutical company focused on the development and commercialization of therapeutics using our proprietary nanoparticle‑based Mucus Penetrating Particles, or MPP, technology, with an initial focus on the treatment of eye diseases. Our MPPs are selectively‑sized nanoparticles and have proprietary coatings. 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 MPP technology to loteprednol etabonate, or LE, a corticosteroid designed for ocular applications, resulting in two lead product candidates. These product candidates are INVELTYS™ (KPI‑121 1.0%) for the treatment of inflammation and pain following ocular surgery, for which we have submitted a new drug application, or NDA, and KPI‑121 0.25% for the temporary relief of the signs and symptoms of dry eye disease. The brand name INVELTYS has been conditionally approved by the U.S. Food and Drug Administration, or the FDA.

KPI‑121 0.25% is our product candidate for patients with dry eye disease utilizing a two‑week course of therapy. In January 2018, we announced topline results from two completed Phase 3 clinical trials of KPI‑121 0.25%, which we refer to as STRIDE 1 and STRIDE 2 (STRIDE - Short Term Relief In  Dry Eye), evaluating the safety and efficacy of KPI-121 0.25% versus placebo in patients with dry eye disease. In STRIDE 1, statistical significance was achieved for the primary sign endpoint of conjunctival hyperemia and the primary symptom endpoint of ocular discomfort severity change from baseline to day 15 in the intent to treat, or ITT, population; in addition, statistical significance was also achieved in STRIDE 1 for a second pre-specified primary symptom endpoint of ocular discomfort severity change from baseline to day 15 in patients with more severe baseline ocular discomfort. In STRIDE 2, statistical significance was achieved for the primary sign endpoint of conjunctival hyperemia, but statistical significance was not achieved for the primary symptom endpoint of ocular discomfort severity. KPI‑121 0.25% was generally well tolerated in both STRIDE 1 and STRIDE 2, with no clinically significant treatment‑related adverse events observed during the course of either trial, and with elevations in intraocular pressure, or IOP, in both trials similar to placebo.  We recently met with the FDA to discuss the results of our dry eye clinical trials and potential next steps for our dry eye disease program. We anticipate receiving formal minutes from this meeting in the second quarter of 2018, and following review of these minutes will determine our plan for this program. If approved, KPI‑121 0.25% could be the first FDA‑approved product for the short‑term treatment of dry eye disease.

In December 2017, the FDA accepted for filing our NDA for the approval of INVELTYS, our topical twice‑a‑day product candidate, for the treatment of inflammation and pain following ocular surgery. The FDA has set

August 24, 2018 as the Prescription Drug User Fee Act action goal date for our NDA. If approved, INVELTYS could be the first 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 four times a day. Supporting the NDA submission are data from two completed Phase 3 clinical trials of INVELTYS in patients with inflammation and pain following cataract surgery, which is the most common type of ocular surgery in the United States. The first Phase 3 clinical trial was conducted in 2014 and was designed to evaluate INVELTYS administered twice a day and KPI‑121 0.25% administered four times a day. Statistical significance was achieved 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 with both INVELTYS and KPI‑121 0.25%. Both INVELTYS and KPI‑121 0.25% were well‑tolerated, with no treatment‑related serious adverse events observed during the course of the trial. In May 2017, the second, confirmatory Phase 3 clinical trial was completed, in which administration of INVELTYS two times a day achieved statistical significance for both 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 and all secondary endpoints. In this trial, INVELTYS was well tolerated with no treatment‑related significant adverse events observed during the course of the trial.

We are evaluating opportunities for MPP nanosuspensions of LE with less frequent daily dosing regimens for the treatment of inflammation and pain following ocular surgery, for the temporary relief of the signs and symptoms of dry eye disease and for potential chronic treatment of dry eye disease. We also are evaluating compounds in our topically applied MPP 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.

For INVELTYS, we are seeking FDA approval under Section 505(b)(2) of the U.S. Federal Food, Drug and Cosmetic Act, or the FDCA, which we plan to rely on for the potential approval of KPI‑121 0.25% as well. We have retained worldwide commercial rights for our current product candidates. If INVELTYS and KPI‑121 0.25% receive marketing approval, we expect to commercialize both in the United States, and we have started to build a commercial infrastructure to do so, with our own focused, specialty sales force. If INVELTYS receives marketing approval, we expect our commercial organization will initially consist of approximately 75 sales and marketing personnel. If KPI-121 0.25% is approved for the short-term treatment of dry eye disease, we expect to further expand our sales force by up to approximately an additional 100 personnel. We expect to commercialize in the United States any of our other product candidates that receive marketing approval as well. In anticipation of the potential to commercialize our product candidates in other global markets, we are evaluating a variety of collaboration, distribution and other marketing arrangements with one or more third parties.

Financial Operations Overview

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 tables under “Results of Operations”.

We expect our research and development expenses to increase for the foreseeable future as we advance our product candidates toward regulatory approval. 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. The probability of success for each product candidate may be affected by numerous factors, including preclinical data, clinical data, competition, manufacturing capability and commercial viability.

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

General and Administrative Expenses

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

We anticipate that our general and administrative expenses will increase in the future as we increase our headcount to support our continued research and development activities and commercialization of our product candidates. We also anticipate that we will incur increased accounting, audit, legal, regulatory, compliance, director and officer insurance costs as well as investor and public relations expenses associated with being a public company.

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, amortization of debt discounts and debt issuance costs recognized on our debt facility.

Change in Fair Value of Warrant Liability

Prior to our IPO, we issued warrants for the purchase of certain series of preferred stock. These warrants were classified as liabilities as they were financial instruments that were issuable for contingently redeemable securities. We recognized gains and losses on the change in the fair value of outstanding warrants and these gains and losses are recorded as a component of other income (expense). Upon the closing of our IPO, the underlying preferred stock was

converted into common stock, the preferred stock warrants were converted into warrants for common stock, and the fair value of the warrant liability at that time was reclassified to additional paid‑in capital.

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 (“U.S. GAAP”). 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 except for the adoption of ASU No. 2016‑02, Leases (Topic 842) (“ASU 2016‑02”) on January 1, 2018 as discussed below. 

We elected to early adopt ASU 2016-02, effective January 1, 2018, as permitted. 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. The standard has been implemented using the required modified retrospective approach and we have also elected to utilize the available practical expedients. In using the modified retrospective approach, we were 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 a material impact on the condensed consolidated balance sheet and condensed consolidated statement of cash flows. The adoption of this standard did not have a material impact on our condensed consolidated statements of operations.

Results of Operations

Comparison of the Three Months Ended March 31, 2018 and 2017

The following table summarizes the results of our operations for the three months ended March 31, 2018 and 2017:

Research and Development Expenses

The following table summarizes the research and development expenses incurred during the three months ended March 31, 2018 and 2017:

Research and development expenses were $5.7 million for the three months ended March 31, 2018 compared to $8.0 million for the three months ended March 31, 2017, a decrease of $2.4 million. This decrease is primarily the result of a $3.8 million decrease in KPI‑121 development costs due to the decrease in external costs associated with the completion of our Phase 3 clinical trials of INVELTYS for the treatment of inflammation and pain following cataract surgery and KPI-121 0.25% for the treatment of dry eye disease. This decrease was partially offset by a $1.3 million increase in employee‑related costs due to the additional hiring of clinical and regulatory personnel, overall merit increases and an increase in stock compensation expense related to stock option grants.

General and Administrative Expenses

General and administrative expenses were $5.5 million for the three months ended March 31, 2018 compared to $1.5 million for the three months ended March 31, 2017, an increase of $4.0 million.

We incurred a $1.8 million increase in employee-related costs primarily due to a $0.8 million increase in general and administrative employee headcount expense and overall merit increases and a $0.9 million increase in stock compensation expenses related to stock options granted during 2018. In addition, we incurred a $2.1 million increase in costs associated with legal, accounting and finance activities primarily as a result of operating as a public company, and costs incurred to begin building a commercial organization as we advance our product candidates toward regulatory approval.

Interest Income

Interest income was $209,000 for the three months ended March 31, 2018 compared to $46,000 for the three months ended March 31, 2017. Interest income consists of interest earned on our balance held in an interest-bearing deposit account. The increase was attributable to a higher average cash balance due to receipt of IPO proceeds.

Interest Expense

We incurred interest expense of $0.4 million for the three months ended March 31, 2018 compared to $0.2 million for the three months ended March 31, 2017. Interest expense is comprised of the contractual coupon interest and the amortization of debt discount associated with our venture debt facility. The increase was primarily attributable to an increase in our outstanding venture debt balance upon the September 2017 draw down of Term B Loan. In addition there was a 75 basis point increase in the interest rate from March 31, 2017 to March 31, 2018.

Change in Fair Value of Warrant Liability

The change in the fair value of our preferred stock warrant liability consisted of no gain or loss for the three months ended March 31, 2018 compared to a loss of $36,000 for the three months ended March 31 2017. Upon closing of our IPO, the underlying preferred stock was converted into common stock, the preferred stock warrants were

converted into warrants for common stock, and the fair value of the warrant liability at that time was reclassified to additional paid‑in capital.

Liquidity and Capital Resources

Since our inception, we have incurred significant operating losses. We have derived limited revenue to date from feasibility studies with collaboration partners. We have not yet commercialized any of our product candidates, which are in various phases of clinical development, and we do not expect to generate revenue from sales of any product before 2019, if ever. We have funded our operations to date with proceeds from our IPO, the sale of preferred stock, borrowings under venture debt facilities, the issuance of convertible promissory notes and warrants and to a lesser extent, payments received in connection with various feasibility studies.

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

Cash Flows

As of March 31, 2018, we had $100.5 million in cash on hand and $20.0 million in indebtedness. The following table summarizes our sources and uses of cash for the three months ended March 31, 2018 and 2017:

Net Cash Used in Operating Activities

During the three months ended March 31, 2017, our cash used in operating activities was primarily due to our net loss of $9.8 million as we incurred external research and development costs associated with our clinical trials during the three months ended March 31, 2017 and increased general and administrative costs, and net cash used by changes in our operating assets and liabilities of $0.3 million partially offset by non-cash charges of $0.7 million, consisting primarily of $0.5 million in stock-based compensation. Net cash used by changes in our operating assets and liabilities primarily consisted of a decrease of $1.4 million in accrued expenses, partially offset by a $1.2 million increase in accounts payable. The decrease in accrued expense was primarily a result of our 2016 bonus payment during March 2017.

During the three months ended March 31, 2018, our cash used in operating activities was primarily due to our net loss of $11.3 million primarily consisting of $5.7 million of research and development costs and $5.5 million of general and administrative costs partially offset by non-cash charges of $2.1 million, consisting primarily of $1.9 million in stock-based compensation. Net cash used by changes in our operating assets and liabilities primarily consisted of a $2.9 million decrease in accrued expenses due primarily to the decrease in external costs associated with our two Phase 3 clinical trials of KPI‑121 0.25% for the treatment of dry eye disease.

Net Cash Used in Investing Activities

Net cash used in investing activities was $0.1 million for the three months ended March 31, 2017, consisting of purchases of property and equipment, primarily laboratory equipment.

Net cash used in investing activities was $0.4 million for the three months ended March 31, 2018 consisting of purchases of property and equipment, primarily laboratory equipment.

Net Cash Provided by (Used in) Financing Activities

Net cash used in financing activities was $19,000 for the three months ended March 31, 2017, consisting of payments of deferred offering costs related to our submission of a draft registration statement on Form S-1 in 2017.

Net cash provided by financing activities was $1.1 million for the three months ended March 31, 2018, consisting of $2.7 million of proceeds from our venture debt facility, net of debt issuance costs, offset by principal payments on our venture debt of $1.7 million and $28,000 in proceeds from the exercise of stock options.

Funding Requirements

We expect our expenses to increase substantially in connection with our ongoing activities, particularly as we advance our preclinical activities and clinical trials. In addition, we expect to incur additional costs associated with operating as a public company and our transisition into a fully integrated commercial organization.

Our expenses will also increase if and as we:

On July 25, 2017, we completed an IPO of our common stock pursuant to which we issued and sold 6,900,000 shares of our common stock at a price of $15.00 per share, which included 900,000 shares sold pursuant to the exercise of the underwriters’ option to purchase additional shares. We received net proceeds of $94.0 million after deducting underwriting discounts and commission of $7.3 million and offering costs incurred in 2017 of $2.2 million.  We believe that our existing cash on hand as of March 31, 2018 will enable us to fund our planned operating expenses, debt service obligations and capital expenditure requirements for at least the next 12 months. We have based these estimates on assumptions that may prove to be wrong, and we could utilize our available capital resources sooner than we expect.

Because of the numerous risks and uncertainties associated with research, development and commercialization of pharmaceutical drugs, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on many factors, including:

Until such time, if ever, that we can generate product revenue sufficient to achieve profitability, we expect to finance our cash needs through a combination of equity offerings, debt financings, collaboration agreements, other third‑party funding, strategic alliances, licensing arrangements and marketing and distribution arrangements.

To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through other third‑party funding, collaboration agreements, strategic alliances, licensing arrangements or marketing and distribution arrangements, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or product candidates or grant licenses on terms that may not be favorable to us. If we are unable to raise additional funds through equity or debt financings when needed, we may be required to delay, limit, reduce or terminate our

product development or future commercialization efforts or grant rights to develop and market products or product candidates that we would otherwise prefer to develop and market ourselves.

Contractual Obligations and Commitments

The following is a summary of our significant contractual obligations as of March 31, 2018: