GLAUKOS Corp (GKOS) FY 2022 MD&A

ITEM 7.MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

You should read the following discussion and analysis of our financial condition and results of operations together with our audited consolidated financial statements and related notes included in this Annual Report on Form 10-K. This discussion and analysis and other parts of this Annual Report on Form 10-K contain forward-looking statements that reflect our current plans, expectations, estimates and beliefs that involve risks, uncertainties and assumptions, such as statements regarding our plans, objectives, expectations, intentions and projections. Our actual results and the timing of selected events may differ materially from those discussed in these forward-looking statements. You should carefully read Item 1A - “Risk Factors” included in this Annual Report on Form 10-K to gain an understanding of the important factors that could cause actual results to differ materially from our forward-looking statements. Please also see the section entitled “Special Note Regarding Forward-Looking Statements and Industry Data.”

Overview

We are an ophthalmic medical technology and pharmaceutical company focused on developing novel therapies for the treatment of glaucoma, corneal disorders, and retinal disease. We first developed Micro-Invasive Glaucoma Surgery (MIGS) as an alternative to the traditional glaucoma treatment paradigm, launching our first MIGS device commercially in 2012, and continue to develop a portfolio of technologically distinct and leverageable platforms to support ongoing pharmaceutical and medical device innovations. Products or product candidates for each of these platforms are designed to advance the standard of care through better treatment options across the areas of glaucoma, corneal disorders such as keratoconus, dry eye and refractive vision correction, and retinal diseases such as neovascular age-related macular degeneration, diabetic macular edema, and retinal vein occlusion.

Impact of the Current Global Economic Environment

Global and regional economies, the markets we serve and financial markets have recently experienced significant volatility including inflation, supply shortages or delays, geopolitical developments, changes in supply and demand, labor shortages and turnover, natural disasters, higher energy costs, health epidemics or pandemics (including the COVID-19 pandemic), currency fluctuations, governmental actions such as mandatory shutdowns, and other conditions which have led to disruptions in commerce and pricing stability. The duration and scope of these conditions cannot be predicted, and therefore, it is uncertain what long-term impacts these economic pressures may have on our business.

While the COVID-19 pandemic materially impacted the global demand for our products, we have seen a general return toward more normalized levels for cataract and keratoconus procedures, with periodic volatility in certain geographies in which we operate, through December 31, 2022. Nevertheless, our business may be impacted by future developments, including any subsequent outbreaks or new variants of the COVID-19 virus, or other future health crises, which may require re-closures or other preventative measures. Additionally, the COVID-19 pandemic has led to widespread staffing shortages, including in ambulatory surgery centers, which has and may continue to impact elective procedures.

Additionally, some of our vendors are continuing to experience supply challenges, both in the acquisition of raw materials as well as due to labor shortages and disruption. As a result of these supply chain challenges and due to current inflationary pressures, we have experienced higher costs for certain components and raw materials. We expect these supply challenges may continue into 2023. These challenges have occasionally led to longer lead times for, and delays and partial or unfulfilled deliveries of certain components needed for the manufacture of our products, in some cases requiring us to find alternative sources for materials. If these delays and partial or unfulfilled deliveries persist, they could impact our ability to ship some of our products to our customers, or bring some of our pipeline products to market, in a timely manner.

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Financial Overview

The most important financial indicators that we use to assess our business are net sales, gross margin, operating expenses, and cash on hand.

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Please see Results of Operations and Liquidity and Capital Resources below for a detailed discussion of each of the above items including analysis of the fluctuations from year to year.

We incurred net losses of $99.2 million, $49.6 million and $120.3 million for the years ended December 31, 2022 and December 31, 2021, and December 31, 2020, respectively and as of December 31, 2022, we had an accumulated deficit of $464.4 million.

Recent Developments

2023 U.S. reimbursement rates

On November 1, 2022, the U.S. Centers for Medicare & Medicaid Services (CMS) published its final rules on 2023 Medicare physician fee and facility fee payment rates (2023 Final Rules) for procedures using our iStent family of products furnished in both the ambulatory surgery center and hospital outpatient settings in conjunction with cataract surgery, as well as the facility fee payment rates, in both hospital and ambulatory surgery center settings, and for standalone insertion of an aqueous drainage device, such as our iStent infinite product. The 2023 Final Rules do not materially modify the Final Rules (as defined below) established for 2022.

iStent infinite

On August 2, 2022, we received 510(k) clearance from the U.S. Food & Drug Administration (FDA) to market the iStent infinite, an implantable device intended to reduce the intraocular pressure of the eye. It is indicated for use in adult patients with primary open-angle glaucoma in whom previous medical and surgical treatment has failed. We began commercial launch activities for this product in the fourth quarter of 2022.

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iLink Epioxa

In November 2022, we made the determination, based upon recommendations from the FDA in recent pre-New Drug Application (NDA) meetings, that we will not submit an NDA for our Epioxa (Epi-On) bio-activated pharmaceutical therapy for the treatment of keratoconus this year, but will instead conduct a second pivotal confirmatory study for this product to support a future NDA submission. We currently estimate that enrollment in this study will commence in the first half of 2023.

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iVeena Exclusive License Agreement

Effective June 9, 2022, we entered into an Exclusive License Agreement (iVeena License Agreement) with iVeena Delivery Systems, Inc. (iVeena), pursuant to which iVeena granted us an exclusive, worldwide license to manufacture and sell products incorporating certain of iVeena’s owned or controlled technologies, including certain chemical compositions, that may be utilized for the treatment of keratoconus. Pursuant to the terms of the iVeena License Agreement, we made a one-time upfront payment to iVeena of $10.0 million. We accounted for the transaction as an asset acquisition as the set of acquired assets did not constitute a business. We may have ongoing milestone and royalty payment obligations depending on the success of the development, approval and commercialization of the proprietary technologies.

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Factors Affecting Our Performance

The CMS final rules for 2022 Medicare physician fee payment rates and 2022 Medicare facility fee payment rates for services furnished in both the ambulatory surgery center and hospital outpatient settings (Final Rules) took effect on January 1, 2022. Compared to the reimbursement rates in effect for 2021, the Final Rules contained a significantly lower physician fee related to the implantation of trabecular bypass stents, such as our iStent family of products, in conjunction with cataract surgery. Conversely, the facility fee schedule related to surgeries that include implantation of trabecular bypass stents, such as our iStent family of products, in conjunction with cataract surgery, slightly decreased reimbursements to an ambulatory surgery center and increased reimbursements to a hospital. Additionally, the Final Rules established facility fee payment rates that were lower than anticipated for standalone insertion of an aqueous drainage device in the ambulatory surgery center and hospital settings, which would be the procedure that such facilities would use with our iStent infinite product. We estimate that approximately 80% of procedures utilizing our trabecular micro-bypass technologies in the U.S. are performed in the ambulatory surgery center setting and the remaining estimated 20% of procedures are performed in the hospital. The significant reduction of the physician fee had a negative impact on 2022 U.S. procedural volumes of our iStent family of products, in conjunction with cataract surgery, which we expect will continue for 2023, adversely affecting our U.S. combo-cataract Glaucoma revenues, gross profit, and net loss, the full extent of which is not known at this time.

We expect our results of operations for 2023 and our near-term performance to reflect increasing competitive dynamics, the impact of the reduced physician fee reimbursement rates contained in the 2023 Final Rules, the continuing disruption resulting from labor and supply shortages and the effects of the macroeconomic environment, the full effects of which are difficult to predict at this time. In addition to the foregoing factors, our operations to date have been, and we believe our future growth and success will be, impacted by the following:

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Further, we have made and expect to continue to make significant investments in our global sales force, marketing programs, research and development (R&D) activities, clinical studies, and general and administrative infrastructure. FDA-approved investigational device exemption (IDE) or investigational new drug (IND) studies and new product development programs in our industry are expensive. Our operating expenses have increased significantly following our acquisition of Avedro, Inc. (Avedro), and we have also incurred additional construction costs related to our new facility in Aliso Viejo, California (Aliso Facility), as well as expansions of our existing facilities in San Clemente, California and Burlington, Massachusetts.

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Although we have been profitable for certain periods in our operating history, there can be no assurance that we will be profitable or generate cash from operations in the future.

Components of Results of Operations

Net Sales

We currently operate in one reportable segment and net sales are generated primarily from sales of our iStent family of products and sales of Photrexa and other associated drug formulations, as well as our proprietary bioactivation systems and royalty income. Revenue is recognized when control of the promised goods or services is transferred to the customer in an amount that reflects the consideration to which we expect to be entitled in exchange for those products or services.

We sell the majority of our products through a direct sales organization in the United States. Internationally, we sell our products primarily through direct sales subsidiaries in seventeen countries and through independent distributors in certain countries in which we do not have a direct presence or maintain a modest commercial presence. The primary end-user customers for our products are surgery centers, hospitals and physician private practices.

While net sales may increase as we expand our global sales and marketing infrastructure and continue to increase awareness of our products by expanding our sales base and increasing our marketing efforts, historically our net sales within a fiscal year have been impacted seasonally, as demand for U.S. ophthalmic procedures is typically softer in the first quarter and stronger in the fourth quarter of a given year. However, we did not experience the same seasonality pattern in 2021 due in part to the COVID-19 pandemic. In 2022, we saw the return of some seasonality patterns, however traditional U.S. revenue patterns were disrupted as a result of the CMS reimbursement cuts. The effect of COVID-19 and other macroeconomic conditions, including higher interest rates and foreign exchange rate fluctuations, on our commercial performance may continue into future reporting periods. The 2022 CMS physician fee and facility fee rate decreases, which were effective in 2022 and will continue into 2023 have also disrupted traditional U.S. customer ordering patterns and have resulted in our customers’ trialing of competitive products, causing reduced U.S. Glaucoma sales volumes during 2022. Our U.S. Corneal Health sales have experienced modest negative impacts due to sporadic reimbursement challenges. Additionally, unfavorable foreign exchange rates and global COVID dynamics in certain geographies in which we operate have negatively impacted our sales during the year ended December 31, 2022.

In addition to the foregoing, we had commercialized our products for several years in the U.S. with few or no direct competitors. Other competitive products have now become available in the U.S. and globally that have impacted and may continue to impact adoption of or demand for our products. We are also aware of similar products being developed by third parties that could enter the market and increase the competitive pressures we face. These other products could achieve greater commercial acceptance or demonstrate better safety or effectiveness, clinical results, ease of use or lower costs than our products, which could adversely impact our net sales.

Cost of Sales

Cost of sales reflects the aggregate costs to manufacture our products and includes raw material costs, labor costs, manufacturing overhead expenses and the effect of changes in the balance of reserves for excess and obsolete inventory.

We manufacture our iStent family of products at our facility in San Clemente, California using components manufactured by third parties. We manufacture our KXL systems at our manufacturing facilities in Burlington, Massachusetts, and we contract with third-party manufacturers in the U.S. and Germany to produce our Photrexa and other associated drug formulations. We currently intend to maintain our manufacturing facilities at our San Clemente and Burlington locations for the foreseeable future.

Due to the relatively low production volumes of our iStent family of products and our KXL systems compared to our potential capacity for those products, a significant portion of our per unit costs is comprised of manufacturing overhead expenses. These expenses include quality assurance, material procurement, inventory control, facilities, equipment and operations supervision and management.

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Cost of sales includes a charge equal to a low single-digit percentage of worldwide net sales of certain iStent products, with a required minimum annual payment of $0.5 million, which amount became payable to the Regents of the University of California (the University) in connection with our December 2014 agreement with the University related to a group of our U.S. patents (the Patent Rights). This ongoing product payment obligation changed as patent coverage on certain products has lapsed, and terminated entirely on the date the last of the Patent Rights expires, which was December 29, 2022.

Cost of sales includes amortization of the $252.2 million developed technology intangible asset. For each of the years ended December 31, 2022, December 31, 2021 and December 31, 2020, the amortization expense was $22.1 million.

Our future gross profit as a percentage of net sales, or gross margin, will be impacted by numerous factors including commencement of sales of products in our pipeline, or any other future products, which may have higher product costs. Our gross margin will also be affected by manufacturing or supply chain inefficiencies that we may experience as we attempt to manufacture our products on a larger scale, manufacture new products and change our manufacturing capacity or output. Additionally, our gross margin will continue to be affected by royalty expenses on current or future products associated with various licensing agreements. Our gross margin in future periods may also be impacted by other factors adversely affecting our net sales in future periods, including the impact of the COVID-19 pandemic, supply chain disruptions, the current macroeconomic environment, including inflationary pressures and fluctuations in foreign currency, and the impact of the reductions on payment rates for certain of our products and related services as a result of the 2023 Final Rules.

Selling, General and Administrative

Our selling, general and administrative (SG&A) expenses primarily consist of personnel-related expenses, including salaries, sales commissions, bonuses, fringe benefits and stock-based compensation for our executive, financial, marketing, sales, and administrative functions. Other significant SG&A expenses include marketing programs; advertising; post-approval clinical studies; conferences and congresses; travel expenses; costs associated with obtaining and maintaining our patent portfolio; professional fees for accounting, auditing, consulting and legal services; costs associated with our global enterprise systems; and allocated facility expenses.

We expect SG&A expenses to continue to grow as we increase our global sales and marketing infrastructure and general administration infrastructure. We also expect other non-employee‐related costs, including sales and marketing program activities for new products, outside services and accounting and general legal costs to increase as our overall operations grow. The timing of these increased expenditures and their magnitude are primarily dependent on the commercial success and sales growth of our products, as well as on the timing of any new product launches and other potential business and operational activities.

Research and Development

Our R&D activities primarily consist of new product development projects, pre-clinical studies, IDE and IND studies, and other clinical trials. Our R&D expenses primarily consist of personnel-related expenses, including salaries, fringe benefits and stock-based compensation for our R&D employees; research materials; supplies and services; in-licenses, including event-based milestones; and the costs of conducting clinical studies, which include payments to investigational sites and investigators, clinical research organizations, consultants, and other outside technical services and the costs of materials, supplies and travel. We expense R&D costs as incurred. We expect our R&D expenses to continue to increase as we initiate and advance our development programs, including our expanding surgical and pharmaceutical development efforts and clinical trials across glaucoma, retinal disease and corneal health.

Completion dates and costs for our clinical development programs include seeking regulatory approvals and our research programs vary significantly for each current and future product candidate and are difficult to predict. As a result, while we expect our R&D costs to continue to increase for the foreseeable future, we cannot estimate with any degree of certainty the costs we will incur in connection with the development of our product candidates. We anticipate we will make determinations as to which programs and product candidates to pursue and how much funding to direct to

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each program and product candidate on an ongoing basis in response to the scientific success of early research programs, results of ongoing and future clinical trials, the availability of funding resources, as well as ongoing assessments as to each current or future product candidate’s commercial potential and our likelihood of obtaining necessary regulatory approvals. We are not currently able to fully track expenses by product candidate.

In-process Research and Development

IPR&D expenses for the year ended December 31, 2022 totaled $10.0 million related to our iVeena licensing agreement previously discussed in Recent Developments above.

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Our IPR&D expenses for the year ended December 31, 2021 relate to a $5.0 million upon signing our exclusive licensing agreement with Attillaps Holdings, Inc. and a $5.0 million payment upon signing our exclusive licensing agreement with Intratus, Inc.

Litigation-related Settlement

The $30.0 million cash payments we received pursuant to the terms of a Settlement Agreement dated September 14, 2021 (Settlement Agreement) are included in litigation-related settlement as a reduction of operating expenses on the consolidated statements of operations in each respective year.

Non-Operating Expense, Net

Non-operating expense, net primarily consists of interest expense associated with our finance lease for our Aliso Facility and for our 2.75% convertible notes due 2027 (Convertible Notes), interest income derived from our short-term investments and unrealized gains and losses arising from exchange rate fluctuations on transactions denominated in a currency other than the U.S. dollar, primarily related to intercompany loans.

Income Taxes

Our tax provision is primarily comprised of state and foreign income taxes. Our net deferred tax liability of $7.3 million at December 31, 2022 primarily represents the excess of our indefinite-lived deferred tax liabilities over our indefinite-lived deferred tax assets. We continue to provide a full valuation allowance against our other net deferred tax assets.

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We record reserves for uncertain tax positions where we believe the ability to sustain the tax position does not reach a more likely than not threshold.

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Results of Operations

For discussion related to the results of operations and changes in financial condition for the year ended December 31, 2021 compared to the year ended December 31, 2020 refer to “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in Part II, Item 7 of our 2021 Annual Report on Form 10-K, which was filed with the United States Securities and Exchange Commission on February 28, 2022.

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Comparison of Years Ended December 31, 2022 and December 31, 2021

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NM = Not Meaningful

Net Sales

Our net sales are generated primarily from sales of iStent family of products to customers and sales of Photrexa and associated drug formulations as well as KXL systems to customers. Customers are primarily comprised of ambulatory surgery centers, hospitals and physician private practices, with distributors being used in certain international locations where we currently do not have a direct commercial presence.

Net sales for the years ended December 31, 2022 and December 31, 2021 were $282.9 million and $294.0 million, respectively, reflecting a decrease of $11.1 million or 4%.

Net sales of glaucoma products in the United States were $144.7 million and $170.8 million for the years ended December 31, 2022 and December 31, 2021, respectively, decreasing by approximately 15%. This decrease is primarily due to lower volumes caused by the significantly reduced CMS physicians’ fee that was implemented on January 1, 2022, which has disrupted traditional U.S. customer ordering patterns and has resulted in our customers’ trialing of competitive products. Additionally, sales in the second half of 2021 were positively impacted by abnormally high demand for cataract and glaucoma procedures following the rollout of the COVID-19 vaccines and increasing normalized economic and operating conditions within certain markets in which we operated at that time.

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International sales of glaucoma products for the years ended December 31, 2022 and December 31, 2021 were $69.6 million and $61.2 million, respectively, increasing by approximately 14%. The increase in international sales reflects broad-based growing demand in many key international markets for combined cataract and glaucoma procedures, the dollar-based results of which were substantially affected by unfavorable foreign exchange rates, primarily related to the Euro and Japanese Yen, during the year ended December 31, 2022 as compared to the year ended December 31, 2021.

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Net sales of corneal health products were $68.6 million and $62.0 million for the years ended December 31, 2022 and December 31, 2021, respectively, increasing by 11%. Of the $6.6 million increase in net sales generated by our corneal health products, $5.6 million related to U.S. sales using direct sales operations, which was comprised of an increase of $6.0 million of Photrexa net sales partially offset by reductions of $0.4 million in U.S. capital equipment sales. Additionally, corneal health sales for the year ended December 31, 2022 were positively impacted by higher realized average sales and continued new account starts. Our international corneal health sales increased $1.0 million, in locations where we utilize distributors given we do not have a direct commercial presence.

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Cost of Sales

Cost of sales for the years ended December 31, 2022 and December 31, 2021 were $69.0 million and $66.6 million, respectively, reflecting an increase of approximately $2.4 million or 4%. Our gross margin was approximately 76% for the year ended December 31, 2022 compared to approximately 77% for the year ended December 31, 2021. The variance from the prior year resulted primarily from an increase in the product mix of modestly lower margin products of international market sales and higher material costs due to the inflationary environment.

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Selling, General and Administrative Expenses

SG&A expenses for the years ended December 31, 2022 and December 31, 2021 were $192.9 million and $179.3 million, respectively, reflecting an increase of $13.6 million or 8%.

Of the total $192.9 million, we incurred approximately $125.1 million of costs associated with commercial personnel and discretionary spending during the year ended December 31, 2022 as compared to $112.4 million during the year ended December 31, 2021, with the increase primarily due to compensation and related employee expenses associated with our sales infrastructure in glaucoma and corneal health, along with increased travel, meetings and accompanying costs as business activities have reopened and expanded over the course of the last twelve months. We also incurred approximately $67.8 million of costs associated with general and administrative personnel and discretionary spending during the year ended December 31, 2022 as compared to $63.4 million during the year ended December 31, 2021, associated with our ongoing administrative functions and amortization of our right-of-use asset related to our long-term lease for the Aliso Facility.

Research and Development Expenses

R&D expenses for the years ended December 31, 2022 and December 31, 2021 were $123.3 million and $101.0 million, respectively, reflecting an increase of $22.3 million or 22%.

For the year ended December 31, 2022, we incurred $80.4 million in core R&D expenses and $42.8 million in clinical expenses, comprised of $63.1 million in compensation and related employee expenses with the remaining $60.2 million spent on the continued research and development, clinical studies, regulatory activities, quality assurance, clinical inventory and supplies for surgical glaucoma product candidates and pharmaceutical projects, such as a pharmaceutical therapeutic system for the treatment of keratoconus without the removal of the epithelium (often referred to as “epi-on”), iDose and our earlier stage programs for dry eye, presbyopia, retina and other therapeutic investments. For the year ended December 31, 2021, we incurred $66.6 million in core R&D expenses and $34.4 million in clinical expenses, comprised of $50.1 million in compensation and related employee expenses with the remaining $50.9 million spent on the abovementioned programs.

In-process Research and Development

IPR&D expenses for the year ended December 31, 2022 totaled $10.0 million related to our iVeena licensing agreement previously discussed in Recent Developments above.

IPR&D expenses for the year ended December 31, 2021 related to the amendment of our exclusive licensing agreement with Intratus, Inc. and our exclusive licensing agreement with Attillaps Holdings, Inc. We paid $5.0 million upon signing of each of these agreements.

Litigation-related Settlement

The $30.0 million cash payments from the Settlement Agreement received during each of the years ended December 31, 2022 and December 31, 2021 are included in litigation-related settlement as a reduction of operating expenses on the consolidated statements of operations.

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Non-Operating Expense, Net

We had non-operating expense, net of $16.1 million and $16.4 million for the years ended December 31, 2022 and December 31, 2021, respectively. The change in non-operating expense, net of $0.3 million primarily relates to increased interest income earned on investments, partially offset by recognition of unrealized foreign currency losses due to higher intercompany loan balances denominated in, and impacted by, unfavorable changes in foreign currency exchange rates and higher interest expense recognized related to the Convertible Notes and to the finance lease for our Aliso Facility.

Income Tax Provision

Our effective tax rate for the year ended December 31, 2022 was (0.78)%. For the year ended December 31, 2022 and December 31, 2021, we recorded a provision for income taxes of $0.8 million and $0.3 million, respectively. For each of the years ended December 31, 2022 and December 31, 2021 our tax provision was primarily comprised of state and foreign income tax expense.

Liquidity and Capital Resources

Our principal sources of liquidity are our existing cash, cash equivalents and short-term investments, and generally cash generated from operating, financing and investing activities. Our primary uses of cash have been for selling and marketing activities, general and administrative expenses, research and development programs, and capital expenditures.

The following table summarizes our cash and cash equivalents, short-term investments and selected working capital data as of December 31, 2022 and December 31, 2021 (in thousands):

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Main Sources of Liquidity

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We plan to fund our operations, commitments for capital expenditures and other short and long-term known contractual and other obligations using existing cash and investments and, to the extent available, cash generated from commercial operations. Our existing cash and investments include the remaining net proceeds from the Convertible Notes issued in June 2020 (after payment for the related capped call transactions), and the two $30.0 million payments received from Ivantis, Inc. during each of the years ended December 31, 2022 and December 31, 2021, which are being used for working capital and general corporate purposes.

Cash, Cash Equivalents, Short-term Investments and Restricted Cash

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Our cash, cash equivalents and short-term investments totaled approximately $352.7 million and our restricted cash totaled approximately $7.1 million.

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Cash Flow used in Operations

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For the twelve months ended December 31, 2022, our operating activities used $33.1 million in net cash.

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Senior Convertible Notes

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Our Convertible Notes may be converted at the option of the holders at the times and under the circumstances and at the conversion rate described in Note 8 of the notes to our consolidated financial statements. As of December 31, 2022, none of the conditions allowing holders of the Convertible Notes to convert had been met. These conditions are measured each quarter. For example, if our trading price remains above 130% of the conversion price for at least 20 trading days during the 30 consecutive trading-day period ending on, and including, March 31, 2023, holders of the Convertible Notes would have the right to convert their Convertible Notes during the calendar quarter beginning April 1, 2023. Upon conversion, we will pay or deliver, as the case may be, cash, shares of our common stock or a combination of cash and shares of our common stock, at our election, in the manner and subject to the terms and conditions provided in the Indenture. Settling all or a portion of the conversion obligation in cash could adversely affect our liquidity. In addition, even if holders of the Convertible Notes do not elect to convert their Convertible Notes, we could be required under applicable accounting rules to reclassify all or a portion of the outstanding principal of the Convertible Notes as a current rather than long-term liability, which would result in a material reduction of our net working capital.

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We may seek to obtain additional financing in the future through other debt or equity financings. There can be no assurance that we will be able to obtain additional financing on terms acceptable to us, or at all and although we have been profitable for certain periods in our operating history, there can be no assurance that we will be profitable or generate cash from operations.

Short-term Liquidity Requirements

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Our short-term liquidity requirements primarily consist of regular operating costs, interest payments related to our Convertible Notes, R&D project funding, capital expenditures as we continue the development of our facilities and office spaces, operating and financing lease obligations and other firm purchase commitments. As of December 31, 2022, we had net working capital of $371.5 million, which indicates that our current assets are sufficient to cover our short-term liabilities.

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Long-term Liquidity Requirements

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Our long-term liquidity requirements primarily consist of interest and principal payments related to our Convertible Notes, capital expenditures for the development of our manufacturing facilities and office spaces, and long-term material cash requirements as described below. As demand grows for our products, we will continue to expand global operations to meet demand through investments in our manufacturing capabilities.

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Material Cash Requirements

The following table summarizes our material cash requirements, including commitments for capital expenditures and known contractual and other obligations as of December 31, 2022, and the amount required to satisfy those requirements in future periods.

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The Convertible Notes will mature on June 15, 2027, unless earlier converted, redeemed or repurchased in accordance with their terms. In addition to the amounts included in the table above, we will incur material cash obligations related to our Convertible Notes, unless we elect to deliver solely shares of our common stock to settle such conversion.

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After funding the current operations of our commercial activities, the first planned use of our cash flow from operations is to provide capital funding for our R&D and clinical activities. In addition to investing in R&D and clinical activities, we expect to utilize cash for various capital expenditures including the expansion and enhancement of our facilities. We have made and expect to continue to make significant investments in our global sales force, marketing programs, research and development activities, clinical studies and general and administrative infrastructure. FDA-approved IDE and IND studies and new product development programs in our industry are expensive.

We believe that cash from operating, financing and investing activities, together with our cash and investment balances, will be sufficient to meet ongoing operations, capital expenditures, commitments, working capital requirements and other known contractual and other obligations and satisfy our liquidity requirements for at least the next 12 months and the foreseeable future.

Cash Flows

Our historical cash outflows have primarily been associated with cash used for operating activities such as the expansion of our sales, marketing and R&D activities; purchase of and growth in inventory and other working capital needs; the acquisition of intellectual property; and expenditures related to equipment and improvements used to increase our manufacturing capacity, to improve our manufacturing efficiency and for overall facility expansion.

The following table is a condensed summary of our cash flows for the periods indicated:

At December 31, 2022, our cash and cash equivalents were held for working capital purposes. We do not enter into investments for trading or speculative purposes. Our policy is to invest any cash in excess of our immediate requirements in investments designed to preserve the principal balance and provide liquidity.

Operating Activities

In the year ended December 31, 2022 our operating activities used $33.1 million and for the year ended December 31, 2021 our operating activities provided $24.7 million.

For the year ended December 31, 2022, our net cash used in operating activities reflected our net loss of $99.2 million, adjusted for non-cash items of $79.6 million, primarily consisting of stock-based compensation expense of $38.6 million, depreciation of $6.7 million, amortization of intangible assets of $24.9 million, amortization of lease right-of-use assets of $4.4 million, and amortization of debt issuance costs of $1.4 million. Additionally, changes in operating assets and liabilities were $13.4 million, which resulted primarily from increases in accounts payable and accrued liabilities of $7.2 million, and decreases in other assets of $0.3 million, offset by increases in inventory of $15.5 million, increases in accounts receivable of $3.1 million and increases in prepaids and other current assets of $1.7 million.

For the year ended December 31, 2021, our net cash used in operating activities reflected our net loss of $49.6 million, adjusted for non-cash items of $70.7 million, primarily consisting of stock-based compensation expense of $30.1 million, depreciation $4.7 million, amortization of intangible assets of $24.9 million, amortization of lease right-

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of-use assets of $4.8 million, and amortization of debt issuance costs of $1.4 million. Additionally, this was partially offset by changes in operating assets and liabilities of $3.6 million, which resulted from increases in accounts payable and accrued liabilities of $12.4 million and decreases in accounts receivable of $1.7 million, partially offset by increases in inventory of $7.7 million and prepaid expenses and other current assets of $3.1 million.

Investing Activities

In the year ended December 31, 2022 our investing activities provided cash of $44.8 million and for the year ended December 31, 2021 net cash from investing activities used approximately $58.2 million.

In the year ended December 31, 2022, we used approximately $59.3 million for purchases of short-term investments, approximately $30.3 million for purchases of property and equipment, primarily related to our facilities in Aliso Viejo, California; Burlington, Massachusetts; and San Clemente, California; and approximately $1.0 million related to investments in company-owned life insurance, and we received cash of approximately $135.2 million from sales and maturities of short-term investments.

In the year ended December 31, 2021, we used approximately $215.3 million for purchases of short-term investments, approximately $47.8 million for purchases of property and equipment, primarily related to our facilities in Aliso Viejo, California and San Clemente, California; and approximately $2.1 million related to investments in company-owned life insurance, and we received cash of approximately $206.9 million from sales and maturities of short-term investments.

We expect to continue our increased levels of capital expenditures into 2023 as we continue expansion of our manufacturing capacity for current and new products, improve our manufacturing efficiency and for overall facility expansion.

Financing Activities

In the years ended December 31, 2022 and December 31, 2021 our financing activities provided $6.3 million and $39.3 million of net cash, respectively.

In the year ended December 31, 2022, we received $9.2 million from the exercises of stock options and purchases of our common stock by employees pursuant to our Employee Stock Purchase Plan and used $2.7 million for payment of employee taxes related to restricted stock unit vestings. Additionally, we received $0.3 million in proceeds from our tenant improvement allowances of our Aliso Facility and paid $0.5 million in principal on our finance lease.

In the year ended December 31, 2021, we received $30.9 million from the exercises of stock options and purchases of our common stock by employees pursuant to our Employee Stock Purchase Plan and used $3.7 million for payment of employee taxes related to restricted stock unit vestings. Additionally, we received $12.7 million in proceeds from our tenant improvement allowances of our Aliso Facility and paid $0.7 million in principal on our finance lease.

We do not have any significant off-balance sheet arrangements or holdings in variable interest entities.

Critical Accounting Policies and Significant Estimates

Management’s discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles (GAAP). The preparation of these consolidated financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities and related disclosure of contingent assets and liabilities, revenue and expenses at the date of the consolidated financial statements. Generally, we base our estimates on historical experience and on various other assumptions in accordance with GAAP that we believe to be reasonable under the circumstances. Actual results may differ materially from these estimates under different assumptions or conditions and such differences could be material to our financial position and results of operations.

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While our significant accounting policies are more fully described below and in the Notes to our consolidated financial statements appearing elsewhere in this Annual Report on Form 10-K, we believe the following accounting policies to be most critical for fully understanding and evaluating our financial condition and results of operations.

Revenue Recognition

We derive our revenue from sales of our products in the United States and internationally. Customers are primarily comprised of ambulatory surgery centers, hospitals and physician private practices, with distributors being used in certain international locations where we do not have a direct commercial presence.

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We concluded that one performance obligation exists for the majority of our contracts with customers which is to deliver products in accordance with our normal delivery times. Revenue is recognized when this performance obligation is satisfied, which is the point in time when we consider control of a product to have transferred to the customer. Revenue recognized reflects the consideration to which we expect to be entitled in exchange for those products or services. We have determined the transaction price to be the invoice price, net of adjustments that reduce revenue, which includes estimates of variable consideration for certain product returns and warranty replacements. We only recognize revenue when it is probable that we will collect the consideration we are entitled to in exchange for the goods transferred to a customer. This requires management to perform an assessment related to the probability of collecting the consideration. The assessment can contain judgment when it is performed for customers with declining credit conditions or those with no history or a limited history of product sales with us.

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We offer volume-based rebate agreements to certain customers and, in these instances, we provide a rebate (in the form of a credit memo) at the contract’s conclusion, if earned by the customer. In such cases, the transaction price is allocated between our delivery of product and the issuance of a rebate at the contract’s conclusion for the customer to utilize on prospective purchases. The performance obligation to issue a customer’s rebate, if earned, is transferred over time and our method of measuring progress is the output method, whereby the progress is measured by the estimated rebate earned to date over the total rebate estimated to be earned over the contract period. The provision for volume-based rebates is estimated based on customers' contracted rebate programs and the customers’ projected sales levels. We periodically monitor our customer rebate programs to ensure the rebate allowance is fairly stated. Our rebate allowance is included in accrued liabilities in the consolidated balance sheets and estimated rebates accrued were not material during the periods presented.

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Additionally, we have performance obligations related to certain customers’ right to a future discount on single dose pharmaceutical purchases in the U.S., as well as voluntary patient assistance programs to provide financial assistance to qualified patients. Each of these performance obligations is expected to be recognized when the customer or patient elects to utilize the discount, which is generally within one year. The impact of these programs on revenue were not material for the periods presented.

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Customers are not granted specific rights of return; however, we may permit returns of certain products from customers if such product is returned in a timely manner and in good condition. We generally provide a warranty on our products for one year from the date of shipment, and offer an extended warranty for our KXL systems. Any product found to be defective or out of specification will be replaced or serviced at no charge during the warranty period. Estimated allowances for sales returns and warranty replacements are recorded at the time of sale of the product and are estimated based upon the historical patterns of product returns matched against sales, and an evaluation of specific factors that may increase the risk of product returns. Product returns and warranty replacements to date have been consistent with amounts reserved or accrued and have not been significant. If actual results in the future vary from our estimates, we will adjust these estimates which would affect net product revenue and earnings in the period such variances become known.

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Stock-Based Compensation Expense

Stock-based compensation expense for a stock option award is measured at the date of grant, based on the estimated fair value of the award using the Black-Scholes option pricing model. The estimation of the fair value of each stock-based option grant or issuance on the date of grant is impacted by numerous assumptions by management,

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including but not limited to expected stock price volatility over the term of the awards and the expected term of stock options. Our stock options have characteristics significantly different from those of traded options, and changes in the assumptions can materially affect the fair value estimates.

Stock-based compensation expense for a restricted stock unit (RSU) award is measured at the date of grant, based on the fair value of the award which is the closing price of our common stock on the date of grant.

For awards that vest based on service conditions, we use the straight-line method to recognize compensation expense over the respective service period. For awards that contain performance conditions, we determine the appropriate amount to expense based on the probable achievement of performance targets, which requires judgment, and which may include forecasting the achievement of future specified targets. At the date performance conditions are determined to be probable of achievement, we record a cumulative expense catch-up, with remaining expense amortized over the remaining service period. Throughout the performance period, we re-assess the estimated performance and update the number of performance-based awards that we believe will ultimately vest.

If factors change and we employ different assumptions, stock-based compensation expense may differ significantly from what we have recorded in the past. If there is a difference between the assumptions used in determining stock-based compensation expense and the actual factors which become known over time, we may change the input factors used in determining stock-based compensation expense for future grants. These changes, if any, may materially impact our results of operations in the period such changes are made. Forfeitures are estimated at the time of grant based on historical experience, and revised, if necessary, in subsequent periods if actual forfeitures differ from those estimates.

Recent Accounting Pronouncements

For a description of recent accounting pronouncements, see Note 2 of the notes to our consolidated financial statements included in Part II, Item 8 of this Annual Report on Form 10-K.

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