Alpha Teknova, Inc. (TKNO) FY 2023 MD&A

Overview

Since our founding in 1996, we have been producing critical reagents for the discovery, development, and commercialization of novel therapies, vaccines, and molecular diagnostics. Our more than 2,500 active customers span the entire continuum of the life sciences market, including leading pharmaceutical and biotechnology companies, contract development and manufacturing organizations, in vitro diagnostics franchises, and academic and government research institutions. Our Company is built around our knowledge, methods, and know-how in our proprietary manufacturing processes, which are highly adaptable and configurable. These proprietary processes enable us to manufacture and deliver high-quality, custom, made-to-order products with short turnaround times and at scale, across all stages of our customers’ product development, from early research through commercialization.

We have two primary product categories: Lab Essentials and Clinical Solutions. Our products cross all stages of development, from early research through commercialization. We offer three primary product types: (i) pre-poured media plates for cell growth and cloning; (ii) liquid cell culture media and supplements for cellular expansion; and (iii) molecular biology reagents for sample manipulation, resuspension, and purification. Our liquid cell culture media and supplements and molecular biology reagents are available in both of our two primary product categories; pre-poured media plates are available in our Lab Essentials category only.

We are ISO 13485:2016 certified, enabling us to manufacture products for use in diagnostic and therapeutic applications. Our certification allows us to offer solutions across the entire customer product development workflow, supporting our customers' need for materials in greater volume and that meet increasingly stringent quality requirements as they scale from research to commercialization.

We manufacture our products at our Hollister, California headquarters and stock inventory of raw materials, components, and finished goods at that campus. We rely on a limited number of suppliers for certain raw materials, and we have no long-term supply arrangements with our suppliers, as we order on a purchase order basis. We ship our products directly from our warehouse in Hollister, California, to our customers and distributors, generally pursuant to purchase orders. We typically recognize revenue when products are shipped.

We generated revenue of $36.7 million in 2023, which represents a decrease of $4.7 million as compared to 2022. In 2023 and 2022, only 4.6% and 3.2%, respectively, of our revenue was generated from customers located outside of the U.S. Our sales outside of the U.S. are denominated in U.S. dollars. We primarily generate sales through direct channels and a small salesforce, however, some of our sales are generated through distributors.

We had an operating loss of $35.6 million in 2023 compared to $49.7 million in 2022. Excluding non-recurring charges, we had an operating loss of $29.8 million in 2023 (excluding the following non-recurring charges: $0.7 million related to the reduction in workforce, $2.2 million tradename impairment, $2.2 million long-lived asset impairment, $0.4 million write-off of ATM Facility costs, and $0.3 million loss contingency) compared to an operating loss of $28.9 million in 2022 (excluding the goodwill impairment of $16.6 million and long-lived asset impairment of $4.2 million). While our expenses may fluctuate over the short term, we expect our expenses will continue to increase in future periods, but at a slower rate, in connection with our ongoing activities as we:

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attract, hire, and retain qualified personnel;

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invest in processes and infrastructure to enable manufacturing automation and expand capacity, including the ramp up of our new, state-of-the-art manufacturing, warehouse, and distribution facilities; and

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build our brand and market, and sell our products and services.

Key Developments

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On February 1, 2023, we carried out a reduction in workforce of approximately 40 positions, aimed at reducing operating expenses. We incurred $0.7 million of costs in connection with the reduction in workforce related to severance pay and other termination benefits during the year ended December 31, 2023.

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On March 30, 2023, we entered into a sales agreement (the ATM Facility) with Cowen and Company, LLC, under which the Company may offer and sell, from time to time, shares of common stock having aggregate gross proceeds of up to $50.0 million. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for more information regarding the ATM Facility.

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On September 19, 2023, we completed our registered direct offering and private placements where we received aggregate gross proceeds of $22.915 million, before deducting $0.4 million offering expenses. At the same time, we entered into Amendment No. 4 to the Credit Agreement which included a waiver from our lender of a revenue covenant violation for the period ending July 31, 2023. As a condition to the effectiveness of Amendment No. 4, we prepaid the principal amount of the Term Loan in an amount equal to $10.0 million and recognized a loss on the extinguishment of debt in the amount of $0.8 million related to this prepayment in the statements of operations. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for more information regarding the credit facility.

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On January 11, 2024, we announced a reduction in workforce that affected approximately 15% of our employees at that time. We estimate that we will incur approximately $1.2 million of costs in connection with the reduction in workforce related to severance pay and other termination benefits. We expect the majority of the costs to be incurred and payments made during the first quarter of 2024. Total annual cost savings from this reduction in workforce are estimated at $6.4 million.

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On January 16, 2024, our board of directors approved a stock option repricing effective on March 14, 2024. The option repricing applies to outstanding options to purchase shares of our common stock as of the repricing date provided that the holder remains employed by us or continues to serve as a member of the board of directors through at least September 14, 2025. Outstanding options with an exercise price that is less than our closing stock price will be reduced to the fair market value on that date. There will be no changes to the number of shares, the vesting schedule, or the expiration date of the repriced options. The option repricing will result in additional share-based compensation expense that will be recognized in our statements of operations in future periods; however, the amount of additional share-based compensation expense and the periods over which it will be recognized have not yet been determined.

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On March 8, 2024, we entered into Amendment No. 5 to the Credit Agreement which includes a waiver of the minimum net revenue covenant violations for each of the periods ending November 30, 2023 and January 31, 2024 and reduced these requirements for future periods up to and including for the twelve months ending December 31, 2024, from $42 million to $34 million. Additionally, Amendment No 5 removed these requirements for the periods ending January 31, 2025 through December 31, 2025, instead requiring that the minimum net revenue requirement will be determined by MidCap in its reasonable discretion in consultation with our senior management subject to provisions contained therein. See "Management’s Discussion and Analysis of Financial Condition and Results of Operations—Liquidity and Capital Resources” for more information regarding Amendment No. 5 to the Credit Agreement and the credit facility.

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On March 8, 2024, as a condition to the effectiveness of Amendment No. 5, we issued a warrant to MidCap to purchase up to an aggregate of 125,000 shares (the Common Warrant) of common stock

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with an exercise price of $2.9934 per share, subject to adjustment as provided therein. See “Notes to Financial Statements—Note 17. Subsequent Events,” for a more detailed discussion of the material terms of the Common Warrant.

Impact of Broader Economic Trends on Our Business

We are closely monitoring economic uncertainty in the U.S. and abroad. General inflation in the U.S. has risen to levels not experienced in recent decades. General inflation, including rising prices for our raw materials and other inputs, as well as rising salaries and other expenses, negatively impact our business by increasing our cost of sales and operating expenses. In addition, the U.S. Federal Reserve has raised, and may again raise, interest rates in response to concerns about inflation. Inflation, together with increased interest rates, may cause our customers to reduce, delay, or cancel orders for our goods and services thereby causing a decrease in or change in timing of sales of our products and services. We cannot predict the impact of future inflation and interest rate increases on the results of our operations. For further information regarding the impact of these economic factors on the Company, please see Item 1A., "Risk Factors" in this report, which is incorporated herein by reference.

Results of Operations

The following tables set forth our results of operations for the years ended December 31, 2023 and 2022 (dollars in thousands):

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Revenue

Our revenue disaggregated by product category, for the years ended December 31, 2023 and 2022 was as follows (dollars in thousands):

Total revenue was $36.7 million in 2023, a decrease of $4.7 million, or 11.4%, compared with $41.4 million in 2022.

Lab Essentials revenue was $28.8 million in 2023, a decrease of $3.0 million, or 9.4%, compared with $31.8 million in 2022. The decrease in Lab Essentials revenue was attributable to a decreased number of customers, partially offset by higher average revenue per customer.

Clinical Solutions revenue was $6.7 million in 2023, a decrease of $1.7 million, or 20.2%, compared with $8.4 million in 2022. The decrease in Clinical Solutions revenue was attributable to lower average revenue per customer, partially offset by an increased number of customers.

Our revenue disaggregated by geographic region for the years ended December 31, 2023 and 2022, was as follows (dollars in thousands):

Revenue from sales to customers in the United States was $35.0 million in 2023, and $40.1 million in 2022. Revenue from U.S. sales was consistent year over year, representing 95.4% and 96.8% of our total revenue in 2023 and 2022, respectively.

Revenue from sales to customers in markets outside of the U.S. was $1.7 million in 2023, and $1.3 million in 2022. Revenue from international sales was also consistent year over year, representing 4.6% and 3.2% of our total revenue in 2023 and 2022, respectively.

Gross profit

Our gross profit for the years ended December 31, 2023 and 2022 was as follows (dollars in thousands):

Gross profit percentage was 28.1% in 2023, and 42.2% in 2022. The decrease in gross profit percentage was primarily driven by the decrease in revenue and the associated lower absorption of fixed manufacturing costs, and to a lesser extent increased overhead costs that were partially offset by reduced headcount.

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Operating expenses

Our operating expenses for the years ended December 31, 2023 and 2022 were as follows (dollars in thousands):

Research and development expenses were $5.6 million in 2023 and $7.7 million in 2022. The decrease was primarily driven by reduced headcount and professional fees as well as reduced supplies and equipment expenses.

Sales and marketing expenses were $9.3 million in 2023 and $9.2 million in 2022. The increase was primarily driven by higher labor and benefit costs as well as stock-based compensation, partially offset by lower marketing expenses.

General and administrative expenses were $25.5 million in 2023 and $28.3 million in 2022. Excluding the one-time, non-recurring charges related to the reduction in workforce of $0.7 million, the $0.4 million write off of ATM Facility costs, and $0.3 million accrual for legal claim recorded in 2023, general and administrative expenses decreased $4.3 million compared to 2022. The decrease was driven by reduced spending, primarily in professional fees and occupancy costs, partially offset by higher stock-based compensation expense.

Amortization of intangible assets was consistent in 2023 and 2022, at $1.1 million.

We incurred a $16.6 million goodwill impairment charge in 2022, with no comparable charges in 2023. Refer to the “Notes to Financial Statements—Note 8. Intangible Assets, Net” in our financial statements for details regarding the goodwill impairment.

We incurred a $2.2 million tradename impairment charge in 2023, with no comparable charges in 2022. Refer to the “Notes to Financial Statements—Note 8. Intangible Assets, Net” in our financial statements for details regarding the tradename impairment.

We recorded long-lived asset impairment charges of $2.2 million in 2023 and $4.2 million in 2022. Refer to “Notes to Financial Statements—Note 6. Property, Plant, and Equipment, Net,” in our financial statements for details regarding the long-lived asset impairment.

Other (expenses) income, net

Other (expenses) income, net for the years ended December 31, 2023 and 2022 was as follows (dollars in thousands):

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Total other expenses, net was $1.5 million in 2023, compared to total other income, net of $0.3 million in 2022. The increase in total other expenses, net was attributable to higher interest expense primarily driven by an increase in our average debt balance coupled with higher interest rates, as well as by a $0.8 million loss on extinguishment of debt related to the partial repayment on the Term Loan. We capitalized a portion of the interest on funds borrowed to finance certain of our capital expenditures. Capitalized interest costs were $0.9 million and $1.6 million in 2023 and 2022, respectively. Offsetting these other expenses is other income, which increased due to higher interest rates and thus income earned on short-term liquid investments.

Benefit from income taxes

Our benefit from income taxes for the years ended December 31, 2023 and 2022 was as follows (dollars in thousands):

Our benefit from income taxes was $0.3 million in 2023, compared to a $1.9 million in 2022. The decrease in our benefit from income taxes was attributable to operating losses not expected to produce a benefit.

Liquidity and Capital Resources

The primary sources of financing for our operations were our (i) initial public offering, which we completed in June 2021 (IPO) and resulted in net proceeds to us of $99.1 million, after deducting underwriting discounts and commissions of $7.7 million and offering expenses of $3.6 million, and (ii) registered direct offering and concurrent private placement (collectively, the Offerings), which we completed in September 2023 and which resulted in aggregate gross proceeds of $22.915 million before deducting offering expenses of $0.4 million and the prepayment of $10.0 million owed under the Term Loan as discussed below.

To facilitate our expected growth, we have used our sources of liquidity to make investments to expand our operations and increase capacity, and may continue to do so in the future. In particular, we have completed the build out of our new manufacturing facility and have made improvements to our warehouse and distribution facilities, all located in Hollister, California.

Our principal liquidity requirements are to fund our operations and capital expenditures. As of December 31, 2023, we have limited capital resources to fund ongoing operations. During the year ended December 31, 2023, we incurred net losses of $36.8 million. In addition, as of December 31, 2023, we had an accumulated deficit of $91.8 million and borrowings outstanding under our Term Loan (defined below). As of December 31, 2023, we had $36.8 million of working capital, which included $28.5 million in cash and cash equivalents. Our available capital resources may not be sufficient for us to continue to meet our obligations as they become due over the next twelve months if we cannot improve our operating results or increase our operating cash inflows. If these capital resources are not sufficient, we may need to raise additional capital through the sale of equity or debt securities, enter into strategic business collaboration agreements with other companies, seek other funding sources, or sell assets. However, there can be no assurance that we will be able to accomplish any of the foregoing or do so on favorable terms. If we are unable to meet our obligations when they become due over the next twelve months through our available capital resources, or obtain new sources of capital when needed, we may have to delay expenditures, reduce the scope of our manufacturing operations, reduce or eliminate one or more of our development programs, make significant changes to our operating plan, or cease our operations.

As of December 31, 2023, we had an outstanding principal amount of $12.1 million under a senior secured term loan (the Term Loan) pursuant to Amendment No. 4 to our Credit Agreement with MidCap Financial Trust (MidCap). On March 8, 2024, we entered into limited waivers and amendments (collectively Amendment No. 5, or, as amended, the Amended Credit Agreement) which includes a waiver from MidCap of the revenue covenant

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violations for each of the periods ending November 30, 2023 and January 31, 2024. Amendment No. 5 also reduced these requirements for future periods up to and including for the twelve months ending December 31, 2024, from $42 million to $34 million. Amendment No. 5 also removed those requirements for the periods ending January 31, 2025 through December 31, 2025, instead requiring that for each applicable twelve-month period ending after December 31, 2024, the Company’s minimum net revenue requirement will be determined by MidCap in its reasonable discretion in consultation with the Company’s senior management and based on financial statements and projections delivered to MidCap in accordance with the financial reporting requirements in the Amended Credit Agreement, so long as the minimum net revenue requirements for those periods shall not be less than the greater of (x) the applicable minimum net revenue requirement for the twelve-month period ending on the last day of the immediately preceding month and (y) $34.0 million. In addition, Amendment No. 5 also removed the advance rate for finished goods inventory in the determination of the borrowing base for the Revolving Loan and increased the minimum cash requirement from $9.0 million to $10.0 million. Finally, Amendment No. 5 conditions the next borrowing under the Revolving Loan on the Company achieving net revenue for the preceding twelve-month period of at least $38.0 million down from $45.0 million. See “Notes to Financial Statements—Note 17. Subsequent Events” for a more detailed discussion of the material terms of our Amended Credit Agreement.

To the extent we continue to experience unfavorable market conditions, like other companies in our industry, we may be unable to comply with the monthly revenue covenant during the twelve-month period following the date on which the financial statements are available for issuance. Failing to comply with the monthly revenue covenant would be an event of default under the Amended Credit Agreement and the lender would have the right, but not the obligation, to accelerate our obligations to pay the outstanding balance due and payable under the Term Loan. If we violate one or more of our covenants under the Amended Credit Agreement and are not able to obtain a waiver from or agree to an accommodation with the lender with respect to any such violation, we could be required to pay all or a portion of the outstanding amount under the Term Loan. In that event, we may need to seek other sources of capital and there can be no assurances that we would be able to do so on acceptable terms.

We also have an ATM Facility under which we may offer and sell, from time to time, shares of our common stock having aggregate gross proceeds of up to $50.0 million. We will pay a commission of up to 3.0% of gross sales proceeds of any common stock sold under the ATM Facility. The aggregate market value of shares eligible for sale under the ATM Facility will be subject to the limitations of General Instruction I.B.6 of Form S-3, to the extent required under such instruction. See “Notes to Financial Statements—Note 2. Basis of Presentation and Summary of Significant Accounting Policies,” for a more detailed discussion of the material terms of our ATM Facility.

As of December 31, 2023, our material cash requirements from known contractual obligations and commitments relate primarily to operating leases for our office, manufacturing, warehouse, and distribution facilities. See “Notes to Financial Statements—Note 7. Leases,” for a discussion of our lease obligations reflected on our balance sheet.

Accounting Standards Codification (ASC) 205-40, Presentation of Financial Statements—Going Concern, requires us to evaluate our ability to continue as a going concern for the twelve-month period following the date on which the financial statements are available for issuance. We performed an assessment to determine whether there were conditions or events that, considered individually and in the aggregate, raised substantial doubt about our ability to continue as a going concern for the twelve-month period following the date on which our financial statements are being issued. This assessment indicated certain negative conditions and events, described further above related to our availability of capital resources and ability to meet the monthly revenue covenant under our Amended Credit Agreement, that raise substantial doubt about our ability to continue as a going concern.

The accompanying financial statements included in Part II, Item 8 of this Annual Report on Form 10-K, have been prepared assuming we will continue as a going concern, which contemplates continuity of operations, realization of assets, and the satisfaction of liabilities in the normal course of business for one year following the issuance of the audited financial statements. As such, the accompanying financial statements do not include any adjustments relating to the recoverability and classification of assets and their carrying amounts, or the amount and classification of liabilities that may result should we be unable to continue as a going concern.

The following table sets forth, for the periods indicated, net cash flows used in operating activities, used in investing activities and provided by financing activities (in thousands):

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Operating Activities

Net cash used in operating activities consists primarily of net loss adjusted for certain non-cash items (including depreciation and amortization, bad debt expense, deferred taxes, loss on disposal of property, plant, and equipment, inventory reserve, amortization of debt issuance costs, and stock-based compensation expense), and the effect of changes in working capital and other operating activities.

Net cash used in operating activities was $18.8 million in 2023, which primarily consisted of net loss of $36.8 million plus net adjustments for non-cash charges of $15.7 million and net changes in operating assets and liabilities of $2.2 million. The primary non-cash adjustments to net loss included $5.7 million of depreciation and amortization, $4.1 million of stock-based compensation, a $2.2 million impairment charge related to long-lived assets, a $2.2 million impairment charge related to the Teknova tradename, a $0.8 million loss on extinguishment of debt, $0.5 million in amortization of debt financing costs, and a $0.3 million provision related to our inventory reserve. The main drivers of the changes in operating assets and liabilities were a $1.9 million increase in accrued liabilities, a $0.4 million decrease in other non-current assets, a $0.3 million decrease in inventories, and a $0.3 million decrease in accounts receivable, partially offset by a $0.8 million decrease in accounts payable.

Net cash used in operating activities was $27.4 million in 2022, which primarily consisted of net loss of $47.5 million plus net adjustments for non-cash charges of $27.4 million, offset by net changes in operating assets and liabilities of $7.3 million. The primary non-cash adjustments to net loss included a $16.6 million goodwill impairment charge, a $4.2 million impairment charge related to long-lived assets, $3.7 million of stock-based compensation, $3.2 million of depreciation and amortization, a $0.7 million provision related to our inventory reserve, partially offset by $1.9 million in deferred taxes. The main drivers of the changes in operating assets and liabilities were a $7.6 million increase in inventories and $2.1 million increase in other non-current assets, partially offset by a $1.2 million decrease in income taxes receivable, $0.6 million increase in accounts payable, and $0.4 million decrease in accounts receivable.

Investing Activities

Net cash used in investing activities relates primarily to capital expenditures, partially offset by proceeds from the sale of certain long-lived assets.

Net cash used in investing activities was $7.7 million in 2023, which consisted of purchases of property, plant, and equipment of $7.9 million, partially offset by proceeds from the sale of certain long-lived assets of $0.2 million.

Net cash used in investing activities was $28.1 million in 2022, which consisted of purchases of property, plant, and equipment.

Financing Activities

Net cash provided by financing activities primarily relates to proceeds from our Offerings, proceeds and payments related to our long-term debt, the exercise of stock options, issuance of common stock under our employee stock purchase plan, and other financing activities.

Net cash provided by financing activities was $12.8 million in 2023, which was primarily attributable to net proceeds from the Offerings of $22.5 million and proceeds from financed insurance premiums of $1.0 million, partially offset by repayment of long-term debt of $10.0 million, repayment of financed insurance premiums of $0.6 million, and payment of offering costs of $0.4 million related to the ATM Facility. We also received proceeds of $0.1 million from the exercise of stock options and $0.3 million from issuance of common stock under our employee stock purchase plan.

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Net cash provided by financing activities was $10.3 million in 2022, which was primarily attributable to proceeds from long-term debt of $10.1 million, partially offset by payment of debt issuance costs of $0.2 million and payment of exit fee costs of $0.1 million related to our debt refinancing. We also received proceeds of $0.1 million from the exercise of stock options and $0.3 million from issuance of common stock under our employee stock purchase plan.

Critical Accounting Policies and Estimates

Our financial statements have been prepared in accordance with GAAP. The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets, liabilities and contingencies as of the date of the financial statements and reported amounts of revenues and expenses during the reporting periods. We evaluate our estimates on an ongoing basis. We base our estimates on historical experience and on other assumptions that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. However, future events may cause us to change our assumptions and estimates, which may require adjustment. Actual results could differ from these estimates.

We believe the following critical accounting policies involve significant areas where management applies judgments and estimates in the preparation of our financial statements.

Revenue Recognition

We account for revenue in accordance with ASC 606. This process involves identifying the contract with a customer, identifying the performance obligations in the contract, determining the transaction price, allocating the transaction price to the performance obligations in the contract, and recognizing revenue when or as we satisfy performance obligations.

We recognize revenue from the sale of manufactured products and services when control of promised goods or services is transferred to customers in an amount that reflects the consideration we expect to be entitled to in exchange for those goods or services. Control is transferred when the customer has the ability to direct the use of and obtain benefits from the goods or services. The majority of our sales agreements contain performance obligations satisfied at a point in time when control is transferred to the customer.

Occasionally, we offer rebates, discounts, and returns on our products, however, returns and refunds occur rarely. We record rebates, discounts, and returns at the time they occur. The difference between recording these as they occur and estimating the amount of consideration in exchange for the transfer of promised goods would not have a material impact on the financial statements.

Intangible Assets and Other Long-Lived Assets

We review our definite-lived intangible assets and other long-lived assets for impairment whenever events or changes in circumstances indicate the carrying amount of these assets may not be recoverable. Recoverability is measured by a comparison of the carrying amount of the assets to future undiscounted net cash flows expected to be generated. Significant judgment is required to estimate the amount and timing of future cash flows and the relative risk of achieving those cash flows. The key assumptions that we use in our discounted cash flow model are the amount and timing of estimated future cash flows to be generated by the asset over an extended period of time and a rate of return that considers the relative risk of achieving the cash flows, the time value of money, and other factors that a willing market participant would consider.

Indefinite lived intangible assets are also subject to an impairment test at least annually, as of October 1, or more frequently if events or circumstances indicate that it is more likely than not that the asset is impaired. If the fair value of the asset is less than the carrying amount, an impairment loss would be recognized in an amount equal to the difference between the carrying amount and the fair value. We determined that as of December 31, 2023, the fair value of our indefinite lived intangible assets was less than the carrying amount. As a result we recorded a $2.2 million impairment charge during the year ended December 31, 2023 related to our tradename, with no comparable

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charges in 2022. Refer to “Notes to Financial Statements—Note 8. Intangible Assets, Net,” in our financial statements for details regarding the impairment.

Assumptions and estimates about future values and remaining useful lives are complex and often subjective. They can be affected by a variety of factors, including external factors such as industry and economic trends, and internal factors such as changes in our business strategy and our internal forecasts.

Income Taxes

The asset and liability method is used in accounting for deferred income taxes. Under this method, deferred income taxes are provided for differences between the carrying amounts of assets and liabilities for financial reporting and tax purposes using the enacted tax rates and laws that will be in effect when the differences are expected to reverse. Accordingly, our tax provision contemplates tax rates currently in effect to determine our current tax provision as well as enacted tax rates expected to apply to taxable income in the fiscal years in which those temporary differences are expected to be recovered or settled to determine our deferred tax provision. Any significant fluctuation in rates or changes in tax laws could lead to either increases or decreases in our effective tax rate.

Our provision for income taxes, deferred tax assets and liabilities, and reserves for unrecognized tax benefits reflect our best assessment of estimated future taxes to be paid. Significant judgments and estimates based on interpretations of existing tax laws or regulations are required in determining our provision for income taxes. Changes in tax laws, statutory tax rates, and estimates of our future taxable income could impact the deferred tax assets and liabilities provided for in the financial statements and would require an adjustment to the provision for income taxes.

Stock-Based Compensation

Stock-based compensation expense is recognized based on the fair value and is expensed on a straight-line basis over the requisite service periods of the award, which generally represents the scheduled vesting period. Forfeitures are recognized as they occur. We account for stock-based compensation expense based on the estimated grant date fair value, using the Black-Scholes option-pricing model which requires us to make a number of assumptions, including expected volatility, the expected risk-free interest rate, the expected term and the expected dividend.

These inputs are subjective and generally require significant analysis and judgment to develop. Changes in the assumptions can materially affect the fair value and ultimately how much stock-based compensation is recognized.

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Volatility. Since we have limited historical data on volatility of our stock, expected volatility is based on the volatility of the stock of similar publicly traded entities. In evaluating similarity, we consider factors such as industry, stage of life cycle, size, and financial leverage.

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Fair value of underlying common stock. The fair value of our common stock is determined by the closing price as reported on the Nasdaq Global Market on the date of grant.

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Risk-free interest rate. The risk-free rate that we use is based on U.S. Treasury zero-coupon issues with remaining terms similar to the expected term on the options.

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Expected term. As we do not have sufficient historical exercise activity to estimate expected life, the expected life of options granted is determined using the simplified method. The simplified method is based on the vesting period and the contractual term for each grant or for each vesting tranche for awards with graded vesting. The midpoint of the vesting date and the maximum contractual expiration date are used to determine the expected term under this method.

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Dividend yield. We have never declared or paid any cash dividends and does not plan to pay cash dividends in the foreseeable future. Therefore, we use an expected dividend yield of zero. In addition, the terms of the Amended Credit Agreement prohibit us from paying dividends, other than dividends payable in our common stock, without the prior consent of the lender.

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Accounting Pronouncements Not Yet Adopted

In November 2023, the Financial Accounting Standards Board (FASB) issued Accounting Standard Update (ASU) 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures, which expands public entities’ segment disclosures by requiring disclosure of significant segment expenses that are regularly provided to the CODM and included within each reported measure of segment profit or loss, an amount and description of its composition for other segment items, and interim disclosures of a reportable segment’s profit or loss and assets. Additionally, all disclosure requirements under the guidance are also required for public entities with a single reportable segment. The amendments are effective for fiscal years beginning after December 15, 2023, and for interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. The amendments should be applied retrospectively to all prior periods presented in the financial statements. We are currently evaluating the impact of this standard to determine its impact on our disclosures.

In December 2023, the FASB issued ASU 2023-09, Income Taxes (Topic 740): Improvements to Income Tax Disclosures, which requires disclosure in the rate reconciliation table additional categories of information about federal, state and foreign income taxes and to provide more details about the reconciliation items in some categories if the items meet a quantitative threshold. The guidance also requires disclosure of income taxes paid, net of refunds, disaggregated by federal (national), state and foreign taxes for annual periods and to disaggregate the information by jurisdiction based on a quantitative threshold. The guidance is effective for fiscal years beginning after December 15, 2024. We are currently evaluating the impact of this standard to determine its impact on our disclosures.

Recent Securities and Exchange Commission (SEC) Final Rules Not Yet Adopted

In March 2024, the SEC adopted final rules under SEC Release No. 33-11275, The Enhancement and Standardization of Climate-Related Disclosures for Investors, which requires registrants to provide certain climate-related information in their registration statements and annual reports. The rules require information about a registrant’s climate-related risks that have materially impacted, or are reasonably likely to have a material impact on its business, results of operations, or financial condition. In addition, certain disclosures related to severe weather events and other natural conditions will be required in the registrant’s audited financial statements. Disclosure requirements will begin phasing in for fiscal years beginning on or after January 1, 2025. We are currently evaluating the impact of these new final rules on our financial statements and disclosures.

Emerging Growth Company and Smaller Reporting Company

We qualify as an “emerging growth company” as defined in the JOBS Act. As long as we qualify as an emerging growth company, we may take advantage of certain exemptions from various reporting requirements and other burdens that are otherwise applicable generally to public companies. These provisions include, but are not limited to:

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reduced obligations with respect to financial data, including presenting only two years of audited financial statements;

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an exemption from compliance with the auditor attestation requirements of Section 404 of the Sarbanes-Oxley Act;

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reduced disclosure about our executive compensation arrangements in our periodic reports, proxy statements, and registration statements; and

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exemptions from the requirements of holding non-binding advisory votes on executive compensation or golden parachute arrangements.

In addition, under the JOBS Act, emerging growth companies can delay adopting new or revised accounting standards until such time as those standards apply to private companies. We have elected to avail ourselves of this exemption from adopting new or revised accounting standards, and, therefore, we will not be subject to the same new or revised accounting standards as other public companies that are not emerging growth companies or that have opted out of using such extended transition period, which may make comparison of our financial statements with those of other public companies more difficult. We may take advantage of these reporting exemptions until we no longer qualify as an emerging growth company, or, with respect to adoption of certain new or revised accounting standards, until we irrevocably elect to opt out of using the extended transition period.

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Under the JOBS Act, we will remain an emerging growth company until the earliest to occur of:

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the last day of the fiscal year in which we have total annual gross revenues of $1.235 billion or more;

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the last day of our fiscal year following the fifth anniversary of the date of the closing of our initial public offering (IPO);

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the date on which we have issued more than $1.0 billion in nonconvertible debt during the previous three years; and

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the date on which we are deemed to be a “large accelerated filer” under the Exchange Act (i.e., the first day of the fiscal year after we have (i) more than $700.0 million in outstanding common equity held by our non-affiliates, measured each year on the last business day of our most recently completed second fiscal quarter, and (ii) been public for at least 12 months).