Vericel Corp (VCEL) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Vericel Corporation is a fully-integrated, commercial-stage biopharmaceutical company and a leader in advanced therapies for the sports medicine and severe burn care markets. We currently market two FDA-approved autologous cell therapy products and also market one specialty biologic product in the U.S. MACI® is an autologous cellularized scaffold product indicated for the repair of symptomatic, single or multiple full-thickness cartilage defects of the knee with or without bone involvement in adults. Epicel® is a permanent skin replacement HUD for the treatment of adult and pediatric patients with deep-dermal or full-thickness burns comprising greater than or equal to 30 percent of TBSA. We also hold an exclusive license from MediWound for North American rights to NexoBrid (anacaulase-bcdb). On December 28, 2022, the FDA approved a BLA for NexoBrid, granting a license for commercial use in the U.S. NexoBrid is a topically-administered biological product containing proteolytic enzymes and is indicated for the removal of eschar in adults with deep partial-thickness and/or full thickness thermal burns. We expect to begin commercial sales of NexoBrid in the U.S. during the second quarter of 2023.

See “Risk Factors - “Our success depends, in part, on the commercial success of NexoBrid for the removal of eschar in adults with deep partial-thickness and/or full-thickness thermal burns following FDA approval of our Biologics License Application.”

COVID-19

In March 2020, the World Health Organization declared the spread of a novel strain of coronavirus (“COVID-19”) to be a pandemic. This pandemic has contributed to an economic downturn on a global scale, as well as significant volatility in the financial markets. Since the pandemic’s inception, and at times, there has been significant volatility in our results of operations on a quarterly basis due to the widespread and periodic cancellation or delay of elective MACI surgical procedures throughout the U.S., staffing shortages and our ability to access customers.

At the outset of the pandemic, we put in place a comprehensive workplace protection plan, which instituted protective measures in response to the spread of the COVID-19 virus. Our workplace protection plan has closely followed fluctuating guidance issued by the Centers for Disease Control and Prevention (“CDC”) and has complied with applicable federal and state law. To date, we have been successful in sustaining our operations and providing our products to patients in need. Although most of the protective measures initially put into place are no longer required because of the pandemic’s waning effects, we continue to review our policies and procedures regularly, including our workplace protection plan, and we may take additional actions in the future to the extent required.

We continue to manufacture MACI and Epicel and have begun efforts to commercialize NexoBrid in North America following the FDA’s approval of the submitted BLA on December 28, 2022. We maintain a significant safety stock of all key raw materials, and we do not expect that current global supply chain interruptions will impact our ongoing manufacturing operations of MACI and Epicel. Additionally, although we have not experienced material shipping delays, significant disruption of air travel could result in the inability to deliver MACI or Epicel final products to customer sites within appropriate timeframes, which could adversely impact our business. Currently, we are not aware of COVID-19 related impacts on our distributors, operations or third-party service providers’ ability to manage patient cases. With the recent FDA approval of NexoBrid, MediWound has begun preparations to manufacture and supply sufficient quantities of NexoBrid to meet customer demand. To date, MediWound has not indicated that it expects pandemic-related disruptions to affect its ability to manufacture and supply NexoBrid.

We believe that a resurgence of COVID-19 because of emerging variants or other factors could result in additional disruptions that could impact our business and operations in the future, including intermittent restrictions on the ability of our personnel to travel and access customers for selling, marketing, training, case support and product development feedback, delays in approvals by regulatory bodies, delays in product development efforts, and additional government requirements or other incremental mitigation efforts that may further impact our capacity to manufacture, sell and support the use of our products.

For a discussion of additional risks associated with the ongoing COVID-19 pandemic, please see Part I, Item 1A. “Risk Factors”.

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The War in Ukraine

The ongoing war between Russia and Ukraine and the related sanctions and other penalties imposed by countries across the globe against Russia are continuing to create substantial uncertainty in the global economy and have resulted in heightened inflation and supply chain disruptions. While we do not have operations in Russia or Ukraine and do not have exposure to distributors, or third-party service providers in Russia or Ukraine, we are unable to predict the ultimate impact that these actions will have on the global economy or on our financial condition, results of operations, and cash flows as of the date of these consolidated financial statements.

Manufacturing

We have a cell manufacturing facility in Cambridge, Massachusetts, which is used for U.S. manufacturing and distribution of MACI and Epicel. The manufacturing process for NexoBrid is conducted by MediWound, primarily at manufacturing locations in Israel. Certain raw materials utilized in NexoBrid’s manufacture, including the supply of the active ingredient bromelain, are obtained from Taiwan.

Product Portfolio

Our marketed products include two FDA-approved autologous cell therapies: MACI, a third-generation autologous cellularized scaffold product indicated for the repair of symptomatic, single or multiple full-thickness cartilage defects of the knee with or without bone involvement in adults; and Epicel, a permanent skin replacement for the treatment of adult and pediatric patients with deep-dermal or full-thickness burns comprising greater than or equal to 30 percent TBSA and a specialty biologic: NexoBrid, a biological orphan product containing proteolytic enzymes indicated for eschar removal in adults with deep partial-thickness and/or full-thickness burn. Both autologous cell therapy products are currently manufactured and marketed in the U.S. In addition, we have entered into exclusive license and supply agreements with MediWound to commercialize NexoBrid in North America. On December 28, 2022, the FDA approved a BLA for NexoBrid, granting a license for commercial use in the U.S. NexoBrid is a topically-administered biological product containing proteolytic enzymes and is indicated for the removal of eschar in adults with deep partial-thickness and/or full thickness thermal burns. We expect to begin commercial sales of NexoBrid in the U.S. during the second quarter of 2023.

MACI

MACI is a third-generation ACI product indicated for the repair of symptomatic, single or multiple full-thickness cartilage defects of the knee with or without bone involvement in adults.

Our target audience of U.S. physicians is approximately 5,000 orthopedic surgeons and is divided into two segments: a group of orthopedic surgeons who self-identify and/or have a formal specialty as sports medicine physicians, and a subpopulation of general orthopedic surgeons who perform a high volume of cartilage repair procedures. As of the date of this report, we have 75 MACI sales representatives to enable the sales force to reach our target audience. Most private payers have a medical policy that covers treatment with MACI with the top 30 largest commercial payers having a formal medical policy for MACI or ACI in general. With respect to private commercial payers that have not yet approved a medical policy for MACI, we often obtain approval on a case-by-case basis.

MACI is currently implanted into the patient’s cartilage defect through an open surgical procedure. We are currently evaluating the potential for the arthroscopic delivery of MACI to the cartilage defect – a procedure in which a surgeon can evaluate, prepare and treat the cartilage defect under direct vision using specialized instruments delivered through a number of smaller incisions or portals. The arthroscopic delivery of MACI could increase the ease of MACI’s use for physicians and reduce both the length of the procedure and a patient’s post-operative pain and recovery. We have designed and are currently developing novel and specialized instruments to be used in and help facilitate such a procedure. We have recently discussed with the FDA a non-clinical regulatory strategy to support the potential inclusion of arthroscopic delivery in MACI’s approved labeling. Specifically, following a Type C meeting with the FDA, we are now planning to initiate a human factors validation study, coupled with published literature, to support expanding the MACI label to include arthroscopic administration of MACI for the treatment of cartilage defects of the knee, and we now anticipate an accelerated potential commercial launch of arthroscopic MACI in 2024. Based on the results of conducted market research, we believe the addition of an arthroscopic MACI delivery option could result in an expansion of the number of surgeons performing MACI procedures, and the number of MACI procedures conducted in the U.S. each year. This assessment is further supported by European studies comparing arthroscopic MACI to the open-knee approach, that showed arthroscopic delivery of the MACI implant to be less invasive, potentially resulting in less surgical time, less postoperative pain, less surgical site morbidity, and faster surgical recovery.

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Additional studies also showed improved clinical and radiologic outcomes over a two year period in patients undergoing arthroscopic MACI.

We also are evaluating the feasibility and potential market opportunity involved in delivering MACI treatment to patients suffering from cartilage damage in the ankle. We believe that this potential lifecycle enhancement and indication expansion for MACI will require the conduct of an additional randomized clinical trial concerning the product’s use in the ankle. Earlier this year we received feedback from the FDA on our clinical development program for MACI to treat cartilage injuries in the ankle without the need for a pre-IND meeting as originally proposed, and our team is actively working to finalize our clinical plan/protocol.

Epicel

Epicel is a permanent skin replacement for deep-dermal or full-thickness burns comprising greater than or equal to 30 percent TBSA. Epicel is regulated by CBER of the FDA under medical device authorities, and is the only FDA-approved cultured epidermal autograft product available for large total surface area burns. Epicel was designated as a HUD in 1998 and an HDE application for the product was submitted in 1999. HUDs are devices that are intended for diseases or conditions that affect fewer than 8,000 individuals annually in the U.S. Under an HDE approval, a HUD cannot be sold for an amount that exceeds the cost of research and development, fabrication and distribution unless certain conditions are met. A HUD is eligible to be sold for profit after receiving HDE approval if the device meets certain eligibility criteria, including where the device is intended for the treatment of a disease or condition that occurs in pediatric patients and such device is labeled for use in pediatric patients. If the FDA determines that a HUD meets the eligibility criteria, the HUD is permitted to be sold for profit so long as the number of devices distributed in any calendar year does not exceed the Annual Distribution Number (“ADN”). The ADN is defined as the number of devices reasonably needed to treat a population of 8,000 individuals per year in the U.S.

On February 18, 2016, the FDA approved our HDE supplement to revise the labeled indications of use for Epicel to specifically include pediatric patients. The revised product label also now specifies that the probable benefit of Epicel, mainly related to survival, was demonstrated in two Epicel clinical experience databases and a physician-sponsored study comparing outcomes in patients with large burns treated with Epicel relative to standard care. Because of the change in the label to specifically include use in pediatric patients, Epicel is no longer subject to the HDE profit restrictions. In conjunction with adding the pediatric labeling and meeting the pediatric eligibility criteria, the FDA has determined the ADN number for Epicel to be 360,400 which is approximately 40 times larger than the volume of grafts sold in 2022. Our burn care field force is currently comprised of approximately 22 individuals, serving in account manager or sales representative roles, as well as two Regional Managers led by a Vice President of National Sales.

NexoBrid

Our portfolio of commercial products now includes NexoBrid (anacaulase-bcdb), a topically-administered biological product containing proteolytic enzymes, which was approved by the FDA on December 28, 2022, and is indicated for the removal of eschar in adults with deep partial-thickness and/or full thickness thermal burns. We have entered into exclusive license and supply agreements with MediWound to commercialize NexoBrid in North America.

NexoBrid is approved in the European Union (“EU”) and other international markets and has been designated as an orphan biologic in the U.S., EU and other international markets. NexoBrid has the potential to change the standard of care for eschar removal with respect to hospitalized burn patients and treat a significant addressable market in the U.S. With respect to NexoBrid, of the approximately 40,000 burn patients that are hospitalized in the U.S. each year, the majority, over 30,000, will likely require some level of eschar removal. NexoBrid’s approval expands our burn care franchise’s total addressable market, which will permit us to treat a significantly larger segment of hospitalized burn patients than with Epicel alone. The expansion of our target addressable market supports a broader commercial footprint, and we believe that this may help drive both increased NexoBrid use as well as increased Epicel awareness throughout the burn care space. With NexoBrid’s approval, our cross-functional commercial launch activities for the product are underway, including education, training and engagement activities and the deployment of additional NexoBrid account managers.

The manufacturing process for NexoBrid is conducted by MediWound, primarily at manufacturing locations in Israel. Certain raw materials utilized in NexoBrid’s manufacture, including the supply of the active ingredient bromelain are obtained from Taiwan. We expect to begin commercial sales of NexoBrid in the U.S. during the second quarter of 2023.

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Results of Operations

The following is a summary of our consolidated results of operations:

Comparison of the Periods Ended December 31, 2022 and 2021

Total Revenue

Revenue by product is as follows:

Total revenue increase for the year ended December 31, 2022, compared to 2021, was driven primarily by MACI volume and price growth, offset primarily by lower Epicel volume associated with lower incidence of severe burns and lower revenue associated with the delivery of NexoBrid to BARDA for emergency response preparedness.

Seasonality. The effects of the ongoing COVID-19 pandemic have disrupted the normal seasonality of our MACI business at times since March of 2020. These effects have included, among others, periodic restrictions on the performance of elective surgical procedures throughout the country, the unavailability of physicians and/or changes to their treatment prioritizations, reductions in the levels of healthcare facility staffing and, in certain instances, the willingness or ability of patients to seek treatment and the inability of our sales representatives to call on surgeon customers. In the last five years through 2022, MACI sales volumes from the first through the fourth quarter on average represented 20% (18%-21% range), 21% (16%-24% range), 24% (21%-26% range) and 35% (33%-38% range) respectively, of total annual volumes. MACI orders are normally stronger in the fourth quarter due to several factors including the satisfaction by patients of insurance deductible limits and the time of year patients prefer to start rehabilitation. Due to the low incidence and variable occurrence of severe burns, Epicel revenue has inherent variability from quarter-to-quarter and does not exhibit significant seasonality.

Gross Profit

Gross profit increased for the year ended December 31, 2022, compared to the same period in 2021, driven by higher MACI volume and price growth, offset by lower Epicel labor utilization, raw material price increases and higher external storage and manufacturing facility costs.

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Research and Development Expenses

The following table summarizes research and development expenses, which include materials, professional fees and an allocation of employee-related salary and fringe benefit costs for our research and development projects:

Research and development expenses for the year ended December 31, 2022 were $19.9 million, compared to $16.3 million for 2021. The increase is primarily due to an increase of $1.1 million in stock-based compensation expense, additional spend on the design of instruments to be used in connection with the potential arthroscopic delivery of MACI to the knee, if approved by the FDA, and increased headcount, partially offset by reimbursement of expenses related to the NexoBrid BLA resubmission.

Selling, General and Administrative Expenses

Selling, general and administrative expenses for the year ended December 31, 2022 were $106.9 million, compared to $97.6 million for 2021. The increase in selling, general and administrative expenses is primarily due to a $1.8 million increase in stock-based compensation expenses, incremental marketing spend for both MACI and burn care franchises, additional travel and in person events across the commercial organization in addition to higher depreciation related to the new office space in Cambridge, Massachusetts.

Total Other Income

The change in total other income for the year ended December 31, 2022, was due primarily to fluctuations in the rates of return on our investments in various marketable debt securities slightly offset by interest expense related to our Revolving Credit Agreement.

Income Tax Expense (Benefit)

For the year-ended December 31, 2022, we recorded $0.7 million of income tax expense as a result of state income taxes primarily due to the elimination of the option to deduct research and development expenditures immediately in the year incurred and instead amortize such expenditures over five years for tax purposes, and in the same period of 2021, we recorded a state income tax benefit of $0.1 million. We continue to maintain a full valuation allowance on all of our net deferred tax assets.

Beginning in 2022, the Tax Cuts and Jobs Act of 2017 eliminated the option to deduct research and development expenditures immediately in the year incurred and requires taxpayers to amortize such expenditures over five years for tax purposes. While the most significant impact of this provision is to the year ended December 31, 2022, the tax year in which the provision took effect, the impact will decline annually over the five-year amortization period.

Stock-based Compensation Expense

Non-cash stock-based compensation expense is summarized in the following table:

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The increase in stock-based compensation expense for the year ended December 31, 2022, is due primarily to fluctuations in stock prices which impacts the fair value of the options and restricted stock units awarded and the expense recognized in the period.

Comparison of the Periods Ended December 31, 2021 and 2020

For a comparison of our results of operations for the fiscal years ended December 31, 2021 and December 31, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 24, 2022.

Cash Flows

The following table summarizes our sources and uses of cash for each of the periods presented:

For a discussion of our liquidity and capital resources related to our cash flow activities for the fiscal year ended December 31, 2020, see “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” of our annual report on Form 10-K for the fiscal year ended December 31, 2021, filed with the SEC on February 24, 2022.

Net Cash Provided by Operating Activities

Our cash and cash equivalents totaled $51.1 million, short-term investments totaled $68.5 million and long-term investments totaled $20.0 million as of December 31, 2022. The $17.7 million of net cash provided by operations in 2022, was primarily the result of non-cash charges of $37.2 million related to stock compensation expense, $4.2 million in operating lease amortization and $4.0 million in depreciation and amortization expense, offset by a net loss of $16.7 million and a net decrease of $11.2 million related to movements in our working capital accounts. The overall decreases in cash from our working capital accounts were primarily driven by an increase in accounts receivable due to an increase in sales volume, an increase in inventory due to increased production needs and payments on operating leases, offset by an increase of accounts payable and accrued expenses due to timing of payments.

Our cash, cash equivalents and restricted cash totaled $68.5 million, short-term investments totaled $35.1 million and long-term investments totaled $25.7 million as of December 31, 2021. The $29.0 million of net cash provided by operations in 2021, was primarily the result of non-cash charges of $34.3 million related to stock compensation expense, $4.4 million in operating lease amortization and $3.0 million in depreciation and amortization expense, offset by a net loss of $7.5 million and a net decrease of $6.2 million related to movements in our working capital accounts. The overall decreases in cash from our working capital accounts were primarily driven by an increase in accounts receivable due to an increase in sales volume, an increase in inventory due to increased production needs and payments on operating leases, offset by an increase of accounts payable and accrued expenses due to timing of payments.

Net Cash Used in Investing Activities

Net cash used in investing activities during the year ended December 31, 2022 was the result of $69.6 million in investment purchases and $7.6 million of property and equipment purchases primarily for manufacturing upgrades, offset by $40.9 million of investment sales and maturities through December 31, 2022.

Net cash used in investing activities during the year ended December 31, 2021 was the result of $60.0 million in investments purchases and $7.9 million of property and equipment purchases primarily for manufacturing upgrades, offset by $64.4 million of investment sales and maturities through December 31, 2021.

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Net Cash Provided by Financing Activities

Net cash provided by financing activities during the year ended December 31, 2022 was the result of net proceeds from the exercise of stock options and the employee stock purchase plan of $3.7 million, partially offset by the payment of employee withholding taxes related to the vesting of restricted stock units of $1.5 million and payments of debt issuance costs of $1.1 million.

Net cash provided by financing activities during the year ended December 31, 2021 was the result of net proceeds from the exercise of stock options and the employee stock purchase plan of $11.2 million, partially offset by the payment of employee withholding taxes related to the vesting of restricted stock units of $1.7 million.

Liquidity

Since our acquisition of MACI and Epicel in 2014, our primary focus has been to invest in our existing commercial business with the goal of growing revenue. We have raised significant funds in order to advance and complete our product development and product life-cycle management programs and to market and commercialize our products, including NexoBrid. To date, we have financed our operations primarily through cash received through Epicel and MACI sales, debt, and public and private sales of our equity securities. We generated $17.7 million in operating cash flows during 2022 and we may finance our operations through the sales of equity securities, revolver borrowings or other debt financings.

We believe that our current cash on hand, cash equivalents, investments, and available borrowing capacity will be sufficient to support our current operations through at least 12 months from the issuance of the consolidated financial statements included in this Annual Report on Form 10-K. Although the effects of the ongoing COVID-19 pandemic have lessened in recent months, our business and operations may be adversely affected in the future if conditions were to worsen. Our actual cash requirements may differ from projections and will depend on many factors, including any future impacts of the COVID-19 pandemic, the level and pace of future research and development efforts, the scope and results of ongoing and potential clinical trials, the costs involved in filing, prosecuting and enforcing patents, the need for additional manufacturing capacity, competing technological and market developments, costs associated with possible acquisitions or development of complementary business activities, and the cost to market our products.

Sources of Capital

On August 27, 2021, we entered into a Sales Agreement with SVB Leerink LLC, as sales agent (“SVB Leerink”), pursuant to which we may offer and sell up to $200.0 million of shares of our common stock, no par value per share (“ATM Shares”). The ATM Shares to be offered and sold under the Sales Agreement will be issued and sold pursuant to an automatically effective shelf registration statement on Form S-3ASR (File No. 333-259119) filed by us on August 27, 2021, which expires three years from the filing date. We also filed a prospectus supplement relating to the offering and sale of the ATM Shares on August 27, 2021. We are not obligated to make any sales of ATM Shares, and SVB Leerink is not required to sell any specific number or dollar amount of the ATM Shares under the Sales Agreement. As of December 31, 2022, we have sold no shares pursuant to the Sales Agreement.

On July 29, 2022, we entered into a $150.0 million five-year senior secured revolving credit agreement by and among the Company, the other loan parties thereto, the lenders party thereto, and JPMorgan Chase Bank, N.A., as the administrative agent (the “Revolving Credit Agreement”). We have no immediate plans to borrow under the Revolving Credit Agreement, but we may use the facility for working capital needs and other general corporate purposes. As of December 31, 2022, there are no outstanding borrowings under the Revolving Credit Agreement, and we are in compliance with all applicable covenant requirements. See Note 8, “Revolving Credit Agreement” in the accompanying consolidated financial statements for further details.

Contractual Obligations

We lease facilities in Ann Arbor, Michigan and Cambridge, Massachusetts. The Cambridge facilities include clean rooms, laboratories for MACI and Epicel manufacturing and office space. We also pay for use of two offsite warehouse spaces and lease computer equipment. In October 2020, we amended our current lease in Cambridge to, among other provisions, extend the term until February 2032. Total remaining obligations related to the operating and finance leases are $61.1 million as of December 31, 2022. In January 2022, we entered into a new lease for approximately 126,000 square feet of to-be-constructed manufacturing, laboratory and office space in Burlington, Massachusetts. The obligations related to this lease are $98.9 million

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and the lease provides for a tenant improvement allowance of $25.1 million. See Note 5, “Leases” in our accompanying consolidated financial statements for further information.

Our purchase commitments consist of minimum purchase amounts of materials used in our cell manufacturing process to manufacture our marketed cell therapy products and total $3.4 million as of December 31, 2022, as well as usage of offsite warehouse space. The total remaining contractual obligations related to the warehouse agreement are $5.8 million as of December 31, 2022. See Note 15, “Commitments and Contingencies” in our accompanying consolidated financial statements for further information.

We have no off-balance sheet arrangements that have or are reasonably likely to have a material effect on our financial condition.

Critical Accounting Policies and Estimates

The preparation of our consolidated financial statements in accordance with U.S. generally accepted accounting principles (“GAAP”) requires management to make estimates and assumptions that could materially impact the consolidated financial statements and disclosures based on varying assumptions. We believe our estimates and assumptions are reasonable; however, actual results and the timing of the recognition of such amounts could differ from these estimates.

The following is a list of accounting policies that are most significant to the portrayal of our financial condition and results of operations and/or that require management’s most difficult, subjective or complex judgments.

Revenue Recognition and Net Product Sales

Revenue from sales to a customer (distributor, hospital or other party) is recognized in accordance with ASC 606, Revenue Recognition. We recognize product revenue from sales to a customer (distributor or hospital) following the five-step model in ASC 606: (i) identify contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenues when (or as) we satisfy the performance obligation. Under this revenue standard, we recognize revenue when our customer obtains control of the promised goods, in an amount that reflects the consideration which we expect to receive in exchange for those goods.

MACI Implants

We have engaged a third-party services provider to provide the patient support program to manage patient cases and to ensure complete and accurate billing information is provided to the insurers and hospitals, to facilitate reimbursement.

Most cases in which MACI is used require prior authorization and confirmation of coverage by the patient’s insurance plan or government payers prior to the shipment of product to a hospital or an ambulatory surgical center. We recognize product revenues from sales of all MACI implants upon delivery at which time the customer obtains control of the implant and the claim is billable. The total consideration which we expect to collect in exchange for MACI implants (the transaction price) may be fixed or variable. Direct sales to hospitals or ambulatory surgical centers are recorded at a contracted price, there are typically no forms of variable consideration.

When we sell MACI the patient is responsible for payment; however, we are typically reimbursed by a third-party insurer or government payer, subject to a patient co-pay amount. Reimbursements from third-party insurers and government payers vary by patient and payer and are based on either contracted rates, publicly available rates or a fee schedule. Net product revenue is recognized net of estimated contractual allowances, which considers historical collection experience from both the payer and patient, denial rates and the terms of our contractual arrangements. We estimate expected collections for these transactions using the portfolio approach. We record a reduction to revenue at the time of sale for the estimate of the amount of consideration that will not be collected. In addition, potential credit risk exposure has been evaluated for our accounts receivable in accordance with ASC 326, Financial Instruments - Credit Losses. We assess risk and determine a loss percentage by pooling accounts receivable based on similar risk characteristics. The loss percentage is calculated through the use of forecasts that are based on current and historical economic and financial information.

Changes in estimates of the transaction price are recorded through revenue in the period in which such change occurs. Changes to the estimate of the amount of consideration that will not be collected could have a material impact to the revenue

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recognized. A 50 basis points change to the estimated uncollectible percentage could result in approximately $0.4 million decrease or increase in the revenue recognized for the year ended December 31, 2022.

Leases

We determine if an arrangement is a lease at inception, in accordance with ASC Topic 842, Leases. All operating lease commitments with a lease term greater than 12 months are recognized as right-of-use (“ROU”) assets and liabilities, on a discounted basis on the balance sheet. Leases with an initial term of 12 months or less are not recorded on the balance sheet. We primarily enter into lease agreements for manufacturing and office space, warehouses space, and other computer-related equipment. The leases have varying terms, some of which may include options to extend. Certain of our lease agreements include lease payments that are adjusted periodically for an index or rate. The leases are initially measured using the present value of the projected payments adjusted for the index or rate in effect at the commencement date. Our lease agreements do not contain any material residual value guarantees or material restrictive covenants.

ROU assets represent our right to control the use of an explicitly or implicitly identified fixed asset for a period of time and lease liabilities represent our obligation to make lease payments arising from the lease. Control of an underlying asset is conveyed to us if we obtain the rights to direct the use of and to obtain substantially all of the economic benefits from using the underlying asset.

Lease payments included in the measurement of the lease liability are comprised of fixed payments. Our leases contain non-lease components and activities that do not transfer a good or service to us which were not considered to be components of the contract and therefore were not included in the net ROU assets or lease liabilities.

The lease term for all of our leases include the non-cancellable period of the lease plus any additional periods covered by either an option to extend (or not to terminate) the lease that is reasonably certain to exercise, or an option to extend (or not to terminate) the lease controlled by the lessor.

Stock-Based Compensation

The accounting for stock-based compensation requires us to determine the fair value of common stock issued in the form of stock option awards and restricted stock units. The fair value of restricted stock units held by the employees is determined based on the fair value of our common stock on the date of the grant. We use the value of our common stock at the date of the grant in the calculation of the fair value of our share-based awards. The fair value of stock options held by our employees is determined using a Black-Scholes option valuation method, which is a valuation technique that is acceptable for share-based payment accounting. Key assumptions in determining fair value include volatility, risk-free interest rate, dividend yield and expected term. The assumptions used in calculating the fair value of stock options represent our best estimates; however, these estimates involve inherent uncertainties and the application of management’s judgment. As a result, if factors change and different assumptions are used, the stock-based compensation expense could be materially different in the future. In addition, we are required to estimate the expected forfeiture rate and only recognize expense for those stock options expected to vest over the service period. We estimate the forfeiture rate considering the historical experience of our stock-based awards. If the actual forfeiture rate is different from the estimate, we adjust the expense accordingly. We record the expense for stock options and restricted stock units using a graded-vesting attribution method.

Tax Valuation Allowance

A valuation allowance is recorded if it is more likely than not that a deferred tax asset will not be realized based on the weight of available evidence, both positive and negative. Due to our three-year cumulative loss position and history of operating losses, a full valuation allowance against our net deferred tax assets was considered necessary. We will continue to monitor our cumulative loss position and forecasts and reevaluate the need for a valuation allowance as it could be reversed in future periods.

This summary of significant accounting policies should be read in conjunction with our consolidated financial statements and related notes and this discussion of our results of operations.

Recent Accounting Pronouncements

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Refer to Note 2, “Summary of Significant Accounting Policies” in the accompanying consolidated financial statements located under Item 8 of this Annual Report on Form 10-K for information regarding recently issued accounting standards that may have a significant impact on our business.