Eton Pharmaceuticals, Inc. 10-Q

Item 2. 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 in conjunction with (i) our unaudited interim condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (ii) our audited financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations Included in our Annual Report on Form 10-K for the year ended December 31, 2020 filed with the Securities and Exchange Commission (the “SEC”) on March 16, 2021 (the “2020 10-K”). Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” “may,” “plan”, “seek” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider other matters set forth in our SEC filings including the Risk Factors set forth in Part I, Item 1A of our 2020 10-K. Overview We are a specialty pharmaceutical company focused on developing, acquiring, and commercializing innovative pharmaceutical products and we have particularly targeted hospital injectable and pediatric rare disease products. We seek to improve the formula, delivery system, or safety of existing molecules in order to address unmet patient needs. We pursue what we perceive to be low-risk candidates where existing published literature, historical clinical trials, or physician usage has established safety and/or efficacy of the molecule, thereby reducing the incremental clinical burden required for us to bring the product to patients. In October 2019, we received FDA approval for Biorphen® which we are marketing in the United States. Biorphen (phenylephrine HCl injection) is an alpha-1 adrenergic receptor agonist indicated for the treatment of clinically important hypotension resulting primarily from vasodilation in the setting of anesthesia. In September 2020, the FDA approved our Alkindi Sprinkle product as a replacement therapy for pediatric adrenal insufficiency (AI), including congenital adrenal hyperplasia (CAH) in patients from birth to less than 17 years of age. In addition, the FDA approved EM-100, an eye allergy product which we sold to Bausch Health whereby we will receive royalties on sales of EM-100 which was launched in late January 2021. We received a $1,500 milestone payment from Bausch in accordance with the product launch for EM-100. In February 2021, we sold three pediatric neurology products we had under development to Azurity Pharmaceuticals (“Azurity”) and have received $12,000 in proceeds. We anticipate additional revenues from Azurity based on various product-related milestones including the commercial launch for these products which are currently under review with the FDA. We have established a diversified pipeline of product candidates in various stages of development, including multiple candidates that have been submitted to the FDA for review. Our product candidates are primarily focused on two core areas: hospital-based products and pediatric rare disease products. We believe these candidates can address situations where patient needs are not being met by current FDA-approved products. Results of Operations For the three-month period ended June 30, 2021 we had $3,067 in revenues mainly from the Azurity milestones revenue of $2,500 discussed above plus $567 in product sales and royalties which generated a total gross profit of $2,931 for the period. We realized $20 in net sales of Biorphen for the three-month period ended June 30, 2020 at a negative gross profit of $8 mainly as a result of the impact of the COVID-19 pandemic which adversely impacted our promotion and in-person sales call activity. For the six-month period ended June 30, 2021 we realized $14,964 in revenues mainly from the $14,000 of Azurity and Bausch and other milestone revenues discussed above plus $964 of product sales and royalties which generated a total gross profit of $13,238 for the period. Revenues for the six-month period ended June 30, 2020 of $119 in net sales of Biorphen at a negative gross profit of $11 mainly as a result of the impact of the COVID-19 pandemic which adversely impacted our promotion and in-person sales call activity. 25 Research and Development Expenses For the three-month periods ended June 30, 2021 and 2020, we incurred $1,990 and $1,609, respectively, of research and development (“R&D”) expenses. The R&D expense reflects an overall $381 higher expense level in 2021 mainly due to increased spending for general product development partially offset by decreased laboratory expenses in the 2021 period. For the six-month periods ended June 30, 2021 and 2020, we incurred $2,876 and $7,877, respectively, of R&D expense. The 2020 period included $4,764 in expense for the licensing payments for the U.S. rights to Alkindi® Sprinkle. The six-month R&D expense reflects an overall $5,001 lower expense level in 2021 mainly as a result of the licensing payments noted for Alkindi Sprinkle in 2020. We discontinued our laboratory operations at the end of March 2021. General and Administrative Expenses General and administrative (“G&A”) expenses consist primarily of employee compensation expenses, legal and professional fees, product marketing expenses, distribution expenses, business insurance, travel expenses and general office expenses. For the three-month periods ended June 30, 2021 and 2020, we incurred $3,266 and $2,921, respectively, of G&A expenses. The $345 increase in G&A expense was mainly due to increased product marketing/distribution and selling expenses related to Alkindi Sprinkle commercialization partially offset by a lower level of legal expenses from our initiating a Paragraph IV patent challenge against Exela Pharma Science’s Elcys product (cysteine hydrochloride injection) in 2020. For the six-month periods ended June 30, 2021 and 2020, we incurred $7,324 and $5,531, respectively, of G&A expenses. The $1,793 increase in G&A expense was mainly due to increased product marketing/distribution and selling expenses related to Alkindi Sprinkle commercialization partially offset by a lower level of legal expenses from our initiating a Paragraph IV patent challenge against Exela Pharma Science’s Elcys product (cysteine hydrochloride injection) in 2020. Interest and other (expense) income We had slightly higher interest expense level for the three and six-month periods ended June 30, 2021 as compared to the same periods in 2020 due to our borrowing an additional $2,000 under our SWK loan facility in August 2020. We recognized a $181 gain from the sale of our laboratory equipment in May 2021 and also recognized a $365 gain from the forgiveness of our SBA PPP loan in May 2021. 26 We incurred a net loss of $2,016 and $4,730 for the three-month periods ended June 30, 2021 and 2020, respectively. The decreased loss in the 2021 period was mainly a result of increased revenues of $3,047 which were partially offset by increased operating expenses as discussed above. In addition, the gain from the sale of our laboratory equipment and the gain from the PPP loan forgiveness contributed to the decrease in the net loss for the period. We realized net income of $3,100 and a net loss of $13,779 for the six-month periods ended June 30, 2021 and 2020, respectively. The improvement in earnings in the 2021 period was mainly a result of increased revenues of $14,845 and lower product research and development spending partially offset by higher general and administrative expenses for sales/promotion activities to support the launch of Alkindi Sprinkle. In addition, the $181 gain from the sale of our laboratory equipment and the $365 gain from the PPP loan forgiveness contributed to net income for the period. Cash Flows The following table sets forth a summary of our cash flows for the six-month periods ended June 30, 2021 and 2020: Six months ended June 30, 2021 Six months ended June 30, 2020 Net cash provided by (used in) operating activities $ 3,346 $ (10,070 ) Cash provided by (used in) investing activities 697 (4 ) Cash flows from financing activities 464 8,278 Change in cash and cash equivalents $ 4,507 $ (1,796 ) The improvement in cash provided by operating activities was mainly due to the higher operating earnings in 2021 that were partially offset by working capital changes when compared to the same period in 2020. Investing activities reflected the $700 sale of lab equipment in May 2021 and only nominal equipment spending requirements in 2020. The change in financing activity cash flows was primarily the result of the sales of our common stock for $7,756 in March and April 2020. 27 Critical Accounting Policies Our condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our condensed financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, costs and expenses in our condensed financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are 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. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 3 to our financial statements included herein, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements. Revenue Recognition We account for contracts with our customers in accordance with Accounting Standards Codification (“ASC”) 606 — Revenue from Contracts with Customers. ASC 606 applies to all contracts with customers, except for contracts that are within the scope of other standards. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the 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 revenue when (or as) the entity satisfies a performance obligation. At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determines those that are performance obligations and assesses whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Arrangements that include rights to additional goods or services that are exercisable at a customer’s discretion are generally considered options. We assess whether these options provide a material right to the customer and, if so, they are considered performance obligations. The exercise of a material right is accounted for as a contract modification for accounting purposes. We recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) each performance obligation is satisfied at a point in time or over time, and if over time this is based on the use of an output or input method. Any amounts received prior to revenue recognition will be recorded as deferred revenue. Amounts expected to be recognized as revenue within the twelve months following the balance sheet date will be classified as current portion of deferred revenue in our balance sheets. Amounts not expected to be recognized as revenue within the twelve months following the balance sheet date are classified as long-term deferred revenue, net of current portion. Milestone Payments – If a commercial contract arrangement includes development and regulatory milestone payments, we will evaluate whether the milestone conditions have been achieved and if it is probable that a significant revenue reversal would not occur before recognizing the associated revenue. Milestone payments that are not within our control or the licensee’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received. Royalties – For arrangements that include sales-based royalties, including milestone payments based on a level of sales, which are the result of a customer-vendor relationship and for which the license is deemed to be the predominant item to which the royalties relate, we will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied or partially satisfied. Significant Financing Component – In determining the transaction price, we will adjust consideration for the effects of the time value of money if the expected period between payment by the licensees and the transfer of the promised goods or services to the licensees will be more than one year. 28 We sell Biorphen in the U.S. to wholesale pharmaceutical distributors, who then sell the product to hospitals and other end-user customers. Sales to wholesalers are made pursuant to purchase orders subject to the terms of a master agreement, and delivery of individual shipments of Biorphen represent performance obligations under each purchase order. We use a third-party logistics (“3PL”) vendor to process and fulfill orders and have concluded it is the principal in the sales to wholesalers because it controls access to the 3PL vendor services rendered and directs the 3PL vendor activities. We have no significant obligations to wholesalers to generate pull-through sales. In addition, we sell our Alkindi Sprinkle product to one pharmacy distributor customer which provides order fulfillment and inventory storage/distribution services. Selling prices initially billed to wholesalers are subject to discounts for prompt payment and subsequent chargebacks when the wholesalers sell Biorphen at negotiated discounted prices to members of certain group purchasing organizations (“GPOs”) and government programs. In addition, we pay fees to wholesalers for their distribution services, inventory reporting and chargeback processing. We pay GPOs fees for administrative services and for access to GPO members and concluded the benefits received in exchange for these fees are not distinct from our sales of Biorphen, and accordingly we apply these amounts to reduce revenues. Wholesalers also have rights to return unsold product nearing or past the expiration date. Because of the shelf life of Biorphen and our lengthy return period, there may be a significant period of time between when the product is shipped and when we issue credits on returned product. For our Alkindi Sprinkle product, we bill at the initial product list prices which are subject to offsets for patient co-pay assistance and potential state Medicaid reimbursements which are recorded as a reduction of net revenues at the date of sale/shipment. We estimate the transaction price when we receive each purchase order, taking into account the expected reductions of the selling price initially billed to the wholesaler arising from all of the above factors. We have developed estimates for future returns and chargebacks of Biorphen and the impact of the other discounts and fees we pay. Our sales of Alkindi Sprinkle to our distributor are not subject to returns. When estimating these adjustments to the transaction price, we reduce it sufficiently to be able to assert that it is probable that there will be no significant reversal of revenue when the ultimate adjustment amounts are known. We recognize revenue from Biorphen product sales and related cost of sales upon product delivery to the wholesaler location. At that time, the wholesalers take control of the product as they take title, bear the risk of loss of ownership, and have an enforceable obligation to pay us. They also have the ability to direct sales of product to their customers on terms and at prices they negotiate. Although wholesalers have product return rights, we do not believe they have a significant incentive to return the product to us. We store our Alkindi Sprinkle inventory at our pharmacy distributor customer location and sales are recorded when stock is pulled and shipped to fulfill specific patient orders. Upon recognition of revenue from product sales, the estimated amounts of credit for product returns, chargebacks, distribution fees, prompt payment discounts, state Medicaid and GPO fees are included in sales reserves, accrued liabilities and net of accounts receivable. We monitor actual product returns, chargebacks, discounts and fees subsequent to the sale. If these amounts end up differing from our estimates, we will make adjustments to these allowances, which are applied to increase or reduce product sales revenue and earnings in the period of adjustment. Stock-Based Compensation We account for stock-based compensation under the provisions of Accounting Standards Codification (“ASC”) – 718 Compensation – Stock Compensation. The guidance under ASC 718 requires companies to estimate the fair value of the stock-based compensation awards on the date of grant and record expense over the related service periods, which are generally the vesting period of the equity awards. Compensation expense is recognized over the period during which services are rendered by consultants and non-employees until completed. At the end of each financial reporting period prior to completion of the service, the fair value of these awards is remeasured using the then-current fair value of our common stock and updated assumption inputs in the Black-Scholes option-pricing model (“BSM”). We estimate the fair value of stock-based option awards to our using the BSM. The BSM requires the input of subjective assumptions, including the expected stock price volatility, the calculation of expected term, forfeitures and the fair value of the underlying common stock on the date of grant, among other inputs. The risk-free interest rate was determined from the implied yields for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options or warrants. Dividends on common stock are assumed to be zero for the BSM valuation of the stock options. The expected term of stock options granted is based on vesting periods and the contractual life of the options. Expected volatilities are based on comparable companies’ historical volatility along with a limited weighting included for our own volatility subsequent to our IPO, which we believe represents the most accurate basis for estimating expected future volatility under the current conditions. We account for forfeitures as they occur. 29 Prior to our initial public offering in November 2018, the fair value of the shares of common stock underlying our stock-based awards was determined by our board of directors, with input from management. Because there had been no public market for our common stock prior to the IPO, our board of directors had determined the fair value of the common stock on the grant-date of the stock-based award by considering a number of objective and subjective factors, including enterprise valuations of our common stock performed by an unrelated third-party specialist, valuations of comparable companies, sales of our convertible preferred stock to unrelated third parties, operating and financial performance, the lack of liquidity of our capital stock, and general and industry-specific economic outlook. Following our IPO, we use the closing stock price on the date of grant for the fair value of the common stock. Research and Development Expenses R&D expenses include both internal R&D activities and external contracted services. Internal R&D activity expenses include salaries, benefits and stock-based compensation and other costs to support our R&D operations. External contracted services include product development efforts including certain product licensor milestone payments, clinical trial activities, manufacturing and control-related activities and regulatory costs. R&D expenses are charged to operations as incurred. We review and accrue R&D expenses based on services performed and rely upon estimates of those costs applicable to the stage of completion of each project. Significant judgments and estimates are made in determining the accrued balances at the end of any reporting period. Actual results could differ from our estimates. Upfront payments and milestone payments made for the licensing of technology for products that are not yet approved by the FDA are expensed as R&D in the period in which they are incurred. Nonrefundable advance payments for goods or services to be received in the future for use in R&D activities are recorded as prepaid expenses and are expensed as the related goods are delivered or the services are performed. Off Balance Sheet Transactions We do not have any off-balance sheet transactions. JOBS Act Transition Period In April 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies. We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements under the JOBS Act. Subject to certain conditions, as an emerging growth company, we may rely on certain of these exemptions, including without limitation, (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (ii) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earlier to occur of (1) the last day of the fiscal year (a) December 31, 2023, which is the end of the fiscal year following the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenues of at least $1.07 billion or (c) in which we are deemed to be a “large accelerated filer” under the rules of the SEC, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.