HARROW, INC. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our unaudited condensed consolidated financial statements and the related notes thereto contained in Part I, Item 1 of this Quarterly Report on Form 10-Q (this “Quarterly Report”). Our condensed consolidated financial statements have been prepared and, unless otherwise stated, the information derived therefrom as presented in this discussion and analysis is presented, in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The information contained in this Quarterly Report is not a complete description of our business or the risks associated with an investment in our common stock. We urge you to carefully review and consider the various disclosures made by us in this Quarterly Report and in our other reports filed with the U.S. Securities and Exchange Commission (the “SEC”), including our Annual Report on Form 10-K for the fiscal year ended December 31, 2019 and subsequent reports, which discuss our business in greater detail. As used in this discussion and analysis, unless the context indicates otherwise, the terms the “Company”, “Harrow” “we”, “us” and “our” refer to Harrow Health, Inc. and its consolidated subsidiaries, consisting of Park Compounding, Inc., ImprimisRx, LLC, ImprimisRx NJ, LLC dba ImprimisRx, Imprimis NJOF, LLC, Radley Pharmaceuticals, Inc., Mayfield Pharmaceuticals, Inc., and Stowe Pharmaceuticals, Inc. In this discussion and analysis, we refer to our consolidated subsidiaries ImprimisRx, LLC, ImprimisRx NJ, LLC and Imprimis NJOF, LLC collectively as “ImprimisRx.” In addition to historical information, the following discussion contains forward-looking statements regarding future events and our future performance. In some cases, you can identify forward-looking statements by terminology such as “will”, “may”, “should”, “expects”, “plans”, “anticipates”, “believes”, “estimates”, “predicts”, “forecasts”, “potential” or “continue” or the negative of these terms or other comparable terminology. All statements made in this Quarterly Report other than statements of historical fact are forward-looking statements. These forward-looking statements involve risks and uncertainties and reflect only our current views, expectations and assumptions with respect to future events and our future performance. If risks or uncertainties materialize or assumptions prove incorrect, actual results or events could differ materially from those expressed or implied by such forward-looking statements. Risks that could cause actual results to differ from those expressed or implied by the forward-looking statements we make include, among others, risks related to: the impact of the COVID-19 pandemic on our financial condition, liquidity or results of operations; our ability to successfully implement our business plan, develop and commercialize our proprietary formulations in a timely manner or at all, identify and acquire additional proprietary formulations, manage our pharmacy operations, service our debt, obtain financing necessary to operate our business, recruit and retain qualified personnel, manage any growth we may experience and successfully realize the benefits of our previous acquisitions and any other acquisitions and collaborative arrangements we may pursue; competition from pharmaceutical companies, outsourcing facilities and pharmacies; general economic and business conditions; regulatory and legal risks and uncertainties related to our pharmacy operations and the pharmacy and pharmaceutical business in general; physician interest in and market acceptance of our current and any future formulations and compounding pharmacies generally; our limited operating history; and the other risks and uncertainties described under the heading “Risk Factors” in Part II, Item 1A of this Quarterly Report and in our other filings with the Securities and Exchange Commission. You should not place undue reliance on forward-looking statements. Forward-looking statements speak only as of the date they are made and, except as required by law, we undertake no obligation to revise or publicly update any forward-looking statement for any reason. Overview Our business specializes in the development, production and sale of innovative medications that offer unique competitive advantages and serve unmet needs in the marketplace through our subsidiaries and deconsolidated companies. We own and operate one of the nation’s leading ophthalmology pharmaceutical businesses, ImprimisRx. In addition to wholly owning ImprimisRx, we also have non-controlling equity positions in Eton Pharmaceuticals, Inc. (“Eton”), Surface Ophthalmics, Inc. (“Surface”), and Melt Pharmaceuticals, Inc. (“Melt”), all companies that began as subsidiaries of Harrow. More recently, we founded drug development subsidiaries Mayfield Pharmaceuticals, Inc. (“Mayfield”) and Stowe Pharmaceuticals, Inc. (“Stowe”), among others. We also intend to launch a new business called Visionology. We own royalty rights in various drug candidates being developed by Surface, Melt and Mayfield. We intend to continue to create and hold equity and royalty rights in new businesses that commercialize drug candidates that are internally developed or otherwise acquired or licensed from third parties. 30 ImprimisRx ImprimisRx is our ophthalmology focused prescription pharmaceutical business. We offer to over 9,000 physician customers and their patients critical medicines to meet their needs that are unmet by commercially available drugs. We make our formulations available at prices that are, in most cases, lower than non-customized commercial drugs. Our current ophthalmology formulary includes over twenty compounded formulations, many of which are patented or patent-pending, and are customizable for the specific needs of a patient. Some examples of our compounded medications are various combinations of drugs formulated into one bottle and numerous preservative free formulations. Depending on the formulation, the regulations of a specific state and ultimately the needs of the patient, ImprimisRx products may be dispensed as patient-specific medications from our 503A pharmacy, or for in-office use, made according to current good manufacturing practices (or cGMPs) or other FDA guidance documents, in our FDA-registered New Jersey Outsourcing Facility (“NJOF”). Visionology Visionology is expected to be an online eye health platform. Visionology will leverage our experience in the ophthalmic pharmaceutical business as well as our relationships with eyecare professionals across the United States. We expect to launch a proof-of-concept model for Visionology within a certain region of the U.S after securing financing. If successful, Visionology will expand the launch on a nationwide basis later in 2021. Pharmaceutical Compounding Businesses Pharmaceutical Compounding Pharmaceutical compounding is the science of combining different active pharmaceutical ingredients (APIs), all of which are approved by the FDA (either as a finished form product or as a bulk drug ingredient) and excipients, to create specialized pharmaceutical preparations. Physicians and healthcare institutions use compounded drugs when commercially available drugs do not optimally treat a patient’s needs. In many cases, compounded drugs, such as ours, have wide market utility and may be clinically appropriate for large patient populations. Examples of compounded formulations include medications with alternative dosage strengths or unique dosage forms, such as topical creams or gels, suspensions, or solutions with more tolerable drug delivery vehicles. Almost all of our sales revenue is derived from making, selling and dispensing our compounded prescription drug formulations as cash pay transactions between us and our end-user customer. As such, the majority of our commercial transactions do not involve distributors, wholesalers, insurance companies, pharmacy benefit managers or other middle parties. By not being reliant on insurance company formulary inclusion and pharmacy benefit manager payment clawbacks, we are able to simplify the prescription transaction process. We believe the outcome of our business model is a simple transaction, involving a patient-in-need, a physician’s diagnosis, a fair price and great service for a quality pharmaceutical product. We sell our products through a network of employees and independent contractors and we dispense our formulations in all 50 states, Puerto Rico and in selected markets outside the United States. Our Compounding Facilities Pharmaceutical compounding businesses are governed by Sections 503A and 503B of the Federal Food Drug and Cosmetic Act (the “FDCA”). Section 503A of the FDCA provides that a pharmacy is only permitted to compound a drug for an individually identified patient based on a prescription for a patient, and is only permitted to distribute the drug interstate if the pharmacy is licensed to do so in the states where it is compounded and where the medication is received. Section 503B of the FDCA provides that a pharmacy engaged in preparing sterile compounded drug formulations may voluntarily elect to register as an “outsourcing facility.” Outsourcing facilities are permitted to compound large quantities of drugs without a prescription and distribute them out of state with certain limitations such as the formulation appearing on the FDA’s drug shortage list or the bulk drug substances contained in the formulations appearing on the FDA’s “clinical need” list. Entities voluntarily registering with FDA as outsourcing facilities are subject to additional requirements that do not apply to compounding pharmacies (operating under Section 503A of the FDCA), including adhering to standards such as current good manufacturing practices (cGMP) or other FDA guidance documents and being subject to regular FDA inspection. We operate two compounding facilities located in Ledgewood, New Jersey. Our New Jersey operations are comprised of two separate entities and facilities, one of which is registered with the FDA as an outsourcing facility under Section 503B of the FDCA. The other New Jersey facility (“RxNJ”), is a licensed pharmacy operating under Section 503A of the FDCA. All products that we sell, produce and dispense are made in the United States. 31 We believe that, with our current compounding pharmacy facilities and licenses and FDA registration of NJOF, we have the infrastructure to scale our business appropriately under the current regulatory landscape and meet the potential growth in demand we are targeting. We plan to invest in one or both of our facilities to further their capacity and efficiencies. Also, we may seek to access greater pharmacy and production related redundancy and markets through acquisitions, partnerships or other strategic transactions. Pharmaceutical Development Businesses We have ownership interests in Eton, Surface, Melt, Mayfield, and Stowe and hold royalty interests in certain of their drug candidates. These companies are pursuing market approval for their drug candidates under the FDCA, including in some instances under the abbreviated pathway described in Section 505(b)(2) which permits the submission of a new drug application (“NDA”) where at least some of the information required for approval comes from studies not conducted by or for the applicant and for which the applicant has not obtained a right of reference. We intend to create additional subsidiaries that will be focused on the development and FDA approval of certain proprietary drug formulations that we currently own, will in-license/acquire and/or otherwise develop. Consolidated Businesses (Controlling Equity Interests) Stowe Pharmaceuticals, Inc. Stowe is a consolidated subsidiary of Harrow that was formed in 2019, focused on the development of its proprietary ophthalmic drug candidate STE-006. STE-006 is a patented, new chemical entity, small molecule topical drug candidate intended to treat various bacterial, fungal, and viral infections in the eye and ear. In initial preclinical models, STE-006 was shown to be significantly more effective compared to current conventional therapies against numerous bacterial and viral pathogens, including strains of methicillin-resistant staphylococcus aureus, or MRSA, and herpes simplex virus. STE-006 has several patents covering matter of composition, methods of production, methods of use and molecule, which are valid until 2038. In October 2020, we completed in vivo preclinical studies of certain anti-viral activity of STE-006 along with another asset DS-007. We also conducted in vitro studies earlier in the year, that studied certain antibacterial activity of STE-006. While the initial data from our studies were positive, we were unable to replicate as strong of data as previously produced on STE-006. Therefore, while we remain interested in pathogen-agnostic topical agents to treat non-specific conjunctivitis, we do not intend to invest further in STE-006. We are currently evaluating the market and clinical potential of DS-007 and other Harrow formulations in the anti-infective category. We own 2,500,000 shares of Stowe common stock, and control 70% of the equity and voting interests issued and outstanding of Stowe, at September 30, 2020. Mayfield Pharmaceuticals, Inc. Mayfield, a consolidated subsidiary of Harrow, is a development-stage pharmaceutical company focused on consequential products that address the conspicuous unmet needs of patients. Its development programs focus on using known molecules in dosage forms for new indications, and by developing new chemical entities with known mechanisms of action. Mayfield recently licensed worldwide rights to a first-in-class antimicrobial drug candidate, called MAY-66, which is being studied to treat recurrent bacterial vaginosis. In February 2019, Mayfield acquired drug formulation assets and intellectual property, including three recently issued patents, for MAY-44, a drug candidate for the treatment of dyspareunia, or pain experienced by women during sexual intercourse. In addition to MAY-44, Mayfield is also developing MAY-88 for patients suffering from interstitial cystitis, which it will acquire from Harrow at the closing of a deconsolidating transaction. We own 2,500,000 shares of Mayfield common stock, and control 79% of the equity and voting interests issued and outstanding of Mayfield, at September 30, 2020. We are currently pursuing a deconsolidating transaction for Mayfield. We have contracted with an experienced life science executive that we expect to lead Mayfield once deconsolidated. Radley Pharmaceuticals, Inc. Radley Pharmaceuticals, Inc. (“Radley”), a consolidated subsidiary of Harrow, is a development-stage pharmaceutical company that has been focused on the development of proprietary drug candidates focused on rare diseases. Radley currently has three drug programs in its pipeline. During the second quarter of 2020, we suspended all activities related to Radley to focus attention and capital on other projects. Currently, we do not intend to resume the activities related to Radley. 32 De-Consolidated Businesses (Noncontrolling Equity Interests) Eton Pharmaceuticals, Inc. Eton is a pharmaceutical company focused on developing and commercializing innovative products utilizing the FDA’s 505(b)(2) regulatory pathway. Its pipeline includes several products and drug candidates in various stages of development across a variety of dosage forms. Eton’s pipeline is focused on innovative 505(b)(2) products and obtaining FDA marketing approval for currently marketed but unapproved drugs. In May 2017, Eton closed an offering of its Series A Preferred Stock and we lost our controlling interest in it. In November 2018, Eton completed an initial public offering of its common stock. We own 3,500,000 shares of Eton common stock, which is less than 20% of the equity and voting interests issued and outstanding of Eton as of September 30, 2020. Surface Ophthalmics, Inc. (f/k/a Surface Pharmaceuticals, Inc.) Surface is a development-stage pharmaceutical company focused on development and commercialization of innovative therapeutics for ocular surface diseases and is seeking FDA approval for the commercialization of its drug candidates through the Section 505(b)(2) regulatory pathway under the FDCA. In 2017 and amended in April 2018, Harrow entered into asset purchase and license agreements (the “Surface License Agreements”) and transferred to Surface its current drug pipeline, which consists of three proprietary drug candidates. Surface’s patent-pending topical eye drop drug candidates, SURF-100 and SURF-200, utilize a patented delivery vehicle known as Klarity Drops (“Klarity”), that was invented by Harrow board member and Surface’s chairman of the board, renowned ophthalmologist Dr. Richard Lindstrom. During the fourth quarter of 2019, Surface filed an investigational new drug application (“IND”) for its drug program SURF-201. SURF-201 is a novel steroid topical eye drop drug candidate for treating pain and inflammation post-ocular surgery. Surface submitted an IND for its lead drug candidate, SURF-100, in May 2020, for treating signs and symptoms associated with chronic dry eye disease. Surface also filed a third IND during the first half of 2020. We expect Surface may release certain clinical data related to these programs near the end of 2020 and beginning of 2021, however such clinical programs were delayed as a result of the ongoing COVID-19 pandemic and as a result, data from these clinical programs will likely be delayed as well. In May and July 2018, Surface closed on an offering of its Series A Preferred Stock. At that time, we lost our controlling interest and deconsolidated Surface from our consolidated financial statements. We own 3,500,000 shares of Surface which is approximately 30% of the equity and voting interests as of September 30, 2020. We expect Surface to complete another round of financing within the next twelve months. Melt Pharmaceuticals, Inc. Melt is a development-stage pharmaceutical company focused on the development and commercialization of proprietary non-intravenous, sedation and anesthesia therapeutics for human medical procedures in hospital, outpatient, and in-office settings. Melt intends to seek regulatory approval for its proprietary technologies, where possible. In December 2018, we entered into an Asset Purchase Agreement with Melt (the “Melt Asset Purchase Agreement”), and Harrow assigned to Melt the underlying intellectual property for Melt’s current pipeline, including its lead drug candidate MELT-100. The core intellectual property Melt owns is a patented series of combination non-opioid sedation drug formulations that we estimate to have multitudinous applications. Pursuant to the terms of the Melt Asset Purchase Agreement, Melt is required to make royalty payments to the Company equal to 5% of net sales of MELT-100, while any patent rights remain outstanding, subject to other conditions. MELT-100 is a novel, sublingually delivered, non-IV, opioid-free drug candidate being developed for procedural sedation. Melt filed an IND in June 2020 and has begun its clinical program for MELT-100. We expect Melt will announce topline data from its Phase 1 study during the fourth quarter of 2020 or first quarter of 2021. In January 2019, Melt closed an offering of its Series A Preferred Stock and we lost our controlling interest in it. We own 3,500,000 shares of Melt common stock, which is approximately 44% of the equity and voting interests issued and outstanding of Melt, as of September 30, 2020. We expect Melt to complete another round of financing within the next twelve months. 33 Factors Affecting Our Performance We believe the primary factors affecting our performance are our ability to increase revenues of our proprietary compounded formulations and certain non-proprietary products, grow and gain operating efficiencies in our pharmacy operations, optimize pricing and obtain reimbursement options for our proprietary compounded formulations, and continue to pursue development and commercialization opportunities for certain of our ophthalmology and other assets that we have not yet made commercially available as compounded formulations. We believe we have built a tangible and intangible infrastructure that will allow us to scale revenues efficiently in the long-term. All of these activities will require significant costs and other resources, which we may not have or be able to obtain from operations or other sources. See “Liquidity and Capital Resources” below. Reimbursement Options Our proprietary ophthalmic compounded formulations are currently primarily available on a cash-pay basis. However, we work with third-party insurers, pharmacy benefit managers and buying groups to offer patient-specific customizable compounded formulations at accessible prices. We may devote time and other resources to seek reimbursement and patient pay opportunities for these and other compounded formulations and we have hired pharmacy billers to process certain existing reimbursement opportunities for certain formulations. However, we may be unsuccessful in achieving these goals, as many third-party payors have imposed significant restrictions on reimbursement for compounded formulations in recent years. Moreover, third-party payors, including Medicare, are increasingly attempting to contain health care costs by limiting coverage and the level of reimbursement for new drugs and by refusing, in some cases, to provide coverage for uses of approved products for disease indications for which the FDA has not granted labeling approval. Further, the Patient Protection and Affordable Care Act, as amended by the Health Care and Education Affordability Reconciliation Act of 2010 (collectively, the “Health Care Reform Law”), may have a considerable impact on the existing U.S. system for the delivery and financing of health care and could conceivable have a material effect on our business. As a result, reimbursement from Medicare, Medicaid and other third-party payors may never be available for any of our products or, if available, may not be sufficient to allow us to sell the products on a competitive basis and at desirable price points. We are communicating with government and third-payor payors in order to make our formulations available to more patients and at optimized pricing levels. However, if government and other third-party payors do not provide adequate coverage and reimbursement levels for our formulations, the market acceptance and opportunity for our formulations may be limited. Additionally, we have previously made efforts to receive reimbursement and/or optimize the pricing for some of our currently available pharmaceutical compounded formulations, including applying for transitional pass-through reimbursement status for one of our formulations. Pass-through status allows for separate payment (i.e., outside the bundled payment) under Medicare Part B for new drugs and other medical technologies that meet well-established criteria specified by federal regulations governing CMS spending. In September 2020, we were informed by CMS that our application for pass-through payment was denied for one of our formulations. Any future efforts to attain optimized pricing or reimbursement of our other proprietary compounded formulations could fail, which could make our products less attractive or unavailable to some patients or could reduce our margins. Recent Developments The following describes certain developments in 2020 to date that are important to understand our financial condition and results of operations as well as operating trends and prospects. See the notes to our condensed consolidated financial statements included in this report for additional information about each of these developments. COVID-19 Pandemic A novel strain of coronavirus was first identified in Wuhan, China in December 2019. The disease caused by it, COVID-19, was declared a global pandemic by the World Health Organization in March 2020. On March 18, 2020, CMS released guidance for U.S. healthcare providers to limit all elective medical procedures in order to conserve personal protective equipment and limit exposure to COVID-19 during the pendency of the pandemic. In addition to limiting elective medical procedures, many hospitals and other healthcare providers have strictly limited access to their facilities during the pandemic. The COVID-19 pandemic has negatively impacted the global economy, disrupted global supply chains and healthcare delivery, led to social distancing recommendation, and created significant volatility in financial markets. In response to the pandemic and business disruptions, first and foremost, we have prioritized the health and safety of our employees, customers, suppliers and others with whom we partner in our business activities. We have instructed employees to work from home when possible and to maintain recommended physical distancing when working in our facilities. We also have eliminated non-essential in-person contact with customers, suppliers and other third parties. 34 Many of the Company’s customers use its drugs in procedures that were impacted by the CMS guidance to limit elective procedures. In addition, the Company and our business partners need access to healthcare providers and facilities to conduct clinical trials and other activities required to achieve regulatory clearance of products under development. We are carefully monitoring rapidly evolving changes in healthcare delivery systems and may adjust our operating and product development plans accordingly. Given the unprecedented and dynamic nature of the COVID-19 pandemic, we cannot reasonably estimate the impacts it may have on our financial condition, results of operations or cash flows in the future. However, the reduction in elective procedures in response to CMS guidance has had a material adverse impact, on our revenues, profitability and cash flows, in particular during the second quarter of 2020. The extent and duration of future impact will depend upon the extent of procedure postponements, the duration of the pandemic and any resurgences of it, especially within certain geographies and states that have retained restrictive measures and social distancing policies. In May 2020 and the following months, some U.S. states and geographies began easing restrictions associated with the COVID-19 pandemic including those restrictions related to elective procedures, as restrictions were lifted in those areas there was a correlation with an increase in our revenues. Despite the recent resurgence of the COVID-19 pandemic in certain parts of the U.S., we are hopeful that the general trend of easing of restrictions will continue, and sales of our products will return to historical norms and historical growth trends, as other states and governmental authorities continue to ease restrictions associated with elective procedures and the COVID-19 pandemic. SWK Amendment In April 2020, the Company and several of its wholly owned subsidiaries entered into a second amendment (the “SWK Amendment”) to the term loan and security agreement dated as of July 19, 2017, as amended (the “SWK Loan”), with SWK Funding LLC, as lender and collateral agent, and certain other lenders (collectively, “SWK”). A summary of the material changes contained in the SWK Amendment are as follows: ● SWK agreed to make available to the Company, and the Company drew down on, an additional principal amount of $1,000,000; ● The definition of the first amortization date was changed to August 14, 2020, permitting the Company to pay interest only on the principal amount loaned for the next payment (payments are due on a quarterly basis) following the SWK Amendment; and ● The interest payment due May 14, 2020 will be paid in-kind by increasing the principal amount of the term loans by an amount equal to the interest that has accrued. PPP Loan In April 2020, we entered into the PPP Loan with Renasant Bank in the principal amount of $1,967,100 and received cash proceeds of the same amount, pursuant to the PPP under the CARES Act, which was enacted March 27, 2020. The PPP is administered by the U.S. Small Business Administration (the “SBA”). Under the terms of the PPP Loan, interest accrues on the outstanding principal at the rate of 1.0% per annum. The term of the PPP Loan is two years, unless sooner required in connection with an event of default under the PPP Loan. To the extent the PPP Loan amount is not forgiven under the PPP, the Company is obligated to make equal monthly payments of principal and interest, beginning seven months from the date of the PPP Loan, until the maturity date. The CARES Act and the PPP provide a mechanism for forgiveness of up to the full amount borrowed. Under the PPP, the Company may apply for and be granted forgiveness for all or part of the PPP Loan. The amount of loan proceeds eligible for forgiveness is based on a formula that takes into account a number of factors, including the amount of loan proceeds used by the Company during the eight-week period after the loan origination for certain purposes including payroll costs, interest on certain mortgage obligations, rent payments on certain leases, and certain qualified utility payments (it being anticipated that at least 75% of the loan amount will be required to be used for eligible payroll costs); the employer maintaining or rehiring employees and maintaining salaries at certain levels; and other factors. Subject to the other requirements and limitations on loan forgiveness, only loan proceeds spent on payroll and other eligible expenses during the covered eight-week period will qualify for forgiveness. While we used proceeds from the PPP Loan for such qualifying expenses, in particular maintaining continuity of our payroll and workforce (including staff critical to the timely production and dispensing of medicines we make), no assurance can be provided that we will apply for or obtain forgiveness of the PPP Loan in whole or in part. 35 Eyepoint Commercial Alliance Agreement On August 1, 2020, our wholly-owned subsidiary ImprimisRx entered into a Commercial Alliance Agreement (the “Dexycu Agreement”) with Eyepoint Pharmaceuticals, Inc. (“Eyepoint”), pursuant to which Eyepoint granted ImprimisRx the non-exclusive right to co-promote DEXYCU ® (dexamethasone intraocular suspension) 9% for the treatment of post-operative inflammation following ocular surgery in the United States. Pursuant to the Dexycu Agreement , Eyepoint will pay ImprimisRx a fee calculated based on the quarterly sales of DEXCYU in excess of predefined volumes to specific customers of ImprimisRx in the U.S. Under the terms of the Dexycu Agreement , ImprimisRx shall use commercially reasonable efforts to promote and market DEXCYU in the U.S. Subject to early termination, the Dexycu Agreement expires on August 1, 2025. Subject to specified notice periods and specified limitations, either party may terminate the Dexycu Agreement in the event of (i) uncured material breach by the other party or (ii) if DEXCYU ceases to have “pass-through” payment status. In addition, subject to certain limitations, ImprimisRx may terminate the Dexycu Agreement (i) for convenience subject to an extended specified notice period or (ii) in the event Eyepoint undergoes a change of control. Eyepoint may terminate the Dexycu Agreement , subject to specified notice periods and specified limitations, if ImprimisRx fails to achieve certain minimum sales levels during specified periods. Results of Operations The following period-to-period comparisons of our financial results for the three and nine months ended September 30, 2020 and 2019, are not necessarily indicative of results for the current period or any future period. Revenues Our revenues include amounts recorded from sales of proprietary compounded formulations and revenues received from royalty payments owed to us pursuant to out-license arrangements. The following presents our revenues for the three and nine months ended September 30, 2020 and 2019: For the Three Months Ended For the Nine Months Ended September 30, September 30, $ 2020 2019 Variance 2020 2019 Variance Product sales, net $ 14,385,000 $ 12,748,000 $ 1,637,000 $ 34,244,000 $ 38,540,000 $ (4,296,000 ) Other revenues 14,000 7,000 7,000 32,000 21,000 11,000 Total revenues $ 14,399,000 $ 12,755,000 $ 1,644,000 $ 34,276,000 $ 38,561,000 $ (4,285,000 ) The increase in revenues between the three months ended September 30, 2020 and the same period in the prior year was largely attributable to an increase in customer demand and unit volumes sold. The decrease in revenues between the nine months ended September 30, 2020 and the same period in the prior year was largely attributed to the COVID-19 pandemic and CMS guidance to limit elective procedures during parts of the first and second quarters of 2020. Net revenues generated from NJOF totaled $10,205,000 and $23,010,000 during the three and nine months ended September 30, 2020, and $8,860,000 and $24,102,000 during the three and nine months ended September 30, 2019, respectively. Cost of Sales Our cost of sales includes direct and indirect costs to manufacture formulations and sell products, including active pharmaceutical ingredients, personnel costs, packaging, storage, royalties, shipping and handling costs, manufacturing equipment and tenant improvements depreciation, the write-off of obsolete inventory and other related expenses. 36 The following presents our cost of sales for the three and nine months ended September 30, 2020 and 2019: For the Three Months Ended For the Nine Months Ended September 30, $ September 30, $ 2020 2019 Variance 2020 2019 Variance Cost of sales $ 3,696,000 $ 4,061,000 $ (365,000 ) $ 10,526,000 $ 13,184,000 $ (2,658,000 ) The decrease in our cost of sales between the three months ended September 30, 2020 and the same period in the prior year was largely attributable to increased efficiencies and the August 2019 closure of our Irvine, California based pharmacy. The decrease in cost of goods sold between the nine months ended September 30, 2020 and the same period in the prior year was largely due to a decrease in unit volumes sold impacted by the COVID-19 pandemic, partially offset by continued improved utilization of capacity at our compounding facilities. Gross Profit and Margin For the Three Months Ended For the Nine Months Ended September 30, $ September 30, $ 2020 2019 Variance 2020 2019 Variance Gross Profit $ 10,703,000 $ 8,694,000 $ 2,009,000 $ 23,750,000 $ 25,377,000 $ (1,627,000 ) Gross Margin 74 % 68 % 6 % 69 % 66 % 3 % Increased efficiencies in our production process, extension of beyond using dating, or BUD, of some of our products, the closure of our Irvine, California based pharmacy in August 2019 and an increase in sales prices has contributed to our gross margin increase. Selling, General and Administrative Expenses Our selling, general and administrative expenses include personnel costs, including wages and stock-based compensation, corporate facility expenses, and investor relations, consulting, insurance, filing, legal and accounting fees and expenses as well as costs associated with our marketing activities and sales of our proprietary compounded formulations and other non-proprietary pharmacy products and formulations. The following presents our selling, general and administrative expenses for the three and nine months ended September 30, 2020 and 2019: For the Three Months Ended For the Nine Months Ended September 30, $ September 30, $ 2020 2019 Variance 2020 2019 Variance Selling, general and administrative $ 8,436,000 $ 8,608,000 $ (172,000 ) $ 23,806,000 $ 25,399,000 $ (1,593,000 ) The decrease in selling, general and administrative expenses between periods was largely attributable to decreased legal expenses incurred associated with certain litigation matters that concluded during 2019, and certain expenses that are correlated with our sales. Research and Development Expenses Our research and development expenses primarily include expenses related to the development of acquired intellectual property, investigator-initiated research and evaluations and other costs related to the clinical development of our assets. The following presents our research and development expenses for the three and nine months ended September 30, 2020 and 2019: For the Three Months Ended For the Nine Months Ended September 30, $ September 30, $ 2020 2019 Variance 2020 2019 Variance Research and development $ 670,000 $ 444,000 $ 226,000 $ 1,822,000 $ 1,659,000 $ 163,000 37 The increase in research and development expenses between periods was primarily attributable to formulation development studies for new ophthalmic formulations and clinical programs related to our drug development segment during the three and nine months ended September 30, 2020. Interest Expense, net Interest expense, net was $498,000 and $1,563,000 for the three and nine months ended September 30, 2020, compared to $620,000 and $1,939,000 for the same respective periods last year. The decrease during the period ended September 30, 2020 compared to the same period in 2019 was primarily due to interest expense recognition related to a decrease in the amortization of our finance lease obligations. Investment Gain (Loss) from Melt, net During the three and nine months ended September 30, 2020, we recorded a loss of $300,000 and $1,536,000, respectively, for our share of losses based on our ownership of Melt. During the nine months ended September 30, 2019, we recorded a net gain of $4,517,000 related to our investment in Melt. We recorded a gain of $5,810,000 for the deconsolidation of Melt, and a loss of $1,293,000 for our share of losses based on our ownership of Melt. We began using the equity method accounting for our investment in Melt beginning on January 30, 2019, the date we no longer had a controlling interest. Prior to that date, Melt’s losses were consolidated within our statements of operations. Investment Loss from Surface, net During the three and nine months ended September 30, 2020, we recorded a loss of $756,000 and $1,694,000, respectively, for our share of losses based on our ownership of Surface. During the three and nine months ended September 30, 2019, we recorded a loss of $400,000 and $904,000, respectively, for our share of losses based on our ownership of Surface. We began using the equity method accounting for our investment in Surface beginning on June 11, 2018, the date we no longer had a controlling interest. Prior to that date, Surface’s losses were consolidated within our statements of operations. Investment Gain (Loss) from Eton, net We recorded a gain of $8,575,000 and $2,450,000 related to the change in fair market value of Eton’s common stock for the three and nine months ended September 30, 2020, respectively. We recorded a loss of $(5,530,000) and a gain of $700,000 related to the change in fair market value of Eton’s common stock for the three and nine months ended September 30, 2019, respectively. We began recording our investment in Eton at fair market value and ceased using the equity method accounting for our investment in Eton in November 2018 following Eton’s Initial Public Offering and our ownership falling below 20%. Other Income, net During the nine months ended September 30, 2019, we recorded other income, net of $630,000. This was the result of income of $630,000 related to expenses that were paid by us and will be reimbursed by Melt following its deconsolidation. During the nine months ended September 30, 2020, we recorded other income, net of $24,000. This was primarily the result of income of $19,000 related to equipment from our Park facility that was sold during the nine months ended September 30, 2020. Net Loss The following table presents our net income (loss) for the three and nine months ended September 30, 2020 and 2019: For the Three Months Ended For the Nine Months Ended September 30, September 30, 2020 2019 2020 2019 Numerator – net income (loss) $ 8,638 $ (11,469 ) $ (4,506 ) $ (2,489 ) Net income (loss) per share, basic $ 0.33 $ (0.45 ) $ (0.17 ) $ (0.10 ) Net income (loss) per share, diluted $ 0.32 $ (0.45 ) $ (0.17 ) $ (0.10 ) 38 Financial Information About Segments and Geographic Areas Management evaluates performance of the Company based on operating segments. Segment performance for our two operating segments are based on segment contribution. Our reportable segments consist of (i) our commercial stage pharmaceutical compounding business (Pharmaceutical Compounding), generally including the operations of our ImprimisRx and Park businesses; and (ii) the start-up operations associated with our pharmaceutical drug development business (Pharmaceutical Drug Development). Segment contribution for the segments represents net revenues less cost of sales, research and development, selling and marketing expenses, and select general and administrative expenses. We do not evaluate the following items at the segment level: ● Selling, general and administrative expenses that result from shared infrastructure, including certain expenses associated with litigation and other legal matters, public company costs (e.g. investor relations), board of directors and principal executive officers, and other like shared expenses. ● Operating expenses within selling, general and administrative expenses that result from the impact of corporate initiatives. Corporate initiatives primarily include integration, restructuring, acquisition and other shared costs. ● Other select revenues and operating expenses including research and development expenses, amortization, and asset sales and impairments, net as not all such information has been accounted for at the segment level, or such information has not been used by all segments. ● Total assets including capital expenditures. The Company defines segment net revenues as pharmaceutical compounded drug sales, licenses and other revenue derived from related agreements. Cost of sales within segment contribution includes direct and indirect costs to manufacture formulations and sell products, including active pharmaceutical ingredients, personnel costs, packaging, storage, royalties, shipping and handling costs, manufacturing equipment and tenant improvements depreciation, the write-off of obsolete inventory and other related expenses. Selling, general and administrative expenses consist mainly of personnel-related costs, marketing and promotion costs, distribution costs, professional service costs, insurance, depreciation, facilities costs, transaction costs, and professional services costs which are general in nature and attributable to the segment. See Note 15 to our condensed consolidated financial statements included in this Quarterly Report for more information about our reportable segments. Liquidity and Capital Resources Liquidity Our cash on hand (including restricted cash) at September 30, 2020 was $5,727,000, compared to $4,949,000 at December 31, 2019. Since inception, July 24, 1998, through September 30, 2020, we have incurred aggregate losses of $78,549,000. These losses are primarily due to selling, general and administrative, and research and development expenses incurred in connection with developing and seeking regulatory approval for a former drug candidate, which activities we discontinued in 2013, the development and commercialization of novel compounded formulations and the development of our pharmacy operations. As of the date of this Quarterly Report, we believe that cash and cash equivalents of $5,527,000 and restricted cash of $200,000, totaling approximately $5,727,000 at September 30, 2020 together with cash generated from revenues, will be sufficient to sustain our planned level of operations and capital expenditures for at least the next 12 months. We also may consider the sale of certain assets including, but not limited to, part of, or all of, our ownership interests in Eton, Surface, Melt, and/or any of our consolidated subsidiaries. However, our plans for this period may change, our estimates of our operating expenses, capital expenditures and working capital requirements could be inaccurate, we may pursue acquisitions of pharmacies or other strategic transactions that involve large expenditures or we may experience growth more quickly or on a larger scale than we expect, any of which could result in the depletion of capital resources more rapidly than anticipated and could require us to seek additional financing earlier than we expect to support our operations. 39 We expect to use our current cash position and funds generated from our operations and any financing to pursue our business plan, which includes developing and commercializing compounded formulations and technologies, integrating and developing our compounding operations, pursuing potential future strategic transactions as opportunities arise, including potential acquisitions of additional pharmacy, outsourcing facilities, drug company and manufacturers, and/or assets or technologies, and otherwise fund our operations. We may also use our resources to conduct clinical trials or other studies in support of our formulations or any drug candidate for which we pursue FDA approval, to pursue additional development programs or to explore other development opportunities. Net Cash Flow The following provides detailed information about our net cash flows: For the Nine Months Ended September 30, 2020 2019 Net cash (used in) provided by: Operating activities $ (534,000 ) $ (702,000 ) Investing activities (891,000 ) (864,000 ) Financing activities 2,203,000 (1,641,000 ) Net change in cash and cash equivalents 778,000 (3,207,000 ) Cash, cash equivalents and restricted cash at beginning of the period 4,949,000 6,838,000 Cash, cash equivalents and restricted cash at end of the period $ 5,727,000 $ 3,631,000 Operating Activities Net cash used in operating activities was $(534,000) during the nine months ended September 30, 2020, compared to $(702,000) in operating activities during the same period in the prior year. The decrease in net cash used in operating activities during the period was mainly attributed to the increase in revenue during the quarter ended September 30, 2020 and increased operational efficiencies. Investing Activities Net cash used in investing activities during the nine months ended September 30, 2020 and 2019 was $(891,000) and $(864,000), respectively. Cash used in investing activities in 2020 and 2019 was primarily associated with equipment purchases and upgrades and investments in our intellectual property portfolio. Financing Activities Net cash provided by (used in) financing activities during the nine months ended September 30, 2020 and 2019 was $2,203,000 and $(1,641,000), respectively. Cash provided by financing activities during the nine months ended September 30, 2020 was related to proceeds received from the amendment to our loan and security agreement with SWK as well as proceeds received from the PPP Loan. Sources of Capital Our principal sources of cash consist of cash provided by operating activities from our pharmaceutical compounding business. We may also sell some or all of our ownership interests in Eton, Surface, Melt or our other subsidiaries. We produced cash from operations during 2018 and 2019, and during the third quarter of 2020; however, during the second quarter of 2020, we experienced a significant downturn in revenues mostly as a result of the COVID-19 pandemic which may have an impact on our ability to produce cash for the current year. In addition, prior to 2017, we had not generated sufficient revenues to support our operations and may not be able to do so in the future. 40 The changing trends and overall economic outlook in light of the COVID-19 pandemic, including any related interim stay-at-home orders and future bans on elective surgeries, have created uncertainty surrounding our operating outlook and may impact our future operating results. As a result, we may need significant additional capital to support our business plan and fund our proposed business operations. We may receive additional proceeds from the exercise of stock purchase warrants that are currently outstanding. We may also seek additional financing from a variety of sources, including other equity or debt financings, funding from corporate partnerships or licensing arrangements, sales of assets or any other financing transaction. If we issue equity or convertible debt securities to raise additional funds, our existing stockholders may experience substantial dilution, and the newly issued equity or debt securities may have more favorable terms or rights, preferences and privileges senior to those of our existing stockholders. If we raise additional funds through collaboration or licensing arrangements or sales of assets, we may be required to relinquish potentially valuable rights to our product candidates or proprietary technologies or formulations or grant licenses on terms that are not favorable to us. If we raise funds by incurring additional debt, we may be required to pay significant interest expenses and our leverage relative to our earnings or to our equity capitalization may increase. Obtaining commercial loans, assuming they would be available, would increase our liabilities and future cash commitments and may impose restrictions on our activities, such as the financial and operating covenants included in the agreements governing the SWK Loan. Further, we may incur substantial costs in pursuing future capital and/or financing transactions, including investment banking fees, legal fees, accounting fees, printing and distribution expenses and other costs. We may also be required to recognize non-cash expenses in connection with certain securities we may issue, such as convertible notes and warrants, which would adversely impact our financial results. We may be unable to obtain financing when necessary as a result of, among other things, our performance, general economic conditions, conditions in the pharmaceuticals and pharmacy industries, or our operating history, including our past bankruptcy proceedings. In addition, the fact that we have a limited history of profitability could further impact the availability or cost to us of future financings. As a result, sufficient funds may not be available when needed from any source or, if available, such funds may not be available on terms that are acceptable to us. If we are unable to raise funds to satisfy our capital needs when needed, then we may need to forego pursuit of potentially valuable development or acquisition opportunities, we may not be able to continue to operate our business pursuant to our business plan, which would require us to modify our operations to reduce spending to a sustainable level by, among other things, delaying, scaling back or eliminating some or all of our ongoing or planned investments in corporate infrastructure, business development, sales and marketing and other activities, or we may be forced to discontinue our operations entirely. Recently Issued and Adopted Accounting Pronouncements See Note 2 to our condensed consolidated financial statements included in this Quarterly Report. Item 3. Quantitative and Qualitative Disclosures About Market Risk Not applicable.