HARROW, INC. 10-K

ITEM 7. 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 the consolidated financial statements and the related notes contained in this annual report on Form 10-K (Annual Report). Our 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 (GAAP). In addition to historical information, the following discussion contains forward-looking statements based upon our current views, expectations and assumptions that are subject to risks and uncertainties. Actual results may differ substantially from those expressed or implied by any forward-looking statements due to a number of factors, including, among others, the risks described in the “Risk Factors” section and elsewhere in this Annual Report. 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 Imprimis Rx NJ, LLC, Imprimis NJOF, LLC, ImprimisRx, LLC, Radley Pharmaceuticals, Inc., Stowe Pharmaceuticals, Inc. and Mayfield Pharmaceuticals, Inc. 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 ophthalmic 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. We also recently launched a new business called Visionology and are exploring opportunities to launch other subsidiaries. We own royalty rights in various drug candidates being developed by Surface and Melt. 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. ImprimisRx ImprimisRx is our ophthalmic focused prescription pharmaceutical business. We offer to over 9,000 physician customers and their patients medically necessary prescription drugs to meet their needs that are otherwise 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 ophthalmic 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 federal current good manufacturing practices (or cGMPs) or other FDA guidance documents, in our FDA-registered New Jersey Outsourcing Facility (“NJOF”). On August 1, 2020, 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 pays ImprimisRx a fee that is calculated based on the quarterly sales of DEXCYU in excess of predefined volumes to specific customers of ImprimisRx in the U.S. We expect to acquire and/or develop additional FDA-approved ophthalmic drugs that allow us to leverage the commercial infrastructure of ImprimisRx to promote, sell, and ultimately bring these products to market. Visionology Visionology is a membership-based online eye health and medication platform. Visionology leverages our experience in the ophthalmic pharmaceutical business, our relationships with eyecare professionals across the United States, and our expertise in developing and deploying telemedicine software. We recently launched a proof-of-concept for Visionology in certain states in the southeast area of the U.S. If successful, we expect Visionology will expand access to the Visionology service 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 medical 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. 36 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 and transparent 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. 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, production related redundancy, and distribution through acquisitions, partnerships or other strategic transactions. Pharmaceutical Development Businesses We have ownership interests in Eton, Surface and Melt and hold royalty interests in some of Surface’s and Melt’s 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. In 2018 and 2019, we formed and created subsidiaries named Radley Pharmaceuticals, Inc. (“Radley”), Mayfield Pharmaceuticals, Inc. (“Mayfield”) and Stowe Pharmaceuticals, Inc. (“Stowe”). In addition, we may 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, we expect any new subsidiaries to be focused on eye care. De-Consolidated Businesses (Noncontrolling Equity Interests) Surface Ophthalmics, Inc. Surface is a clinical-stage pharmaceutical company focused on development and commercialization of innovative therapeutics for ocular surface diseases. During January 2021, Surface announced positive top-line results from a phase 2 trial of its drug candidate SURF-201, a 0.2% betamethasone, preservative-free ophthalmic solution in the Klarity delivery vehicle for the treatment of post cataract surgery pain and inflammation. According to the Surface, SURF-201 was dosed twice daily, and met its primary endpoints of absence of inflammation at both Day 8 and Day 15 and was found to be safe and well-tolerated by the patient group. In addition, a secondary endpoint showed almost 90% of patients given SURF-201 were pain free at Day 15. SURF-201 marks the first ophthalmic therapeutic in the United States to utilize betamethasone as well as being the first preservative-free unit dose therapy for the treatment of post-operative pain and inflammation. Also in January 2021, Surface announced the first patient dosed in a head-to-head phase 2 trial for its drug candidate SURF-100 (mycophenolate sodium and betamethasone in Klarity vehicle) for the treatment of chronic dry eye disease. The head-to-head study will compare SURF-100 against two leading on-market competitors lifitegrast ophthalmic solution 5% and cyclosporine ophthalmic emulsion 0.05%. 37 In February 2021, Surface announced the first patient dosed in a phase 2 trial for its drug candidate SURF-200 (betamethasone in Klarity vehicle) for the treatment of episodic dry eye flares. The dose ranging study for SURF-200 will be administered in two different low concentration formulations of betamethasone in the Klarity vehicle. The trial will enroll 120 to 140 patients with a primary endpoint of Symptom Improvement of one unit based on the University of North Carolina Dry Eye Management Scale by the eighth day. In 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 December 31, 2020. Harrow owns mid-single digit royalty rights on net sales of SURF-100, SURF-200 and SURF-201. We expect Surface to complete another round of financing within the next twelve months. Melt Pharmaceuticals, Inc. Melt is a clinical-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. 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 began its clinical program for MELT-100. In February 2021, Melt announced data from, and successful completion of, its phase 1 study. Melt expects to begin its phase 2 study for MELT-100 in the second half of 2021. In January 2019, Melt closed an offering of its Series A Preferred Stock. At that time, we lost our controlling interest and deconsolidated Melt from our consolidated financial statements. We own 3,500,000 shares of Melt common stock, which was approximately 44% of the equity and voting interests issued and outstanding, as of December 31, 2020. We expect Melt to complete another round of financing within the next twelve months. Pursuant to the terms of the Melt Asset Purchase Agreement, Melt is required to make mid-single digit royalty payments to the Company on net sales of MELT-100, while any patent rights remain outstanding, subject to other conditions. Melt can require the Company to cease compounding like products at the time of FDA approval of MELT-100. If approved, we do not expect a cessation of compounding like products to have a material impact on our operations and financial performance. Eton Pharmaceuticals, Inc. Eton is a commercial-stage pharmaceutical company focused on developing and commercializing innovative drug products. Its pipeline includes several products and drug candidates in various stages of development across a variety of dosage forms. In May 2017, Eton closed an offering of its Series A Preferred Stock. At that time, we lost our controlling interest and deconsolidated Eton from our consolidated financial statements. In November 2019, Eton completed an initial public offering of its common stock. We own 3,500,000 shares of Eton common stock, which was less than 20% of the equity and voting interests issued and outstanding of Eton as of December 31, 2020. Consolidated Businesses (Controlling Equity Interests) Mayfield, Stowe and Radley are consolidated subsidiaries of Harrow. Mayfield is a development-stage pharmaceutical company focused on developing urology related drug candidates. Stowe is focused on the development of proprietary ophthalmic drug candidates. Radley is a development-stage pharmaceutical company that has been focused on the development of proprietary drug candidates focused on rare diseases. Recently, and as part of our strategic focus within eyecare, we discontinued nearly all of the activities related to Mayfield, Stowe and Radley, and may not resume those activities in the near term. We control over 50% of the equity and voting interests issued and outstanding of Mayfield, Stowe and Radley as of the date of this Annual Report. 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. Recent Developments The following describes certain developments in 2020 to date that are important to understand our financial condition and results of operations. See the notes to our consolidated financial statements included in this report for additional information about each of these developments. 38 COVID-19 Pandemic A novel strain of coronavirus was first identified in Wuhan, China in December 2020. 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. 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 that 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, 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. Assuming the strictest of lockdown scenarios are avoided, we believe we have sufficient liquidity resources to sustain our planned level of operations. 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 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 payment is 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. We applied for forgiveness for all of the PPP Loan during the year ended December 31, 2020, however as of the date of this Annual Report the SBA has not made a decision related to the Company’s application for forgiveness. 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 us during the twenty-four-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 twenty-four-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 obtain forgiveness of the PPP Loan in whole or in part. 39 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 are not necessarily indicative of results for any future period. Comparison of Years Ended December 31, 2020 and 2019 Revenues Our revenues include amounts recorded from sales of proprietary and non-proprietary pharmaceutical compounded drug formulations and revenues received from royalty and milestone payments owed to us pursuant to out-license arrangements. The following presents our revenues for the years ended December 31, 2020 and 2019: For the Year Ended December 31, $ 2020 2019 Variance Product sales, net $ 48,479,000 $ 51,137,000 $ (2,658,000 ) Other revenues 392,000 28,000 364,000 Total revenues $ 48,871,000 $ 51,165,000 $ (2,294,000 ) The decrease in revenue between periods was largely attributable 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 our New Jersey based outsourcing facility (“NJOF”) totaled $32,949,000 for the year ended December 31, 2020, compared to $33,240,000 in 2019. 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. The following presents our cost of sales for the years ended December 31, 2020 and 2019: For the Year Ended December 31, $ 2020 2019 Variance Cost of sales $ 14,463,000 $ 16,749,000 $ (2,286,000 ) The decrease in our cost of sales between periods 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. 40 Gross Profit and Margin For the Year Ended December 31, $ 2020 2019 Variance Gross Profit $ 34,408,000 $ 34,416,000 $ (8,000 ) Gross Margin 70.4 % 67.3 % 3.1 % The increase in gross margin between periods is largely attributable to increased utilization of capacities as a result of increased output, in particular, at NJOF and increased per unit sales prices. We estimate gross margins at NJOF were greater than 71% during 2020. 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 years ended December 31, 2020 and 2019: For the Year Ended December 31, $ 2020 2019 Variance Selling, general and administrative $ 31,247,000 $ 33,088,000 $ (1,841,000 ) 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 years ended December 31, 2020 and 2019: For the Year Ended December 31, $ 2020 2019 Variance Research and development $ 2,413,000 $ 2,083,000 $ 330,000 The increase in research and development expenses between periods was primarily attributable to the increase in formulation development studies with our ImprimisRx subsidiary and the clinical development programs for our subsidiaries Radley, Mayfield and Stowe that occurred during the year ended December 31, 2020. Impairment of Long-Lived Assets During the year ended December 31, 2020, we recorded a loss of $363,000 related to the impairment of patents and patent applications. During the year ended December 31, 2019, we recorded a loss of $4,040,000 related to the impairment and disposal of long-lived assets. Of these costs $3,781,000 were related to the Park Restructuring and $259,000 of these expenses were related to the impairment of patents and patent applications related to a terminated asset purchase agreement. Interest Expense, net Interest expense, net was $2,236,000 for the year ended December 31, 2020 compared to $2,500,000 in 2019. The decrease during the year ended December 31, 2020 compared to 2019 was primarily due to interest expense recognition related to a decrease in the amortization of our finance lease obligations and reduction of the principal balance of our term loan. Investment Gain (Loss) from Melt, net During the year ended December 31, 2020, we recorded a loss of $2,313,000 for our share of losses based on our ownership of Melt. During the year ended December 31, 2019, we recorded a net gain of $3,968,000 related to our investment in Melt. In 2019, we recorded a gain of $5,810,000 for the deconsolidation of Melt, and a loss of $(1,842,000) for our share of losses based on our ownership of Melt after its deconsolidation. 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. 41 Investment Loss from Surface During the year ended December 31, 2020, we recorded a loss of $2,433,000 for our share of losses based on our ownership of Surface. During the year ended December 31, 2019, we recorded a loss of $1,200,000 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 from Eton, net We recorded a gain of $3,255,000 related to the change in fair market value of Eton’s common stock for the year ended December 31, 2020. We recorded a gain of $3,780,000 related to the change in fair market value of Eton’s common stock for the year ended December 31, 2019. Other Income, net During the year ended December 31, 2020, we recorded other expense, net of $(73,000). This was primarily the result of income of $13,000 related to equipment from our Park facility that was sold during the year ended December 31, 2020 and $(105,000) related to the disposal of property, plant and equipment related to the discontinued use of certain computer software and hardware. During the year ended December 31, 2019, we recorded other income, net of $630,000 related to expenses that were paid by us and were reimbursed by Melt following its deconsolidation. Net Income (Loss) The following table presents our net income (loss) for the years ended December 31, 2020 and 2019: For the Year Ended December 31, 2020 2019 Net (loss) income attributable to Harrow Health, Inc. $ (3,357,000 ) $ 168,000 Net income per share, basic $ (0.13 ) $ 0.01 Net income per share, diluted $ (0.13 ) $ 0.01 Liquidity and Capital Resources Liquidity Our cash on hand (including restricted cash) at December 31, 2020 was $4,301,000, compared to $4,949,000 at December 31, 2019. Since inception through December 31, 2020, we have incurred aggregate losses of $77,400,000. 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 have now discontinued, the development and commercialization of novel compounded formulations and the development of our pharmacy operations. As of the date of this Annual Report, we believe that cash and cash equivalents of $4,101,000 and restricted investments of $200,000, totaling approximately $4,301,000 at December 31, 2020, 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 interest 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. 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, FDA-approved products and technologies, integrating and developing our compounding operations, pursuing potential future strategic transactions as opportunities arise, including potential acquisitions of products, compounding pharmacies and outsourcing facilities, drug companies 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. 42 Net Cash Flows The following provides detailed information about our net cash flows for the years ended December 31, 2020 and 2019: For the Year Ended December 31, 2020 2019 Net cash (used in) provided by: Operating activities $ (1,100,000 ) $ 950,000 Investing activities (981,000 ) (1,833,000 ) Financing activities 1,433,000 (1,006,000 ) Net change in cash and cash equivalents (648,000 ) (1,889,000 ) Cash and cash equivalents at beginning of the year 4,949,000 6,838,000 Cash and cash equivalents at end of the year $ 4,301,000 $ 4,949,000 Operating Activities Net cash (used in) provided by operating activities was $(1,100,000) in 2020, compared to $950,000 in the prior year. Net cash (used in) provided by operating activities during the years ended December 31, 2020 was primarily the result of paydown of aged accounts payable and accrued expenses. Investing Activities Net cash used in investing activities in 2020 and 2019 was $(981,000) and $(1,833,000), respectively. Cash used in investing activities in 2020 and 2019 were primarily associated with additional equipment purchases, software upgrades, facility expansions and upgrades, and investments in our intellectual property portfolio. Financing Activities Net cash provided by (used in) financing activities in 2020 and 2019 was $1,433,000 and $(1,006,000), respectively. The cash provided by financing activities during 2020 is primarily related to proceeds received from the amendment to our loan and security agreement with SWK as well as proceeds received from the PPP Loan. The cash used in financing activities during 2019 is primarily attributable to the principal payments on the SWK loan payable and finance leases. 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 2019; however, we currently are experiencing a downturn in revenues mostly as a result of the COVID-19 pandemic which will have an impact on our ability to produce cash in 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. The changing trends and overall economic outlook in light of the COVID-19 pandemic, including the related interim stay at home orders and 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. 43 Critical Accounting Policies We rely on the use of estimates and make assumptions that impact our financial condition and results. These estimates and assumptions are based on historical results and trends as well as our forecasts of how results and trends might change in the future. Although we believe that the estimates we use are reasonable, actual results could differ materially from these estimates. We believe that the accounting policies described below are critical to understanding our business, results of operations and financial condition because they involve the use of more significant judgments and estimates in the preparation of our consolidated financial statements. An accounting policy is deemed to be critical if it requires an accounting estimate to be made based on assumptions about matters that are highly uncertain at the time the estimate is made, and any changes in the assumptions used in making the accounting estimates that are reasonably likely to occur could materially impact our consolidated financial statements. Revenue Recognition and Deferred Revenue We account for contracts with customers in accordance with ASC 606, Revenues from Contracts with Customers. We have three primary streams of revenue: (1) revenue recognized from our sale of products within our pharmacy services (2) revenue recognized from a commission agreement with a third party and (3) revenue recognized from intellectual property license and asset purchase agreements. Product Revenues from Pharmacy Services We sell prescription drugs directly through our pharmacy and outsourcing facility network. Revenue from our pharmacy services divisions includes: (i) the portion of the price the client pays directly to us, net of any volume-related or other discounts paid back to the client, (ii) the price paid to us by individuals, and (iii) customer copayments made directly to the pharmacy network. Sales taxes are not included in revenue. Following the core principles of ASC 606, we have identified the following: 1. Identify the contract(s) with a customer: A contract exists with a customer at the time the prescription or order is received by the Company. 2. Identify the performance obligations in the contract: The order received contains the performance obligations to be met, in almost all cases the product the customer is wishing to receive. If we are unable to be meet the performance obligation the customer is notified. 3. Determine the transaction price: the transaction price is based on the product being sold to the customer, and any related customer discounts. These amounts are pre-determined and built into our order management software. 4. Allocate the transaction price to the performance obligations in the contract: The transaction price associated with the product(s) being ordered is allocated according to the pre-determined amounts. 5. Recognize revenue when (or as) the entity satisfies a performance obligation: At the time of shipment from the pharmacy or outsourcing facility the performance obligation has been met. The following revenue recognition policy has been established for the pharmacy services division: Revenues generated from prescription or office use drugs sold by our pharmacies and outsourcing facility are recognized when the prescription is shipped. At the time of shipment, the pharmacy services division has performed substantially all of its obligations under its client contracts and does not experience a significant level of returns or reshipments. Determination of criteria (3) and (4) is based on management’s judgments regarding the fixed nature of the selling prices of the products delivered and the collectability of those amounts. We record reductions to revenue for discounts at the time of the initial sale. Estimated returns and allowances and other adjustments are provided for in the same period during which the related sales are recorded and are based on actual returns history. The rate of returns is analyzed annually to determine historical returns experience. If the historical data we use to calculate these estimates do not properly reflect future returns, then a change in the allowance would be made in the period in which such a determination is made and revenues in that period could be materially affected. We will defer any revenues received for a product that has not been delivered or is subject to refund until such time that we and the customer jointly determine that the product has been delivered and no refund will be required. Commission Revenues During the year ended December 31, 2020, the Company entered into an agreement whereby it is paid a fee calculated based on sales it generates from a pharmaceutical product that is owned by a third party. The revenue earned from this arrangement is recognized at the time a customer has ordered the pharmaceutical product and it has shipped from the third party (or one of its distributors or affiliates), at which point there is no future performance obligation required by the Company and no consequential continuing involvement on the part of the Company to recognize the associated revenue. 44 Intellectual Property License Revenues We currently hold four intellectual property license and related agreements in which we have promised to grant a license or sale which provides a customer with right to access our intellectual property. License arrangements may consist of non-refundable upfront license fees, data transfer fees, research reimbursement payments, exclusive license rights to patented or patent pending compounds, technology access fees, and various performance or sales milestones. These arrangements can be multiple element arrangements, each of which revenue is recognized at the point of time the performance obligation is met. Non-refundable fees that are not contingent on any future performance by us and require no consequential continuing involvement on our part are recognized as revenue when the license term commences and the licensed data, technology, compounded drug preparation and/or other deliverable is delivered. Such deliverables may include physical quantities of compounded drug preparations, design of the compounded drug preparations and structure-activity relationships, the conceptual framework and mechanism of action, and rights to the patents or patent applications for such compounded drug preparations. We defer recognition of non-refundable fees if it has continuing performance obligations without which the technology, right, product or service conveyed in conjunction with the non-refundable fee has no utility to the licensee and that are separate and independent of our performance under the other elements of the arrangement. In addition, if our continued involvement is required, through research and development services that are related to its proprietary know-how and expertise of the delivered technology or can only be performed by us, then such non-refundable fees are deferred and recognized over the period of continuing involvement. Guaranteed minimum annual royalties are recognized on a straight-line basis over the applicable term. Investment in Eton Pharmaceuticals, Inc. We own 3,500,000 shares of Eton common stock, which represents approximately 14.4% of the equity and voting interests of Eton as of December 31, 2020. At December 31, 2020, the fair market value of Eton’s common stock was $8.13 per share. In accordance with Accounting Standard Update (“ASU”) 2016-01, Financial Instruments-Overall (Subtopic 825-10): Recognition and Measurement of Financial Assets and Financial Liabilities , for the years ended December 31, 2020 and 2019, we recorded an investment gains from its Eton common stock position of $3,255 and $3,780, respectively, related to the change in fair market value of our investment in Eton during the measurement periods. As of December 31, 2020 and 2019, the fair market value of our investment in Eton was $28,455 and $25,200, respectively. Mark Baum, our Chief Executive Officer, is a member of the board of directors of Eton. Investment in Surface Ophthalmics, Inc. – Related Party We own 3,500,000 common shares (which is approximately 30% of the equity interests as of December 31, 2020) of Surface and uses the equity method of accounting for this investment, as management has determined that we have the ability to exercise significant influence over the operating and financial decisions of Surface. Under this method, we recognize earnings and losses in Surface in its consolidated financial statements and adjusts the carrying amount of its investment in Surface accordingly. Our share of earnings and losses are based on our ownership interest of Surface. Any intra-entity profits and losses are eliminated. We recorded equity in the net loss of Surface of $1,200 during the year ended December 31, 2019. We recorded equity in the net loss of Surface of $2,433 during the year ended December 31, 2020. As of December 31, 2020 and 2019, the carrying value of our investment in Surface was $1,314 and $3,747, respectively. Investment in Melt Pharmaceuticals, Inc. – Related Party In April 2018, we formed Melt as a wholly-owned subsidiary. In January and March of 2019, Melt entered into definitive stock purchase agreements (collectively, the “Melt Series A Preferred Stock Agreement”) with certain investors and closed on the purchase and sale of Melt’s Series A Preferred Stock (the “Melt Series A Stock”), totaling approximately $11,400,000 of proceeds (collectively the “Melt Series A Round”) at a purchase price of $5.00 per share. As a result, we lost voting and ownership control of Melt and ceased consolidating Melt’s financial statements. In connection with the Melt Series A Preferred Stock Agreement, Melt also entered into a Registration Rights Agreement and agreed to use commercially reasonable efforts to file, or confidentially submit, a registration statement on Form S-1 with the United States Securities and Exchange Commission (“SEC”) by September 30, 2020 relating to an initial public offering of its common stock, however, during the year ended December 31, 2020 this requirement was waived by the majority of Series A Preferred Stock holders. At the time of deconsolidation, we recorded a gain of $5,810,000 and adjusted the carrying value in Melt to reflect the increased valuation of Melt and our new ownership interest in accordance with ASC 810-10-40-4(c), Consolidation . We own 3,500,000 common shares (which is approximately 44% of the equity interest as of December 31, 2020) of Melt and uses the equity method of accounting for this investment, as management has determined that we have the ability to exercise significant influence over the operating and financial decisions of Melt. Under this method, we recognize earnings and losses of Melt in its consolidated financial statements and adjusts the carrying amount of its investment in Melt accordingly. Our share of earnings and losses are based on our ownership interest of Melt. Any intra-entity profits and losses are eliminated. We recorded equity in net loss of Melt of $2,313,000 during the year ended December 31, 2020. As of December 31, 2020, our investment in Melt was $2,506,000 of which $1,655,000 was the carrying value of our investment in Melt and $851,000 due from Melt for reimbursable expenses and amounts due under the Melt Master Service Agreement (“Melt MSA”). 45 Stock-Based Compensation All stock-based payments to employees, directors and consultants, including grants of stock options, warrants, restricted stock units and restricted stock, are recognized in the consolidated financial statements based upon their estimated fair values. We use the Black-Scholes option pricing model and Monte-Carlo simulation model to estimate the fair value of stock-based awards. Fair value is determined at the date of grant. The financial statement effect of forfeitures is estimated at the time of grant and revised, if necessary, if the actual effect differs from those estimates. Income Taxes As part of the process of preparing our consolidated financial statements, we must estimate the actual current tax assets and liabilities and assess permanent and temporary differences that result from differing treatment of items for tax and accounting purposes. The temporary differences result in deferred tax assets and liabilities, which are included within the consolidated balance sheets. We must assess the likelihood that the deferred tax assets will be recovered from future taxable income and, to the extent we believe that recovery is not more likely than not, a valuation allowance must be established which reduces the amount of deferred tax assets recorded on the consolidated balance sheets. To the extent we establish a valuation allowance or increase or decrease this allowance in a period, the impact will be included in income tax expense in the consolidated statements of operations. We account for income taxes under the provisions of Financial Accounting Standards Board (the “FASB”) Accounting Standards Codification (“ASC”) 740, Income Taxes . As of December 31, 2020 and 2019, there were no unrecognized tax benefits included in the consolidated balance sheets that would, if recognized, affect the effective tax rate. Our practice is to recognize interest and/or penalties related to income tax matters in income tax expense. We had no accrual for interest or penalties in its consolidated balance sheets at December 31, 2020 and 2019, and have not recognized interest and/or penalties in the consolidated statements of operations for the years ended December 31, 2020 and 2019. We are subject to taxation in the United States, California, Florida, Georgia, Illinois, New Jersey, New York, Tennessee, and Wisconsin. Our tax years since 2000 may be subject to examination by the federal and state tax authorities due to the carryforward of unutilized net operating losses. Research and Development We expense all costs related to research and development as they are incurred. Research and development expenses consist of expenses incurred in performing research and development activities, including salaries and benefits, other overhead expenses, and costs related to clinical trials, contract services and outsourced contracts. Intellectual Property The costs of acquiring intellectual property rights to be used in the research and development process, including licensing fees and milestone payments, are charged to research and development expense as incurred in situations where we have not identified an alternative future use for the acquired rights, and are capitalized in situations where we have identified an alternative future use for the acquired rights. Patents and trademarks are recorded at cost and capitalized at a time when the future economic benefits of such patents and trademarks become more certain (see “—Goodwill and Intangible Assets” below). We began capitalizing certain costs associated with acquiring intellectual property rights during 2015, if costs are not capitalized, they are expensed as incurred. Impairment of Long-Lived Assets Long-lived assets, such as property, plant and equipment, purchased intangibles subject to amortization and patents and trademarks, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated future cash flows, an impairment charge is recognized in the amount by which the carrying amount of the asset exceeds the fair value of the asset. Assets to be disposed would be separately presented in the consolidated balance sheet and reported at the lower of the carrying amount or fair value less costs to sell, and are no longer depreciated. The assets and liabilities of a disposal group classified as held-for-sale would be presented separately in the appropriate asset and liability sections of the consolidated balance sheet, if material. Goodwill and Intangible Assets Patents and trademarks are recorded at cost and capitalized at a time when the future economic benefits of such patents and trademarks become more certain. At that time, we capitalize third party legal costs and filing fees associated with obtaining and prosecuting claims related to its patents and trademarks. Once the patents have been issued, we amortize these costs over the shorter of the legal life of the patent or its estimated economic life, generally 20 years, using the straight-line method. Trademarks are an indefinite life intangible asset and are assessed for impairment based on future projected cash flows as further described below. 46 We review our goodwill and indefinite-lived intangible assets for impairment as of January 1 of each year and when an event or a change in circumstances indicates the fair value of a reporting unit may be below its carrying amount. Events or changes in circumstances considered as impairment indicators include but are not limited to the following: ● significant underperformance of the our business relative to expected operating results; ● significant adverse economic and industry trends; ● significant decline in the our market capitalization for an extended period of time relative to net book value; and ● expectations that a reporting unit will be sold or otherwise disposed. The goodwill impairment test consists of a two-step process as follows: Step 1. We compare the fair value of each reporting unit to its carrying amount, including the existing goodwill. The fair value of each reporting unit is determined using a discounted cash flow valuation analysis. The carrying amount of each reporting unit is determined by specifically identifying and allocating the assets and liabilities to each reporting unit based on headcount, relative revenues or other methods as deemed appropriate by management. If the carrying amount of a reporting unit exceeds its fair value, an indication exists that the reporting unit’s goodwill may be impaired and we then perform the second step of the impairment test. If the fair value of a reporting unit exceeds its carrying amount, no further analysis is required. Step 2. If further analysis is required, we compare the implied fair value of the reporting unit’s goodwill, determined by allocating the reporting unit’s fair value to all of its assets and its liabilities in a manner similar to a purchase price allocation, to its carrying amount. If the carrying amount of the reporting unit’s goodwill exceeds its fair value, an impairment loss will be recognized in an amount equal to the excess. Debt Issuance Costs and Debt Discount Debt issuance costs and the debt discount are recorded net of loans payable in the consolidated balance sheet. Amortization of debt issuance costs and the debt discount is calculated using the effective interest method over the term of the debt and is recorded in interest expense in the accompanying consolidated statement of operations. Off-Balance Sheet Arrangements Since our inception, except for standard operating leases, we have not engaged in any off-balance sheet arrangements, including the use of structured finance, special purpose entities or variable interest entities. We have no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to stockholders. 47 ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA The financial statements and supplementary data required by this item are included in this Annual Report beginning on page F-1 immediately following the signature page hereto and are incorporated herein by reference. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE None.