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Eton Pharmaceuticals, Inc. - Quarter Report: 2019 September (Form 10-Q)

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

 

 

FORM 10-Q

 

 

(Mark One)

 

[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the quarterly period ended September 30, 2019

 

OR

 

[  ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
   
  For the transition period from _________________ to _______________________

 

Commission file number: 001-38738

 

 

ETON PHARMACEUTICALS, INC.

(Exact name of registrant as specified in its charter)

 

 

Delaware   37-1858472
(State of incorporation)  

(I.R.S. Employer

Identification Number)

 

21925 W. Field Parkway, Suite 235

Deer Park, Illinois 60010-7208

(Address of principal executive offices) (Zip code)

 

Registrant’s telephone number, including area code: (847) 787-7361

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class   Trading Symbol   Name of exchange on which registered
Common stock, $0.001 par value per share   ETON   Nasdaq Global Market

 

Indicate by check mark whether the Registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the Registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [  ]

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter time that the registrant was required to submit and post such files). Yes [X] No [  ]

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company, or an emerging growth company. See the definitions of “large accelerated filer,” “accelerated filer,” “smaller reporting company” and “emerging growth company” in Rule 12b-2 of the Exchange Act.

 

Large accelerated filer [  ] Accelerated filer [  ]
Non-accelerated filer [  ] Smaller reporting company [X]
    Emerging growth company [X]

 

If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [X]

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [  ] No [X]

 

As of October 31, 2019, Eton Pharmaceuticals, Inc. had outstanding 17,807,167 shares of common stock, $0.001 par value.

 

 

 

 
 

 

Eton Pharmaceuticals, Inc.

 

TABLE OF CONTENTS

 

Part No   Item No   Description  

Page

No.

             
I       FINANCIAL INFORMATION   1
             
    1   Financial Statements   1
             
        Condensed Balance Sheets as of September 30, 2019 (unaudited) and December 31, 2018   1
             
        Unaudited Condensed Statements of Operations for the three and nine months ended September 30, 2019 and 2018   2
             
        Unaudited Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the three months ended September 30, 2019 and 2018   3
             
        Unaudited Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit) for the nine months ended September 30, 2019 and 2018   4
             
        Unaudited Condensed Statements of Cash Flows for the nine months ended September 30, 2019 and 2018   5
             
        Notes to Condensed Financial Statements   6
             
    2   Management’s Discussion and Analysis of Financial Condition and Results of Operations   22
             
    3   Quantitative and Qualitative Disclosures About Market Risk   26
             
    4   Controls and Procedures   26
             
II       OTHER INFORMATION   27
             
    1   Legal Proceedings   27
             
    1A   Risk Factors   27
             
    2   Unregistered Sales of Equity Securities and Use of Proceeds   27
             
    3   Defaults Upon Senior Securities   27
             
    4   Mine Safety Disclosures   27
             
    5   Other Information   27
             
    6   Exhibits   27
             
        Index to Exhibits   28
             
        Signatures   29

 

i
 

 

PART I - FINANCIAL INFORMATION

 

Item 1. Financial Statements

 

Eton Pharmaceuticals, Inc.

Condensed Balance Sheets

(in thousands, except share and per share amounts)

 

   September 30, 2019   December 31, 2018 
   (Unaudited)     
Assets          
Current assets:          
Cash and cash equivalents  $11,777   $26,735 
Prepaid expenses and other current assets   330    767 
Total current assets   12,107    27,502 
           
Property and equipment, net   1,169    773 
Operating lease right-of-use assets, net   191     
Other long-term assets, net   40    52 
Total assets  $13,507   $28,327 
           
Liabilities and stockholders’ equity          
Current liabilities:          
Accounts payable  $549   $1,421 
Accrued liabilities   558    603 
Total current liabilities   1,107    2,024 
           
Operating lease liabilities, net of current portion   52     
           
Total liabilities   1,159    2,024 
           
Commitments and contingencies (Note 13)          
           
Stockholders’ equity          
Common stock, $0.001 par value; 50,000,000 shares authorized as of September 30, 2019 and December 31, 2018; 17,807,167 and 17,607,928 shares issued and outstanding at September 30, 2019 and December 31, 2018, respectively   18    18 
Additional paid-in capital   73,822    72,153 
Accumulated deficit   (61,492)   (45,868)
Total stockholders’ equity   12,348    26,303 
           
Total liabilities and stockholders’ equity  $13,507   $28,327 

 

The accompanying notes are an integral part of these condensed financial statements.

 

1
 

 

Eton Pharmaceuticals, Inc.

Condensed Statements of Operations

(In thousands, except per share amounts)

(Unaudited)

 

   For the three months ended   For the nine months ended 
  

September 30, 2019

  

September 30, 2018

  

September 30, 2019

  

September 30, 2018

 
Revenue  $   $   $500   $ 
                     
Operating expenses:                    
Research and development   3,418    1,544    11,322    4,525 
General and administrative   1,624    830    5,123    3,510 
Total operating expenses   5,042    2,374    16,445    8,035 
                     
Loss from operations   (5,042)   (2,374)   (15,945)   (8,035)
Other income (expense):                    
Interest and other income, net   77    25    321    82 
Change in fair value of warrant liability       (561)       (1,057)
                     
Loss before income tax expense   (4,965)   (2,910)   (15,624)   (9,010)
                     
Income tax expense                
                     
Net loss   (4,965)   (2,910)   (15,624)   (9,010)
Accrued dividends on redeemable convertible preferred stock       (300)       (900)
Deemed dividends for accretion of redeemable convertible preferred stock issuance costs       (429)       (1,257)
                     
Net loss attributable to common stockholders  $(4,965)  $(3,639)  $(15,624)  $(11,167)
Net loss per share attributable to common stockholders, basic and diluted  $(0.28)  $(0.65)  $(0.88)  $(2.40)
Weighted average number of common shares outstanding, basic and diluted   17,878    5,615    17,706    4,658 

 

The accompanying notes are an integral part of these condensed financial statements.

 

2
 

 

Eton Pharmaceuticals, Inc.

Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

For the three months ended September 30, 2019 and 2018

(in thousands, except share amounts)

(Unaudited)

 

   

Redeemable Convertible

Preferred Stock

    Common Stock     Additional Paid-in     Accumulated     Total Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Deficit     Equity  
Balances at June 30, 2019         $       17,763,045     $ 18     $ 73,208     $ (56,527 )   $ 16,699  
                                                         
Stock-based compensation                             537             537  
                                                         
Stock option exercises                 44,122             77             77  
                                                         
Net loss                                   (4,965 )     (4,965 )
                                                         
Balances at September 30, 2019         $       17,807,167     $ 18     $ 73,822     $ (61,492 )   $ 12,348  
                                                         
   

Redeemable Convertible

Preferred Stock

    Common Stock     Additional Paid-in     Accumulated     Total Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Deficit     Deficit  
Balances at June 30, 2018     6,685,082     $ 20,432       6,218,980     $ 6     $ 3,225     $ (16,167 )   $ (12,936 )
                                                         
Stock-based compensation                             165             165  
                                                         
Accrued dividends on redeemable convertible preferred stock           300                         (300 )     (300 )
                                                         
Deemed dividends for accretion of redeemable convertible preferred stock issuance costs           429                         (429 )     (429 )
                                                         
Net loss                                   (2,910 )     (2,910 )
                                                         
Balances at September 30, 2018     6,685,082     $ 21,161       6,218,980     $ 6     $ 3,390     $ (19,806 )   $ (16,410 )

 

The accompanying notes are an integral part of these condensed financial statements.

 

3
 

 

Eton Pharmaceuticals, Inc.

Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit)

For the nine months ended September 30, 2019 and 2018

(in thousands, except share amounts)

(Unaudited)

 

   

Redeemable Convertible

Preferred Stock

    Common Stock     Additional Paid-in     Accumulated     Total Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Deficit     Equity  
Balances at December 31, 2018         $       17,607,928     $ 18     $ 72,153     $ (45,868 )   $ 26,303  
                                                         
Stock-based compensation                             1,387             1,387  
                                                         
Stock option exercises                 134,122             154             154  
                                                         
Employee stock purchase plan                 23,083             128             128  
                                                         
Stock warrant exercises                 42,034                          
                                                         
Net loss                                   (15,624 )     (15,624 )
                                                         
Balances at September 30, 2019         $       17,807,167     $ 18     $ 73,822     $ (61,492 )   $ 12,348  
                                                         
   

Redeemable Convertible

Preferred Stock

    Common Stock     Additional Paid-in     Accumulated     Total Stockholders’  
    Shares     Amount     Shares     Amount     Capital     Deficit     Deficit  
Balances at December 31, 2017     6,685,082     $ 19,004       6,000,000     $ 6     $ 1,759     $ (8,639 )   $ (6,874 )
                                                         
Stock-based compensation                 218,980             1,631             1,631  
                                                         
Accrued dividends on redeemable convertible preferred stock           900                         (900 )     (900 )
                                                         
Deemed dividends for accretion of redeemable convertible preferred stock issuance costs           1,257                         (1,257 )     (1,257 )
                                                         
Net loss                                   (9,010 )     (9,010 )
                                                         
Balances at September 30, 2018     6,685,082     $ 21,161       6,218,980     $ 6     $ 3,390     $ (19,806 )   $ (16,410 )

 

The accompanying notes are an integral part of these condensed financial statements.

 

4
 

 

Eton Pharmaceuticals, Inc.

Condensed Statements of Cash Flows

(In thousands)

(Unaudited)

 

   

Nine months ended

September 30, 2019

   

Nine months ended

September 30, 2018

 
Cash flows from operating activities                
Net loss   $ (15,624 )   $ (9,010 )
                 
Adjustments to reconcile net loss to net cash used in operating activities:                
Stock-based compensation     1,387       1,631  
Depreciation and amortization     299       40  
Change in fair value of warrant liability           1,057  
Changes in operating assets and liabilities:                
Prepaid expenses and other assets     426       (493 )
Accounts payable      (403)       254  
Accrued liabilities     (263)       150  
Net cash used in operating activities     (14,178 )     (6,371 )
                 
Cash used in investing activities                
Purchases of property and equipment     (1,062 )     (182 )
                 
Cash flows from financing activities                
Proceeds from employee stock purchase plan and stock option exercises     282        
Net cash provided by financing activities     282        
                 
Change in cash and cash equivalents     (14,958 )     (6,553)  
Cash and cash equivalents at beginning of period     26,735       13,156  
Cash and cash equivalents at end of period   $ 11,777     $ 6,603  
                 
Supplemental disclosures of cash flow information                
Cash paid for interest   $     $  
Cash paid for income taxes   $     $  
                 
Supplemental disclosures of non-cash investing and financing activities:                
Accrued dividends on redeemable convertible preferred stock   $     $ 900  
Deemed dividends for accretion of redeemable convertible preferred stock issuance costs   $     $ 1,257  

 

The accompanying notes are an integral part of these condensed financial statements.

 

5
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 1 — Company Overview

 

Eton Pharmaceuticals, Inc. (“Eton” or the “Company”) was incorporated as a Delaware corporation on April 27, 2017 and was initially set up as a wholly owned subsidiary of Harrow Health, Inc. or “Harrow” (fka Imprimis Pharmaceuticals, Inc.)

 

Eton raised $20,055 in start-up capital through the sale of its Series A redeemable convertible preferred stock (“Series A Preferred”) in June 2017, and a separate management team was then established for Eton with its corporate offices located in Deer Park, Illinois. Eton is a specialty pharmaceutical company focused on developing and commercializing prescription drug products utilizing the U.S. Food and Drug Administration’s (the “FDA”) 505(b)(2) regulatory pathway. The Company’s business model is to develop proprietary innovative product candidates that offer commercial and/or functional advantages to currently available alternatives.

 

In November 2018, the Company completed an initial public offering (the “IPO”), selling 4,140,000 shares of its common stock at an offering price of $6.00 per share, including the underwriter’s exercise in full of its option to purchase additional shares. The Company received net proceeds of $21,960, after deducting underwriting discounts and commissions and offering-related expenses.

 

Note 2 — Liquidity Considerations

 

As of September 30, 2019, the Company had an accumulated deficit of $61,492 and for the nine months ended September 30, 2019, the Company had net cash used in operating activities of $14,178.

 

To date, the Company has generated limited revenues and has incurred negative cash flows from operating activities since its inception in 2017. The Company received its first product approval from the FDA, Biorphen®, in October 2019, and currently believes its future revenues and its existing cash and cash equivalents of $11,777 will be sufficient to fund its operating expenses and capital expenditure requirements for at least the next twelve months from the date of issuance of these financial statements. This estimate is based on the Company’s current assumptions, including expected sales for Biorphen and its ability to manage its spending. The Company could use its available capital resources sooner than currently expected. Accordingly, the Company could seek to obtain additional capital through equity financings, the sale of debt or other arrangements. However, there can be no assurance that the Company will be able to raise additional capital if needed or under acceptable terms, if at all. The sale of additional equity may dilute existing stockholders and newly issued shares may contain senior rights and preferences compared to currently outstanding common shares. Issued debt securities may contain covenants and limit the Company’s ability to pay dividends or make other distributions to stockholders. If the Company is delayed in completing its product development and obtaining regulatory approval for its product candidates and is unable to obtain such additional financing, operations would need to be scaled back or discontinued.

 

Note 3 — Summary of Significant Accounting Policies

 

Basis of Presentation

 

The Company has prepared the accompanying financial statements in accordance with accounting principles generally accepted in the United States of America (“GAAP”).

 

Unaudited Interim Financial Information

 

The accompanying interim condensed financial statements are unaudited and have been prepared on the same basis as the audited financial statements and, in the opinion of management, reflect all adjustments necessary for the fair presentation of the Company’s financial position as of September 30, 2019 and the results of its operations and its cash flows for the periods ended September 30, 2019 and 2018. The financial data and other information disclosed in these notes related to the three and nine-month periods ended September 30, 2019 and 2018 are also unaudited. The results for the nine-month period ended September 30, 2019 are not necessarily indicative of results to be expected for the year ending December 31, 2019, any other interim periods or any future year or period.

 

6
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 3 — Summary of Significant Accounting Policies (continued)

 

Use of Estimates

 

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the condensed financial statements and the reported amounts of revenue and expenses during the reporting periods. Significant estimates and assumptions reflected in these condensed financial statements include, but are not limited to, the accrual of research and development expenses and the valuation of common stock, stock options, warrants and derivative instruments. Estimates are periodically reviewed in light of changes in circumstances, facts and experience. Changes in estimates are recorded in the period in which they become known. Actual results could differ from those estimates or assumptions.

 

Segment Information

 

The Company operates the business on the basis of a single reportable segment, which is the business of developing and commercializing prescription drug products. The Company’s chief operating decision-maker is the Chief Executive Officer (“CEO”), who evaluates the Company as a single operating segment.

 

Cash and Cash Equivalents

 

The Company considers all highly liquid investments with an original maturity of three months or less to be cash equivalents. All cash and cash equivalents are held in U.S. financial institutions. Cash equivalents consist of an interest-bearing checking account. From time to time, amounts deposited exceed federally insured limits. The Company believes the associated credit risk to be minimal.

 

Property and Equipment

 

Property and equipment are stated at cost. Depreciation of property and equipment is computed utilizing the straight-line method based on the following estimated useful lives. Computer software and hardware is depreciated over three years. Equipment, furniture and fixtures is depreciated over five years. Leasehold improvements are amortized over their estimated useful lives or the remaining lease term, whichever is shorter. Construction in progress is capitalized but not depreciated until it is placed into service.

 

Maintenance and repairs are charged to expense as incurred, while renewals and improvements are capitalized.

 

Impairment of Long-Lived Assets

 

Long-lived assets 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 Company’s statements of operations for the amount by which the carrying amount of the asset exceeds the fair value of the asset. No impairment has been recognized since the Company’s inception in 2017.

 

Classification and Accretion of Redeemable Convertible Preferred Stock

 

Prior to the Company’s IPO in November 2018, the Company had classified the Series A Preferred outside of stockholders’ equity (deficit) because the shares contained certain redemption features that were not solely within the control of the Company. The carrying value of the Series A Preferred was accreted to its redemption value from the date of issuance through November 15, 2018, the date of the IPO. In conjunction with the IPO, the Series A Preferred, including accrued and unpaid dividends, automatically converted to shares of the Company’s common stock (see Note 6).

 

7
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 3 — Summary of Significant Accounting Policies (continued)

 

Revenue Recognition for Contracts with Customers

 

The Company intends to generate its future revenues from direct sales of its products, many of which are in development. In addition, the Company anticipates it will receive revenues from product licensing agreements where it has contracted for milestone payments and royalties from products it has developed or for which it has acquired the rights to a product developed by a third party.

 

The Company accounts for contracts with its customers in accordance with Accounting Standards Codification (“ASC”) 606 — Revenue from Contracts with Customers. ASC 606 applies to all contracts with customers, except for contracts that are within the scope of other standards. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

 

At contract inception, once the contract is determined to be within the scope of ASC 606, the Company assesses the goods or services promised within each contract and determines those that are performance obligations and assesses whether each promised good or service is distinct. The Company then recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Arrangements that include rights to additional goods or services that are exercisable at a customer’s discretion are generally considered options. The Company assesses whether these options provide a material right to the customer and, if so, they are considered performance obligations. The exercise of a material right is accounted for as a contract modification for accounting purposes.

 

The Company recognizes as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) each performance obligation is satisfied at a point in time or over time, and if over time this is based on the use of an output or input method. Any amounts received prior to revenue recognition will be recorded as deferred revenue. Amounts expected to be recognized as revenue within the twelve months following the balance sheet date will be classified as current portion of deferred revenue in the Company’s balance sheets. Amounts not expected to be recognized as revenue within the twelve months following the balance sheet date are classified as long-term deferred revenue, net of current portion.

 

Milestone Payments – If a commercial contract arrangement includes development and regulatory milestone payments, the Company will evaluate whether the milestone conditions have been achieved and if it is probable that a significant revenue reversal would not occur before recognizing the associated revenue. Milestone payments that are not within the Company’s control or the licensee’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received.

 

Royalties – For arrangements that include sales-based royalties, including milestone payments based on a level of sales, which are the result of a customer-vendor relationship and for which the license is deemed to be the predominant item to which the royalties relate, the Company will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied or partially satisfied. To date, the Company has not recognized any royalty revenue resulting from any of its licensing arrangements.

 

Significant Financing Component – In determining the transaction price, the Company will adjust consideration for the effects of the time value of money if the expected period between payment by the licensees and the transfer of the promised goods or services to the licensees will be more than one year.

 

8
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 3 — Summary of Significant Accounting Policies (continued)

 

Research and Development Expenses

 

Research and development (“R&D”) expenses include both internal R&D activities and external contracted services. Internal R&D activity expenses include salaries, benefits and stock-based compensation and other costs to support the Company’s R&D operations. External contracted services include product development efforts including certain product licensor milestone payments, clinical trial activities, manufacturing and control-related activities and regulatory costs. R&D expenses are charged to operations as incurred. The Company reviews and accrues R&D expenses based on services performed and relies upon estimates of those costs applicable to the stage of completion of each project. Significant judgments and estimates are made in determining the accrued balances at the end of any reporting period. Actual results could differ from the Company’s estimates.

 

Upfront payments and milestone payments made for the licensing of technology on products which are not yet approved by the FDA are expensed as R&D in the period in which they are incurred. Milestone payments for FDA-approved products are capitalized and amortized over the expected economic life of the product. Nonrefundable advance payments for goods or services to be received in the future for use in R&D activities are recorded as prepaid expenses and are expensed as the related goods are delivered or the services are performed.

 

Earnings (Loss) Per Share

 

Basic net loss per common share is computed by dividing net loss attributable to common stockholders for the period by the weighted average number of common shares outstanding during the period. Diluted net loss per share is computed by dividing the net loss attributable to common stockholders for the period by the weighted average number of common and common equivalent shares, such as Series A Preferred, unvested restricted stock, stock options and warrants, outstanding during the period. Common stock equivalents are excluded from the computation where their inclusion would be anti-dilutive. No such adjustments were made for the three-month or nine-month periods ended September 30, 2019 or 2018 as the Company reported a net loss for these periods and including the effects of common stock equivalents in the diluted EPS calculation would have been antidilutive (see Note 10).

 

Stock-Based Compensation

 

The Company accounts for stock-based compensation under the provisions of ASC 718 Compensation — Stock Compensation. The guidance under ASC 718 requires companies to estimate the fair value of the stock-based compensation awards on the date of grant and record expense over the related service periods, which are generally the vesting period of the equity awards. The Company estimates the fair value of stock-based option awards using the Black-Scholes-Merton option-pricing model (“BSM”). The BSM requires the input of subjective assumptions, including the expected stock price volatility, the calculation of expected term, forfeitures and the fair value of the underlying common stock on the date of grant, among other inputs. The risk-free interest rate was determined from the implied yields for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options or warrants. Dividends on common stock are assumed to be zero for the BSM valuation of the stock options. The expected term of stock options granted is based on vesting periods and the contractual life of the options. Expected volatilities are based on comparable companies’ historical volatility along with a limited weighting included for the Company’s own volatility subsequent to its IPO, which management believes represents the most accurate basis for estimating expected future volatility under the current conditions. The Company accounts for forfeitures as they occur.

 

Prior to the IPO, the fair value of the shares of the Company’s common stock underlying its stock-based awards was determined by its board of directors, with input from management. Because there had been no public market for the Company’s common stock prior to the IPO, the board of directors had determined the fair value of the common stock on the grant-date of the stock-based award by considering a number of objective and subjective factors, including enterprise valuations of its common stock performed by an unrelated third-party specialist, valuations of comparable companies, sales of its Series A Preferred to unrelated third parties, operating and financial performance, the lack of liquidity of the capital stock, and general and industry-specific economic outlook. Since the IPO in November 2018, the Company has used the closing common stock price on the date of grant for the fair value of the common stock.

 

9
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 3 — Summary of Significant Accounting Policies (continued)

 

Fair Value Measurements

 

We measure certain of our assets and liabilities at fair value. Fair value represents the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value accounting requires characterization of the inputs used to measure fair value into a three-level fair value hierarchy as follows:

 

Level 1 — Inputs based on quoted prices in active markets for identical assets or liabilities. An active market is a market in which transactions occur with sufficient frequency and volume to provide pricing information on an ongoing basis.

 

Level 2 — Observable inputs that reflect the assumptions market participants would use in pricing the asset or liability developed based on market data obtained from sources independent from the entity.

 

Level 3 — Unobservable inputs that reflect the entity’s own assumptions about the assumptions market participants would use in pricing the asset or liability developed based on the best information available.

 

Fair value measurements are classified based on the lowest level of input that is significant to the measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment, which may affect the valuation of the assets and liabilities and their placement within the fair value hierarchy levels. The determination of the fair values stated below takes into account the market for the Company’s financials, assets and liabilities, the associated credit risk and other factors as required. The Company considers active markets as those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

 

The carrying amounts of cash and cash equivalents, accounts payable and accrued liabilities approximate their fair values due to the short-term maturities of these instruments.

 

The fair values of the Company’s warrant liability at inception and for subsequent mark-to-market fair value measurements were based on management’s valuation model and expectations with respect to the method and timing of settlement. The Company had determined that the warrant liability fair values were classified as Level 3 measurements within the fair value hierarchy. At the date of the Company’s IPO in November 2018, the fair value was reclassified to additional paid-in-capital as the final number of shares for the warrants previously reflected as a liability became fixed.

 

Impact of New Accounting Pronouncements

 

In February 2016, the FASB issued ASU 2016-02 (Topic 842) – Leases (“ASC 842”), which requires the lease rights and obligations arising from lease contracts, including existing and new arrangements for substantially all leases with terms more than twelve months to be recognized as assets and liabilities on the balance sheet. Recognition, measurement and presentation of expenses depends upon classification as a finance or operating lease. The Company adopted ASC 842 effective January 1, 2019 utilizing the modified retrospective approach such that prior year financial statements were not recast under the new standard. The adoption of ASU 2016-02 did not have a material effect on the Company’s financial condition from the recognition of the lease rights and obligations as assets and liabilities or its results of operations and cash flows. See Note 12 for additional information regarding the new standard and its impact on the Company’s financial statements.

 

10
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 4 — Revenues

 

Prior to 2019, the Company did not have any revenues. The Company’s revenues of $500 for the nine months ended September 30, 2019 resulted from the sale of its EM-100 product rights to Bausch Health Ireland Limited (“Bausch”) per an Asset Purchase Agreement dated February 18, 2019 (the “Asset Purchase Agreement”). Pursuant to the Asset Purchase Agreement, Bausch paid the Company an upfront payment of $500 and Bausch is required to pay the Company a milestone payment of $1,500 upon the first commercial sale of the EM-100 product. In addition, Bausch is required to pay the Company a royalty on net sales for a period of ten years from the date of the first commercial sale of the EM-100 product in the United States.

 

Note 5 – Property and Equipment

 

Property and equipment consist of the following:

 

   September 30, 2019   December 31, 2018 
Computer hardware and software  $170   $93 
Furniture and fixtures   115    98 
Equipment   993    99 
Leasehold improvements   147    53 
Construction in progress   3    492 
    1,428    835 
Less: accumulated depreciation   (259)   (62)
Property and equipment, net  $1,169   $773 

 

Depreciation expense for the nine-month periods ended September 30, 2019 and 2018 was $197 and $33, respectively.

 

Note 6 — Redeemable Convertible Preferred Stock — Series A

 

The Company has 10,000,000 authorized shares of $0.001 par value preferred stock as per its Amended and Restated Certificate of Incorporation. In June 2017, the Company issued 6,685,082 shares of Series A Preferred at a price of $3.00 per share, and all shares remained outstanding until the Company’s IPO in November 2018. The gross proceeds were $20,055 from the Series A Preferred stock offering. The Series A Preferred shares, including accrued and unpaid dividends, automatically converted to the Company’s common shares at the date of the IPO.

 

As a result of the Series A Preferred having a possible cash redemption feature in the event that an IPO or alternate financing was not completed by December 31, 2018, the Series A Preferred was classified as temporary equity and not included as part of Company’s stockholders’ equity (deficit) prior to the November 2018 IPO. In accordance with that classification, $2,534 of issuance costs associated with the Series A Preferred offering were being ratably accreted as a deemed dividend using the effective interest method through the expected redemption date.

 

The Series A Preferred automatically converted to common stock upon completion of the IPO in November 2018. The conversion share calculation was based on the $3.00 initial issue price for the Series A Preferred plus accrued and unpaid dividends, and automatically converted into shares of the Company’s common stock using a stated divisor conversion price equal to 50% of the IPO price to the public which was $6.00 per share. In accordance with relevant accounting literature, since the terms of the conversion option did not permit the Company to compute the additional number of shares that it would need to issue upon conversion of the Series A Preferred when the contingent event occurred, the Company recorded the beneficial conversion amount of $21,747 as a deemed dividend at the date of the IPO in November 2018.

 

Note 7 — Common Stock

 

The Company has 50,000,000 authorized shares of $0.001 par value common stock as per its Amended and Restated Certificate of Incorporation. During the nine months ended September 30, 2019, the Company issued 134,122 shares of its common stock for stock option exercises, 23,083 shares for awards under its Employee Stock Purchase Plan (see Note 9) and 42,034 shares for the exercise of stock warrants.

 

11
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 8 — Common Stock Warrants

 

In May 2017, the Company issued a warrant to purchase 600,000 shares of its common stock to consultants for business strategy and intellectual property advisory services. The warrant vested at issuance in May 2017, has a $0.01 exercise price per warrant share and expires five years from the date of issuance.

 

In conjunction with the closing of the Series A Preferred offering in June 2017 (see Note 6), the Company issued a warrant to purchase 649,409 shares of its common stock to the placement agent at an exercise price of $3.00 per share, provided, however, upon the conversion of the Series A Preferred to common stock, the warrant adjusted to entitle the holder to purchase shares of common stock equal to 10.0% of the shares of common stock issuable upon conversion of the Series A Preferred (excluding 191,000 shares of Series A Preferred that were purchased by insiders) and the exercise price would adjust to the conversion price of the Series A Preferred. This warrant vested at issuance in June 2017. The Company used the BSM to value the warrant and the fair value at the date of issuance was $479. The fair value assumptions included an expected term of five years, expected volatility of 85%, a risk-free interest rate of 2.9% and estimate of the conversion rate.

 

These warrants were classified as warrant liability on the Company’s balance sheets prior to the IPO in November 2018 as the number of shares of common stock issuable upon the exercise of this warrant was not fixed as it could vary by a factor of 1.000 to 1.333 shares of common stock per warrant share in accordance with the IPO price, and the Company had considered the warrant to be a derivative instrument. The $479 amount was recorded as a component of the issuance costs for the Series A Preferred in June 2017, and subsequent changes in the fair value of this warrant were recorded as a component of other income and expense. As of September 30, 2018, the fair value of the warrant was $1,577 and the $1,057 increase in fair value during the nine months ended September 30, 2018 was recorded as a component of other income and expense. For the three months ended September 30, 2018, the $561 increase in fair value for the warrants was recorded as a component of other income and expense.

 

In connection with the IPO, the number of shares of common stock issuable upon the exercise of these warrants became fixed at 704,184 shares which eliminated the fair value adjustment after that date. At the IPO date, the warrant liability was reclassified to additional paid-in-capital. In June 2019, 67,737 of these warrant shares were exercised on a cashless basis which resulted in the Company issuing 42,034 shares of its common stock.

 

During November 2018, in connection with the IPO, the Company issued warrants for 414,000 shares of its common stock to the placement agent at an exercise price of $7.50 per share.

 

The outstanding warrants are summarized in the table below.

 

Description of Warrants   No. of Shares     Exercise Price  
Business Advisory Warrants     600,000     $ 0.01  
Placement Agent Warrants - Series A Preferred     636,447     $ 3.00  
Placement Agent Warrants - IPO     414,000     $ 7.50  
Total     1,650,447     $ 3.04 (Avg)  

 

The holders of these warrants or their permitted transferees, are entitled to rights with respect to the registration under the Securities Act of 1933, as amended (the “Securities Act”) for their shares that are converted to common stock, including demand registration rights and piggyback registration rights. These rights are provided under the terms of a registration rights agreement between the Company and the investors.

 

12
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 9 — Share-Based Payment Awards

 

The Company’s board of directors and stockholders approved the Eton Pharmaceuticals, Inc. 2017 Equity Incentive Plan in May 2017 (the “2017 Plan”), which authorized the issuance of up to 5,000,000 shares of the Company’s common stock. In conjunction with the Company’s IPO in November 2018, the Company’s stockholders and board of directors approved the 2018 Equity Incentive Plan (the “2018 Plan”) which succeeded the 2017 Plan. The Company has granted restricted stock awards (“RSAs”), stock options and restricted stock units (“RSUs”) for its common stock under the 2017 Plan and 2018 Plan as detailed in the tables below. There were 872,837 shares available for future issuance under the 2018 Plan as of September 30, 2019.

 

Shares that are expired, terminated, surrendered or canceled without having been fully exercised will be available for future awards under the 2018 Plan. In addition, the 2018 Plan provides that commencing January 1, 2019 and through January 1, 2028, the share reserve will be increased by 4% of the total number of shares of common stock outstanding as of the preceding December 31, subject to a reduction at the discretion of the Company’s board of directors. On January 1, 2019, the share reserve was increased by 704,317 shares based on the 17,607,928 shares of common stock outstanding at December 31, 2018. The exercise price for stock options granted is not less than the fair value of common stock as determined by the board of directors as of the date of grant. Prior to the IPO, the Company’s board of directors valued the Company’s common stock, taking into consideration its most recently available valuation of common stock performed by third parties as well as additional factors which might have changed since the date of the most recent contemporaneous valuation through the date of grant. Following the IPO, the Company has used the closing stock price on the date of grant as the exercise price.

 

On January 1, 2018, the Company issued 54,745 restricted shares of its common stock to each of its four outside directors (218,980 total shares). The restricted shares issued to the outside directors vested 25% at each quarter-end in 2018 and were 100% vested at December 31, 2018.

 

During the third quarter of 2017, the Company issued 25,000 RSU’s to each of its four outside directors (100,000 total share units). The RSU’s issued to the outside directors vested 25% at each subsequent quarter-end in 2017 and 2018 and were 100% vested at June 30, 2018. The associated 100,000 shares of the Company’s common stock will not be issued until the individual director retires from service from the Company’s board of directors. The Company has not issued any additional RSU’s.

 

To date, all stock options issued have been non-qualified stock options, and the exercise prices were set at the fair value for the shares at the dates of grant. Options typically have a ten-year life, except for options to purchase 50,000 shares of the Company’s common stock granted to product consultants that expire within five years if the Company is not able to file certain product submissions to the FDA prior to the five-year expiration date. Furthermore, these option awards to the Company’s product consultants do not vest unless certain product submissions are made to the FDA, and accordingly, the Company has not recorded any expense for these contingently vesting option awards to its product consultants.

 

For the three months ended September 30, 2019 and 2018, the Company’s total stock-based compensation expense was $537 and $165, respectively. Of these amounts, $460 and $147 was recorded in general and administrative expenses, respectively, and $77 and $18 was recorded in research and development expenses, respectively.

 

For the nine months ended September 30, 2019 and 2018, the Company’s total stock-based compensation expense was $1,387 and $1,631, respectively. Of these amounts, $1,150 and $1,581 was recorded in general and administrative expenses, respectively, and $237 and $50 was recorded in research and development expenses, respectively.

 

13
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 9 — Share-Based Payment Awards (continued)

 

A summary of stock option activity is as follows:

 

 

 

 

 

 

Shares

  

 

Weighted Average Exercise

Price

   Weighted Average Remaining Contractual Term (Yrs)  

Aggregate Intrinsic

Value

 
Options outstanding as of December 31, 2018   1,295,000   $1.78   8.3   $5,627 
Issued   717,500    7.44          
Exercised   (134,122)   1.15          
Forfeited/Cancelled                 
Options outstanding as of September 30, 2019   1,878,378   $3.99   8.4   $5,188 
Options exercisable at September 30, 2019   643,431   $2.65   7.6   $2,505 
Options vested and expected to vest at September 30, 2019   1,828,378   $4.06   8.4   $4,941 

 

The aggregate intrinsic value of stock options is calculated as the difference between the exercise price of the stock options and the fair value of the Company’s common stock for those stock options that had strike prices lower than the fair value of the Company’s common stock.

 

The assumptions used to calculate the fair value of options granted during the nine months ended September 30, 2019 under the BSM were as follows:

 

    September 30, 2019  
Expected dividends     %
Expected volatility     90 %
Risk-free interest rate     1.9-2.5 %
Expected term     5.3 – 6.3 years  
Weighted average fair value   $ 5.54  

 

Expected Term — The Company has opted to use the “simplified method” for estimating the expected term of options granted to employees and directors, whereby the expected term equals the arithmetic average of the vesting term and the original contractual term of the option (generally ten years). The expected term of options granted to non-employees equals the contractual life of the options.

 

Expected Volatility — Due to the Company’s limited operating history and a lack of Company-specific historical and implied volatility data, the Company had based its estimate of expected volatility on the historical volatility of a group of similar companies that are publicly traded. During 2019, the Company has continued this methodology plus given some limited weighting to its own volatility in the periods subsequent to its November 2018 IPO. The historical volatility data was computed using the daily closing prices for the selected companies’ shares during the equivalent period of the calculated expected term of the stock-based awards.

 

Risk-Free Interest Rate — The risk-free rate assumption is based on the U.S. Treasury instruments with maturities similar to the expected term of the Company’s stock options.

 

Expected Dividend — The Company has not issued any dividends in its history and does not expect to issue dividends over the life of the options and therefore has estimated the dividend yield to be zero.

 

14
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 9 — Share-Based Payment Awards (continued)

 

Fair Value of Common Stock — Prior to the Company’s IPO in November 2018, the fair value of the shares of common stock underlying the stock-based awards was determined by the board of directors, with input from management. Because there was no public market for the Company’s common stock, the board of directors determined the fair value of the common stock on the grant-date of the stock-based award by considering a number of objective and subjective factors, including enterprise valuations of the Company’s common stock performed by an unrelated third-party specialist, valuations of comparable companies, sales of the Company’s Series A Preferred to unrelated third parties, operating and financial performance, the lack of liquidity of the Company’s capital stock, and general and industry-specific economic outlook. The board of directors intended all options granted to be exercisable at a price per share not less than the estimated per share fair value of common stock underlying those options on the date of grant. Following the IPO, the Company has used the closing stock price on the date of grant for the fair value of the common stock.

 

A summary of activity for the RSAs is as follows:

 

Restricted Stock Awards   Number of shares  
Unvested as of December 31, 2018     312,500  
Issued      
Vested     (312,500 )
Forfeited/Cancelled      
Unvested as of September 30, 2019      

 

There were no RSAs issued during the nine months ended September 30, 2019. The fair value of the RSAs vested during the nine months ended September 30, 2019 was $66.

 

As of September 30, 2019, there was a total of $4,017, $0 and $0 of unrecognized compensation costs related to non-vested stock option awards, RSAs and RSUs, respectively. In the nine-month period ended September 30, 2019, stock option exercises totaled 134,122 shares at a weighted average exercise price of $1.15 per share with an intrinsic value of $786. There were no exercises of stock options during the nine months ended September 30, 2018.

 

In December 2018, the Company’s board of directors adopted an initial offering of the Company’s common stock under the Company’s 2018 Employee Stock Purchase Plan (the “ESPP”). The Company’s ESPP provides for an initial reserve of 150,000 shares and this reserve is automatically increased on January 1 of each year by the lesser of 1% of the outstanding common shares at December 31 of the preceding year or 150,000 shares, subject to reduction at the discretion of the Company’s board of directors.

 

The initial offering of the ESPP began on December 17, 2018 and will end on December 10, 2019, unless terminated earlier pursuant to the ESPP. The initial offering consists of two purchase periods, with the first purchase period ending on June 10, 2019 and the second purchase period ending on December 10, 2019. The terms of the ESPP permit employees of the Company to use payroll deductions to purchase stock at a price per share that is at least the lesser of (1) 85% of the fair market value of a share of common stock on the first date of an offering or (2) 85% of the fair market value of a share of common stock on the date of purchase. After the initial offering ends, subsequent twelve-month offering periods will automatically commence over the term of the ESPP on the day that immediately follows the conclusion of the preceding offering, each consisting of two purchase periods approximately six months in duration ending on or around June 10 and December 10 each year.

 

The weighted average grant date fair value of share awards under the ESPP in the first nine months of 2019 was $2.57 per share. Employees contributed $199 via payroll deductions during the nine months ended September 30, 2019 and the Company recorded an expense of $93 in the nine-month period ended September 30, 2019 related to the ESPP offering period that commenced on December 17, 2018. In June 2019, 23,083 shares of the Company’s common stock were issued under the ESPP at $5.53 per share (85% of the Company’s $6.50 per share closing price of its common stock on December 17, 2018). The Company collected $128 in proceeds from the issuance of these shares. As of September 30, 2019, the accompanying condensed balance sheet includes $79 in accrued liabilities for remaining employee contributions.

 

15
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 10 — Basic and Diluted Net Loss per Common Share

 

Basic and diluted net loss per share is computed using the weighted average number of shares of common stock outstanding during the period. Common stock equivalents (using the treasury stock and “if converted” method) from stock options, unvested RSAs and RSUs, warrants and convertible preferred stock at September 30, 2019 and 2018 were 3,573,885 and 9,039,088, respectively, and are excluded from the calculation of diluted net loss per share because the effect is anti-dilutive. The decline in common stock equivalents was primarily due to the automatic conversion of the Company’s Series A Preferred at the IPO in November 2018. Included in the basic and diluted net loss per share calculation are RSUs awarded to directors that have vested, but the issuance and delivery of the common shares are deferred until the director retires from service as a director.

 

The following table shows the computation of basic and diluted net loss per common share:

 

   

Three months ended

September 30, 2019

(unaudited)

   

Three months ended

September 30, 2018

(unaudited)

 
Net loss   $ (4,965 )   $ (2,910 )
Series A Preferred – dividends (accrued and deemed)           (729 )
Net loss attributable to common stockholders   $ (4,965 )   $ (3,639 )
Weighted average common shares outstanding basic and diluted)     17,878,114       5,614,892  
Net loss per common share (basic and diluted)   $ (0.28 )   $ (0.65 )

 

   

Nine months ended

September 30, 2019

(unaudited)

   

Nine months ended

September 30, 2018

(unaudited)

 
Net loss   $ (15,624 )   $ (9,010 )
Series A Preferred – dividends (accrued and deemed)           (2,157 )
Net loss attributable to common stockholders   $ (15,624 )   $ (11,167 )
Weighted average common shares outstanding basic and diluted)     17,705,852       4,657,900  
Net loss per common share (basic and diluted)   $ (0.88 )   $ (2.40 )

 

16
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 11 — Related Party Transactions

 

Harrow

 

Harrow was issued 3,500,000 shares of the Company’s common stock at the formation of the Company at the $0.001 par value per share price as the paid-in-capital contribution from Harrow. The Company and Harrow signed licensing agreements for two products developed by Harrow whereby Harrow assigned the product rights to the Company. The Company was obligated to pay Harrow a $50 milestone payment upon patent approval for each product and a royalty fee at a rate of six percent on the net sales of those two products. On December 26, 2017, one of the products had its patent approved and a $50 milestone fee was recognized as R&D expense by the Company in 2017 and paid to Harrow in January 2018. In July 2018, the Company determined the patent-approved product was not viable for its portfolio of product opportunities and Harrow paid the Company $50 to cancel the licensing agreement for the one product and retain the product rights at Harrow.

 

On May 6, 2019, the Company entered into an Asset Purchase Agreement (the “CT-100 Asset Purchase Agreement”) with Harrow. Pursuant to the CT-100 Asset Purchase Agreement, the Company sold all of its right, title and interest in CT-100 to Harrow, including any such product that incorporates or utilizes its intellectual property rights (a “Product” or, collectively, “Products”). Pursuant to the CT-100 Asset Purchase Agreement, Harrow will make certain payments to the Company upon the achievement of certain development and commercial milestones. In addition, Harrow is required to pay the Company a royalty in the low-single digit percentage range worldwide on a country-by-country basis on net sales for a period of the longer of 15 years from the date of the first commercial sale of a product in a particular country or the time that a valid intellectual property claim on such Product remains in force in the applicable country. The CT-100 Asset Purchase Agreement also contains customary representations, warranties, covenants and indemnities by the parties.

 

As part of the early start-up for the Company’s pharmaceutical business, key executives at Harrow received 1,500,000 shares of restricted common stock in the Company for consulting services, and certain Harrow managers also received options to purchase 130,000 shares of common stock from the Company (20,000 of these options were forfeited in 2018). The restricted stock and stock options vested 100% after one year on April 30, 2018. The Company recorded stock-based compensation expense of $0 and $970 for the Harrow restricted common stock and $0 and $51 for Harrow stock options, respectively, for the nine-month periods ended September 30, 2019 and 2018 as a component of its general and administrative expenses.

 

Additionally, the Chief Executive Officer of Harrow is a member of the Company’s board of directors.

 

Chief Executive Officer

 

The Company’s CEO has a partial interest in several companies that the Company is working with for product development and potential marketing if the products are approved by the FDA as detailed below.

 

The Company acquired the exclusive rights to sell the EM-100 product in the United States pursuant to a sales and marketing agreement (the “Eyemax Agreement”) dated August 11, 2017 between the Company and Eyemax LLC (“Eyemax”), an entity affiliated with the Company’s CEO. The Company also held a right of first refusal to obtain the exclusive license rights for geographic areas outside of the United States. Pursuant to the Eyemax Agreement, the Company is responsible for all costs of testing and FDA approval of the product, other than the FDA filing fee which will be paid by Eyemax. The Company was also responsible for commercializing the product in the United States at its expense. The Company paid Eyemax $250 upon execution of the Eyemax Agreement, which was recorded as a component of R&D expense. Under the terms of the original agreement, the Company would pay Eyemax $250 upon FDA approval and $500 upon the first commercial sale of the product and pay Eyemax a royalty of 10% on the net sales of all products. The Eyemax Agreement was for an initial term of 10 years from the date of the Eyemax Agreement, subject to successive two-year renewals unless the Company elected to terminate the Eyemax Agreement. There were no amounts due under the terms of the Eyemax Agreement as of September 30, 2019 or December 31, 2018.

 

17
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 11 — Related Party Transactions (continued)

 

On February 18, 2019, The Company entered into an Amended and Restated Agreement with Eyemax amending the Sales Agreement (the “Amended Agreement”). Pursuant to the Amended Agreement, Eyemax sold the Company all of its right, title and interest in EM-100, including any such product that incorporates or utilizes Eyemax’s intellectual property rights. Under the Amended Agreement, the Company assumed certain liabilities of Eyemax under its Exclusive Development & Supply Agreement with Excelvision SAS dated as of July 11, 2013, as amended (the “Excelvision Agreement”), with respect to certain territories and arising during certain time periods. Pursuant to the Amended Agreement, the Company remains obligated to pay Eyemax two milestones payments: (i) one milestone payment for $250 upon regulatory approval in the territory by the FDA of the first single agent product and (ii) one milestone payment for $500 following the first commercial sale of the first single agent product in the territory. Following payment of the milestones, the Company is entitled to retain all of the non-royalty transaction revenues and royalties up to $2,000 (the “Recovery Amount”). After the Company has retained the full Recovery Amount, it is entitled to retain half of all royalty and non-royalty transaction revenue. The Amended Agreement also contains customary representations, warranties, covenants and indemnities by the parties. The EM-100 asset and its associated product rights were sold to Bausch on February 18, 2019 and future potential royalties on Bausch sales of EM-100, pending an FDA approval for EM-100, will be split between Eyemax and the Company. There were no amounts due under the terms of the Amended Agreement as of September 30, 2019 or December 31, 2018.

 

The Company acquired the exclusive rights to sell the DS-100 product in the United States pursuant to an exclusive development and supply agreement (the “Andersen Agreement”) dated July 9, 2017 between the Company and Andersen Pharma, LLC (“Andersen”), an entity affiliated with the Company’s CEO. The Company also holds an option to purchase the DS-100 product and all related intellectual property and government approvals at a price of one dollar. Pursuant to the Andersen Agreement, Andersen is responsible for obtaining FDA approval at its expense and manufacturing the product for sale to the Company at its cost. The Company is responsible for commercializing the product in the United States at its expense. The Company paid Andersen $750 upon execution of the Andersen Agreement, which was recorded as a component of R&D expense and will pay Andersen $750 upon successful completion of three registration batches of product, $750 upon submission of a New Drug Application (“NDA”) and $750 upon FDA approval. The Company will also pay Andersen 50% of the net profit from the sale of the product. The Andersen Agreement is for an initial term of five years from the first commercial sale of the product, subject to successive two-year renewals unless either party elects to terminate the Andersen Agreement. There were no amounts due under the terms of the Andersen Agreement as of September 30, 2019 or December 31, 2018. The aforementioned option to purchase the product and all related intellectual property and government approvals was considered to represent variable interest in the affiliated entity. The affiliated entity was not considered to be a variable interest entity.

 

The Company acquired the DS-200 product and all related intellectual property and government approvals pursuant to an asset purchase agreement (the “Selenix Agreement”) dated June 23, 2017 between the Company and Selenix LLC (“Selenix”), an entity affiliated with the Company’s CEO. Pursuant to the Selenix Agreement, the Company paid Selenix $1,500 at signing, which was recorded as a component of R&D expense and paid $1,500 in April 2019 upon submission of an NDA on March 13, 2019 which was reflected as a component of R&D expense for the nine-month period ended September 30, 2019. The Company will pay $1,000 upon FDA approval of the DS-200 product. The Company has also agreed to pay Selenix 50% of the net profit from the sale of the product for the first 10 years following the date of the Selenix Agreement. There were no amounts due under the terms of the Selenix Agreement as of September 30, 2019 or December 31, 2018.

 

Note 12 — Leases

 

Effective January 1, 2019, the Company adopted ASC 842, which requires an entity to recognize a right-of-use (“ROU”) asset and a lease liability on the balance sheet for substantially all leases, including operating leases, using the modified retrospective approach. The Company elected to use the package of practicable expedients which allows companies to not reassess the following: (1) the lease classification for any expired or existing leases, (2) the treatment of initial direct costs as they related to existing leases, and (3) whether expired or existing contracts are or contain leases. The Company did not elect the use of the hindsight practical expedient, but did elect to separate lease components from non-lease components related to its office space lease.

 

Upon adoption of ASC 842, the Company had non-cancellable operating leases for its office and laboratory space subject to recognition as ROU assets. Accordingly, on January 1, 2019 the Company recorded $281 in ROU assets and $272 in operating lease liabilities (the difference of $9 related to existing prepaid rent as of December 31, 2018). The Company has not entered into any other lease arrangements through September 30, 2019.

 

18
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 12 — Leases (continued)

 

The Company does not have any lease contracts that contain: (1) an option to extend that the Company is reasonably certain to exercise, (2) an option to terminate that the Company is reasonably certain not to exercise, or (3) an option to extend (or not to terminate) in which exercise of the option is controlled by the lessor. Additionally, the Company does not have any leases with residual value guarantees or material restrictive covenants. For leases already commenced, the lease term was determined to be the remaining months in the lease term as of January 1, 2019, the date of adoption. Lease liabilities and their corresponding right-of-use assets have been recorded based on the present value of the future lease payments over the expected lease term. One of the Company’s lease agreements contains provisions for escalating rent payments over the term of the lease.

 

The Company’s leases do not contain readily determinable implicit discount rates, and therefore, the Company was required to use its incremental borrowing rate of 7.8% to discount the future lease payments based on information available at lease commencement. The incremental borrowing rate was estimated by determining the rate of interest that the Company would have to pay to borrow on a collateralized basis over a similar term an amount equal to the lease payments in a similar economic environment.

 

The Company’s operating lease cost as presented in the “Research and Development” and “General and Administrative” captions in the condensed statements of operations was $13 and $21, respectively, for the three months ended September 30, 2019 and $41 and $64, respectively, for nine months ended September 30, 2019. Cash paid for amounts included in the measurement of operating lease liabilities was $90 for the nine months ended September 30, 2019. The ROU asset amortization for the three month and nine-month periods ended September 30, 2019 was $31 and $90, respectively, and is reflected within depreciation and amortization on the Company’s condensed statements of cash flows. As of September 30, 2019, the weighted-average remaining lease term was 1.5 years, and the weighted-average incremental borrowing rate was 7.8%.

 

The table below presents the lease-related assets and liabilities recorded on the balance sheet as of September 30, 2019 (in thousands).

 

Assets   Classification      
Operating lease right-of-use assets   Operating lease right-of-use assets, net   $ 191  
Total leased assets       $ 191  
Liabilities            
Operating lease liabilities, current   Accrued liabilities   $ 130  
Operating lease liabilities, noncurrent   Operating lease liabilities, net of current portion     52  
Total operating lease liabilities       $ 182  

 

The Company’s future lease commitments for its administrative offices in Deer Park, Illinois and its laboratory facility in Lake Zurich, Illinois as of September 30, 2019 are as indicated below:

 

   Total   2019   2020   2021   Thereafter 
Undiscounted lease payments  $193    34    140    19     
Less: Imputed interest   (11)                    
Total lease liabilities  $182                     

 

The Company’s future operating lease payments as of December 31, 2018 were as follows:

 

Total     2019     2020     2021     Thereafter  
$ 308     $ 137     $ 140     $ 31     $  

 

19
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 13 — Commitments and Contingencies

 

Legal

 

The Company is subject to legal proceedings and claims that may arise in the ordinary course of business. The Company is not aware of any pending or threatened litigation matters at this time that may have a material impact on the operations of the Company.

 

License and product development agreements

 

The Company has entered into various agreements in addition to those discussed above which are described below.

 

The Company acquired the exclusive rights to sell the DS-300 product in the United States pursuant to a sales and marketing agreement dated November 17, 2017 with an unaffiliated third party (the “Sales Agreement”). Pursuant to the Sales Agreement, the licensor is responsible for obtaining FDA approval, at its expense, and the Company is responsible for commercializing the product in the United States at its expense. The Company will pay the third party 50% of the net profit from the sale of the product. The initial term is for the first 10 years following the first commercial sale of the product.

 

The Company acquired the exclusive license to develop, manufacture and sell ET-103 in the United States pursuant to an Exclusive License and Supply Agreement dated August 3, 2018 between the Company and Liqmeds Worldwide Limited (“LMW”), an unaffiliated entity. Pursuant to the agreement, the Company will be responsible for, and will own, all regulatory filings and approvals at its expense, provided that it shall have the right to recoup 35% of any regulatory filing fees from the initial profits from the sale of ET-103 and, provided further, the licensor shall be responsible for any bioequivalence study and shall be responsible for 60% of the costs of such study. An affiliate of the licensor shall manufacture the ET-103 and sell it to the Company at its cost. The Company paid the licensor $350 upon execution of the agreement and will pay the licensor $1,500 upon the FDA’s acceptance of an NDA for review, $1,000 upon FDA approval, $1,500 upon issuance of patent covering ET-103 listed in the FDA’s Orange Book and $500 in the event of product sales in excess of $10,000 in any calendar year. In addition, the Company is required to pay the licensor 35% of the net profit from product sales. The license agreement is for an initial term of 10 years from the date of the first commercial sale of the product, subject to two-year renewals unless either party elects to terminate no less than 12 months prior to the then current term. The agreement also contains customary representations, warranties, covenants and indemnities by the parties.

 

On January 23, 2019 the Company entered into a Licensing and Supply Agreement (the “Agreement”) with LMW for ET-104 oral liquid, a development stage product candidate (“ET-104”). Pursuant to the terms of the Agreement, the Company will be responsible for regulatory and marketing activities. LMW will be responsible for development and manufacturing of ET-104. The Company paid the licensor $350 upon execution of the Agreement and an additional $350 after receiving successful bioequivalence study results, and will pay $325 upon the FDA’s acceptance of an NDA for review, $325 upon FDA approval of the NDA, $650 upon issuance of patent covering ET-104 listed in the FDA’s Orange Book and $500 in the event that product sales in excess of $10,000 are achieved within a calendar year. In addition, the Company is required to pay the licensor 35% of the net profit from product sales. The Agreement is for an initial term of 10 years from the date of the first commercial sale of the product. The Company will retain sole ownership of the NDA after expiration of the Agreement

 

On February 8, 2019, the Company entered into an Exclusive Licensing and Supply Agreement (the “ET-202 License Agreement”) with Sintetica SA (“Sintetica”) for marketing rights in the United States to Biorphen® which is used for the treatment of clinically important hypotension resulting primarily from vasodilation in the setting of anesthesia. The product was submitted to the FDA for review and subsequently received FDA approval on October 21, 2019. Pursuant to the terms of the ET-202 License Agreement, the Company will be responsible for marketing activities and Sintetica is responsible for development, manufacturing, and regulatory activities related to obtaining regulatory approval. The Company paid Sintetica a licensing payment of $2,000 upon execution of the ET-202 License Agreement and will pay $750 upon the commencement of commercial product shipments. Sintetica will supply Biorphen to the Company at its direct costs and the Company will retain 5% of net sales as a marketing fee. Sintetica is entitled to receive the first $500 of product profits. All additional profit will be split 50% to the Company and 50% to Sintetica. The ET-202 License Agreement has a ten-year term from the first commercial sale of Biorphen.

 

20
 

 

Eton Pharmaceuticals, Inc.

Notes to Condensed Financial Statements

(in thousands, except share and per share amounts)

(Unaudited)

 

Note 13 — Commitments and Contingencies (continued)

 

On February 8, 2019, the Company also entered into an Exclusive Licensing and Supply Agreement (the “ET-203 License Agreement”) with Sintetica for marketing rights in the United States to ET-203, an injectable product candidate for use in the hospital setting. Pursuant to the terms of the ET-203 License Agreement, the Company will be responsible for marketing activities and Sintetica will be responsible for development, manufacturing, and regulatory activities related to obtaining regulatory approval. The Company paid Sintetica a licensing payment of $1,000 upon execution of the ET-203 License Agreement and will pay $750 upon FDA approval and the commercial sale of the product candidate. Upon approval, Sintetica will supply ET-203 to the Company at its direct costs. The Company will retain 5% of net sales as a marketing fee. Sintetica will be entitled to receive the first $500 of product profits. All additional profit will be split 50% to the Company and 50% to Sintetica. The ET-203 License Agreement has a ten-year term from first commercial sale of product.

 

On June 12, 2019, the Company entered into an Exclusive Licensing and Supply Agreement (the “ET-105 License Agreement”) with Aucta Pharmaceuticals, Inc. (“Aucta”) for marketing rights in the United States to ET-105, a product candidate for use as an adjunct therapy for partial seizures, primary generalized tonic-clonic seizures, and generalized seizures of Lennox-Gastaut syndrome in patients two years of age and older. Pursuant to the terms of the ET-105 License Agreement, the Company will be responsible for marketing activities and Aucta will be responsible for development, manufacturing, and regulatory activities related to obtaining regulatory approval. The Company paid Aucta a licensing payment of $2,000 in August 2019 upon receiving an acceptance for review letter from the FDA and will pay $2,000 upon FDA approval and commercial sales of the product candidate and another $1,000 upon issuance of an Orange-book listed patent. Aucta will receive a low double-digit royalty on net sales and will be entitled to receive milestone payments of up to $18,000 based on commercial success of the product, including:

 

  $1,000 when net sales exceed $10 million in a calendar year
  $2,000 when net sales exceed $20 million in a calendar year
  $5,000 when net sales exceed $50 million in a calendar year
  $10,000 when net sales exceed $100 million in a calendar year

 

Indemnifications

 

As permitted under Delaware law and in accordance with the Company’s Amended and Restated Bylaws, the Company is required to indemnify its officers and directors for certain events or occurrences while the officer or director is or was serving in such capacity. The Company is also party to indemnification agreements with its directors and officers. The Company believes the fair value of the indemnification rights and agreements is minimal. Accordingly, the Company has not recorded any liabilities for these indemnification rights and agreements as of September 30, 2019 or December 31, 2018.

 

Note 14 — Subsequent Events

 

On November 13, 2019, the Company entered into a credit agreement (the “Credit Agreement”) with SWK Holdings Corporation (“SWK”) which provides for up to $10,000 in financing. The Company received proceeds of $5,000 at closing and may borrow an additional $5,000 upon the FDA approval of a second product developed by the Company, excluding EM-100. Alternatively, the Company can borrow $2,000 upon FDA approval of the EM-100 product candidate and then an additional $3,000 upon FDA approval of another one of its product candidates. The term of the Credit Agreement is five years and borrowings bear interest at a rate of LIBOR 3-month plus 10.0%, subject to a stated LIBOR floor rate of 2.0%. In connection with the Credit Agreement, the Company will issue warrants to SWK to purchase common stock of the Company in an amount equal to 6.0% of the principal amounts drawn under the Credit Agreement, utilizing the prior ten-day average closing price of the Company’s common stock as a divisor to calculate the number shares issuable under the warrant. A 2.0% unused credit limit fee is assessed during the first twelve months after the date of the Credit Agreement and loan fees include a 5.0% exit fee based on the principal amounts drawn which is payable at the end of the term of the Credit Agreement. The Company is required to maintain a minimum cash balance of $3,000 and will pay 4.0% of the loan principal balance after each quarter-end. Borrowings under the Credit Agreement are secured by the Company’s assets. The Credit Agreement contains customary default provisions and covenants which include limits on additional indebtedness. SWK and the Company will negotiate covenant targets for EBITDA and revenue within 180 days of the date of the Credit Agreement.

 

21
 

 

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

 

You should read the following discussion and analysis of our financial condition and results of operations in conjunction with (i) our unaudited interim condensed financial statements and the related notes thereto included elsewhere in this Quarterly Report on Form 10-Q and (ii) our audited financial statements and notes thereto and management’s discussion and analysis of financial condition and results of operations Included in our Annual Report on Form 10-K for the year ended December 31, 2018 filed with the Securities and Exchange Commission (the “SEC”) on March 25, 2019 (the “2018 10-K”).

 

Forward-Looking Statements

 

This Quarterly Report on Form 10-Q contains forward-looking statements within the meaning of Section 27A of the Securities Act and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”), including, without limitation, statements regarding our expectations, beliefs, intentions or future strategies that are signified by the words “expect,” “anticipate,” “intend,” “believe,” “may,” “plan”, “seek” or similar language. All forward-looking statements included in this document are based on information available to us on the date hereof, and we assume no obligation to update any such forward-looking statements. Our business and financial performance are subject to substantial risks and uncertainties. Actual results could differ materially from those projected in the forward-looking statements. In evaluating our business, you should carefully consider other matters set forth in our SEC filings including the Risk Factors set forth in Part I, Item 1A of our 2018 10-K.

 

Overview

 

We were formed in April 2017 as a specialty pharmaceutical company focused on developing and commercializing innovative pharmaceutical products. We seek to improve the formula, delivery system, or safety of existing molecules in order to address unmet patient needs. We pursue what we perceive to be low-risk candidates where existing published literature, historical clinical trials, or physician usage has established safety and/or efficacy of the molecule, thereby reducing the incremental clinical burden required for us to bring the product to patients.

 

In October 2019, we received FDA approval for Biorphen® which we will market in the United States. Biorphen (phenylephrine HCl injection) is an alpha-1 adrenergic receptor agonist indicated for the treatment of clinically important hypotension resulting primarily from vasodilation in the setting of anesthesia. We acquired U.S marketing rights to Biorphen in February 2019.

 

We have established a diversified pipeline of product candidates in various stages of development, including multiple candidates that have been submitted to the FDA for review. Our product candidates are primarily focused on two core areas: hospital-based products and pediatric oral liquid products. We believe these candidates can address situations where patient needs are not being met by current FDA-approved products.

 

Results of Operations

 

We were formed on April 27, 2017. Through September 2019 we have generated only limited revenues, however we received FDA approval in October 2019 for our Biorphen® product and expect to commence significant revenue-generating activities in late 2019 and beyond. (Note: Dollar amounts are listed in thousands below).

 

Research and Development Expenses

 

For the three-month periods ended September 30, 2019 and 2018, we incurred $3,418 and $1,544 of research and development expenses (“R&D”), respectively. The comparative three-month detail of our R&D expense is listed in the table below with milestone spending for ET-105 and higher indirect expenses for new personnel and operating costs associated with our new laboratory facility and additional product development staff being only partially offset by lower testing expenses for DS-200 and lower clinical study expenses for EM-100 and other product candidates.

 

For the nine-month periods ended September 30, 2019 and 2018, we incurred $11,322 and $4,525 of R&D, respectively. The comparative nine-month detail of our R&D expense is listed in the table below with licensing fees and milestone payments for DS-200, ET-202, ET-203 and ET-104 being only partially offset by lower clinical study expenses for EM-100. In addition, the indirect expenses for 2019 were $1,248 higher due to new personnel and operating costs associated with our new laboratory facility and additional product development staff.

 

22
 

 

Set forth in the table below is our research and development spending for our current product candidates for the three and nine-month periods ended September 30, 2019 and 2018. We currently have eleven employees that support our overall product development and we also have facility and operating costs for a laboratory that will support product development. We do not track internal costs by product for our employees and laboratory expenses and they are listed as indirect expenses in the table below.

 

  

Three months ended

September 30, 2019

  

Three months ended

September 30, 2018

  

Nine months ended

September 30, 2019

  

Nine months ended

September 30, 2018

 
DS-200  $29   $202   $1,853   $597 
DS-300   139    148    907    1,032 
EM-100   22    264    122    1,242 
ET-202           2,000     
ET-203           1,000     
ET-104   367        762     
ET-105   2,060        2,060     
Other products   160    648    573    857 
Indirect expenses   641    282    2,045    797 
TOTAL  $3,418   $1,544   $11,322   $4,525 

 

General and Administrative Expenses

 

General and administrative expenses (“G&A”) consist primarily of employee compensation expenses, stock-based consulting service fees, legal and professional fees, product marketing expenses, distribution set-up expenses, business insurance, travel expenses and general office expenses.

 

For the three-month periods ended September 30, 2019 and 2018, we incurred $1,624 and $830, respectively, of G&A. The increase in G&A was mainly due to increased headcount/personnel expenses and public company expenses as well as initial product marketing expenses along with set-up expenses for product distribution incurred in the 2019 period.

 

For the nine-month periods ended September 30, 2019 and 2018, we incurred $5,123 and $3,510, respectively, of G&A. The increase in G&A was mainly due to increased headcount/personnel expenses and public company expenses as well as initial product marketing expenses along with set-up expenses for product distribution incurred in the 2019 period which were only partially offset by lower stock-based consulting service fees. We anticipate that our G&A expenses will increase to support our sales/marketing efforts, general business growth and the additional costs associated with being a public company.

 

The three-month and nine-month periods ended September 30, 2018 also included charges of $561 and $1,057, respectively, in other expense to recognize the increase in the fair value of warrants issued that were associated with our initial June 2017 Series A Preferred financing.

 

We incurred a net loss of $4,965 and $2,910 for the three-month periods ended September 30, 2019 and 2018, respectively. We incurred a net loss of $15,624 and $9,010 for the nine-month periods ended September 30, 2019 and 2018, respectively.

 

Cash Flows

 

The following table sets forth a summary of our cash flows for the nine-month periods ended September 30, 2019 and 2018:

 

   Nine months ended
September 30, 2019
   Nine months ended
September 30, 2018
 
Net cash used in operating activities  $(14,178)  $(6,371)
Cash used in investing activities   (1,062)   (182)
Cash flows from financing activities   282     
Change in cash and cash equivalents  $(14,958)  $(6,553)

 

The increase in cash used in operating activities is primarily a result of higher operating losses due to increased product candidate licensing and development activity along with higher personnel and operating expenses for our new laboratory combined with the expansion of our overall business operations including additional administrative personnel to support our initial marketing/sales development activities. Investing activities consist primarily of capital expenditures for setting up our new laboratory facility. The financing activity was the result of ESPP stock purchases and stock option exercises in 2019.

 

23
 

 

Critical Accounting Policies

 

Our condensed financial statements are prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”). The preparation of our condensed financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, costs and expenses in our condensed financial statements. We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions.

 

While our significant accounting policies are described in more detail in Note 2 to our financial statements included herein, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

 

Revenue Recognition

 

Prior to 2019, we did not have any revenues. Our revenues of $500 for the nine months ended September 30, 2019 resulted from the sale of our EM-100 product rights to Bausch Health Ireland Limited (“Bausch”) per an Asset Purchase Agreement dated February 18, 2019 (the “Asset Purchase Agreement”). We expect to generate future revenues from direct sales of our FDA-approved Biorphen® product as well as products we have in development which will typically require advance review and approval by the FDA. Additionally, we anticipate we will receive revenues from product licensing agreements where we have contracted for milestone payments and royalties from products we have developed or for which we have acquired the rights to a product developed by a third party.

 

We account for contracts with our customers in accordance with Accounting Standards Codification (“ASC”) 606 — Revenue from Contracts with Customers. ASC 606 applies to all contracts with customers, except for contracts that are within the scope of other standards. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606, the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation.

 

At contract inception, once the contract is determined to be within the scope of ASC 606, we assess the goods or services promised within each contract and determine those that are performance obligations and assesses whether each promised good or service is distinct. We then recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) the performance obligation is satisfied. Arrangements that include rights to additional goods or services that are exercisable at a customer’s discretion are generally considered options. We assess if these options provide a material right to the customer and, if so, they are considered performance obligations. The exercise of a material right is accounted for as a contract modification for accounting purposes.

 

We recognize as revenue the amount of the transaction price that is allocated to the respective performance obligation when (or as) each performance obligation is satisfied at a point in time or over time, and if over time this is based on the use of an output or input method. Any amounts received prior to revenue recognition will recorded as deferred revenue. Amounts expected to be recognized as revenue within the twelve months following the balance sheet date will be classified as current portion of deferred revenue in the Company’s consolidated balance sheets. Amounts not expected to be recognized as revenue within the twelve months following the balance sheet date are classified as long-term deferred revenue, net of current portion.

 

Milestone Payments – If a commercial contract arrangement includes development and regulatory milestone payments, we will evaluate whether the milestone conditions have been achieved and if it is probable that a significant revenue reversal would not occur before recognizing the associated revenue. Milestone payments that are not within our control or the licensee’s control, such as regulatory approvals, are generally not considered probable of being achieved until those approvals are received.

 

Royalties – For arrangements that include sales-based royalties, including milestone payments based on a level of sales, which are the result of a customer-vendor relationship and for which the license is deemed to be the predominant item to which the royalties relate, we will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or all of the royalty has been allocated has been satisfied or partially satisfied. To date, we have not recognized any royalty revenue resulting from any of our licensing arrangements.

 

24
 

 

Significant Financing Component – In determining the transaction price, we will adjust consideration for the effects of the time value of money if the expected period between payment by the licensees and the transfer of the promised goods or services to the licensees will be more than one year.

 

Stock-Based Compensation

 

We account for stock-based compensation under the provisions of ASC 718 Compensation – Stock Compensation. The guidance under ASC 718 requires companies to estimate the fair value of the stock-based compensation awards on the date of grant and record expense over the related service periods, which are generally the vesting period of the equity awards.

 

We estimate the fair value of stock-based option awards to our employees and directors using the Black-Scholes-Merton option-pricing model (“BSM”). The BSM requires the input of subjective assumptions, including the expected stock price volatility, the calculation of expected term, forfeitures and the fair value of the underlying common stock on the date of grant, among other inputs. The risk-free interest rate was determined from the implied yields for zero-coupon U.S. government issues with a remaining term approximating the expected life of the options or warrants. Dividends on common stock are assumed to be zero for the BSM valuation of the stock options. The expected term of stock options granted is based on vesting periods and the contractual life of the options. Expected volatilities are based on comparable companies’ historical volatility along with limited weighting for our volatility experience from the date of our IPO in November 2018, which management believes represents the most accurate basis for estimating expected future volatility under the current conditions. We account for forfeitures as they occur.

 

Research and Development Expenses

 

R&D expenses include both internal R&D activities and external contracted services. Internal R&D activity expenses include salaries, benefits and stock-based compensation, laboratory operating costs and other expenses to support our R&D operations. External contracted services include product development efforts including certain product licensor milestone payments, clinical trial activities, manufacturing and control-related activities and regulatory costs. R&D expenses are charged to operations as incurred. We review and accrue R&D expenses based on services performed and rely upon estimates of those costs applicable to the stage of completion of each project. Significant judgments and estimates are made in determining the accrued balances at the end of any reporting period. Actual results could differ from our estimates.

 

Upfront payments and milestone payments made for the licensing of technology on products which are not yet approved by the FDA are expensed as R&D in the period in which they are incurred. Milestone payments for FDA-approved products are capitalized and amortized over the expected economic life of the product. Nonrefundable advance payments for goods or services to be received in the future for use in R&D activities are recorded as prepaid expenses and are expensed as the related goods are delivered or the services are performed.

 

Off Balance Sheet Transactions

 

We do not have any off-balance sheet transactions.

 

JOBS Act Transition Period

 

In April 2012, the Jumpstart Our Business Startups Act of 2012 (the “JOBS Act”), was enacted. Section 107 of the JOBS Act provides that an “emerging growth company” can take advantage of the extended transition period provided in Section 7(a)(2)(B) of the Securities Act for complying with new or revised accounting standards. Thus, an emerging growth company can delay the adoption of certain accounting standards until those standards would otherwise apply to private companies. We have irrevocably elected not to avail ourselves of this extended transition period and, as a result, we will adopt new or revised accounting standards on the relevant dates on which adoption of such standards is required for other public companies.

 

We are in the process of evaluating the benefits of relying on other exemptions and reduced reporting requirements under the JOBS Act. Subject to certain conditions, as an emerging growth company, we may rely on certain of these exemptions, including without limitation, (i) providing an auditor’s attestation report on our system of internal controls over financial reporting pursuant to Section 404(b) of the Sarbanes-Oxley Act and (ii) complying with any requirement that may be adopted by the Public Company Accounting Oversight Board regarding mandatory audit firm rotation or a supplement to the auditor’s report providing additional information about the audit and the financial statements, known as the auditor discussion and analysis. We will remain an emerging growth company until the earlier to occur of (1) the last day of the fiscal year (a) December 31, 2023, which is the end of the fiscal year following the fifth anniversary of the completion of our IPO, (b) in which we have total annual gross revenues of at least $1.07 billion or (c) in which we are deemed to be a “large accelerated filer” under the rules of the SEC, which means the market value of our common stock that is held by non-affiliates exceeds $700 million as of the prior June 30th, and (2) the date on which we have issued more than $1.0 billion in non-convertible debt during the prior three-year period.

 

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Item 3. Quantitative and Qualitative Disclosures About Market Risk

 

The primary objective of our investment activities is to preserve capital. We do not utilize hedging contracts or similar instruments. We are exposed to certain market risks relating primarily to interest rate risk on our cash and cash equivalents and risks relating to the financial viability of the institutions which hold our capital and through which we have invested our funds. We manage such risks by investing in short-term, liquid, highly-rated instruments. As of September 30, 2019, our cash equivalents and investments are invested exclusively in money market funds. We do not believe we have any material exposure to interest rate risk due to the extremely low interest rate environment and the short duration of the invested funds we hold. Declines in interest rates would reduce our investment income but would not have a material effect on our financial condition or results of operations. We do not currently have exposure to foreign currency risk.

 

Item 4. Controls and Procedures

 

Disclosure Controls and Procedures

 

We maintain “disclosure controls and procedures,” as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Exchange Act, that are designed to ensure that information required to be disclosed by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in SEC rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and our Chief Financial Officer, to allow timely decisions regarding required disclosure.

 

The design of any disclosure controls and procedures also is based in part upon certain assumptions about the likelihood of future events, and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

 

With respect to the nine-month period ended September 30, 2019, under the supervision and with the participation of our management, we conducted an evaluation of the effectiveness of the design and operations of our disclosure controls and procedures. Based upon this evaluation, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that the Company’s disclosure controls and procedures are effective.

 

Management does not expect that our internal control over financial reporting will prevent or detect all errors and all fraud. A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control systems are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in a cost-effective control system, no evaluation of internal control over financial reporting can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been or will be detected.

 

Changes in Internal Control over Financial Reporting

 

There has not been any change in our internal control over financial reporting (as defined in Rules 13a-15(f) and 15d-15(f) under the Exchange Act) that occurred during the period ended September 30, 2019 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II. OTHER INFORMATION

 

Item 1. Legal Proceedings

 

None

 

Item 1A. Risk Factors

 

You should carefully consider the factors discussed in Part I, Item 1A. “Risk Factors” in our 2018 10-K, which could materially affect our business, financial condition, cash flows or future results. There have been no material changes in the risk factors included in our 2018 10-K. The risk factors described in our 2018 10-K are not the only risks facing our company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition or future results.

 

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds

 

None.

 

Item 3. Defaults Upon Senior Securities

 

Not applicable.

 

Item 4. Mine Safety Disclosures

 

Not applicable.

 

Item 5. Other Information

 

Not applicable.

 

Item 6. Exhibits

 

The exhibits listed on the Exhibit Index are either filed or furnished with this report or incorporated herein by reference.

 

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EXHIBIT INDEX

 

Exhibit

No.

  Description

 

10.1

 

 

Exclusive License and Product Development Agreement between Eton Pharmaceuticals, Inc. and Aucta Pharmaceuticals, Inc., effective as of July 30, 2019 (but executed as of June 12, 2019). (Note: Portions of this exhibit have been omitted in accordance with the SEC’s Rules on omission of confidential information)

     
31.1   Certification of President and Chief Executive Officer (Principal Executive Officer), pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
31.2   Certification of Chief Financial Officer (Principal Financial Officer), pursuant to Section 302 of the Sarbanes-Oxley Act of 2002.
     
32.1*   Certifications of President and Chief Executive Officer (Principal Executive Officer) and Chief Financial Officer (Principal Financial Officer), pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
     
101   The following financial information from the Company’s Quarterly Report on Form 10-Q for the period ended September 30, 2019, formatted in Extensible Business Reporting Language (XBRL): (i) the Condensed Balance Sheets, (ii) the Condensed Statements of Operations, (iii) the Condensed Statements of Redeemable Convertible Preferred Stock and Stockholders’ Equity (Deficit), (iv) the Condensed Statements of Cash Flows and (v) Notes to Condensed Financial Statements.

 

* These certifications are being furnished solely to accompany this quarterly report pursuant to 18 U.S.C. Section 1350, and are not being filed for purposes of Section 18 of the Securities Exchange Act of 1934, as amended, and are not to be incorporated by reference into any filing of the registrant, whether made before or after the date hereof, regardless of any general incorporation language in such filing.

 

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SIGNATURES

 

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

  ETON PHARMACEUTICALS, INC.
     
November 14, 2019 By: /s/ Sean E. Brynjelsen
    Sean E. Brynjelsen
    President and Chief Executive Officer
    (Principal Executive Officer)
     
  By: /s/ W. Wilson Troutman
    W. Wilson Troutman
    Chief Financial Officer
    (Principal Financial Officer)

 

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