Eton Pharmaceuticals, Inc. (ETON) FY 2021 MD&A

Management’s Discussion and Analysis of Financial Condition and Results of Operations

You
should read the following discussion and analysis together with our financial statements and the related notes thereto included in “Item
8. Financial Statements and Supplementary Data” in this Annual Report on Form 10-K. The following discussion contains forward-looking
statements that involve risks and uncertainties. For a complete discussion of forward-looking statements, see the section above entitled
“Forward Looking Statements.” Our actual results could differ materially from those expressed or implied in any forward-looking
statements as a result of various factors, including those set forth under the caption “Item 1A. Risk Factors.”

Overview

We
are a unique pharmaceutical company focused on developing, acquiring, and commercializing innovative pharmaceutical products that fulfill
an unmet patient need. Since the formation of our company in 2017, we have used our expertise in business development, regulatory, and
product development to assemble a diversified portfolio of eleven products. Six of our products have been approved by
the FDA and commercially launched. We plan to continue growing our business through the acquisition of additional late-stage, high-value
product candidates.

Results
of Operations

To
date, we have realized revenues from the sale of our neurology products portfolio to Azurity in 2021, a licensing arrangement on our
EM-100 product that was sold to Bausch Health and also the launch of our Biorphen®, Alkindi Sprinkle®, and Carglumic Acid products
in December 2019, December 2020, and December 2021, respectively. We anticipate successfully growing our sales for these products and
commercializing additional product candidates in 2022 and beyond.

Year
Ended December 31, 2021 Compared to Year Ended December 31, 2020

Net
revenues of $21.8 million in 2021 included $19.0 million of milestones, including $17.0 million from Azurity on three neurology
products sold to them at the beginning of the year. Revenues were nominal in 2020 for Biorphen and reflected the launch of Alkindi Sprinkle®
late in mid-December.

Our
2021 gross profit of $19.2 million was up significantly as the prior year negative gross profit level was adversely impacted by Biorphen
price discounts and a reserve charge to cost of sales for certain slow-moving Biorphen inventory that we do not believe we will be able
to sell before its expiry date.

For
the years ended December 31, 2021 and 2020, we incurred $6.2 million and $14.1 million of research and development (“R&D”)
expenses, respectively, and $14.5 million and $12.8 million of general and administrative (“G&A”) expenses, respectively.
The $7.9 million decrease in R&D was driven by significant milestone payments on a number of our products in development that
did not recur in 2021. The $1.7 million increase in G&A expenses was primarily due to personnel additions and increased professional/consulting
spending to support our growing business. We incurred a net loss of $2.0 million and $28.0 million for the years ended December
31, 2021 and 2020, respectively.

General
and Administrative Expenses

G&A
expenses consist primarily of employee compensation expenses, selling and adverting/promotional expenses, legal and professional fees,
business insurance and FDA fees. We anticipate that our G&A expenses will increase to support our business growth – particularly
with respect to sales and marketing for additional personnel and promotional expenses.

Research
and Development Expenses

We
currently have seven employees that support our overall product development function. The majority of our spend in R&D is to third
parties we contract with to develop and test our products in addition to development partner milestone payments. We closed our R&D
facility in May 2021.

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Year
Ended December 31, 2020 Compared to Year Ended December 31, 2019

Net
revenues for 2020 reflected limited benefit from Alkindi Sprinkle which launched in mid-December. In addition, revenue was negatively
impacted by a price discount for Biorphen in 2020 related to the shelf stock at our wholesale customers. Our 2020 gross profit was also
adversely impacted by a reserve charge to cost of sales for certain slow-moving Biorphen inventory that we do not believe we will be
able to sell before its expiry date. Revenue and gross profit in 2019 reflected the initial launch for Biorphen and a $0.5 million milestone
payment for our sale of EM-100 to Bausch Health.

For
the years ended December 31, 2020 and 2019, we incurred $14.1 million and $11.6 million of research and development (“R&D”)
expenses, respectively, and $12.8 million and $7.6 million of general and administrative (“G&A”) expenses, respectively.
The increase in R&D expense was primarily due to $4.8 million of licensing and development fees for Alkindi Sprinkle in 2020 offset
by reduced spending for Topiramate and Lamotrigine. The $5.2 million increase in G&A expenses was primarily due to personnel additions
and increased sales/marketing spending to support product launches. In addition, we incurred significant legal expenses associated with
our patent challenge against Exela Pharma Sciences for the Cysteine product that we have in development. We incurred a net loss of $28.0
million and $18.3 million for the years ended December 31, 2020 and 2019, respectively.

General
and Administrative Expenses

G&A
expenses consisted primarily of employee compensation expenses, selling and adverting/promotional expenses, legal and professional fees,
business insurance and travel expenses. Our G&A expenses increased to support our business growth – particularly with respect
to sales and marketing for additional personnel and promotional expenses.

Research
and Development Expenses

As
of December 31, 2020, we had six employees that supported our overall product development and we had facility and operating costs for
a laboratory to support product development which we subsequently closed in May 2021.

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Liquidity
and Capital Resources

As
of December 31, 2021, we had total assets of $27.5 million, cash and cash equivalents of $14.4 million and working capital of
$19.0 million. We had previously capitalized our operations from the June 2017 private placement of approximately $20.1 million
of Series A preferred stock which converted into shares of our common stock concurrent with our IPO in November 2018 and also the IPO
which provided us with net proceeds of $22.0 million. In addition, we entered into a Credit Agreement with SWK Holdings in November 2019
whereby we drew a $5.0 million loan amount at closing and an additional $2.0 million in August 2020. In March and April 2020, we received
net proceeds of approximately $7.8 million from the sale of shares of our common stock, and in October 2020, we received net proceeds
of approximately $21.0 million from a public offering of our common stock at an offering price of $7.00 per share. We believe that our
existing funding, revenues from our approved products and milestone payments expected to be paid in 2022 will be sufficient for at least
the next twelve months of our operations. However, our projected estimates for our product development spending, administrative expenses
and our working capital requirements could be inaccurate, or we may experience growth more quickly or on a larger scale than we expect,
any of which could result in the depletion of capital resources more rapidly than anticipated and could require us to seek additional
financing earlier than we expect to support our operations.

Cash
Flows

The
following table sets forth a summary of our cash flows for the years ended December 31, 2021, 2020 and 2019 (amounts are in thousands):

The
decrease in cash used in operating activities is primarily a result of lower operating losses, driven by higher revenue. Investing activities
in 2021 consist primarily of licensing fees for Carglumic Acid, partially offset by the proceeds from the sale of equipment from our
laboratory facility which we closed in May 2021. The financing activity primarily consists of the October 2020 follow-on common stock
offering and the November 2019 Credit Agreement borrowing from SWK Holdings.

Critical
Accounting Policies

Our
financial statements are prepared in accordance with GAAP. The preparation of our 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 financial statements.
We base our estimates on historical experience, known trends and events and various other factors that we believe are reasonable under
the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that
are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ
from these estimates under different assumptions or conditions.

While
our significant accounting policies are described in more detail in Note 3 to our financial statements included herein, we believe that
the following accounting policies are those most critical to the judgments and estimates used in the preparation of our financial statements.

Revenue
Recognition

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

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

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

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

Royalties
– For arrangements that include sales-based royalties, including milestone payments based on a level of sales, which are the
result of a customer-vendor relationship and for which the license is deemed to be the predominant item to which the royalties relate,
we will recognize revenue at the later of (i) when the related sales occur, or (ii) when the performance obligation to which some or
all of the royalty has been allocated has been satisfied or partially satisfied.

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

We
sell Biorphen in the U.S. to wholesale pharmaceutical distributors, who then sell the product to hospitals and other end-user customers.
Sales to wholesalers are made pursuant to purchase orders subject to the terms of a master agreement, and delivery of individual shipments
of Biorphen represent performance obligations under each purchase order. We use a third-party logistics (“3PL”) vendor to
process and fulfill orders and have concluded it is the principal in the sales to wholesalers because it controls access to the 3PL vendor
services rendered and directs the 3PL vendor activities. We have no significant obligations to wholesalers to generate pull-through sales.
In addition, we sell our Alkindi Sprinkle and Carglumic Acid products to one pharmacy distributor customer which provides order fulfillment
and inventory storage/distribution services.

Selling
prices initially billed to wholesalers are subject to discounts for prompt payment and subsequent chargebacks when the wholesalers sell
Biorphen at negotiated discounted prices to members of certain group purchasing organizations (“GPOs”) and government programs.
In addition, we pay fees to wholesalers for their distribution services, inventory reporting and chargeback processing. We pay GPOs fees
for administrative services and for access to GPO members and concluded the benefits received in exchange for these fees are not distinct
from our sales of Biorphen, and accordingly we apply these amounts to reduce revenues. Wholesalers also have rights to return unsold
product nearing or past the expiration date. Because of the shelf life of Biorphen and our lengthy return period, there may be a significant
period of time between when the product is shipped and when we issue credits on returned product. For our Alkindi Sprinkle and Carglumic
Acid products, we bill at the initial product list prices which are subject to offsets for patient co-pay assistance and potential state
Medicaid reimbursements which are estimated and recorded as a reduction of net revenues at the date of sale/shipment.

We
estimate the transaction price when we receive each purchase order, taking into account the expected reductions of the selling price
initially billed to the wholesaler arising from all of the above factors. We have developed estimates for future returns and chargebacks
of Biorphen and the impact of the other discounts and fees we pay. Our sales of Alkindi Sprinkle and Carglumic Acid to our distributor
are not subject to returns. When estimating these adjustments to the transaction price, we reduce it sufficiently to be able to assert
that it is probable that there will be no significant reversal of revenue when the ultimate adjustment amounts are known.

We
recognize revenue from Biorphen product sales and related cost of sales upon product delivery to the wholesaler location. At that time,
the wholesalers take control of the product as they take title, bear the risk of loss of ownership, and have an enforceable obligation
to pay us. They also have the ability to direct sales of product to their customers on terms and at prices they negotiate. Although wholesalers
have product return rights, we do not believe they have a significant incentive to return the product to us. We store our Alkindi Sprinkle
and Carglumic Acid inventory at our pharmacy distributor customer location and sales are recorded when stock is pulled and shipped to
fulfill specific patient orders.

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Upon
recognition of revenue from product sales, the estimated amounts of credit for product returns, chargebacks, distribution fees, prompt
payment discounts, state Medicaid and GPO fees are included in sales reserves, accrued liabilities and net of accounts receivable. We
monitor actual product returns, chargebacks, discounts and fees subsequent to the sale. If these amounts end up differing from our estimates,
we will make adjustments to these allowances, which are applied to increase or reduce product sales revenue and earnings in the period
of adjustment.

In
addition, 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.

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. Compensation expense is recognized over the
period during which services are rendered by consultants and non-employees until completed. At the end of each financial reporting period
prior to completion of the service, the fair value of these awards is remeasured using the then-current fair value of our common stock
and updated assumption inputs in the Black-Scholes option-pricing model (“BSM”).

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

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

Research
and Development Expenses

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

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

Off
Balance Sheet Transactions

We
do not have any off-balance sheet transactions.

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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.

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.