Eton Pharmaceuticals, Inc. (ETON) FY 2022 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 an innovative pharmaceutical company focused on developing, acquiring, and commercializing innovative products to address unmet needs
in patients suffering from rare diseases. 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 rare disease products.

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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, the launch of our Biorphen®, ALKINDI SPRINKLE®, and Carglumic Acid products in
December 2019, December 2020, and December 2021, respectively, and also from the sale of our hospital products portfolio to Dr. Reddy’s in 2022. We anticipate successfully growing sales of our commercialized products and commercializing
additional product candidates in 2023 and beyond.

Year
Ended December 31, 2022 Compared to Year Ended December 31, 2021

Net
revenues of $21.3 million in 2022 included $10.0 million of licensing revenue, consisting of $5.0 million from Azurity on the launch of Zonisamide
and $5.0 million from the sale of our hospital products to Dr. Reddy’s. Net revenue of $21.8 million in 2021 included $19.0 million
of licensing revenue, primarily consisting of $17.0 million from Azurity on three neurology products sold to them at the beginning of 2021.
Net product revenue of $11.3 million in 2022 increased by $8.4 million from $2.8 million in 2021 as a result of growth in ALKINDI SPRINKLE®
and Carglumic Acid.

Our
2022 gross profit of $14.3 million was down from $19.0 million in 2021, as a result of lower licensing revenue.

For
the years ended December 31, 2022 and 2021, we incurred $4.0 million and $6.2 million of research and development (“R&D”)
expenses, respectively, and $18.6 million and $14.3 million of general and administrative (“G&A”) expenses, respectively.
The $2.2 million decrease in R&D was driven by milestone payments on a number of our products in development in 2021 that did not
recur in 2022. The $4.3 million increase in G&A expenses was primarily due to personnel additions and increased sales & marketing
spending to support our growing business. We incurred a net loss of $9.0 million and $2.0 million for the years ended December 31, 2022
and 2021, 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 associated with approved products. 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 eight 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.

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 licensing revenue, 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 $19.0 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 did not believe we would 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 $14.3 million and $12.6 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 in 2020
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.

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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 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
had seven employees that supported our overall product development function. The majority of our spend in R&D was to third parties
we contracted with to develop and test our products in addition to development partner milestone payments. We closed our R&D facility
in May 2021.

Liquidity
and Capital Resources

As
of December 31, 2022, we had total assets of $25.0 million, cash and cash equivalents of $16.3 million and working capital of $13.5 million.
We believe that our existing funding and revenues from our approved products 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, 2022, 2021 and 2020 (amounts are in thousands):

The
decrease in cash used in operating activities is primarily a result of increased revenue. Investing
activities in 2022 and 2021 consist primarily of licensing fees for Betaine and Carglumic Acid respectively. Financing activities in
2020 consisted of a follow-on common stock offering in October 2020.

Critical
Accounting Policies

Our
financial statements are prepared in accordance with accounting principles generally accepted in the United States of America
(“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.

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Revenue
Recognition

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

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

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

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

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

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

The
Company sells its ALKINDI SPRINKLE® and Carglumic Acid product to one pharmacy distributor customer which provides order fulfilment
and inventory storage/distribution services. The Company may sell products 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 represent performance obligations under each purchase order. The
Company uses a third-party logistics (“3PL”) vendor to process and fulfill orders and has 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. The Company
has no significant obligations to wholesalers to generate pull-through sales.

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For
its ALKINDI SPRINKLE® and Carglumic Acid products, the Company bills at the initial product list price which are subject to offsets
for patient co-pay assistance and potential state Medicaid reimbursements which are recorded as a reduction of net revenues at the date
of sale/shipment. Selling prices initially billed to wholesalers are subject to discounts for prompt payment and subsequent chargebacks
when the wholesalers sell products at negotiated discounted prices to members of certain group purchasing organizations (“GPOs”)
and government programs. Because of the shelf life of the product and the Company’s lengthy return period, there may be a significant
period of time between when the product is shipped and when it issues credits on returned product.

The
Company estimates the transaction price when it receives each purchase order taking into account the expected reductions of the selling
price initially billed to the wholesaler/distributor arising from all of the above factors. The Company has developed estimates for future
returns and chargebacks and the impact of other discounts and fees it pays, although ALKINDI SPRINKLE® and Carglumic Acid sales are
not subject to returns. When estimating these adjustments to the transaction price, the Company reduces 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.

The
Company stores its ALKINDI SPRINKLE® and Carglumic Acid inventory at its pharmacy distributor customer location, and sales are recorded
when stock is pulled and shipped to fulfill specific patient orders. The Company recognizes revenue and cost of sales from products sold
to wholesalers upon 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 the Company. 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, the Company does
not believe they have a significant incentive to return the product.

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 accounts receivable. The Company
monitors actual product returns, chargebacks, discounts and fees subsequent to the sale. If these amounts end up differing from its estimates,
it 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, the Company anticipates it will continue to receive revenues from product licensing agreements where it has contracted for
milestone payments and royalties from products it has developed or acquired.

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.

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

Research
and Development Expenses

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

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

Off
Balance Sheet Transactions

We
do not have any off-balance sheet transactions.

JOBS
Act Transition Period

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

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 (“PCAOB”) 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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