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March 10, 2021, 7:18 a.m. EST


(EDGAR Online via COMTEX) -- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations

The following discussion summarizes the significant factors affecting the operating results, financial condition, liquidity and cash flows of our company as of and for the periods presented below. The following discussion and analysis should be read in conjunction with the financial statements and the related notes thereto included elsewhere in this Report. The statements in this discussion regarding industry outlook, our expectations regarding our future performance, liquidity and capital resources and all other non-historical statements in this discussion are forward-looking statements and are based on the beliefs of our management, as well as assumptions made by, and information currently available to, our management. Actual results could differ materially from those discussed in or implied by forward-looking statements as a result of various factors, including those discussed below and elsewhere in this Report, particularly in the section entitled "Risk Factors."


Company Overview

We are the leader in pharmaceutically-produced transdermal cannabinoid therapies for rare and near-rare neuropsychiatric disorders. We are committed to improving the lives of patients and their families living with severe, chronic health conditions including Fragile X syndrome, or FXS, autism spectrum disorder, or ASD, 22q11.2 deletion syndrome, or 22q, and a heterogeneous group of rare and ultra-rare epilepsies known as developmental and epileptic encephalopathies, or DEE.

Cannabinoids are a class of compounds derived from Cannabis plants. The two primary cannabinoids contained in Cannabis are cannabidiol and Tetrahydrocannabinol, or THC. Clinical and preclinical data suggest that cannabidiol has positive effects on treating behavioral symptoms of FXS, ASD, 22q and seizures in patients with epilepsy.

We are currently developing Zygel, the first and only pharmaceutically-produced cannabidiol formulated as a permeation-enhanced gel for transdermal delivery, which is patent protected through 2030. Five additional patents expiring in 2038 are directed to methods of use relating to Zygel, including methods of treating FXS and ASD.

In preclinical animal studies, Zygel's permeation enhancer increased delivery of cannabidiol through the layers of the skin and into the circulatory system. These preclinical studies suggest increased bioavailability, consistent plasma levels and the avoidance of first-pass liver metabolism of cannabidiol when delivered transdermally. In addition, an in vitro study published in Cannabis and Cannabinoid Research in April 2016 demonstrated that cannabidiol is degraded to THC (the major psychoactive cannabinoid in Cannabis) in an acidic environment such as the stomach. As a result, we believe such degradation may lead to increased psychoactive effects if cannabidiol is delivered orally. These effects may be avoided with the transdermal delivery of Zygel, which maintains cannabidiol in a neutral pH. Zygel is being developed as a clear gel with once- or twice-daily dosing and is targeting treatment of behavioral symptoms of FXS, ASD and 22q and the reduction of seizures in patients with DEE syndromes. We have been granted orphan drug designations from United States Food and Drug Administration, or FDA, for the use of cannabidiol for the treatment of FXS and for the treatment of 22q. In May 2019, we received Fast Track designation from the FDA for treatment of behavioral symptoms associated with FXS. The FDA's Fast Track program is designed to facilitate the development of drugs intended to treat serious conditions and fill unmet medical needs and can lead to expedited review by the FDA in order to get new important drugs to the patient earlier.

Our clinical program for Zygel includes clinical trials evaluating Zygel in the treatment of behavioral symptoms of FXS, ASD and 22q and the reduction of seizures and the treatment of associated symptoms in patients with DEE syndromes. As of March 2021, the Zygel safety database across all clinical studies conducted by us includes data from 906 volunteers and patients. Across these clinical studies, Zygel has been well tolerated and consistent with previously reported data.

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In June 2020 we announced results of our pivotal CONNECT-FX clinical trial, a multi-national randomized, double-blind, placebo-controlled, 14-week study designed to assess the efficacy and safety of Zygel in children and adolescents ages three through 17 years who have full mutation of the FMR1 gene. While Zygel did not achieve statistical significance versus placebo in the primary endpoint of improvement in the Social Avoidance subscale of the Aberrant Behavior Checklist - Community FXS (ABC-CFXS), a pre-planned ad hoc analysis of the most severely impacted patients in the trial, as defined by patients having at least 90% methylation ("highly methylated") of the impacted FMR1 gene, demonstrated that those patients receiving Zygel achieved statistical significance in the primary endpoint of improvement at 12 weeks of treatment in the Social Avoidance subscale of the ABC-CFXS compared to placebo. Following discussions with the FDA regarding the CONNECT-FX trial and the regulatory path forward for Zygel, we plan to conduct a double-blind for Zygel, placebo-controlled pivotal trial in pediatric and adolescent patients with FXS who have a highly methylated FMR1 gene to confirm the positive results observed in the CONNECT-FX trial. We plan to review the trial design and protocol for the new trial through a Type C meeting with the FDA in the first half of 2021 and expect to initiate the pivotal trial before the end of 2021.

Phase 2 BRIGHT Trial (ASD)

In May 2020, we reported positive top-line results of the Phase 2 BRIGHT clinical trial, a 14- week open label clinical trial designed to assess the safety, tolerability and efficacy of Zygel for the treatment of pediatric and adolescent patients with ASD. Patients treated with Zygel demonstrated statistically significant improvement at week 14 compared to baseline for each ABC-C subscale (Irritability, Inappropriate Speech, Stereotypy, Social Withdrawal, and Hyperactivity). The results of the other efficacy assessments were consistent with the results demonstrated in the ABC-C. We expect to discuss a path forward with the FDA in the first half of 2021.

Phase 2 INSPIRE Trial (22q)

In May 2019, we initiated the open-label Phase 2 INSPIRE clinical trial, a 14-week open label clinical trial designed to assess the safety, tolerability and efficacy of Zygel for treatment of behavioral symptoms of 22q. We expect to enroll approximately 20 male and female patients (ages six through 17 years). Recruitment into the INSPIRE trial has been delayed due to the impact of COVID-19 and resulting significant travel restrictions in Australia. Once these restrictions are lifted and enrollment is complete, we will provide a timeframe for disclosing top line results of this trial. In September 2020, we were granted orphan drug designation from the FDA for the use of cannabidiol for the treatment of 22q.

Phase 2 BELIEVE Trial (DEE)

In September 2019, we reported top-line results from the Phase 2 BELIEVE clinical trial, a six-month, open-label, multi-dose clinical trial designed to evaluate the efficacy and safety of Zygel in children and adolescents (ages three through 17 years) with DEE. Following discussions with the FDA regarding the clinical pathway for Zygel in DEE, we plan to pursue individual syndromes. We are evaluating potential target indications and expect to finalize target syndrome selection for one or more DEE syndromes in 2021.

Zygel Clinical Development Timelines

We are closely monitoring the progression of the COVID-19 pandemic, including its potential impact on our clinical development plans and timelines going forward. In response to COVID-19, for our current clinical development programs, we implemented multiple measures consistent with the FDA's guidance on the conduct of clinical trials of medical products during the COVID-19 pandemic, including remote site monitoring and patient visits using telemedicine where needed, direct to patient drug shipment from investigator sites, and local study-related clinical laboratory collection. Except with respect to our Phase 2 open-label INSPIRE trial, timelines for delivery of top-line results for our

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clinical trials were not adversely impacted by COVID-19 and we intend to implement similar measures, as necessary, for our planned clinical trials in 2021.

We have never been profitable and have incurred net losses since inception. Our net losses were $51.3 million, $32.9 million and $39.9 million for the years ended December 31, 2020, 2019, and 2018, respectively. As of December 31, 2020, our accumulated deficit was $202.2 million. We expect to incur losses for the foreseeable future, and we expect these losses to increase as we continue our development of, and seek regulatory approvals for, our product candidates. Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when, or if, we will be able to achieve or maintain profitability.

Financial Operations Overview

The following discussion sets forth certain components of our consolidated statements of operations as well as factors that impact those items.

Research and Development Expenses - Our research and development expenses relating to our product candidates consisted of the following:

? expenses associated with preclinical development and clinical trials;

? personnel-related expenses, such as salaries, benefits, travel and other related expenses, including stock-based compensation;

? payments to third-party CROs, CMOs, contractor laboratories and independent contractors; and

? depreciation, maintenance and other facility-related expenses.

We expense all research and development costs as incurred. Clinical development expenses for our product candidates are a significant component of our current research and development expenses. Generally speaking, expenses associated with clinical trials will increase as our clinical trials progress. Product candidates in later stage clinical development generally have higher research and development expenses than those in earlier stages of development, primarily due to increased size and duration of the clinical trials. We track and record information regarding external research and development expenses for each grant, study or trial that we conduct. We use third-party CROs, CMOs, contractor laboratories and independent contractors in preclinical studies and clinical trials. We recognize the expenses associated with third parties performing these services for us in our preclinical studies and clinical trials based on the percentage of each study completed at the end of each reporting period.

Our Australian subsidiary, Zynerba Pharmaceuticals Pty Ltd, or the Subsidiary, is incorporated in Australia and is eligible to participate in an Australian research and development tax incentive program. As part of this program, the Subsidiary is eligible to receive a cash refund from the Australian Taxation Office for a percentage of the research and development costs expended by the Subsidiary in Australia. The cash refund is available to eligible companies with an annual aggregate revenue of less than $20.0 million (Australian dollars) during the reimbursable period. We estimate the amount of cash refund we expect to receive related to the Australian research and development tax incentive program and record the incentives when it is probable 1) we will comply with relevant conditions of the program and 2) the incentive will be received.

Certain research and development expenses incurred with respect to Zygel outside of Australia may also be eligible for the Australian research and development tax incentive program. To receive a cash refund with respect to such expenses incurred outside of Australia, the expenses must have been for eligible research and development activities, as determined by AusIndustry, and the expenditures must have a scientific link to the Australian activities, be unable to be conducted in Australia and be less than the expenditures for activities conducted in Australia, as determined by the ATO. In December 2018, the Subsidiary submitted an AOF application to AusIndustry for a determination that its activities are eligible research and development activities, which was approved by AusIndustry in July 2019.

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As a result of this finding, we believe the Subsidiary is eligible to receive a cash refund from the ATO for qualifying expenditures related to its research and development activities outside of Australia in 2018, 2019 and 2020. During the year ended December 31, 2019, we recorded $8.3 million as an incentive and tax receivable and recorded a corresponding credit to research and development expense for amounts expected to be received through the AOF for the period January 1, 2018 through December 31, 2019. As of December 31, 2020, incentive and tax receivables included $9.0 million related to the AOF. The increase of $0.7 million was due to unrealized foreign currency gains related to the remeasurement of the Subsidiary's assets and liabilities.

We evaluate the Subsidiary's eligibility under tax incentive programs as of each balance sheet date based on the most current and relevant data available. If the Subsidiary is deemed to be ineligible or unable to receive the Australian research and development tax credit, or the Australian government significantly reduces or eliminates the tax credit, the actual cash refund we receive may materially differ from our estimates. In June 2020, the ATO informed us that we may not qualify for the AOF program based on their interpretation of certain eligibility requirements. Although we continue to believe that we comply with the relevant conditions of the AOF program that were in place when we received our original approval from AusIndustry, we have determined it is no longer probable that the AOF claim will be received. As a result, during the three months ended June 30, 2020, we recorded a full reserve against the AOF receivable.

The following table summarizes research and development expenses for the years ended December 31, 2020, 2019 and 2018.

                                                              Year ended December 31,
                                                      2020             2019             2018
        Research and development expenses -
        before R&D incentive                      $  29,437,551    $  31,549,954    $  30,631,258
        Research and development incentive
        (non-AOF)                                   (1,890,252)      (2,895,896)      (3,386,215)
        Research and development expenses (before
        impact of AOF)                               27,547,299       28,654,058       27,245,043
        AOF - cumulative change in estimate for
        the period 1/1/18 through 12/31/19                    -      (8,270,009)                -
        Amounts reserved against AOF refund           8,107,695                -                -
        Total research and development expenses   $  35,654,994    $  20,384,049    $  27,245,043

Excluding the 2020 change in research and development expenses related to the AOF, we expect research and development expenses to decrease in 2021 as compared to 2020 as we concluded our pivotal CONNECT-FX clinical trial during 2020. We expect to initiate another pivotal trial in FXS before the end of 2021. These expenditures are subject to numerous uncertainties regarding timing and cost to completion. Completion of our preclinical development and clinical trials may take several years or more and the length of time generally varies according to the type, complexity, novelty and intended use of a product candidate. The cost of clinical trials may vary significantly over the life of a project as a result of differences arising during clinical development, including, among others:

? the number of sites included in the clinical trials;

? the length of time required to enroll suitable patients;

? the size of patient populations participating in the clinical trials;

? the duration of patient follow-ups;

? the development stage of the product candidates; and

? the efficacy and safety profile of the product candidates.

Due to the early stages of our research and development, we are unable to determine the duration or completion costs of our development of our product candidates. As a result of the difficulties of forecasting research and development costs

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of our product candidates as well as the other uncertainties discussed above, we are unable to determine when and to what extent we will generate revenue from the commercialization and sale of an approved product candidate.

General and Administrative Expenses - General and administrative expenses consist primarily of salaries, benefits and other related costs, including stock-based compensation, for personnel serving in our executive, finance, legal, human resource, investor relations and commercial functions. Our general and administrative expenses also include facility and related costs not included in research and development expenses, professional fees for legal services, including patent-related expenses, litigation settlement expenses, consulting, tax and accounting services, insurance, market research and general corporate expenses. We expect that our general and administrative expenses will increase for the next several years as we increase our headcount with the continued development and potential commercialization of our product candidates.

Interest Income - Interest income primarily consists of interest earned on balances maintained in our money market bank account.

Foreign Exchange Gain (Loss) - Foreign exchange gain (loss) relates to the effect of exchange rates on transactions incurred by the Subsidiary.

Income Taxes - As of December 31, 2020, we had $129.7 million of federal operating loss carryforwards and $3.7 million of research tax credit carryforwards available to offset future taxable income and income tax, respectively. These operating loss and research tax credit carryforwards will begin to expire in 2028 and 2027, respectively. At December 31, 2020 and 2019, we concluded that a full valuation allowance is necessary for our deferred tax assets.

The closing of our IPO in August 2015, together with our follow-on equity offerings, private placements and other transactions that have occurred since our inception, may trigger, or may have already triggered, an "ownership change" pursuant to Section 382 of the Internal Revenue Code of 1986. If an ownership change is triggered, it will limit our ability to use some of our net operating loss carryforwards. In addition, since we will need to raise substantial additional funding to finance our operations, we may undergo further ownership changes in the future, which could further limit our ability to use net operating loss carryforwards. As a result, if we generate taxable income, our ability to use some of our net operating loss carryforwards to offset U.S. federal taxable income may be subject to limitations, which could result in increased future tax liability to us. Additionally, U.S. tax laws limit the time during which these carryforwards may be applied against future taxes; therefore, we may not be able to take full advantage of these carryforwards for federal income tax purposes.

Critical Accounting Estimates

Our management's discussion and analysis of our financial condition and results of operations is based on our consolidated financial statements, which have been prepared in accordance with U.S. generally accepted accounting principles, or GAAP. The preparation of these financial statements requires us to make estimates and judgments that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during the reported period. In accordance with GAAP, we base our estimates on historical experience, known trends and events and various other factors that we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying amounts of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We define our critical accounting policies as those that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations, as well as the specific manner in which we apply those principles. While our significant accounting policies are more fully discussed in note 2 to our audited consolidated financial statements appearing elsewhere in this Report, we believe that the following accounting policy is critical to the process of making significant judgments and estimates in the preparation of our financial statements.

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Research and Development Expenses

We rely on third parties to conduct our preclinical studies and clinical trials, and to provide services, including data management, statistical analysis and electronic compilation. At the end of each reporting period, we compare the payments made to each service provider to the estimated progress towards completion of the related project. Factors that we will consider in preparing these estimates include the number of patients enrolled in studies, milestones achieved and other criteria related to the efforts of our vendors. These estimates will be subject to change as additional information becomes available. Depending on the timing of payments to vendors and estimated services provided, we will record net prepaid or accrued expenses related to these costs.

Results of Operations

        Comparison of the Years Ended December 31, 2020 and December 31, 2019
                                               Year Ended                     Increase
                                              December 31,                   (Decrease)
                                          2020             2019              $            %
        Operating expenses:
        Research and development     $   35,654,994   $   20,384,049   $   15,270,945      75 %
        General and administrative       16,407,548       13,935,761        2,471,787      18 %
        Total operating expenses         52,062,542       34,319,810       17,742,732      52 %
        Loss from operations           (52,062,542)     (34,319,810)     (17,742,732)      52 %
        Other income                        725,711        1,376,227        (650,516)    (47) %
        Net loss                     $ (51,336,831)   $ (32,943,583)   $ (18,393,248)      56 %

        Research and Development Expenses
                                                              Year ended December 31,
                                                               2020             2019
        Research and development expenses (before impact
        of AOF)                                            $  27,547,299    $  28,654,058
        AOF - cumulative change in estimate for the period
        1/1/18 through 12/31/19                                        -      (8,270,009)
        Amounts reserved against AOF refund                    8,107,695                -
        Total research and development expenses            $  35,654,994    $  20,384,049

Excluding AOF activity for the years ended December 31, 2020 and 2019, research and development expenses decreased by $1.1 million, or 4%, to $27.5 million for the year ended December 31, 2020 from $28.7 million for the year ended December 31, 2019. The decrease was primarily related to decreased clinical trial and manufacturing costs associated with our Zygel program, partially offset by an increase in employee-related costs and a reduction in the non-AOF Australian research and development incentive.

General and Administrative Expenses

General and administrative expenses increased by $2.5 million, or 18%, to $16.4 million for the year ended December 31, 2020 from $13.9 million for the year ended December 31, 2019. The increase was primarily related to legal fees and litigation settlement expenses related to our shareholder lawsuits, increases in liability insurance for our directors and officers and higher employee-related costs, including recruiting costs; partially offset by decreases in pre-commercialization expense for our product candidates.

Other Income

During the years ended December 31, 2020 and 2019, we recognized $0.2 million and $1.5 million, respectively, in interest income. The decrease in interest income was primarily related to lower average interest rates earned on our investments. During the year ended December 31, 2020, we recognized a foreign currency gain of $0.5 million and

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during the year ended December 31, 2019, we recognized a foreign currency loss of $0.1 million. Foreign currency gains and losses are due primarily to the remeasurement of the Subsidiary's assets and liabilities, which are denominated in the local currency to the Subsidiary's functional currency, which is the U.S. dollar.

Liquidity and Capital Resources

Since our inception in 2007, we have devoted most of our cash resources to research and development and general and administrative activities. We have financed our operations primarily with the proceeds from the sale of equity securities (most notably our initial public offering, our follow-on public offerings and sales under our "at-the-market" offering) and convertible promissory notes, state and federal grants and research services.

To date, we have not generated any revenue from the sale of products, and we do not anticipate generating any revenue from the sales of products for the foreseeable future. We have incurred losses and generated negative cash flows from operations since inception. As of December 31, 2020, our principal sources of liquidity were our cash and cash equivalents of $59.2 million. Our working capital was $59.5 million as of December 31, 2020.

Management believes that cash and cash equivalents as of December 31, 2020 and the net proceeds from the $42.2 million in cash generated between January 1, 2021 and February 9, 2021 from sales under the 2019 Sales Agreement (defined below), are sufficient to fund operations and capital requirements well into the first half of 2024. The economic effects of the COVID-19 pandemic remain fluid and management will continue to closely monitor the situation to ensure our cash and cash equivalents will help us manage the impact of the COVID-19 pandemic on our business and related liquidity needs. Substantial additional financings will be needed to fund our operations and to complete clinical development of and to commercially develop our product candidates. There is no assurance that such financing will be available when needed or on acceptable terms. Our ability to access the capital markets or otherwise raise such capital may be adversely impacted by potential worsening global economic conditions and the recent disruptions to, and volatility in, financial markets in the United States and worldwide resulting from the ongoing COVID-19 pandemic.

Equity Financings

In August 2019, we entered into a Controlled Equity OfferingSM Sales Agreement, or the 2019 Sales Agreement, with Cantor Fitzgerald & Co., Canaccord Genuity, LLC, H.C. Wainwright & Co. LLC and Ladenburg Thalmann & Co. Inc., as sales agents pursuant to which we may sell, from time to time, up to $75.0 million of our common stock. From January 1, 2021 through February 9, 2021, we have sold and issued 10,244,326 shares of our common stock under the 2019 Sales Agreement in the open market at a weighted average selling price of $4.22 per share, resulting in gross proceeds of $43.2 million. Net proceeds after deducting commissions and offering expenses were $42.2 million. In 2020, we sold and issued 6,596,873 shares of our common stock in the open market at a . . .

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