Summary of CUMBERLAND PHARMACEUTICALS INC

ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
The following discussion contains certain forward-looking statements which reflect management's current views of future events and operations. These statements involve certain risks and uncertainties, and actual results may differ materially from them. Forward-looking statements are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. We caution you that our actual results may differ significantly from the results we discuss in these forward looking statements. Some important factors which may cause results to differ from expectations include: availability of additional debt and equity capital required to finance the business model; market conditions at the time additional capital is required; significant leverage and debt service requirements of the Company; our ability to continue to acquire branded products; product sales; and management of our growth and integration of our acquisitions. Other important factors that may cause actual results to differ materially from forward-looking statements are discussed in "Risk Factors" on pages 7 through 22 and "Special note regarding forward-looking statements" on page 23 of our Prospectus filed pursuant to Rule 424(b) under the Securities Act filed with the SEC on August 12, 2009. The Company does not undertake to publicly update or revise any of its forward-looking statements, even in the event that experience or future changes indicate that the anticipated results will not be realized. The following presentation of management's discussion and analysis of financial condition and results of operations should be read in conjunction with the Company's unaudited consolidated financial statements and related notes thereto.
OVERVIEW
Our Business
We are a profitable and growing specialty pharmaceutical company focused on the acquisition, development and commercialization of branded prescription products. Cumberland is dedicated to providing innovative products which improve quality of care for patients. Our primary target markets are hospital acute care and gastroenterology, which are characterized by relatively concentrated physician prescriber bases that we believe can be penetrated effectively by relatively small, targeted sales forces.
Our product portfolio includes Caldolor® (ibuprofen) Injection, the first injectable treatment for pain and fever available in the United States, Acetadote® (acetylcysteine) Injection for the treatment of acetaminophen poisoning and Kristalose® (lactulose) for Oral Solution, a prescription laxative. We market our products through our dedicated hospital and gastroenterology sales forces in the United States, and work to partner our products to reach international markets.
We have both product development and commercial capabilities, and believe we can leverage our existing infrastructure to support our expected growth. Our management team consists of pharmaceutical industry veterans experienced in business development, clinical and regulatory affairs, and sales and marketing. Our internal product development and regulatory executives develop proprietary product formulations, design and manage our clinical trials, prepare all regulatory submissions and manage our medical call center. Our products are manufactured by third parties, which are overseen and managed by Cumberland's quality control and manufacturing group. All aspects of commercialization are handled by our sales and marketing professionals, and we work closely with our distribution partner to make our products available across the United States. Our strategy to grow our company includes maximizing the potential of our existing products and continuing to build a portfolio of differentiated products. Our current products are approved for sale in the United States, and we are working to bring them to select international markets. We also look for opportunities to expand into additional patient populations through new product indications, whether through our own studies or by supporting investigator-initiated studies at reputable research institutions. We actively pursue opportunities to acquire additional late-stage development product candidates as well as marketed products in our target medical specialties. Further, we are supplementing the aforementioned

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growth strategies with the early-stage drug development activities of Cumberland Emerging Technologies (CET), our majority-owned subsidiary. CET partners with universities and other research organizations to cost-effectively develop promising, early-stage product candidates, which Cumberland has the opportunity to commercialize.
We were incorporated in 1999 and have been headquartered in Nashville, Tennessee since inception.
Recent Developments
Caldolor®
In June 2009, the U.S. Food and Drug Administration (FDA) approved Caldolor, an intravenous formulation of ibuprofen, for marketing in the United States through a priority review. Caldolor is the first and only injectable product approved for sale in the United States for the treatment of both pain and fever. Following FDA approval, in preparation for the product launch, Cumberland conducted comprehensive market research, prepared a full package of educational materials, optimized territory design and launched the product website. We expanded our hospital sales force to 77 representatives and managers to prepare for the launch, and enlisted the services of our field sales force of 36 representatives and managers to promote the product. We also expanded our internal professional affairs group to support the product.
In September 2009, we successfully implemented the U.S. launch of Caldolor, with our 113 experienced sales professionals promoting the product across the country. Caldolor is fully stocked at the wholesalers serving hospitals nationwide, available in both 400mg and 800mg vials. We are working to secure formulary approval nationally for Caldolor, and the product is already stocked in a number of medical facilities.
We also filed the first of several expected new patent applications for Caldolor in September. A part of an ongoing initiative to protect the value of our intellectual property, this new application addresses our proprietary method of dosing intravenous ibuprofen.
In October 2009, we announced that we entered into an exclusive agreement with Phebra Pty Ltd., an Australian-based specialty pharmaceutical company, for the commercialization of Caldolor in Australia and New Zealand. Phebra has responsibility for obtaining any regulatory approval for the product, and for handling all ongoing regulatory requirements, product marketing, distribution and sales in the territories. We will maintain responsibility for product formulation, development and manufacturing. Under the terms of the agreement, Cumberland will receive upfront and milestone payments as well as a transfer price, and we will receive royalties on any future sales of Caldolor in those territories.
Initial Public Offering
In August 2009, we completed our initial public offering of 5,000,000 shares of common stock at a price to the public of $17.00 per share, raising $85.0 million in gross proceeds. After deducting underwriting discounts and offering costs, the net proceeds to us were approximately $74.8 million. The proceeds from this offering are primarily for potential acquisitions, the launch of Caldolor, expansion of our hospital sales force, product development, debt repayment and general corporate purposes. Our common stock began trading on the NASDAQ Global Select Market on August 11, 2009, under the trading symbol "CPIX". Following our initial public offering and the completion of the quarter ended September 30, 2009, we notified Mellon Investor Services LLC that we will be retaining Continental Stock Transfer & Trust Company as our transfer agent and registrar, effective December 2009.

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CRITICAL ACCOUNTING POLICIES AND SIGNIFICANT JUDGMENTS AND ESTIMATES Please see a discussion of our critical accounting policies and significant judgments and estimates in Management's Discussion and Analysis for the year ended December 31, 2008 on pages 33 through 38 in the Prospectus filed pursuant to Rule 424(b) under the Securities Act filed with the SEC on August 12, 2009. There have been no changes to these policies or estimates as of September 30, 2009, except as noted below.
Accounting Estimates and Judgments
The preparation of consolidated financial statements in conformity with U.S. generally accepted accounting principles requires management to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the period. We base our estimates on past experience and on other factors we deem reasonable given the circumstances. Past results help form the basis of our judgments about the carrying value of assets and liabilities that are not determined from other sources. Actual results could differ from these estimates. These estimates, judgments and assumptions are most critical with respect to our accounting for revenue recognition, provision for income taxes, stock-based compensation, research and development expenses and intangible assets. Revenue Recognition
Our revenue is derived primarily from the product sales of Acetadote, Kristalose and Caldolor. Revenue is recognized when persuasive evidence of an arrangement exists, delivery has occurred, the fee is fixed and determinable and collectability is probable. Delivery is considered to have occurred upon either shipment of the product or arrival at its destination based on the shipping terms of the transaction. When these conditions are satisfied, we recognize gross product revenue, which is the price we charge generally to our wholesalers for a particular product.
Our return policy is to accept returns from wholesalers for expired product within six months of the designated expiration date on the product label and no more than six months beyond that date. In addition to accepting returns for expired product, we also accept returns for damaged products that are deemed to be our fault. Prior to recognizing revenue when a right of return exists, companies must be able to estimate the amount of future returns. Our estimates of future returns are based on relevant, historical return data, estimated inventory levels in the distribution channel, estimated remaining shelf life and projected demand for our product. Although Caldolor is a new product, it represents a new formulation of ibuprofen, a compound that is widely used in today's marketplace.
Our net product revenue reflects the reduction of gross product revenue at the time of initial sales recognition for estimated accounts receivable allowances for chargebacks, discounts and damaged product, as well as provisions for sales related accruals of rebates, product returns and administrative fees and fee-for-services.
The following table reflects our sales-related accrual activity:

                                                Nine months ended September 30,
   Sales related accruals                           2008                 2009

   Balance at beginning of period             $        738,362       $   1,040,203
   Current provision                                 1,139,834           2,436,064
   Current provision for prior period sales            (73,960 )            75,589
   Actual returns/credits                             (927,015 )        (1,916,834 )

   Balance at end of period                   $        877,221       $   1,635,022

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RESULTS OF OPERATIONS
Three months ended September 30, 2009 compared to the three months ended September 30, 2008
Net revenues. Net revenues for the three months ended September 30, 2009 totaled approximately $13.6 million, representing an increase of approximately $5.0 million, or 58%, over the same period in 2008. The increase was primarily due to (1) increased net revenue of $1.4 million for Acetadote and (2) net revenue associated with the launch of Caldolor of $3.2 million. Acetadote volume increased 19% as we continued to gain market share in our target market. The remainder of the increase in net revenue of Acetadote was due to an increase in the selling price.
For the three months ended September 30, 2009, gross sales were reduced by approximately $1.6 million, of which approximately $1.0 million related to product returns and fee-for-service. The remaining deductions included rebates, cash discounts and similar items. For the three months ended September 30, 2008, gross sales were reduced by approximately $0.8 million, consisting of deductions for product returns, cash discounts, fee-for-services and rebates. Cost of products sold. Cost of products sold for the three months ended September 30, 2009 totaled approximately $1.8 million, representing an increase of approximately $1.0 million, or 139%, over the same period in 2008. As a percentage of net revenues, cost of products sold increased from 8.5% of net revenues for the three months ended September 30, 2008 to 13.0% of net revenues for the three months ended September 30, 2009. The increase in cost of products sold as a percentage of net revenues was primarily due to a change in the sales mix between the periods.
Selling and marketing. Selling and marketing expense for the three months ended September 30, 2009 totaled approximately $6.1 million, representing an increase of approximately $2.5 million, or 68%, over the same period in 2008. The increase was primarily due to additional expenses associated with the launch of Caldolor, including the expansion of our sales force in the third quarter of 2009.
General and administrative. General and administrative expense for the three months ended September 30, 2009 totaled approximately $2.5 million, representing an increase of approximately $1.4 million, or 117%, over the same period in 2008. The increase is primarily due to (1) increased payroll tax expense of approximately $1.0 million associated with the exercise of nonqualified options in the third quarter of 2009 and (2) increased personnel and related expenses of $0.2 million.
Income tax expense. As a percentage of net income before income taxes, the tax rate decreased from 43.9% for the three months ended September 30, 2008 to 40.0% for the same period in 2009. The decrease in the tax rate was primarily due to the inclusion in 2009 of research and development tax credits that were not in effect during the three months ended September 30, 2008. The research and development tax credits were enacted by Congress in the fourth quarter of 2008. In the third quarter of 2009, nonqualified stock options were exercised which resulted in a tax benefit of approximately $26.7 million to us. In recognizing tax benefits, we follow the tax-law ordering of deductions, which preclude the recognition of tax benefits until those benefits are used to offset income taxes payable. We do not believe the tax benefit generated in the third quarter of 2009 will be used in 2009. As a result, we have not recognized the tax benefit from the exercise of those options. The tax benefit, with a corresponding increase to common stock, will be recognized in future periods when they are used to offset the income tax liability generated in those periods.

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Nine months ended September 30, 2009 compared to the nine months ended September 30, 2008
Net revenues. Net revenues for the nine months ended September 30, 2009 totaled approximately $32.8 million, representing an increase of approximately $7.6 million, or 30%, over the same period in 2008. The increase in net revenues was primarily due to (1) approximately $3.2 million associated with the launch of Caldolor in September 2009 and (2) an increase in net revenues of Acetadote. Acetadote volume increased 17% as we continued to gain market share in our target market. The remainder of the increase in net revenues of Acetadote was due to an increase in the selling price.
For the nine months ended September 30, 2009, gross sales were reduced by approximately $3.8 million, of which approximately $2.4 million related to product returns and fee-for-service. The remaining deductions included cash discounts, rebates and similar items. For the nine months ended September 30, 2008, gross sales were reduced by approximately $1.9 million, consisting of deductions for product returns, cash discounts, fee-for-services and rebates. Cost of products sold. Cost of products sold for the nine months ended September 30, 2009 totaled approximately $3.3 million, representing an increase of approximately $1.0 million, or 47%, over the same period in 2008. As a percentage of net revenues, cost of products sold increased from 8.8% for the nine months ended September 30, 2008 to 10.0% for the nine months ended September 30, 2009. The increase in cost of products sold as a percentage of net revenues was primarily due to a change in the sales mix between the periods. Selling and marketing. Selling and marketing expense for the nine months ended September 30, 2009 totaled approximately $14.6 million, representing an increase of approximately $4.0 million, or 38%, over the same period in 2008. The increase was primarily due to (1) increased marketing, advertising and market research for Caldolor and Acetadote, (2) increased payroll and related costs due to the expansion of our sales force, (3) increased royalty expense as a result of our increase in sales and (4) increased freight and distribution costs. Research and development. Research and development expense for the nine months ended September 30, 2009 totaled approximately $4.0 million, representing an increase of approximately $1.3 million, or 47%, over the same period in 2008. The increase was primarily due to the recognition of approximately $2.0 million of milestone obligations due upon FDA approval of Caldolor in June 2009. The milestone payments include approximately $1.0 million of cash payments to a third-party who assisted in early development efforts. We have paid approximately $0.8 million of the liability, with the remaining due in equal monthly installments through July 2010. In addition to the cash payments, the third party immediately vested in 60,000 stock options with a fair value of approximately $0.8 million at the time of approval, calculated using the Black-Scholes methodology. A separate third-party research institution immediately vested in 10,000 shares of common stock valued at $150,000 upon FDA approval.
The increase in research and development expense resulting from the milestone obligations was offset by a decrease in supplies expense in 2009 as compared to 2008. In 2008, we incurred setup and validation costs associated with entering into a new supplier agreement for two of our products that did not reoccur in 2009.
General and administrative. General and administrative expense for the nine months ended September 30, 2009 totaled approximately $5.2 million, representing an increase of approximately $1.9 million, or 60%, over the same period in 2008. The increase is primarily due to (1) increased payroll-related taxes associated with the exercise of nonqualified options in 2009, (2) increased stock compensation expense due to the timing of when stock options were issued in 2009 as compared to 2008 and (3) increased personnel and related expenses primarily due to personnel additions.

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Income tax expense. Income tax expense for the nine months ended September 30, 2009 totaled approximately $1.9 million, representing a decrease of approximately $0.2 million, or 10%, over the same period in 2008. As a percentage of net income before income taxes, income tax expense increased from 36.8% for the nine months ended September 30, 2008 to 40.9% for the same period in 2009. The increase in the tax rate was primarily due to (1) the recognition in the first quarter of 2008 of approximately $0.4 million of previously unrecognized tax benefits and (2) an increase in incentive stock options expense in 2009 for which we do not receive a tax benefit.
In the third quarter of 2009, nonqualified stock options were exercised which resulted in a tax benefit of approximately $26.7 million to us. In recognizing tax benefits, we follow the tax-law ordering of deductions, which preclude the recognition of tax benefits until those benefits are used to offset income taxes payable. We do not believe the tax benefit generated in the third quarter of 2009 will be used to offset the tax liability created from the results of operations in 2009. As a result, we have not recognized the tax benefit from the exercise of those options. The tax benefit, with a corresponding increase to common stock, will be recognized in future periods when they are used to offset the income tax liability generated in those periods.
LIQUIDITY AND CAPITAL RESOURCES
Working Capital
Our primary sources of liquidity are cash flows provided by our operations, our borrowings and the cash proceeds from our initial public offering of common stock. We believe that our internally generated cash flows and amounts available under our credit facilities will be adequate to service existing debt, finance internal growth and fund capital expenditures. As of December 31, 2008 and September 30, 2009, cash and cash equivalents was $11.8 million and $79.5 million, respectively, working capital (current assets minus current liabilities) was $10.1 million and $78.0 million, respectively, and our current ratio (current assets to current liabilities) was 2.3x and 6.8x, respectively. As of September 30, 2009, we had an additional $2.2 million available to us on our line of credit.
On August 10, 2009, we completed our initial public offering of 5,000,000 shares of common stock at $17.00 per share, raising gross proceeds of $85.0 million. After deducting underwriting discounts of approximately $6.0 million and offering costs of approximately $4.2 million, the net proceeds were approximately $74.8 million.
In July 2009, we amended our debt agreement to provide for $18.0 million in term debt and a $4.0 million revolving credit facility. We used $4.2 million of the proceeds from our initial public offering to repay the outstanding balance from our previous term debt agreement. Further, we used the proceeds from the new term debt to pay, in part, the minimum statutory tax withholding requirements of approximately $24.6 million due from the exercise of options to purchase shares of our common stock at the pricing of our initial public offering on August 10, 2009. The remaining balance due of approximately $6.6 million related to the minimum statutory tax withholding requirements was funded by our existing cash balances. The exercise of stock options generated a tax benefit of approximately $26.7 million to us. We will recognize this benefit as a reduction in income taxes payable when those benefits are realized.

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The following table summarizes our net changes in cash and cash equivalents for the nine months ended September 30, 2008 and 2009:

                                                   Nine Months Ended September 30,
                                                     2008                  2009
                                                           (in thousands)
Net cash provided by (used in):
Operating activities                            $         4,239       $         1,924
Investing activities                                       (124 )                (271 )
Financing activities                                     (3,767 )              66,059

Net increase in cash and cash equivalents (1)   $           349       $        67,712

(1) The sum of the individual amounts may not agree due to rounding.

Cash provided by operating activities for the nine months ended September 30, 2009 of approximately $1.9 million was primarily due to net income of approximately $2.8 million adjusted for (1) noncash expenses of approximately $2.2 million and (2) a decrease in working capital of $0.2 million. Also impacting cash provided by operating activities is the requirement that the tax benefit recognized from the exercise of nonqualified options be reflected as a cash outflow in operations and a cash inflow in financing activities. Cash used by investing activities for the nine months ended September 30, 2009 of approximately $0.3 million was primarily due to the purchase of property and equipment.
Cash provided by financing activities for the nine months ended September 30, 2009 of approximately $66.1 million was primarily due to (1) proceeds from our initial public offering of $85.0 million, net of offering costs paid of approximately $7.4 million, (2) additional borrowings of $18.0 million of term debt, (3) principal payments of $5.0 million related to the payoff of our old term debt balance, (4) the excess tax benefit derived from the exercise of stock options that is required to be reflected as a cash inflow from financing activities and (5) payments made in connection with the repurchase of common shares that were tendered to settle the minimum statutory withholding requirements associated with the exercise of stock options in 2009.
OFF-BALANCE SHEET ARRANGEMENTS
During the nine months ended September 30, 2009, we did not engage in any off-balance sheet arrangements.