Note Regarding Company References and Other Defined Terms

Unless the context otherwise requires, in this Quarterly Report, (i) references to the “Company,” “we,” “our” or “us” refer to Diffusion Pharmaceuticals Inc. and its subsidiaries and (ii) references to “common stock” refer to the common stock, par value $0.001 per share, of the Company.Company and all share and per share amounts related to our common stock give effect to our 1-for-50 reverse stock split effected April 18, 2022. We have also used several other defined terms in this Quarterly Report, many of which are explained or defined below:

Note Regarding Forward-Looking Statements

This Quarterly Report (including, for purposes of this Note Regarding Forward-Looking Statements, any information or documents incorporated herein by reference) includes express and implied forward-looking statements. By their nature, forward-looking statements involve risks and uncertainties because they relate to events, competitive dynamics and industry change, and depend on the economic circumstances that may or may not occur in the future or may occur on longer or shorter timelines than anticipated. Although we believe that we have a reasonable basis for each forward-looking statement contained in this Quarterly Report, we caution you that forward-looking statements are not guarantees of future performance and that our actual results of operations, financial condition, liquidity, and prospects may differ materially from the forward-looking statements contained in this Quarterly Report. In addition, even if our results of operations, financial condition, liquidity, and prospects are consistent with the forward-looking statements contained in this Quarterly Report, they may not be predictive of actual results or reflect unanticipated developments in future periods.

Forward-looking statements appear in a number of places throughout this Quarterly Report.Report . We may, in some cases, use terms such as “believes,” “estimates,” “anticipates,” “expects,” “plans,” “intends,” “may,” “could,” “might,” “will,” “should,” “approximately,” or other words that convey uncertainty of future events or outcomes to identify these forward-looking statements. Forward-looking statements also include statements regarding our intentions, beliefs, projections, outlook, analyses or expectations concerning, among other things:

As a result of these and other factors, known and unknown, actual results could differ materially from our intentions, beliefs, projections, outlook, analyses, or expectations expressed in any forward-looking statements in this Quarterly Report. Accordingly, we cannot assure you that the forward-looking statements contained or incorporated by reference in this Quarterly Report will prove to be accurate or that any such inaccuracy will not be material. You should also understand that it is not possible to predict or identify all such factors, and you should not consider any such list to be a complete set of all potential risks or uncertainties. In light of the foregoing and the significant uncertainties in these forward-looking statements, you should not regard these statements as a representation or warranty by us or any other person that we will achieve our objectives and plans in any specified time frame, or at all. For all forward-looking statements, we claim the protection of the safe harbor for forward-looking statements contained in the Private Securities Litigation Reform Act of 1995.

Any forward-looking statements that we make in this Quarterly Report speak only as of the date of such statement, and, except as required by applicable law or by the rules and regulations of the SEC, we undertake no obligation to update such statements to reflect events or circumstances after the date of this Quarterly Report or to reflect the occurrence of unanticipated events. Comparisons of current and any prior period results are not intended to express any ongoing or future trends or indications of future performance, unless explicitly expressed as such, and should only be viewed as historical data.

Note Regarding Trademarks, Trade Names and Service Marks

This Quarterly Report contains certain trademarks, trade names, and service marks of ours, including “DIFFUSIO₂N.“DIFFUSIO2N.” All other trade names, trademarks, and service marks appearing in this Quarterly Report are, to the knowledge of Diffusion, the property of their respective owners. To the extent any such terms appear without the trade name, trademark, or service mark notice, such presentation is for convenience only and should not be construed as being used in a descriptive or generic sense.

PART I – FINANCIAL INFORMATION

Diffusion Pharmaceuticals Inc.

Consolidated Balance Sheets

(unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

Diffusion Pharmaceuticals Inc.

Consolidated Statements of Operations and Comprehensive Loss

(unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

Diffusion Pharmaceuticals Inc.

Consolidated Statement of Changes in Stockholders' Equity

Three and Six Months Ended June 30, 2021 and 2022

(unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

Diffusion Pharmaceuticals Inc.

Consolidated Statement of Changes in Stockholders' Equity

Three and Six Months Ended June 30, 2020

(unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

Diffusion Pharmaceuticals Inc.

Consolidated Statements of Cash Flows

(unaudited)

See accompanying notes to unaudited interim consolidated financial statements.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Diffusion Pharmaceuticals Inc., a Delaware corporation, is an innovativea biopharmaceutical company developing novel therapies thatto enhance the body’s ability to deliver oxygen to the areas where it is needed most. The Company’s lead product candidate, TSC, is being developedinvestigated to enhance the diffusion of oxygen to tissues with low oxygen levels, also known as hypoxia, a serious complication of many of medicine’s most intractable and difficult-to-treat conditions. In additionconditions, including hypoxic solid tumors.

On April 18, 2022, the Company effected a 1-for-50 reverse split of its common stock. Any references in the unaudited condensed consolidated financial statements and related notes to TSC, the Company's product candidate DFN-529, a novel, allosteric PI3K/Akt/mTOR pathway inhibitor, is in early-stage development.share or per share amounts give retroactive effect to this reverse stock split.

The Company has not generated any revenues from product sales and has funded operations primarily from the proceeds of public and private offerings of equity, convertible debt and convertible preferred stock. Substantial additional financing will be required by the Company to continue to fund its research and development activities. No assurance can be given that any such financing will be available when needed, or at all, or that the Company’s research and development efforts will be successful.

The Company regularly explores alternative means of financing its operations and seeks funding through various sources, including public and private securities offerings, collaborative arrangements with third parties and other strategic alliances and business transactions. The Company does not have any commitments to obtain additional funds and may be unable to obtain sufficient funding in the future on acceptable terms, if at all. If the Company cannot obtain the necessary funding, it will need to delay, scale back or eliminate some or all of its research and development programs or enter into collaborations with third parties to commercialize potential products or technologies that it might otherwise seek to develop or commercialize independently; consider other various strategic alternatives, including a merger or sale of the Company; or cease operations. If the Company engages in collaborations, it may receive lower consideration upon commercialization of such products than if it had not entered such arrangements or if it entered into such arrangements at later stages in the product development process.

In July 2022, the Company entered into an at-the-market sales agreement (the "2022 Sales Agreement") with BTIG, LLC, ("BTIG") as agent, pursuant to which the Company may sell up to an aggregate of $20.0 million in shares of the Company’s common stock, from time to time through BTIG, by any method permitted that is deemed an “at the market offering” as defined in Rule 415(a)(4) under the Securities Act of 1933, as amended.

Operations of the Company are subject to certain risks and uncertainties including various internal and external factors that will affect whether and when the Company’s product candidates become approved drugs and how significant their market share will be, some of which are outside of the Company’s control. The length of time and cost of developing and commercializing these product candidates and/or failure of them at any stage of the drug approval process will materially affect the Company’s financial condition and future operations. The Company currently expects that its existing cash, and cash equivalents and marketable securities as of June 30, 2021 2022will enable it to fund its operating expenses and capital expenditure requirements including expected costs relatedinto the first quarter of 2024, without giving effect to the planned Oxygenation Trials and the Planned Hypoxia-related Indication Trial(s), throughany business development activities we 2023.may undertake.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The Summary of Significant Accounting Policies included in the Company's Annual Report for the year ended December 31, 20202021 have not materially changed.

Basis of Presentation

The accompanying unaudited interim consolidated financial statements of the Company have been prepared in accordance with GAAP for interim financial information as found in the ASC and ASUs of the FASB, and with the instructions to Form 10-Q and Article 10 of Regulation S-X promulgated by the SEC. In the opinion of management, the accompanying unaudited interim consolidated financial statements of the Company include all normal and recurring adjustments (which consist primarily of accruals, estimates and assumptions that impact the unaudited interim consolidated financial statements) considered necessary to present fairly the Company’s financial position as of June 30, 2021,2022, and its results of operations for the three and six months ended June 30, 20212022 and 20202021 and cash flows for the six months ended June 30, 20212022 and 2020.2021. Operating results for the six months ended June 30, 20212022 are not necessarily indicative of the results that may be expected for the year ending December 31, 2021.2022. The unaudited interim consolidated financial statements presented herein do not contain the required disclosures under GAAP for annual financial statements. The accompanying unaudited consolidated interim financial statements should be read in conjunction with the annual audited financial statements and related notes as of and for the year ended December 31, 20202021 filed with the SEC as part of the Company's Annual Report on Form 10-K on March 16, 2021.Report.

Use of Estimates

The preparation of unaudited interim consolidated financial statements in conformity with GAAP requires managementthe Company to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of expenseexpenses during the reporting period. The COVID-19 pandemic had no material impact on

On an ongoing basis, the Company'sCompany evaluates its estimates using historical experience and other factors, including the current economic environment. Significant items subject to such estimates are assumptions used in the preparationfor purposes of the unaudited interim consolidated financial statementsdetermining stock-based compensation and accounting for the three and six months ended June 30,2021. However, the full extent to which the ongoing COVID-19 pandemic will directly or indirectly impact the Company's business, results of operations and financial condition, including sales, expenses, reserves and allowances, clinical trials, research and development costs and employee-related amounts, will depend on future developments that are highly uncertain, including as a result of new information that may emerge concerning COVID-19, governmental and business responsesactivities. Management believes its estimates to be reasonable under the pandemic, further actions taken to contain or treat COVID-19, the ongoing economic impact on local, regional, national and international markets, and the speed of the anticipated economic recovery. Due to the uncertainty of factors surrounding these estimates or judgments, actualcircumstances. Actual results may materially varycould differ significantly from the Company’sthose estimates. Estimates and assumptions are periodically reviewed, and the effects of revisions are reflected in the unaudited interim consolidated financial statements in the period they are determined. The Company’s future assessment of the magnitude and duration of COVID-19, as well as other factors, could result in material impacts to the Company’s consolidated financial statements in future reporting periods.

Fair Value of Financial Instruments

The carrying amounts of the Company’s financial instruments, including cash equivalents and accounts payable approximate fair value due to the short-term nature of those instruments.

Concentration of Credit Risk

Financial instruments that potentially expose the Company to concentrations of credit risk consist principally of cash on deposit with multiple financial institutions, the balances of which frequently exceed federally insured limits.

Intangible AssetCash and Cash Equivalents

The Company's DFN-529 (formerly RES-529) intangible asset is assessed for impairment annually on October 1 Company considers any highly-liquid investments, such as money market funds and commercial paper with an original maturity of the Company’s fiscal year or more frequently if impairment indicators exist. There was 0 impairment to the Company’s DFN-529 intangible asset recognized during the three months or six months ended June 30,2021less to be cash and 2020.cash equivalents.

Marketable Securities

The Company classifies its marketable securities as available-for-sale, which include commercial paper and U.S. government debt securities with original maturities of greater than three months from date of purchase. The Company considers its marketable securities as available for use in current operations, and therefore classify these securities as current assets on the consolidated balance sheet. These securities are carried at fair value, with unrealized gains and losses reported in comprehensive loss and accumulated other comprehensive loss within stockholders’ equity. Gains or losses on marketable securities sold will be based on the specific identification method.

Reverse Stock Split

On April 18, 2022, the Company filed a Certificate of Amendment to its Certificate of Incorporation, as amended, with the Secretary of State of the State of Delaware to implement the Reverse Stock Split at a ratio of 1-to-50. NaN fractional shares were issued in connection with the Reverse Stock Split. Stockholders who otherwise would have been entitled to receive fractional shares of common stock became entitled to receive an amount in cash (without interest or deduction) equal to the fraction of one share to which such stockholder would otherwise be entitled multiplied by $12.93, representing the split-adjusted average closing price of the Company’s common stock on the Nasdaq Capital Market for the five consecutive trading days immediately preceding the effective date of the Reverse Stock Split. Proportional adjustments were made to the Company’s outstanding warrants, stock options, and other equity securities, as well as to the reserve of shares available for future issuance under the 2015 Equity Plan, to reflect the Reverse Stock Split, in each case, in accordance with the respective terms thereof.

Net Loss Per Common Share

Basic net loss per share is computed by dividing net loss attributable to common stockholders by the weighted average number of shares of common stock outstanding during each period. Diluted net loss per share includes the effect, if any, from the potential exercise or conversion of securities, such as convertible debt, convertible preferred stock, common stock warrants, stock options and unvested restricted stock that would result in the issuance of incremental shares of common stock. In computing the basic and diluted net loss per share applicable to common stockholders, the weighted average number of shares remains the same for both calculations due to the fact that when a net loss exists, dilutive shares are not included in the calculation as the impact is anti-dilutive.

The following potentially dilutive securities outstanding as of June 30,2022 and 2021have been excluded from the computation of diluted weighted average shares outstanding, as they would be anti-dilutive as of the dates indicated below:anti-dilutive:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Recently AdoptedIssued Accounting Pronouncements

In December 2019,June 2016, the FASB issued ASU No.20192016-12,13, Income TaxesFinancial Instruments—Credit Losses, Measurement of Credit Losses on Financial Instruments (Topic 740326): Simplifying. The standard amends the Accountingimpairment model by requiring entities to use a forward-looking approach based on expected losses to estimate credit losses for Income Taxes.most financial assets and certain other instruments that aren’t measured at fair value through net income. For available-for-sale debt securities, entities will be required to recognize an allowance for credit losses rather than a reduction in carrying value of the asset. Entities will no longer be permitted to consider the length of time that fair value has been less than amortized cost when evaluating when credit losses should be recognized. This new guidance applies to all entities and aims to reduce the complexity of tax accounting standards while enhancing reporting disclosures. This guidance wasis effective for fiscal years beginning afterthe Company as of December 15, 2020January 1, 2023. and interim periods therein. The Company adoptedis currently evaluating the impact of this ASU No.2019-12 in the first quarter of 2021 and the adoption didbut does not expect that adoption of this standard will have a material impact on the Company's consolidated financial statements.statements and related disclosures.

The following is a summary of the Company's cash and cash equivalents as of the dates indicated:

The following is a summary of the Company's marketable securities as of June 30,2022:

The Company did not have any marketable securities as of December 31, 2021. The Company's marketable securities generally have contractual maturity dates between 3 and 12 months. Most of the Company’s marketable securities are in an unrealized loss position at June 30,2022. Unrealized losses on marketable securities as of June 30,2022 were not significant and were primarily due to changes in interest rates, and not due to increased credit risks associated with specific securities. Accordingly, 0 other-than-temporary impairment was recorded for the six months ended June 30,2022 and there were 0 realized gains or losses recorded during the six months ended June 30,2021.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Fair value is the price that could be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants. Fair value determination in accordance with applicable accounting guidance requires that a number of significant judgments be made. Additionally, fair value is used on a nonrecurring basis to evaluate assets for impairment or as required for disclosure purposes by applicable accounting guidance on disclosures about fair value of financial instruments. Depending on the nature of the assets and liabilities, various valuation techniques and assumptions are used when estimating fair value. The carrying amounts of certain of the Company’s financial instruments, including prepaid expense and accounts payable are shown at cost, which approximates fair value due to the short-term nature of these instruments. The Company follows the provisions of FASB ASC Topic 820,Fair Value Measurement, for financial assets and liabilities measured on a recurring basis. The guidance requires fair value measurements be classified and disclosed in one of the following three categories:

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

The following table presents the Company’s assets that are measured at fair value on a recurring basis (amounts in thousands):

The fair values of the Company’s Level 2 marketable securities are estimated primarily based on benchmark yields, reported trades, market-based quotes, issuer spreads, two-sided markets, benchmark securities, bids, offers, and reference data including market research publications, which represent a market approach. In general, a market approach is utilized if there is readily available and relevant market activity for an individual security. This valuation technique may change from period to period, based on the relevance and availability of market data.

Accrued expenses and other current liabilities consisted of the following as of the dates indicated below:

February 2021 CommonPrivate Placement of Series C Preferred Stock Offering

          InOn February 2021,March 18, 2022, the Company completed the February 2021 Offering in which it offeredissued and sold 33,658,538 shares ofto Robert J. Cobuzzi, Jr., Ph.D., its common stock in an underwritten, public offering for a purchase price to the public of $1.025 per share, inclusive of shares offeredPresident & Chief Executive Officer, and sold pursuant to the exercise-in-full by the underwriter ofWilliam R. Elder, its 30-day option to purchase additional shares. The February 2021 Offering resulted in aggregate net proceeds to the Company of $31.1 million, after deducting underwriting commissions, discounts, and expenses but prior to deducting other offering costs. In addition, at the closings of the February 2021 Offering, the Company issued to designees of the underwriter of the transaction warrants to purchase up toGeneral Counsel & Corporate Secretary, an aggregate of 1,682,92710,000 shares of Series C Preferred Stock at an offering price of $0.50 per share, representing 100% of the stated value per share of the Series C Preferred Stock, for aggregate gross proceeds of $5,000.

The Series C Certificate provides that, among other things, (i) each share of Series C Preferred Stock is convertible into 0.02 shares of the Company's common stock, representing a conversion price of $25.00 per share, subject to certain conditions, (ii) each share of Series C Preferred Stock outstanding is counted on an as converted basis, together with the Company’s common stock as a single class, for purposes of determining the presence of a quorum at any meeting at which holders are asked to vote on matters related to the Reverse Stock Split (subject to any applicable exchange listing rules), (iii) each share of Series C Preferred Stock outstanding has the right to cast 1,600 votes per share of Series C Preferred Stock on the Reverse Stock Split on a “mirrored” basis — this means that the holders of the Series C Preferred Stock are required to vote their shares in a manner that “mirrors” the proportions of “For” and “Against” votes cast by the holders of the Company’s common stock are voted on the Amendment (excluding, for the avoidance of doubt, any shares of common stock that are not voted), and (iv) the holders of outstanding shares of Series C Preferred Stock are entitled to designees. The underwriter warrants havedividends, on an exercise priceas converted basis, equal to dividends actually paid, if any, on shares of $1.28125 per sharecommon stock and a termparticipate in any liquidation of five years from the date of issuance.Company on an as converted basis.

             On April 18, 2022, following approval of the Reverse Stock Split by the Company's stockholders, all 10,000 shares of Series C Preferred Stock were converted into an aggregate of 200 shares of the Company's common stock in accordance with the terms of the Series C Certificate.

Common Stock Warrants

During its evaluation of equity classification for the Company's common stock warrants issued in previous periods, the Company considered the conditions as prescribed within ASC 815-40,Derivatives and Hedging, Contracts in an Entity’s own Equity. The conditions within ASC 815-40 are not subject to a probability assessment. The warrants do not fall under the liability criteria within ASC 480Distinguishing Liabilities from Equity as they are not puttable and do not represent an instrument that has a redeemable underlying security. The warrants do meet the definition of a derivative instrument under ASC 815, but are eligible for the scope exception as they are indexed to the Company’s own stock and would be classified in permanent equity if freestanding.

As of June 30, 2021,2022, the Company had the following warrants outstanding to acquire shares of its common stock:

During the six months ended June 30, 2021,2022, 53,57018,077 warrants expired and 4,230,000 warrants were exercised for aggregate proceeds of approximately $2.2 million.expired.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

2015 Equity Plan

The 2015 Equity Plan provides for increases to the number of shares reserved for issuance thereunder each January 1 equal to 4.0% of the total shares of the Company’s common stock outstanding as of the immediately preceding December 31, unless a lesser amount is stipulated by the Compensation Committee of the Company's board of directors. Accordingly, 2,560,61881,531 shares were added to the reserve as of January 1, 2021,2022, which shares may be issued in connection with the grant of stock-based awards, including stock options, restricted stock, restricted stock units, stock appreciation rights and other types of awards as deemed appropriate, in each case, in accordance with the terms of the 2015 Equity Plan. As of June 30, 2021, 2022,there were 1,181,62942,461 shares available for future issuance under the 2015 Equity Plan.

The Company recorded stock-based compensation expense in the following expense categories of its unaudited interim consolidated statements of operations for the periods indicated:

The following table summarizes the activity related to all stock option grants for the six months ended June 30, 2021:2022:

The weighted average grant date fair value of stock option awards granted during the six months ended June 30, 20212022 was $1.05.$10.35. The total fair value of options vested during the three months ended June 30, 2021 2022and 20202021 was $0.1$0.3 million and $0.1 million, respectively. The total fair value of options vested during the six months June 30, 2021 2022and 20202021 was $0.3$0.5 million and $0.3 million, respectively. NaN options were exercised during any of the periods presented. At June 30, 2021,2022, there was $1.1 million of unrecognized compensation expense that will be recognized over a weighted-average period of 2.221.93 years. During the six months ended June 30, 2021, the Company granted 385,267 performance-based stock options with an exercise price of $1.11 per share, subject to vesting based on the satisfaction of specified performance criteria. Compensation expense for the performance-based awards is recorded over the estimated service period for each milestone when the performance conditions are deemed probable of achievement. The Company recorded stock-based compensation expense of approximately $0.1 million and $0.2 million during the three and six months ended June 30, 2021, for service-based awards and performance conditions deemed probable of achievement and/or achieved.

Options granted were valued using the Black-Scholes option-pricing model and the weighted average assumptions used to value the options granted during the six months ended June 30, 20212022 and 20202021 were as follows:

Restricted Stock Unit Awards

As of the six months ended June 30,2021, theThe Company has granted an aggregate of 153,000issues restricted stock awardsunits ("RSU") to newly elected, non-executive members of the board of directors of the Company. The shares begin tothat vest in six, tri-monthly installments beginning 18 months after the respective grant date. The fair value of a RSU is equal to the fair market value price of the Company’s common stock on the date of grant. RSU expense is recorded on a straight-line basis over the service period.

The following table summarizes activity related to RSU awards during the period indicated:

(1)  The RSUs vested during the six months ended June 30, 2022 were settled on a hybrid basis. The Company withheld 308 shares of common stock and, in lieu of delivering such shares, paid the RSU holder an amount in cash equal to the fair market value of such shares on vesting date, representing the holder's approximate tax liability associated with such vesting amount in cash equal to the fair market value of such shares on vesting date, representing the holder's approximate tax liability associated with such vesting.

The Company recognized approximately $5,000$16,000 and $4,000$5,000 in expense related to these awards during the three months ended June 30, 2021 2022and 2020,2021, respectively. The Company recognized approximately $10,000$32,000 and $8,000$10,000 in expense related to these awards during the six months ended June 30, 20212022 and 2020,2021, respectively. At June 30, 2021,2022, there was approximately $72,000$96,000 of unrecognized compensation cost that will be recognized over a weighted average period of 1.961.69 years.

Office Space RentalLease Commitment

The Company has a non-cancelable operating lease for office and laboratoryshort term agreements to utilize membership-based co-working space in both Charlottesville, Virginia which began in April 2017, and as of June 30,2021, has a remaining lease term of approximately 0.8 years. The discount rate used to account for the Company's operating lease under ASC 842 is the Company’s estimated incremental borrowing rate of 10%. The original term of the lease ends in the second quarter of 2022 and the Company has an option to extend for another five (5) years. This option to extend was not recognized as part of the Company's measurement of the right-of-use asset and operating lease liability as of June 30,2021.

Philadelphia, Pennsylvania. Rent expense related to the Company's operating leaseshort-term agreements for the three months ended June 30, 2022 30,and 2021 and 2020 was approximately $29,000$2,000 and $30,000,$29,000, respectively. Rent expense related to the Company's short-term agreements was approximately $11,000 and $60,000 for the six months ended June 30, 20212022 and 2020 was approximately $60,000. Future minimum rental payments under the Company's non-cancelable operating lease at June 30,2021, were as follows:respectively.

Research and Development Arrangements

In the course of normal business operations, the Company enters into agreements with universities and CROs to assist in the performance of research and development activities and contract manufacturers to assist with chemistry, manufacturing, and controls related expenses. Expenditures to CROs represent a significant cost in clinical development for the Company. The Company could also enter into additional collaborative research, contract research, manufacturing, and supplier agreements in the future, which may require upfront payments and long-term commitments of cash.

Defined Contribution Retirement Plan

The Company has established aits 401(k) defined contribution plan thatPlan, which covers all employees who qualify under the terms of the plan. Eligible employees may elect to contribute to the 401(k) Plan up to 90% of their compensation, limited by the IRS-imposed maximum. The Company provides a safe harbor match with a maximum amount of 4% of the participant’s compensation. The Company made matching contributions under the 401(k) Plan of approximately $24,000$26,000 and $14,000$24,000 for the three months ended June 30, 2021 and 2020, respectively and matched contributions under the 401(k) Plan of approximately $53,000 and $40,000 and $31,000 duringfor the six months ended June 30, 2021 2022and 2020,2021, respectively.

DIFFUSION PHARMACEUTICALS INC.

NOTES TO UNAUDITED CONSOLIDATED FINANCIAL STATEMENTS

Legal Proceedings

On August 7, 2014, a complaint was filed in the Superior Court of Los Angeles County, California by Paul Feller, the former Chief Executive Officer of the Company'sCompany’s legal predecessor under the caption Paul Feller v. RestorGenex Corporation, Pro Sports & Entertainment, Inc., ProElite, Inc. and Stratus Media Group, GmbH (Case No. BC553996). The complaint asserts various causes of action, including, among other things, promissory fraud, negligent misrepresentation, breach of contract, breach of employment agreement, breach of the covenant of good faith and fair dealing, violations of the California Labor Code and common counts. The plaintiff is seeking, among other things, compensatory damages in an undetermined amount, punitive damages, accrued interest and an award of attorneys’ fees and costs. On December 30, 2014, the Company filed a petition to compel arbitration and a motion to stay the action. On April 1, 2015, the plaintiff filed a petition in opposition to the Company’s petition to compel arbitration and a motion to stay the action. After a related hearing for the petition and motion on April 14, 2015, the Courtcourt granted the Company’s petition to compel arbitration and a motion to stay the action. On January 8, 2016, the plaintiff filed an arbitration demand with the American Arbitration Association. On November 19, 2018 at an Order to Show Cause Re Dismissal Hearing, the Courtcourt found sufficient grounds not to dismiss the case and an arbitration hearing was scheduled, originally for November 2020. In August 2020 but later postponed due to the ongoing COVID-19 pandemic and related restrictions on gatherings in the State of California,California. In addition, following the November 2018 hearing, an automatic stay was placed on the arbitration hearingin connection with the plaintiff filing for personal bankruptcy protection. On October 22, 2021, following a determination by the bankruptcy trustee not to pursue the claims and release them back to the plaintiff, the parties entered into a stipulation to abandon arbitration and return the matter to state court. A case management conference was postponedheld on February 23, 2022 at which a trial date of May 24, 2023 was set, and the parties have agreed to August 16, 2021. stipulate to mediation in advance of the trial.

The Company believes the claims in this matter isare without merit and intends to defend the arbitrationitself vigorously. However, at this stage, the Company is unable to predict itsthe outcome and the possible loss or range of loss, if any, associated with its resolution or any potential effect the matter may have on the Company’s financial position. Depending on the outcome or resolution of this matter, it could have a material effect on the Company’s financial position, results of operations and cash flows.

You should read the following discussion of our financial condition and results of operations together with the unaudited interim consolidated financial statements and the notes thereto included elsewhere in this report and other financial information included in this report. The following discussion may contain predictions, estimates and other forward-looking statements that involve a number of risks and uncertainties, including those discussed under “Part I — Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations—Special Note Regarding Forward-Looking Statements” in this report and under “Part I — Item 1A. Risk Factors” in our Annual Report and under “Part II—Other Information – Item 1A. Risk Factors” in our Quarterly Report on Form 10-Q for the quarterly period ended March 31, 2021.Report. These risks could cause our actual results to differ materially from any future performance suggested below.

Diffusion Pharmaceuticals: Enhancing Oxygen, Fueling Life

We are an innovativea biopharmaceutical company developing novel therapies thatto enhance the body’s ability to deliver oxygen to the areas where it is needed most. Our lead product candidate, TSC, is being developedinvestigated to enhance the diffusion of oxygen to tissues with low oxygen levels, also known as hypoxia, a serious complication of many of medicine’s most intractable and difficult-to-treat conditions. In addition to TSC, our product candidate DFN-529, a novel, allosteric PI3K/Akt/mTOR pathway inhibitor, is in early-stage development.

TSC Second Quarter Development Update

In May 2021, we announced final results of our COVID Trial, which we initiated in 2020 due to a belief in the potential of TSC to improve low tissue oxygen levels, a common complication of COVID-19. The study’s primary objective was to evaluate the safety and tolerability of TSC administered on a more frequent dosing regimen not previously tested in a clinical trial setting, and the secondary and exploratory endpoints for the trial included time to improvement in World Health Organization ordinal scale by day 7 and through day 29, time on oxygen supplementation, and hospital length of stay. Although the study was not designed or powered to evaluate efficacy, the study’s external safety monitoring committee observed that patients receiving the 1.5 mg/kg dose had improved outcomes in these secondary and exploratory endpoints compared to those receiving lower doses.

In June 2021, the Company reported a positive trend in oxygenation from the TCOM Trial. The TCOM Trial was designed to evaluate the effect of TSC versus placebo on peripheral tissue oxygenation in healthy normal volunteers. Topline results based upon analyses of primary endpoint data indicated, as compared to placebo, a positive dose-response trend in TCOM readings after TSC administration that persisted through the measurement period with no evidence of hyperoxygenation. TSC was also safe and well-tolerated at all doses tested.

The TCOM Trial was a randomized, double-blind, placebo controlled, pharmacokinetic and pharmacodynamic study of TSC that enrolled and dosed 30 healthy volunteers. Trial participants were randomized into one of six subgroups, each of which received a single intravenous dose of placebo or one of five different doses of TSC ranging from 0.5 mg/kg to 2.5 mg/kg. All trial participants received supplemental oxygen during equivalent, one-hour monitoring periods before and after TSC or placebo was administered while subjects were continuously monitored with TCOM sensors applied to their lower extremity. The primary endpoint evaluated the relative change in TCOM readings from baseline after TSC administration compared to placebo.

TSC Development Plans for 2021 and 2022

We remain focused on our over-arching clinical development plan announced in November 2020 designed to accomplish two principal strategic objectives: (1) Optimize the clinical dose and dosing frequency for TSC; and (2) Evaluate TSC in clinical models designed to establish proof of concept for improvement in oxygenation. As part of this plan, we are currently focused on the execution of our three, short-term Oxygenation Trials to explore the relationship between TSC dose and change in oxygenation. These studies are being conducted in the U.S. during 2021in and will be funded with cash-on-hand.conditions, including hypoxic solid tumors.

TheBusiness Update

Altitude Trial

During the second quarter, we reported positive trend observed in the TCOMeffects from our second Oxygenation Trial, is being used to guide dose selection in the additional Oxygenation Trials planned for the latter part of 2021 -- the Altitude Trial, followed by  the ILD-DLCO Trial.

Altitude Trial: TSC’s Effects Under Induced Hypoxic Conditions

This trial will bewas a double-blind, randomized, placebo-controlled crossover dose exploration study which will evaluate thedesigned to investigate TSC’s effects of TSC on oxygen enhancement using an experimental model to induce hypoxia in study participants. The primary endpoints measured in this study were maximal oxygen consumption or VO2, and partial pressure of arterial blood oxygen or PaO2, in normal healthy volunteers subjected to incremental levels of physical exertion while exposed to hypoxic and hypobaric conditions (i.e.,at a simulated altitude).altitude of 15,000 feet above sea level. The study is designedsecondary endpoints were to evaluateassess the effect of TSC on oxygen availabilitySpO2 and consumption comparedlactate.

A total of 30 healthy volunteers were enrolled in the trial with each subject serving as their own control by completing the experiment twice in a random, blinded order in the same day with a 3-hour rest and wash out period between experimental intervals. During one ascent, study subjects received IV placebo administration and the other ascent the same subject received a single IV dose of TSC at one of three dose levels (0.5 mg/kg, 1.5 mg/kg, or 2.5 mg/kg).

In the trial, following exercise under hypoxic conditions, an increase in pH and a decrease in lactate were observed in the study subjects treated with the highest dose of TSC (2.5 mg/kg), both at the end of the exercise period and at 10 minutes post-exercise relative to placebo. We anticipate initiatingThese data suggest the 2.5 mg/kg dose of TSC decreased blood acidity (i.e., lactic acid accumulation) and completingenhanced metabolic recovery at 10 minutes after completion of exercise under the stressful conditions of simulated high altitude and exercise. These positive changes observed in blood markers of oxygen utilization results in the Altitude Trial suggest TSC may enhance oxygen availability at the cellular level and reinforce our belief in the fourth quartertherapeutic potential of 2021, with topline results available within one to two months of study completion.TSC.

ILD-DLCO Trial: TSC's Effects on Oxygen Transfer EfficiencyPhase 2 Trial in Patients with GBM Incorporating Innovative Imaging Methodology (Study 200-208)

        Taken together, the combination of positive effects observed in each of the TCOM, Altitude, and COVID-19 Trials affirmed our belief in TSC's potential as an adjuvant treatment to standard of care therapy for hypoxic solid tumors. As such, on July 26, 2022, we announced that we had aligned with the FDA on the design of an open-label, dose-escalation, Phase 2 safety and efficacy study of TSC administered with standard of care to newly diagnosed GBM patients. This trial will be a double-blind, randomized, placebo-controlled study which will evaluatehas been designated Study "200-208," and we currently expect to initiate the effectstrial by the end of TSC on2022 and to dose the diffusion of carbon monoxide through the lungs, or DLCO, in patients with previously diagnosed interstitial lung disease who have an abnormal baseline DLCO test result. DLCO will act as a surrogate measure of oxygen transfer efficiency, or uptake, from the alveoli of the lungs, through the plasma, and onto hemoglobin within red blood cells. The study will be statistically powered to evaluate the difference in effect of TSC on improvement in DLCO, as well as distance covered in a standard six-minute walk test.

We now anticipate initiating the ILD-DLCO Trialfirst patient in the late fourth quarter of 2021 and completing the trialstudy in the first quarter of 2022, with topline results available within one2023, subject to two monthsthe outcome of study completion.our ongoing business development processes described below.

Planned Phase 2 Hypoxia-related Indication TrialGBM is an aggressive, deadly, and treatment-resistant type of malignant brain tumor, affecting approximately 13,000 newly diagnosed patients each year in the United States. Few treatment options are available for patients with GBM, and none have extended life expectancy beyond a few months. In fact, according to the National Brain Tumor Society, the five-year survival rate for GBM is only 6.8 percent with an average survival time of eight months.

We expectStudy 200-208 will include a dose-escalation phase, enrolling patients in a 3+3+3 design, to announceevaluate the safety, tolerability, pharmacokinetics, and pharmacodynamics of TSC at doses of 1.5 mg/kg, 2.0 mg/kg and 2.5 mg/kg administered in combination with concomitant standard of care radiotherapy plus temozolomide. An additional 17 subjects will be treated at the highest tolerable dose identified in the fourth quarterdose escalation phase. The primary objective of 2021 the initial indicationstudy is to evaluate the safety and tolerability of TSC for the treatment of patients with newly diagnosed GBM when administered with standard of care. Secondary objectives of the study are to evaluate progression-free survival at six months by magnetic resonance imaging, assessment using Response Assessment in which TSC will be studied to support the planned pathway for regulatory approvalNeuro-Oncology criteria, and to initiate the Planned Phase 2 Hypoxia-related Indication Trial during the first half of 2022, funded with cash-on-hand.

Organizational Update

During the second quarter, we enhanced our operating team with the addition of new employees in the areas of administration, quality assurance, clinical operations, and finance. In addition, in connection with our annual meeting of stockholders in June 2021, Jane Hollingsworth was elected as the new Chair of our board of directors and Diana Lanchoney, M.D. and Eric Francois were newly elected to our board of directors.

We believe the totality of these organizational additions has already had a significant, positive impact on our ability to develop, implement and execute on our corporate strategy and development plans and position us well to build shareholder value through our next stage of growth.evaluate overall survival at 12 months.

Study 200-208 will vary in a variety of ways from the GBM trials we have conducted in the past, including three particularly notable differentiators:

Business Development

Our current strategy for TSC is focused on advancing it through development with the ultimate objective of obtaining market authorizations and entering commercialization, whether alone, with a partner, or through a partner, to provide treatment options to patients suffering from life-threatening medical conditions like GBM. We believe that our recent clinical development efforts, including the completion of our TCOM and Altitude Trials and our design of Study 200-208, are positive steps for our Company and our stockholders and create the potential to drive meaningful value if we are successful in advancing TSC to the subsequent development milestones we have identified. However, drug development is an extremely expensive, risky, and time-consuming endeavor, particularly so for drugs being developed to treat oncological indications. Accordingly, while we continue our internal efforts to advance the development of TSC, including Study 200-208, we are also taking active steps to identify potential partnership and other opportunities to obtain additional resources for our programs, including opportunities that are non-dilutive to our stockholders.

We also believe we can leverage what we have learned from the development of TSC and the significant skills and experience of our team to opportunistically identify and acquire or in-license novel product candidates that complement our overall strategy and/or are synergistic with our team's core competencies and strengths. We have taken, and intend to continue to take, active steps to identify assets and/or companies for acquisition and/or partnership, as well as a range of other transactions, across a variety of therapeutic indications, that we believe may complement, supplement and/or de-risk our current development programs, as well as provide additional value for our stockholders.

At-The-Market Sales Agreement

In July 2022, we entered into the 2022 Sales Agreement with BTIG, pursuant to which we may sell, from time to time, shares of our common stock having an offering price of up to $20 million in sales deemed to be “at-the-market” equity offerings as defined in Rule 415 of the Securities Act, subject to the offering limits in General Instruction I.B.6 of Form S-3.

As of the date of this Quarterly Report, we have not sold any shares of common stock pursuant to the Sales Agreement.

ILD-DLCO Trial Update

From our initial announcement of the Oxygenation Trials in early 2021, we have stated our belief that positive data from any one or more of the three Oxygenation Trials would provide evidence of a definitive effect of TSC on oxygenation, as well as guide the subsequent steps of our development strategy focused on demonstrating the clinical and therapeutic benefits of TSC in a relevant patient population affected by hypoxia. As noted above, the positive effects observed in and data obtained from both the TCOM and Altitude Trials have been used to design and align with the FDA on a novel GBM trial design for Study 200-208 and to develop our Hypoxic Solid Tumor Program, more generally. On August 9, 2022, in order to, among other things, dedicate more of our human and other resources to Study 200-208 and our business development activities, as well as ongoing challenges enrolling patients in clinical trials for respiratory indications during the ongoing COVID-19 pandemic, we made the decision to terminate recruitment and enrollment in the ILD-DLCO Trial and begin winding the trial down.

Financial Summary

As of June 30, 2021,2022, we had cash, and cash equivalents, and marketable securities of $43.3 million.$28.5 million, in the aggregate. We have incurred operating losses since inception, have not generated any product revenue and have not achieved profitable operations. We incurred net losses of $3.8$4.2 million and $8.4$8.7 million for the three and six months ended June 30, 2021,2022, respectively. Our accumulated deficit as of June 30, 20212022 was $114.3$138.7 million, and we expect to continue to incur substantial losses in future periods. We anticipate that our operating expenses will increase substantially as we continue to advance the development of TSC and any other assets we may in-license or acquire, including any costs related to:

We currently intend to use our existing cash, and cash equivalents and marketable securities for working capital and to fund the research and development of TSC including the Altitude Trial and the ILD-DLCO Trial.any business development activities we may undertake. We currently expect that our cash, and cash equivalents and marketable securities as of June 30, 20212022 will enable us to fund our operating expenses and capital expenditure requirements including expected costs relatedinto the first quarter of 2024, without giving effect to the planned Oxygenation Trials and our Planned Hypoxia-related Indication Trial(s) through 2023.any business development activities we may undertake.

Financial Operations Overview

Revenues

We have not yet generated any revenue from product sales. We do not expect to generate revenue from product sales for the foreseeable future.

Research and Development Expense

R&D expenses include, but are not limited to, third-party CRO arrangements and employee-related expenses, including salaries, benefits, stock-based compensation, and travel expense reimbursement. R&D activities are central to our business model. Product candidates in later stages of clinical development generally have higher development costs than those in earlier stages of clinical development, primarily due to the increased size and duration of later-stage clinical studies. As we advance our product candidates, we expect the amount of R&D costs will continue to increase for the foreseeable future. R&D costs are charged to expense as incurred.

General and Administrative Expense

G&A expenses consist principally of salaries and related costs for executive and other personnel, including stock-based compensation, other employee benefit costs, expenses associated with investment bank and other financial advisory services, and travel expenses. Other G&A expenses include, facility-related costs, communication expenses and professional fees for legal, patent prosecution and maintenance, consulting, accounting, and other professional services.

Interest Income

Interest income is interest earned from our cash, cash equivalents and cash equivalents.marketable securities.

Income Tax Benefit

We recognize income tax benefit to utilize indefinite deferred tax liabilities as a source of income against indefinite lived portions of our deferred tax assets. Our NOLs and tax credit carryforwards are subject to review and possible adjustment by the Internal Revenue Service and state tax authorities. NOL and tax credit carryforwards may become subject to an annual limitation in the event of a greater than 50.0% cumulative change in the ownership interest of significant stockholders over a three year period, as defined under Sections 382 and 383 of the Internal Revenue Code as well as similar state provisions. These limitations may, in certain cases, limit the amount of income tax benefit that can be utilized annually to offset taxable income or tax liabilities in future periods. The amount of the annual limitation is determined based on the Company’s value immediately prior to the ownership change, and subsequent ownership changes may further affect the limitation in future years. In 2019, due to the significant changes to our stockholder base as a result of the equity financing we completed during that year, we performed an analysis under Section 382 of the Internal Revenue Code and, as a result, reduced the magnitude of our NOL carryforwards to account for the ownership changes. In addition, the cumulative benefit of our NOLs was remeasured, resulting in tax expense recognized during the year ended December 31, 2019. We have not yet performed an analysis to determine whether or not ownership changes that have occurred in the year ended December 31, 2020 or during the three or six months ended June 30, 2021 give rise to any further limitations.

Results of Operations for Three Months Ended June 30, 20212022 Compared to Three Months Ended June 30, 20202021

The following table sets forth our results of operations for the three months ended June 30, 20212022 and 2020.2021.