CATALYST PHARMACEUTICALS, INC. (CPRX) FY 2021 MD&A

Basis of Presentation

Revenues.

During the fiscal year ended December 31, 2021, we continued to generate revenues from product sales of FIRDAPSE
®
in the U.S. We expect these revenues to fluctuate in future periods based on our sales of FIRDAPSE
®
. We received approval from Health Canada on July 31, 2020, for FIRDAPSE
®
for the symptomatic treatment of LEMS and as of December 31, 2020, we had launched FIRDAPSE
®
in Canada. During the fiscal year ended December 31, 2021, revenues generated under our collaboration agreement with KYE Pharmaceuticals were immaterial. We expect our revenues from the KYE collaboration agreement to fluctuate in future periods based on our collaborator’s ability to sell FIRDAPSE
®
in Canada.

For the fiscal year ended December 31, 2021, we did not generate revenues under our collaborative agreement with Endo. We expect our revenues from the Endo collaborative agreement to fluctuate in future periods based on our collaborator’s ability to meet various regulatory milestones set forth in such agreement.

For the fiscal year ended December 31, 2021, we generated revenues of approximately $2.9 million from our collaborative agreement with DyDo Pharma. We expect our revenue from the DyDo license agreement to fluctuate in future periods based on DyDo’s ability to meet various regulatory milestones set forth in such agreement.

Cost of Sales.

Cost of sales consists of third-party manufacturing costs, freight, royalties, and indirect overhead costs associated with sales of FIRDAPSE
®
. Cost of sales may also include period costs related to certain inventory manufacturing services, inventory adjustments charges, unabsorbed manufacturing and overhead costs, and manufacturing variances.

Research and Development Expenses.

Our research and development expenses consist of costs incurred for company-sponsored research and development activities, as well as support for selected investigator-sponsored research. The major components of research and development costs include preclinical study costs, clinical manufacturing costs, clinical study and trial expenses, insurance coverage for clinical trials, consulting, and other third-party costs, salaries and employee benefits, stock-based compensation expense, supplies and materials, and allocations of various overhead costs related to our product development efforts. To date, all of our research and development resources have been devoted to the development of FIRDAPSE
®
,
CPP-109
(our version of vigabatrin), and formerly
CPP-115,
and until we acquire or license new products we currently expect that our future development costs will be attributable principally to the continued development of FIRDAPSE
®
.

Our cost accruals for clinical studies and trials are based on estimates of the services received and efforts expended pursuant to contracts with numerous clinical study and trial sites and clinical research organizations (CROs). In the normal course of our business we contract with third parties to perform various clinical study and trial activities in the
on-going
development of potential products. The financial terms of these agreements are subject to negotiation and vary from contract to contract and may result in uneven

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payment flows. Payments under the contracts depend on factors such as the achievement of certain events or milestones, the successful enrollment of patients, the allocation of responsibilities among the parties to the agreement, and the completion of portions of the clinical study or trial or similar conditions. The objective of our accrual policy is to match the recording of expenses in our consolidated financial statements to the actual services received and efforts expended. As such, expense accruals related to preclinical and clinical studies or trials are recognized based on our estimate of the degree of completion of the event or events specified in the specific study or trial contract. We monitor service provider activities to the extent possible; however, if we underestimate activity levels associated with various studies or trials at a given point in time, we could be required to record significant additional research and development expenses in future periods. Preclinical and clinical study and trial activities require significant
up-front
expenditures. We anticipate paying significant portions of a study or trial’s cost before they begin and incurring additional expenditures as the study or trial progresses and reaches certain milestones.

Selling, General and Administrative Expenses.

During 2019, we actively committed funds to developing our commercialization program for FIRDAPSE
®
and we have continued to incur substantial commercialization expenses, including sales, marketing, patient services, patient advocacy and other commercialization related expenses as we have continued our sales program for FIRDAPSE
®
.

Our general and administrative expenses consist primarily of salaries and personnel expenses for accounting, corporate, compliance, and administrative functions. Other costs include administrative facility costs, regulatory fees, insurance, and professional fees for legal including litigation cost, information technology, accounting, and consulting services.

Stock-Based Compensation.

We recognize expense for the fair value of all stock-based awards to employees, directors, and consultants in accordance with accounting principles generally accepted in the U.S. (U.S. GAAP). For stock options, we use the Black-Scholes option valuation model in calculating the fair value of the awards.

Income Taxes.

Our effective income tax rate is the ratio of income tax expense (benefit) over our income before income taxes.

We incurred operating losses from inception through the three-month period ended March 31, 2019. As of December 31, 2021 and 2020, respectively, we had federal net operating loss carry-forwards of approximately $0 million and $3 million. Additionally, we had state net operating loss carry-forwards of approximately $28 million and $42 million, respectively, available to reduce future Florida taxable income for the years ended December 31, 2021 and 2020.

In the third quarter of 2020, we determined that there was sufficient positive evidence to conclude that it is more likely than not that our additional deferred taxes of approximately $33.0 million are realizable. As a result, we reduced the valuation allowance accordingly.

Recently Issued Accounting Standards.

For discussion of recently issued accounting standards, please see Note 2, “Basis of Presentation and Significant Accounting Policies,” in the consolidated financial statements included in this report.

Critical Accounting Policies and Estimates

Our discussion and analysis of our financial condition and results of operations are based on our consolidated financial statements, which have been prepared in accordance with U.S. GAAP. The preparation of these consolidated financial statements requires us to make judgments, estimates, and assumptions that affect the reported amounts of assets and liabilities and the disclosure of contingent assets and liabilities at the date of the consolidated financial statements, as well as the reported revenue and expenses during the reporting periods. We continually evaluate our judgments, estimates and assumptions. We base our estimates on the terms of underlying agreements, our expected course of development, historical experience and other factors we believe are reasonable based on the circumstances, the results of which form our management’s basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates.

The amounts of assets and liabilities reported in our consolidated balance sheets and the amounts reported in our consolidated statements of comprehensive income are affected by estimates and assumptions, which are used for, but not limited to, the accounting for revenue recognition, leases, preclinical study and clinical trial expenses, stock-based compensation and valuation allowance for deferred tax assets. The accounting policies described below are not intended to be a comprehensive list of all of our accounting policies but represent the accounting estimates which involve a significant level of estimation uncertainty and have had or are reasonably likely to have a material impact on our financial condition or results of operations. In many cases, the accounting treatment of a particular transaction is specifically dictated by U.S. GAAP. There are also areas in which our management’s judgment in selecting any available alternative would not produce a materially different result. Our consolidated financial statements and the notes thereto included elsewhere in this report contain accounting policies and other disclosures as required by U.S. GAAP.

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Revenue Recognition.

Revenue from product sales are recorded at the net sales price (transaction price), which includes estimates of variable consideration for which reserves are established. Components of variable consideration include trade discounts and allowances, product returns, provider chargebacks and discounts, government rebates, and other incentives, such as voluntary patient assistance, and other allowances that are offered within contracts with our customer, payors, and other indirect customers relating to the sale of our products. These reserves are based on the amounts earned, or to be claimed on the related sales, and are classified as reductions of accounts receivable (if the amount is payable to the customer) or a current liability (if the amount is payable to a party other than a customer). These estimates take into consideration a range of possible outcomes which are probability-weighted in accordance with the expected value method in Topic 606 for relevant factors such as current contractual and statutory requirements, specific known market events and trends, industry data, and forecasted customer buying and payment patterns. Overall, these reserves reflect our best estimates of the amount of consideration to which we are entitled based on the terms of the respective underlying contracts.

The amount of variable consideration which is included in the transaction price may be constrained, and is included in the net sales price only to the extent that it is probable that a significant reversal in the amount of the cumulative revenue recognized under the contract will not occur in a future period. Our analyses also contemplated application of the constraint in accordance with the guidance, under which it determined a material reversal of revenue would not occur in a future period for the estimates as of December 31, 2021 and 2020 and, therefore, the transaction price was not reduced further during the years ended December 31, 2021 and 2020. Actual amounts of consideration ultimately received may differ from our estimates. If actual results in the future vary from our estimates, we will adjust these estimates, which would affect net product revenue and earnings in the period such variances become known. Refer to Note 2, “Basis of Presentation and Significant Accounting Policies,” in the consolidated financial statements included in this report for further details on revenue recognition.

Stock-Based Compensation.

We recognize stock-based compensation for the fair value of all share-based payments, including grants of stock options and restricted stock units. For stock options, we use the Black-Scholes option valuation model to determine the fair value of stock options on the date of grant. This model derives the fair value of stock options based on certain assumptions related to expected stock price volatility, expected option life, risk-free interest rate and dividend yield. Expected volatility is based on reviews of historical volatility of our common stock. The estimated expected option life is based upon the simplified method. Under this method, the expected option life is presumed to be the
mid-point
between the vesting date and the end of the contractual term. We will continue to use the simplified method until we have sufficient historical exercise data to estimate the expected life of the options. The risk-free interest rate assumption is based upon the U.S. Treasury yield curve appropriate for the expected life of our stock option awards. For the years ended December 31, 2021 and 2020, the assumptions used were an estimated annual volatility of 70.0% and 81.4%, expected holding periods of primarily four and a half years, and risk-free interest rates of 0.34% to 1.18% and 0.24% to 1.64%, respectively.

Valuation Allowance for Deferred Tax Assets.

We assess the need for a valuation allowance against our deferred tax asset each quarter through the review of all available positive and negative evidence. Deferred tax assets are reduced by a tax valuation allowance when, in the opinion of management, it is more likely than not that some portion of the deferred tax assets will not be realized. Management’s analysis depends on historical and projected taxable income. Projected taxable income includes significant assumptions related to revenue, commercial expenses and research and development activities. In the third quarter of 2020, we determined that there was sufficient positive evidence to conclude that it is more likely than not that our additional deferred taxes are realizable. As a result, we reduced the valuation allowance accordingly.

Results of Operations

Years Ended December 31, 2021 and 2020

Revenues.

For the year ended December 31, 2021, we recognized $138.0 million in net revenue from product sales of FIRDAPSE
®
primarily in the U.S. compared to $118.8 million for the year ended December 31, 2020. The increase of approximately $19.2 million was due to increases in sales volumes of approximately 10.4% and net price increases. For the year ended December 31, 2021, we also recognized $2.8 million in license and other revenue, as compared to $0.3 million during the year ended December 31, 2020. The increase was primarily due to our license agreement with DyDo Pharma for the commercialization of FIRDAPSE
®
in Japan that was signed in 2021.

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Cost of Sales.

Cost of sales was approximately $21.9 million for the year ended December 31, 2021, compared to $17.0 million for the year ended December 31, 2020. Cost of sales in both periods consisted principally of royalty payments, which are based on net revenue as defined in the applicable license agreement. Royalties are payable on the terms set forth below in Liquidity and Capital Resources -

Contractual Obligations and Arrangements

, and increase by 3% when net sales (as defined in the applicable license agreement) exceed $100 million in any calendar year.

Research and Development Expenses.

Research and development expenses for the years ended December 31, 2021 and 2020 were approximately $16.9 million and $16.5 million, respectively, and represented approximately 19% and 21% of total operating costs and expenses, respectively. Research and development expenses for the years ended December 31, 2021 and 2020 were as follows (in thousands):

Research and development expenses stayed relatively consistent for the 2021 fiscal year, when compared to the same period in 2020. For the 2020 fiscal year, research and development expenses included costs related to
our MuSK-MG
clinical trial and our SMA type

3 proof-of-concept trial,

both of which were completed in the second half of 2020. For the fiscal year ended December 31, 2021, research and development expenses included costs relating to closing out sites for both
the MuSK-MG
clinical trial and SMA type 3

proof-of-concept

trial. Research and development costs in both the 2020 and 2021 periods also included expenses relating to medical and regulatory affairs, our expanded access programs, and our efforts to develop a long-acting formulation of amifampridine phosphate.

We expect that research and development expenses will continue to be substantial in 2022 and beyond as we execute on our strategic initiative to acquire
or in-license innovative
technology platforms and/or earlier stage programs in rare disease categories outside of neuromuscular diseases.

Selling, General and Administrative Expenses.

Selling, general and administrative expenses for the years ended December 31, 2021 and 2020 were approximately $49.6 million and $44.2 million, respectively, and represented approximately 56% and 57% of total operating costs and expenses for the years ended December 31, 2021, and 2020, respectively. Selling, general and administrative expenses for the years ended December 31, 2021 and 2020 were as follows (in thousands):

For the year ended December 31, 2021, selling, general and administrative expenses increased approximately $5.4 million, compared to the same period in 2020, primarily attributable to the timing of our commitments to make contributions to 501(c)(3) organizations supporting LEMS patients of approximately $1 million and increases of legal fees of approximately $1.9 million. The increase was also due to increased costs due to the expansion of our operations and headcount required to support our ongoing efforts to commercialize FIRDAPSE
®
.

We expect that selling, general and administrative expenses will continue to be substantial in future periods as we continue our efforts to increase our revenues from FIRDAPSE
®
and take steps to expand our business.

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Stock-Based Compensation.

Total stock-based compensation for the years ended December 31, 2021 and 2020 was $6.1 million and $6.3 million, respectively. In 2021 and 2020, grants were principally for stock options relating to
year-end
bonus awards and grants to new employees.

Other Income, Net.

We reported other income, net in all periods, primarily relating to our investment of our cash and cash equivalents and investments. The decrease in other income, net for the year ended December 31, 2021 of approximately $0.3 million when compared to the same period in 2020 is primarily due to lower yields on investments, despite higher invested balances. Other income, net, consists primarily of interest and dividend income.

Income Taxes.

As of December 31, 2021 and 2020, respectively, we had federal net operating loss carryforwards of approximately $0 million and $3 million. The federal net operating loss carryforwards were utilized in 2020. Additionally, we had state net operating loss carryforwards of approximately $28 million and $42 million, respectively, available to reduce future Florida taxable income. We had no uncertain tax positions as of December 31, 2021 and December 31, 2020.

For the year ending December 31, 2020 we recorded a net valuation release of $41.6 million ($0.40 per basic share and $0.39 per diluted share) on the basis of management’s determination that it is more likely than not that the amount of our deferred tax assets will be realized.

Our effective income tax rate was 25% and (79%), respectively, for fiscal year 2021 and fiscal year 2020. The difference in the effective rates between periods is driven by the release of the valuation allowance against deferred taxes in the third quarter of 2020. Differences in the effective tax and the statutory federal income tax rate of 21% are driven by state income taxes and anticipated annual permanent differences, and offset by the orphan drug credit claimed.

Net Income.

Our net income was approximately $39.5 million in the year ended December 31, 2021 ($0.38 per basic and $0.37 per diluted share) as compared to $75.0 million in the year ended December 31, 2020 ($0.72 per basic and $0.71 per diluted share).

Years Ended December 31, 2020 and 2019

The information comparing results of operations for the year ended 2020 compared to 2019 was included in our Annual Report on Form
10-K
for 2020.

Liquidity and Capital Resources

Since our inception, we have financed our operations primarily through multiple offerings of our securities and, since January 2019, from revenues from product sales of FIRDAPSE
®
. At December 31, 2021 we had cash and cash equivalents and investments aggregating $191.3 million and working capital of $183.0 million. At December 31, 2020, we had cash and cash equivalents and investments aggregating $140.3 million and working capital of $136.5 million. At December 31, 2021, substantially all of our cash and cash equivalents were deposited with one financial institution, and such balances were in excess of federally insured limits. Further, as of such date, substantially all such funds were invested in money market accounts, short-term interest bearing obligations and U.S. Treasuries.

Based on forecasts of available cash, we believe that we have sufficient resources to support our currently anticipated operations for at least the next 12 months from the date of this report. There can be no assurance that we will remain profitable or that we will be able to obtain any additional funding that we may require in the future.

In the future, we may require additional working capital to support our operations depending on our future success with FIRDAPSE
®
sales, or the products we acquire and continue to develop and whether our results continue to be profitable and cash flow positive. There can be no assurance as to the amount of any such funding that will be required for these purposes or whether any such funding will be available to us when it is required.

In that regard, our future funding requirements will depend on many factors, including:

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We may raise additional funds through public or private equity offerings, debt financings, corporate collaborations or other means. We also may seek governmental grants for a portion of the required funding for our clinical trials and preclinical trials. We may further seek to raise capital to fund additional product development efforts or product acquisitions, even if we have sufficient funds for our planned operations. Any sale by us of additional equity or convertible debt securities could result in dilution to our stockholders. There can be no assurance that any such required additional funding will be available to us at all or available on terms acceptable to us. Further, to the extent that we raise additional funds through collaborative arrangements, it may be necessary to relinquish some rights to our technologies or grant sublicenses on terms that are not favorable to us. If we are not able to secure additional funding when needed, we may have to delay, reduce the scope of or eliminate one or more research and development programs, which could have an adverse effect on our business.

On July 23, 2020, we filed a shelf registration statement with the SEC to sell up to $200 million of common stock, preferred stock, warrants to purchase common stock, debt securities and units consisting of one or more of such securities (the “2020 Shelf Registration Statement”). The 2020 Shelf Registration Statement (file no.
333-240052)
was declared effective by the SEC on July 31, 2020. As of the date of this report, no offerings have been completed under the 2020 Shelf Registration Statement.

Cash Flows.

Net cash provided by operating activities was $60.4 million and $45.0 million, respectively, for the years ended December 31, 2021 and 2020. During the year ended December 31, 2021, net cash provided by operating activities was primarily attributable to our net income of $39.5 million, a decrease of $4.0 million in prepaid expenses and other current and
non-current
assets, increases of $5.5 million in accrued expenses and other liabilities, $0.9 million in operating lease liability, $9.3 million in deferred taxes and of $6.6 million of
non-cash
expenses. This was partially offset by increases of $0.6 million in accounts receivable, net and $3.2 million in inventory and a decrease of $1.5 million in accounts payable. During the year ended December 31, 2020, net cash provided by operating activities was primarily attributable to our net income of $75.0 million, a decrease of $4.5 million in accounts receivable, net, an increase of $0.1 million in accounts payable and $7.1 million net of
non-cash
expenses. This was partially offset by increases of $4.0 million in prepaid expenses and other current and
non-current
assets and $2.7 million in inventory and decreases of $1.2 million in accrued expenses and other liabilities, $0.9 million in operating lease liability and $33.0 million in
non-cash
deferred taxes.

Net cash used in investing activities was $11.0 million for the year ended December 31, 2021, consisting primarily of purchases of investments. Net cash used in investing activities was $5.0 million for the year ended December 31, 2020, consisting primarily of purchases of investments of $10.0 million, partially offset by proceeds from sales/maturities of investments of $5.0 million.

Net cash used in financing activities during the year ended December 31, 2021 was $8.1 million, consisting primarily of repurchases of common stock, partially offset by proceeds from the exercise of options to purchase shares of common stock. Net cash provided by financing activities during the year ended December 31, 2020 was $0.7 million, consisting primarily of proceeds from the exercise of options to purchase shares of common stock.

Contractual Obligations and Arrangements.

We have entered into the following contractual arrangements:

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For the year ended December 31, 2021, we recognized an aggregate of approximately $19.5 million of royalties, which is included in cost of sales in the accompanying consolidated statement of operations and comprehensive income.

Off-Balance
Sheet Arrangements.

We currently have no debt or finance leases. We have an operating lease for our office facilities. We do not have any
off-balance
sheet arrangements as such term is defined in rules promulgated by the SEC.

Caution Concerning Forward-Looking Statements

This report contains “forward-looking statements”, as that term is defined in the Private Securities Litigation Reform Act of 1995. These include statements regarding our expectations, beliefs, plans or objectives for future operations and anticipated results of operations. For this purpose, any statements contained herein that are not statements of historical fact may be deemed to be forward-looking statements. Without limiting the foregoing, “believes”, “anticipates”, “proposes”, “plans”, “expects”, “intends”, “may”, and other similar expressions are intended to identify forward-looking statements. Such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or other achievements to be materially different from any future results, performances or achievements expressed or implied by such forward-looking statements. Factors that might cause such differences include, but are not limited to, those discussed in the section entitled “Item 1A – Risk Factors.”

The continued successful commercialization of FIRDAPSE
®
is highly uncertain. Factors that will affect our success include the uncertainty of:

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Our current plans and objectives are based on assumptions relating to the continued commercialization of FIRDAPSE
®
. Although we believe that our assumptions are reasonable, any of our assumptions could prove inaccurate. In light of the significant uncertainties inherent in the forward-looking statements we have made herein, which reflect our views only as of the date of this report, you should not place undue reliance upon such statements. We undertake no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.