Harmony Biosciences Holdings, Inc. (HRMY) FY 2022 MD&A

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

You should read the following discussion and analysis of our financial condition and results of operations together with our consolidated financial statements and related notes included elsewhere in this Annual Report. This discussion contains forward-looking statements based upon current plans, expectations and beliefs involving risks and uncertainties. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of various factors, including those set forth under “Risk Factors” and in other parts of this Annual Report.

Overview

We are a commercial-stage pharmaceutical company focused on developing and commercializing innovative therapies for patients living with rare neurological diseases as well as patients living with other neurological diseases who have unmet medical needs. Our product, WAKIX (pitolisant), is a first-in-class molecule with a novel mechanism of action (“MOA”) specifically designed to increase histamine signaling in the brain by binding to H3 receptors. In August 2019, WAKIX was approved by the U.S. Food and Drug Administration (the “FDA”) for the treatment of excessive daytime sleepiness (“EDS”) in adult patients with narcolepsy, and its U.S. commercial launch was initiated in November 2019. In October 2020, WAKIX was approved by the FDA for the treatment of cataplexy in adult patients with narcolepsy. WAKIX is the first-and-only approved product for patients with narcolepsy that is not scheduled as a controlled substance by the U.S. Drug Enforcement Administration (the “DEA”).

We believe that pitolisant’s ability to regulate histamine gives it the potential to provide therapeutic benefit in other rare neurological diseases that are mediated through H3 receptors and histamine signaling. We are taking a mechanism-based approach to managing the life cycle of pitolisant and have identified idiopathic hypersomnia (“IH”), another central disorder of hypersomnolence like narcolepsy, as our next potential new indication for WAKIX. In April 2022, we initiated a Phase 3 registrational trial, the INTUNE Study, to evaluate the efficacy and safety of pitolisant in adult patients with IH and have seen continued strong momentum in patient enrollment, with approximately 85% of the targeted clinical trial sites activated. We are focusing our development efforts on other rare neurological disorders in which EDS is a prominent symptom, including Prader-Willi Syndrome (“PWS”) and myotonic dystrophy, otherwise known as dystrophia myotonica (“DM”). We recently received the initial topline data from our Phase 2 proof-of-concept clinical trial to evaluate pitolisant for the treatment of EDS and other key symptoms in patients with PWS, which showed a positive signal on the primary outcome related to EDS. We received the full data set at the end of 2022, which our team has been analyzing in preparation for an end-of-phase 2 meeting with the FDA to discuss the data. We intend to advance our development program in patients with PWS into a Phase 3 trial. In June 2021, we initiated a Phase 2 proof-of-concept clinical trial to evaluate pitolisant for the treatment of EDS, fatigue and cognitive dysfunction in adult patients with DM1 and anticipate topline results from this trial in the fourth quarter of 2023.

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Our partner, Bioprojet, completed a Phase 3 trial in pediatric patients with narcolepsy and submitted the trial data to the European Medical Agency (“EMA”) seeking approval for a pediatric narcolepsy indication. On January 26, 2023, Bioprojet received a positive opinion from the EMA’s Committee for Medicinal Products for Human Use (“CHMP”) with an approval for a pediatric narcolepsy indication expected by the EMA within 60 days of the positive CHMP opinion.  We are working with Bioprojet on a path forward towards the submission to the FDA of a supplemental NDA for pediatric narcolepsy and, in addition, we remain committed to obtaining pediatric exclusivity for WAKIX.

We also seek to expand our pipeline through the acquisition of additional assets that focus on addressing the unmet needs of patients living with rare neurological diseases as well as patients living with other neurological diseases who have unmet medical needs. We are targeting assets that will allow us to further leverage the expertise and infrastructure that we have successfully built at Harmony so we can optimize the benefit of internal synergies. Consistent with this objective, in July 2022, we entered into a License and Commercialization Agreement (the “2022 LCA”) with Bioprojet whereby we obtained exclusive rights to manufacture, use and commercialize one or more new products based on pitolisant in the United States and Latin America, with the potential to add additional indications and formulations upon the agreement of both parties.

In addition, in August 2021, we acquired HBS-102, a Melanin-concentrating hormone receptor 1 (MCHR1) antagonist previously developed as CSTI-100/ALB-127258(a)/ALB-127258 (the “Compound”), along with intellectual property and other assets related to the development, manufacture, and commercialization of the Compound from ConSynance Therapeutics, Inc. In connection with the acquisition, we made an upfront payment of $3.5 million and will be required to make additional payments upon the achievement of certain development milestones, regulatory milestones, and sales milestones and pay ongoing royalties upon commercialization. We acquired full development and commercialization rights globally, but we have provided a grant-back license to ConSynance for the development and commercialization of the Compound in Greater China. We have recently initiated a preclinical proof-of-concept study to assess the effect of HBS-102 on hyperphagia, weight gain, and other metabolic parameters in a mouse model of PWS.

Pitolisant was developed by Bioprojet and approved by the EMA in 2016 for the treatment of narcolepsy in adult patients with or without cataplexy and in 2021 for the treatment of EDS in adult patients with obstructive sleep apnea. We acquired an exclusive license to develop, manufacture and commercialize pitolisant in the United States pursuant to our license agreement with Bioprojet (as amended, the “2017 LCA”) in July 2017. See “Part I—Item 1. Business.—Strategic Agreement—License and Commercialization Agreement with Bioprojet” for further information regarding the 2017 LCA. Pitolisant was granted Orphan Drug Designation for the treatment of narcolepsy by the FDA in 2010. It received Breakthrough Therapy designation for the treatment of cataplexy in patients with narcolepsy and Fast Track status for the treatment of EDS and cataplexy in patients with narcolepsy in April 2018.

We were founded in July 2017 as Harmony Biosciences II, LLC, a Delaware limited liability company. We converted to a Delaware corporation named Harmony Biosciences II, Inc. in September 2017 and, in February 2020, we changed our name to Harmony Biosciences Holdings, Inc. Our operations are conducted by our wholly owned subsidiary, Harmony Biosciences, LLC (“Harmony”), which was formed in May 2017. Our operations to date have consisted of building and staffing our organization, acquiring the rights to pitolisant, raising capital, opening an investigational new drug application (“IND”) for pitolisant in narcolepsy, conducting an Expanded Access Program (“EAP”) for pitolisant for appropriate patients with narcolepsy in the United States, preparing and submitting our NDA for pitolisant, gaining NDA approval for WAKIX for the treatment of EDS or cataplexy in adult patients with narcolepsy, and launching and commercializing WAKIX in the United States. In addition, we have opened INDs for the development of pitolisant in PWS, DM and IH and have initiated clinical trials in pursuit of potential new indications in those rare disease patient populations.

Commercial Performance Metrics

As of December 31, 2022, we continued to see growth in the number of unique healthcare professional (“HCP”) prescribers of WAKIX since it became available in November 2019. The average number of patients on WAKIX at the end of 2022 was approximately 4,900. Additionally, as of December 31, 2022, we have secured formulary access for more than 80% of all insured lives (Commercial, Medicare and Medicaid) in the United States. Within these covered lives, we have observed favorable access to WAKIX subsequent to the expanded approval of WAKIX for the treatment of cataplexy in adult patients with narcolepsy in October 2020.

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Financial Operations Overview

Revenue

Net product sales includes gross sales of WAKIX less provisions for sales discounts and allowances, which includes trade allowances, rebates to government and commercial entities, and discounts. Although we expect net sales to increase over time, provisions for sales discounts and allowances may fluctuate based on the mix of sales to different customer segments and/or changes in our estimates. For further discussion of the components of Revenue, see “—Critical Accounting Policies and Significant Judgments and Estimates.”

Cost of Product Sales

Cost of product sales includes manufacturing and distribution costs, the cost of the drug substance, FDA program fees, royalties due to third parties on net product sales, freight, shipping, handling, storage costs and salaries of employees involved with production. We expect the cost of product sales to increase as we continue to ramp up production in order to meet future demand for WAKIX and diversify our supply chain for WAKIX.

The shelf life of WAKIX is three years from date of manufacture, with the earliest expiration of current inventory expected to be May 2023. We regularly review our inventory levels and expect write-offs from time to time. We will continue to assess inventory levels in future periods as demand for WAKIX and the rate of inventory turnover evolves. We currently expect to have adequate supply of WAKIX into the first quarter of 2024, with additional API on-hand inventory to support at least 36 months beyond this time frame.

Research and Development Expenses

Research and development expenses primarily include development programs for potential new indications for pitolisant in patients with IH, PWS and DM. We also incur research and development expenses related to our team of Medical Science Liaisons (“MSLs”) who interact with key opinion leaders, with a focus on the science, the role of histamine in sleep-wake state stability and the novel mechanism of action of pitolisant. In addition, our MSLs support our market access team with the presentation of clinical data to payors upon request and our clinical development team to identify potential clinical trial sites. Research and development costs are expensed as incurred. We have significantly increased our research and development efforts as we advance our clinical programs in IH, PWS and DM and assess other product candidates to expand our pipeline. Research and development expenses also include:

We do not track research and development expenses on an indication-by-indication basis. A significant portion of our research and development costs are external costs, such as fees paid to CROs and CMOs, central laboratories, contractors, and consultants in connection with our clinical development programs. Internal expenses primarily relate to personnel who are deployed across multiple programs.

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 trials, milestone

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payments, and the cost of submitting an NDA to the FDA (and/or other regulatory authorities). We expect our research and development expenses to be significant over the next several years as we advance our current clinical development programs and prepare to seek regulatory approval for additional indications for pitolisant, advance HBS-102 from preclinical studies into the clinic, and identify potential new product candidates to develop toward new indications.

At this time, we cannot reasonably estimate or know the nature, timing and estimated costs of the efforts that will be necessary to complete the development of any additional indications for pitolisant or other product candidates that we move forward for regulatory approval. There are numerous risks and uncertainties associated with developing product candidates, including uncertainty related to:

A change in the outcome of any of these variables with respect to the development of any of our programs or any product candidate we develop would significantly change the costs, timing and viability associated with the development and/or regulatory approval of such programs or product candidates.

Sales and Marketing Expenses

Our sales and marketing expenses primarily relate to the market development and commercialization activities of WAKIX for the treatment of EDS and cataplexy in adult patients with narcolepsy. Market development and commercial activities account for a significant portion of our operating expenses and are expensed as incurred. We expect our sales and marketing expenses to increase in the near- and mid-term to support WAKIX indications for the treatment of EDS or

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cataplexy in adult patients with narcolepsy and to expand our portfolio with the anticipated growth from potential additional indications.

Sales and marketing expenses include:

In addition, sales and marketing expenses include external costs such as website development, media placement fees, agency fees for patient, medical education and promotional expenses, market research, analysis of secondary data, conference fees, and consulting fees.

General and Administrative Expenses

General and administrative expenses consist primarily of employee-related expenses, such as salaries, share-based compensation, benefits and travel expenses for our personnel in executive, legal, finance and accounting, human resources, investor relations, and other administrative departments. General and administrative expenses also consist of office leases, and professional fees, including legal, tax and accounting and consulting fees.

We anticipate that our general and administrative expenses will increase in the future to support our continued commercialization efforts, ongoing and future potential research and development activities, and increased costs of operating as a public company. These increases will likely be driven by costs associated with the hiring of additional personnel and fees paid to outside consultants, lawyers and accountants, among other expenses. Additionally, we anticipate increased costs associated with being a public company, including expenses related to services associated with maintaining compliance with the requirements of Nasdaq and the SEC, insurance and investor relations costs. If any of our current or future indication expansion programs or new product candidates obtain U.S. regulatory approval, we expect that we would incur significantly increased expenses associated with building a sales and marketing team.

Paragon Agreements

We were party to a management services agreement with Paragon Biosciences, LLC (“Paragon”), which was terminated upon the consummation of our IPO, pursuant to which Paragon provided us with certain professional services.

We are also party to a right-of-use agreement with Paragon whereby we have access to and the right to use certain office space leased by Paragon in Chicago, Illinois. For the year ended December 31, 2022, we paid fees of $0.3 million pursuant to this agreement.

Interest Expense, Net

Interest expense, net consists primarily of interest expense on debt facilities, amortization of debt issuance costs and amortization of premiums on our debt securities, partially offset by interest income earned on our cash and investments balances and accretion of discount on our debt securities.

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Results of Operations

The following table sets forth selected items in our consolidated statements of operations for the periods presented:

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Net Product Revenue

Net product revenue increased by $132.4 million, or 43.4%, for the year ended December 31, 2022 compared to the same period in 2021. The increase was due to the growth in the average number of patients on WAKIX and price increases.

Cost of Product Sales

Cost of product sales increased by $28.0 million, or 50.4%, for the year ended December 31, 2022 compared to the same period in 2021. The increase was due to higher sales of WAKIX. Cost of product sales is primarily comprised of the royalty to Bioprojet.

Research and Development Expenses

Research and development expenses increased by $40.5 million, or 133.4%, for the year ended December 31, 2022 as compared to the same period in 2021. The increase was primarily related to the $30 million licensing fee incurred upon entering the 2022 LCA with Bioprojet, as well as increased clinical development work associated with IH, PWS and DM, and increased personnel costs. This increase was partially offset by $3.5 million asset acquisition of HBS-102 that was incurred during the year ended December 31, 2021.

Sales and Marketing Expenses

Sales and marketing expenses increased by $11.2 million, or 16.4%, for the year ended December 31, 2022 as compared to the same period in 2021. The increase was primarily due to increased personnel costs related to sales force expansion, marketing activities driven by our commercialization of WAKIX, and increased patient assistance.

General and Administrative Expenses

General and administrative expenses increased by $20.1 million, or 31.5%, for the year ended December 31, 2022 as compared to the same period in 2021. This increase was primarily due to an increase in stock compensation associated with new awards, an increase in intangible asset amortization as a result of the capitalized $40.0 million milestone payment

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made upon attaining $500.0 million in life-to-date aggregate net sales of WAKIX in the United States, an increase in personnel costs and increased travel costs.

Loss on Debt Extinguishment

There were no extinguishments of debt for the year ended December 31, 2022. Loss on debt extinguishment was $26.1 million for the year ended December 31, 2021, due to the prepayment of the Credit Agreement with OrbiMed.

Interest Expense, Net

Interest expense decreased by $8.3 million, or 34.6%, for the year ended December 31, 2022, as compared to the same period in 2021 primarily due to lower interest rates as a result of entering into the Blackstone Credit Agreement in August 2021 and interest income on our investments, partially offset by an increase in amortization of deferred financing costs.

Income Taxes

Income tax benefit was $76.8 million for the year ended December 31, 2022, and included $96.4 million related to the release of the valuation allowance on our deferred tax assets, partially offset by current period state and federal income tax expense.

Liquidity, Sources of Funding and Capital Resources

Overview

To date, we have financed our operations primarily with (a) proceeds from sales of our convertible preferred stock; (b) borrowings under our debt agreements; (c) the proceeds from our IPO; and (d) the proceeds from the sale of common stock to Blackstone. From our inception through our IPO, we received aggregate proceeds of $345.0 million from sales of our convertible preferred stock. In August 2020, we completed the IPO of our common stock, in which we sold 6,151,162 shares of our common stock, including 802,325 shares of our common stock pursuant to the underwriters’ over-allotment option. The shares were sold at a price of $24.00 per share for net proceeds of approximately $135.4 million. As of December 31, 2022, we had cash, cash equivalents, restricted cash and investments of $346.4 million and accumulated deficit of $272.1 million. As of December 31, 2022, we had outstanding debt of $197.5 million.

The consolidated financial statements have been prepared as though we will continue as a going concern, which contemplates the realization of assets and satisfaction of liabilities in the normal course of business.

We believe that our anticipated cash from operating and financing activities, existing cash, cash equivalents and investments, as well as our ability to borrow additional funds under the Blackstone Credit agreement, will enable us to meet our operational liquidity needs and fund our planned investing activities for the next 12 months. We have based our liquidity and cash flow projections on assumptions that may prove to be incorrect, and we could use our capital resources sooner than we expect.

Blackstone Credit Agreement

In August 2021, we entered into the Blackstone Credit Agreement that provided for (i) a senior secured term loan facility in an aggregate original principal amount of $200.0 million (the “Initial Term Loan”) and (ii) a senior secured delayed draw term loan facility in an aggregate principal amount up to $100.0 million (the “DDTL” and, together with the Initial Term Loans, the “Loans”). The DDTL was initially available to draw down through August 9, 2022. In August 2022, we entered into an agreement to extend the expiration date of the DDTL to August 9, 2023, for which we will pay a ticking fee at a rate of 1% per annum on the undrawn portion of the DDTL, which commenced on August 10, 2022. We used substantially all of the proceeds from the Blackstone Credit Agreement, and the related sale of our common stock, to repay the balance of the OrbiMed Credit Agreement.

The repayment schedule for the Initial Term Loan consists of quarterly $0.5 million principal payments commencing on December 31, 2021 and increasing to quarterly $5.0 million payments beginning on March 31, 2024, with a $145.5 million

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payment due on the maturity date of August 9, 2026 (“Maturity Date”). Interest is payable quarterly commencing on November 9, 2021 and continuing through the Maturity Date. The Initial Term Loan bears interest at a per annum rate equal to LIBOR, subject to a 1.00% floor, plus 6.50%. The Loans are guaranteed by our subsidiary Harmony Biosciences, LLC.

The Blackstone Credit Agreement contains affirmative and negative covenants, including limitations on our ability, among other things, to incur additional debt, grant or permit additional liens, make investments and acquisitions, merge or consolidate with others, dispose of assets, pay dividends and distributions and enter into affiliate transactions, in each case, subject to certain exceptions. In addition, the Blackstone Credit Agreement contains a financial covenant that requires us to maintain at all times cash and cash equivalents in certain deposit accounts in an amount at least equal to $10.0 million. We were in compliance with all covenants as of December 31, 2022.

Agreement Related to Intellectual Property

In August 2021, we entered into an asset purchase agreement with ConSynance Therapeutics, Inc. to acquire HBS-102, a potential first-in-class molecule with a novel mechanism of action. Under the terms of the agreement, the Company acquired full development and commercialization rights globally, with the exception of Greater China, for $3.5 million, which was recorded in research and development expense in the Company’s statement of operations and comprehensive income (loss) for the year ended December 31, 2021. Additionally, there are payments due upon the achievement of certain milestones including $1.8 million for preclinical milestones, $19.0 million for development milestones, $44.0 million for regulatory milestones and $110.0 million for sales milestones.

License Agreement

In July 2022, we entered into the 2022 LCA with Bioprojet whereby we obtained exclusive rights to manufacture, use and commercialize one or more new products based on pitolisant in the United States and Latin America, with the potential to add additional indications and formulations upon the agreement of both parties. We paid an initial, non-refundable $30.0 million licensing fee in October 2022 and additional payments of up to $155.0 million are potentially due under the 2022 LCA upon the achievement of certain future development and sales-based milestones. In addition, certain payments will become due upon the achievement of development milestones for new indications and formulations as agreed upon by both parties. The 2022 LCA also includes a fixed trademark royalty and a tiered royalty payable on net sales of any new products commercialized. Upon closing of the 2022 LCA on September 28, 2022, the $30.0 million licensing fee was recorded in research and development expenses within the consolidated statement of operations and comprehensive income (loss) for the year ended December 31, 2022.

Recent Milestone Payments

In January 2021, we made a $100.0 million to Bioprojet upon the FDA approval of the NDA for WAKIX for the treatment of cataplexy in adult patients with narcolepsy. In addition, we made a final $40.0 million milestone payment to Bioprojet in March 2022 upon WAKIX attaining $500.0 million in life-to-date aggregate net sales in the United States.

Cash Flows

The following table sets forth a summary of our cash flows for the years ended December 31, 2022 and 2021:

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Operating Activities

Net cash provided by operating activities for the year ended December 31, 2022 consisted of our net income of $181.5 million adjusted for non-cash items of $23.4 million related to intangible amortization and depreciation and $26.9 million related to stock-based compensation expense. Net working capital excluding cash decreased by $4.1 million.

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Net cash provided by operating activities for the year ended December 31, 2021 consisted of our net income of $34.6 million adjusted for non-cash items of $26.1 million related to loss on extinguishment of debt, $18.8 million related to intangible amortization and depreciation and $16.1 million related to stock-based compensation expense. Net working capital excluding cash increased by $0.6 million.

Investing Activities

Net cash used in investing activities for the year ended December 31, 2022 was $141.8 million, which was primarily attributable to $110.7 million in purchases of debt securities and a final $40.0 million initial payment associated with the 2017 LCA, partially offset by $9.1 million in proceeds from sales and maturities of investments.

Net cash used in investing activities for the year ended December 31, 2021 was $100.3 million, which was primarily attributable to the $100.0 million milestone payment associated with the Bioprojet License Agreement.

Financing Activities

Net cash provided by financing activities for the year ended December 31, 2022 was $6.8 million, which primarily consisted of $8.8 million in proceeds from exercised options and stock issuances offset by $2.0 million in principal payments associated with the Blackstone Credit Agreement.

Net cash provided by financing activities for the year ended December 31, 2021 was $7.4 million, which primarily consisted of $190.9 million in proceeds associated with the Blackstone Credit Agreement, net of issuance costs, and $29.7 million in proceeds associated with issuance of common stock to Blackstone, net of issuance costs. These proceeds were partially offset by $222.0 million in payments of principal and exit fees associated with the extinguishment of the OrbiMed Credit Agreement, $0.9 million in proceeds from exercised options and $0.5 million in principal payments associated with the Blackstone Credit Agreement.

Critical Accounting Estimates

Our management’s discussion and analysis of our financial condition and results of operations is based on our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America, or GAAP. The preparation of these financial statements requires us to make estimates, judgments and assumptions that affect the reported amounts of assets and liabilities, disclosure of contingent assets and liabilities as of the dates of the balance sheets and the reported amounts of expenses during the reporting periods. In accordance with GAAP, we evaluate our estimates and judgments on an ongoing basis.

Significant estimates include assumptions used in the determination of the amount of revenue recognized on sales of WAKIX, our costs incurred under services type agreements related to the performance of research and development activities, and the measurement of compensation expense pursuant to stock-based awards. We base our estimates on contractual terms, historical experience and various other factors that we believe are reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

We define our critical accounting policies as those under GAAP that require us to make subjective estimates and judgments about matters that are uncertain and are likely to have a material impact on our financial condition and results of operations, as well as the specific manner in which we apply those principles. While our accounting policies are more fully described in Note 3 to our consolidated financial statements included herein under “Part II—Item 8. Financial Statements and Supplementary Data.”, we believe the following are the critical accounting policies used in the preparation of our consolidated financial statements that require significant estimates and judgments.

Revenue Recognition

We account for contracts with our customers in accordance with ASC 606, Revenue from Contracts with Customers (ASC 606), or ASC 606. Under ASC 606, an entity recognizes revenue when its customer obtains control of promised goods or services, in an amount that reflects the consideration which the entity expects to receive in exchange for those goods or services. To determine revenue recognition for arrangements that an entity determines are within the scope of ASC 606,

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the entity performs the following five steps: (i) identify the contract(s) with a customer; (ii) identify the performance obligations in the contract; (iii) determine the transaction price; (iv) allocate the transaction price to the performance obligations in the contract; and (v) recognize revenue when (or as) the entity satisfies a performance obligation. We only apply the five-step model to contracts when it is probable that we will collect the consideration we are entitled to in exchange for the goods or services it transfers to the customer. 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 contracts will not occur in a future period. Our analyses contemplate the application of the constraint in accordance with ASC 606. 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.

We have determined that the delivery of our product to our customer constitutes a single performance obligation as there are no other promises to deliver goods or services in contracts with our customers. Shipping and handling activities are considered to be fulfilment activities and are not considered to be a separate performance obligation. The payment terms with our customers do not exceed one year and therefore, no amount of consideration has been allocated as a financing component. Taxes collected related to product sales are remitted to governmental authorities and are excluded from revenue.

Product Sales, Net

We recognize revenue on sales of WAKIX when the customer obtains control of the product, which occurs at a point in time, typically upon delivery. Product revenues are recorded at the product’s list price, net of reserves for variable consideration that are offered within contracts between us and our customers, payors, and other indirect customers relating to the sale of WAKIX. Components of variable consideration include government (as detailed below) and commercial rebates, commercial co-payment assistance program transactions and distribution service fees. These deductions are based on the amounts earned, or to be claimed on the related sales, and are classified as a current liability or reduction of receivables.

Government Contracts

We have entered into contracts (i) to participate in the Medicaid Drug Rebate Program and the Medicare Part D program, and (ii) to sell to the U.S. Department of Veterans Affairs, 340b entities and other government agencies, or government payors, so that WAKIX will be eligible for purchase by, in partial or full reimbursement from, such government payors. We record reserves for rebates due pursuant to these contracts as a reduction of revenue in the same period in which the revenue is recognized. The liability for government rebates is included in accrued expenses in our consolidated balance sheet.

We estimate rebates due pursuant to government contracts based upon our historical payment and payor mix trends, information obtained from third parties estimating current payor mix, the government-mandated discounts applicable to government-funded programs, as well as information obtained from our customers. The liability for these government rebates consists of estimates of claims for WAKIX dispensed in the current period, plus an estimate for product which has shipped and has been recognized as revenue but remains in the distribution channel at the end of a reporting period.

Research and Development Expenses

We base our expenses for research and development services rendered on estimates of the services received and efforts expended pursuant to quotes, contracts and communicating with our vendors. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payments. There may be instances in which payments made to our vendors will exceed the level of services provided and result in a prepayment of the expense. In accruing service fees, we estimate the time period over which services will be performed and level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort is materially different from our estimates, we adjust the accrual or amount of prepaid or accrued expenses accordingly. Although we do not expect our estimates to be materially different from amounts actually incurred, our understanding of the status and timing of services performed relative to the actual status and timing of services performed may vary and may result in us reporting amounts

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that are too high or too low in any particular period. To date, we have not made any material adjustments to our prior estimates of research and development expenses.

Stock-Based Compensation

The Company recognizes compensation expense relating to stock-based payment transactions in operating results using a fair value measurement method, in accordance with FASB ASC 718, Compensation-Stock Compensation. ASC 718 requires all stock-based payments to employees to be recognized in operating results as compensation expense based on fair value over the requisite service period of the awards. The vesting periods have a time-based provision consisting of three to five years and expire no more than 10 years after the date of grant. Upon a change of control, certain unvested awards will immediately vest. The Company determines the fair value of stock-based awards using the Black-Scholes option-pricing model, which uses both historical and current market data to estimate fair value. The method incorporates various assumptions, such as the risk-free interest rate, expected volatility, expected dividend yield, and expected life of the options.

Income Taxes

Income taxes are accounted for under the asset and liability method. Deferred tax assets and liabilities are recognized for the future tax consequences attributable to differences between the financial statement carrying amounts of existing assets and liabilities and their respective tax bases and operating loss and tax credit carryforwards. Deferred tax assets and liabilities are measured using enacted rates expected to apply to taxable income in the years in which those temporary differences are expected to be recovered or settled. The effect on deferred tax assets and liabilities of a change in tax rates is recognized in income in the period that includes the enactment date.

Deferred tax assets may be reduced by a valuation allowance if, based on all available evidence, it is more likely than not that some portion or all of the deferred income tax assets will not be realized. Management judgment is required in determining the period in which a reversal of a valuation allowance should occur. We are required to consider all available evidence, both positive and negative, such as historical levels of income and future forecasts of taxable income among other items, in determining whether a full or partial release of its valuation allowance is required. During the year ended December 31, 2022, in part because in the current year we achieved three years of cumulative pretax income, which is a positive indication of the Company’s ability to generate sufficient future taxable income, we determined that there was sufficient positive evidence to conclude that it is more likely than not that additional deferred taxes are realizable and, therefore, released the valuation allowance accordingly. Our accounting for deferred tax consequences represents the best estimate of those future events. We present deferred income taxes on the Consolidated Balance Sheet on a jurisdictional basis as either a net noncurrent asset or liability.

We record liabilities for uncertain tax positions based on a two-step approach. The first step is recognition, where we evaluate whether an individual tax position has a likelihood of greater than 50% of being sustained upon examination based solely on the technical merits of the position, including resolution of any related appeals or litigation processes. For tax positions that are currently estimated to have less than a 50% likelihood of being sustained, no tax benefit is recorded. For tax positions that have met the recognition threshold in the first step, we perform the second step of the approach of measuring the benefit (expense) to be recorded. The actual benefits (expense) ultimately realized may differ from our estimates. In future periods, changes in facts, circumstances, and new information may require us to change the recognition and measurement estimates with regard to individual tax positions. Changes in recognition and measurement estimates are recorded in the statement of income and balance sheet in the period in which such changes occur. As of December 31, 2022, we did not have any liabilities for unrecognized tax positions. As it relates to any interest and penalties associated with any uncertain tax positions, our position is to include those interest and penalties as a component of income tax expense.

Recent Accounting Pronouncements

See Note 3 to our consolidated financial statements included herein under “Part II—Item 8. Financial Statements and Supplementary Data.” for more information.

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