Ensysce Biosciences, Inc. 10-K

Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations Overview Ensysce is a clinical stage pharmaceutical company seeking to develop innovative solutions for severe pain relief while reducing the fear of and the potential for addiction, opioid misuse, abuse and overdose. We have also incorporated a 79.2%-owned subsidiary, Covistat, a clinical stage pharmaceutical company that is developing a compound utilized in our overdose protection program for the treatment of COVID-19. Our lead product candidate, PF614, is an extended release TAAP prodrug of oxycodone. TAAP modification of prescription drugs removed the ability to crush, chew or manipulate and inject to achieve the medication more quickly than by swallowing. MPAR™ adds a layer of overdose protection to each TAAP product. Since our inception in 2003, we devoted substantially all of our efforts and financial resources to organizing and staffing our company, business planning, raising capital, discovering product candidates and securing related intellectual property rights and conducting research and development activities for our product candidates. We do not have any products approved for sale and we have not generated any revenue from product sales. We may never be able to develop or commercialize a marketable product. Our lead product candidate, PF614, is in Phase 1b clinical development, PF614-MPAR™ is in Phase 1 clinical development and nafamostat is proceeding towards Phase 2 clinical development. Our other product candidates and our research initiatives are in preclinical or earlier stages of development. Our ability to generate revenue from product sales sufficient to achieve profitability will depend heavily on the successful development and eventual commercialization of one or more of our product candidates. We have not yet successfully completed any pivotal clinical trials, nor have we obtained any regulatory approvals, manufactured a commercial-scale drug, or conducted sales and marketing activities. We expect to continue to incur net losses for the foreseeable future, and we expect our clinical development expenses, and general and administrative expenses to continue to increase. We have incurred significant operating losses since inception. Our net loss was $29.1 million for the year ended December 31, 2021 and as of December 31, 2021, we had an accumulated deficit of $85.8 million. We expect that our expenses and capital requirements will increase substantially in connection with our ongoing development activities, particularly if and as we: ● continue preclinical studies and continues existing and initiates new clinical trials for PF614, PF614-MPAR™ and nafamostat, our lead product candidates being tested for chronic pain and infectious disease; ● advance the development of our product candidate pipeline of other product candidates, including through business development efforts to invest in or in-license other technologies or product candidates; ● maintain, expand and protect our intellectual property portfolio; ● hire additional clinical, quality control, medical, scientific and other technical personnel to support our clinical operations; ● seek regulatory approval for any product candidates that successfully complete clinical trials; ● undertake any pre-commercialization activities to establish sales, marketing and distribution capabilities for any product candidates for which we may receive regulatory approval; ● expand our infrastructure and facilities to accommodate our growing employee base; and ● add operational, financial and management information systems and personnel, including personnel to support our research and development programs, any future commercialization efforts and our transition to operating as a public company. 78 We expect to incur additional costs associated with operating as a public company, including significant legal, accounting, insurance, investor relations and other expenses that we did not incur as a private company. We may never become profitable. We require substantial additional funding to support our continuing operations and pursue our growth strategy. Until we can generate significant revenue from product sales, if ever, we expect to finance our operations through a combination of private and public equity offerings, debt financings or other capital sources, which may include collaborations with other companies or other strategic transactions. To the extent that we raise additional capital through the sale of private or public equity or convertible debt securities, existing ownership interests will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect the rights of our equity holders. Debt financing and preferred equity financing, if available, may involve agreements that include covenants limiting or restricting our ability to take specific actions, such as incurring additional debt, making acquisitions or capital expenditures or declaring dividends. If we raise additional funds through collaborations or other strategic transactions with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or drug candidates, or grant licenses on terms that may not be favorable to us. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. If we fail to raise capital or enter into such agreements as and when needed, we may have to significantly delay, scale back or discontinue the development and commercialization of one or more of our product candidates or delay our pursuit of potential in-licenses or acquisitions. Because of the numerous risks and uncertainties associated with product development, we are unable to predict the timing or amount of increased expenses or when or if we will be able to achieve or maintain profitability. Even if we are able to generate product sales, we may not become profitable. If we fail to become profitable or are unable to sustain profitability on a continuing basis, we may be unable to continue our operations at planned levels and be forced to reduce or terminate our operations. We have generated limited revenues and have incurred significant operating losses since our inception, and as of December 31, 2021, have an accumulated deficit of $85.8 million. In addition, we expect to continue to incur significant and increasing expenses and operating losses for the foreseeable future. These factors raise substantial doubt about our ability to continue as a going concern. We believe that our available resources and existing cash and cash equivalents will enable us to fund our operating expenses and capital expenditure requirements through the third quarter of 2022. We based this estimate on assumptions that may prove to be wrong, and we could exhaust our available capital resources sooner than we expect. See “— Liquidity and Capital Resources .” Our future viability beyond the twelve months is dependent on our ability to raise additional capital to finance our operations. We expect to incur substantial expenses in the foreseeable future for the development and potential commercialization of our product candidates and ongoing internal research and development programs. At this time, we cannot reasonably estimate the nature, timing or aggregate amount of costs for our development, potential commercialization, and internal research and development programs. However, in order to complete our current and future preclinical studies and clinical trials, and to complete the process of obtaining regulatory approval for our product candidates, as well as to build the sales, marketing and distribution infrastructure that we believe will be necessary to commercialize our product candidates, if approved, we may require substantial additional funding in the future. COVID-19 Pandemic Business Update In March 2020, the World Health Organization declared COVID-19 a global pandemic. To date, our financial condition and operations have not been significantly impacted by the ongoing COVID-19 pandemic. However, we cannot at this time predict the specific extent, duration, or full impact that the ongoing COVID-19 pandemic will have on our financial condition and operations, including ongoing and planned clinical trials and other operations required to support those clinical trials and research and development activities to advance our pipeline. The impact of the ongoing COVID-19 pandemic on our financial performance will depend on future developments, including the duration and spread of the pandemic and related governmental advisories and restrictions. These developments and the impact of the ongoing COVID-19 pandemic on the financial markets and the overall economy are highly uncertain and cannot be predicted. If the financial markets and/or the overall economy are impacted for an extended period, our results may be materially adversely affected. 79 We are continuing to evaluate the impact of the ongoing COVID-19 pandemic on our business and continue to take proactive measures to protect the health and safety of our employees, as well as to maintain business continuity. We believe that the current measures we have implemented with respect to the ongoing COVID-19 pandemic are appropriate, reflecting both regulatory and public health guidance, to maintain business continuity. We will continue to closely monitor and seek to comply with guidance from governmental authorities and adjust our activities as appropriate. Convertible Promissory Notes On September 24, 2021, we entered into the SPA for an aggregate financing of $15.0 million with institutional investors. A first closing under the SPA occurred on September 24, 2021 and a second closing under the SPA occurred on November 5, 2021. At the first closing, the Company issued to the investors (i) senior secured convertible promissory notes in the aggregate principal amount of $5.3 million for an aggregate purchase price of $5.0 million (collectively, the “ First Closing Notes ”) and (ii) warrants to purchase 361,158 shares of the Company’s common stock in the aggregate at an exercise price of $7.63 per share. At the second closing, the Company issued to the institutional investors referenced above, (i) senior secured convertible promissory notes in the aggregate principal amount of $10.6 million (collectively, the “ Second Closing Notes ”, together with the First Closing Notes, the “ 2021 Notes ”) for an aggregate purchase price of $10.0 million and (ii) warrants to purchase 722,317 shares of the Company’s common stock in the aggregate at an exercise price of $7.63 per share. The Notes, subject to an original issue discount of six percent (6%), have a term of twenty-one months from the date of issuance and accrue interest at the rate of 5.0% per annum. The Notes are convertible into common stock, at a per share conversion price equal to $5.87, a 30% premium to the average price of the common stock for the three trading days prior to the first closing under the SPA. Under the 2021 Notes, on the first day of each month, we are obligated to redeem (i) an amount equal to ninety-two percent (92%) of the average of the three lowest VWAPs (as defined in the SPA) in the ten trading days prior to such date or (ii) an amount in cash with a premium of eight percent of the one eighteenth (1/18 th ) of the original principal amount under the applicable Note, plus accrued but unpaid interest, liquidated damages and any other amounts then owing to the holder of such Note. Our redemption obligation commenced on January 1, 2022 for the First Closing Notes and February 1, 2022 for the Second Closing Notes. The Company may elect to pay all or part of the redemption amount in the conversion of the 2021 Notes into shares of common stock based on a conversion price equal to the lesser of (i) the conversion price and (ii) 92% of the average of the three lowest VWAPs (as defined in the SPA) during the ten (10) consecutive trading days ending on the trading day that is immediately prior to the applicable redemption date, but in no event may we pay the redemption amount in conversion shares of common stock unless the conversion price is at least equal to $0.78 and certain equity conditions are satisfied. On December 27, 2021, the Company issued a Letter of Agreement amending the Securities Purchase Agreement to allow for conversion of the outstanding notes at an exercise price of $4.50 per share of the Company’s common stock for fourteen trading days, commencing December 28, 2021 and ending January 14, 2022. Following this period, the initial conversion price of $5.87 was restored. The warrants have an exercise price of $7.63, a 30% premium to the conversion price (and subject to downward adjustments based on certain issuances of the Company’s common stock) and are exercisable for five years following issuance. The Company issued, to the purchasers’ signatory to the SPA, warrants to purchase up to a number of shares of common stock equal to forty percent (40%) of the shares of common stock issuable to each purchaser under the SPA upon conversion of the Note such purchaser holds on each of the first and second closing date under the SPA. We registered with the Securities and Exchange Commission the resale of the shares of common stock issuable upon conversion of the Notes as well as the shares of common stock issuable upon the exercise of the warrants pursuant to a Registration Rights Agreement, dated September 24, 2021, by and among the Company and the purchasers’ signatory to the SPA. The 2021 Notes contain certain covenants, and events of default and triggering events, respectively, which would require repayment of the obligations outstanding pursuant to such instruments. Our obligations pursuant to the 2021 Notes are (i) secured by all assets of the Company and all subsidiaries of the Company pursuant to the Security Agreement and Patent Security Agreement, each dated September 24, 2021, by and among the Company, the subsidiaries of the Company and the holders of the 2021 Notes and (ii) guaranteed jointly and severally by the subsidiaries of the Company pursuant to the Subsidiary Guarantee, dated September 24, 2021, by and among the Company, the subsidiaries of the Company and the purchasers signatory to the SPA. 80 Business Combination Transaction On June 30, 2021, the Merger with LACQ was consummated and we became a public company. We received net proceeds of approximately $7.8 million at the closing and we continue to operate under our management team, led by our Chief Executive Officer Lynn Kirkpatrick. On July 2, 2021, the combined company’s common stock began trading on Nasdaq under the ticker symbol “ENSC”. Components of Our Operating Results Revenue We have generated limited revenue since our inception and we do not expect to generate any revenue from the sale of products in the near future, if at all. If our development efforts are successful and we commercialize our products, or if we enter into collaboration or license agreements with third parties, we may generate revenue in the future from product sales, as well as upfront, milestone and royalty payments from such collaboration or license agreements, or a combination thereof. We have received funding under federal grants from the NIH through NIDA. In September 2018, we were awarded the MPAR Grant. In September 2019, we were awarded a second research and development grant, the OUD Grant. Grant funds are awarded annually through a Notice of Award which contains certain terms and conditions including, but not limited to, complying with the grant program legislation, regulation and policy requirements, complying with conditions on expenditures of funds with respect to other applicable statutory requirements such as the federal appropriations acts, periodic reporting requirements, and budget requirements. Operating Expenses Research and Development Expenses Research and development expenses consist primarily of costs incurred for research activities, including drug discovery efforts and the development of our product candidates. We expense research and development costs as incurred, which include: ● expenses incurred to conduct the necessary preclinical studies and clinical trials required to obtain regulatory approval; ● expenses incurred under agreements with CROs that are primarily engaged in the oversight and conduct of our drug discovery efforts and preclinical studies, clinical trials and CMOs that are primarily engaged to provide preclinical and clinical drug substance and product for our research and development programs; ● other costs related to acquiring and manufacturing materials in connection with our drug discovery efforts and preclinical studies and clinical trial materials, including manufacturing validation batches, as well as investigative sites and consultants that conduct our clinical trials, preclinical studies and other scientific development services; ● payments made in cash or equity securities under third-party licensing, acquisition and option agreements; ● employee-related expenses, including salaries and benefits, travel and stock-based compensation expense for employees engaged in research and development functions; ● costs related to compliance with regulatory requirements; and ● allocated facilities-related costs, depreciation and other expenses, which include rent and utilities. 81 We recognize external development costs as incurred. Any advance payments that we make for goods or services to be received in the future for use in research and development activities are recorded as prepaid expenses. Such amounts are expensed as the related goods are delivered or the related services are performed, or until it is no longer expected that the goods will be delivered or the services rendered. We estimate and accrue for the value of goods and services received from CROs and other third parties each reporting period based on an evaluation of the progress to completion of specific tasks using information provided to us by our service providers. This process involves reviewing open contracts and purchase orders, communicating with our personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when we have not yet been invoiced or otherwise notified of actual costs. We do not track our research and development expenses on a program-by-program basis. Our direct external research and development expenses consist primarily of external costs, such as fees paid to outside consultants, CROs, CMOs and research laboratories in connection with our preclinical development, process development, manufacturing and clinical development activities. We do not allocate employee costs, costs associated with our discovery efforts, laboratory supplies, and facilities, including depreciation or other indirect costs, to specific programs because these costs are deployed across multiple programs and, as such, are not separately classified. We use internal resources primarily to conduct our research and discovery as well as for managing our preclinical development, process development, manufacturing and clinical development activities. These employees work across multiple programs and, therefore, we do not track our costs by program and cannot state precisely the total costs incurred for each of our clinical and preclinical programs on a project-by-project basis. Research and development 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 trials. As a result, we expect that our research and development expenses will increase substantially over the next several years as we continue our existing, and commences additional, planned clinical trials for PF614, PF614-MPAR™ and nafamostat, as well as conduct other preclinical and clinical development, including submitting regulatory filings for our other product candidates. We also expect our discovery research efforts and our related personnel costs to increase and, as a result, we expect our research and development expenses, including costs associated with stock-based compensation, to increase above historical levels. In addition, we may incur additional expenses related to milestone and royalty payments payable to third parties with whom we may enter into license, acquisition and option agreements to acquire the rights to future product candidates. At this time, we cannot reasonably estimate or know the nature, timing and costs of the efforts that will be necessary to complete the preclinical and clinical development of any of our product candidates or when, if ever, material net cash inflows may commence from any of our product candidates. The successful development and commercialization of our product candidates are highly uncertain. This uncertainty is due to the numerous risks and uncertainties associated with product development and commercialization, including the uncertainty of the following: ● the scope, progress, outcome and costs of our preclinical development activities, clinical trials and other research and development activities; ● establishing an appropriate safety and efficacy profile with IND enabling studies; ● successful patient enrollment in and the initiation and completion of clinical trials; ● the timing, receipt and terms of any marketing approvals from applicable regulatory authorities including the FDA and non-U.S. regulators; ● the extent of any required post-marketing approval commitments to applicable regulatory authorities; ● establishing clinical and commercial manufacturing capabilities or making arrangements with third-party manufacturers in order to ensure that we or our third-party manufacturers are able to make product successfully; 82 ● development and timely delivery of clinical-grade and commercial-grade drug formulations that can be used in our clinical trials and for commercial launch; ● obtaining, maintaining, defending and enforcing patent claims and other intellectual property rights; ● significant and changing government regulation; ● launching commercial sales of our product candidates, if and when approved, whether alone or in collaboration with others; and ● maintaining a continued acceptable safety profile of our product candidates following approval, if any, of our product candidates. Any changes in the outcome of any of these variables with respect to the development of our product candidates in preclinical and clinical development could mean a significant change in the costs and timing associated with the development of these product candidates. For example, if the FDA or another regulatory authority were to delay our planned start of clinical trials or require us to conduct clinical trials or other testing beyond those that we currently expect or if we experience significant delays in enrollment in any of our planned clinical trials, we could be required to expend significant additional financial resources and time on the completion of clinical development of that product candidate. General and Administrative Expenses General and administrative expenses consist primarily of employee-related expenses, including salaries and related benefits, travel and stock-based compensation for personnel in executive, business development, finance, human resources, legal, information technology, and administrative functions. General and administrative expenses also include direct and allocated facility-related costs as well as insurance costs and professional fees for legal, patent, consulting, investor and public relations, accounting and audit services. We expense general and administrative costs as incurred. We anticipate that our general and administrative expenses, excluding non-cash expenses to recognize the fair value of warrants issued with the share subscription facility, will increase in the future as we increase our headcount to support the continued development of our product candidates. We also anticipate that we will incur significantly increased accounting, audit, legal, regulatory, compliance and director and officer insurance costs as well as investor and public relations expenses associated with operating as a public company. Additionally, if and when we believe a regulatory approval of a product candidate appears likely, we anticipate an increase in payroll and other employee-related expenses as a result of our preparation for commercial operations, especially as it relates to the sales and marketing of that product candidate. Other Income (Expense) Derivative Liabilities Between 2018 and 2021, we entered into a series of notes that were determined to have embedded derivative instruments in the form of a contingent put option. The notes were recognized at the value of proceeds received after allocating issuance proceeds to the bifurcated contingent put option. The notes were subsequently measured at amortized cost using the effective interest method to accrete interest over their term to bring the notes’ initial carrying value to their principal balance at maturity. The bifurcated put option was initially measured at fair value and subsequently measured at fair value with changes in fair value recognized as a component of other expenses in the consolidated statements of operations. These notes and associated derivatives were settled during 2021. Convertible Notes We elected the fair value option to account for the 2021 Notes as we believe the fair value option provides users of the financial statements with greater ability to estimate the outcome of future events as facts and circumstances change, particularly with respect to changes in the fair value of the common stock underlying the conversion option. We use a Monte Carlo analysis to estimate the fair value of the conversion feature of the notes, which relies on unobservable Level 3 inputs. We use a discounted cash flow model to estimate the fair value of the debt component of the 2021 Notes. Changes in the fair value of the notes are recognized through earnings for each reporting period. The impact to the consolidated statement of operations related to these 2021 Notes is reflected in the following lines: Change in fair value of convertible notes and issuance costs for convertible notes. Such issuance costs include investment banking and legal fees as well as original issue discounts on the 2021 Notes. 83 Liability Classified Warrants The warrants issued with the 2021 Notes were liability classified due to certain cash settlement features. We use a Black-Scholes option pricing model to estimate the fair value of the warrants. Changes in the fair value of the warrants are recognized through earnings for each reporting period. Interest Expense Interest expense consists of interest accrued on our convertible and other promissory notes and the amortization of debt discounts in our convertible promissory notes that were settled on June 30, 2021, in conjunction with the Merger. Interest expense related to the 2021 Notes is included in the estimate of fair value of the convertible notes. Provision for Income Taxes We have not recorded any significant amounts related to income tax expense, we have not recognized any reserves related to uncertain tax positions, nor have we recorded any income tax benefits for the majority of our net losses we have incurred to date or for our research and development tax credits. We account for income taxes using the asset and liability method, which requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of events that have been included in the financial statements or our tax returns. Deferred tax assets and liabilities are determined based on difference between the financial statement carrying amounts and tax bases of existing assets and liabilities and for loss and credit carryforwards, which are measured using the enacted tax rates and laws in effect in the years in which the differences are expected to reverse. The realization of our deferred tax assets is dependent upon the generation of future taxable income, the amount and timing of which are uncertain. Valuation allowances are provided, if, based upon the weight of available evidence, it is more likely than not that some or all of the deferred tax assets will not be realized. As of December 31, 2021 and 2020, we continue to maintain a full valuation allowance against all of our deferred tax assets based on our evaluation of all available evidence. We file income tax returns in the United States federal tax jurisdiction and state jurisdictions and may become subject to income tax audit and adjustments by related tax authorities. Our tax return period for United States federal income taxes for the tax years since 2017 remain open to examination under the statute of limitations by the Internal Revenue Service and state jurisdictions. We record reserves for potential tax payments to various tax authorities related to uncertain tax positions, if any. The nature of uncertain tax positions is subject to significant judgment by management and subject to change, which may be substantial. These reserves are based on a determination of whether and how much a tax benefit taken by us in our tax filings or whether our position is more likely than not to be realized following the resolution of any potential contingencies related to the tax benefit. We develop our assessment of uncertain tax positions, and the associated cumulative probabilities, using internal expertise and assistance from third-party experts. As additional information becomes available, estimates are revised and refined. Differences between estimates and final settlement may occur resulting in additional tax expense. Potential interest and penalties associated with such uncertain tax positions is recorded as a component of our provision for income taxes. To date, no amounts are being presented as an uncertain tax position. 84 Results of Operations Comparison of the Years ended December 31, 2021 and 2020 The following table summarizes our results of operations for the years ended December 31, 2021 and 2020: Year Ended December 31, 2021 2020 Change Federal grants $ 3,531,199 $ 3,931,209 $ (400,010 ) Operating expenses: Research and development $ 4,690,082 $ 4,389,579 $ 300,503 General and administrative 18,711,548 1,154,917 17,556,631 Total operating expenses 23,401,630 5,544,496 17,857,134 Loss from operations (19,870,431 ) (1,613,287 ) (18,257,144 ) Other income (expense): Change in fair value of derivative liabilities 673,314 2,447,908 (1,774,594 ) Issuance costs for convertible notes (1,920,158 ) - (1,920,158 ) Change in fair value of convertible notes (2,993,060 ) - (2,993,060 ) Issuance of liability classified warrants (1,865,403 ) - (1,865,403 ) Change in fair value of liability classified warrants (1,438,186 ) - (1,438,186 ) Interest expense (1,295,307 ) (995,496 ) (299,811 ) Other income and expense, net (436,670 ) - (436,670 ) Total other income (expense), net (9,275,470 ) 1,452,412 (10,727,882 ) Net loss $ (29,145,901 ) $ (160,875 ) $ (28,985,026 ) Net loss attributable to noncontrolling interests (62,190 ) (217,645 ) 155,455 Deemed dividend related to warrants down round provision (803,140 ) - (803,140 ) Net income (loss) attributable to common stockholders $ (29,886,851 ) $ 56,770 $ (29,943,621 ) Federal Grants Revenue from federal grants totaled $3.5 million for the year ended December 31, 2021, compared to $3.9 million for the year ended December 31, 2020. The decrease related to two grants from the NIH through NIDA. Revenue decreased $0.4 million during the year ended December 31, 2021, due to the timing of research activities eligible for funding under the grants under the MPAR TM grant awarded in September 2018. We expect funding from federal grants in the future to approximate current levels. Research and Development Expenses Research and development expenses were $4.7 million for the year ended December 31, 2021, compared to $4.4 million for the year ended December 31, 2020. The increase was primarily the result of increased external research and development costs related to the clinical programs for PF614 and PF614-MPAR™. We do not currently track expenses on a program-by-program basis. We expect research and development expenses to increase in the future due to planned clinical trials and higher preclinical and clinical development costs for our product candidates. General and Administrative Expenses General and administrative expenses were $18.7 million for the year ended December 31, 2021, compared to $1.2 million for the year ended December 31, 2020. The increase was primarily driven by a one-time $11.6 million non-cash expense related to warrants issued for the share subscription facility, reflecting the fair value of 1,106,108 warrants issued with an exercise price of $10.01 per share in July 2021, based on the $14.49 share price on the date of issuance. Also contributing to the increase was $1.3 million of non-cash expense for consultants and $1.1 million expense for commitment fees for the share subscription facility. Excluding the one-time expenses related to the share subscription facility, which were recorded due to the uncertainty of future issuance of shares under the facility, and consultant expenses, we expect our general and administrative expenses to increase in the future due to increased director and officer insurance costs and various expenses related to operating as a public company. 85 Other Income and Expense The change in fair value of derivative liabilities was an increase of $0.7 million for the year ended December 31, 2021, compared to an increase of $2.4 million for the year ended December 31, 2020. The change resulted from changes in the likelihood of realization of the embedded derivative instrument in previous convertible notes payable. Interest expense was $1.3 million for the year ended December 31, 2021, compared to $1.0 million for the year ended December 31, 2020. The totals primarily reflect stated interest expense and debt discount accretion for the convertible notes converted upon the closing of the Merger on June 30, 2021. The remaining elements of other income and expense primarily relate to the 2021 Notes, reflecting issuance costs and changes in valuation of the notes and related warrants. There was no corresponding activity in the year ended December 31, 2020. Liquidity and Capital Resources Sources of Liquidity and Capital As of December 31, 2021, we had $12.3 million of cash and cash equivalents. Since inception, we have generated limited revenues and have incurred significant operating losses and negative cash flows from our operations, and we anticipate that we will continue to incur losses for at least the foreseeable future. We have not yet commercialized any of our product candidates and we do not expect to generate revenue from sales of any product candidates for several years, if at all. As of December 31, 2021, we had an accumulated deficit of $85.8 million. We have funded our operations to date primarily with proceeds from the sale of common equity, funding under federal research grants and borrowings under promissory notes. To fund future operations, we will need to raise additional capital. The amount and timing of future funding requirements will depend on many factors, including the timing and results of our ongoing research and development efforts and related general and administrative support. We anticipate that we will fund our operations through public or private equity or debt financings or other sources, such as potential collaboration agreements. We cannot make assurances that anticipated additional financing will be available to us on favorable terms, if at all. Remaining funding under two approved federal research grants totals $4.3 million and is expected to be utilized by December 31, 2022. Pursuant to the terms and conditions of the two grants, we are required to submit progress reports to NIDA on an annual basis and a final research performance progress report within 120 days of the performance period end date. Additionally, the grants limit the use of funds to activities that are clearly severable and independent from activities that involve human subjects until the receipt by NIDA of (i) Institutional Review Board (“ IRB ”) approval, (ii) federal-wide assurance from the Office for Human Research Protections, (iii) a Data and Safety Monitoring Plan, (iv) certification that all key personnel have completed education on the protection of human subjects and (v) a Clinical Trials Dissemination Plan. We must also comply with the data sharing policies of NIDA and the NIH Public Access Policy, that require submission of final peer-reviewed journal manuscripts that arise from the use of grants to PubMed Central immediately upon acceptance for publication. Neither grant has to be repaid. To receive the remaining funding for each respective study covered by a grant, we must meet certain milestones. We have met the required milestones under the MPAR Grant. The remaining milestone under the OUD Grant is identification of a R-methadone-TAAP clinical candidate that meet the specified criteria. Inventions arising from the research projects funded with the grants are required to be reported to NIDA, per the Bayh-Dole Act (the Patent and Trademark Law Amendments Act), that permits us to retain ownership of the inventions, while also giving NIDA the license to practice the subject invention. In turn, we are expected to file for patent protection and to ensure commercialization upon licensing for the benefit of public health. 86 Pursuant to the GEM Agreement, we are entitled to draw down up to $60.0 million of gross proceeds (“ Aggregate Limit ”) from GEM Global in exchange for shares of our common stock, subject to meeting the terms and conditions of the GEM Agreement. This share subscription facility is available for a period of 36 months from the closing date of the Merger. A draw down is subject to limitations on the amount that is drawn under the facility and must comply with certain conditions precedent including the listing of our shares on a principal market (which includes Nasdaq), having the necessary number of shares that are issuable pursuant to the draw down registered under an effective registration statement, and other notice and timing requirements. Upon our valid exercise of a draw down, pursuant to delivery of a notice and in accordance with other conditions, GEM Global is required to pay, in cash, a per-share amount equal to 90% of the average closing bid price of the shares of our common stock recorded by Nasdaq during the 30 consecutive trading days commencing on the first trading day that is designated on the draw down notice. In no event may our draw down requests exceed 400% (“ Draw Down Limit ”) of the average daily trading volume for the 30 trading days immediately preceding the date we deliver the draw down notice. Our ability to utilize this share subscription facility is restricted while the 2021 Notes are outstanding. Upon the closing of the Merger, GEM Global became entitled to a commitment fee in the form of cash or freely tradeable shares of our common stock in an amount equal to 2% of the Aggregate Limit or $1.2 million to be paid in two tranches. The commitment fee for the first tranche, which is equal to 67% of the commitment fee, or $800,000, becomes payable on the first anniversary of the closing of the Merger and the commitment fee for the second tranche, which is equal to the remaining 33% of the commitment fee, or $400,000, becomes payable on the eighteen-month anniversary of the closing of the Merger. Additionally, we issued a warrant with a 36-month term at the closing of the Merger granting GEM Global the right to purchase 1,106,108 shares of our common stock (an amount equal to 4% of the total number of our common stock outstanding as of the closing date of the Merger (subject to adjustments described below), calculated on a fully diluted basis), at a strike price per share equal to $10.01, which was the closing bid price for such common stock on the first day of trading on Nasdaq. The strike price was reduced to $4.50 per share at December 31, 2021 because of a pricing adjustment per the GEM Agreement. The warrant can be exercised on a cashless basis in part or in whole at any time during the term. Any failure by us to timely transfer the shares under the warrant pursuant to GEM Global’s exercise will entitle GEM Global to compensation in addition to other remedies. The number of shares underlying the warrant as well as the strike price is subject to adjustments for recapitalizations, reorganizations, change of control, stock split, stock dividend, reverse stock splits, and issuances of additional common shares at a price per share less than the exercise price. The GEM Agreement contains certain negative covenants restricting us from securing an share subscription line similar to the financing provided under the GEM Agreement and requiring prompt notice of events constituting an alternate transaction. An “alternate transaction” includes an issuance of common stock at a price less than the then current market price, an “at-the-market” offering of securities, and an issuance of options, warrants, or similar rights of subscription or the issuance of convertible equity or debt securities. See “ Risks Related to Our Business, Financial Condition and Capital Requirements ” for additional information. Finally, pursuant to the terms of the GEM Agreement, we are required to indemnify GEM Global for any losses it incurs as a result of a breach by us or of our representations and warranties and covenants under the GEM Agreement or for any misstatement or omission of a material fact in a registration statement registering those shares pursuant to the GEM Agreement. Also, GEM Global is entitled to be reimbursed for legal or other costs or expenses reasonably incurred in investigating, preparing, or defending against any such loss. On September 24, 2021, we entered into the SPA for an aggregate financing of $15.0 million with institutional investors. A first closing under the SPA occurred on September 24, 2021 and a second closing under the SPA occurred on November 5, 2021. At the first closing, the Company issued to the investors (i) 2021 Notes in the aggregate principal amount of $5.3 million for an aggregate purchase price of $5.0 million and (ii) warrants to purchase 361,158 shares of the Company’s common stock in the aggregate at an exercise price of $7.63 per share. At the second closing, the Company issued to the institutional investors referenced above, (i) 2021 Notes in the aggregate principal amount of $10.6 million for an aggregate purchase price of $10.0 million and (ii) warrants to purchase 722,317 shares of the Company’s common stock in the aggregate at an exercise price of $7.63 per share. 87 Cash Flows for the years ended December 31, 2021 and 2020 The following table summarizes our cash flows for each of the periods presented: Year Ended December 31, 2021 2020 Net cash used in operating activities $ (8,242,177 ) $ (1,247,342 ) Net cash provided by financing activities 20,312,699 1,100,020 Net increase (decrease) in cash and cash equivalents $ 12,070,522 $ (147,322 ) Operating Activities During the years ended December 31, 2021 and 2020, we used cash in operating activities of $8.2 million and $1.2 million, respectively, primarily resulting from the clinical advancement of our product candidates, the timing of vendor invoicing and payments, legal and accounting fees, and increased costs related to operating as a public company. Financing Activities During the years ended December 31, 2021 and 2020, net cash provided by financing activities was $20.3 million and $1.1 million, respectively. The increase consisted primarily of net proceeds from the Merger in June 2021 and net proceeds from the issuance of the 2021 Notes. Funding Requirements Our primary use of cash is to fund operating expenses, primarily related to our research and development activities. Cash used to fund operating expenses is impacted by the timing of when we pay these expenses, as reflected in the change in our outstanding accounts payable, accrued expenses and prepaid expenses. We expect our expenses, excluding non-cash expenses to recognize the fair value of warrants and convertible notes, to increase substantially in connection with our ongoing activities, particularly as we advance the preclinical activities and clinical trials of our product candidates. In addition, upon the completion of the Merger, we have incurred, and will continue to incur, additional costs associated with operating as a public company, including significant legal, accounting, insurance, investor relations and other expenses that we did not incur as a private company. The timing and amount of our operating expenditures will depend largely on our ability to: ● advance preclinical development of our early-stage programs and clinical trials of our product candidates; ● manufacture, or have manufactured on our behalf, our preclinical and clinical drug material and develop processes for late state and commercial manufacturing; ● seek regulatory approvals for any product candidates that successfully complete clinical trials; ● establish a sales, marketing, medical affairs and distribution infrastructure to commercialize any product candidates for which we may obtain marketing approval and intend to commercialize on our own; ● hire additional clinical, quality control and scientific personnel; ● expand our operational, financial and management systems and increase personnel, including personnel to support our clinical development, manufacturing and commercialization efforts and our operations as a public company; ● obtain, maintain, expand and protect our intellectual property portfolio; ● manage the costs of preparing, filing and prosecuting patent applications, maintaining and protecting our intellectual property rights, including enforcing and defending intellectual property related claims; and ● manage the costs of operating as a public company. 88 Our commitments as of December 31, 2021 included an estimated $13.0 million related to open purchase orders and contractual obligations that occurred in the ordinary course of business, including commitments with contract research organizations for multi-year pre-clinical and clinical research studies. Although open purchase orders are considered enforceable and legally binding, the terms generally allow us the option to cancel, reschedule, and adjust requirements based on our business needs prior to the delivery of goods or the performance of services. Going Concern We have generated limited revenues and have incurred significant operating losses since our inception and, as of December 31, 2021, we have an accumulated deficit of $85.8 million. We expect to continue to incur significant expenses and operating losses for the foreseeable future. Following the completion of the Merger and public listing of our common stock on Nasdaq, we had access to up to $60.0 million from a share subscription facility entered into in December 2020. The SPA for the 2021 Notes limits our ability to execute certain debt and equity financings, including our existing $60.0 million share subscription facility, while the notes are outstanding. Without the availability of proceeds through the share subscription facility, existing cash resources are not sufficient to allow us to fund current planned operations through the next 12 months following the filing of this Annual Report on Form 10-K, which raises substantial doubt about the Company’s ability to continue as a going concern. For additional information on risks associated with our substantial capital requirements, please read the section titled “ Risk Factors ” included elsewhere in this Annual Report on Form 10-K. Working Capital Because of the numerous risks and uncertainties associated with research, development and commercialization of biologic product candidates, we are unable to estimate the exact amount of our working capital requirements. Our future funding requirements will depend on and could increase significantly as a result of many factors, including: ● the scope, progress, results and costs of researching and developing our product candidates, and conducting preclinical and clinical trials; ● the costs, timing and outcome of regulatory review of our product candidates; ● the costs, timing and ability to manufacture our product candidates to supply our clinical and preclinical development efforts and our clinical trials; ● the costs of future activities, including product sales, medical affairs, marketing, manufacturing and distribution, for any of our product candidates for which we receive marketing approval; ● the costs of manufacturing commercial-grade product and necessary inventory to support commercial launch; ● the ability to receive additional non-dilutive funding, including grants from organizations and foundations; ● the revenue, if any, received from commercial sale of our products, should any of our product candidates receive marketing approval; ● the costs of preparing, filing and prosecuting patent applications, obtaining, maintaining, expanding and enforcing our intellectual property rights and defending intellectual property-related claims; ● our ability to establish and maintain collaborations on favorable terms, if at all; and ● the extent to which we acquire or in-license other product candidates and technologies. 89 Critical Accounting Policies and Significant Judgments and Estimates Our consolidated financial statements are prepared in accordance with GAAP. The preparation of our consolidated financial statements and related disclosures requires us to make estimates and judgments that affect the reported amounts of assets, liabilities, costs and expenses. We base our estimates on historical experience, known trends and events 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 values of assets and liabilities that are not readily apparent from other sources. We evaluate our estimates and assumptions on an ongoing basis. Our actual results may differ from these estimates under different assumptions or conditions. While our significant accounting policies are described in more detail in Note 3 to our audited consolidated financial statements, we believe that the following accounting policies are those most critical to the judgments and estimates used in the preparation of our consolidated financial statements. Accrued Research and Development Expenses As part of the process of preparing our consolidated financial statements, we are required to estimate our accrued research and development expenses. This process involves reviewing open contracts and purchase orders, communicating with our applicable personnel to identify services that have been performed on our behalf and estimating the level of service performed and the associated cost incurred for the service when it has not yet been invoiced or otherwise notified of actual costs. The majority of our service providers invoice us in arrears for services performed, on a pre-determined schedule or when contractual milestones are met; however, some require advance payments. We make estimates of our accrued expenses as of each balance sheet date in the consolidated financial statements based on facts and circumstances known to us at that time. We periodically confirm the accuracy of the estimates with the service providers and makes adjustments if necessary. Examples of estimated accrued research and development expenses include fees paid to: ● vendors, including research laboratories, in connection with preclinical development activities; ● CROs and investigative sites in connection with preclinical studies and clinical trials; and ● CMOs in connection with drug substance and drug product formulation of preclinical studies and clinical trial materials. We base our expenses related to preclinical studies and clinical trials on our estimates of the services received and efforts expended pursuant to quotes and contracts with multiple research institutions and CROs that supply, conduct and manage preclinical studies and clinical trials on our behalf. The financial terms of these agreements are subject to negotiation, vary from contract to contract and may result in uneven payment flows. 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. Payments under some of these contracts depend on factors such as the successful enrollment of patients and the completion of clinical trial milestones. In accruing service fees, we estimate the time period over which services will be performed and the level of effort to be expended in each period. If the actual timing of the performance of services or the level of effort varies from the estimate, we adjust the accrual or the prepaid expense 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 reporting amounts that are too high or too low in any particular period. Stock-Based Compensation We measure all stock-based awards granted to employees, directors and non-employees based on their fair value on the date of the grant and recognize the corresponding compensation expense of those awards over the requisite service period, which is generally the vesting period of the respective award. Forfeitures are accounted for as they occur. We grant stock options and restricted stock awards that are subject to either service or market-based vesting conditions. Compensation expense related to awards to employees and non-employees with market-based vesting conditions is recognized based on the grant date fair value, which includes a probability assessment of the achievement of the market condition, over the requisite service period using the accelerated attribution method. 90 We classify stock-based compensation expense in our statements of operations in the same manner in which the award recipient’s payroll costs are classified or in which the award recipient’s service payments are classified. We estimate the fair value of each stock option grant using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our stock options, the risk-free interest rate for a period that approximates the expected term of our stock options and our expected dividend yield. Fair Value of Liabilities We elected the fair value option to account for the 2021 Notes as we believe the fair value option provides users of the financial statements with greater ability to estimate the outcome of future events as facts and circumstances change, particularly with respect to changes in the fair value of the common stock underlying the conversion option. We use a Monte Carlo analysis to estimate the fair value of the conversion feature of the notes, which relies on unobservable Level 3 inputs. We use a discounted cash flow model to estimate the fair value of the debt component of the 2021 Notes. Changes in the fair value of the notes are recognized through other income (expense) for each reporting period. Determination of the Fair Value of Common Stock As there has historically been no public market for Former Ensysce common stock prior to the date of the closing of the Merger, the estimated fair value of Former Ensysce common stock was determined by our most recently available third-party valuations of common stock. These third-party valuations were performed in accordance with the guidance outlined in the American Institute of Certified Public Accountants’ Accounting and Valuation Guide, Valuation of Privately-Held-Company Equity Securities Issued as Compensation. Our common stock valuations were prepared using an option pricing method (“ OPM ”). The OPM treats common stock and preferred stock as call options on the total equity value of a company, with exercise prices based on the value thresholds at which the allocation among the various holders of a company’s securities changes. Under the OPM method, the common stock has value only if the funds available for distribution to stockholders exceeded the value of the preferred stock liquidation preferences at the time of the liquidity event, such as a strategic sale or a merger. A discount for lack of marketability of the common stock is then applied to arrive at an indication of value for the common stock. These third-party valuations were performed at various dates, which resulted in valuations of Former Ensysce common stock of $1.37 per share as of July 1, 2017, $1.82 per share as of February 28, 2018, $2.58 per share as of October 1, 2018, and $2.58 per share as of December 31, 2019 (prices adjusted for the exchange ratio of 0.06585 per the merger agreement). In addition to considering the results of these third-party valuations, our board of directors considered various objective and subjective factors to determine the fair value of our common stock as of each grant date, including: ● the progress of our research and development programs, including the status and results of preclinical studies and clinical trials for our product candidates; ● our stage of development and commercialization and our business strategy; ● external market conditions affecting the biopharmaceutical industry and trends within the biopharmaceutical industry; ● our financial position, including cash on hand, and our historical and forecasted performance and results of operations; ● the lack of an active public market for our common stock and our preferred stock; ● the likelihood of achieving a liquidity event, such as an initial public offering, or IPO, or our sale in light of prevailing market conditions; and ● the analysis of initial public offerings and the market performance of similar companies in the specialty biopharmaceutical industry. 91 The assumptions underlying these valuations represented management’s best estimate, which involved inherent uncertainties and the application of management’s judgment. As a result, if we had used significantly different assumptions or estimates, the fair value of our common stock and our stock-based compensation expense could have been materially different. Shares of our common stock are now listed and trade on Nasdaq, so it will no longer be necessary for our board of directors to estimate the fair value of our common stock in connection with our accounting for granted stock options and other such awards we may grant, as the fair value of our common stock will be determined based on the publicly-traded quoted market price of our common stock. Off-Balance Sheet Arrangements We did not have during the periods presented, nor do we currently have, any off-balance sheet arrangements, as defined in the rules and regulations of the SEC. Recently Issued Accounting Pronouncements A description of recently issued accounting pronouncements that may potentially impact our financial position and results of operations is disclosed in Note 3 to our consolidated financial statements included elsewhere in this Annual Report on Form 10-K. Emerging Growth Company and Smaller Reporting Company Status We are an “emerging growth company,” as defined in the JOBS Act, and we may take advantage of certain exemptions from various reporting requirements that are applicable to other public companies that are not emerging growth companies. We may take advantage of these exemptions until we are no longer an emerging growth company under Section 107 of the JOBS Act, which provides that an emerging growth company can take advantage of the extended transition period afforded by the JOBS Act for the implementation of new or revised accounting standards. We have elected to avail ourselves of the extended transition period and, therefore, while we are an emerging growth company we are not be subject to new or revised accounting standards at the same time that they become applicable to other public companies that are not emerging growth companies, unless we choose to early adopt a new or revised accounting standard. Additionally, we are a “smaller reporting company” as defined in Item 10(f)(1) of Regulation S-K. Smaller reporting companies may take advantage of certain reduced disclosure obligations, including, among other things, providing only two years of audited financial statements. We will remain a smaller reporting company until the last day of the fiscal year in which (i) the market value of our common stock held by non-affiliates exceeds $250 million as of the prior June 30, or (ii) our annual revenues exceeded $100 million during such completed fiscal year and the market value of our common stock held by non-affiliates exceeds $700 million as of the prior June 30.