Skye Bioscience, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations. The following discussion and analysis of our financial condition and results of operations should be read in conjunction with our Condensed Consolidated Financial Statements (unaudited) for the three and nine months ended September 30, 2022 and 2021 (unaudited) and the consolidated financial statements and the related notes thereto included in our Annual Report on Form 10-K for the year ended December 31, 2021, together with the notes thereto. In addition to historical information, this discussion and analysis contains forward-looking statements that involve risks, uncertainties and assumptions. Our actual results may differ materially from those anticipated in these forward-looking statements as a result of certain factors, including, but not limited, to those set forth under “Risk Factors” and elsewhere in this Quarterly Report on Form 10-Q. Unless otherwise provided in this Quarterly Report, references to “we,” “us,” “our” and “Skye Bioscience” in this discussion and analysis refer to Skye Bioscience, Inc., a Nevada corporation formerly known as Emerald Bioscience, Inc., together with its wholly owned subsidiaries, Nemus, a California corporation, and SKYE Bioscience Pty Ltd. (formerly known as "EMBI Australia Pty Ltd."), an Australian proprietary limited company. About Skye Bioscience, Inc. We are a preclinical pharmaceutical company focused on the discovery, development and commercialization of a novel class of cannabinoid derivatives to modulate the endocannabinoid system, which has been shown to play a vital role in overall human health and, notably, in multiple ocular indications. We are developing novel cannabinoid derivatives through our own directed research efforts and multiple license agreements. We have retained Novotech as our contract research organization "CRO" in Australia and expect to commence a Phase 1 trial in the fourth quarter of 2022. We are also working towards filing our IND for SBI-100 by year end in anticipation of the start of our Phase 2 clinical trial in 2023. On May 11, 2022, we entered into an Arrangement Agreement (as amended, the “Arrangement Agreement”)with Emerald Health Therapeutics, Inc., a corporation existing under the laws of the Province of British Columbia, Canada (“EHT”), pursuant to which we agreed to acquire all of the issued and outstanding common shares of EHT (the “EHT Shares”) pursuant to a plan of arrangement under the Business Corporations Act (British Columbia) (the “Acquisition”). On November 7, 2022, EHT and the Company agreed to waive the mutual closing condition requiring the Company to obtain conditional approval from the Canadian Stock Exchange to list the common stock of the Company. The Acquisition was consummated on November 10, 2022. Under the terms of the Arrangement Agreement and the Plan of Arrangement, on November 10, 2022, each shares of EHT common stock (“EHT Shares”) outstanding immediately prior to the effective time of the Acquisition (the “Effective Time”) was transferred to the Company in exchange for 1.95 shares (the “Exchange Ratio”) of Company common stock. The cash and assets of EHT acquired in the Acquisition will be used to fund our Phase 1 and Phase 2 clinical trials. EHT is currently in the advanced stages of its realization process to wind down all prior operations and liquidate substantially all of its remaining assets. We expect this strategic opportunity to be a pivotal financing event for our business allowing us to extend our cash runway into at least the second quarter of 2023 and obtain meaningful clinical data. In addition, EHT has a lab facility which we are currently evaluating to determine whether it is practical to bring certain aspects of our research and development activities in house. Our Product Candidates and Significant Contracts Refer to our more recent Form 10-K filed with the Securities Exchange Commission for information regarding our product candidates and significant contracts. In June 2022, we received approval from Belberry Limited, a certified Australian Human Research Ethics Committee, to begin our Phase 1 clinical trial for the study of our lead product candidate, SBI - 100 OE. We subsequently notified the Australian Therapeutics Goods Administration of our intent to initiate our Phase 1 clinical trial through the Clinical Trial Notification scheme. In connection with this approval to initiate the first-in-human trial for SBI-100 by a governmental regulatory authority, we triggered the first milestone payment under our license agreement for UM 5050 with UM. In addition, during September of 2022 we completed the manufacture of the clinical trial material, SBI - 100 OE, for our Phase 1 clinical trial which is expected to commence before the end of 2022. During the quarter ended September 30, 2022, we initiated the manufacture of the active pharmaceutical ingredient to be used in our Phase 2 clinical trial. We obtained feedback from the FDA during our pre-IND meeting that we may commence our Phase 2 trial in the United States without having conducting a Phase 1 study. We expect to begin our Phase 2 trial in the first half of 2023. 36 Table of Contents General Trends and Outlook During the second quarter of 2022, we were indirectly impacted by a cyberattack on our Phase 1 clinical supply contract manufacturer. This disruption delayed our production timeline and the anticipated initiation of enrollment in our Phase 1 clinical studies for SBI-100 Ophthalmic Emulsion ("SBI-100 OE") to the fourth quarter of 2022. The overall potential delay in our drug product research and development from these types of incidents is unknown, but our operations and financial condition may continue to suffer in the event of continued business interruptions, supply chain issues, delayed clinical trials, production or a lack of laboratory resources due to the pandemic and other global conditions. It is possible that we may encounter other similar issues relating to the current situation that will need to be managed in the future. The factors to take into account in going concern judgements and financial projections include travel bans, restrictions, government assistance and potential sources of replacement financing, financial health of service providers and the general economy. Financial Overview We have incurred net losses and generated negative cash flows from operations since inception and expect to incur losses in the future as we continue development activities to support our product candidates through clinical trials. As a result, we expect to continue to incur operating losses and negative cash flows until our product candidates gain market acceptance and generate significant revenues. We have incurred operating losses and negative cash flows from operations since inception and as of September 30, 2022, had a working capital deficit of $3,462,290 and an accumulated deficit of $56,846,123. As of September 30, 2022, we had unrestricted cash in the amount of $415,389. For the three and nine months ended September 30, 2022 and 2021, we incurred losses from operations of $2,922,282 and $1,819,109, and 9,028,662 and 5,386,044, respectively. For the three and nine months ended September 30, 2022 and 2021, we incurred net losses of $3,127,283 and $1,824,818, and $9,589,960 and $6,009,362, respectively. We expect to continue to incur significant losses through 2022 and expects to incur significant losses and negative cash flows from operations in the future. Critical Accounting Policies and Estimates Our Management’s Discussion and Analysis of Financial Condition and Results of Operations section discusses our financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities at the date of the financial statements and the reported amounts of income and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgements, including those related to accrued expenses, the percentage of completion as it relates to our clinical accruals, financing operations, contingencies and litigation. Management bases its estimates and judgements on historical experience and on various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgements 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. The most significant accounting estimates inherent in the preparation of our financial statements include estimates and judgements as to the appropriate carrying values of our equity instruments, derivative liability, debt with embedded features, clinical accruals and the valuation of our stock based compensation awards, which are not readily apparent from other sources. We consider certain accounting policies related to fair value measurements, convertible instruments, warrants issued in connection with financings, stock-based compensation expense and earnings per share to be critical accounting policies that require the use of significant judgements and estimates relating to matters that are inherently uncertain and may result in materially different results under different assumptions and conditions. Management assessed the critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2021 and included a new " Asset Acquisition " policy note and made updates to its " Stock-based Compensation" policy note which are critical to its accounting policies and estimates during the nine months ended September 30, 2022 (Note 2). Recently Issued and Adopted Accounting Pronouncements See Note 2 to the accompanying Condensed Consolidated Financial Statements included in Part I, Item 1 of this Quarterly Report on Form 10-Q for information on recently issued accounting pronouncements and recently adopted accounting pronouncements. While we expect certain recently adopted accounting pronouncements to impact our estimates in future periods, the impact upon adoption was not significant to our current estimates and operations. 37 Table of Contents Results of Operations Our results of operations have fluctuated from period to period and may continue to fluctuate in the future, based upon the progress of our clinical trials, our research and development efforts, variations in the level of expenditures related to investor relations and seeking new sources of capital, debt service obligations during any given period, and the uncertainty as to the extent and magnitude of the residual global impacts from the COVID-19 pandemic such as supply chain disruptions and inflation. Results of operations for any period may be unrelated to results of operations for any other period. In addition, historical results should not be viewed as indicative of future operating results. Three months ended September 30, 2022 and 2021 Research and Development Expenses Research and development expenses included the following: • license fees; • employee-related expenses, which include salaries, benefits and stock-based compensation; • payments to third party contract research organizations and investigative sites; and • payments to third party manufacturing organizations and consultants. We expect to incur future research and development expenditures to support our preclinical and clinical studies. Preclinical activities include laboratory evaluation of product chemistry, toxicity and formulation, as well as animal studies to assess safety and efficacy. Our application to administer our lead drug candidate, SBI-100 OE, in human subjects has been submitted and approval was obtained by Belberry Limited, an Australian Human Research Ethics Committee (HREC) during the second quarter of 2022 and during the quarter ended September 30, 2022, we completed the production of SBI-100 OE clinical trial material for our Phase 1 study. We have received authorization from a certified Human Research Ethics Committee in Australia and appropriately notified the Australian Therapeutics Goods Administration that we intend to commence the Phase 1 clinical trial. We expect to initiate enrollment in our first-in-human study during the fourth quarter of 2022. Below is a summary of our research and development expenses during the three months ended September 30, 2022 and 2021: Three Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 Research and development expenses $ 1,781,724 $ 327,731 $ 1,453,993 444 % Research and development expenses for the three months ended September 30, 2022 increased by $1,453,993 as compared to the three months ended September 30, 2021. The increase in research and development expenses was primarily due to an increase in contract research and development activities, including $1,400,531 for the manufacturing of our Phase 1 clinical trial material for SBI-100 OE and the manufacture of API for our Phase 2 study. In addition, the Australian regulatory approval triggered a license fee milestone payment to UM for regulatory approval in Australia of $100,000. This increase was offset by a decrease in consulting fees of $56,696. General and Administrative Expenses Below is a summary of general and administrative expenses for the three months ended September 30, 2022 and 2021: Three Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 General and administrative expenses $ 1,140,558 $ 1,491,378 $ (350,820) (24) % 38 Table of Contents General and administrative expenses for the three months ended September 30, 2022 decreased by $350,820 as compared to the three months ended September 30, 2021. The decrease in general and administrative expenses was primarily due to a decrease in stock compensation expense of $278,321 related to the acceleration of a vesting provision and the extension of the post termination exercise period for two stock option awards that were modified in connection with the termination of a consultant which resulted in higher stock compensation expense during the three months ended September 30, 2021, as compared to the three months ended September 30, 2022. Decreases in general and administrative expenses also included decreases in consulting fees of $61,467, a decrease in employee wages of $82,360 related to a change in estimate in bonus accruals, decreases in investor relations expenses of $100,535 and decrease in recruiting fees of $49,120. The aggregate decrease was offset by increases of approximately $181,000 and $55,351 in employee salaries due to increases in headcount and software expenses, respectively. Other Expense (Income) Below is a summary of other expense (income) during the three months ended September 30, 2022 and 2021: Three Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 Change in fair value of derivative liabilities $ (6,228) $ (189,649) $ 183,421 (97) % Interest expense 211,229 195,358 15,871 8 % Total other expense $ 205,001 $ 5,709 $ 199,292 3491 % For the three months ended September 30, 2022, we had net other expense of $205,001 related to interest expense and a gain from the change in fair value of our warrant liability. When comparing the three months ended September 30, 2022 and 2021, total other expense increased by $199,292. Gains and losses from the change in fair value of our derivative liabilities are due primarily to fluctuations in our stock price and our volatility during each period. The increase in interest expense was due to an increase in the amortization of the debt discount on our Amended Credit Agreement for the period ended September 30, 2022, as compared to the period ended September 30, 2021. Nine months ended September 30, 2022 and 2021 Below is a summary of our research and development expenses during the nine months ended September 30, 2022 and 2021: Nine Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 Research and development expenses $ 4,474,531 $ 1,818,059 $ 2,656,472 146 % Research and development expenses for the nine months ended September 30, 2022 increased by $2,656,472 as compared to the nine months ended September 30, 2021. The increase in research and development expenses was primarily due to an increase in contract research and development activities, including $1,879,964 for the manufacturing of our Phase 1 clinical trial material for SBI-100 OE, the manufacture of API for our Phase 2 study and contracted site initiation costs for our Phase 1 clinical study. In addition, we incurred $113,717 in expense for the use of specialized consultants, had increased costs related to lab supplies and materials of $45,964, an increase in compensation cost of $467,370 due to bonus expense and additional headcount from the addition of regulatory and development personnel, an increase in software of $31,637 and an increase in license fees from meeting the first milestone under our license agreement with UM. General and Administrative Expenses Total general and administrative expenses for the nine months ended September 30, 2022 and 2021, were as follows: Nine Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 General and administrative expenses $ 4,554,131 $ 3,567,985 $ 986,146 28 % 39 Table of Contents General and administrative expenses for the nine months ended September 30, 2022 increased by $986,146 as compared to the nine months ended September 30, 2021. The increase in general and administrative expenses was primarily due to an increase in employee wages and board fees of $422,584 related to the hiring of our chief financial officer and the addition of two board members. Additionally, there were increases in professional and legal fees of $794,893 related primarily to preliminary diligence costs associated with the EHT Acquisition which were expensed as incurred during the first quarter and general legal fees, an increase in software expense of $113,596, and an increase in facilities and rent expense of $72,164. The aggregate increase was offset by decreases of $234,490 and 159,789 and $54,244 in investor relations expenses, consulting and recruiting expenses, respectively. Other Expense (Income) Total other expense (income) for the nine months ended September 30, 2022 and 2021, was as follows: Nine Months Ended September 30, 2022 2021 $ Change 2022 vs. 2021 % Change 2022 vs. 2021 Change in fair value of derivative liabilities $ (59,406) $ 169,349 $ (228,755) (135) % Interest expense 615,563 570,322 45,241 8 % Gain on forgiveness of PPP loan — (117,953) 117,953 100 % Total other expense $ 556,157 $ 621,718 $ (65,561) (11) % For the nine months ended September 30, 2022, we had net other expense of $556,157 related to interest expense, offset in part by a gain from the change in fair value of derivative liabilities. The primary reason for the gain on the change in fair value of our derivative liabilities was due to the decrease in our stock price and volatility, for the period ended September 30, 2022 as compared to the period ended September 30, 2021. The increase in interest expense was primarily due to an in increase in the amortization of the debt discount on our Amended Credit Agreement for the period ended September 30, 2022, as compared to the period ended September 30, 2021. For the nine months ended September 30, 2021, we had net other expense of $621,718 related to interest expense and a loss from the change in fair value of derivative liabilities. The primary reason for the loss on the change in fair value of our derivative liabilities was due to a increase in our stock price and volatility, for the period ended September 30, 2021, Other expenses during the period were offset by the gain on debt forgiveness realized from the PPP Loan. Liquidity, Going Concern and Capital Resources Liquidity and Going Concern We have incurred operating losses and negative cash flows from operations since our inception. We expect to continue to incur significant losses and negative cash flows from operations through 2022 and into the foreseeable future. We anticipate that we will continue to incur net losses in order to advance and develop potential drug candidates in preclinical and clinical development activities and support our corporate infrastructure, which includes the costs associated with being a public company and raising capital. Historically, we have funded our operations primarily through the issuance of equity securities and borrowings from Sciences. During the latter part of 2022 and in 2023, we expect to fund our operations through the strategic acquisition of EHT and subsequent liquidation of EHT's assets. Management expects that this funding opportunity will provide us with financing at least through the second quarter of 2023 which will allow Skye to complete its Phase 1 trial and commence its Phase 2 trial. During the nine months ended September 30, 2022, we expended significant resources on the acquisition of EHT and experienced transactional delays which resulted in the further extension of the outside date to close the transaction. Due to these delays, in October 2022 we obtained a working capital loan from EHT to continue operations through the date of closing. These two factors, among others, have resulted in an overall increase in cash used in operating activities for the nine months ended September 30, 2022. On November 10, 2022, we closed the Acquisition and acquired its remaining assets consisting primarily of cash and real estate. However, based on our expected cash requirements, without obtaining additional funding by the end of the second half of 2023, we will not have enough funds to continue operations. These conditions give rise to substantial doubt as to our ability to continue as a going concern within one year after the date that the financial statements are issued. 40 Table of Contents During the third quarter of 2022, we met our operational funding requirements during the pre-closing period by, among other things, laying off two employees and entered into a $700,000 working capital bridge loan from EHT. In late 2022 and early 2023, we will continue with the liquidation of EHT's assets and pursue financing transactions. However, we cannot provide any assurances that such additional funds will be available on reasonable terms, or at all. If we raise additional funds by issuing equity securities, dilution to existing stockholders would result. On October 5, 2018, we secured a Credit Agreement with Sciences, that provided us with a credit facility of up to $20,000,000. On April 29, 2020, we entered into the first amendment to the Credit Agreement with Sciences, which amended and restated the Credit Agreement. On March 29, 2021, we entered the second amendment to the Amended Credit Agreement to defer interest payments until the earlier of maturity or prepayment of the principal balance. Effective September 15, 2021, the disbursement line under the credit facility was closed and the Amended Credit Agreement no longer serves as a potential source of liquidity to the Company. The outstanding principal advances of $2,464,500 plus accrued interest of $305,734 was due on October 5, 2022 and we are currently within the 30 business day grace period for repayment. As of September 30, 2022, we had an accumulated deficit of $56,846,123, stockholders’ deficit of $3,284,981 and a working capital deficit of $3,462,290. We had unrestricted cash of $415,389 as of September 30, 2022, as compared to $8,983,007 as of December 31, 2021. The decrease was attributable to operating cash burn during the nine months ended September 30, 2022, which was accelerated due to Acquisition related costs and increases in our research and development expenses as we approach our Phase 1 clinical study. Without additional funding, management believes that we will not have enough funds to meet our obligations and continue our preclinical and clinical studies beyond one year after the date the Condensed Consolidated Financial Statements are issued. These conditions indicate it is probable that there is substantial doubt as to our ability to continue as a going concern, unless we are able to raise sufficient capital to continue our operations. Our prior independent registered public accounting firm has issued a report on our audited consolidated financial statements as of and for the year ended December 31, 2021, that included an explanatory paragraph referring to our recurring operating losses and expressing substantial doubt in our ability to continue as a going concern. Our Condensed Consolidated Financial Statements have been prepared on a going concern basis, which assumes the realization of assets and settlement of liabilities in the normal course of business. Our ability to continue as a going concern is dependent upon our ability to generate profitable operations in the future and/or to obtain the necessary financing to meet our obligations and repay our liabilities arising from normal business operations when they become due. The outcome of these matters cannot be predicted with any certainty at this time and raise substantial doubt that we will be able to continue as a going concern. Our Condensed Consolidated Financial Statements do not include any adjustments to the amount and classification of assets and liabilities that may be necessary should we be unable to continue as a going concern. Cash Flows The following is a summary of our cash flows for the periods indicated and has been derived from our Condensed Consolidated Financial Statements which are included elsewhere in this Form 10-Q: Nine Months Ended September 30, 2022 2021 Net cash used in operating activities $ (7,872,550) $ (4,506,032) Net cash used in investing activities (452,110) (36,828) Net cash (used in) provided by financing activities (242,955) 13,163,078 Cash Flows from Operating Activities The primary use of cash for our operating activities during the period was to fund research development activities for our preclinical product candidates and general and administrative activities. Our cash used in operating activities also reflected changes in our working capital, net of adjustments for non-cash charges, such as stock-based compensation, non-cash interest expense related to the amortization of our debt discounts on our related party Amended Credit Agreement, fair value adjustments related to our warrant liability and depreciation and amortization. Cash used in operating activities of $7,872,550 during the nine months ended September 30, 2022, reflected a net loss of $9,589,960, partially offset by aggregate non-cash charges of $930,372 and included a $787,038 net change in our operating assets and liabilities. Non-cash charges included $425,846 for stock-based compensation expense, $480,466 non-cash interest expense from the amortization of the debt discount on the multi-draw credit facility – related party, a $59,406 gain from the decrease in fair value of our warrant liability and $83,466 in depreciation and amortization. The net change in our operating assets and liabilities included a $334,127 increase in our accrued expense and other current liabilities and a $488,222 increase in our accounts payable. 41 Table of Contents Cash used in operating activities of $4,506,032 during the nine months ended September 30, 2021, reflected a net loss of $6,009,362, partially offset by aggregate non-cash charges of $1,247,113 and included a $256,217 net change in our operating assets and liabilities. Non-cash charges included $747,252 for stock-based compensation expense, $439,053 non-cash interest expense from the amortization of the debt discount on the multi-draw credit facility – related party, $9,412 depreciation and amortization of property and equipment, $169,349 loss from the increase in fair value of our warrant liability and $117,953 related to the forgiveness of the PPP loan. The net change in our operating assets and liabilities included a $149,213 decrease in our prepaid expense and other current assets, a $69,751 decrease in accounts payable and a $483,490 increase in our accrued expense and other current liabilities. Cash Flows from Investing Activities Our investing activities consist of our capital expenditures in relation to the purchase of property plant and equipment and costs incurred in connection with the acquisition of EHT. During the nine months ended September 30, 2022 and 2021, the Company purchased $15,556 and $36,828 in machinery office equipment, respectively. During the nine months ended September 30, 2022, the Company made $436,554 in payments for costs related to the Acquisition of EHT. During the nine months ended September 30, 2021, our investing activities have consisted primarily of our capital expenditures in relation to the purchase of property plant and equipment. Cash Flows from Financing Activities Cash flows from financing activities primarily reflect proceeds from the sale of our securities and debt financings. During the nine months ended September 30, 2022, cash used in financing activities included $1,967 in proceeds received in connection with the exercise of pre-funded warrants and a $244,922 repayment on the our insurance premium loan payable. During the nine months ended September 30, 2021, cash provided by financing activities included $7,011,799 in proceeds received in connection with the exercise of warrants, $6,146,496 in net proceeds from the issuance of common stock, pre-funded warrants and common stock warrants, and $4,783 received from employee stock option exercises. Off-Balance Sheet Arrangements There are no off-balance sheet arrangements that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources that is material to investors. Item 3. Quantitative and Qualitative Disclosures about Market Risk. Not applicable.