What changed in this filing

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Item 2. Management’s Discussion and Analysis

2021-08-13 compared with 2021-05-17 · 94 added, 53 removed, 219 unchanged (40% of the section changed)

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CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

This Quarterly Report on Form 10-Q, including the sections entitled “Risk Factors,” “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Description of Business,” contains express or implied forward-looking statements that are based on our management’s belief and assumptions and on information currently available to our management.

This Quarterly Report on Form 10-Q, including the sections entitled “Risk Factors” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” contains express or implied forward-looking statements that are based on our management’s belief and assumptions and on information currently available to our management.

Although we believe that the expectations reflected in forward-looking statements are reasonable, such statements involve known and unknown risks, uncertainties and other factors that may cause our actual results, performance or achievements to be materially different from any future results, performance or achievements expressed or implied by forward-looking statements.

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As a result of the Exchange and the change in our business and operations, a discussion of our past financial results is not pertinent, and under applicable accounting principles, the historical financial results of SmartKem, the accounting acquirer, prior to the Exchange are considered our historical financial results.

We are a pioneer in the development of materials and processes used to make organic thin-film transistors (OTFTs) for the manufacture of flexible electronics.

Our TRUFLEX® semiconductor technology deposits organic ink on a substrate at a temperature as low as 80°C, enabling manufacturers to use a range of low-cost flexible plastic substrates using existing industry standard equipment and infrastructure.

Our transistor stacks are flexible, bendable, wearable and lightweight and can be used in a number of different applications, including bendable smart-phone displays, curved automotive displays, e-paper displays, wearables, fingerprint sensors and printed biosensors.

We are a pioneer in the in the manufacture of Application Specific Organic Materials for organic thin-film transistor (OTFT) backplanes that power the next generation of flexible electronics, displays, sensors and logic.

Our unique TRUFLEX® technology allows inks to be deposited at a low temperature on low-cost substrates, resulting in transistor stacks that are flexible, bendable, wearable, and lightweight.

These can be used in a number of next generation display technologies including bendable smartphone displays, curved automotive displays, full color e-paper displays, wearables, fingerprint sensors, printed biosensors and logic.

Since our inception in 2009, we have devoted substantial resources to the research and development of materials and production processes for the manufacture of organic thin film transistors and the enhancement of our intellectual property.

Our loss before income taxes was $9.4 million and $20.0 million for the three months ended March 31, 2021 and 2020 respectively.

As of March 31, 2021, our accumulated deficit was $67.3 million.

Our loss before income taxes was $2.4 million and $1.1 million for the three months ended June 30, 2021 and 2020, respectively.

Our loss before income taxes was $11.8 million and $21.1 million for the six months ended June 30, 2021 and 2020, respectively.

As of June 30, 2021, our accumulated deficit was $69.7 million.

Substantially all of our

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We expect our expenses will increase in connection with our ongoing activities as we:

● continue to develop or core material, EDA tools and foundry services;

● continue to develop our core material, EDA tools and foundry services;

● add sales and field applications personnel and incur related expenses to support operational growth;

● increase activity directly related to promoting our products to increase revenues and add financial accounting and management systems and select personnel and incur additional legal and accounting expense as we operate as a public company.

● increase activity directly related to promoting our products to increase revenues;

● add financial accounting and management systems to position us for growth and incur additional legal and accounting expense as we operate as a public company.

Recent Developments

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The income associated with these items are recognized in the period which the research and development expenses occurred.

Additionally, during the three months ended March 31, 2021, the Company received government grants under the United Kingdom’s Coronavirus Job Retention Scheme.

Additionally, during the three months ended June 30, 2021, the Company received government grants under the United Kingdom’s Coronavirus Job Retention Scheme.

Operating Expenses

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The period-to-period comparisons of financial results in the tables below are not necessarily indicative of future results.

Three Months Ended March 31,

Three month-periods ended June 30, 2021 and 2020

Our results of operations for the three month-periods ended June 30, 2021 and 2020 are as follows:

Three Months Ended June 30,

Increase (Decrease)

Cost of revenue

Cost of revenues

Other Operating Income

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Loss from operations

Non-Operating Income (Expense)

Non Operating Income

Gain on foreign currency transactions

Interest expense

Interest income

Total non operating income

Loss before income tax

Income tax expense

Foreign Currency Translation

Total comprehensive loss

We did not record any revenue in the three months ended June 30, 2021 or for the comparable period of 2020.

Accordingly, revenue, cost of revenues and gross profit were all unchanged at $0 for both periods.

Other operating income increased by $70 thousand, or 37%, to $256 thousand for the three months ended June 30, 2021, compared to $186 thousand for the 2020 period.

Other operating income in the 2021 period largely comprised $252 thousand in research and development tax credit.

Other operating income in the comparable period of 2020 comprised $186 thousand in research and development tax credits.

Operating expenses increased $1.5 million, or 119%, to $2.7 million for the three months ended June 30, 2021, compared to $1.2 million for the comparable period of 2020.

The increase was primarily due to the matters described below.

Research and development expense, which represents 50% and 80% of our total operating expenses for the three months ended June 30, 2021 and 2020, respectively, increased by $0.4 million, or 36%, to $1.4 million for the three months ended June 30, 2021, compared to $1.0 million for the three months ended June 30, 2020.

The increase was primarily due to expenses incurred in further developing core materials and in fabricating demonstrator devices to promote our technology to prospective customers and partners.

Selling, general and administrative expense, which represents 50% and 20% of our total operating expenses for the three months ended June 30, 2021 and 2020 respectively increased by $1.1 million or 454% to $1.3 million for the three months ended June 30, 2021, compared to $0.2 million for the three months ended June 30, 2020.

This increase was mainly due to an increase in staff costs resulting from adding to our sales teams in the US and Asia and the strengthening of our finance team to prepare our company for US public company financial reporting, as well as from the additional legal, accounting and insurance expenses of operating as a public company.

The gain on foreign currency transactions was $57 thousand for the three months ended June 30, 2021, compared to $0 thousand for the three months ended June 30, 2020, an increase of $57 thousand.

The increase was due to fluctuations in U.S.

pound value arising from transactions denominated in foreign currencies and the translation of certain foreign currency subsidiary balances.

Interest income was less than $2 thousand for the three months ended June 30, 2021, compared to $1 thousand for the three months ended June 30, 2020.

The increase was due to higher average cash deposits during the second quarter of 2021 compared to the second quarter of 2020, offset by reductions in the credit interest rates on our cash deposits.

The loss before income taxes was $2.4 million for the three months ended June 30, 2021, an increase of $1.3 million, compared to a loss before income taxes of $1.1 million for the three months ended June 30, 2020.

The increase in loss was attributable to the higher research and development expense and the higher selling, general and administrative expense described in the preceding paragraphs.

Six month-periods ended June 30, 2021 and 2020

Our results of operations for the six month-periods ended June 30, 2021 and 2020 are as follows:

Six Months Ended June 30,

Increase (Decrease)

Cost of revenues

Other Operating Income

Operating Expenses

Research and development

Selling, general and administrative

Transaction expenses

Total operating expenses

Loss from operations

Non Operating Expense

Loss on foreign currency transactions

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Total non operating expense

Loss before income taxes

Loss before income tax

Income tax expense

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Total comprehensive loss

We did not record any revenue in the three months ended March 31, 2021.

Accordingly, and revenue, cost of revenues and gross profit were all $0 for the first quarter of 2021, a 100% decrease compared to the three months ended March 31, 2020.

Other operating income increased by $241 thousand, or 125%, to $433 thousand for the three months ended March 31, 2021, compared to $192 thousand for the 2020 period.

Other operating income in 2021 largely comprised $180

thousand in research and development grant monies plus $248 thousand of research and development tax credits.

Other income in 2020 comprised $192 thousand in research and development tax credits.

Operating expenses increased $7.7 million, or 468%, to $9.3 million for the three months ended March 31, 2021 compared to $1.6 million for the prior period of 2020.

We did not record any revenue in the six months ended June 30, 2021, compared to $20.8 thousand of revenue for the six months ended June 30, 2020.

Accordingly, revenue, cost of revenues and gross profit were all $0 for the first half of 2021, a 100% decrease in each of these balances compared to the six months ended June 30, 2020.

Other operating income increased by $310 thousand, or 82%, to $688 thousand for the six months ended June 30, 2021, compared to $378 thousand for the 2020 period.

Other operating income in 2021 largely comprised $499 thousand of research and development tax credits and $181 thousand in research and development grant monies.

Other operating income in 2020 comprised $378 thousand in research and development tax credits.

Operating expenses increased $9.1 million, or 318%, to $12.0 million for the six months ended June 30, 2021 compared to $2.9 million for the comparable period of 2020.

The increase was primarily due to the matters described below.

Research and development expense, which represents 43% and 68% of our total operating expenses for the three months ended March 31, 2021 and 2020, respectively, increased $2.9 million, or 261%, to $4.0 million for the three months ended March 31, 2021, compared to $1.1 million for the three months ended March 31, 2020.

The increase was due primarily to stock-based compensation expense in 2021 as detailed in Note 11 Stock-Based Compensation to our unaudited consolidated financial statements (Part I, Item 1 of this Form 10-Q).

Selling, general and administrative expense, which represents 43% and 32% of our total operating expenses for the three months ended March 31, 2021 and 2020 respectively increased by $3.5 million or 657% to $4.0 million for the three months ended March 31, 2021, compared to $0.5 million for the three months ended March 31, 2020.

This increase was mainly due to stock based-compensation expense in 2021 as detailed in Note 11 Stock-Based Compensation to our unaudited consolidated financial statements (Part I, Item 1 of this Form 10-Q).

Transaction costs of $1.3 million associated with the Exchange were incurred in the three months ended 31 March 2021.

Non-Operating Income (Expense)

The loss on foreign currency transactions was $470 thousand for the three months ended March 31, 2021, compared to $2 thousand for the three months ended March 31, 2020, an increase of $468 thousand.

Research and development expense, which represents 45% and 73% of our total operating expenses for the six months ended June 30, 2021 and 2020, respectively, increased by $3.3 million, or 154%, to $5.4 million for the six months ended June 30, 2021, compared to $2.1 million for the six months ended June 30, 2020.

The increase was primarily due to stock-based compensation expense in 2021 as detailed in Note 11 Share-Based Compensation to our unaudited consolidated financial statements (Part I, Item 1 of this Form 10-Q) and expenses incurred in further developing core materials and in fabricating demonstrator devices to promote our technology to prospective customers and partners.

Selling, general and administrative expense, which represents 44% and 27% of our total operating expenses for the six months ended June 30, 2021 and 2020, respectively, increased by $4.6 million or 593% to $5.3 million for the six months ended June 30, 2021, compared to $0.8 million for the six months ended June 30, 2020.

This increase was mainly due stock-based compensation expense in 2021 as detailed in Note 11 Share-Based Compensation to our

unaudited consolidated financial statements (Part I, Item 1 of this Form 10-Q), from adding to our sales teams in the US and Asia and the strengthening of our finance team to prepare our company for US public company financial reporting, as well as from the additional legal, accounting and insurance expenses of operating as a public company.

Transaction costs of $1.3 million associated with the Exchange were incurred in the six months ended June 30, 2021.

The loss on foreign currency transactions was $413 thousand for the six months ended June 30, 2021, compared to $1 thousand for the six months ended June 30, 2020, an increase of $412 thousand.

The increase was due to fluctuations in U.S.

pound value arising from transactions denominated in foreign currencies and the translation of certain foreign currency subsidiaries balance.

Interest expense was $19 thousand for the three months ended March 31, 2021, compared to $6.8 million for the three months ended March 31, 2020, a decrease of $6.8 million.

pound value arising from transactions denominated in foreign currencies and the translation of certain foreign currency subsidiary balances.

Interest expense was $19 thousand for the six months ended June 30, 2021, compared to $6.8 million for the six months ended June 30, 2020, a decrease of $6.8 million.

The decrease resulted from the conversion in early 2020 of all outstanding loan notes to equity which resulted in the interest expense recognition of unamortized loan discounts.

Interest income was less than $1 thousand for the three months ended March 31, 2021, compared to $2 thousand for the three months ended March 31, 2020 as a result of lower average cash deposits during the first quarter of 2021 compared to the first quarter of 2020.

The change in fair value of derivative assets was zero for the three months ended March 31, 2021, compared to $6.3 million for the three months ended March 31, 2020, a decrease of $6.3 million or 100%.

Interest income was $2 thousand for the six months ended June 30, 2021, compared to $3 thousand for the six months ended June 30, 2020 as a result of reductions in the credit interest rates on our cash deposits.

The change in fair value of derivative assets was zero for the six months ended June 30, 2021, compared to $6.3 million for the six months ended June 30, 2020, a decrease of $6.3 million or 100%.

The 2020 change in market value reflected the change in probability of conversion immediately before the conversion date.

The loss on conversion of convertible notes payable was zero for the three months ended March 31, 2021, compared to $5.5 million for the three months ended March 31, 2020.

The loss on conversion of convertible notes payable was zero for the six months ended June 30, 2021, compared to $5.5 million for the six months ended June 30, 2020.

This loss was measured as the difference between the fair value of the A ordinary shares issued and the carrying value of the convertible loan notes plus accrued interest and the fair market value of the embedded derivative on the date of conversion in 2020.

The net loss was $9.4 million for the three months ended March 31, 2021, a decrease of $10.6 million, compared to a net loss of $20.0 million for the three months ended March 31, 2020.

The decrease in loss was attributable to a reduction in non-operating losses resulting from the accounting recognition of loans converted to equity during 2020, offset by stock compensation expense and transaction costs from the Exchange in the 2021 period.

The loss before income taxes was $11.8 million for the six months ended June 30, 2021, a decrease of $9.3 million, compared to a loss before income taxes of $21.1 million for the six months ended June 30, 2020.

The decrease in loss was attributable to a reduction in non-operating losses resulting from the accounting recognition of loans converted to equity during 2020, partially offset by higher stock compensation expense, transaction costs from the Exchange in 2021 and operating expenses associated with being a public company.

Liquidity and Capital Resources

Since inception, we have not generated significant revenue from product sales, and we have incurred significant operating losses and had an accumulated deficit of $67.3 million as of March 31, 2021.

Since inception, we have not generated significant revenue from product sales, and we have incurred significant operating losses and had an accumulated deficit of $69.7 million as of June 30, 2021.

We have not commercialized any products and may not generate significant revenue from product sales during 2021, if at all.

To date, we have funded our operations primarily with proceeds from the private sale of equity and debt securities and borrowing against our research and development credits.

As of March 31, 2021, our cash and cash equivalents were $19.2 million.

As of June 30, 2021, our cash and cash equivalents were $16.4 million.

The following table shows a summary of our cash flows for the periods presented:

Three Months Ended March 31,

Six Months Ended June 30,

Net cash used in operating activities

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Operating Activities

Net cash used in operating activities was $3.7 million for the three months ended March 31, 2021, compared to $1.6 million for the three months ended March 31, 2020, an increase of $2.1 million.

The increase resulted primarily from lower R&D grant receipts in 2021 and the expenses incurred in connection with the Exchange.

Net cash used in operating activities was $6.4 million for the six months ended June 30, 2021, compared to $2.8 million for the six months ended June 30, 2020, an increase of $3.6 million.

The increase resulted primarily from lower research and development grant receipts in 2021, the expenses incurred in connection with the Exchange and increased operating expenses associated with being a public company.

Investing Activities

We used no cash in investing activities during the three months ended March 31, 2021, compared to net cash used of $15 thousand for the three months ended March 31, 2020, a decrease of $15 thousand.

The decrease resulted primarily from a lower level of investment in laboratory and capital equipment in 2021.

We used $121 thousand of cash in investing activities during the six months ended June 30, 2021, compared to net cash used of $88 thousand for the six months ended June 30, 2020, an increase of $33 thousand.

The increase resulted primarily from a higher level of investment in laboratory and capital equipment in 2021.

Financing Activities

Net cash provided by financing activities was $22.2 million for the three months ended March 31, 2021 compared with $4.3 million generated from financing activities in 2020.

Net cash provided by financing activities during the three months ended March 31, 2021 resulted primarily from the net proceeds of the Offering.

We expect that our cash and the net proceeds from the Offering will be sufficient to support our operations through the first half of 2023.

Net cash provided by financing activities was $22.2 million for the six months ended June 30, 2021 compared with $4.3 million generated from financing activities in 2020.

Net cash provided by financing activities during the six months ended June 30, 2021 resulted primarily from the net proceeds of the Offering.

We expect that our cash and the net proceeds from the Offering will be sufficient to support our operations through the first quarter of 2023.

We will need to obtain additional funds to satisfy our operational needs and to fund our sales and marketing efforts, research and development expenditures, and business development activities.

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To the extent that we raise additional capital through the sale of equity or convertible debt securities, your ownership interest will be diluted, and the terms of these securities may include liquidation or other preferences that adversely affect your rights as a common stockholder.

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.

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, strategic alliances or marketing, distribution or licensing arrangements with third parties, we may have to relinquish valuable rights to our technologies, future revenue streams, research programs or products, or grant licenses on terms that may not be favorable to us.

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SmartKem has agreed to certain affirmative and negative covenants in the Facility Agreement requiring SmartKem to provide certain information to the Lender and preventing SmartKem from, among other things:

(i) incurring additional indebtedness for borrowed money, (ii) making certain payments to insiders, (iii) selling, transferring or otherwise disposing of assets other than in the ordinary course of business or in other limited circumstances, (iv) creating any additional security interest on any of its assets, (v) engaging in any sale lease-back transaction, (vi) selling, transferring or otherwise disposing of its receivables on recourse terms, (vii) entering into any arrangement under which money or the benefit of a bank or other account may be applied, set-off or made subject to a combination of accounts, or (viii) entering into any other preferential arrangement.

(i) incurring additional indebtedness for borrowed money,

(ii) making certain payments to insiders, (iii) selling, transferring or otherwise disposing of assets other than in the ordinary course of business or in other limited circumstances, (iv) creating any additional security interest on any of its assets, (v) engaging in any sale lease-back transaction, (vi) selling, transferring or otherwise disposing of its receivables on recourse terms, (vii) entering into any arrangement under which money or the benefit of a bank or other account may be applied, set-off or made subject to a combination of accounts, or (viii) entering into any other preferential arrangement.

Upon the occurrence of any event of default (defined to include, among other things, payment defaults, a breach of any representation, warranty or covenant, certain bankruptcy-related events or a Change of Control of SmartKem), the Lender may declare all amounts outstanding under the Facility due and owing (at which point interest would begin to accrue at a default rate of 4% per month) and exercise its rights with respect to its security interest in SmartKem’s assets.

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To the extent that there are differences between our estimates and actual results, our future financial statement presentation, financial condition, results of operation, and cash flows will be affected.

A summary of our critical accounting policies is presented in Note 2 Summary of Significant Accounting Policies to our unaudited

consolidated financial statements (Part I, Item 1 of this Form 10-Q).

There were no material changes to our critical accounting policies during the three months ended March 31, 2021.

A summary of our critical accounting policies is presented in Note 2 Summary of Significant Accounting Policies to our unaudited consolidated financial statements (Part I, Item 1 of this Form 10-Q).

There were no material changes to our critical accounting policies during the three and six months ended June 30, 2021.

Going Concern Evaluation

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We have experienced recurring losses since inception and expect to incur additional losses in the future in connection with research and development activities.

In the three months ended March 31, 2021, we raised net proceeds of $22.2 million through the Offering and at March 31, 2021 we had $19.2 million of cash after funding net cash used in operations for the three month period ended March 31, 2021 of $3.7 million.

In the six months ended June 30, 2021, we raised net proceeds of $22.2 million through the Offering and at June 30, 2021 we had $16.4 million of cash after funding net cash used in operations for the six month period ended June 30, 2021 of $6.4 million, $2.7 million of which was used in the three months ended June 30, 2021.

We expect that our available cash balances will provide sufficient liquidity to fund our current obligations and projected working capital and capital expenditure requirements for at least the next 12 months.

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Internal Control Over Financial Reporting

During the year ended December 31, 2020 and for the period ended March 31, 2021, our management and independent registered public accounting firm identified material weaknesses related (i) the fact that certain members of our finance team and personnel are able to operate across a number of different functions and have user access that gives rise to segregation of duties risks in connection with our information technology infrastructure and (ii) the fact that policies and procedures with respect to the review, supervision and monitoring of our accounting and reporting functions were either not designed and in place, or not operating effectively.

During the year ended December 31, 2020 and for the period ended June 30, 2021, our management and independent registered public accounting firm identified material weaknesses related (i) the fact that certain members of our finance team and personnel are able to operate across a number of different functions and have user access that gives rise to segregation of duties risks in connection with our information technology infrastructure and (ii) the fact that policies and procedures with respect to the review, supervision and monitoring of our accounting and reporting functions were either not designed and in place, or not operating effectively.

We are currently in the process of remediating these material weaknesses and are taking steps that we believe will address their underlying causes.

We have recruited additional finance personnel including those with expertise in generally accepted accounting principles and controls over financial reporting, have implemented measures to restrict system access and have commenced design, documentation and operation of policies and procedures covering our accounting and reporting functions.

We have recruited additional finance personnel including those with expertise in generally accepted accounting principles and controls over financial reporting, have implemented measures to restrict system access and have, with the support of external experts, commenced design, documentation and operation of policies and procedures covering our accounting and reporting functions.

Under the direction of the Audit Committee, management will continue to review and make necessary changes to the overall design of our internal control environment, as well as to policies and procedures to improve the overall effectiveness of internal controls during the period ending December 31, 2021.

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Compared sentence by sentence after normalising whitespace, quotation marks, case and digits, so re-formatting and restated figures do not read as changed language. Wording changes appear as one removal and one addition. The current filing and the prior one are authoritative.

What changed 10-Q

Item 2. Management’s Discussion and Analysis