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Item 2. Management’s Discussion and Analysis

2022-08-23 compared with 2022-08-23 · 210 added, 93 removed, 117 unchanged (72% of the section changed)

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 together with our unaudited interim condensed consolidated financial statements and the related notes and other financial information included in this Report.

The following discussion and analysis of our financial condition and results of operations should be read together with our unaudited condensed consolidated interim financial statements and the related notes and other financial information included in this Report.

Some of the information contained in this discussion and analysis or set forth elsewhere in this Report, including information with respect to our plans and strategy for our business, includes forward-looking statements that involve risks and uncertainties as described under the heading “Cautionary Note on Forward-Looking Statements” below.

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CAUTIONARY NOTE ON FORWARD-LOOKING STATEMENTS

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.

This Quarterly Report on Form 10-Q/A, 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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● our relationships with our executive officers, directors and significant stockholders;

● our expectations regarding our classification as a “smaller reporting company,” as defined under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), and an “emerging growth company” under the JOBS Act (as defined below) in future periods;

● our expectations regarding our classification as a “smaller reporting company,” as defined under the

Securities Exchange Act of 1934, as amended (the “Exchange Act”), and an “emerging growth company” under the JOBS Act (as defined below) in future periods;

● our future financial performance;

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● the identified material weaknesses in our internal control over financial reporting and our ability to remediate those material weaknesses;

● the timing of the consummation of the purchase by the Octopus Investors (as defined below) of our common stock;

● other risks and uncertainties, including those listed under the caption “Risk Factors.”

These statements relate to future events or our future operational or financial performance, and 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 these forward-looking statements.

Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” and elsewhere in this Form 10-Q.

Any forward-looking statement in this Form 10-Q reflects our current view with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our business, results of operations, industry and future growth.

Factors that may cause actual results to differ materially from current expectations include, among other things, those listed under “Risk Factors” and elsewhere in this Form 10-Q/A.

Any forward-looking statement in this Form 10-Q/A reflects our current view with respect to future events and is subject to these and other risks, uncertainties and assumptions relating to our business, results of operations, industry and future growth.

Given these uncertainties, you should not place undue reliance on these forward looking statements.

No forward-looking statement is a guarantee of future performance.

You should read this Form 10-Q and the documents that we reference in this Form 10-Q and have filed with the SEC as exhibits hereto completely and with the understanding that our actual future results may be materially different from any future results expressed or implied by these forward-looking statements.

You should read this Form 10-Q/A and the documents that we reference in this Form 10-Q/A and have filed with the SEC as exhibits hereto completely and with the understanding that our actual future results may be materially different from any future results expressed or implied by these forward-looking statements.

Except as required by law, we assume no obligation to update or revise these forward looking statements for any reason, even if new information becomes available in the future.

On February 23, 2021, we entered into a Share Exchange Agreement (the “Exchange Agreement”) with SmartKem Limited (“SmartKem”), a private company incorporated under the Laws of England and Wales, and the former shareholders of SmartKem.

Pursuant to the Exchange Agreement, all of the equity interests in SmartKem, except certain “deferred shares” which had no economic or voting rights (“Deferred Shares”) and which were purchased by us for an aggregate purchase price of $1.40, were exchanged for shares of our common stock, par value $0.0001 per share (“common stock”), and SmartKem became our wholly owned subsidiary (the “Exchange”).

The Exchange was consummated on February 23, 2021.

As a result of the Exchange, we legally acquired the business of SmartKem and are continuing the existing business operations of SmartKem as a public reporting company under the name SmartKem, Inc.

The Exchange was treated as a recapitalization and reverse acquisition for us for financial reporting purposes, and SmartKem is considered the acquirer for accounting purposes.

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 seeking to reshape the world of electronics with a revolutionary semiconductor platform that enables a new generation of displays, sensors and logic.

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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 $2.8 million and $9.4 million for the three months ended March 31, 2022 and 2021, respectively.

As of March 31, 2022, our accumulated deficit was $77.8 million.

Substantially all our operating losses have resulted from expenses incurred in connection with research and development activities and from general and administrative costs associated with our operations.

Our loss before income taxes was $2.7 million and $0.6 million for the three months ended September 30, 2021 and 2020, respectively.

Our loss before income taxes was $14.4 million and $21.7 million for the nine months ended September 30, 2021 and 2020, respectively.

As of September 30, 2021, our accumulated deficit was $72.4 million.

Substantially all of our operating losses have resulted from expenses incurred in connection research and development activities and from general and administrative costs associated with our operations.

We expect to continue to incur significant expenses and operating losses for the foreseeable future.

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

● 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;

● 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

Octopus Share Purchase

On January 27, 2022, we sold an aggregate of 1,000,000 shares of our common stock at a purchase price of $2.00 per share to Octopus Titan VCT plc and Octopus Investments Nominees Limited in accordance with the Letter Agreement, dated as of February 23, 2021, between the Company and Octopus Titan VCT plc and certain related parties.

Nanosys Inc., Joint Development Agreement

In February 2022, we entered into a joint development agreement with Nanosys Inc., a leader in developing and delivering quantum dot and micro-LED technology.

Under this agreement the two parties will work together on a new generation of low-cost solution printed micro-LED and quantum dot materials for advanced displays.

The Exchange was consummated on February 23, 2021.

On February 23, 2021, our board of directors and all of our pre-Exchange stockholders approved an amended and restated certificate of incorporation, which was effective upon its filing with the Secretary of State of the State of Delaware on February 23, 2021 and through which we changed our name to “SmartKem, Inc.” On February 23, 2021, our board of directors and all of our pre-Exchange stockholders also adopted restated bylaws.

At the closing of the Exchange (the “Closing”), each SmartKem ordinary share issued and outstanding immediately prior to the Closing (other than the Deferred Shares) was exchanged for 0.0111907 of a share of our common stock and each SmartKem A ordinary share issued and outstanding immediate prior to the Closing was exchanged for 0.0676668 of a share of our common stock, with the maximum number of shares of our common stock issuable to the former holders of SmartKem’s ordinary shares and A ordinary shares equal to 12,725,000.

This includes enterprise management incentive options to purchase 124,497,910 SmartKem ordinary shares (the “SmartKem EMI Options”) issued and outstanding immediately prior to the Closing that were accelerated and exercised by the holders thereof for a like number of ordinary shares and exchanged for shares of our common stock pursuant to the Exchange.

Immediately prior to the Closing, an aggregate of 2,500,000 shares of our common stock owned by our stockholders prior to the Exchange were forfeited and cancelled (the “Stock Forfeiture”).

In addition, pursuant to the Exchange Agreement and upon Closing, the unexercised non tax- advantaged options (the “SmartKem Unapproved Options”) to purchase SmartKem ordinary shares issued and outstanding were waived and released by the holders in consideration for new options to purchase such number of shares of our common stock equal to the number of shares of SmartKem ordinary shares subject to the relevant SmartKem Unapproved Option immediately prior to the Exchange, multiplied by the applicable Exchange conversion ratio (which was equal to 0.0111907), with any fraction rounded to the nearest whole number.

The exercise price per share of each such new

option is equal to the then-current exercise price of the relevant SmartKem Unapproved Option divided by the applicable Exchange conversion ratio (which was equal to 0.0111907) (rounded to the nearest one-tenth of one cent), except for new options issued to a U.S.

person which have an exercise price of $2.00 per share.

The new options were issued pursuant to our 2021 Plan.

The new options replacing the SmartKem Unapproved Options cover an aggregate of 402,586 shares of our common stock, with options covering 336,557 shares of our common stock having an exercise price of $0.001 per share and the options covering the remaining 66,029 shares of our common stock having an exercise price of $2.00 per share.

SmartKem is considered the accounting acquirer in the Exchange and will account for the transaction as a capital transaction because SmartKem’s former shareholders received substantially all of the voting rights in the combined entity and SmartKem’s senior management represents all of the senior management of the combined entity.

Private Placement

Following the Closing, on February 23, 2021, we sold 10,162,000 shares of our common stock and pre- funded warrants to purchase up to 2,168,000 shares of our common stock for aggregate gross proceeds of approximately $24.6 million pursuant to a private placement offering of our common stock (or pre-funded warrants in lieu thereof) at a purchase price of $2.00 per share or $1.99 per pre-funded warrant, as applicable.

Pursuant to the offering, we offered to certain purchasers whose purchase of shares of our common stock in the offering would otherwise have resulted in the purchaser, together with its affiliates and certain related parties, beneficially owning more than 4.99% (or, at the election of the purchaser, 9.99%) of our outstanding common stock immediately following the closing of the offering, the opportunity to purchase, if any such purchaser so chose, pre-funded warrants in lieu of shares of our common stock that would otherwise have resulted in such purchaser’s beneficial ownership exceeding 4.99% (or, at the election of the purchaser, 9.99%) of our outstanding common stock, at a purchase price of $1.99 per pre-funded warrant.

Each pre-funded warrant is exercisable for one share of our common stock at an exercise price of $0.01 per share.

The private placement offering is referred to herein as the “Offering.”

Key Factors Affecting Our Performance

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Components of Results of Operations

There have been no material changes to the key components of our Condensed Consolidated Statements of Operations as described in “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in our 2021 Form 10-K.

Our revenue currently consists of revenue from the sale of demonstration products.

Cost of Revenues.

Cost of revenues consists of (1) direct product costs incurred for the raw materials and manufacturing services for our products, (2) fixed product costs primarily relating to production, manufacturing and personnel and (3) depreciation consisting primarily of expenses related to our fixed assets.

We expect our cost of goods sold attributable to direct product costs to increase proportionately with increases in revenue, and our cost of goods sold attributable to fixed product costs to remain substantially flat or moderately increase in connection with increases in revenue.

Other Operating Income.

Our other income includes government grants received for qualifying research and development projects, and research and development tax credits related to the United Kingdom’s Research and Development Expenditure Credit scheme, which is a government tax incentive designed to reward innovative companies for investing in research and development.

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

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

Operating Expenses

Research and Development.

Research and development expenses consist primarily of compensation and related costs for personnel, including share-based compensation and employee benefits as well as costs associated with design, fabrication and testing of OTFT devices.

In addition, research and development expenses include depreciation expenses related to our fixed assets.

We expense research and development expenses as incurred.

As we continue to invest in developing our technology for new products, we expect research and development expenses to remain flat or moderately increase in absolute dollars but to decline as a percentage of revenue.

Selling, General and Administrative.

Selling, general and administrative expenses consist primarily of allocated compensation and related costs for personnel, including share-based compensation, employee benefits and travel.

In addition, general and administrative expenses include third-party consulting, legal, audit, accounting services, allocations of overhead costs, such as rent, facilities and information technology.

We expect general and administrative expenses to increase in absolute dollars in future periods due to additional legal, accounting, insurance, investor relations and other costs associated with being a public company, as well as other costs associated with growing our business.

Non Operating Income (Expense)

Interest Expense.

We issued convertible loans to a number of investors in 2018 and 2019.

These loans were all converted to equity in 2020.

The loans contained a beneficial conversion feature that resulted in a loan discount upon issue which was recognized as interest expense over the lifetime of the loan.

Upon conversion of the loans the remaining unamortised loan discount was recognized as interest expense in 2020.

Interest Income.

Interest income is interest on our cash deposits.

Other Income;

Other income is the gain or loss on remeasurement of lease liabilities

Changes in Fair Value of Derivative Assets.

The convertible loans contained variable conversion price scenarios that were evaluated and determined to be derivatives that were bifurcated from the loan notes and accounted for separately.

The resulting derivative is accounted for at estimated market value with changes in the market value recorded in income.

Loss on Conversion of Convertible Notes.

In January 2020 when the convertible loan notes were converted to A ordinary shares, a loss on conversion was recognized.

The loss represents 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.

Income Tax Expense.

Income tax expense consists primarily of income taxes in jurisdictions in which we conduct business.

We did not incur any income tax in 2021 or 2020.

Foreign Currency Translation.

Foreign currency translation reflect adjustments made due to currency fluctuations.

Results of Operations

The following tables set forth our results of operations for the periods presented.

The information in the tables below should be read in conjunction with our unaudited interim condensed consolidated financial statements and related notes included in Part I, Item 1 of this Form 10-Q.

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

The following information has been adjusted to reflect the restatement of our financial statements as described under the heading Restatement of Previously Issued Financial Statements in Note 1 Business and Basis of Preparation in the Notes to Financial Statements of this Quarterly Report.

Comparison of Loss from Operations for the three month-periods ended March 31, 2022 and 2021

Our results of operations for the three month-periods ended March 31, 2022 and 2021 are as follows:

Three Months Ended March 31,

The following information has been adjusted to reflect the restatement of our financial statements as described under the heading Restatement of Previously Issued Financial Statements in Note 1 Business and Liquidity in the Notes to Financial Statements of this Quarterly Report.

Three month-periods ended September 30, 2021 and 2020

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

Three Months Ended September 30,

Increase (Decrease)

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Loss from operations

Revenue and Cost of Revenue

Revenues were $30 thousand in the three months ended March 31, 2022, compared with none in the same period of 2021.

Revenue in the first quarter of 2022 resulted from the one-time sale of TRUFLEX® materials to a leading applied technology research institute.

Cost of revenue was $23 thousand in the three months ended March 31, 2022, compared with none in the same period of 2021.

Cost of revenue resulted from the sale of the materials described above.

Other operating income

Three Months Ended March 31,

Non Operating (Expense)/Income

(Loss)/gain on foreign currency transactions

Interest expense

Interest income

Total non operating (expense)/income

Loss before income taxes

Income tax expense

Foreign Currency Translation

Total comprehensive loss

We did not record any revenue in the three months ended September 30, 2021, compared to $50 thousand of revenue for the three months ended September 30, 2020.

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

Other operating income decreased by $300 thousand, or 40%, to $447 thousand for the three months ended September 30, 2021, compared to $747 thousand for the 2020 period.

Other operating income in 2021 comprised research and development tax credits while in 2020 it comprised $245 thousand of research and development tax credits and $502 thousand of research and development grant monies.

Operating expenses increased $1.3 million, or 95%, to $2.7 million for the three months ended September 30, 2021, compared to $1.4 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 79% of our total operating expenses for the three months ended September 30, 2021 and 2020, respectively, increased by $0.3 million, or 23%, to $1.4 million for the three months ended September 30, 2021, compared to $1.1 million for the three months ended September 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 21% of our total operating expenses for the three months ended September 30, 2021 and 2020, respectively increased by $1.1 million or 368% to $1.4 million for the three months ended September 30, 2021, compared to $0.3 million for the three months ended September 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’s US public company financial reporting, as well as from the additional legal, accounting and insurance expenses of operating as a public company.

The loss on foreign currency transactions was $386 thousand for the three months ended September 30, 2021, compared to a gain of $1 thousand for the three months ended September 30, 2020, an increase of $387 thousand.

The loss 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 $1 thousand for the three months ended September 30, 2021, compared to $0 for the three months ended September 30, 2020.

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

The loss before income taxes was $2.7 million for the three months ended September 30, 2021, an increase of $2.0 million, compared to a loss before income taxes of $0.6 million for the three months ended September 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.

Nine month-periods ended September 30, 2021 and 2020

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

Nine Months Ended September 30,

Increase (Decrease)

Research & development tax credit

Research & development grants

Total other operating income

Other Operating Income was $284 thousand in the three months ended March 31, 2022, compared to $433 thousand in the same period of 2021, a decrease of $149 thousand, or 34%.

The decrease resulted primarily from the absence of research and development grants in the first three months of 2022, partially offset by an increase in research and development tax credits.

In the first quarter of 2021, we received $179 thousand in research and development funding for our work on the “SmartLight” project that successfully demonstrated OTFT mini-LED backlights for displays with improved light uniformity and lower defects.

The increase in research and development tax credits in the first quarter of 2022 resulted from a higher level of eligible expenditure compared to the comparable period of 2021.

Cost of revenue

Other Operating Income

Operating Expenses

Three Months Ended March 31,

Increase (Decrease)

Research and development

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Total operating expenses

Operating expenses decreased $6.6 million, or 71%, to $2.7 million for the three months ended March 31, 2022, compared to $9.3 million for the comparable period of 2021.

Research and development expense, which represents 54% and 43% of our total operating expenses for the three months ended March 31, 2022 and 2021, respectively, decreased by $2.6 million to $1.5 million for the quarter, primarily due to a $3.0 million decrease in stock compensation expense, partially offset by a $400 thousand increase in 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 46% and 43% of our total operating expenses for the three months ended March 31, 2022 and 2021, respectively decreased by $2.7 million to $1.2 million for the quarter.

This decrease was mainly due to a $3.1 million decrease in stock compensation expense offset by $0.4 million additional expense from the additional legal, accounting and insurance expenses of operating as a public company and from increased marketing and related expenses promoting our products.

Transaction costs of $1.3 million associated with the Exchange were incurred in the three-month period ended March 31, 2021.

The Exchange was consummated during the first quarter of 2021 and no additional Exchange-related expenses were recorded thereafter.

Non-operating (expense)/income

Three Months Ended March 31,

Increase (Decrease)

Loss from operations

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Interest expense

Interest income

Change in fair value of derivative asset

Loss on conversion of convertible notes payable

Total non operating expense

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Income tax expense

Non-operating expenses for the three months ended March 31, 2022 decreased $135 thousand, or 28%, to $354 thousand, compared to $489 thousand for the three months ended March 31, 2021, as a result of lower losses on foreign currency transactions due to fluctuations in U.S.

pound value arising from transactions denominated in foreign currencies and the translation of foreign currency denominated balances on intra-group loans.

Loss before income taxes was $2.8 million for the three months ended March 31, 2022, a decrease of $6.6 million, or 71%, compared to $9.4 million for the three months ended March 31, 2021.

The decrease in loss before income taxes was attributable to the lower research and development expense and the lower selling, general and administrative expense described in the preceding paragraphs.

Foreign Currency Translation

Total comprehensive loss

We did not record any revenue in the nine months ended September 30, 2021, compared to $71 thousand of revenue for the nine months ended September 30, 2020.

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

Other operating income was $1.1 million for both the nine months ended September 30, 2021 and the nine months ended September 30, 2020.

Other operating income in 2021 largely comprised $944 thousand of research and development tax credits and $181 thousand in research and development grant monies.

Other operating income in 2020 comprised $623 thousand of research and development tax credits and $502 thousand of research and development grant monies.

Operating expenses increased $10.5 million, or 245%, to $14.7 million for the nine months ended September 30, 2021, compared to $4.3 million for the comparable period of 2020.

The increase was primarily due to the matters described below.

Research and development expense, which represents 46% and 75% of our total operating expenses for the nine months ended September 30, 2021 and 2020, respectively, increased by $3.5 million, or 109%, to $6.7 million for the nine months ended September 30, 2021, compared to $3.2 million for the nine months ended September 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/A) 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 45% and 25% of our total operating expenses for the nine months ended September 30, 2021 and 2020, respectively, increased by $5.6 million, or 531%, to $6.7 million for the nine months ended September 30, 2021, compared to $1.1 million for the nine months ended September 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/A), from adding to our sales teams in the US and Asia and the strengthening of our finance team to prepare our company’s 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 nine months ended September 30, 2021.

The loss on foreign currency transactions was $799 thousand for the nine months ended September 30, 2021, compared to $0 for the nine months ended September 30, 2020, an increase of $799 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 expense was $19 thousand for the nine months ended September 30, 2021, compared to $6.8 million for the nine months ended September 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 $3 thousand for the nine months ended September 30, 2021, unchanged from the nine months ended September 30, 2020.

Reductions in the credit interest rates on our cash deposits offset the higher average cash deposits held in 2021.

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

The decrease resulted from 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 $0 for the nine months ended September 30, 2021, compared to $5.5 million for the nine months ended September 30, 2020.

The 2020 loss resulted from 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 loss before income taxes was $14.4 million for the nine months ended September 30, 2021, a decrease of $7.3 million, compared to a loss before income taxes of $21.7 million for the nine months ended September 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

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

On January 27, 2022, we sold an aggregate of 1,000,000 shares of our common stock to existing investors at a price of $2.00 per share for total gross proceeds of $2.0 million.

As of March 31, 2022, our cash and cash equivalents were $10.6 million compared with $12.2 million as of December 31, 2021.

We believe that our existing cash as of March 31, 2022 will be sufficient to fund our operations through to April 2023 if we continue to spend as forecasted to, and that we will require additional capital to continue our operations and research and development activity thereafter.

There can be no assurance, however, that such financing will be available when needed, if at all, or on acceptable terms and conditions.

The precise amount and timing of the funding needs cannot be determined accurately at this time, and will depend on a number of factors, including the market demand for our products, the quality of product development efforts, management of working capital, and the continuation of normal payment terms and conditions for purchase of services.

In order to address our capital needs, including our planned research and development activities and other expenditures, we are assessing options for financing our working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements.

Adequate financing opportunities might not be available to us, when and if needed, on acceptable terms or at all.

The following table shows a summary of our cash flows for the three months ended March 31, 2022 and 2021:

Three Months Ended

Increase (Decrease)

Since inception, we have not generated significant revenue from product sales, and we have incurred significant operating losses and had an accumulated deficit of $72.5 million as of September 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 September 30, 2021, our cash and cash equivalents were $14.7 million.

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

Nine Months Ended September 30,

Net cash used in operating activities

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Net cash provided by financing activities

Net change in cash before effect of exchange rate changes on cash

Effect of exchange rate changes on cash

Net change in cash

Cash, beginning of period

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Operating Activities

Net cash used in operating activities was $3.2 million for the three months ended March 31, 2022, compared to $3.3 million for the three months ended March 31, 2021, a decrease of $56 thousand, or 2%.

The decrease resulted primarily from $0.5 million lower vendor payments as transaction expenses were paid in 2021, offset by $0.3 million higher payroll payments reflecting the investment in staff and, and $0.1 million adverse movements in working capital.

Net cash used in operating activities was $7.3 million for the nine months ended September 30, 2021, compared to $2.6 million for the nine months ended September 30, 2020, an increase of $4.7 million.

The increase resulted primarily from our increased research and development activity, the operating expenses associated with being a public company, the expenses incurred in connection with the Exchange and movements in our working capital balances.

Investing Activities

Net cash used in investing activities was $41 thousand for the three months ended March 31, 2021, compared to $0 in the corresponding period of 2021.

Net cash used in investing activities in the 2022 period resulted from purchase of laboratory and capital equipment to support our increasing research and development activity.

In the future, we expect to continue to incur additional capital expenditures to support our research and development activities and wider business operations.

We used $282 thousand of cash in investing activities during the nine months ended September 30, 2021, compared to net cash used of $90 thousand for the nine months ended September 30, 2020, an increase of $192 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 $1.8 million for the three months ended March 31, 2022, compared to $22.2 million, a decrease of $20.4 million, or 92%.

During the first quarter of 2022, we consummated a private placement of our common stock resulting in net proceeds of $1.8 million.

In connection with the Exchange in February 2021, we consummated a private placement resulting in net cash of $22.2 million in the first quarter of 2021.

Contractual Payment Obligations

Our principal commitments primarily consist of obligations under leases for office space and purchase commitments in the normal course of business for research & development facilities and services, communications infrastructure and administrative services.

These will be funded from the company’s cash balances and working capital.

Payments Due by Period

Operating lease obligations

Purchase obligations

Net cash provided by financing activities was $22.2 million for the nine months ended September 30, 2021 compared with $4.6 million generated from financing activities in 2020.

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

We expect that our cash and cash equivalents 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.

Our future capital requirements will depend on many factors including our ability to generate revenue from product sales, the timing and extent of spending to support our sales and marketing, product development and research and development efforts and our needs for working capital to support our business operations.

We may in the future enter into arrangements to acquire or invest in complementary businesses, services and technologies, including intellectual property rights.

Until such time, if ever, as we can generate substantial product revenue, we expect to finance our working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements.

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.

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.

If we are unable to raise additional funds through equity or debt financings or other arrangements when needed, we may be required to delay, limit, reduce or terminate commercialization, our research and product development, or grant rights to develop and market our products that we would otherwise prefer to develop and market ourselves.

In January 2021 SmartKem entered into a Facility Agreement (the “Facility Agreement”) with FRCF 2 Limited (“Lender”) pursuant to which the Lender provided SmartKem with a secured term loan facility in the amount of $738 thousand (the “Facility”) as an advance against certain research and development tax credit payments expected to be received by SmartKem.

Interest on amounts outstanding on the Facility bore interest at a monthly rate of 1.25%, compounded monthly, and were payable on demand.

Payment of all amounts outstanding on the Facility were due on July 26, 2021.

SmartKem had the right to prepay all or part of the outstanding amounts under the Facility, subject to a pre-payment penalty equal to two months’ accrued interest if such amounts were repaid prior to March 26, 2021.

SmartKem was required to repay the Facility with the proceeds of the expected tax credit payments.

SmartKem paid the Lender an arrangement fee of $37 thousand in connection with the establishment of the Facility.

SmartKem 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.

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.

Pursuant to the terms of a Debenture entered into in connection with the Facility Agreement, SmartKem granted a security interest in all of its assets to the Lender.

The consummation of the Exchange constituted a Change of Control of SmartKem under the Facility.

Under the terms of the Facility Agreement, a Change of Control would constitute an event of default commencing on the tenth business day after the Change of Control.

We repaid the amounts that were outstanding under the Facility Agreement with a portion of the proceeds of the Offering before the end of such ten business day period.

Off-Balance Sheet Transactions

We did not have during the periods presented, and we do not currently have, any off-balance sheet financing arrangements or any relationships with unconsolidated entities or financial partnerships, such as structured finance or special purpose entities, that were established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Critical Accounting Policies and Estimates

Our unaudited interim condensed consolidated financial statements and the related notes thereto included in this Report are prepared in accordance with U.S.

The preparation of interim condensed consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures.

Our consolidated financial statements and the related notes thereto included in this Report are prepared in accordance with U.S.

The preparation of consolidated financial statements also requires us to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenue, costs and expenses, and related disclosures.

These estimates are developed based on historical experience and various other assumptions that we believe to be reasonable under the circumstances.

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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 interim condensed 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, 2022.

A summary of our critical accounting estimates was presented in our management’s discussion and analysis of financial condition and results of operations contained in our Annual Report on Form 10-K for the year ended December 31, 2021.

There were no material changes to our critical accounting estimates during the three months ended March 31, 2022.

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/A).

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

Going Concern Evaluation

Our unaudited interim condensed consolidated financial statements included elsewhere herein have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

Our condensed consolidated financial statements included elsewhere herein have been presented on a going concern basis, which contemplates the realization of assets and the satisfaction of liabilities in the normal course of business.

We have financed our activities principally from the issuance of ordinary shares, and debt securities.

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, 2022, we raised net proceeds of $1.8 million through the sale of our common stock and as of March 31, 2022 we had $10.6 million of cash after funding net cash used in operations for the three month period ended March 31, 2022 of $3.2 million.

We believe that our existing cash as of March 31, 2022 will be sufficient to fund our operations through to April 2023 and that we will require additional capital to continue our operations and research and development activity thereafter.

There can be no assurance, however, that such financing will be available when needed, if at all, or on acceptable terms and conditions.

The precise amount and timing of the funding needs cannot be determined accurately at this time,

and will depend on a number of factors, including the market demand for our products, the quality of product development efforts, management of working capital, and the continuation of normal payment terms and conditions for purchase of services.

Adequate financing opportunities might not be available to us, when and if needed, on acceptable terms or at all.

If we are unable to obtain additional financing in sufficient amounts or on acceptable terms, we will be forced to delay, reduce or eliminate some or all of its research and development programs and product portfolio expansion, which could adversely affect our operating results or business prospects.

Although management continues to pursue these plans, there is no assurance that we will be successful in obtaining sufficient funding on terms acceptable to us to fund continuing operations, if at all.

After considering the uncertainties, management consider it is appropriate to continue to adopt the going concern basis in preparing the consolidated financial statements.

The accompanying unaudited interim condensed consolidated financial statements do not include any adjustments that might be necessary should we be unable to continue as a going concern.

In the nine months ended September 30, 2021, we raised net proceeds of $22.2 million through the Offering and at September 30, 2021 we had $14.7 million of cash after funding net cash used in operations for the nine month period ended September 30, 2021 of $7.3 million, $1.3 million of which was used in the three months ended September 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.

Our management consider it is appropriate to continue to adopt the going concern basis in preparing the consolidated financial statements.

Internal Control Over Financial Reporting

During the year ended December 31, 2020 and for the period ended September 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.

The Company has determined that it made an error in the presentation and accounting of its consolidated statement of cash flows in the Company’s annual and interim consolidated financial statements during 2021 and 2022.

The management of the company has assessed its accounting policies as well as the presentation and accounting for the gain and loss on foreign currency and has concluded that it was necessary to restate its previously issued financial statements for the correction of this error related to incorrect classification of gain and loss on foreign currency in effect of exchange rate changes on cash instead of including such non-cash unrealized gains and losses in cash flows from operating activities.

The effect of this error was to overstate net cash used in operating activities and effect of exchange rate changes on cash by $799 thousand for the nine months ended September 30, 2021.

The errors and the required restatement had no effect on the Company’s cash flows from investing activities, financing activities, net changes in cash or cash and cash equivalents as of September 30, 2021 and had no impact on the Company’s consolidated balance sheet, statements of operations and comprehensive loss and stockholders’ equity as of and for the three and nine-month periods ended September 30, 2021.

As a result, we determined that there was a material error in the cashflow statement that required a restatement of the financial statements for the fiscal year ended December 31, 2021 and to our Form 10-Qs for the periods ended September 30, 2021 and March 31, 2022 (including comparative information for March 31, 2021) to restate the previously issued financial statements, with comparatives for June 30, 2021 restated in our Form 10-Q for the period ended June 30, 2022.

This was due to inadequate design and implementation of controls to evaluate and monitor the presentation and compliance with accounting principles generally accepted in the United States of America related to the cash flow statement.

Remediation Plan for Material Weakness

Management is actively engaged in the planning for, and implementation of, remediation efforts to address the material weaknesses.

The remediation plan includes enhancement of our existing monitoring and review controls over

the preparation of financial statements, including designing and documenting additional procedures, reconciliations and analysis to evaluate and monitor presentation of the cash flow statement.

We can provide no assurance that our remediation efforts described herein will be successful and that we will not have material weaknesses in the future.

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, 2022.

Notwithstanding the material weaknesses in our internal control over financial reporting, we have concluded that the condensed consolidated financial statements included in this Form 10-Q/A fairly present, in all material respects, our financial position, results of operations and cash flows for the periods presented in conformity with accounting principles generally accepted in the United States of America.

JOBS Act Accounting Election

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What changed 10-Q/A

Item 2. Management’s Discussion and Analysis