SmartKem, Inc. 10-Q

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations The following discussion and analysis of the financial condition and results of operations of SmartKem, Inc. (“SmartKem” or the “Company”) should be read in conjunction with the unaudited interim condensed consolidated financial statements and notes thereto contained in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2022 to provide an understanding of its results of operations, financial condition and cash flows. All references in this Quarterly Report to “we,” “our,” “us” and the “Company” refer to SmartKem, Inc., and its subsidiaries unless the context indicates otherwise. DISCLOSURE REGARDING FORWARD-LOOKING STATEMENTS This Quarterly Report on Form 10-Q contains certain “forward-looking statements” within the meaning of the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995 with respect to our business, financial condition, liquidity, and results of operations. Words such as “anticipates,” “expects,” “intends,” “plans,” “predicts,” “believes,” “seeks,” “estimates,” “could,” “would,” “will,” “may,” “can,” “continue,” “potential,” “should,” and the negative of these terms or other comparable terminology often identify forward-looking statements. Statements in this Quarterly Report on Form 10-Q (this “Report”) that are not historical facts are hereby identified as “forward-looking statements” for the purpose of the safe harbor provided by Section 21E of the Securities Exchange Act of 1934, as amended, and Section 27A of the Securities Act of 1933, as amended. These forward-looking statements are not guarantees of future performance and are subject to risks and uncertainties that could cause actual results to differ materially from the results contemplated by the forward-looking statements, including the risks discussed in our Annual Report on Form 10-K for the fiscal year ended December 31, 2022 (the “10-K”) in Item 1A under “Risk Factors” and the risks detailed from time to time in our future reports filed with the Securities and Exchange Commission (the “SEC”). These forward-looking statements include, but are not limited to, statements about: ​ ● the implementation of our business model and strategic plans for our business, technologies and products; ● the rate and degree of market acceptance of any of our products or organic semiconductor technology in ● general, including changes due to the impact of (i) new semiconductor technologies, (ii) the performance of organic semiconductor technology, whether perceived or actual, relative to competing semiconductor materials, and (iii) the performance of our products, whether perceived or actual, compared to competing silicon-based and other products; ● the timing and success of our, and our customers’, product releases; ● our ability to develop new products and technologies; ● our estimates of our expenses, ongoing losses, future revenue and capital requirements, including our our needs for additional financing; ● our ability to obtain additional funds for our operations and our intended use of any such funds; ● our ability to remain eligible on an over-the-counter quotation system; ● our receipt and timing of any royalties, milestone payments or payments for products, under any current or future collaboration, license or other agreements or arrangements; ● our ability to obtain and maintain intellectual property protection for our technologies and products and our ability to operate our business without infringing the intellectual property rights of others; ● the strength and marketability of our intellectual property portfolio; ● our dependence on current and future collaborators for developing, manufacturing or otherwise bringing our products to market; ● the ability of our third-party supply and manufacturing partners to meet our current and future business needs; ● our exposure to risks related to international operations; ● our dependence on third-party fabrication facilities; ● the impact of the COVID-19 pandemic and any future communicable disease outbreak on our business and operations; ● our relationships with our executive officers, directors, and significant stockholders; 25 Table of Contents ● 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 Jumpstart Our Business Startups Act (the “JOBS Act”) in future periods; ● our future financial performance; ● the competitive landscape of our industry; ● the impact of government regulation and developments relating to us, our competitors, or our industry; and ● other risks and uncertainties, including those listed under the caption “Risk Factors” in our 10-K. 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” in our 10-K and in this Report and elsewhere in this Report. Any forward-looking statement in this Report 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 Report and the documents that we reference in this Report 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. Company Overview We are seeking to reshape the world of electronics with our disruptive organic thin-film transistors (OTFTs) that have the potential to drive the next generation of displays. Our patented TRUFLEX® semiconductor and dielectric inks, or electronic polymers, are used to make a new type of transistor that could potentially revolutionize the display industry. Our inks enable low temperature printing processes that are compatible with existing manufacturing infrastructure to deliver low-cost displays that outperform existing technologies. Our electronic polymer platform can be used in a number of display technologies including microLED, miniLED and AMOLED displays for next generation televisions, laptops, augmented reality (AR) and virtual reality (VR) headsets, smartwatches, and smartphones. ​ We develop our materials at its research and development facility in Manchester, UK, our semiconductor manufacturing processes at the Centre for Process Innovation (CPI) at Sedgefield, UK and retain a field application office in Taiwan. We have an extensive IP portfolio including 125 granted patents across 19 patent families and 40 codified trade secrets. ​ 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 $3.0 million and $4.0 million for the three months ended September 30, 2023 and 2022, and $7.1 million and $10.4 million for the nine months ended September 30, 2023 and 2022, respectively. As of September 30, 2023, our accumulated deficit was $93.7 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. 26 Table of Contents Results of Operations for the three and nine months ended September 30, 2023 Three months ended September 30, 2023 compared with three months ended September 30, 2022 Revenue and Cost of revenue Revenues were $3.0 thousand in the three months ended September 30, 2023, compared with $26.0 thousand in the same period of 2022. Cost of revenue was $1.0 thousand in the three months ended September 30, 2023, compared with $26.0 thousand in the same period of 2022. The decrease is mainly the results of less unit sales in 2023 compared to 2022. Both revenues and related cost of revenue for the three months ended September 30, 2023 and 2022 are a result of sales of organic thin-film transistor ( OTFT) backplanes and TRUFLEX® materials for customer assessment and development purposes. Other operating income Other operating income was $0.3 million in the three months ended September 30, 2023, compared to $0.3 million in the same period of 2022. The primary source of the income is related to a research grant and research and development tax credits. Operating expenses Operating expenses were $3.0 million for the three months ended September 30, 2023, compared to $2.7 million in the same period of 2022, an increase of $0.3 million. Research and development expenses are incurred for the development of TRUFLEX® inks to make OTFT circuits and consists primarily of payroll and technical development costs. The research and development expenses represent 53.1% and 49.2% of the total operating expenses for the three months ended September 30, 2023 and 2022, respectively. Research and development expenses increased $0.2 million for the three months ended September 30, 2023 compared to the same period for the prior year. This increase was mainly due personnel severance expenses and technical service fees. Selling, general and administrative expenses consist primarily of payroll and professional services such as accounting, legal services and investor relations . These expenses represent 42.9% and 50.8% of our total operating expenses for the three months ended September 30, 2023 and 2022, respectively. Selling, general and administrative expenses decreased by $0.1 million for the three months ended September 30, 2023 compared to the same period for the prior year. This decrease was primarily a result of a reductions in investor relations expenses. Non-Operating income/(expense) We recorded a gain of $0.5 million related to the valuation of the warrant liability for the three months ended September 30, 2023. There were no similar gains or losses during the same period of the prior year. We recorded losses on foreign currency transactions related to intercompany loans of $0.8 million for the three months ended September 30, 2023 compared to the losses of $1.5 million for the three months ended September 30, 2022. The decrease of $0.7 million is related to favorable changes in the exchange rates. Nine months ended September 30, 2023 compared with nine months ended September 30, 2022 Revenue and Cost of revenue Revenues were $27.0 thousand in the nine months ended September 30, 2023, compared with $60.0 thousand in the same period of 2022. Cost of revenue was $23.0 thousand in the nine months ended September 30, 2023, compared with $50.0 thousand in the same period of 2022. The decrease is mainly the results of less unit sales in 2023 compared to 2022. Both revenues and related cost of revenue for the nine months ended September 30, 2023 and 2022 are a result of sales of organic thin-film transistor ( OTFT) backplanes and TRUFLEX® materials for customer assessment and development purposes. 27 Table of Contents Other operating income Other operating income was $0.7 million and $0.9 million the nine months ended September 30, 2023 and 2022. The primary source of the other operating income is related to a research grant and research and development tax credits. Operating expenses Operating expenses for the nine months ended September 30, 2023 were $8.3 million compared to $8.2 million in the same period of 2022. Research and development expenses are incurred for the development of TRUFLEX® inks to make OTFT circuits and consists primarily of payroll and technical development costs. Research and development expenses were $4.1 million and $4.2 million for the nine months ended September 30, 2023 and 2022. The decrease of $0.1 million is primarily due to the reduction of personnel and professional service fee expenses. The research and development expenses represents 49.4% and 50.9% of total operating expenses for the nine months ended September 30, 2023 and 2022, respectively. Selling, general and administrative expenses consist primarily of payroll and professional services such as accounting, legal services and investor relations , These expenses represent 48.4% and 49.1% of our total operating expenses for the nine months ended September 30, 2023 and 2022, respectively. Selling, general and administrative expenses were $4.0 million for the nine months ended September 30, 2023, as compared to $4.0 million for the nine months ended September 30, 2022. Losses on foreign currency transactions related to operating expense were $0.2 million for the nine months ended September 30, 2023. Non-Operating income/(expense) Issuance costs of $0.2 million allocated to the warrant liability were expensed in full during the nine months ended September 30, 2023. The majority of costs were legal, placement and consulting fees specifically related to the private placement transaction. We recorded a gain of $0.5 million related to the valuation of the warrant liability for the nine months ended September 30, 2023. There were no similar gains or losses during the same period of the prior year. We recorded gains on foreign currency transactions related to intercompany loans of $0.2 million for the nine months ended September 30, 2023 compared to the losses of $3.1 million for the nine months ended September 30, 2022. The increase of $3.3 million is related to the favorable changes in the exchange rates. 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. As of September 30, 2023, our cash and cash equivalents were $11.2 million compared with $4.2 million as of December 31, 2022. The increase of $7.0 million is due to net proceeds of $12.7 million received related to the June 2023 PIPE financing and was offset by cash usage of $5.6 million related to operating activities. We believe that our existing cash as of September 30, 2023 will be sufficient to fund our operations through for the next twelve months if we continue to spend to our forecast, and that we may require additional capital funding to continue our operations and research and development activity thereafter. Our capital commitments over the next twelve months include (a) $1.5 million to satisfy accounts payable and accrued expenses and (b) $0.2 million to satisfy the lease liabilities. Additional capital commitments beyond the next twelve months include $0.1 million of lease liabilities. Critical Accounting Estimates We allocated part of the proceeds of private placement of the Series A-1 and Series A-2 Preferred Stock to warrant liability relating to the warrants issued in connection with the transaction. The valuations of the 28 Table of Contents warrants were determined using option pricing models. These models use inputs such as the underlying price of the shares issued at the measurement date, volatility, risk free interest rate and expected life of the instrument. We have classified the warrants as a long-term liability due to certain provisions relating to the holders’ ability to exercise the warrants beyond twelve months of the reporting date and has accounted for them as derivative instruments in accordance with ASC 815, adjusting the fair value at the end of each reporting period. ​ Our financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim reporting. Other than the accounting for the valuation of warrant liability, during the three and nine months ended September 30, 2023, there were no material changes to our critical accounting policies as reported in the 10-K. A description of certain accounting policies that may have a significant impact on amounts reported in the financial statements is disclosed in Note 3 to the audited consolidated financial statements contained in the 10-K. Warrant Liability We account for our outstanding warrants in accordance with the guidance contained in Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) 815-40, Derivatives and Hedging, under which warrants that do not meet the criteria for equity treatment must be recorded as liabilities. In accordance with that guidance, we have classified our outstanding warrants as liabilities at their fair value and adjust the warrants to fair value in respect of each reporting period. The valuation of the warrant liability is determined using an option pricing model. This model uses inputs such as the underlying price of the shares issued at the measurement date, expected volatility, risk free interest rate and expected life of the instrument. Since our common stock was not publicly traded until February 2022 there has been insufficient volatility data available. Accordingly, we have used an expected volatility based on historical common stock volatility of our peers. In addition, we have used the probability of uplisting as an input in the model to determine the fair value of the warrant liability as certain features of the warrants will be eliminated or adjusted upon an uplisting. We will adjust the fair value of the warranty liability at the end of each reporting period. Issuance Costs ​ We have assessed the issuance cost in connection with the issuance of an equity offering. ASC 340-10-S99-1 states that specific incremental costs directly attributable to a proposed or actual offering of equity securities may properly be deferred and charged against the gross proceeds of the offering. Analogizing to that guidance, specific incremental costs directly attributable to the issuance of an equity contract to be classified in equity should generally be recorded as a reduction in equity. However, issuance costs for equity contracts that are classified as a liability are required to be expensed immediately. The issuance costs are allocated to the equity and liability components of the underlying transaction on a basis of the allocated fair value of the gross proceeds in the overall transactions. ​ Item 3. Quantitative and Qualitative Disclosures about Market Risk Not applicable.