SMARTKEM, INC. Our Management's Discussion and Analysis of Financial Condition and Results of
Operations (MD&A) is provided in addition to the accompanying consolidated
financial statements and notes to assist readers in understanding our results of
operations, financial condition, and cash flows. The following discussion and
analysis of our financial condition and results of operations should be read
together with our consolidated 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"
above. You should review the disclosure under the heading "Item1A. Risk Factors"
in this Report for a discussion of important factors that could cause actual
results to differ materially from the results described in or implied by the
forward-looking statement.
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Overview
We are seeking to reshape the world of electronics with our proprietary organic
semiconductor platform that we believe has the potential to affect the form and
function of the next generation of low-cost displays and sensors. Our patented
TRUFLEX® inks are solution deposited at a low temperature, on low-cost
substrates to make OTFT circuits. Our organic semiconductor platform can be used
in a number of applications including mini- and micro-LED displays, AMOLED
displays, AR and VR headsets, fingerprint sensors and integrated logic circuits.
We have a research and development facility in Manchester, UK , and manufacture
product protypes for prospective customers using our semiconductor manufacturing
processes housed at the Centre for Process Innovation (CPI) at Sedgefield, UK .
We have an extensive IP portfolio including over 125 issued patents across 19
patent families. Since our inception in 2009, we have devoted substantial
amounts of our 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 $11.5 million and $17.1 million for the year
ended December 31, 2022 , and 2021, respectively. As of December 31, 2022 , our
accumulated deficit was $86.6 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.
Key Factors Affecting Our Performance
There are a number of industry factors that affect our business which include, among others:
Overall Demand for Products and Applications using Organic thin film transistors
Our potential for growth depends significantly on the adoption of organic thin film transistor (OTFT) materials in the display and sensor markets and our ability to capture a significant share of any market that does develop. We expect that demand for our technology will also fluctuate based on various market cycles, continuously evolving industry supply chains, trade and tariff terms, as well as evolving competitive dynamics in each of the respective markets. These uncertainties make demand difficult to forecast for us and our customers.
Intense and Constantly Evolving Competitive Environment
Competition in the industries we serve is intense. Many companies have made significant investments in product development and production equipment. To remain competitive, market participants must continuously increase product performance, reduce costs, and develop improved ways to serve their customers. To address these competitive pressures, we have invested in research and development activities to support new product development, improve ease of use, lower product costs and deliver higher levels of performance to differentiate our products in the market.
Governmental Trade and Regulatory Conditions
Our potential for growth depends on a balanced and stable trade, political, economic and regulatory environment among the countries where we do business. Changes in trade policy such as the imposition of tariffs or export bans to specific customers or countries could reduce or limit demand for our products in certain markets.
Technological Innovation and Advancement
Innovations and advancements in organic materials continue to expand the potential commercial application for our products. However, new technologies or standards could emerge, or improvements could be made in existing technologies that could reduce or limit the demand for our products in certain markets.
Intellectual Property Issues
We rely on patented and non-patented proprietary information relating to product development, manufacturing capabilities and other core competencies of our business. Protection of intellectual property is critical. Therefore, steps
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such as additional patent applications, confidentiality, and non-disclosure agreements, as well as other security measures are important. While we believe we have a strong patent portfolio and there is no actual or, to our knowledge, threatened litigation against us for patent-related matters, litigation or threatened litigation is a common method to effectively enforce or protect intellectual property rights. Such action may be initiated by or against us and would require significant management time and expenses.
Components of Results of Operations
Revenue
Our revenue currently consists of revenue from the sale of TRUFLEX® inks and 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 Operating Income includes government grants received for qualifying research and development projects, and research and development tax credits related to theUnited Kingdom's Research and Development tax relief for small and medium-sized enterprises, which is a government tax incentive designed to reward innovative companies for investing in research and development. The income associated with these items is recognized in the period which the research and development expenses occurred. Additionally, during the year endedDecember 31, 2021 , the Company received government grants under theUnited 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. We do not believe that it is possible at this time to accurately project total program-specific expenses through commercialization. There are numerous factors associated with the successful commercialization of our technology, many of which cannot be determined with accuracy at this time based on our stage of development. Additionally, future commercial and other factors beyond our control will impact our development programs and plans. 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)
Financial Income/(Expense), Net aggregates the following amounts:
Interest Expense. We entered into a term loan facility agreement in 2021 and incurred interest charges on the amount drawn down. The facility was repaid in full and there were no balances outstanding atDecember 31, 2022 , and 2021.
Interest Income. Interest income is interest on our cash deposits.
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Income Tax Expense. Income tax expense consists primarily of income taxes in jurisdictions in which we conduct business. We incurred income tax expense of$24 thousand in 2022 and zero in 2021.
Foreign Currency Translation. Foreign currency translation reflects 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 consolidated financial statements and related notes included in Part II, Item 8 of this Form 10-K. The period-to-period comparisons of financial results in the tables below are not necessarily indicative of future results.
Comparison of Loss from Operations for the years ended
Our results of operations for the years endedDecember 31, 2022 and 2021 are as follows: Year Ended December 31, Increase (Decrease)US$000 2022 2021 Amount Percentage Revenue $ 40$ 18 $ 22 122 % Cost of revenue 33 8 25 313 % Gross profit 7 10 (3) (30) % Other operating income 1,172 1,285 (113) (9) %
Research and development expenses 5,802 8,199 (2,397) (29) % Selling, general and administrative expenses 5,071
8,069 (2,998) (37) % Transaction expenses - 1,329 (1,329) (100) % Total operating expenses 10,873 17,597 (6,724) (38) % Loss from operations$ (9,694) $ (16,302) $ 6,608 (41) % Revenue and Cost of Revenue Our revenue currently consists of revenue from the sale of TRUFLEX® inks and demonstration products. The year-over-year change in revenue and gross profit reflects the largely one-off nature of these sales, consistent with our current stage of commercialization. Other Operating Income Year Ended December 31, Increase (Decrease) % of total % of totalUS$000 2022 2021 Amount Percentage 2022 2021
Research & development tax credit$ 1,168 $ 1,095 $ 73 7 % 100% 85% Research & development grants - 181
(181) (100) % 0% 14% Sale of fixed assets 4 - 4 100 % 0% 0% Other grants - 9 (9) (100) % 0% 1%
Total other operating income
(9) % 100% 100%
Our Other Operating 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 tax relief for small
and medium-sized enterprises, which is a government tax incentive designed to
reward innovative companies for investing in research and development. The
increase in R&D Tax Credit reflects higher eligible expenditure in 2022
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compared to 2021. In 2021, R&D grant funding was secured for the "SmartLight" project that successfully demonstrated OTFT mini-LED backlights for displays with improved light uniformity and lower defects.
Operating Expenses
Year Ended December 31, Increase (Decrease) % of total % of total
US$000 2022 2021 Amount Percentage 2022 2021
Research and
development $ 5,802 $ 8,199 $ (2,397) (29) % 53% 47%
Selling, general and
administrative 5,071 8,069 (2,998) (37) % 47% 46%
Transaction expenses - 1,329 (1,329) (100) % 0% 7%
Total operating
expenses $ 10,873 $ 17,597 $ (6,724) (38) % 100% 100%
Operating expenses decreased by
Research and development expense, which represents 53% and 47% of our total operating expenses for the twelve months endedDecember 31, 2022 and 2021, respectively, decreased by$2.4 million to$5.8 million for the period, primarily due to a$2.7 million decrease in stock compensation expense, a$0.6 million reduction from the effect of exchange rate movement compared to the prior year, partially offset by a$0.9 million 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 47% and 46% of our total operating expenses for the twelve months endedDecember 31, 2022 and 2021, respectively decreased by$3.0 million to$5.1 million for the period. This decrease was mainly due to a$2.9 million decrease in stock compensation expense, a$0.3 million reduction from the effect of exchange rate movements compared to the prior period, partially offset by$0.2 million additional expense from the additional insurance and professional services 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 Share Exchange Agreement withSmartKem Limited , pursuant to which all of the equity interests inSmartKem Limited , except certain "deferred shares" which had no economic or voting rights and which were purchased by us for an aggregate purchase price of$1.40 , were exchanged for shares of our common stock andSmartKem Limited became our wholly owned subsidiary (the "Exchange") were incurred in the year endedDecember 31, 2021 . The Exchange was consummated during the first quarter of 2021 and no significant additional Exchange-related expenses were recorded thereafter. 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; and
? add financial accounting and management systems to position us for growth.
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Non-Operating (Expenses)/Income and Net Loss
Year Ended December 31, (Increase) Decrease
US$000 2022 2021 Amount Percentage
Loss from operations $ (9,694) $ (16,302) $ 6,608 (41) %
Non-operating (expense)/income
Loss on foreign currency transactions (1,782) (808)
(974) 121 %
Interest expense - (19) 19 (100) %
Interest income 5 3 2 67 %
Total non-operating expense (1,777) (824) (953) 116 %
Loss before income taxes (11,471) (17,126) 5,655 (33) %
Income tax expense (24) - (24) -
Net loss $ (11,495) $ (17,126) $ 5,631 (33) %
The increase in loss on foreign currency transactions was due to fluctuations in
U.S. dollar/U.K. pound value arising from transactions denominated in foreign
currencies and the translation of foreign currency denominated balances on
intra-group loans that were first advanced in 2021.
The loss before income taxes was $11.5 million for the year ended December 31,
2022 , a decrease of $5.7 million , compared to a loss before income taxes of
$17.1 million for the year ended December 31, 2021 . The decrease in loss was
attributable to lower stock compensation expense, the absence of transaction
costs in 2022, partially offset by increases in loss on foreign currency
transactions and lower operating expenses as described in the preceding
paragraphs.
Liquidity and Capital Resources
Our future results are subject to substantial risks and uncertainties. We have operated at a loss for our entire history and anticipate that losses will continue over the coming year. 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. 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 liquidity and working 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, our entry into one or more material agreements containing significant performance obligations and our needs for working capital to support our business operations. Until such time, if ever, as we can generate sufficient cash through 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. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. As ofDecember 31, 2022 , our cash and cash equivalents were$4.2 million compared with$12.2 million as ofDecember 31, 2021 . We believe that our cash and cash equivalents will be sufficient to support our expected liquidity and working capital requirements through the end ofMay 2023 . However, in the event that we enter into contracts involving significant sales of our products, development agreements, license agreements, collaborations, acquisitions or other material transactions, we may require additional working capital to support our increased obligations. To date, we have not recorded significant revenues related to product sales and therefore do not have any present need to fund inventory or accounts receivable. Our consolidated financial statements as ofDecember 31, 2022 have been prepared under the assumption that we will continue as a going concern for the next twelve months. We expect to incur significant expenses and operating losses for the foreseeable future. These factors raise substantial doubt about our ability to continue as a going concern. Because our business does not generate positive cash flow from operating activities, we will need to obtain substantial additional capital in order to support our development efforts and fully commercialize our technology. We believe we 41
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will be able to raise additional capital in the event it is in our best interest to do so. Management's plans are to finance the working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. If we raise additional funds by issuing equity securities, our existing security holders will likely experience dilution. If we borrow money, the incurrence of indebtedness would result in increased debt service obligations and could require us to agree to operating and financial covenants that could restrict our operations. If we enter into a collaboration, strategic alliance or other similar arrangement, we may be forced to give up valuable rights. To the extent additional capital is not available when needed or on acceptable terms, we may be forced to abandon some or all of our development and commercialization efforts, which would have a material adverse effect on the prospects of the business. Further, our assumptions relating to our cash requirements may differ materially from our actual requirements because of a number of factors, including significant unforeseen delays, changes in timing, scope, focus and direction of our development efforts and costs related to commercialization.
The following table shows a summary of our cash flows for the years ended
Year Ended December 31, Increase (Decrease)
US$000 2022 2021
Amount Percentage
Net cash used in operating activities
(7) %
Net cash used by investing activities (79) (341) 262 (77) %
Net cash provided by financing activities 1,830 22,204 (20,374) (92) %
Effect of exchange rate changes on cash (693) (673) (20) 3 %
Net change in cash (7,991) 11,462 (19,453) (170) %
Cash, beginning of year 12,226 764 11,462 1,500 % Cash, end of year$ 4,235 $ 12,226 $ (7,991) (65) % Operating Activities
Net cash used in operating activities was
Investing Activities
Net cash used in investing activities was$79 thousand for the year endedDecember 31, 2021 , compared to$0.3 million for the year endedDecember 31, 2021 , a decrease of$0.2 million . The decrease resulted from a reduced level of investment in laboratory and capital equipment purchases in 2022 after investment in these in previous years. In the future, we expect to continue to incur capital expenditures to support our research and development activities and wider business operations.
Financing Activities
Net cash flows provided by financing activities was$1.8 million for the year endedDecember 31, 2022 , compared to$22.2 million for the year endedDecember 31, 2021 , a decrease of$20.4 million . During the first half of 2022, we consummated a private placement of our common stock resulting in net proceeds of$1.8 million . In connection with the Exchange inFebruary 2021 , we consummated a private placement resulting in net cash of$22.2 million in the first half of 2021.
Contractual Payment Obligations
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Our principal commitments primarily consist of obligations under leases for office space and purchase commitments in the normal course of business for research & development facilities and services, communications infrastructure, and administrative services. These will be funded from the Company's cash balances and working capital.
Payments Due by Period
US$(000) 2023 2024 2025 Total
Operating lease liabilities $ 234 $ 234 $ 19 $ 487
Purchase obligations 613 68 - 681
$ 847 $ 302 $ 19 $ 1,168 Recently Issued Accounting Pronouncements
For recently issued accounting announcements, see "Recently Issued Accounting Pronouncements" in Note 2, Significant Accounting Policies and Recent Accounting Pronouncements, in the Notes to our Consolidated Financial Statements included in this Annual Report on Form 10-K.
Critical Accounting Policies and Estimates
Our consolidated financial statements and the related notes thereto included in this Report are prepared in accordance with US GAAP. 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. Actual results could differ significantly from the estimates made by management. 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. We believe that the accounting policies discussed below are critical to understanding our historical and future performance, as these policies relate to the more significant areas involving management's judgments and estimates. Critical accounting policies and estimates are those that we consider the most important to the portrayal of our financial condition and results of operations because they require our most difficult, subjective, or complex judgments, often as a result of the need to make estimates about the effect of the matters that are inherently uncertain.
Accounting for Stock-Based Compensation
We account for stock-based compensation in accordance with ASC 718, Compensation-Stock Compensation. ASC 718 requires companies to estimate the fair value of equity-based payment awards on the date of grant using a Black-Scholes option-pricing model. We recognize compensation expenses for the value of our equity awards granted based on the straight-line method over the requisite service period of each of the awards. We periodically grant stock options for a fixed number of shares of common stock to our employees, directors, and non-employee contractors, with an exercise price greater than or equal to the fair market value of the common stock at the date of the grant. We estimate the fair value of each stock option award using the Black-Scholes option-pricing model, which uses as inputs the fair value of our common stock and assumptions we make for the volatility of our common stock, the expected term of our stock-based awards, the risk-free interest rate for a period that approximates the expected term of our stock-based awards, and our expected dividend yield. Estimates of fair value are not intended to predict actual future events or the value ultimately realized by persons who receive equity awards. Prior toFebruary 2022 , the Company's common stock was not traded on an over the counter or national securities exchange and consequently the Company developed estimates for the inputs to the option-pricing model.
The assumptions used in determining the fair value of stock-based awards represent our best estimates, but the estimates involve inherent uncertainties and the application of our judgment. As a result, if factors change and we use
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significantly different assumptions or estimates, our stock-based compensation expense could be materially different in the future.
Valuation allowance of deferred tax assets
Income taxes are recorded in accordance with ASC 740, Income Taxes ("ASC 740"),
which provides for deferred taxes using an asset and liability approach. We
recognize deferred tax assets and liabilities for the expected future tax
consequences of events that have been included in the consolidated financial
statements or tax returns. Deferred tax assets and liabilities are determined
based on the difference between the financial statement and tax basis of assets
and liabilities using enacted tax rates in effect for the year in which the
differences are expected to reverse. Valuation allowances are provided, if based
upon the weight of available evidence, it is more likely than not that some or
all of the deferred tax assets will not be realized.
We considered the positive and negative evidence bearing upon our ability to
realize the deferred tax assets. In addition to our history of cumulative
losses, we cannot be certain that future taxable income will be sufficient to
realize our deferred tax assets. Accordingly, a full valuation allowance has
been provided against our net deferred tax assets at both December 31, 2022 , and
2021. Should we change our determination, based on the evidence available as to
the amount of our deferred tax assets that can be realized, the valuation
allowance will be adjusted with a corresponding impact to the provision for
income taxes in the period in which such determination is made and which may be
material.
Derivative Asset for Embedded Conversion Features
We do not use derivative instruments to hedge exposures to cash flow, market, or foreign currency risks.
We evaluate convertible notes to determine if those contracts or embedded components of those contracts qualify as derivatives to be accounted for separately. In circumstances where the embedded conversion option in a convertible instrument is required to be bifurcated and there are also other embedded derivative instruments in the convertible instrument that are required to be bifurcated, the bifurcated derivative instruments are accounted for as a single, compound derivative instrument. The result of this accounting treatment is that the fair value of the embedded derivative is recorded as either an asset or a liability and marked-to-market each balance sheet date, with the change in fair value recorded in the statements of operations as other income or expense. Upon conversion or exercise of a derivative instrument, the instrument is marked to fair value at the conversion date and then that fair value is reclassified to equity. The fair value of the embedded conversion features is estimated using a Monte Carlo simulation model, in which possible outcomes and their values are simulated repeatedly and randomly. Under theMonte Carlo method we estimated the fair value of the convertible notes conversion feature at the time of issuance and subsequent remeasurement dates, utilizing the with-and without method, where the value of the derivative feature is the difference in values between a note simulated with the embedded conversion feature and the value of the same note simulated without the embedded conversion feature. Estimating fair values of embedded conversion features requires the development of significant and subjective estimates that may, and are likely to, change over the duration of the instrument with related changes in internal and external market factors. For more information regarding our accounting policies, see Note 2, Summary of Significant Accounting Policies and Recent Accounting Pronouncements, in our Notes to Consolidated Financial Statements in this Annual Report on Form 10-K.
Going Concern Evaluation
Our 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.
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In the year ended
Our future viability is dependent on our ability to raise additional capital to satisfy our operational needs and to fund our sales and marketing efforts, research and development expenditures, and business development activities. Until such time, if ever, as we can generate sufficient cash through revenue, management's plans are to finance our working capital requirements through a combination of equity offerings, debt financings, collaborations, strategic alliances and marketing, distribution or licensing arrangements. We may be unable to raise additional funds or enter into such other agreements or arrangements when needed on favorable terms, or at all. There is substantial doubt that the Company will be able to pay its obligations as they fall due, and this substantial doubt is not alleviated by management plans. The consolidated financial statements as ofDecember 31, 2022 have been prepared assuming that the Company will continue as a going concern. Accordingly, the consolidated financial statements do not include any adjustments to the amounts and classification of assets and liabilities that may be necessary should the Company be unable to continue as a going concern.
JOBS Act Accounting Election
We are an emerging growth company, as defined in the JOBS Act. The JOBS Act provides that an emerging growth company can take advantage of an extended transition period for complying with new or revised accounting standards. This provision allows an emerging growth company to either early adopt or delay the adoption of some accounting standards until those standards would otherwise apply to private companies. We have elected to use the extended transition period under the JOBS Act until the earlier of the date we (i) are no longer an emerging growth company or (ii) affirmatively and irrevocably opt out of the extended transition period provided in the JOBS Act. As a result, our consolidated financial statements may not be comparable to companies that comply with new or revised accounting pronouncements as of public company effective dates.
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