SmartKem, Inc. — Q2 2021 Form 10-Q Summary
Business context and reporting period
Unaudited results cover the three and six months ended June 30, 2021; balance-sheet comparisons are with December 31, 2020. SmartKem develops organic thin-film transistor materials and processes for flexible electronics, displays, sensors and logic. It has not commercialized products; revenue to date has primarily come from demonstrator units. The company reported 124 issued patents, 11 pending patent applications, 25 future national applications and more than 30 trade secrets.
On February 23, 2021, SmartKem completed a share exchange with former shell company Parasol Investments Corporation. The transaction was accounted for as a reverse recapitalization, with SmartKem Limited as accounting acquirer. The company also completed a private placement.
Financial results and liquidity
| Metric | Q2 2021 | Q2 2020 | Six months 2021 | Six months 2020 |
|---|---|---|---|---|
| Revenue | $0 | $0 | $0 | $20,770 |
| Operating expenses | $2.716 million | $1.242 million | $12.026 million | $2.880 million |
| Operating loss | $2.460 million | $1.056 million | $11.338 million | $2.493 million |
| Net loss | $2.401 million | $1.054 million | $11.767 million | $21.078 million |
| Net loss per share | $0.09 | $0.08 | $0.52 | $1.80 |
- Gross profit was zero in Q2 2021 and for the first half of 2021; no meaningful revenue margin was reported.
- Other operating income, mainly UK R&D tax credits and grants, was $256,000 for Q2 and $688,000 for the first half of 2021. The first-half amount included approximately $499,000 in tax credits and $181,000 in grants.
- First-half R&D expense was $5.369 million, up 154%, and SG&A was $5.328 million, up 593%. The increases reflected development and demonstrator work, $6.095 million of stock-based compensation, expanded teams and public-company costs. First-half transaction expenses were $1.329 million.
- Cash used in operations was $6.441 million for the first half, versus $2.835 million in 2020; capital spending was $121,000. Financing provided $22.204 million, primarily from the private placement.
- Cash was $16.431 million at June 30, 2021, versus $764,000 at year-end 2020. Current assets were $19.125 million and current liabilities $1.484 million. Accumulated deficit was $69.713 million.
- The company had no notes payable or convertible notes outstanding at June 30. A $738,000 tax-credit-backed facility drawn in January was repaid March 2. Operating lease liabilities totaled $210,000.
Material changes versus comparable periods
Q2 operating loss increased 133% year over year, principally because of higher R&D and SG&A spending; the company recorded no revenue in either Q2 period. First-half net loss improved from $21.078 million to $11.767 million, but operating loss worsened substantially. The improvement in net loss chiefly reflects the absence of large 2020 non-operating charges associated with conversion of convertible notes and derivative accounting, including $6.835 million of interest expense, a $6.282 million derivative fair-value loss and a $5.470 million conversion loss. These prior-period items make the net-loss comparison less indicative of underlying operating performance.
The February private placement issued 10.162 million common shares and 2.168 million pre-funded warrants for gross proceeds of approximately $24.638 million; issuance costs were $2.454 million. As of June 30, 25.462 million common shares were issued and outstanding. The filing reported 25.462 million shares outstanding as of August 11, 2021.
Outlook, risks and unusual items
- Management said cash at June 30 was expected to fund operations for at least 12 months after issuance of the financial statements. The MD&A separately projected funding through the first quarter of 2023. Management also said additional funding would be needed for operating needs and planned commercial and development activity.
- The company expected significant expenses and operating losses to continue and did not expect significant product revenue during 2021, if any. R&D spending was expected to remain flat or rise moderately; public-company and growth-related SG&A was expected to increase.
- Key risks include lack of commercialized products and limited revenue, uncertain adoption and long sales cycles, competition and technology changes, dependence on third-party fabrication access (including CPI), intellectual-property protection, COVID-19 disruption, foreign-exchange exposure and the need for future financing.
- Management concluded disclosure controls were not effective and identified material weaknesses involving segregation of duties and accounting review and monitoring. Remediation efforts included adding finance expertise, restricting system access and developing procedures; there was no assurance remediation would be timely or successful.
- The company reported no legal proceedings in Part II and said it did not expect ordinary-course disputes to have a material adverse effect. It also disclosed related-party reimbursements and consulting expenses; see the filing’s Note 14 for amounts and payables.
- Common stock was not listed on a national exchange or OTC market, and the filing said there was no active trading market. The company also disclosed that a proposed $2.0 million Octopus share purchase remained conditional and could not be assured.
Important facts for investors to verify
- Reconcile management’s stated cash runway through Q1 2023 with the separate “at least 12 months” liquidity statement, and assess the effect of actual cash burn and planned spending.
- Track commercialization evidence: customer evaluations, demonstrator-to-order conversion, revenue generation and the timing and economics of any manufacturing arrangements.
- Review quarterly cash use, R&D tax-credit collections, financing needs and potential dilution, including the pre-funded warrants and registered resale shares.
- Monitor progress in remediating material weaknesses and the accuracy and timeliness of future financial reporting.
- Confirm the status of the conditional Octopus purchase, the company’s trading-market plans and its ability to maintain access to fabrication facilities.