Skye Bioscience Inc

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

1. Organization, Basis of Presentation and Significant Accounting Policies

Nature of Operations

Skye Bioscience, Inc. (the “Company” or “Skye”) was incorporated in Nevada on March 16, 2011. The Company is a clinical stage biopharmaceutical company developing next-generation molecules that modulate G protein-coupled receptors to treat obesity and metabolic diseases.

As of September 30, 2024, the Company has devoted substantially all its efforts to securing its product pipeline, carrying out its own research and development, preparing for and conducting clinical trials, building infrastructure and raising capital. The Company has not yet realized revenue from its planned principal operations and is a number of years away from potentially being able to do so.

Basis of Presentation

The accompanying Unaudited Condensed Consolidated Financial Statements have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by GAAP for complete financial statements. Interim financial results are not necessarily indicative of results anticipated for the full year, or any future periods.

The Unaudited Condensed Consolidated Financial Statements included in this Quarterly Report on Form 10-Q should be read in conjunction with the Audited Consolidated Financial Statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2023, from which the prior year balance sheet information herein was derived.

Certain reclassifications have been made to the amounts in prior periods to conform to the current period’s presentation, primarily the separate classification of prepaid expenses and other current assets on the Company's condensed balance sheet, and condensed statement of cash flows and change in fair value of derivative liability and interest expense on the condensed statement of operations. Such reclassifications did not have a material impact on the Unaudited Condensed Consolidated Financial Statements.

During thenine months ended September 30, 2024, there were no changes to the Company's significant accounting policies as described in the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2023.

Pronouncements Implemented

In August 2020, the FASB issued ASU 2020-06, Debt - Debt with Conversion and Other Options (Subtopic 470-20) and Derivatives and Hedging - Contracts in Entity’s Own Equity (Subtopic 815-40). The new standard reduces the number of accounting models for convertible debt instruments, amends the accounting for certain contracts in an entity’s own equity, and modifies how certain convertible instruments and contracts that may be settled in cash or shares impact the calculation of diluted earnings per share. Specifically, the guidance removes certain accounting models that separate the embedded conversion features from the host contract for convertible instruments and requires the use of the if-converted method to calculate diluted earnings per share. This standard was effective for fiscal years beginning after December 15, 2023 and interim periods within those fiscal years. The Company adopted this standard as of January 1, 2024 and the adoption of this standard did not have an impact on the Company's Unaudited Condensed Consolidated Financial Statements or related disclosures.

Recent Accounting Pronouncements Not Yet Adopted

In December 2023, the FASB issued ASU 2023-09, Improvements to Income Tax Disclosures. This ASU requires greater disaggregation of information about a reporting entity's effective tax rate reconciliation as well as information on income taxes paid. This ASU applies to all entities subject to income taxes and is intended to help investors better understand an entity’s exposure to potential changes in jurisdictional tax legislation and assess income tax information that affects cash flow forecasts and capital allocation decisions. This ASU is effective for annual periods beginning after December 15, 2024, with early adoption permitted. This ASU should be applied on a prospective basis although retrospective application is permitted. The Company does not expect the impact of adopting ASU 2023-09 to be material on its consolidated financial statements.

In November 2023, the Financial Account Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2023-07, Segment Reporting (Topic 280): Improvements to Reportable Segment Disclosures. The amendments in this ASU require disclosures, on an annual and interim basis, of significant segment expenses that are regularly provided to the chief operating decision maker (“CODM”), as well as the aggregate amount of other segment items included in the reported measure of segment profit or loss. This ASU requires that a public entity disclose the title and position of the CODM and an explanation of how the CODM uses the reported measure(s) of segment profit or loss in assessing segment performance and deciding how to allocate resources. ASU 2023-07 is to be applied retrospectively to all prior periods presented in the financial statements with an effective date for all public entities for fiscal years beginning after December 15, 2023, and interim periods within fiscal years beginning after December 15, 2024. Early adoption is permitted. The Company does not expect the impact of adopting ASU 2023-07 to be material on its consolidated financial statements.

2. Asset Acquisitions and Dispositions

Sale of real estate

The wind down of Emerald Health Therapeutics, Inc. ("EHT's") operations included the disposition of real estate held by Avalite Sciences, Inc. ("AVI") (the "AVI building"). At the time of the Company’s acquisition of EHT on November 10, 2022 (the “EHT Acquisition”), none of the purchase consideration was allocated to the fair value of the AVI building. As a result of the sale of the AVI building, for the nine months ended September 30, 2024, the Company recorded a gain of $1,145,141 recorded as a (Gain) Loss from Asset Sales within the Other Income and Expense section of the Company's Unaudited Condensed Consolidated Statements of Operations.

Divestiture of VDL, Release and Discharge Agreement

On February 9, 2023, the Company sold Verdélite Sciences, Inc. ("VDL"). For the nine months ended September 30, 2023, the Company has recorded a loss on sale of asset of $307,086 in other (income) expense based on the difference between the carrying amount of the assets sold and the net cash proceeds.

On July 17, 2024, the Company reached a transaction, release and discharge agreement with the purchaser of VDL. Under the transaction, release and discharge agreement, the purchase price of VDL was adjusted in exchange for a full release of any future claims by VDL against the Company. As part of the agreement, the parties agreed to an installment payment schedule for the remaining aggregate balance of the purchase price of $2,047,080 through December 2027. The remainder of the purchase price receivable bears interest at 8%. Upon signing the transaction, release and discharge agreement, the Company received the first installment payment of $72,837 recorded as a (Gain) Loss from Asset Sales within the Other Income and Expense section of the Company's Unaudited Condensed Consolidated Statements of Operations.

BRB Acquisition

On August 18, 2023, the Company acquired 100% of the equity interests in Bird Rock Bio Sub, Inc. ("BRB") pursuant to an Agreement and Plan of Merger and Reorganization, dated August 15, 2023 (the "BRB Acquisition"). The purpose of the acquisition was to acquire BRB's clinical asset, nimacimab, an antibody targeting the CB1 receptor, for development to treat metabolic conditions. Pursuant to the BRB Acquisition, the Company issued 3,872,184 shares of Company common stock to the former preferred stockholders of BRB equal to $20,000,000 in base merger consideration priced at $5.16.

In addition, the former preferred stockholders of BRB were entitled to additional merger consideration for each dollar invested in a concurrent private investment in public equity transaction (the "2023 PIPE Financing"). Because the 2023 PIPE Financing and BRB Acquisition occurred contemporaneously and in contemplation of each other, in accounting for the transaction, the Company allocated the shares issued as additional merger consideration between the BRB Acquisition and 2023 PIPE Financing using a residual allocation method, whereby the fair value of the consideration transferred was first allocated to the monetary assets and 2023 PIPE Financing proceeds with the remainder allocated to the in-process research and development (" IPR&D") asset, nimacimab. As a result,1,564,194 additional shares of common stock were allocated to the BRB Acquisition.

Below is a summary of the total consideration, assets acquired and the liabilities assumed in connection with the BRB Acquisition:

(a) Equal to the aggregate of 5,436,378 shares of common stock issued, multiplied by the Company's closing stock price of $3.98 as of August 18, 2023.

The cost to acquire the IPR&D asset, nimacimab, was expensed on the date of the BRB Acquisition as it was determined to have no future alternative use. Accordingly, costs associated with the BRB Acquisition to acquire the asset were expensed as incurred.

3. Property and Equipment, Prepaid Expenses, Other Current Assets and Liabilities

Property and equipment, net consists of the following:

Depreciation expense for the three and nine months ended September 30, 2024 was $47,519 and $69,873, respectively. Depreciation expense for the three and nine months ended Sepember 30, 2023 was $12,788 and $38,107, respectively.

Prepaid expenses consist of the following:

Other current assets consist of the following:

Other current liabilities consist of the following:

4. Warrants

There are significant judgements and estimates inherent in the determination of the fair value of the Company’s warrants. These judgements and estimates include assumptions regarding the Company’s future operating performance and the determination of the appropriate valuation methods.

Warrants

Warrants vested and outstanding as of September 30, 2024 are summarized as follows:

As of September 30, 2024, all of the Company's warrants are fully vested.

January 2024 Pre-Funded Warrants

In connection with the January 2024 PIPE Financing (as defined below), the Company issued the Pre-Funded Warrants (as defined below) (See Note 6). The Pre-Funded Warrants have an exercise price of $0.001 per share, and were exercisable immediately upon issuance until exercised in full. The gross proceeds from the issuance of these Pre-Funded Warrants was $22,991,015. The Company determined that the Pre-Funded Warrants are freestanding instruments that do not meet the definition of a liability or derivative. The Pre-Funded Warrants are indexed to the Company’s common stock and meets all other conditions for equity classification. Accordingly, the Pre-Funded Warrants are classified as equity and are accounted for as a component of additional paid-in capital at the time issued. The Company also determined that the Pre-Funded Warrants should be included in the determination of basic and diluted earnings per share.`

5. Debt

The Company’s convertible debt consists of the following:

Convertible Note - Related Party

On August 15, 2023, the Company entered into a secured note and warrant purchase agreement (the "Secured Note and Warrant Purchase Agreement") with MFDI, LLC (“MFDI”), pursuant to which the Company issued to MFDI a $5,000,000 secured convertible promissory note (the "Convertible Note") and a warrant to purchase 340,000 shares of common stock on August 18, 2023 (the "Convertible Note Financing") (See Note 4). The Convertible Note had an interest rate of 10% per annum and had a fixed conversion rate of $5.16.

On August 8, 2024, MFDI exercised the conversion option under the Convertible Note and converted the full principal balance of $5,000,000 under the Convertible Note. This conversion resulted in the issuance of 968,973 shares of the Company's common stock and the payment of accrued interest in cash, thereby fully satisfying the Company's debt obligations to MFDI.

Accrued interest was payable quarterly within 30 days of the last day of each calendar quarter. The debt discounts related to the warrants, and debt issuance costs, were amortized over the term of the Convertible Note using the effective interest rate method. Amortization of the debt discount is recognized as non-cash interest expense in Other (income) expense within the Consolidated Statements of Operations. Through the date of conversion, the Convertible Note is classified as Level 2 of the fair value hierarchy model based on market prices that can be corroborated with observable market data for the Company's common stock.

For the three and nine months ended September 30, 2024, the effective interest rate on the Convertible Note was 31.39%.

Interest Expense (Income)

The Company’s interest expense consists of the following:

6. Stockholders’ Equity and Capitalization

PIPE Financings

January 2024 PIPE Financing

On January 29, 2024, the Company entered into a Securities Purchase Agreement with certain institutional investors, pursuant to which on January 31, 2024, the Company issued an aggregate of 11,713,664 shares of common stock and 9,978,739 pre-funded warrants (the "Pre-Funded Warrants") to purchase up to 9,978,739 shares of common stock (the "January 2024 PIPE Financing") for an aggregate purchase price of$49,991,010. The January 2024 PIPE Financing was priced at$2.31 per common share and$2.30 per Pre-Funded Warrant based on the 5-day average share price preceding January 29, 2024. The Pre-Funded Warrants are exercisable at any time for an exercise price of$0.001.

In connection with the January 2024 PIPE Financing, the Company incurred$3,823,752 in direct equity issuance costs for net proceeds of$46,167,258.

March 2024 PIPE Financing

On March 11, 2024, the Company entered into a Securities Purchase Agreement with certain institutional investors, pursuant to which on March 13, 2024, the Company issued an aggregate of 4,000,000 shares of common stock (the "March 2024 PIPE Financing") for an aggregate purchase price of $40,000,000. The March 2024 PIPE Financing was priced at $10.00 per common share.

In connection with the March 2024 PIPE Financing, the Company incurred $2,610,695 in direct equity issuance costs for net proceeds of approximately $37,389,305.

Prefunded Warrant Exercise

On July 1, 2024,1,301,573 pre-funded warrants issued in the January 2024 PIPE Financing with an intrinsic value of $10,424,294 were exercised on a cashless basis, resulting in the issuance of 1,301,410 shares of Company's common stock.

Conversion of Debt

On August 8, 2024, the Company issued 968,973 shares of common stock to MFDI upon conversion in full of the Convertible Note (see Note 5).

7. Stock-Based Compensation

Stock Incentive Plan

On October 31, 2014, the Board of Directors of the Company ("Board") approved the Company’s 2014 Omnibus Incentive Plan. On June 14, 2022, the Board approved the 2014 Amended and Restated Omnibus Incentive Plan (as amended, the “2014 Amended and Restated Plan”) which replaced the 2014 Omnibus Incentive Plan in its entirety.

On September 29, 2023, the Board and holders of the voting power of the outstanding capital stock of the Company adopted and approved Amendment No. 1 to the 2014 Amended and Restated Plan. Amendment No. 1 to the 2014 Amended and the Restated Plan became effective on November 6, 2023. As of September 30, 2024, 2,464,345 shares were authorized for the issuance under the 2014 Amended and Restated Plan.

As of September 30, 2024, the Company had 27,578 shares available for future grant under the 2014 Amended and Restated Plan.

2024 Inducement Equity Incentive Plan

On July 2, 2024, the Board adopted the Skye Bioscience, Inc. 2024 Inducement Equity Incentive Plan (the "Inducement Plan"). The Inducement Plan was adopted in order to grant share-based awards to newly hired employees as an inducement to join the Company. The terms of the Inducement Plan are substantially similar to the terms of the Company’s 2014 Amended and Restated Plan with the exception that awards may only be made to an employee who has not previously been an employee or member of the Board of Directors of the Company if the award is in connection with commencement of employment. The Company has reserved 600,000 shares of the Company’s common stock for issuance pursuant to awards granted under the Inducement Plan. As of September 30, 2024, the Company had 246,500 shares available for future grant under the Inducement Plan.

Stock Options

The following is a summary of option activity under the Company’s 2014 Amended and Restated Plan and the Inducement Plan, for the nine months ended September 30, 2024:

*The aggregate intrinsic value is the sum of the amounts by which the quoted market price of the Company’s stock exceeded the exercise price of the stock options at September 30, 2024 for those stock options for which the quoted market price was in excess of the exercise price ("in-the-money options").

The weighted-average grant-date fair value of stock options granted during the nine months ended September 30, 2024, was$8.82.

The fair value of the Company's stock option grants were estimated on the date of grant using the Black-Scholes option-pricing model under the following assumptions:

Restricted Stock Units

On February 29, 2024, the Company granted restricted stock units ("RSUs") to its executive management team and to certain members of the Board with market-based vesting conditions. The RSUs are eligible to vest subject to the achievement and attainment of certain market capitalization target goals and share price targets (market-based vesting conditions). The Company used the Monte Carlo Simulation model to evaluate the derived service period and fair value of awards with market and performance conditions, including assumptions of historical volatility and risk-free interest rate commensurate with the vesting term.

The fair value of the Company's market-based RSUs were estimated on the date of grant under the following assumptions:

On August 22, 2024, the Board approved a modification to the terms of the RSUs issued on August 25, 2023, and September 29, 2023 to its executive management team and to a member of the Board. The vesting condition was modified from a performance-based condition to a market-based condition. Since the performance condition under the original award was improbable of being met at the time of the modification, no expense was previously recognized. Therefore, on the modification date, the Company established a new fair value and will recognize the expense over the derived service period. The Company used the Monte Carlo Simulation model to evaluate the derived service period and fair value of the awards.

The fair value of the Company's market-based RSUs were estimated on the modification date under the following assumptions:

The following is a summary of RSU activity during the period ended September 30, 2024:

Common Stock Issued for Services

Additionally, during the nine months ended September 30, 2024, the Company issued 5,000 shares of common stock to a service provider as compensation for services provided. Such shares were issued in a private placement outside of the Company's equity incentive plans.

Stock-Based Compensation Expense

The Company recognizes stock-based compensation expense using the straight-line method over the requisite service period or derived service period. The Company recognized stock-based compensation expense for the stock options and the RSUs discussed above, in its Unaudited Condensed Consolidated Statements of Operations as follows:

During the nine months ended September 30, 2024, the first three market-based vesting conditions of the RSUs granted in August and September 2023 were met.

Stock Compensation Adjustments Related to Board Member Resignations

On July 2, 2024, the Board accepted the resignations of several Board members effective August 1, 2024. Concurrently, the Board approved a modification to the option awards granted such Board members, which modification accelerated the vesting of all unvested options as of the resignation date and extended the post-termination exercise period to December 31, 2025. As a result of the modification, the Company recognized $274,019 in incremental stock compensation expense during the three and nine months ended September 30, 2024.

The total amount of unrecognized compensation cost was$11,758,346 as of September 30, 2024. This amount will be recognized over a weighted average period of 2.61 years.

8. Loss Per Share of Common Stock

The following tables are a reconciliation of the numerators and denominators used in the calculation of basic and diluted net loss per share computations:

The following outstanding shares of common stock equivalents were excluded from the computation of diluted net loss per share of common stock for the periods presented because including them would have been anti-dilutive:

9. Contingencies

General Litigation and Disputes

From time to time, in the normal course of operations, the Company may be a party to litigation and other dispute matters and claims. Litigation can be expensive and disruptive to normal business operations. Moreover, the results of complex legal proceedings are difficult to predict. An unfavorable outcome to any legal matter, if material, could have a materially adverse effect on the Company’s operations or financial position, liquidity or results of operations.

Wendy Cunning vs Skye Bioscience, Inc.

The Company is a party to a legal proceeding with a former employee alleging, among other things, wrongful termination, violation of whistleblower protections under the Sarbanes-Oxley Act of 2002, and retaliation under California law against the Company relating to certain actions and events that occurred with the Company's former management during the employee's employment term from March 2018 to July 2019. The case, entitled Wendy Cunning vs Skye Bioscience, Inc., was filed in U.S. District Court (the "District Court") for the Central District of California (the “Cunning Lawsuit”). On January 18, 2023, a jury rendered a verdict in favor of Ms. Cunning and awarded her $512,500 in economic damages (e.g., lost earnings, future earnings and interest), $840,960 in non-economic damages (e.g., emotional distress) and $3,500,000 in punitive damages. On August 2, 2023, the District Court ruled on the plaintiff's motion for attorney fees and awarded the plaintiff $1,200,008. Based on this order, the Company reduced the aggregate estimate for the legal contingency by $151,842, the difference between the attorney fees awarded by the District Court and the Company's previous estimate. On August 17, 2023, the Company obtained a stay on enforcement of the judgment in the Cunning Lawsuit by posting an appeal bond in the amount of $9,080,202.

In March of 2023, the Company appealed the judgment in the Cunning Lawsuit to the United States Court of Appeals for the Ninth District (the "Ninth Circuit"). Subsequent to quarter end, on October 22, 2024, the Ninth Circuit issued its decision in the Company's favor which vacated the judgment and remanded the case back to the District Court for a new trial. As a result, the Company will be able to recover the $9,080,202 restriction on its cash related to the bond.

Skye Bioscience, Inc. vs Partner Re Ireland Insurance

In February 2023, the Company brought a suit against the Company's D&O insurance carrier, Partner Re Ireland Insurance DAC ("Partner Re"), bringing claims for (a) breach of contract, (2) tortious breach of the implied covenant of good faith and fair dealing and (3) declaratory relief that Partner Re is obligated to reimburse the Company for the defense fees and costs incurred in defense of the Cunning Lawsuit and must indemnify the Company for any settlement or judgment in the Cunning Lawsuit (the "Partner Re Lawsuit"). The Company's allegations arise out of Partner Re's refusal to reimburse the Company for costs incurred by the Company in defending the Cunning Lawsuit. The case, entitled Skye Bioscience, Inc., v. Partner Re Ireland Insurance DAC, was filed in the United Stated District Court for the Central District of California.

On April 17, 2023, Partner Re filed a motion to dismiss the Company's complaint. On June 20, 2023, the court issued a ruling in favor of the Company and denied Partner Re's motion to dismiss the Company's lawsuit. In April 2024, the Company filed a motion for judgment on the pleadings. In June of 2024, the court granted in part and denied in part the Company's motion for judgment on the pleadings. The court granted the Company's motion for judgment on the pleadings with respect to Partner Re's affirmative defense related to whether the Cunning Lawsuit constituted a “Securities Claim” as defined in the Partner Re policy, rejecting what had been Partner Re's primary basis for denying coverage.

The Company is pursuing up to $5,000,000 in coverage less the deductible to cover legal expenses incurred and any potential loss incurred from the Cunning Lawsuit.

Estimate for accrued legal contingencies and related expenses

Following the Ninth Circuit's favorable decision and the Company's mediation efforts with PartnerRe, a change in estimate for legal contingencies was recorded. As of September 30, 2024, the Company has reversed the accrued interest on the original judgment and adjusted its potential loss for accrued legal contingencies and related expenses, which includes legal accruals and all other costs related to its ongoing litigation matters.

Management uses significant judgment in developing its estimates related to legal contingencies and loss recoveries. These adjustments are based on the evaluation of case history, mediation efforts, the facts of the cases and take into consideration both future potential judgment amounts, damages and potential attorney fee awards if the cases were to be retried.

The final amount of the loss and loss recoveries remain uncertain. The ultimate amount of the potential loss may be significantly less than the amount of the revised legal contingency and there is no guarantee that the Company will be successful in its efforts to recover additional losses. The Company believes that it is at least reasonably possible that the estimated amount of the potential loss may change in the near term.

10. Subsequent Events

Approval of Amended and Restated Omnibus Incentive Plan

On October 22, 2024, the Company's stockholders voted to approve the second amendment and restatement of the Company's Amended and Restated 2014 Omnibus Incentive Plan to increase the number of shares of the Company's common stock issuable thereunder by 1,535,655 to increase the number of incentive stock options that may be granted thereunder to 4,000,000, extend the expiration date of the plan to September 10, 2034, update the name of the plan to the “Skye Bioscience, Inc. Amended and Restated Omnibus Incentive Plan” and make certain administrative amendments (as so amended and restated, the "Amended and Restated Plan").

Stock Option Grants

Subsequent to September 30, 2024, the Company granted an aggregate of 1,456,400 common stock options to members of management, employees and directors under the Amended and Restated Plan.

San Francisco Office Lease

On September 25, 2024, the Company entered into a new lease agreement for approximately 2,077 square feet of office space located at 632 Commercial Street, 5th Floor, San Francisco, California 94111. The lease has a term ofthree years and two months, beginning on October 1, 2024, with a monthly rent of $9,000 and annual increases of 3%. This office space will support our continued growth and operational needs as we expand our development activities. No material changes to our financial position are anticipated as a result of this lease.

Legal Contingencies

See Note 9 for disclosure of the recognized subsequent event related to our estimate for legal contingencies.