Item 7. Management’s Discussion and Analysis
of Financial Condition and Results of Operations.
The following discussion and analysis is intended
as a review of significant factors affecting our financial condition and results of operations for the periods indicated. The discussion
should be read in conjunction with our consolidated financial statements and the notes presented herein. In addition to historical information,
the following Management’s Discussion and Analysis of Financial Condition and Results of Operations contains forward-looking statements
that involve risks and uncertainties. See “Risk Factors” and “Cautionary Note Regarding Forward-Looking Statements”
included elsewhere in this Annual Report on Form 10-K. Our actual results could differ significantly from those expressed, implied or
anticipated in these forward-looking statements as a result of certain factors discussed herein and any other periodic reports filed and
to be filed by us with the Securities and Exchange Commission.
Overview
We are a clinical-stage
biopharmaceutical company focused on the development of therapeutics for the treatment or prevention of addiction and related disorders.
Our lead investigational new drug product, AD04, is a genetically targeted therapeutic agent being developed for the treatment of alcohol
use disorder (“AUD”). AD04 was recently investigated in a Phase 3 clinical trial, designated the ONWARD trial, for the potential
treatment of AUD in subjects with certain target genotypes, which were identified using our companion diagnostic genetic test. Based on
our analysis of the subgroup data from the ONWARD trial, we are now focused on commercializing AD04 in the U.S. and Europe.
We continue to explore
opportunities to expand our portfolio in the field of addiction and related disorders such as pain reduction, both through internal development
and through acquisitions. Our vision is to create the world’s leading addiction focused pharmaceutical company.
In January 2021, we expanded our portfolio in
the field of addiction with the acquisition of Purnovate, LLC via a merger into our wholly owned subsidiary, Purnovate, Inc., (“Purnovate”)
and in January 2023, we entered into an option agreement with Adenomed LLC (“Buyer”), pursuant to which we granted to the
Buyer an exclusive option for a period of one hundred twenty (120) days from the effective date of the Option Agreement for Buyer or its
designated affiliate to acquire all of the assets of Purnovate. We have been using Purnovate’s adenosine drug discovery and development
platform to invent and develop novel chemical entities as drug candidates for large unmet medical needs.
We have devoted the vast majority of our resources
to development efforts relating to AD04, including preparation for conducting clinical trials, providing general and administrative support
for these operations and protecting our intellectual property.
We currently do not have any products approved
for sale and we have not generated any significant revenue since our inception. From our inception through the date of this Annual Report
on Form 10-K, we have funded our operations primarily through the private and public placements of debt and equity securities and an equity
line.
Our current cash and cash equivalents are not
expected to be sufficient to fund operations for the twelve months from the date of filing this Annual report on Form 10-K, based our
current projections.
We have incurred net losses in each year since our inception, including net losses of approximately $12.7 million
and $19.4 million for the years ended December 31, 2022 and 2021. We had accumulated deficits of approximately $63.7 and $50.9 million
as of December 31, 2022 and 2021, respectively. Substantially all our operating losses resulted from costs incurred in connection with
our research and development programs, from general and administrative costs associated with our operations, and from financing costs.
76
We will not generate revenue from product sales
unless and until we successfully complete development and obtain marketing approval for AD04, which we expect will take a number of years
and is subject to significant uncertainty. We do not believe our current cash and equivalents will be sufficient to fund our operations
for the next twelve months from the filing of these financial statements.
Until such time, if ever, as we can generate substantial
revenue from product sales, we expect to finance our operating activities through a combination of equity offerings, debt financings,
government or other third-party funding, commercialization, marketing and distribution arrangements and other collaborations, strategic
alliances and licensing arrangements. However, we may be unable to raise additional funds or enter into such other arrangements when needed
on favorable terms or at all. Our failure to raise capital or enter into such other arrangements as and when needed would have a negative
impact on our financial condition and our ability to develop AD04.
Clinical Trials — Research and
Development Schedule
We currently anticipate that we, working in collaboration
with our vendors, upon execution of collaborative research and development agreements with them, will be able to execute the following
timeline:
AD04 — Two-Stage Clinical Development Strategy — Conduct
the Phase 3 clinical trials sequentially
We have completed initial Phase 3 trial, the ONWARDTM
pivotal Phase 3 clinical trial using AD04 for the potential treatment of AUD in subjects with certain target genotypes.
We do not anticipate significant additional direct
expenses resulting from the ONWARD trial as of the date of the filing, though continued expenditures relating to data analysis, strategic
planning, and regulatory follow-up resulting from the trial continue.
Additional funds are expected to be raised through
grants, partnerships with other pharmaceutical companies or through additional debt or equity financings, including pursuant to the terms
of our equity line. We expect the second Phase 3 Trial, if required, to cost approximately $8-12 million, such estimate subject to the
factors stated above.
77
2022 Financing Developments
On February 23, 2023, we entered into a securities
purchase agreement (the “2023 Purchase Agreement”) with an accredited institutional investor providing for the issuance of
1,829,269 shares (the “Shares”) of the Company’s common stock, par value $0.001 (the “Common Stock”). Pursuant
to the 2023 Purchase Agreement, the Investor purchased the Shares for an aggregate purchase price of $750,000 and expected net proceeds
of approximately $550,000. Pursuant to the 2023 Purchase Agreement, we issued an aggregate of 1,829,269 shares of common stock to the
Investor.
On February
10, 2022, we entered into a securities purchase agreement (the “2022 Purchase Agreement”) with an accredited institutional
investor providing for the issuance of (i) 2,322,250 shares of Common Stock, (ii) pre-funded warrants (the “Pre-Funded Warrants”)
to purchase up to 1,865,000 shares of Common Stock (the “Pre-Funded Warrant Shares”) with an exercise price of $0.001 per
share, which Pre-Funded Warrants are to be issued in lieu of shares of Common Stock to ensure that the investor does not exceed certain
beneficial ownership limitations, and (iii) warrants (the “20222 Warrants”), with a term of five years and six months
from the date of issuance, to purchase an aggregate of up to 3,977,888 shares of Common Stock (the “2022 Warrant Shares”)
at an exercise price of $2.52 per share, subject to customary adjustments thereunder. The total net proceeds, after expenses, to us were
approximately $9.1 million. All 1,865,000 Pre-Funded Warrants were exercised on June 8, 2022, resulting in the issue of 1,865,000 shares
of common stock for proceeds of $1,865.
Clinical and Research Developments
In March 2023, we announced
an update to our regulatory strategy for AD04. Key highlights included:
● Advancing discussions with potential U.S. and European partners
On July 20, 2022, we announced the following results
from the Company’s ONWARDTM trial. We also announced our intent to share the results of the ONWARD trial with the relevant
health authorities to discuss the appropriate next steps towards the expeditious development of AD04 and to seek product approval.
78
Additionally, and consistent with results from
our Phase 2b study, AD04 had a safety and tolerability profile that was similar to placebo:
● Serious Adverse Events (SAEs)
* No SAEs were determined to be related to AD04 treatment.
* There were two cardiac events in placebo group and none in the AD04 group.
● Side effects/Adverse Events (AEs)
* The AE profiles between AD04 and placebo were similar.
On January 26, 2021, we closed the Acquisition
contemplated by that Equity Purchase Agreement that we entered into on December 7, pursuant to which we purchased all of the outstanding
membership interests of Purnovate from the members of Purnovate, such that after the Acquisition, Purnovate became our wholly owned subsidiary.
On January 27, 2023, we entered into the Option Agreement with Adenomed, LLC pursuant to which we granted to the Buyer an exclusive option
for a period of one hundred twenty (120) days from the effective date of the Agreement for Buyer or its designated affiliate to acquire
all of the assets of Purnovate,. William Stilley, a director and Executive Vice President for us and Chief Executive Officer of Purnovate,
serves as the President of the Buyer and is the principal stockholder of the Buyer.
79
Results of operations for the years ended December
31, 2022 and 2021 (rounded to nearest thousand)
The following table sets forth the components
of our statements of operations in dollars for the periods presented:
For the Year Ended December 31, Change
Research and development (“R&D”) expenses
Research and development expenses decreased by
$4,219,000 (50%) during year ended December 31, 2022 compared to the year ended December 31, 2021. This decrease was due to the sharp
decrease in direct trial expenses of $5,585,000, trials insurance of $85,000, and in ONWARD-supporting manufacturing expenses of $396,000
with the completion of the ONWARD trial clinical activities during the year ended December 31, 2022, compared to the year ended December
31, 2021 when the ONWARD trial was actively recruiting patients. These decreases were partially offset by increases in post-trial regulatory
and statistical consulting of $224,000 and added Purnovate research and development project costs of $1,641,000, as several new preclinical
programs began.
General and administrative expenses
The year ended December 31, 2022 saw a modest
decrease of $205,000 in G&A expenses compared to the year ended December 31, 2021, driven primarily by a large decrease in G&A
equity compensation expense of $752,000 due to decreased use of stock grants and the completed vesting of a number of options grants in
the period, substantial decreases in business development, PR, IR consultants of $305,000 as a result of management efforts to rationalize
this expense category, and modest decrease in corporate legal expenses of $55,000. These decreases were partially offset by increases
in G&A-directed salaries of $633,000 associated with increased headcounts and increased use of strategic consultants to assist management
in formulating a strategy in response to the ONWARD trial data, increasing this expense category by $247,000.
Change in Impairment Charges
Impairment charges decreased by $1,548,000 (100%)
during the year ended December 31, 2022, compared to the year ended December 31, 2021. This difference was due to the impairment of the
Purnovate supply assets resulting in this expense being a one time charge which took place during the year ended December 31, 2021.
Change in Fair Value of Contingent Consideration
The change in the fair value of contingent consideration
resulted in our recognizing a differential gain of $804,000 (285%) in the year ended December 31, 2022, when the Company recognized a
gain of $522,000, compared to the year ended December 31, 2022, when the Company recognized a loss of $282,000. This difference is due
to our strategic decision to focus our efforts on AD04 development and take steps for Purnovate to secure independent funding of its programs
through sale to a new company, Adenomed, LLC, formed for that purpose. While Purnovate’s programs remain commercially viable and
highly valuable, this strategy does increase the time before the milestone payments reflected in the contingent liability will be realized
and increases the risk around these milestones, as the programs must now be capitalized independently.
80
Income Tax Benefit
Benefit from deferred taxes decreased by approximately $93,000 during
the year ended December 31, 2022 compared to the year ended December 31, 2021. The benefit from deferred taxes was the result of substantial
taxes deferred through the purchase of Purnovate, an event which took place during the year ended December 31, 2021.
Liquidity and Capital Resources
Overview
Our principal liquidity needs have historically
been working capital, R&D, patent costs and personnel costs. We expect these needs to continue to increase in the near term as we
develop and eventually commercialize our compound, if approved. Over the next several years, we expect to increase our R&D expenses
as we undergo clinical trials to demonstrate the safety and efficacy of our lead product candidate and as we further develop product candidates
acquired from Purnovate. To date, we have funded our operations primarily with the proceeds from our initial and secondary public offerings,
private placements and our equity line, as well as other equity financings and the issuance of debt securities prior to that. On July
31, 2018, we closed our initial public offering.
During the year ended December 31, 2022, our primary
sources of funding were sales of common stock, pre-funded warrants, and warrants, and option exercises.
On February 10, 2022, we entered into a securities
purchase agreement with an accredited institutional investor providing for the issuance of (i) 2,322,250 shares of our common stock, par
value $0.001, (ii) pre-funded warrants to purchase up to 1,865,000 shares of Common Stock with an exercise price of $0.001 per share,
which Pre-Funded Warrants are to be issued in lieu of shares of Common Stock to ensure that the Investor does not exceed certain beneficial
ownership limitations, and (iii) warrants, with a term of five years and six months from the date of issuance, to purchase an aggregate
of up to 3,977,888 shares of Common Stock at an exercise price of $2.52 per share. We realized net proceeds from the offering of approximately
$9.1 million after deducting fees due to the placement agent and our transaction expenses.
On February 23, 2023, we entered into an equity
purchase agreement with an accredited investor for the purchase of 1,829,269 shares of commons stock at at-the-market price of $0.41 per
share in a registered direct offering. We realized expected net proceeds from the offering of approximately $550,000 after deducting fees
due to the placement agent and our transaction expenses. We also issued the placement agent warrant to purchase 182,927 shares of common
stock at an exercise price of $0.41 per share.
Our current cash and cash equivalents are not
expected to be sufficient to fund operations for the twelve months from the date of filing this Annual Report on Form 10-K, based our
current projections.
We would expect to use approximately $7.6 million in cash during the
twelve months ended December 31, 2023 for both AD04 development costs, other R&D project costs, and general corporate expenses, assuming
that the option for the purchase of Purnovate is not exercised and no other changes were made to project commitments. There is no assurance
that funds could be raised in that period on acceptable terms.
We will also require additional financing as we
continue to execute our overall business strategy, including an estimated $8-12 million for a second phase three trial of AD04. Our liquidity
may be negatively impacted as a result of research and development cost increases in addition to general economic and industry factors.
Our continued operations will depend on our ability to raise additional capital through various potential sources, such as equity and/or
debt financings, grant funding, strategic relationships, or out-licensing in order to complete its subsequent clinical trial requirements
for AD04. Management is actively pursuing financing and other strategic plans but can provide no assurances that such financing or other
strategic plans will be available on acceptable terms, or at all. Without additional funding, the Company would be required to delay,
scale back or eliminate some or all of its research and development programs, which would likely have a material adverse effect on us
and our financial statements.
81
If we raise additional funds by issuing equity
securities or convertible debt, our shareholders will experience dilution. Debt financing, if available, would result in increased fixed
payment obligations and may involve agreements that include covenants limiting or restricting our ability to take specific actions, such
as incurring additional debt, making capital expenditures or declaring dividends. If we raise additional funds through collaboration and
licensing arrangements with third parties, it may be necessary to relinquish valuable rights to our products, future revenue streams or
product candidates or to grant licenses on terms that may not be favorable to us. We cannot be certain that additional funding will be
available on acceptable terms, or at all. Any failure to raise capital in the future could have a negative impact on our financial condition
and our ability to pursue our business strategies.
Cash flows
For the Year Ended December 31,
Provided by (used in)
Investing activities – (34,000 )
Net increase (decrease) in cash and cash equivalents $ (2,060,000 ) $ 1,661,000
Net cash used in operating activities
Net cash used in operating activities decreased by $763,000 in the
year ended December 31, 2022 compared to the year ended December 31, 2021. This reduction in cash used was substantially less than the
$6,694,000 decrease in net loss when comparing the same two periods. This difference is due to much of the reduction in expense being
non-cash based, such as $866,000 in expense decrease being reduction in equity compensation expense, $1,548,000 being reduced non-cash
impairment charges, and $804,000 being the difference in the non-cash gain of $522,000 in 2022 and the non-cash loss in 2021 on the change
in value of the contingent liability. We also used $642,000 more cash to pre-pay expenses and $2,702,000 more cash to pay previously accrued
expenses in the year ended December 31, 2022 than we did in the year ended December 31, 2021.
Net cash provided by investing activities
The Company purchased Purnovate and capital equipment
in the year ended December 31, 2021, resulting in net negative cash flow due to investing activities of $34,000. No such investing activity
took place in the year ended December 31, 2022.
Net cash provided by financing activities
Net cash provided by financing activities decreased
by $4,518,000 during the year ended December 31, 2022 compared to the year ended December 31, 2021. This decrease was due to the combination
of management’s assessment that less financing would be needed to take the Company to its next critical milestone of releasing the
ONWARD trial data with generally tighter capital markets. During the year ended December 31, 2022, substantially all of our cash flows
from financing activities was from the proceeds that we received from the sale of $9,124,000 of common stock and warrants in February
2022. During the year ended December 31, 2021, our cash flows from financing activities was primarily from the sale of $11,750,000 from
shares of common stock and warrants and to a lesser extent proceeds of $1,425,000 from exercise of existing warrants.
Off-balance sheet arrangements
We do not have any off-balance sheet arrangements.
Recent Accounting Pronouncements
See Note 3 to the financial statements for a discussion
of recent accounting pronouncements.
82
Critical Accounting Policies and Estimates
The preparation of the financial statements requires
us to make assumptions, estimates and judgments that affect the reported amounts of assets and liabilities, the disclosures of contingent
assets and liabilities as of the date of the financial statements, our expected liquidity needs and expected future cash positions, and
the reported amounts of sales and expenses during the reporting periods. Certain of our more critical accounting policies require the
application of significant judgment by management in selecting the appropriate assumptions for calculating financial estimates. By their
nature, these judgments are subject to an inherent degree of uncertainty. On an ongoing basis, we evaluate our judgments, including those
related to prepaid research and development, accruals associated with third party providers supporting clinical trials, realization of
income tax assets, as well as the, fair value of stock based compensation to employees and service providers. We use historical experience
and other assumptions as the basis for our judgments and making these estimates. Because future events and their effects cannot be determined
with precision, actual results could differ significantly from these estimates. Any changes in those estimates will be reflected in our
financial statements as they occur.
While our significant accounting policies are
more fully described in Note 3 to our financial statements included elsewhere in this Annual Report on Form 10-K, we believe that the
following accounting policies and estimates are most critical to a full understanding and evaluation of our reported financial results.
Business Combinations
We account for our business combinations under
the provisions of Accounting Standards Codification (“ASC”) Topic 805-10, Business Combinations (“ASC 805-10”),
which requires that the purchase method of accounting be used for all business combinations. Assets acquired and liabilities assumed are
recorded at the date of acquisition at their respective fair values. For transactions that are business combinations, the Company evaluates
the existence of goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net assets and intangible
assets acquired in a business combination. ASC 805-10 also specifies criteria that intangible assets acquired in a business combination
must meet to be recognized and reported apart from goodwill. Acquisition-related expenses are recognized separately from the business
combinations and are expensed as incurred.
The estimated fair value of net assets acquired,
including the allocation of the fair value to identifiable assets and liabilities, was determined using established valuation techniques.
A fair value measurement is determined as the price we would receive to sell an asset or pay to transfer a liability in an orderly transaction
between market participants at the measurement date. In the context of purchase accounting, the determination of fair value often involves
significant judgments and estimates by management, including the selection of valuation methodologies, estimates of future revenues, costs
and cash flows, discount rates, and selection of comparable companies. The estimated fair values reflected in the purchase accounting
rely on management’s judgment.
Contingent Consideration
We record contingent consideration resulting from
a business combination at fair value on the acquisition date. On a quarterly basis, we revalue these obligations and record increases
or decreases in their fair value as an adjustment to operating expenses. Changes to contingent consideration obligations can result from
adjustments to discount rates, accretion of the liability due to the passage of time, changes in our estimates of the likelihood or timing
of achieving development or commercial milestones, changes in the probability of certain clinical events or changes in the assumed probability
associated with regulatory approval.
R&D Expenses
Recognition and accrual of expenses associated
with our clinical trial are dependent on the judgment of our contractors and subcontractors in their reporting and communication of information
to us. Occurrence of certain fees to our CRO, clinical trial sites, and subcontractors are tied to events, for which the determination
of likelihood requires judgment both on our part and on the part of our contractors.
Stock Based Compensation
We estimate the fair value of options and stock
warrants granted using the Black Scholes Merton model. We estimate when and if performance-based awards will be earned. If an award is
not considered probable of being earned, no amount of equity-based compensation expense is recognized. If the award is deemed probable
of being earned, related equity-based compensation expense is recorded. The fair value of an award ultimately expected to vest is recognized
as an expense, net of forfeitures, over the requisite service periods in our statements of operations, which is generally the vesting
period of the award.
83
The Black Scholes Merton model requires the input
of certain subjective assumptions and the application of judgment in determining the fair value of the awards. The most significant assumptions
and judgments include the expected volatility, risk-free interest rate, the expected dividend yield, and the expected term of the awards.
In addition, the recognition of equity-based compensation expense is impacted by our forfeitures, which are accounted for as they occur.
The assumptions used in our option pricing model
represent management’s best estimates. If factors change and different assumptions are used, our equity-based compensation expense
could be materially different in the future. The key assumptions included in the model are as follows:
Commitments and Contingencies
We follow subtopic 450-20 of the FASB Accounting
Standards Codification to report accounting for contingencies. Certain conditions may exist as of the date the financial statements are
issued, which may result in a loss to us but which will only be resolved when one or more future events occur or fail to occur. We assess
such contingent liabilities, and such assessment inherently involves an exercise of judgment.
If the assessment of a contingency indicates that
it is probable that a material loss has been incurred and the amount of the liability can be estimated, then the estimated liability would
be accrued in our financial statements. If the assessment indicates that a potentially material loss contingency is not probable but is
reasonably possible, or is probable but cannot be estimated, then the nature of the contingent liability, and an estimate of the range
of possible losses, if determinable and material, would be disclosed.
Loss contingencies considered remote are generally
not disclosed unless they involve guarantees, in which case the guarantees would be disclosed. Our legal costs associated with contingent
liabilities are recorded to expense as incurred.
Item 7A. Quantitative and Qualitative Disclosures
About Market Risk.
The Company is a smaller reporting company as
defined by Rule 12b-2 of the Exchange Act and is not required to provide the information required under this item.
84
Item 8. Financial Statements and Supplemental Data.
ADIAL PHARMACEUTICALS, INC.
FINANCIAL STATEMENTS
Contents
Page
Consolidated Balance Sheets as of December 31, 2022 and 2021 F-4
Notes to Consolidated Financial Statements F-8
F-1
REPORTS OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING
FIRMS
To the Shareholders and Board of Directors of
Adial Pharmaceuticals, Inc.
Opinion on the Financial Statements
We have audited the accompanying consolidated balance sheet of Adial
Pharmaceuticals, Inc. (the “Company”) as of December 31, 2022, the related consolidated statements of operations, stockholders’
equity and cash flows for the year ended December 31, 2022, and the related notes (collectively referred to as the “financial statements”).
In our opinion, the financial statements present fairly, in all material respects, the financial position of the Company as of December
31, 2022, and the results of its operations and its cash flows for the year ended December 31, 2022, in conformity with accounting principles
generally accepted in the United States of America.
Explanatory Paragraph – Going Concern
The accompanying financial statements have been prepared assuming that
the Company will continue as a going concern. As more fully described in Note 2, the Company has a significant working capital deficiency,
has incurred significant losses and needs to raise additional funds to meet its obligations and sustain its operations. These conditions
raise substantial doubt about the Company's ability to continue as a going concern. Management's plans in regard to these matters are
also described in Note 2. The financial statements do not include any adjustments that might result from the outcome of this uncertainty.
Basis for Opinion
These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on the Company's financial statements based on our audit. We are a public accounting
firm registered with the Public Company Accounting Oversight Board (United States) ("PCAOB") and are required to be independent
with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities
and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit
of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control
over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company's internal control over
financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material
misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation
of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Marcum LLP
We have served as the Company’s auditor since 2017 (such date
takes into account the acquisition of certain assets of Friedman LLP by Marcum LLP effective September 1, 2022)
Marlton, New Jersey
March 30, 2023
F-2
To the Board of Directors and
Stockholders of Adial Pharmaceuticals, Inc.
Opinion on the Consolidated Financial Statements
We have audited the accompanying consolidated balance sheet of Adial
Pharmaceuticals, Inc. (the “Company”) as of December 31, 2021, and the related consolidated statements of operations, changes
in stockholders’ equity and cash flows the year ended December 31, 2021, and the related notes (collectively referred to as the
“financial statements”). In our opinion, the financial statements present fairly, in all material respects, the financial
position of the Company as of December 31, 2021, and the results of its operations and its cash flows for the year ended December 31,
2021, in conformity with accounting principles generally accepted in the United States of America.
Basis for Opinion
These financial statements are the responsibility of the Company’s
management. Our responsibility is to express an opinion on the Company’s financial statements based on our audit. We are a public accounting
firm registered with the Public Company Accounting Oversight Board (United States) (“PCAOB”) and are required to be independent
with respect to the Company in accordance with the U.S. federal securities laws and the applicable rules and regulations of the Securities
and Exchange Commission and the PCAOB.
We conducted our audit in accordance with the standards of the PCAOB.
Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free
of material misstatement, whether due to error or fraud. The Company is not required to have, nor were we engaged to perform, an audit
of its internal control over financial reporting. As part of our audit we are required to obtain an understanding of internal control
over financial reporting but not for the purpose of expressing an opinion on the effectiveness of the Company’s internal control over
financial reporting. Accordingly, we express no such opinion.
Our audit included performing procedures to assess the risks of material
misstatement of the financial statements, whether due to error or fraud, and performing procedures that respond to those risks. Such procedures
included examining, on a test basis, evidence regarding the amounts and disclosures in the financial statements. Our audit also included
evaluating the accounting principles used and significant estimates made by management, as well as evaluating the overall presentation
of the financial statements. We believe that our audit provides a reasonable basis for our opinion.
/s/ Friedman LLP
We served as the Company’s auditor from 2017 to 2022.
Marlton, New Jersey
March 28, 2022
F-3
ADIAL PHARMACEUTICALS, INC.
CONSOLIDATED BALANCE SHEETS
ASSETS
Current Assets:
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities:
Accrued expenses, related party 175,000 —
Long-term Liabilities:
Commitments and contingencies – see Note 12
Stockholders’ Equity
The accompanying notes are an integral part of
these consolidated financial statements.
F-4
ADIAL PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
For the Years Ended December 31,
Operating Expenses:
Other Income (Expense)
Change in fair value of contingent liability 522,000 (281,713 )
Net loss per share, basic and diluted $ (0.51 ) $ (1.04 )
The accompanying notes are an integral part of
these consolidated financial statements.
F-5
ADIAL PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’
EQUITY
FOR THE YEARS ENDED DECEMBER 31, 2022 and 2021
Common Stock Additional Paid In Accumulated Total Stockholders’
Shares Amount Capital Deficit Equity
The accompanying notes are an integral part of
these consolidated financial statements.
F-6
ADIAL PHARMACEUTICALS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Years Ended December 31,
CASH FLOWS FROM OPERATING ACTIVITIES:
Adjustments to reconcile net loss to net cash used in operating activities:
Gain on forgiveness of loan — (29,088 )
Fixed asset disposal — 6,954
Amortization of intangible assets 564 565
Change in fair value of contingent liability (522,000 ) 281,713
Changes in operating assets and liabilities:
Prepaid expenses and other current assets 40,060 112,188
Accrued expenses, related party 175,000 —
Change in operating lease liability (49,585 ) (37,337 )
Accounts payable and other current liabilities 108,346 (353,771 )
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchase of fixed assets — (64,605 )
Purchase consideration paid for acquisition, net of cash acquired — 30,589
Net cash used in investing activities — (34,016 )
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds of options exercises — 469,501
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS (2,060,379 ) 1,661,059
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Interest paid $ — $ —
Income taxes paid $ — $ —
Issuance of common stock for acquisition $ — $ 1,060,150
Contingent consideration for acquisition $ — $ 732,287
The accompanying notes are an integral part of
these consolidated financial statements.
F-7
ADIAL PHARMACEUTICALS, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
1 — DESCRIPTION OF BUSINESS
Adial Pharmaceuticals, Inc.
( “Adial”) was converted from a limited liability company formed under the name Adial Pharmaceuticals, LLC, formed on November
23, 2010 in the Commonwealth of Virginia to a corporation and reincorporated in Delaware on October 1, 2017. Adial is presently engaged
in the development of medications for the treatment or prevention of addictions and related disorders.
Adial’s wholly owned
subsidiary, Purnovate, Inc., was acquired on January 26, 2021, having been formed as Purnovate, LLC in December of 2019. Purnovate is
a drug development company with a platform focused on developing drug candidates for non-opioid pain reduction and other diseases and
disorders potentially targeted with adenosine analogs that are selective, potent, stable, and soluble. These consolidated financial statements
include the accounts of both Adial and Purnovate for the year ended December 31, 2022 and 2021.
In June of 2022, the Company
released data from its ONWARDTM Phase 3 pivotal trial of its lead compound AD04 (“AD04”) for the treatment of Alcohol
Use Disorder. Both the U.S. Food and Drug Administration (“FDA”) and the European Medicines Authority (“EMA”)
have indicated they will accept heavy-drinking-based endpoints as a basis for approval for the treatment of Alcohol Use Disorder rather
than the previously required abstinence-based endpoints. The Company has obtained meetings with the FDA and national medicines authorities
in Europe to determine the path toward approval. Key patents have been issued in the United States, the European Union, and other jurisdictions
for which the Company has exclusive license rights. The active ingredient in AD04 is ondansetron, a serotonin-3 antagonist. Due to its
mechanism of action, AD04 has the potential to be used for the treatment of other addictive disorders, such as Opioid Use Disorder, obesity,
smoking, and other drug addictions.
2 — GOING CONCERN AND OTHER UNCERTAINTIES
The consolidated financial statements have been prepared in conformity
with accounting principles generally accepted in the United States of America (“GAAP”), which contemplate continuation of
the Company as a going concern. The Company is in a development stage and has incurred losses each year since inception and has experienced
negative cash flows from operations in each year since. Based on the current development plans for AD04 in both the U.S. and international
markets, planned R&D activities to develop Purnovate drug candidates, and other operating requirements, the Company does not believe
that the existing cash and cash equivalents are sufficient to fund operations for the next twelve months following the filing of these
consolidated financial statements. These factors raise substantial doubt about the Company’s ability to continue as a going concern.
Based on the recently announced
results of its ONWARD Phase 3 trial, the Company has scheduled meetings with the FDA and various European national authorities to discuss
the appropriate next steps towards the expeditious development of AD04 and to seek product approval. The results of these meetings may
materially change the Company’s expectations concerning the expected development cost of AD04. The Company has also initiated a
number of research and development projects associated with Purnovate, including Purnovate’s lead compound, PNV5030, for treatment
of pain and potentially for treatment of cancer. The Company has entered into an option agreement for the sale and support of the Purnovate
programs by an independent company formed for that purpose. Should this option agreement be exercised, the exercise fee and cash reimbursement
of previous Purnovate expenses would generate a modest amount of operating capital, and would eliminate the Company’s Purnovate-related
operating expenses. However, there is no guarantee that the option holder will be able to raise sufficient capital in its own right to
exercise the option. Neither is there any certainty that the Company will be able to access additional capital on acceptable terms, if
at all, with or without the option having been exercised. If unable to access sufficient capital, the Company would be required to delay,
scale back or eliminate some or all of its research and development programs or delay its approach to regulators concerning AD04, which
would likely have a material adverse effect on the Company and its financial statements.
The Company’s continued
operations will depend on its ability to raise additional capital through various potential sources, such as equity and/or debt financings,
grant funding, strategic relationships, or out-licensing in order to complete its subsequent clinical trial requirements for AD04. Management
is actively pursuing financing and other strategic plans but can provide no assurances that such financing or other strategic plans will
be available on acceptable terms, or at all. Without additional funding, the Company would be required to delay, scale back or eliminate
some or all of its research and development programs, which would likely have a material adverse effect on the Company and its financial
statements.
F-8
Other Uncertainties
Generally, the industry in
which the Company operates subjects the Company to a number of other risks and uncertainties that can affect its operating results and
financial condition. Such factors include, but are not limited to: the timing, costs and results of clinical trials and other development
activities versus expectations; the ability to obtain regulatory approval to market product candidates; the ability to manufacture products
successfully; competition from products sold or being developed by other companies; the price of, and demand for, Company products once
approved; the ability to negotiate favorable licensing or other manufacturing and marketing agreements for its products.
With the results of the ONWARD
trial having been released and regulatory approaches underway, the risk of delays to the Company’s development programs from COVID-19
are reduced. However, the ongoing effects of the ongoing coronavirus pandemic, such as supply chain disruptions and post-stimulus inflation,
may increase non-trial costs such as insurance premiums, increase the demand for and cost of capital, increase loss of work time from
key personnel, and negatively impact our other key vendors and suppliers. The full extent to which the COVID-19 pandemic impacts the clinical
development of AD04 and the Company’s suppliers and other commercial partners, will depend on future developments that are still
highly uncertain and cannot be predicted with confidence at this time, all of which could have a material adverse effect on our business,
financial condition, and results of operations.
3 — SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
Basis of Presentation and Principals of Consolidation
The accompanying consolidated
financial statements have been prepared in accordance with GAAP. The financial statements represent the consolidation of the Company and
its subsidiary in conformity with GAAP. All intercompany transactions have been eliminated in consolidation.
Use of Estimates
The preparation of consolidated
financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amounts of
assets and liabilities, and disclosure of contingent liabilities at the date of the financial statements, and the reported amounts of
revenues and expenses during the reporting period. Actual results could differ from those estimates.
Significant items subject
to such estimates and assumptions include the valuation of stock-based compensation, accruals associated with third party providers supporting
clinical trials and pre-clinical activities, estimated fair values of long-lived assets used to assess the value of intangible assets,
acquired in-process research and development (“IPR&D”), and goodwill, allocation of purchase price in business acquisitions,
measurement of contingent liabilities, and income tax asset realization.
Basic and Diluted Loss per Share
Basic and diluted loss per
share are computed based on the weighted-average outstanding shares of common stock, which are all voting shares. Diluted net loss
per share is computed giving effect to all proportional shares of common stock, including stock options, restricted stock, and warrants
to the extent dilutive. Basic net loss per share was the same as diluted net loss per share for the years ended December 31, 2022 and
2021 as the inclusion of all potential common shares outstanding would have an anti-dilutive effect.
The total potentially dilutive
common shares that were excluded for the years ended December 31, 2022 and 2021 were as follows:
Potentially Dilutive Common Shares Outstanding December 31,
Restricted shares subject to repurchase 1,083,333 –
F-9
Cash and Cash Equivalents
The Company considers all
highly liquid investments with original maturities of three months or less to be cash equivalents. At times, the Company’s cash
balances may exceed the current insured amounts under the Federal Deposit Insurance Corporation. At December 31, 2022, the Company did
not exceed FDIC insurance limits but held approximately $3.8 million in non-FDIC insured cash equivalent accounts. Included in cash equivalents
are money market investments with maturity dates less than ninety days and are carried at fair value. Unrealized gain or loss are included
in the interest income and are immaterial to the financial statements. At December 31, 2021, the Company did not exceed FDIC insurance
limits but held approximately $3.7 million in non-FDIC insured cash equivalent investments.
Fair Value Measurements
FASB ASC 820, Fair Value Measurement,
(“ASC 820”) defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit
price) in an orderly transaction between market participants at the reporting date. The methodology establishes consistency and comparability
by providing a fair value hierarchy that prioritizes the inputs to valuation techniques into three broad levels, which are described below:
The fair value of cash and
cash equivalents and accounts payable approximate their carrying value due to their short-term maturities.
Acquisition-Related Contingent Consideration
In connection with the Purnovate
business combination, the Company may be required to pay future consideration that is contingent upon the achievement of specified development,
regulatory approvals or sales-based milestone events. The Company determines the fair value of these obligations using various estimates
that are not observable in the market and represent a Level 3 measurement within the fair value hierarchy. As of December 31, 2022, the
resulting probability-weighted cash flows were discounted using a weighted average cost of capital of 44% for regulatory and sales-based
milestones.
Opening balance $ –
Total losses recorded (281,713 )
F-10
Business Combinations
The Company accounts for its
business combinations under the provisions of Accounting Standards Codification (“ASC”) Topic 805-10, Business Combinations
(“ASC 805-10”), which requires that the purchase method of accounting be used for all business combinations. Assets acquired
and liabilities assumed are recorded at the date of acquisition at their respective fair values. For transactions that are business combinations,
the Company evaluates the existence of goodwill. Goodwill represents the excess purchase price over the fair value of the tangible net
assets and intangible assets acquired in a business combination. ASC 805-10 also specifies criteria that intangible assets acquired in
a business combination must meet to be recognized and reported apart from goodwill. Acquisition-related expenses are recognized separately
from the business combinations and are expensed as incurred.
The estimated fair value of
net assets acquired, including the allocation of the fair value to identifiable assets and liabilities, was determined using established
valuation techniques. A fair value measurement is determined as the price the Company would receive to sell an asset or pay to transfer
a liability in an orderly transaction between market participants at the measurement date. In the context of purchase accounting, the
determination of fair value often involves significant judgments and estimates by management, including the selection of valuation methodologies,
estimates of future revenues, costs and cash flows, discount rates, and selection of comparable companies. The estimated fair values reflected
in the purchase accounting are subject to management’s judgment.
Contingent Consideration
The Company records contingent
consideration resulting from a business combination at fair value on the acquisition date. At each reporting date, the Company revalues
these obligations and record increases or decreases in their fair value as an adjustment to other income and expenses. Changes to contingent
consideration obligations can result from adjustments to discount rates, accretion of the liability due to the passage of time, changes
in our estimates of the likelihood or timing of achieving development or commercial milestones, changes in the probability of certain
clinical events or changes in the assumed probability associated with regulatory approval.
Intangible Assets
Intangible assets generally
consist of patents, purchased technology, acquired IPR&D and other intangibles. Intangible assets with definite lives are amortized
based on their pattern of economic benefit over their estimated useful lives and reviewed periodically for impairment.
Intangible assets related
to acquired IPR&D projects are considered to be indefinite-lived until the completion or abandonment of the associated research and
development efforts. During the period the assets are considered indefinite-lived, they will not be amortized but will be tested for impairment.
Impairment testing is performed at least annually or when a triggering event occurs that could indicate a potential impairment. Having
assessed the assets qualitatively, the Company did not recognize any impairment to IPR&D in the years ended December 31, 2022 and
2021. If and when development is complete, which generally occurs when regulatory approval to market a product is obtained, the associated
assets are deemed finite-lived and are amortized over a period that best reflects the economic benefits provided by these assets.
Goodwill
Goodwill, which represents
the excess of purchase price over the fair value of net assets acquired, is carried at cost. Goodwill is not amortized; rather, it is
subject to a periodic assessment for impairment by applying a fair value-based test. The Company is organized in one reporting unit and
evaluates the goodwill for the Company as a whole. The Company reviews goodwill for impairment on a reporting unit basis annually during
the fourth quarter of each year and whenever events or changes in circumstances indicate the carrying value of goodwill might not be recoverable.
Under the authoritative guidance issued by the FASB, the Company has the option to first assess the qualitative factors to determine whether
it is more likely than not that the fair value of the reporting unit is less than its carrying amount as a basis for determining whether
it is necessary to perform a quantitative goodwill impairment test. If the Company determines that it is more likely than not that the